SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. )
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(as permitted by Rule 14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-12
Aetna Inc.
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(Name of Registrant as Specified In Its Charter)
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[AETNA LOGO]
2003 Aetna Inc.
Notice of Annual Meeting and
Proxy Statement
and
Aetna 2002 Annual Report,
Financial Report
PRELIMINARY PROXY MATERIALS
DATED MARCH 3, 2002
SUBJECT TO COMPLETION
[AETNA LOGO]
AETNA INC. JOHN W. ROWE, M.D.
151 Farmington Avenue Chairman and
Hartford, Connecticut 06156 Chief Executive Officer
To Our Shareholders:
Aetna Inc.'s 2003 Annual Meeting of Shareholders will be held on Friday, April
25, 2003, at 9:30 a.m. at our Company Headquarters in Hartford, Connecticut, and
I hope you will attend.
This booklet includes the formal notice of the Annual Meeting, Aetna's 2003
Proxy Statement and Aetna's 2002 Annual Report, Financial Report.
At the meeting, in addition to specific agenda items, I will discuss generally
the operations of Aetna. I welcome any questions you have concerning Aetna and
will provide time during the meeting for questions from shareholders.
If you are unable to attend the Annual Meeting, it is still important that your
shares be represented. Please vote your shares promptly.
/s/ JOHN W. ROWE
John W. Rowe, M.D.
Chairman and Chief Executive Officer
March [14], 2003
2003 Aetna Inc.
Notice of Annual Meeting
and
Proxy Statement
[AETNA LOGO]
AETNA INC. WILLIAM J. CASAZZA
151 Farmington Avenue Vice President and
Hartford, Connecticut 06156 Corporate Secretary
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS OF AETNA INC.
NOTICE IS HEREBY GIVEN that the Annual Meeting of the Shareholders of Aetna Inc.
will be held at the Company's Headquarters, 151 Farmington Avenue, Hartford,
Connecticut, on Friday, April 25, 2003, at 9:30 a.m. for the following purposes:
1. To elect five Directors to terms expiring at the 2004 Annual Meeting;
2. To approve the appointment of KPMG LLP as independent auditors for the
current calendar year;
3. To approve an amendment to Aetna's Articles of Incorporation reducing the
shareholder voting requirements for business combinations;
4. To approve an amendment to Aetna's Articles of Incorporation permitting
shareholders to call special meetings of shareholders;
5. To approve an amendment to Aetna's By-Laws reducing the shareholder voting
requirements for certain By-Law amendments;
6. To consider and act on one shareholder proposal, if properly presented at
the meeting; and
7. To transact any other business that may properly come before the meeting or
any adjournment thereof.
The Board of Directors has fixed the close of business on February 28, 2003 as
the record date for determination of the shareholders entitled to vote at the
Annual Meeting or any adjournment thereof.
The Annual Meeting is open to all shareholders or their authorized
representatives. In order to attend the Annual Meeting, you must present an
admission ticket. You may request a ticket in advance by following the
instructions below. Shareholders who do not have admission tickets will be
admitted only following proof of share ownership. If you hold Aetna Common
Shares in your own name, please signify your intention to attend by checking the
appropriate box on your proxy card. If you hold your shares through the Aetna
Incentive Savings Plan, please indicate your intention to attend by checking the
appropriate box on your voting instruction card. If you hold your shares through
a broker, bank or other holder of record and plan to attend, you must send a
written request to attend along with proof that you own the shares (such as a
copy of your brokerage or bank account statement) to the Corporate Secretary at
the above address.
It is important that your shares be represented and voted at the Annual Meeting.
You can vote your shares by one of the following methods: vote over the Internet
or by telephone using the instructions on the enclosed proxy card (if these
options are available to you), or mark, sign, date and promptly return the
enclosed proxy card in the postage-paid envelope furnished for that purpose. If
you attend the Annual Meeting, you may vote in person if you wish, even if you
have previously voted.
This Proxy Statement booklet, including the 2002 Annual Report, Financial
Report, and the Company's 2002 Annual Report are available on Aetna's Internet
site at http://www.aetna.com/investor/proxy.htm and
http://www.aetna.com/investor/annualrept.htm, respectively.
By order of the Board of Directors,
/s/ William J. Casazza
William J. Casazza
Vice President and Corporate Secretary
March [14], 2003
TABLE OF CONTENTS
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Questions and Answers About the Proxy Materials and the Annual 1
Meeting...........................................................
Governance of the Company......................................... 8
Aetna's Corporate Governance Guidelines..................... 8
Aetna's Director Independence Standards..................... 8
Aetna's Code of Conduct..................................... 9
Board and Committee Membership.............................. 9
I. Election of Directors....................................... 11
Nominees for Directorships with Terms Expiring at the 2004
Annual Meeting.............................................. 12
Directors Continuing in Office with Terms Expiring at the
2004 Annual Meeting......................................... 14
Nonemployee Director Compensation in 2002................... 18
Other Information Regarding Directors....................... 19
Certain Transactions and Relationships...................... 19
Section 16(a) Beneficial Ownership Reporting Compliance..... 19
Security Ownership of Certain Beneficial Owners, Directors,
Nominees and Executive Officers............................. 20
Beneficial Ownership Table.................................. 21
Executive Compensation...................................... 23
Summary Compensation Table................................ 23
Stock Option Grants Table................................. 25
Stock Option Exercises and December 31, 2002 Stock Option
Value Table............................................... 26
Long-Term Incentive Awards Table.......................... 26
Pension Plan.............................................. 26
Other Agreements.......................................... 27
Report of the Committee on Compensation and Organization.... 29
Report of the Audit Committee............................... 32
Corporate Performance Graph................................. 34
II. Appointment of Auditors..................................... 35
Corporate Governance Proposals.................................... 37
III. Amendment to Aetna's Articles of Incorporation Reducing the
Shareholder Voting Requirements For Business Combinations... 37
IV. Amendment to Aetna's Articles of Incorporation Permitting
Shareholders to Call Special Meetings of Shareholders....... 38
V. Amendment to Aetna's By-Laws Reducing the Shareholder Voting
Requirements for Certain By-Law Amendments.................. 39
VI. Shareholder Proposal to Implement Cumulative Voting in the
Election of Directors....................................... 39
Additional Information............................................ 40
Appendix A -- Amendment to Aetna's Articles of Incorporation
Reducing the Shareholder Voting Requirements For
Business Combinations
Appendix B -- Amendment to Aetna's Articles of Incorporation
Permitting Shareholders to Call Special Meetings of
Shareholders
Appendix C -- Amendment to Aetna's By-Laws Reducing the
Shareholder Voting Requirements for Certain By-Law
Amendments
Annex 1 -- Aetna Inc. Corporate Governance Guidelines
Annex 2 -- Aetna Inc. Independence Standards for Directors
Annex 3 -- Aetna Inc. Audit Committee Charter
Annex 4 -- Aetna Inc. Committee on Compensation and Organization
Charter
Annex 5 -- Aetna Inc. Executive Committee Charter
Annex 6 -- Aetna Inc. Investment Committee Charter
Annex 7 -- Aetna Inc. Medical Affairs Committee Charter
Annex 8 -- Aetna Inc. Nominating and Corporate Governance
Committee Charter
AETNA INC.
151 FARMINGTON AVENUE, HARTFORD, CONNECTICUT 06156
MARCH [14], 2003
PROXY STATEMENT
FOR THE ANNUAL MEETING OF SHAREHOLDERS
TO BE HELD ON FRIDAY, APRIL 25, 2003
QUESTIONS AND ANSWERS ABOUT THE PROXY MATERIALS AND
THE ANNUAL MEETING
Q: WHY AM I RECEIVING THESE MATERIALS?
A: The Board of Directors (the "Board") of Aetna Inc. ("Aetna") is providing
these proxy materials to you in connection with the solicitation by the Board of
proxies to be voted at Aetna's Annual Meeting of Shareholders that will take
place on April 25, 2003, and any adjournments or postponements of the Annual
Meeting. You are invited to attend the Annual Meeting and are requested to vote
on the proposals described in this Proxy Statement. These proxy materials and
the enclosed proxy card are being mailed to shareholders on or about March [14],
2003.
Q: WHAT INFORMATION IS CONTAINED IN THESE MATERIALS?
A: The information included in this Proxy Statement relates to the proposals to
be voted on at the Annual Meeting, the voting process, the compensation of
Directors and our most highly paid executive officers, and certain other
required information. Our 2002 Annual Report, Financial Report is included in
this booklet and also is available to those accessing this Proxy Statement
booklet via the Internet.
Q: WHAT PROPOSALS WILL BE VOTED ON AT THE ANNUAL MEETING?
A: There are six proposals scheduled to be voted on at the Annual Meeting:
- The election of five Directors to terms expiring at the 2004 Annual
Meeting.
- Approval of the appointment of KPMG LLP, independent auditors, to audit
the consolidated financial statements of Aetna and its subsidiaries (the
"Company") for the year 2003.
- Approval of an amendment to Aetna's Articles of Incorporation reducing
the shareholder voting requirements for business combinations.
- Approval of an amendment to Aetna's Articles of Incorporation permitting
shareholders to call special meetings of shareholders.
- Approval of an amendment to Aetna's By-Laws reducing the shareholder
voting requirements for certain By-Law amendments.
- Consideration of a shareholder proposal relating to cumulative voting in
the election of Directors, if properly presented at the Annual Meeting.
Q: WHAT ARE AETNA'S VOTING RECOMMENDATIONS?
A: The Board recommends that you vote your shares FOR each of Aetna's nominees
to the Board, FOR the approval of the appointment of KPMG LLP as the Company's
independent auditors for 2003, FOR the approval of each of the proposed
amendments to Aetna's Articles of Incorporation and By-Laws and AGAINST the
shareholder proposal.
Q: WHICH OF MY SHARES CAN I VOTE?
A: You may vote all Aetna Inc. Common Shares, par value $.01 per share ("Common
Stock"), you owned as of the close of business on February 28, 2003, the RECORD
DATE. These shares include those (1) held
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directly in your name as the SHAREHOLDER OF RECORD, including shares purchased
through Aetna's DirectSERVICE Investment Program, and (2) held for you as the
BENEFICIAL OWNER through a stockbroker, bank or other nominee.
Q: WHAT IS THE DIFFERENCE BETWEEN HOLDING SHARES AS A SHAREHOLDER OF RECORD AND
AS A BENEFICIAL OWNER?
A: Many Aetna shareholders hold their shares through a stockbroker, bank or
other nominee rather than directly in their own names. As summarized below,
there are some distinctions between shares held of record and those owned
beneficially:
- SHAREHOLDER OF RECORD -- If your shares are registered directly in your
name with Aetna's Transfer Agent, EquiServe Trust Company, N.A., you are
considered the shareholder of record with respect to those shares, and
Aetna is sending these proxy materials directly to you. As the
shareholder of record, you have the right to grant your voting proxy to
the persons appointed by Aetna or to vote in person at the Annual
Meeting. Aetna has enclosed a proxy card for you to use. Any shares held
for you under the DirectSERVICE Investment Program are included on the
enclosed proxy card.
- BENEFICIAL OWNER -- If your shares are held in a stock brokerage account
or by a bank or other nominee, you are considered the beneficial owner of
shares held in street name, and these proxy materials are being forwarded
to you by your broker or nominee who is considered the shareholder of
record with respect to those shares. As the beneficial owner, you have
the right to direct your broker or nominee on how to vote your shares and
are also invited to attend the Annual Meeting. However, since you are not
the shareholder of record, you may not vote these shares in person at the
Annual Meeting unless you bring with you to the Annual Meeting a proxy,
executed in your favor, from the shareholder of record. Your broker or
nominee is obligated to provide you with a voting instruction card for
you to use.
Q: HOW CAN I VOTE MY SHARES BEFORE THE ANNUAL MEETING?
A: Whether you hold shares directly as the shareholder of record or beneficially
in street name, you may vote before the Annual Meeting by granting a proxy or,
for shares held in street name, by submitting voting instructions to your broker
or nominee. Most shareholders have a choice of voting over the Internet, by
using a toll-free telephone number or by completing a proxy card and mailing it
in the postage-paid envelope provided. Please refer to the summary instructions
below, and please follow carefully the instructions included on your proxy card
or, for shares held in street name, the voting instruction card included by your
broker or nominee.
- BY MAIL -- You may vote by mail by signing and dating your proxy card or,
for shares held in street name, the voting instruction card provided by
your broker or nominee and mailing it in the enclosed, postage-paid
envelope. If you provide specific voting instructions, your shares will
be voted as you instruct. IF YOU SIGN AND DATE YOUR PROXY OR VOTING
INSTRUCTION CARD, BUT DO NOT PROVIDE INSTRUCTIONS, YOUR SHARES WILL BE
VOTED AS DESCRIBED BELOW IN WHAT IF I RETURN MY PROXY CARD OR VOTING
INSTRUCTION CARD BUT DO NOT PROVIDE VOTING INSTRUCTIONS?
- BY INTERNET -- Go to http://www.eproxyvote.com/aet and follow the
instructions. You will need to provide the personal identification number
contained on your proxy card.
- BY TELEPHONE -- Call toll-free on a touchtone telephone 1-877-779-8683
inside the United States or 1-201-536-8073 outside the United States and
follow the instructions. You will need to provide the personal
identification number on your proxy card.
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The Internet and telephone voting procedures are designed to authenticate
shareholders by use of a Control Number and to allow shareholders to confirm
that their instructions have been properly recorded. In order to provide
shareholders of record with additional time to vote their shares while still
permitting an orderly tabulation of votes, Internet and telephone voting for
these shareholders will be available until 11:59 p.m. on April 24, 2003.
Q: HOW CAN I VOTE THE SHARES I HOLD THROUGH THE ISP?
A: Participants in Aetna's Incentive Savings Plan (the "ISP") who receive this
Proxy Statement in their capacity as participants in the ISP will receive voting
instruction cards in lieu of proxy cards. The voting instruction cards direct
the trustee of the ISP how to vote the shares. Shares held in the ISP may be
voted by using a toll-free telephone number or by marking, signing and dating
the voting instruction card and mailing it in the postage-paid envelope
provided. Shares held in the ISP for which no directions are received are voted
by the trustee in the same percentage as the shares held in the ISP for which
directions are received.
Q: HOW CAN I VOTE THE SHARES I HOLD THROUGH THE ESPP?
A: You hold the Common Stock you acquired through Aetna's Employee Stock
Purchase Plan (the "ESPP") as the beneficial owner of shares held in street
name. You can vote these shares as described above under HOW CAN I VOTE MY
SHARES BEFORE THE ANNUAL MEETING?
Q: CAN I CHANGE MY VOTE?
A: You may change your vote at any time before the polls close at the Annual
Meeting. For shares you hold directly in your name, you may change your vote by
(1) signing another proxy card with a later date and delivering it to us before
the date of the Annual Meeting, or (2) attending the Annual Meeting in person
and voting your shares at the Annual Meeting. The last-dated proxy card will be
the only one that counts. Attendance at the Annual Meeting will not cause your
previously granted proxy to be revoked unless you specifically so request. For
shares you hold beneficially, you may change your vote by submitting new voting
instructions to your broker or nominee in a manner that allows your broker or
nominee sufficient time to vote your shares.
Q: CAN I VOTE AT THE ANNUAL MEETING?
A: You may vote your shares at the Annual Meeting if you attend in person. You
may vote shares you hold directly in your name by completing a ballot at the
Annual Meeting. You may only vote the shares you hold in street name at the
Annual Meeting if you bring to the Annual Meeting a proxy, executed in your
favor, from the shareholder of record. You may not vote shares you hold through
the ISP at the Annual Meeting.
Q: HOW CAN I VOTE ON EACH PROPOSAL?
A: In the election of Directors, you may vote FOR all of the nominees or your
vote may be WITHHELD with respect to one or more of the nominees. For all other
proposals, you may vote FOR, AGAINST or ABSTAIN.
Q: WHAT IF I RETURN MY PROXY CARD OR VOTING INSTRUCTION CARD BUT DO NOT PROVIDE
VOTING INSTRUCTIONS?
A: All shares entitled to vote and represented by properly completed proxy cards
received prior to the Annual Meeting and not revoked will be voted at the Annual
Meeting in accordance with your instructions.
IF YOU SIGN AND DATE YOUR PROXY CARD WITH NO FURTHER INSTRUCTIONS, YOUR SHARES
WILL BE VOTED (1) FOR THE ELECTION OF EACH OF AETNA'S NOMINEE DIRECTORS NAMED ON
PAGES 12 AND 13 OF THIS PROXY STATEMENT, (2) FOR THE APPROVAL OF KPMG LLP AS THE
COMPANY'S INDEPENDENT AUDITORS FOR 2003, (3) FOR THE PROPOSED AMENDMENT TO
AETNA'S ARTICLES OF INCORPORATION REDUCING THE SHAREHOLDER VOTING REQUIREMENTS
FOR BUSINESS COMBINATIONS, (4) FOR THE
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PROPOSED AMENDMENT TO AETNA'S ARTICLES OF INCORPORATION PERMITTING SHAREHOLDERS
TO CALL SPECIAL MEETINGS OF SHAREHOLDERS, (5) FOR THE PROPOSED AMENDMENT TO
AETNA'S BY-LAWS REDUCING THE SHAREHOLDER VOTING REQUIREMENTS FOR CERTAIN BY-LAW
AMENDMENTS, AND (6) AGAINST THE SHAREHOLDER PROPOSAL.
If you sign and date your broker voting instruction card with no further
instructions, your shares will be voted as described on your broker voting
instruction card.
If you sign and date your ISP voting instruction card with no further
instructions, any shares you hold in the ISP will be voted by the trustee as
described above in HOW CAN I VOTE THE SHARES I HOLD THROUGH THE ISP?
Q: WHAT IF I DON'T RETURN MY PROXY CARD OR VOTING INSTRUCTION CARD?
A: Shares that you hold directly in your name will not be voted at the Annual
Meeting. Shares that you beneficially own that are held in the name of a
brokerage firm or other nominee may be voted in certain circumstances even if
you do not provide the brokerage firm with voting instructions. Under New York
Stock Exchange rules, brokerage firms have the authority to vote shares for
which their customers do not provide voting instructions on certain routine
matters. The election of Directors and the approval of KPMG LLP as the Company's
independent auditors are considered routine matters for which brokerage firms
may vote unvoted shares. The other proposals to be voted on at the Annual
Meeting are not considered routine under the applicable rules, and therefore
brokerage firms may not vote unvoted shares on those matters. Any shares you
hold through Aetna's ISP will be voted by the trustee as described above in HOW
CAN I VOTE THE SHARES I HOLD THROUGH THE ISP?
Q: WHAT DOES IT MEAN IF I RECEIVE MORE THAN ONE PROXY OR VOTING INSTRUCTION
CARD?
A: It means your shares are registered differently or are in more than one
account. Please provide voting instructions for all proxy and voting instruction
cards you receive.
Q: HOW CAN I OBTAIN AN ADMISSION TICKET FOR THE MEETING?
A: In order to attend the Annual Meeting, you must present an admission ticket.
You may request a ticket in advance by following these instructions.
Shareholders who do not have admission tickets will be admitted only following
proof of share ownership. If you hold Aetna Common Stock directly as the
shareholder of record, please signify your intention to attend by checking the
appropriate box on your proxy card. If you hold your shares through the ISP,
please indicate your intention to attend by checking the appropriate box on your
voting instruction card. If your shares are held in street name and you plan to
attend, you must send a written request to attend along with proof that you own
the shares (such as a copy of your brokerage or bank account statement) to
Aetna's Corporate Secretary at 151 Farmington Avenue, RC4A, Hartford, CT 06156.
Q: WHERE CAN I FIND THE VOTING RESULTS OF THE MEETING?
A: We will publish the voting results of the meeting in a Quarterly Report on
Form 10-Q.
Q: WHAT CLASS OF SHARES IS ENTITLED TO BE VOTED?
A: Each share of Aetna's Common Stock outstanding as of the close of business on
February 28, 2003, the RECORD DATE, is entitled to one vote at the Annual
Meeting. On February 28, 2003, we had [ ] shares of Common Stock
outstanding.
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Q: HOW MANY SHARES MUST BE PRESENT TO HOLD THE ANNUAL MEETING?
A: A majority of the shares of Common Stock outstanding as of the close of
business on February 28, 2003 must be present in person or by proxy for us to
hold the Annual Meeting and transact business. This is referred to as a quorum.
Both abstentions and broker nonvotes are counted as present for the purpose of
determining the presence of a quorum. Generally, broker nonvotes occur when
shares held by a broker for a beneficial owner are not voted with respect to a
particular proposal because the proposal is not a routine matter, and the broker
has not received voting instructions from the beneficial owner of the shares.
Q: WHAT IS THE VOTING REQUIREMENT TO APPROVE EACH OF THE PROPOSALS AND HOW WILL
VOTES BE COUNTED?
A: Under Pennsylvania corporation law, the approval of any corporate action
taken at a shareholder meeting is based on votes cast. "Votes cast" means votes
actually cast "for" or "against" a particular proposal, whether by proxy or in
person. Abstentions and broker nonvotes are not considered "votes cast."
Directors are elected by a plurality of votes cast. Shareholder approval of the
amendment to Aetna's Articles of Incorporation reducing the shareholder voting
requirements for business combinations requires the affirmative vote of at least
two-thirds of Aetna's outstanding shares of Common Stock. Shareholder approval
of the amendment to Aetna's By-Laws reducing the shareholder voting requirements
for certain By-Law amendments requires the affirmative vote of at least 80% of
Aetna's outstanding shares of Common Stock. Shareholder approval of each of the
other three proposals to be considered at the Annual Meeting occurs if the votes
cast in favor of the proposal exceed the votes cast against the proposal. If you
are a beneficial owner and do not provide the shareholder of record with voting
instructions, your shares may constitute broker nonvotes, as described above in
HOW MANY SHARES MUST BE PRESENT TO HOLD THE ANNUAL MEETING?
Q: WHO WILL BEAR THE COST OF SOLICITING VOTES FOR THE ANNUAL MEETING?
A: Aetna will pay the entire cost of preparing, assembling, printing, mailing,
and distributing these proxy materials, except that you will pay certain
expenses for Internet access if you choose to access these proxy materials over
the Internet. In addition to the mailing of these proxy materials, the
solicitation of proxies or votes may be made in person, by telephone, or by
electronic communication by our Directors, officers and employees, none of whom
will receive any additional compensation for such solicitation activities. We
also have hired Georgeson Shareholder Communications Inc. to assist us in the
distribution of proxy materials and the solicitation of votes for a fee of
$35,000 plus reasonable out-of-pocket expenses for these services. We also will
reimburse brokerage houses and other custodians, nominees, and fiduciaries for
their reasonable out-of-pocket expenses for forwarding proxy and solicitation
materials to beneficial owners of Aetna Common Stock.
Q: DOES AETNA OFFER SHAREHOLDERS THE OPTION OF VIEWING ANNUAL REPORTS TO
SHAREHOLDERS AND PROXY STATEMENTS VIA THE INTERNET?
A: Yes. Aetna offers shareholders of record the option to view future annual
reports to shareholders and proxy statements via the Internet instead of
receiving paper copies of these documents in the mail. The 2003 Aetna Inc.
Notice of Annual Meeting and Proxy Statement and Aetna 2002 Annual Report,
Financial Report and Aetna's 2002 Annual Report are available on Aetna's
Internet Web site at http://www.aetna.com/investor/proxy.htm and
http://www.aetna.com/investor/annualrept.htm, respectively. Under Pennsylvania
law, Aetna may provide shareholders who give the Company their e-mail addresses
with electronic notice of its shareholder meetings as described below.
If you are a shareholder of record, you can choose this option and save Aetna
the cost of producing and mailing these documents in the future by following the
instructions under HOW DO I ELECT THIS OPTION? below. If you hold your shares
through a broker, bank or other holder of record, check the
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information provided by that entity for instructions on how to elect to view
future notices of shareholder meetings, proxy statements and annual reports over
the Internet.
If you are a shareholder of record and choose to receive future notices of
shareholder meetings by e-mail and view future proxy statements and annual
reports over the Internet, you must supply an e-mail address, and you will
receive your notice of the meeting by e-mail when those materials are posted.
That notice will include instructions and contain the Internet address of those
materials.
Many shareholders who hold their shares through a broker, bank or other holder
of record and who elect electronic access will receive an e-mail containing the
Internet address to access Aetna's notices of shareholder meetings, proxy
statements and annual reports when those materials are posted.
Q: HOW DO I ELECT THIS OPTION?
A: If you are a record shareholder and are interested in receiving future
notices of shareholder meetings by e-mail and viewing future annual reports and
proxy statements on the Internet, instead of receiving paper copies of these
documents, please do the following:
(1) You will need your account number, which can be found above your name and
address on your dividend check stub, and your Social Security number, if you
have a Social Security number.
(2) Go to the Web site http://www.econsent.com/aet.
(3) Review Important Considerations and Frequently Asked Questions.
(4) Follow the prompts.
Q: WHAT IF I GET MORE THAN ONE COPY OF AETNA'S SUMMARY ANNUAL REPORT?
A: Aetna's Summary Annual Report is being mailed to shareholders in advance of
or together with this Proxy Statement. If you hold Aetna shares in your own name
and you received more than one copy of the Summary Annual Report at your address
and you wish to reduce the number of reports you receive and save Aetna the cost
of producing and mailing these reports, we will discontinue the mailing of
reports on the accounts you select if you mark the designated box on the
appropriate proxy card(s), or follow the instructions provided to you when you
vote over the Internet or by telephone. At least one account at your address
must continue to receive an annual report, unless you elect to review future
annual reports over the Internet. Mailing of dividends, dividend reinvestment
statements, proxy materials and special notices will not be affected by your
election to discontinue duplicate mailings of annual reports. Registered
shareholders may discontinue or resume the mailing of an annual report to an
account by calling Aetna's Transfer Agent at 1-800-446-2617. If you own shares
through a broker, bank or other holder of record and received more than one
Summary Annual Report, please contact the holder of record to eliminate
duplicate mailings.
Q: WHAT IF A DIRECTOR NOMINEE IS UNWILLING OR UNABLE TO SERVE?
A: If for any unforeseen reason any of Aetna's nominees is not available as a
candidate for Director, the persons named as proxy holders on your proxy card
may vote your shares for such other candidate or candidates as may be nominated
by the Board, or the Board may reduce the number of Directors to be elected.
Q: WHAT HAPPENS IF ADDITIONAL PROPOSALS ARE PRESENTED AT THE MEETING?
A: Other than the election of Directors and the five other proposals described
in this Proxy Statement, Aetna has not received proper notice of, and is not
aware of, any matters to be presented for a vote at the Annual Meeting. If you
grant a proxy using the enclosed proxy card, the persons named as proxies on the
enclosed
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proxy card, or any of them, will have discretion to, and intend to, vote your
shares according to their best judgment on any additional proposals or other
matters properly presented for a vote at the Annual Meeting, including, among
other things, consideration of a motion to adjourn the Annual Meeting to another
time or place.
Q: MAY I PROPOSE ACTIONS FOR CONSIDERATION AT NEXT YEAR'S ANNUAL MEETING OF
SHAREHOLDERS OR NOMINATE INDIVIDUALS TO SERVE AS DIRECTORS?
A: You may submit proposals for consideration at future annual meetings,
including Director nominations.
- SHAREHOLDER PROPOSALS: In order for a shareholder proposal to be
considered for inclusion in Aetna's proxy statement for next year's
Annual Meeting, the written proposal must be RECEIVED by the Corporate
Secretary no later than November [15], 2003. SUCH PROPOSALS MUST BE SENT
TO: CORPORATE SECRETARY, AETNA INC., 151 FARMINGTON AVENUE, RC4A,
HARTFORD, CT 06156. Such proposals also will need to comply with
Securities and Exchange Commission ("SEC") regulations regarding the
inclusion of shareholder proposals in Aetna sponsored proxy materials.
In order for a shareholder proposal to be raised from the floor during next
year's Annual Meeting, the shareholder's written notice must be RECEIVED by
Aetna's Corporate Secretary at least 90 calendar days before the date of next
year's Annual Meeting and must contain the information required by Aetna's By-
Laws. Please note that the 90-day advance notice requirement relates only to
matters a shareholder wishes to bring before the Annual Meeting from the floor.
It does not apply to proposals that a shareholder wishes to have included in
Aetna's proxy statement; that procedure is explained in the paragraph above.
- NOMINATION OF DIRECTOR CANDIDATES: You may propose Director candidates
for consideration by the Board's Nominating and Corporate Governance
Committee. In addition, Aetna's By-Laws permit shareholders to nominate
Directors at a shareholder meeting. In order to make a Director
nomination at next year's Annual Meeting, the shareholder's written
notice must be RECEIVED by Aetna's Corporate Secretary at least 90
calendar days before the date of next year's Annual Meeting and must
contain the information required by Aetna's By-Laws.
- COPY OF BY-LAWS PROVISIONS: You may contact the Corporate Secretary at
Aetna's Headquarters for a copy of the relevant provisions of Aetna's
By-Laws regarding the requirements for making shareholder proposals and
nominating Director candidates or visit Aetna's Web site at
www.aetna.com/governance for a copy of Aetna's By-Laws.
Q: MAY SHAREHOLDERS ASK QUESTIONS AT THE ANNUAL MEETING?
A: Yes. You can ask questions regarding each of the items to be voted on when
those items are discussed at the Annual Meeting. Also, shareholders will be
given an opportunity to ask questions of general interest at the end of the
Annual Meeting.
Q: WHO COUNTS THE VOTES CAST AT THE ANNUAL MEETING?
A: Votes are counted by tellers of Aetna's Transfer Agent who have been
appointed as judges of election for the Annual Meeting. The judges will
determine the number of shares outstanding and the voting power of each share,
determine the shares represented at the Annual Meeting, determine the validity
of proxies and ballots, count all votes and determine the results of the actions
taken at the Annual Meeting.
7
GOVERNANCE OF THE COMPANY
Aetna's reputation for excellence and integrity is one of our Company's most
valuable assets. We have earned this reputation over the course of 150 years by
delivering quality products and services, and by adhering to the highest
standards of business conduct. By having in place sound corporate governance
principles, we help ensure our standards of excellence, integrity and
accountability are applied to all aspects of our operations.
At Aetna, we have embraced the principles behind the Sarbanes-Oxley Act of 2002,
as well as the recent rule changes proposed by the New York Stock Exchange.
These principles are reflected in the structure and composition of our Board of
Directors and in our Committee Charters, and are reinforced through Aetna's Code
of Conduct, which applies to every employee and to our Directors.
We believe sound corporate governance principles are good for our business, the
industry, the competitive marketplace and for all of those who place their trust
in us.
In 2002, Aetna's Board conducted a comprehensive review of Aetna's governance
structure and took a number of actions. On October 25, 2002, the Board
terminated Aetna's shareholder rights plan by accelerating its expiration date
from 2010 to October 31, 2002. The Board, however, retains the right to adopt a
new plan at a future date in the event of changed circumstances. The Board also
decided to recommend to shareholders that the shareholder voting requirement for
approving business combinations be reduced from two-thirds to a majority of
outstanding shares, that shareholders representing two-thirds of the voting
power of the shares entitled to vote on the matter to be considered at a special
meeting of shareholders also be permitted to call the special meeting, and that
the shareholder voting requirement for certain By-Law changes be reduced from
80% to two-thirds. These three items require shareholder approval to implement,
and are described in further detail in this Proxy Statement.
During 2002 and 2003, the Board also took a number of other corporate governance
actions which are reflected in new or revised corporate governance documents
described below. In 2003, the Board also formally established a new Board
Committee, the Medical Affairs Committee, to assist the Board in the general
oversight of policies and practices that relate to providing members with access
to cost-effective quality health care. That Committee is also described in
further detail below.
AETNA'S CORPORATE GOVERNANCE GUIDELINES
These Guidelines provide the framework for the governance of Aetna. The Board
has embraced the governance changes proposed (but not yet effective) by the New
York Stock Exchange and contained in the Sarbanes-Oxley Act of 2002, and these
changes are reflected in the Guidelines. The Board will review these principles
and other aspects of governance periodically.
The Guidelines address the role of the Board of Directors, the composition and
selection of Directors, the functioning of the Board, the Committees of the
Board, the compensation of Directors and the conduct and ethics standards for
Directors. A copy of these Guidelines is attached as Annex 1 to this Proxy
Statement and is available at www.aetna.com/governance.
Among other things, Aetna's nonmanagement Directors meet at regularly scheduled
executive sessions, without management present. Anyone wishing to make their
concerns known to Aetna's nonmanagement Directors may contact the Aetna Director
who leads the nonmanagement Directors' sessions (currently Gerald Greenwald) by
writing to Mr. Greenwald at P.O. Box 370205, West Hartford, CT 06137-0205.
AETNA'S DIRECTOR INDEPENDENCE STANDARDS
The Board has established guidelines to assist it in determining Director
independence. A copy of these Standards is attached as Annex 2 to this Proxy
Statement and is available at www.aetna.com/governance.
8
Based on these Standards, the Board has determined in its business judgment that
each of the 11 non-management Directors on the Board of 13 members is
independent. Dr. Rowe and Mr. Williams are members of management and as a result
are not considered independent Directors.
AETNA'S CODE OF CONDUCT
Aetna's Code of Conduct applies to every employee and to our Directors and is
available at www.aetna.com/governance and as an exhibit to Aetna's 2002 Annual
Report on Form 10-K. Aetna will disclose any amendments to the Code of Conduct,
or waivers of the Code of Conduct relating to Aetna's Directors, executive
officers and principal financial and accounting officers or persons performing
senior functions, on its Web site at www.aetna.com/governance.
BOARD AND COMMITTEE MEMBERSHIP
Aetna's Board oversees and guides the Company's management and its business.
Committees support the role of the Board on issues that benefit from
consideration by a smaller, more focused subset of Directors.
The following table presents, as of February 28, 2003, the key Committees of the
Board, the membership of such Committees and the number of times each such
Committee met in 2002.
--------------------------------------------------------------------------------------------------------
COMMITTEE
--------------------------------------------------------------------
NOMINATING
COMPENSATION AND
AND MEDICAL CORPORATE
NOMINEE/DIRECTOR AUDIT ORGANIZATION EXECUTIVE INVESTMENT AFFAIRS GOVERNANCE
--------------------------------------------------------------------------------------------------------
Betsy Z. Cohen.................... X X
Barbara Hackman Franklin.......... X * X X
Jeffrey E. Garten................. X X
Earl G. Graves.................... X X X
Gerald Greenwald.................. X X X*
Ellen M. Hancock.................. X X
Michael H. Jordan................. X* X X
Jack D. Kuehler................... X X X*
Joseph P. Newhouse................ X X
Judith Rodin...................... X X X*
John W. Rowe, M.D................. X* X
Ronald A. Williams................ X
R. David Yost..................... X X
--------------------------------------------------------------------------------------------------------
Number of Meetings in 2002:....... 10 6 2 4 0 6
--------------------------------------------------------------------------------------------------------
* Committee Chair
All members of the Audit Committee, the Committee on Compensation and
Organization and the Nominating and Corporate Governance Committee are, in the
business judgment of the Board, independent Directors (as independence is
defined under the rules of the New York Stock Exchange, Inc.).
During 2002, the Board met eight times. Each Director attended at least 86% of
the regularly scheduled and special meetings of the Board and the Committees on
which he or she served in 2002, and the average attendance of Directors at all
meetings during the year was 94%.
The functions and responsibilities of the key Committees of Aetna's Board are
described below.
- Audit Committee. This Committee is composed entirely of independent
Directors. The Committee assists the Board in its oversight of (1) the
integrity of the financial statements of the Company, (2) the independent
accountant's qualifications and independence, (3) the performance of the
Company's internal audit functions and independent accountants, and (4) the
compliance by the Company with legal and regulatory requirements. The
Committee is directly responsible for the appointment, compensation
9
and oversight of the work of the independent accountants, including the
resolution of any disagreements between management and the independent
accountants regarding financial reporting. The independent accountants report
directly to the Committee. For more information regarding the role,
responsibilities and limitations of the Committee, please refer to the Report
of the Audit Committee beginning on page 32. A copy of this Committee's
Charter is attached as Annex 3 to this Proxy Statement and is available at
www.aetna.com/governance.
Ms. Franklin currently serves on four other public company audit committees.
After reviewing Ms. Franklin's other time commitments and her performance as a
member of Aetna's Audit Committee, the Board determined that Ms. Franklin's
service on those other audit committees does not impair her ability to serve as
a member of Aetna's Audit Committee.
The Audit Committee can be confidentially contacted by those wishing to raise
concerns or complaints about the Company's accounting, internal accounting
controls or auditing matters by calling AlertLine(R), an independent toll-free
service, at 1-888-891-8910 (available seven days a week, 24 hours a day), or by
writing to: Corporate Compliance, P.O. Box 370205, West Hartford, CT 06137-0205.
- Committee on Compensation and Organization. This Committee is composed
entirely of independent Directors. The Committee evaluates and determines the
compensation of the Company's senior executives and oversees the compensation
and benefit plans, policies and programs of the Company. The Committee also
administers Aetna's stock incentive plans and its Annual Incentive Plan. On a
regular basis, the Committee reviews and makes recommendations, as
appropriate, to the Board as to the development and succession plans for the
senior management of the Company. A copy of this Committee's Charter is
attached as Annex 4 to this Proxy Statement and is available at
www.aetna.com/governance.
- Executive Committee. This Committee is authorized to act on behalf of the
full Board between regularly scheduled Board meetings, usually when timing is
critical. A copy of this Committee's Charter is attached as Annex 5 to this
Proxy Statement and is available at www.aetna.com/governance.
- Investment Committee. This Committee assists the Board in reviewing
investment policies, strategies, transactions and performance of Aetna and its
subsidiaries. A copy of this Committee's Charter is attached as Annex 6 to
this Proxy Statement and is available at www.aetna.com/governance.
- Medical Affairs Committee. This Committee provides general oversight of
Company policies and practices that relate to providing Aetna's members with
access to cost-effective quality health care. A copy of this Committee's
Charter is attached as Annex 7 to this Proxy Statement and is available at
www.aetna.com/governance.
- Nominating and Corporate Governance Committee. This Committee is composed
entirely of independent Directors. The primary purpose of this Committee is to
assist the Board in identifying and recommending individuals to the Board for
nomination as members of the Board and its Committees, and in developing and
recommending to the Board corporate governance principles applicable to the
Company. A copy of this Committee's Charter is attached as Annex 8 to this
Proxy Statement and is available at www.aetna.com/governance.
In recommending Director nominees to the Board, the Nominating Committee
solicits candidate recommendations from its own members, other Directors and
management. Although the Nominating Committee does not specifically solicit
suggestions for possible candidates from shareholders, the Nominating Committee
will consider candidates meeting the criteria set by the Committee with the
concurrence of the full Board and re-evaluated periodically, including those set
out in the Committee's Charter. (Suggestions, together with a description of the
proposed nominee's qualifications, other relevant biographical information and
an indication of the willingness of the proposed nominee to serve, should be
sent to the Nominating and Corporate Governance Committee Chairman, in care of
the Corporate Secretary, Aetna Inc., 151 Farmington Avenue, RC4A, Hartford, CT
06156.)
10
I. ELECTION OF DIRECTORS
Aetna will nominate five individuals for election as Directors at the Annual
Meeting (the "Nominees"). The terms of office for the Directors to be elected at
this meeting will run until the Annual Meeting in 2004 and until their
successors are duly elected and qualified. The Directors elected at the Annual
Meeting, together with the eight Directors whose terms continue beyond the
Annual Meeting until the Annual Meeting in 2004 (the "Continuing Directors"),
will comprise the Board. At and after Aetna's Annual Meeting in 2004,
shareholders will elect all Directors annually for a one-year term.
All Nominees are currently Directors of Aetna. The following pages list the
names and ages of the Nominees and the Continuing Directors as of the date of
the Annual Meeting, the year each first became a Director of Aetna or one of its
predecessors, the principal occupation and publicly traded company and certain
other directorships of each as of February 28, 2003, and a brief description of
the business experience of each for at least the last five years.
THE FIVE INDIVIDUALS (OR SUCH LESSER NUMBER IF THE BOARD HAS REDUCED THE NUMBER
OF DIRECTORS TO BE ELECTED AT THE ANNUAL MEETING AS DESCRIBED ABOVE UNDER WHAT
IF A DIRECTOR NOMINEE IS UNWILLING OR UNABLE TO SERVE?) RECEIVING THE GREATEST
NUMBER OF VOTES CAST AT THE ANNUAL MEETING WILL BE ELECTED DIRECTORS.
THE BOARD RECOMMENDS A VOTE FOR EACH OF THE FIVE NOMINEES. IF YOU COMPLETE THE
ENCLOSED PROXY CARD, UNLESS YOU DIRECT TO THE CONTRARY ON THAT CARD, THE SHARES
REPRESENTED BY THAT PROXY CARD WILL BE VOTED FOR THE ELECTION OF THE FIVE
NOMINEES.
11
NOMINEES FOR DIRECTORSHIPS WITH TERMS EXPIRING AT THE 2004 ANNUAL MEETING
[BETSY Z. COHEN PHOTO] BETSY Z. COHEN, age 61, is Chairman, Chief Executive Officer
Director since 2000 and trustee of Resource Asset Investment Trust (real estate
Director of Aetna's investment trust), a position she assumed in August 1997.
predecessors from 1994 to 2000 She also serves as Chief Executive Officer of The
Bancorp.com, Inc. (Internet banking and financial services).
From 1999 to 2000, Mrs. Cohen also had served as a director
of Hudson United Bancorp (holding company), the successor to
JeffBanks, Inc. where she had been Chairman and Chief
Executive Officer since its inception in 1981 and also
served as Chairman and Chief Executive Officer of its
subsidiaries, Jefferson Bank (which she founded in 1974) and
Jefferson Bank New Jersey (which she founded in 1987) prior
to JeffBanks' merger with Hudson United Bancorp in December
1999. From 1985 until 1993, Mrs. Cohen was a director of
First Union Corp. of Virginia (bank holding company) and its
predecessor, Dominion Bankshares, Inc. In 1969, Mrs. Cohen
co-founded a commercial law firm and served as a Senior
Partner until 1984. Mrs. Cohen also is a director of The
Maine Merchant Bank, LLC and is a trustee of Corporate
Office Properties Trust.
[JEFFREY E. GARTEN photo] JEFFREY E. GARTEN, age 56, is the Dean of the Yale School of
Director since 2000 Management, a position he assumed in 1995. Mr. Garten held
Director of Aetna's senior posts on the White House Staff and at the U.S.
predecessors from 2000 Department of State from 1973 to 1979. He joined Shearson
Lehman Brothers (investment banking) in 1979 and served as
Managing Director from 1984 to 1987. In 1987, Mr. Garten
founded Eliot Group, Inc. (investment banking) and served as
President until 1990, when he became Managing Director of
The Blackstone Group (private merchant bank). From 1992 to
1993, Mr. Garten was Professor of Finance and Economics at
Columbia University's Graduate School of Business. He was
appointed U.S. Under Secretary of Commerce for International
Trade in 1993 and served in that position until 1995. Mr.
Garten is a director of Calpine Corporation (power company)
and CarMax, Inc. (automotive retailer) and also a director
of 53 Credit Suisse mutual funds. He is the author of A Cold
Peace: America, Japan, Germany and the Struggle for
Supremacy; The Big Ten: Big Emerging Markets and How They
Will Change Our Lives; The Mind of the CEO; and The Politics
of Fortune: A New Agenda for Business Leaders. Mr. Garten
also writes a monthly column for Business Week magazine. He
also serves on the Board of Directors of Aetna Foundation,
Inc.
12
[JACK D. KUEHLER photo] JACK D. KUEHLER, age 70, retired in August 1993 as Vice
Director since 2000 Chairman and a director of International Business Machines
Director of Aetna's Corporation (information-handling systems, equipment and
predecessors from 1990 to 2000 services), having held various positions with IBM since
joining that company in 1958. Prior to his appointment as
Vice Chairman of IBM in January 1993, Mr. Kuehler served as
President from 1989 to 1993, as Vice Chairman from 1988 to
1989 and as Executive Vice President from 1987 to 1988. Mr.
Kuehler is a director of Arch Chemicals Inc. (specialty
chemicals) and The Parsons Corporation (heavy construction
and engineering services). He also is a member of the
National Academy of Engineering, a Fellow of the Institute
of Electrical and Electronics Engineers, Inc. and a trustee
of Santa Clara University.
[JOHN W. ROWE photo] JOHN W. ROWE, M.D., age 58, is Chairman and Chief Executive
Director since 2000 Officer of Aetna. He was appointed Chairman of Aetna on
Director of Aetna's April 1, 2001 and was appointed President and Chief
predecessors from 2000 Executive Officer of Aetna on September 15, 2000. He served
as President of Aetna until May 27, 2002. Prior to joining
Aetna, Dr. Rowe served as President and Chief Executive
Officer of Mount Sinai NYU Health, a position he assumed in
1998 after overseeing the 1998 merger of the Mount Sinai and
NYU Medical Centers. Dr. Rowe joined The Mount Sinai
Hospital and the Mount Sinai School of Medicine as President
in 1988. Before that, Dr. Rowe was a Professor of Medicine
and the founding Director of the Division on Aging at
Harvard Medical School and Chief of Gerontology at Boston's
Beth Israel Hospital. He has authored over 200 scientific
publications, mostly on the physiology of the aging process,
and a leading text book of geriatric medicine. Dr. Rowe has
received many honors and awards for his research and health
policy efforts regarding care of the elderly. He was
Director of the MacArthur Foundation Research Network on
Successful Aging and is co-author, with Robert Kahn, Ph.D.,
of Successful Aging. Dr. Rowe is a member of the Institute
of Medicine of the National Academy of Sciences and the
Medicare Payment Advisory Commission. He also is a director
of Cantel Medical Corporation (infection prevention and
control products and diagnostic and medical equipment).
[RONALD A. WILLIAMS photo] RONALD A. WILLIAMS, age 53, became President of Aetna on May
Director since 2002 27, 2002, having served as Executive Vice President and
Chief of Health Operations of the Company since March 15,
2001. Prior to joining Aetna, Mr. Williams held various
executive positions from 1987 to 2001 at WellPoint Health
Networks Inc. and its Blue Cross of California subsidiary.
From October 1995 to March 1999, he served as Executive Vice
President of the Blue Cross of California Businesses of
WellPoint and as President of its Blue Cross of California
subsidiary and from April 1999 to March 2001, he served as
Executive Vice President, Large Group Businesses, of
WellPoint and as Group President of WellPoint's Large Group
Division.
13
DIRECTORS CONTINUING IN OFFICE WITH TERMS EXPIRING AT THE 2004 ANNUAL MEETING
[BARBARA H. FRANKLIN PHOTO] BARBARA HACKMAN FRANKLIN, age 63, is President and Chief
Director since 2000 Executive Officer of Barbara Franklin Enterprises (private
Director of Aetna's investment and international trade consulting firm). From
predecessors from 1979 to 1992 1992 to 1993, she served as the 29th U.S. Secretary of
and from 1993 to 2000 Commerce. Before her appointment, Ms. Franklin was
President and Chief Executive Officer of Franklin
Associates (management consulting firm), which she founded
in 1984. Ms. Franklin also served as Alternate
Representative to the 44th Session of the United Nations
General Assembly, and as a public member of the Board of
the American Institute of Certified Public Accountants and
of the Auditing Standards Board. She has received the John
J. McCloy award for contributions to audit excellence. Ms.
Franklin has served as Senior Fellow of The Wharton School
of the University of Pennsylvania, an original Commissioner
and Vice Chair of the U.S. Consumer Product Safety
Commission, a Staff Assistant to the President of the
United States, and an Assistant Vice President of Citibank,
N.A. Ms. Franklin is a director of several international
organizations, including the U.S. China Business Council,
chairs the Asia Studies Advisory Council of the Heritage
Foundation, is a trustee of the Economic Club of New York,
a member of the Board of Directors of the Associates of the
Harvard Business School and the National Association of
Corporate Directors, and a regular commentator on PBS'
"Nightly Business Report." She is a director of The Dow
Chemical Company (chemicals, plastics and agricultural
products), GenVec, Inc. (biotechnology company), MedImmune,
Inc. (biotechnology company) and Milacron Inc. (plastics
processing technologies and industrial products for
metalworking).
[EARL G. GRAVES photo] EARL G. GRAVES, age 68, is Chairman and Chief Executive
Director since 2000 Officer of Earl G. Graves, Ltd. (a multifaceted
Director of Aetna's communications company) and is the Publisher of Black
predecessors from 1994 to 2000 Enterprise magazine, which he founded in 1970.
Additionally, since 1998, Mr. Graves has been Managing
Director of Black Enterprise/Greenwich Street Corporate
Growth Partners, L.P. Mr. Graves is a director of AMR
Corporation and its subsidiary, American Airlines, Inc.,
Federated Department Stores Inc. (retailer) and Rohm and
Haas Company (specialty chemicals and plastics) and is a
member of the Supervisory Board of DaimlerChrysler AG
(transportation products and financial and other services).
Mr. Graves also is a trustee of Howard University and is a
member of the Executive Board and Executive Committee of
the National Office of the Boy Scouts of America. He also
serves on the Board of Directors of Aetna Foundation, Inc.
14
[GERALD GREENWALD photo] GERALD GREENWALD, age 67, is a founding principal of the
Director since 2000 Greenbriar Equity Group (invests in the global
Director of Aetna's transportation industry). Mr. Greenwald retired in July
predecessors from 1993 to 2000 1999 as Chairman and Chief Executive Officer of UAL
Corporation and United Airlines (UAL), its principal
subsidiary, having served in those positions since July
1994. He was Chairman Emeritus of UAL Corporation from 1999
to 2002. Mr. Greenwald held various executive positions
with Chrysler Corporation (automotive manufacturer) from
1979 to 1990, serving as Vice Chairman of the Board from
1989 to May 1990 and as Chairman of Chrysler Motors from
1985 to 1988. In 1990, Mr. Greenwald was selected to serve
as Chief Executive Officer of United Employee Acquisition
Corporation in connection with the proposed 1990 employee
acquisition of UAL. From 1991 to 1992, he was a Managing
Director of Dillon Read & Co., Inc. (investment banking)
and, from 1992 to 1993, he was President and Deputy Chief
Executive Officer of Olympia & York Developments Ltd.
(Canadian real estate company). Mr. Greenwald then served
as Chairman and Managing Director of Tatra Truck Company
(truck manufacturer in the Czech Republic) from 1993 to
1994. Mr. Greenwald is a director of Calpine Corporation
(power company) and Sentigen Holding Corp. (provides goods
and services in the domestic biotechnology and
pharmaceutical industries). He is also a trustee of the
Aspen Institute.
[ELLEN M. HANCOCK photo] ELLEN M. HANCOCK, age 60, is the former Chairman of the
Director since 2000 Board and Chief Executive Officer of Exodus Communications,
Director of Aetna's Inc. (Internet system and network management services).
predecessors from 1995 to 2000 Mrs. Hancock joined Exodus in March 1998 and served as
Chairman from June 2000 to September 2001, Chief Executive
Officer from September 1998 to September 2001, and
President from March 1998 to June 2000. Mrs. Hancock held
various staff, managerial and executive positions at
International Business Machines Corporation
(information-handling systems, equipment and services) from
1966 to 1995. She became a Vice President of IBM in 1985
and served as President, Communication Products Division,
from 1986 to 1988, when she was named General Manager,
Networking Systems. Mrs. Hancock was elected an IBM Senior
Vice President in November 1992, and in 1993 was appointed
Senior Vice President and Group Executive, which position
she held until February 1995. Mrs. Hancock served as an
Executive Vice President and Chief Operating Officer of
National Semiconductor Corporation (semiconductors) from
September 1995 to May 1996 and served as Executive Vice
President for Research and Development and Chief Technology
Officer of Apple Computer, Inc. (personal computers) from
July 1996 to July 1997. Mrs. Hancock is a director of
Colgate-Palmolive Company (consumer products).
15
[MICHAEL H. JORDAN photo] MICHAEL H. JORDAN, age 66, retired on December 31, 1998 as
Director since 2000 Chairman and Chief Executive Officer of CBS Corporation
Director of Aetna's (media company), having assumed that position with CBS
predecessors from 1992 to 2000 (then Westinghouse Electric Corporation) in 1993.
Currently, Mr. Jordan is serving as a General Partner of
Global Asset Capital, LLC (private equity investment firm)
and as Chairman of the Board of eOriginal, Inc. (electronic
document services). He served as Chairman of Luminant
Worldwide Corporation (Internet and electronic commerce
services) from September 1999 to May 2001. Mr. Jordan was a
partner with Clayton, Dubilier & Rice, Inc. (private
investing firm) from 1992 to 1993. Mr. Jordan retired in
July 1992 as Chairman and Chief Executive Officer of the
PepsiCo International Foods and Beverages Division of
PepsiCo, Inc. (snack foods and beverages), having held
various positions with PepsiCo since 1974. Mr. Jordan also
is a director of Dell Computer Corporation (personal
computers), Galaxy Nutritional Foods, Inc. (natural and
organic foods), i2 Technologies, Inc. (global provider of
e-business solutions), MVC Capital (venture capital fund),
Pinnacor Inc. (global content and technology solutions
provider) and WPP Group plc (global communication services
company).
[JOSEPH P. NEWHOUSE photo] JOSEPH P. NEWHOUSE, age 61, is the John D. MacArthur
Director since 2001 Professor of Health Policy and Management at Harvard
University, a position he assumed in 1988. At Harvard, he
also is a Director of the Division of Health Policy
Research and Education, a Director of the Interfaculty
Initiative on Health Policy, Chair of the Committee on
Higher Degrees in Health Policy and a member of the
faculties of the John F. Kennedy School of Government, the
Harvard Medical School, the Harvard School of Public Health
and the Faculty of Arts and Sciences. Prior to joining
Harvard, Dr. Newhouse held various positions at The RAND
Corporation from 1968 to 1988, serving as a faculty member
of the RAND Graduate School from 1972 to 1988, as Deputy
Program Manager for Health Sciences Research from 1971 to
1988, Senior Staff Economist from 1972 to 1981, Head of the
Economics Department from 1981 to 1985 and as a Senior
Corporate Fellow from 1985 to 1988. Dr. Newhouse is the
Editor of the Journal of Health Economics, which he founded
in 1981. He is a Faculty Research Associate of the National
Bureau of Economic Research, a member of the Medicare
Payment Advisory Commission, a member of the Institute of
Medicine of the National Academy of Sciences, a member of
the New England Journal of Medicine Editorial Board, and a
Fellow of the American Academy of Arts and Sciences. Dr.
Newhouse is the author of Free for All: Lessons from the
RAND Health Insurance Experiment. He also serves on the
Board of Directors of Aetna Foundation, Inc.
16
[JUDITH RODIN photo] JUDITH RODIN, age 58, became President of the University of
Director since 2000 Pennsylvania in July 1994 where she also holds positions on
Director of Aetna's the faculty as Professor of Psychology in the School of
predecessors from 1995 to 2000 Arts and Sciences and as Professor of Medicine and
Psychiatry in the School of Medicine. Prior to assuming her
current position, Dr. Rodin had served as Provost of Yale
University since 1992. Dr. Rodin joined the Yale faculty in
1972, and held teaching and research positions of
increasing responsibility in the Department of Psychology.
She became a Professor of Psychology in 1979 and a
Professor of Medicine and Psychiatry in 1985, and served as
Chair of the Department of Psychology from 1989 to 1991 and
Dean of the Graduate School of Arts and Sciences from 1991
to 1992 when she became Provost. Dr. Rodin has published
more than 200 articles and chapters in academic
publications and authored or co-authored ten books. Dr.
Rodin is a director of AMR Corporation and its subsidiary,
American Airlines, Inc., Comcast Corporation
(communications, media and entertainment company) and
Electronic Data Systems Corporation (information technology
services) and a trustee of 43 of the mutual funds managed
by The BlackRock Funds.
[R. DAVID YOST photo] R. DAVID YOST, age 55, is Chief Executive Officer and a
Director since 2002 director of AmerisourceBergen Corporation (pharmaceutical
distributor), a position he assumed in August 2001. Mr.
Yost has held various managerial and executive positions at
AmerisourceBergen or its predecessor since 1974. He served
as Executive Vice President -- Operations of AmeriSource
Health Corporation from 1995 to May 1997, when he was
appointed President and Chief Executive Officer. In
December 2000, Mr. Yost was appointed Chairman and Chief
Executive Officer of AmeriSource Health, a position he held
until August 2001 when AmeriSource Health merged with
Bergen Brunswig Corporation to form AmerisourceBergen
Corporation and Mr. Yost became President and Chief
Executive Officer of AmerisourceBergen. Mr. Yost served as
President of AmerisourceBergen until October 2002.
17
NONEMPLOYEE DIRECTOR COMPENSATION IN 2002
The Nominating and Corporate Governance Committee (the "Nominating Committee")
reviews compensation for nonemployee Directors annually. The Nominating
Committee's goal of attracting and retaining qualified Directors is supported
through a competitive compensation program that provides remuneration for
Directors' contributions, while offering stock-based compensation alternatives
that strengthen the Directors' mutuality of interests with other shareholders.
Directors who are officers of Aetna receive no additional compensation for
membership on the Board or any of its Committees. The following table sets forth
the cash and stock-based compensation Aetna paid to each Nominee and Continuing
Director who was an outside Director of Aetna in 2002.
--------------------------------------------------------------------------------
CASH STOCK
COMPENSATION(1) STOCK UNITS OPTIONS
------------------ ----------- ----------
ANNUAL NUMBER OF NUMBER
RETAINER MEETING UNITS OF OPTIONS
NAME FEES(2) FEES(3) GRANTED(4) GRANTED(5)
---- -------- ------- ----------- ----------
Betsy Z. Cohen.................................... $33,000 $20,000 350 5,500
Barbara Hackman Franklin.......................... 38,667 26,000 350 5,500
Jeffrey E. Garten................................. 34,000 19,000 350 5,500
Earl G. Graves.................................... 41,000 26,000 350 5,500
Gerald Greenwald.................................. 38,667 22,000 350 5,500
Ellen M. Hancock.................................. 33,000 25,000 350 5,500
Michael H. Jordan................................. 38,667 19,000 350 5,500
Jack D. Kuehler................................... 38,667 19,000 350 5,500
Joseph P. Newhouse................................ 34,000 20,000 350 5,500
Judith Rodin...................................... 33,000 16,000 350 5,500
R. David Yost..................................... 6,250 2,000 1,500 0
--------------------------------------------------------------------------------
(1) Under the Aetna Inc. Nonemployee Director Compensation Plan (the "Director
Plan"), nonemployee Directors may defer payment of some or all of their
annual retainer fees, meeting fees and dividend equivalents paid on stock
units to a stock unit or interest account until after they have resigned or
retired (as defined in the Director Plan) from the Board. During the period
of deferral, amounts deferred to the stock unit account track the value of
the Common Stock and earn dividend equivalents. Amounts deferred to the
interest account accrue interest pursuant to a formula equal to the rate of
interest paid from time to time under a fixed interest rate fund option of
Aetna's ISP for employees (currently yielding 5.2% a year). In 2002, seven
Directors deferred all or a portion of their Director cash compensation to a
stock unit account. The table above includes cash compensation that was
deferred by Directors during 2002 under the Director Plan.
(2) Aetna currently pays a retainer fee of $25,000 a year to nonemployee
Directors for Board membership. Aetna also pays a $4,000 retainer to such
Directors for membership on Committees of the Board ($7,000 in the case of
each Committee Chair).
(3) Aetna currently pays $1,000 to outside Directors for attendance at each
Board or Committee meeting.
(4) Pursuant to the Director Plan, nonemployee Directors, upon their initial
election to the Board, receive a one-time grant of units convertible upon
retirement from Board service into 1,500 shares of Common Stock ("Initial
Units"). Additionally, on the date of each Annual Meeting during the term of
the Director Plan, each nonemployee Director will receive units convertible
upon retirement from Board service into 350 shares of Common Stock ("Annual
Units"). Generally, to become fully vested in the units, a Director must
complete, in the case of the Initial Units, three years of service and, in
the case of the Annual Units, one year of service following the grant of the
units. If service is sooner terminated by reason of death, disability,
retirement or acceptance of a position in government service, a Director is
entitled to receive the full grant if the Director has completed a minimum
of six consecutive months of service as a Director since such grant. A
Director's right with respect to unvested units also will vest upon a
change-in-control of Aetna (as defined in the Director Plan). If a Director
terminates Board service prior to completion of three years or one year of
service, as applicable, from the grant date of
18
any units that have not otherwise vested under the terms of the Director
Plan, the Director will be entitled to receive a pro rata portion of the
award. Although Directors receive dividend equivalents, they have no voting
rights with respect to the units granted. The units granted are not
transferable.
(5) In furtherance of the previously disclosed goal of increasing over time the
proportional share of stock-based compensation that will be received by the
Directors, beginning in 2002, nonemployee Directors were granted stock
options under the Director Plan. On January 25, 2002, each nonemployee
Director was granted options to purchase 5,500 shares of Common Stock. The
exercise price of the options was $35.78, the fair market value of the
Common Stock on the date of grant. The options have a ten year term and vest
in three equal annual installments commencing on January 25, 2003. All
options granted to a nonemployee Director will vest immediately if the
Director ceases to be a Director because of death, disability, retirement or
his or her acceptance of a position in government service. All options
granted to nonemployee Directors also vest immediately upon a
change-in-control of Aetna (as defined in the Director Plan).
OTHER INFORMATION REGARDING DIRECTORS
As part of its overall program of support for charitable institutions and in
order to attract and retain qualified Directors, Aetna maintains a Director
Charitable Award Program. Only nonemployee Directors are eligible to participate
in the program. The program may be funded by life insurance on the lives of the
participating Directors. Each of the Directors other than Dr. Newhouse and Mr.
Yost is fully vested in the program. Dr. Newhouse, Mr. Yost and each new
Director who participates in the program will be fully vested in the program
upon completion of five years of service as a Director or upon death or
disability. Under the program, Aetna intends to make a charitable contribution
of $1 million in ten equal annual installments, with the first installment made
following each participating Director's retirement from the Board, allocated
among up to five charitable organizations recommended by the Director.
Beneficiary organizations recommended by Directors must be, among other things,
tax exempt under Section 501(c)(3) of the Internal Revenue Code of 1986, as
amended (the "Code"). Donations Aetna ultimately pays are expected to be
deductible from taxable income for purposes of U.S. federal and other income
taxes payable by Aetna. Directors derive no personal financial or tax benefit
from the program, since all insurance proceeds and charitable deductions accrue
solely to Aetna. The program will not result in a material cost to Aetna.
Aetna provides $150,000 of group life insurance for its nonemployee Directors.
Optional medical, dental and long-term care coverage for nonmanagement Directors
and their eligible dependents is available to Directors at a cost similar to
that charged to Aetna employees.
CERTAIN TRANSACTIONS AND RELATIONSHIPS
Mrs. Hancock resigned as Chairman of the Board and Chief Executive Officer of
Exodus Communications, Inc. on September 4, 2001. Exodus filed a voluntary
petition under Chapter 11 of the federal bankruptcy laws on September 26, 2001.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our Directors and
executive officers to file reports of holdings and transactions in Aetna Common
Stock with the SEC and the New York Stock Exchange. Based on our records and
other information, we believe that during our fiscal year ended December 31,
2002, our Directors and executive officers timely met all applicable SEC filing
requirements.
19
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS, DIRECTORS, NOMINEES AND
EXECUTIVE OFFICERS
The following table presents, as of December 31, 2002, the names of persons
known to Aetna to be the beneficial owners of more than 5% of the outstanding
shares of its Common Stock. The information set forth in the table below and in
the related footnotes was furnished by the respective persons.
--------------------------------------------------------------------------
NAME AND ADDRESS OF AMOUNT AND NATURE
BENEFICIAL OWNER OF BENEFICIAL OWNERSHIP PERCENT
--------------------------------------------------------------------------
Capital Research and Management Company 15,082,000 shares(1) 10.1%
333 South Hope Street
Los Angeles, California 90071
AXA Financial, Inc. 14,905,676 shares(2) 9.9%
1290 Avenue of the Americas
New York, New York 10104
Morgan Stanley 7,998,041 shares(3) 5.3%
1585 Broadway
New York, New York 10036
--------------------------------------------------------------------------------
(1) Of the reported shares, Capital Research and Management Company reports that
it does not have sole or shared voting power with respect to any shares and
that it has sole dispositive power with respect to 15,082,000 shares.
(2) Also reported as beneficially owned by the following affiliates of AXA
Financial, Inc.: AXA Conseil Vie Assurance Mutuelle, AXA Assurances I.A.R.D.
Mutuelle, and AXA Assurances Vie Mutuelle, each with an address at 370, rue
Saint Honore, 75001 Paris, France; AXA Courtage Assurance Mutuelle, with an
address at 26, rue Louis le Grand, 75002 Paris, France; and AXA, with an
address at 25, avenue Matignon, 75008 Paris, France (collectively, the "AXA
Group"). Of the reported shares, the AXA Group reports that it has sole
voting power with respect to 8,203,774 shares, that it shares voting power
with respect to 1,375,565 shares, that it has sole dispositive power with
respect to 14,905,676 shares and shared dispositive power with respect to no
shares. The AXA Group reports that its shares are deemed to be beneficially
owned by the following subsidiaries of AXA Financial, Inc.: Alliance Capital
Management L.P. (14,904,617 shares) and The Equitable Life Assurance Society
of the United States (1,059 shares).
(3) Of the reported shares, Morgan Stanley reports that it has sole voting power
with respect to no shares, shared voting power with respect to 7,961,624
shares, sole dispositive power with respect to no shares and shared
dispositive power with respect to 7,998,041 shares.
20
BENEFICIAL OWNERSHIP TABLE
The following table presents, as of January 31, 2003, the beneficial ownership
of, and other interests in, shares of Common Stock of each current Director and
Nominee, each executive officer named in the Summary Compensation Table on page
23, and Aetna's Directors and executive officers as a group. The information set
forth below and in the related footnotes on the following page has been
furnished by the respective persons.
AMOUNT AND NATURE OF BENEFICIAL OWNERSHIP
------------------------------------------------------
----------------------------------------------------------------------------------------------
COMMON
NAME OF BENEFICIAL COMMON STOCK
OWNER AND POSITION STOCK PERCENT EQUIVALENTS(1) TOTAL
----------------------------------------------------------------------------------------------
Betsy Z. Cohen
(current Director and Nominee)....
3,405(2) * 10,767 14,172
Barbara Hackman Franklin
(current Director)
9,325(2) * 8,284 17,609
Jeffrey E. Garten
(current Director and Nominee)....
2,034(2) * 4,544 6,578
Earl G. Graves
(current Director)
2,334(2) * 12,413 14,747
Gerald Greenwald
(current Director)
4,834(2)(3) * 22,317 27,151
Ellen M. Hancock
(current Director)
3,834(2)(4) * 19,139 22,973
Michael H. Jordan
(current Director)
4,834(2) * 16,370 21,204
Jack D. Kuehler
(current Director and Nominee)
13,834(2)(4) * 21,492 35,326
Joseph P. Newhouse
(current Director)
2,334(2)(4) * 3,135 5,469
Judith Rodin
(current Director)
2,336(2) * 19,673 22,009
R. David Yost
(current Director)
* 1,500 1,500
John W. Rowe, M.D.
(Chairman and Chief
Executive Officer, current
Director and Nominee)
1,093,793(5) * 51,994(10) 1,145,787
Alan M. Bennett
(named executive)
112,753(6) * 112,753
David B. Kelso
(named executive)
165,000(7) * 165,000
L. Edward Shaw, Jr.
(named executive)
387,708(8) * 387,708
Ronald A. Williams
(named executive, current
Director and Nominee)
596,668(9) * 105,107(11) 701,775
Directors and executive
officers as a group
(17 persons)
2,511,496(12) 1.6% 296,735 2,808,231
--------------------------------------------------------------------------------
* Less than 1%
Unless noted in the footnotes, each person currently has sole voting and
investment powers over the shares set forth above.
21
NOTES TO BENEFICIAL OWNERSHIP TABLE
--------------------------------------------------------------------------------
(1) Except as set forth in Notes 10 and 11, represents stock units issued under
the Director Plan and plans of Aetna's predecessors. Certain of the stock
units are not fully vested -- see description of the Director Plan on pages
18 and 19. Stock units track the value of Aetna Common Stock and earn
dividend equivalents that may be reinvested, but do not have voting rights.
(2) Includes 1,834 shares that the Director has the right to acquire currently
or within 60 days of January 31, 2003 upon the exercise of stock options.
(3) Represents shares held by his spouse, as to which Mr. Greenwald has no
voting or investment power.
(4) Held jointly with the Director's spouse, as to which the Director shares
voting and investment powers.
(5) Includes 1,072,643 shares that Dr. Rowe has the right to acquire currently
or within 60 days of January 31, 2003 upon the exercise of stock options.
Also includes 21,000 shares held by Dr. Rowe, of which 1,000 shares are
held jointly with his spouse as to which Dr. Rowe shares voting and
investment powers, and 150 shares held under the ISP.
(6) Includes 99,184 shares that Mr. Bennett has the right to acquire currently
or within 60 days of January 31, 2003 upon the exercise of stock options,
10,884 shares held by Mr. Bennett and 2,685 shares held under the ISP.
(7) Includes 150,000 shares that Mr. Kelso has the right to acquire currently
or within 60 days of January 31, 2003 upon the exercise of stock options.
Also includes 12,500 shares held by Mr. Kelso and 2,500 shares held in a
Community Property Trust of which Mr. Kelso and his spouse are sole
trustees and beneficiaries.
(8) Includes 375,618 shares that Mr. Shaw has the right to acquire currently or
within 60 days of January 31, 2003 upon the exercise of stock options. Also
includes 12,000 shares held by Mr. Shaw, of which 2,000 shares are held
jointly with his spouse as to which Mr. Shaw shares voting and investment
powers, and 90 shares held under the ISP.
(9) Includes 566,668 shares that Mr. Williams has the right to acquire
currently or within 60 days of January 31, 2003 upon the exercise of stock
options. Also includes 27,500 shares that Mr. Williams held jointly with
his spouse, as to which Mr. Williams shares voting and investment powers,
and 2,500 shares held in a Guaranteed Retained Annuity Trust of which Mr.
Williams is the sole Trustee.
(10) Includes 17,312 restricted stock units which vest on September 15, 2003.
Also includes 34,682 fully vested deferred stock units which earn dividend
equivalents that are reinvested in stock units. Stock units do not have
voting rights.
(11) Includes 13,333 restricted stock units which vest on March 15, 2003 and
13,334 such units which vest on March 15, 2004. Also includes 78,440 fully
vested deferred stock units which earn dividend equivalents that are
reinvested in stock units. Stock units do not have voting rights.
(12) Directors and executive officers as a group have sole voting and investment
powers over 89,203 shares and share voting and investment powers with
respect to 47,500 shares. Included in the number of shares shown in the
table are 2,925 shares held under the ISP and beneficially owned by
executive officers, and 2,368,868 shares that Directors and executive
officers have the right to acquire currently or within 60 days of January
31, 2003 upon the exercise of stock options.
22
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth for the periods indicated compensation of the
Chairman and Chief Executive Officer and each of the four other most highly
compensated executive officers of Aetna in 2002.
--------------------------------------------------------------------------------
LONG-TERM COMPENSATION
-----------------------
AWARDS
ANNUAL COMPENSATION -----------------------
----------------------------------------- SECURITIES
OTHER RESTRICTED UNDERLYING
NAME AND PRINCIPAL ANNUAL STOCK STOCK
POSITION IN 2002 YEAR SALARY BONUS COMPENSATION(3) AWARDS(4) OPTIONS(5)
----------------------------------------------------------------------------------------------------
John W. Rowe, M.D. 2002 $1,000,000 $2,500,000 $89,490 $ 350,000
Chairman and 2001 1,000,000 1,000,000 250,000
Chief Executive Officer 2000 273,077 375,000 1,367,188 1,246,464
Alan M. Bennett 2002 $ 425,000 $ 450,000 60,000
Senior Vice President 2001 377,885 83,725 75,000
and Chief Financial
Officer(1)
David B. Kelso 2002 $ 700,000 $ 925,000 $76,648 150,000
Executive Vice
President, 2001 188,462 400,000 250,000
Strategy and Finance(1)
L. Edward Shaw, Jr. 2002 $ 525,000 $ 700,000 60,000
Executive Vice 2001 525,000 420,000 60,000
President and 2000 492,308 650,000 140,227
General Counsel
Ronald A. Williams 2002 $ 848,077 $1,500,000 $ 372 $ 200,000
President(2) 2001 621,538 600,000 87 1,496,000 800,000
----------------------------------------------------------------------------------------------------
LONG-TERM COMPENSATION
----------
PAYOUTS
----------
LONG-TERM
NAME AND PRINCIPAL INCENTIVE ALL OTHER
POSITION IN 2002 PLAN(6) COMPENSATION
-------------------------------------------------------------------------
John W. Rowe, M.D. $5,198,400 $ 139,115(7)
Chairman and 1,544,242
Chief Executive Officer 2,013,654
Alan M. Bennett $ 996,360 $ 121,262(8)
Senior Vice President 37,394
and Chief Financial
Officer(1)
David B. Kelso $2,599,200 $ 61,562(9)
Executive Vice
President, 209,423
Strategy and Finance(1)
L. Edward Shaw, Jr. $ 797,088 $ 34,350(10)
Executive Vice 58,750
President and 581,788 14,928
General Counsel
Ronald A. Williams $3,465,600 $ 299,442(11)
President(2) 561,168
---------------------------------------------------------------------------------------
(1) Neither Mr. Bennett nor Mr. Kelso was an executive officer of Aetna or its
predecessors at any time in 2000.
(2) Mr. Williams became President of Aetna on May 27, 2002. Mr. Williams was
not an executive officer of Aetna or its predecessors at any time in 2000.
(3) Includes $80,360 and $66,204 for personal use of corporate aircraft for Dr.
Rowe and Mr. Kelso, respectively. This benefit is included in each
executive's taxable income, and each executive is responsible for taxes due
on that income. Mr. Williams was reimbursed $372 for income taxes.
(4) At December 31, 2002, Dr. Rowe held 17,312 restricted stock units with a
value of $711,870 and Mr. Williams held 26,667 restricted stock units with
a value of $1,096,547. Any unvested restricted stock units granted to Dr.
Rowe or Mr. Williams will immediately vest upon either the occurrence of a
"change in control" of Aetna or upon termination of the named executive's
employment without "cause" by Aetna or for "good reason" by the named
executive, or by reason of death or disability.
(5) Represents stock options granted under Aetna's 2000 Stock Incentive Plan
(the "2000 Stock Plan").
(6) Represents the value of previously awarded performance units that vested
upon attainment of specified performance criteria.
(7) Includes $73,500 in life insurance premiums. Also includes $59,615 in
matching contributions made by Aetna under the ISP and/or the Supplemental
ISP and a $6,000 performance based contribution by Aetna under the ISP for
performance year 2002. The ISP is a 401(k) plan qualified under the Code.
For 2002, Aetna matched 50% of the amount deferred by employees under the
ISP up to 6% of eligible pay. In addition, employees are eligible to
receive an additional performance based ISP contribution of up to 3% of
eligible pay, not to exceed $6,000. Performance based contributions vest
after the employee attains three years of service with the Company. Aetna
has established the Supplemental ISP to provide the deferred and matching
benefits that would have been credited to the ISP but for limits imposed by
the Employee Retirement Income Security Act and the Code. The Supplemental
ISP also is used to provide other benefits not otherwise payable under the
ISP, as provided from time to time by the Board.
23
(8) Includes $100,000 retention bonus. Also includes $15,262 in matching
contributions made by Aetna under the ISP and/or the Supplemental ISP and a
$6,000 performance based contribution by Aetna under the ISP for
performance year 2002.
(9) Includes $33,538 in matching contributions made by Aetna under the ISP
and/or the Supplemental ISP and a $6,000 performance based contribution by
Aetna under the ISP for performance year 2002. Also includes $22,024 in
living expenses paid in accordance with Mr. Kelso's employment agreement.
(10) Includes a matching contribution of $28,350 made by Aetna under the ISP
and/or the Supplemental ISP and a $6,000 performance based contribution by
Aetna under the ISP for performance year 2002.
(11) Includes $250,000 retention bonus paid in accordance with Mr. Williams'
employment agreement. Also includes $43,442 in matching contributions made
by Aetna under the ISP and/or the Supplemental ISP and a $6,000 performance
based contribution by Aetna under the ISP for performance year 2002.
24
STOCK OPTION GRANTS TABLE
The following table sets forth information concerning stock options granted
during 2002 by Aetna to the persons listed in the Summary Compensation Table on
page 23. The hypothetical grant date present values of stock options granted in
2002 shown below are presented pursuant to SEC rules and are calculated under
the modified Black-Scholes Model for pricing options.
--------------------------------------------------------------------------------
INDIVIDUAL GRANTS(1)
--------------------------------------------------------------------------------------------------------
PERCENT OF
NUMBER OF TOTAL STOCK
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE GRANT DATE
STOCK OPTIONS EMPLOYEES IN PRICE PER EXPIRATION PRESENT
NAME GRANTED 2002 SHARE DATE VALUE
--------------------------------------------------------------------------------------------------------
John W. Rowe, M.D. ................. 350,000(2) 6.63% $35.78 01/25/12 $5,439,000(4)
Alan M. Bennett..................... 60,000(2) 1.14% 35.78 01/25/12 932,400(4)
David B. Kelso...................... 150,000(2) 2.84% 35.78 01/25/12 2,331,000(4)
L. Edward Shaw, Jr. ................ 45,000(2) 0.85% 35.78 01/25/12 699,300(4)
15,000(3) 0.28% 37.05 09/27/12 231,900(5)
Ronald A. Williams.................. 200,000(2) 3.79% 35.78 01/25/12 3,108,000(4)
--------------------------------------------------------------------------------------------------------
(1) All options were granted under the 2000 Stock Plan. The 2000 Stock Plan
permits participants to use shares of Aetna Common Stock to exercise
options. The 2000 Stock Plan provides that the option price shall not be
less than 100% of the fair market value of the Common Stock on the date the
option is granted. Under the 2000 Stock Plan, options may be granted until
November 30, 2010.
(2) Date of grant was January 25, 2002; initial exercise date was January 25,
2003; option vests in equal annual installments over a period of three years
from the date of grant.
(3) Date of grant was September 27, 2002; initial exercise date is September 27,
2003; option vests in equal annual installments over a period of three years
from the date of grant.
(4) The assumptions made and factors used by Aetna in the Black-Scholes Model
calculation for the options granted January 25, 2002 were as follows: (i) a
volatility factor of 42.9%, representing the four-year historical volatility
of the Common Stock as of the date of the option grant; (ii) a risk-free
rate of return of 4.46%, representing the five-year U.S. Treasury bond rate
in effect on the date of the option grant; (iii) a dividend yield of 0.1%,
representing Aetna's then current annual dividend, divided by the Common
Stock price on the date of the option grant; and (iv) a five-year option
term, representing the historical average life of the options granted. No
further discount to the option value calculated was taken to give effect to
the fact that the options are not freely transferable or to the exercise or
lapse of the options after the vesting period but prior to the end of the
option period.
(5) The assumptions made and factors used by Aetna in the Black-Scholes Model
calculation for the options granted September 27, 2002 were as follows: (i)
a volatility factor of 44.2%, representing the four-year historical
volatility of the Common Stock as of the date of the option grant; (ii) a
risk-free rate of return of 2.74%, representing the five-year U.S. Treasury
bond rate in effect on the date of the option grant; (iii) a dividend yield
of 0.1%, representing Aetna's then current annual dividend, divided by the
Common Stock price on the date of the option grant; and (iv) a five-year
option term, representing the historical average life of the options
granted. No further discount to the option value calculated was taken to
give effect to the fact that the options are not freely transferable or to
the exercise or lapse of the options after the vesting period but prior to
the end of the option period.
There is no assurance that the hypothetical present values of stock options
presented in the preceding table represent the actual values of such options.
The hypothetical values shown should not be construed as predictions by Aetna as
to the future value of its Common Stock.
25
STOCK OPTION EXERCISES AND DECEMBER 31, 2002 STOCK OPTION VALUE TABLE
The following table sets forth information concerning stock options exercised
during 2002 by the persons listed in the Summary Compensation Table on page 23
and the number and value of specified options held by those persons at December
31, 2002. The values of unexercised in-the-money stock options at December 31,
2002 shown below are presented pursuant to SEC rules. There is no assurance that
the values of unexercised in-the-money stock options reflected in this table
will be realized.
--------------------------------------------------------------------------------
VALUE OF
NUMBER OF SECURITIES UNEXERCISED
UNDERLYING IN-THE-MONEY
SHARES VALUE UNEXERCISED OPTIONS AT OPTIONS AT
ACQUIRED REALIZED DECEMBER 31, 2002 DECEMBER 31, 2002(1)
ON ON ------------------------------ ------------------------------
NAME EXERCISE EXERCISE EXERCISABLE UNEXERCISABLE(2) EXERCISABLE UNEXERCISABLE(2)
-----------------------------------------------------------------------------------------------------------------
John W. Rowe, M.D. 0 0 955,976 890,488 $10,556,570 $8,082,910
Alan M. Bennett 36,834 $919,847 79,184 100,000 517,148 891,800
David B. Kelso 0 0 100,000 300,000 1,298,000 2,748,000
L. Edward Shaw, Jr. 0 0 360,618 124,624 4,318,446 1,251,272
Ronald A. Williams 0 0 300,002 699,998 1,180,002 3,556,998
-----------------------------------------------------------------------------------------------------------------
(1) Based on the December 31, 2002 closing stock price of $41.12.
(2) Represents stock options that are not vested.
LONG-TERM INCENTIVE AWARDS TABLE
The following table sets forth information concerning long-term incentive awards
granted during 2002 to persons listed in the Summary Compensation Table on page
23 under the 2000 Stock Plan.
--------------------------------------------------------------------------------
PERFORMANCE ESTIMATED FUTURE PAYOUTS
OR OTHER (IN SHARES) UNDER
NUMBER OF PERIOD UNTIL NON-STOCK PRICE BASED PLANS
UNITS GRANTED MATURATION ------------------------------
NAME IN 2002(1) OR PAYOUT(2) THRESHOLD TARGET MAXIMUM
--------------------------------------------------------------------------------------------------
John W. Rowe, M.D. 50,000 2002-2006 25,000 50,000 100,000
Alan M. Bennett 12,250 2002-2006 6,125 12,250 24,500
David B. Kelso 20,000 2002-2006 10,000 20,000 40,000
L. Edward Shaw, Jr. 15,000 2002-2006 7,500 15,000 30,000
Ronald A. Williams 45,000 2002-2006 22,500 45,000 90,000
--------------------------------------------------------------------------------------------------
(1) The Performance Units will vest and become payable if Aetna meets specified
performance objectives set annually during the performance period. The
performance goal for 2003 is based on Aetna attaining a specified level of
earnings. If the performance objectives are not met by December 31, 2006,
the units are payable at 50% of target provided the executive remains an
active employee of the Company on that date. The units are payable in shares
of Common Stock and/or cash, at the discretion of the Committee on
Compensation and Organization.
(2) Under the terms of the Performance Unit awards, the units can vest as early
as January 2004 if the 2003 performance goal is met.
PENSION PLAN
Aetna provides for certain of its employees a noncontributory, defined benefit
pension plan (the "Pension Plan"). Effective January 1, 1999, the Pension Plan
was amended to convert the plan's final average pay benefit formula to a cash
balance design. Under this design, the pension benefit is expressed as a cash
balance account. Each year a participant's cash balance account is credited with
(i) a pension credit based on the participant's age, years of service and
eligible pay for that year, and (ii) an interest credit based on the
participant's account balance as of the beginning of the year and an interest
rate that equals the average 30-year U.S. Treasury bond rate for October of the
prior calendar year. (For 2002, the interest rate was
26
5.32%.) For purposes of the Pension Plan, eligible pay is generally base pay and
certain other forms of cash compensation, including annual performance bonuses,
but excluding long-term incentive compensation and proceeds from stock option
exercises.
Employees with former Aetna pension benefits as of December 31, 1998 are
considered transition participants under the Pension Plan. Under the current
plan design, transition participants continue to accrue benefits under the
Pension Plan's final average pay formula until December 31, 2006. Under the
final average pay formula, retirement benefits are calculated on the basis of
(i) the number of years of credited service (maximum credit is 35 years), and
(ii) the employee's average annual earnings during the 60 consecutive months out
of the last 120 months of service that yield the highest annual compensation. On
termination of employment, the value of the cash balance account is compared to
the lump sum value of the benefit under the final average pay formula, and the
greater of these two amounts becomes the cash balance account value.
The estimated annual benefit expressed as a single life annuity payable at age
65 for Dr. Rowe is $240,480, for Mr. Bennett is $185,699, for Mr. Kelso is
$362,709, for Mr. Shaw is $101,051 and for Mr. Williams is $1,146,270. Under his
employment agreement, Dr. Rowe is eligible to vest to a minimum annual benefit
expressed as a single life annuity of not less than $300,000 in five equal
annual installments commencing on his date of employment. These estimates assume
each named executive continues working for Aetna until age 65, the account
balance receives annual interest credits of 5.32% for 2002, 4.93% for 2003 and
6% thereafter, pension eligible pay increases 4% per year, there are no future
annual performance bonuses, the Social Security wage base increases 4% per year,
and the Pension Plan continues unchanged until the projection date. Actual
benefits will vary. The estimated benefits do not take into account any
reduction for joint and survivorship payments, any offset for Social Security
benefits to be received by the employee, or, in the case of estimated benefits,
payment of lump sum benefits of up to 50% of the employee's cash balance account
at the election of the employee.
The Code limits the maximum annual benefit that may be accrued under and paid
from a tax-qualified plan such as the Pension Plan. As a result, Aetna has
established a supplemental pension plan to provide benefits (included in the
amounts listed in the preceding paragraph) that would exceed the Code limit. The
supplemental pension plan also is used to pay other pension benefits not
otherwise payable under the Pension Plan, including additional years of credited
service beyond years actually served, additional years of age, and covered
compensation in excess of that permitted under the Pension Plan.
OTHER AGREEMENTS
Aetna administers a Job Elimination Benefits Plan (the "Severance Plan") under
which employees, including Aetna's executive officers, terminated by Aetna due
to re-engineering, reorganization or staff reduction efforts may receive a
maximum of 52 weeks of continuing salary depending on years of service and pay
level. Under certain circumstances, determined on a case-by-case basis,
additional severance pay benefits may be granted for the purposes of inducing
employment of senior officers or rewarding past service. Certain benefits
continue for part of the severance period.
Aetna has entered into an employment agreement with Dr. Rowe. Under the
agreement, which is for a remaining term ending December 31, 2003, with two
one-year extensions, Dr. Rowe is entitled to an annual salary of not less than
$1,000,000, a target annual bonus opportunity of $1,500,000 and a maximum annual
bonus opportunity of $3,000,000. In addition to certain other benefits, Dr. Rowe
will be entitled (subject to vesting in five equal annual installments) to a
minimum annual pension of $300,000 commencing at age 65. If Aetna terminates Dr.
Rowe's employment other than for "cause" (as defined in the agreement), death or
disability, or Dr. Rowe terminates it for "good reason" (as defined in the
agreement), he will be entitled to 104 weeks (156 weeks, if such termination is
within two years following a change in control) of cash compensation (calculated
as annual base salary and target annual bonus) and his pro rata bonus for the
year of termination. If Aetna does not renew Dr. Rowe's agreement for a one-year
term on December 31, 2003 or 2004, he will be entitled to a cash payment of
$3,000,000 or $1,500,000,
27
respectively. Aetna has agreed generally to make Dr. Rowe whole for any excise
taxes incurred as a result of payments made under his agreement or otherwise.
Aetna has entered into an employment agreement with Mr. Bennett. Under this
agreement, if Aetna terminates Mr. Bennett's employment other than for cause,
Mr. Bennett will be entitled to 78 weeks of cash compensation (calculated as
base salary and target annual bonus) and his stock options will continue to vest
and be exercisable during the severance period. In addition, if the Company
notifies Mr. Bennett at the end of any severance period that he is unable to
sell the underlying stock in an open market transaction due to access to
material nonpublic information pertaining to the Company, Mr. Bennett will have
an additional 90 days to exercise his options from the date the Company notifies
him he is no longer precluded from selling such shares (but in no event may the
options be exercised beyond the original term of the option).
Aetna has entered into an employment agreement with Mr. Kelso. Under the
agreement, which is for a remaining term ending September 30, 2003, with two
one-year extensions, Mr. Kelso is entitled to an annual salary of not less than
$700,000, a target annual bonus opportunity of $560,000 and a maximum annual
bonus opportunity of $1,120,000. Mr. Kelso also is entitled to reimbursement of
his living expenses in the Hartford area through March 15, 2003. In addition to
certain other benefits, Mr. Kelso will receive annual pension credits under
Aetna's supplemental pension plan of at least 15% of his pension eligible
compensation. If Aetna terminates Mr. Kelso's employment other than for "cause"
(as defined in the agreement), death or disability, or Mr. Kelso terminates it
for "good reason" (as defined in the agreement), he will be entitled to 104
weeks (156 weeks, if such termination is within two years following a change in
control) of cash compensation (calculated as annual base salary and target
annual bonus) and his pro rata bonus for the year of termination. If Aetna does
not renew Mr. Kelso's agreement for a one-year term on September 30, 2003 or
September 30, 2004, and Mr. Kelso elects to terminate his employment, he will be
entitled to his then current base salary and target bonus through September
2005. Aetna has agreed generally to make Mr. Kelso whole for certain excise
taxes incurred as a result of payments made under his agreement or otherwise.
Aetna has entered into an employment agreement with Mr. Shaw. Under this
agreement, which runs through December 31, 2003, Mr. Shaw is entitled to an
annual salary of not less than $525,000. Under this agreement, if Aetna
terminates Mr. Shaw's employment other than for "cause" (as defined in the
agreement), death or disability, Mr. Shaw will be entitled to 156 weeks of cash
compensation (calculated as annual base salary and target annual bonus), and
continued health and dental benefits. Mr. Shaw may elect special retirement on
or after January 2002, in which case he will be entitled to 50% of his current
base salary and target annual bonus for the balance of the agreement term and
continued health and dental benefits. Aetna has agreed generally to make Mr.
Shaw whole for any excise taxes incurred as a result of payments made under his
agreement or otherwise.
Aetna has entered into an employment agreement with Mr. Williams. Under the
agreement, which is for a remaining term ending December 31, 2003, with a single
one-year extension, Mr. Williams is entitled to an annual salary of not less
than $800,000, a target annual bonus opportunity of $800,000 and a maximum
annual bonus opportunity of $1,600,000. Under the agreement, Mr. Williams
received a retention bonus of $250,000 in March 2002. In addition to certain
other benefits, Mr. Williams will vest in a pension benefit in five equal annual
installments, and for each of calendar years 2006 through 2011, Mr. Williams
will receive an additional fully vested pension accrual in an amount equal to
his base salary for such year. This additional pension accrual will not be
credited if Mr. Williams is not actively employed by Aetna and will be offset by
the value of Mr. Williams' vested benefit under his prior employer's pension
plan. If Aetna terminates Mr. Williams' employment other than for "cause" (as
defined in the agreement), death or disability, or Mr. Williams terminates it
for "good reason" (as defined in the agreement), he will be entitled to 104
weeks (156 weeks, if such termination is within two years following a change in
control) of cash compensation (calculated as annual base salary and target
annual bonus) and his pro rata bonus for the year of
28
termination. Aetna has agreed generally to make Mr. Williams whole for certain
excise taxes incurred as a result of payments made under his agreement or
otherwise.
The Board has approved provisions for certain benefits of Aetna employees upon a
change-in-control of Aetna (as defined). The provisions provide that the
Severance Plan shall become noncancelable for a period of two years following a
change-in-control. Upon a change-in-control, all previously granted stock
options that have not yet vested will become vested and immediately exercisable
and bonuses payable under Aetna's Annual Incentive Plan will become payable
based on the target award for participants. Outstanding long-term incentive
awards also vest and become payable at a target level. Provision has been made
to maintain the aggregate value of specified benefits for one year following a
change-in-control.
REPORT OF THE COMMITTEE ON COMPENSATION AND ORGANIZATION
What is Aetna's compensation philosophy?
The executive compensation program is designed to:
- create a performance-oriented environment to attract and retain high
performing executives and in which high performing executives can earn
increased levels of compensation by achieving superior annual and long-term
business results; and
- focus executives on increasing shareholder value by awarding them stock-based
compensation directly linked to improvements in Company earnings and stock
price.
What are the elements of Aetna's executive compensation program?
The compensation program for executive officers consists of four principal
elements:
- salaries;
- annual incentive bonuses;
- stock options; and
- long-term incentive awards.
The compensation program is designed to set total compensation opportunity
(salary, annual bonus, stock options and long-term incentive award) at a level
relative to the median level of total compensation paid to similarly positioned
executives at companies in a comparison group selected for each position (the
"Comparison Group"). In designing the compensation programs available to
executive officers the Committee consults an outside compensation consultant.
Executive officers are also eligible for other employee benefits as set forth in
the Summary Compensation Table (see page 23).
How were salaries determined?
Salaries for executive officers are reviewed annually by the Committee. Salaries
are based on the competitive marketplace for comparable jobs. Individual
salaries are determined by the Committee after evaluating the executive's
experience, level and scope of responsibility, and individual performance.
How were bonuses determined?
The annual bonus program is designed to incent executive officers to achieve
specific financial and operational goals. Under the Annual Incentive Plan and
Management Incentive Plan the Committee establishes specific goals at the
beginning of each performance year and bonus funding is linked directly to their
achievement.
Annual Incentive Plan. The Annual Incentive Plan applies to executives named in
the Company's Proxy Statement. For 2002, the two goals established under the
Annual Incentive Plan related to achievement of specified levels of (i)
corporate net income (including amortization of goodwill and interest expense)
and
29
(ii) revenue. If 100% of either goal is met, the maximum award permitted under
the Plan may be paid. If neither of these goals is met at the 100% level, the
maximum bonus payable is proportionately reduced. The Committee has discretion
to pay less than the maximum amount permitted by the Plan. For 2002, the
performance goals were exceeded. The bonus amounts paid to the named executive
officers were determined by the Committee after an evaluation of individual
performance.
Management Incentive Plan. Executive officers who do not participate in the
Annual Incentive Plan participate in the Management Incentive Plan ("MIP").
Under MIP, the Committee sets the amount of the bonus pool funding based on
various levels of financial and operational performance. For 2002, bonus pool
funding under this Plan depended upon the Company's performance against three
measurement categories: (i) constituent focus (21% -- measured by member,
provider, plan sponsor and broker/consultant satisfaction and employee
engagement); (ii) operational excellence (12% -- measured by consolidation of
membership systems and claim process improvement); and (iii) financial
(67% -- measured by attaining a specific level of Company earnings, cash flow
from operations and return on capital).
Under MIP, if 100% of the goals are met, in the aggregate, up to 100% of the
target bonus pool is funded. If the goals are exceeded, in the aggregate, up to
200% of the bonus pool is funded. If the financial performance is less than a
minimum level no more than 30% of the bonus pool may be funded.
For performance year 2002, the goals, in the aggregate, were exceeded. For 2002,
the Company reported operating earnings from continuing operations (excluding
other items) of $450.3 million compared with a significant 2001 operating loss.
As a result of this financial performance, the financial goal was met at the
maximum level. The constituent focus and operational excellence goals were met
at a target level. Based on this performance, the Committee determined to fund
the bonus pool at 166% of target.
The bonus amounts paid to executive officers were determined by the Committee
after an evaluation of individual performance.
How were stock option and restricted stock awards determined?
Aetna awards stock options to align the interests of its executive officers with
those of its shareholders in increasing shareholder value. Stock options are
granted at not less than 100% of the fair market value of the Common Stock on
the date of grant. Because stock options provide value only in the event of
share price appreciation, the Committee believes stock options represent an
important component of Aetna's executive compensation program.
Stock options are granted annually to set total compensation opportunity at a
level relative to the median level of total compensation paid to similarly
positioned executives at companies in the executive's Comparison Group. The
value of the stock option component of an executive officer's compensation
opportunity is converted into a specific number of shares subject to option by
assigning each option an estimated realizable value using a modified
Black-Scholes formula.
From time to time Aetna also grants stock options or restricted stock in
connection with hiring, promotions or other situations where the Committee
believes the circumstances warrant a stock option or restricted stock award. The
amount granted in these instances is determined by the Committee based on the
individual circumstances.
How was the Long-Term Incentive Payout determined?
In 2001, the Committee granted performance units to senior Company employees,
including the executive officers. Each unit represents one share of Common
Stock. Under the award agreements, units would vest and become payable if the
Company met specific performance goals set annually during the four-year
performance period. Under the program, the units could vest as early as January
2003 if the performance goal for 2002 was met. The performance goal for 2002 was
based on the Company attaining a specified level of earnings. In January 2003,
the Committee determined that the Company had exceeded the 2002 earnings
30
goal, and the previously granted awards vested at a 200% level. The Committee
determined that the amount of an award, after tax, in excess of 10,000 shares
(20,000 shares in the case of Dr. Rowe) would be paid in cash.
The long-term incentive program was designed in 2001 as a series of annual
performance periods due to the "turn-around" position of the Company at that
time and the need to focus immediate attention to returning the Company to
profitability.
How is Compensation Used to Focus Management on Longer-Term Creation of
Shareholder Value?
The purpose of Aetna's long-term incentive award program is to increase
shareholder value over time. Under this program performance stock units vest and
become payable if Aetna meets specified performance goals set annually over the
four-year performance period.
The number of performance units granted to executive officers in 2002 was
determined by the Committee to set, at target performance level, the total
compensation opportunity at a median level relative to similarly positioned
executives in the executive officer's Comparison Group. Each unit represents one
share of Common Stock and is payable in cash or stock as determined by the
Committee. The units vest and become payable if the Company meets specific
performance goals set annually during the four-year performance period. The
units can vest as early as January 2004 if the 2003 performance goal is met. The
performance goal for 2003 is based on the Company attaining a specified level of
earnings.
How has the Company responded to IRS limits on deductibility of compensation?
Section 162(m) of the Code limits the tax deductibility of compensation in
excess of $1 million paid to certain executive officers, unless the payments are
made under plans that satisfy the technical requirements of the Code. The
Committee believes that performance-based pay over $1 million is, in some
circumstances, necessary to attract and retain executives in a competitive
marketplace. Stock options granted under the 2000 Stock Plan and annual bonuses
paid under the Annual Incentive Plan are designed so that the compensation paid
will be tax deductible by the Company. The Committee believes that there are
circumstances under which it is appropriate for the Committee to elect to forgo
deductibility to maintain flexibility or to continue to pay competitive
compensation.
What was the basis for Dr. Rowe's 2002 compensation?
Salary. Dr. Rowe's salary was not changed in 2002.
Annual Incentive Bonus. Under the Annual Incentive Plan, described above, the
Committee established two financial goals at the start of 2002. The Committee
determined that these goals were exceeded. The Committee also established
specific strategic and operations objectives. The financial performance, which
resulted in the Company's return to profitability, as well as the Committee's
review of Dr. Rowe's performance in leading the execution of the Company's
turn-around plan, achieving operational excellence and positioning of the
Company for long-term success, was the basis for the Committee's decision to
award Dr. Rowe a bonus of $2,500,000.
Equity Awards.
Stock Options. Dr. Rowe was granted a stock option in 2002 for 350,000 shares
of Common Stock. The amount of the grant was determined by the Committee after a
review of competitive market pay data.
Long-Term Incentive Award Payout. In January 2003, the Committee determined
that the 2002 performance target for the incentive units granted in 2001 had
been exceeded. In accordance with the terms of the award, 200% of Dr. Rowe's
units vested (120,000 units). Each unit represented one share of Common Stock,
and the awards were to be settled in cash or stock as determined by the
Committee. The Committee determined that the amount of the award, after tax, in
excess of 20,000 shares would be paid in cash.
31
Long-Term Incentive Grant. In 2002, Dr. Rowe was granted 50,000 performance
units under the 2000 Stock Plan. The units will vest and become payable if
established performance objectives are met during the performance period (see
description on page 31). The amount of the grant was determined by the Committee
after a review of competitive market pay data.
The Committee on Compensation and Organization
Michael H. Jordan, Chairman
Betsy Z. Cohen
Jack D. Kuehler
Gerald Greenwald
REPORT OF THE AUDIT COMMITTEE
The Audit Committee is composed entirely of independent Directors, as determined
by the Board in its business judgment. The Committee assists the Board in its
oversight of (1) the integrity of the financial statements of the Company, (2)
the independent accountant's qualifications and independence, (3) the
performance of the Company's internal audit functions and independent
accountants, and (4) the compliance by the Company with legal and regulatory
requirements. The Committee is directly responsible for the appointment,
compensation and oversight of the work of the independent accountants, including
the resolution of any disagreements between management and the independent
accountants regarding financial reporting. The independent accountants report
directly to the Committee. The Committee operates pursuant to a Charter that was
last amended and restated by the Board on December 11, 2002, a copy of which is
attached to this Proxy Statement as Annex 3. As set forth in the Charter,
Aetna's management is responsible for the preparation, presentation and
integrity of Aetna's financial statements. Aetna's management and Internal Audit
Department are responsible for maintaining appropriate accounting and financial
reporting principles and policies and internal controls and procedures designed
to assure compliance with accounting standards and applicable laws and
regulations. The independent accountants are responsible for planning and
carrying out proper annual audits and quarterly reviews of Aetna's financial
statements. The independent accountants express an opinion as to the conformity
of the annual financial statements with accounting principles generally accepted
in the United States of America and also provide a review report regarding
Aetna's interim financial statements.
In the performance of its oversight function, the Committee has reviewed and
discussed the audited financial statements with management and the independent
accountants. The Committee has also discussed with the independent accountants
the matters required to be discussed by Statement on Auditing Standards No. 61,
Communication with Audit Committees, as currently in effect. The Committee has
also received the written disclosures and the letter from the independent
accountants required by Independence Standards Board Standard No. 1,
Independence Discussions with Audit Committees, as currently in effect,
including disclosures with respect to nonaudit services provided by the
independent accountants. The Committee has considered whether the provision of
all nonaudit services by the independent accountants to Aetna is compatible with
maintaining the independent accountants' independence and has discussed with
them their independence.
Members of the Committee are not employees of Aetna and, as such, it is not the
duty or responsibility of the Committee or its members to conduct auditing or
accounting reviews or procedures. In performing their oversight responsibility,
members of the Committee rely on information, opinions, reports or statements,
including financial statements and other financial data prepared or presented by
officers or employees of Aetna, legal counsel, independent accountants or other
persons with professional or expert competence. Accordingly, the Committee's
oversight does not provide an independent basis to determine that management has
maintained appropriate accounting and financial reporting principles, policies,
or appropriate internal controls and procedures designed to assure compliance
with accounting standards and applicable laws and regulations. Furthermore, the
Committee's considerations and discussions referred to above do not assure
32
that the audit of Aetna's financial statements by Aetna's independent
accountants has been carried out in accordance with auditing standards generally
accepted in the United States of America, that the financial statements are
presented in accordance with accounting principles generally accepted in the
United States of America or that Aetna's independent accountants are in fact
"independent."
Based upon the reports, review and discussions described in this Report, and
subject to the limitations on the role and responsibilities of the Committee,
certain of which are referred to above and in its Charter, the Committee
recommended to the Board that the audited financial statements be included in
Aetna's Annual Report on Form 10-K for the year ended December 31, 2002 filed
with the Securities and Exchange Commission.
The Audit Committee
Barbara Hackman Franklin, Chairman
Jeffrey E. Garten
Earl G. Graves
Ellen M. Hancock
Joseph P. Newhouse
33
CORPORATE PERFORMANCE GRAPH
The following graph compares the cumulative total shareholder return on Aetna's
Common Stock (assuming reinvestment of dividends) with the cumulative total
return on the published Standard & Poor's 500 Stock Index ("S&P 500") and the
cumulative total return on the published Morgan Stanley Healthcare Payor Index
(currently 12 companies)* from December 14, 2000, the date the Common Stock was
first traded publicly, until the end of 2002. The graph assumes a $100
investment in shares of Aetna Common Stock on December 14, 2000.
CUMULATIVE TOTAL RETURN FROM DECEMBER 14, 2000 TO
DECEMBER 31, 2002 OF AETNA COMMON STOCK,
S&P 500 AND MORGAN STANLEY HEALTHCARE PAYOR INDEX
[PERFORMANCE GRAPH]
MORGAN STANLEY HEALTHCARE
AETNA INC. S&P 500 PAYOR INDEX*
---------- ------- -------------------------
12/14/00 100.00 100.00 100.00
12/31/00 119.23 98.49 115.68
06/30/01 75.18 91.90 92.22
12/31/01 95.93 86.80 103.47
06/30/02 139.49 75.36 140.38
12/31/02 119.69 67.52 118.46
* The companies currently included in the Morgan Stanley Healthcare Payor Index
are: Aetna, CIGNA Corporation, Coventry Health Care, Inc., First Health Group
Corp., Health Net, Inc., Humana Inc., MidAtlantic Medical Services, Inc., Oxford
Health Plans, Inc., PacifiCare Health Systems, Inc., Sierra Health Services,
Inc., UnitedHealth Group Incorporated and WellPoint Health Networks, Inc.
Cumulative total return calculations were provided by SNL Financial LC.
34
II. APPOINTMENT OF AUDITORS
The Audit Committee has appointed, and the Audit Committee and the Board
recommend shareholder approval of, KPMG LLP as the Company's independent
auditors for the current calendar year. Representatives of the firm are expected
to be available at the Annual Meeting to make a statement if the firm desires
and to respond to appropriate questions.
NONAUDIT SERVICES AND OTHER RELATIONSHIPS BETWEEN THE COMPANY AND THE
INDEPENDENT AUDITORS
The Company's practice is not to have its independent auditing firm provide
financial information systems design and implementation consulting services.
Instead, these services are provided by other accounting or consulting firms.
Other types of consulting services have been provided in the past by the
independent auditing firm or other accounting and consulting firms from time to
time. To the extent these other consulting services were provided in the past by
the Company's independent auditing firm, they were closely monitored and
controlled to ensure that the nature and extent of those services did not
interfere with the independence of the auditors, the level of nonaudit service
fees overall was monitored by the Audit Committee and engagements over a
specified size were approved by the Audit Committee. During 2002, the Audit
Committee took certain actions to further strengthen the independence of the
Company's independent auditors. First, effective February 2002, all new nonaudit
services provided by the independent auditing firm need to be approved in
advance by the Audit Committee regardless of the size of the engagement. Since
that date, no new nonaudit services have been rendered to the Company by the
independent auditors. Further, management may not hire as an employee a person
who within the last three years was an employee of the Company's independent
accountants and participated in the audit engagement of the Company's financial
statements if the Audit Committee determines that the hiring of such person
would impair the independence of the outside accountants. The independence of
the auditing firm also is considered annually by the Audit Committee and the
full Board of Directors.
FEES INCURRED FOR 2002 SERVICES PERFORMED BY THE INDEPENDENT AUDITORS
The tables below provide details of the fees paid to KPMG LLP by the Company for
services rendered in 2002. The first table is required under the current rules
and regulations of the SEC. The SEC has recently prospectively changed the
required format of this fee presentation. Although this new format is not
required at this time, the Company is providing information regarding fees paid
for 2002 services in the new format as supplemental information. Certain types
of fees are classified differently under the current and proposed fee formats.
For example, fees for certain audit-related services, such as statutory audits,
are shown as "All Other Fees" under the current rules, but shown as "Audit Fees"
under the new rules because generally only the independent auditors can provide
these services.
As shown in the tables below, audit and audit-related fees totaled approximately
79% of the aggregate fees paid to KPMG for 2002 services, and other fees made up
the remainder. Approximately two-thirds of these other fees paid to KPMG for
2002 services were for litigation support, primarily in connection with the
purported health care class action lawsuits filed against the Company. These
engagements were entered into with KPMG prior to 2002. At that time, the Company
considered using another firm for this work, but decided to engage KPMG based on
that firm's in-depth knowledge of the Company's systems, processes and controls.
The Company believed that KPMG's familiarity with its systems, class action
strategies and case knowledge put them in a position to perform this consulting
work in a more timely and cost-effective manner than another firm. In accordance
with Company policy in effect at the time, these engagements were approved by
the Audit Committee. Effective during 2002, the Company discontinued using KPMG
for these services.
35
--------------------------------------------------------------------------------
2002
----
AUDIT FEES(1) $3,021,125
----------
FINANCIAL INFORMATION SYSTEMS DESIGN AND IMPLEMENTATION FEES -0-
----------
ALL OTHER FEES:
Recurring:
Audit-Related Fees(2) 2,935,655
Non-Recurring:
Litigation Support Services(3) 1,086,570
Regulatory Support(4) 500,000
Other 26,000
----------
TOTAL ALL OTHER FEES 4,548,225
----------
TOTAL FEES $7,569,350
==========
--------------------------------------------------------------------------------
(1) Amount represents fees for the annual audit of the Company as of and for the
year ended December 31, 2002 and reviews of the Company's financial
statements for all interim periods in 2002.
(2) Amount represents fees for statutory and other separate audits performed on
financial statements of Aetna's subsidiaries, separate accounts, employee
benefit plans, and certain of the Company's other businesses and invested
assets. Also includes fees for agreed-upon procedures, control review
reports and services related to SEC registration statements.
(3) Amount represents fees for compilation and analysis of data in connection
with legal proceedings, primarily the purported health care class action
lawsuits filed against the Company.
(4) Amount represents fees for analysis of data in connection with a regulatory
requirement.
--------------------------------------------------------------------------------
2002
----
AUDIT FEES(1) $5,203,280
----------
AUDIT-RELATED FEES(2)
Internal Control Reviews 486,000
Employee Benefit Plan Audits 93,500
Attest Services Not Required by Statute or Regulation 200,000
----------
779,500
TAX FEES(3) --
ALL OTHER FEES(4)
Litigation Support Services(5) 1,086,570
Regulatory Support(6) 500,000
----------
1,586,570
TOTAL FEES $7,569,350
==========
--------------------------------------------------------------------------------
(1) Audit Fees include all services performed to comply with generally accepted
auditing standards, and services that generally only the independent
accountant can provide, such as comfort letters, statutory audits, attest
services, consents and assistance with and review of documents filed with
the SEC. For the Company, these fees include the audit of the Company,
quarterly reviews, statutory audits, real estate partnership and separate
account audits, and actuarial and attest services required by applicable
law.
(2) Audit-Related Fees are assurance and related services that traditionally are
performed by the independent auditor, and include, among other services,
employee benefit plan audits, internal control reviews, and attest services
that are not required by applicable law.
(3) Tax Fees would include all services performed by professional staff in the
independent accountant's tax division, except for those services related to
the audit.
(4) All Other Fees represent fees not included in any other category.
(5) Amount represents fees for compilation and analysis of data in connection
with legal proceedings, primarily the purported health care class action
lawsuits filed against the Company.
36
(6) Amount represents fees for analysis of data in connection with a regulatory
requirement.
THE AFFIRMATIVE VOTE OF A MAJORITY OF THE VOTES CAST IS REQUIRED FOR APPROVAL OF
THE APPOINTMENT OF KPMG LLP AS THE COMPANY'S INDEPENDENT AUDITORS FOR THE
CURRENT CALENDAR YEAR.
THE AUDIT COMMITTEE AND THE BOARD RECOMMEND A VOTE FOR THE APPROVAL OF KPMG LLP
AS THE COMPANY'S INDEPENDENT AUDITORS FOR THE CURRENT CALENDAR YEAR. IF YOU
COMPLETE THE ENCLOSED PROXY CARD, UNLESS YOU DIRECT TO THE CONTRARY ON THAT
CARD, THE SHARES REPRESENTED BY THAT PROXY CARD WILL BE VOTED FOR THE
APPOINTMENT OF KPMG LLP AS INDEPENDENT AUDITORS FOR THE CURRENT CALENDAR YEAR.
CORPORATE GOVERNANCE PROPOSALS
As announced in October 2002, the Board of Directors has approved, and
recommends that shareholders approve, amendments to the Company's Articles of
Incorporation and By-Laws to:
- Reduce the vote required for shareholders to approve mergers, consolidations
and similar transactions from two-thirds of the Company's outstanding voting
power to a simple majority of the Company's outstanding voting power;
- Grant the right to call a special meeting of shareholders to shareholders
representing two-thirds of the voting power of the Company's shares that are
entitled to vote on the matter to be considered at the special meeting; and
- Reduce the vote required for shareholders to amend or repeal certain
provisions of Aetna's By-Laws from 80% of the Company's outstanding voting
power to two-thirds of the Company's outstanding voting power.
The Board's proposed changes are intended to facilitate shareholder action in
various circumstances. Except for the proposed amendments described in
Appendices A, B and C, all other provisions of the Company's Articles of
Incorporation and By-laws will remain the same.
The specific amendments are separately detailed below. The three proposed
amendments are to be voted on separately and are not conditioned on one another.
III. AMENDMENT TO AETNA'S ARTICLES OF INCORPORATION REDUCING THE SHAREHOLDER
VOTING REQUIREMENTS FOR BUSINESS COMBINATIONS
The Board has approved and recommends shareholder approval of an amendment to
the Company's Articles of Incorporation reducing the required vote from
two-thirds to a majority of all the votes entitled to be cast to approve a
merger, consolidation, share exchange or division to which the Company is a
party or a sale of all or substantially all of the assets of the Company, or any
amendment to the provisions of the Company's Articles of Incorporation governing
the required votes for these transactions. The text of the proposed amendment is
attached to this Proxy Statement as Appendix A and is marked to show changes
from the Company's current Articles of Incorporation.
Under the Company's Articles of Incorporation as currently in effect, business
combination transactions such as mergers, share exchanges, divisions of the
Company and asset sales that require shareholder approval must receive an
affirmative vote of at least two-thirds of the votes that all voting
shareholders are entitled to cast. If you approve this amendment, approval of
these business combination transactions will be more likely because such
approval will require a majority vote of all votes entitled to be cast. On the
other hand, if this proposal is adopted, it will be more difficult for
shareholders to prevent business combinations that they oppose.
37
The Board urges each shareholder to read Appendix A carefully before voting on
this proposal. If the proposed amendment is approved by Aetna's shareholders, it
would become effective upon filing with the Secretary of the Commonwealth of
Pennsylvania.
The Board believes that it is appropriate for shareholders representing a
majority of the Company's outstanding voting power to have the ability to
approve mergers, consolidations and other business combination transactions.
THE AFFIRMATIVE VOTE OF AT LEAST TWO-THIRDS OF AETNA'S OUTSTANDING SHARES OF
COMMON STOCK IS REQUIRED FOR APPROVAL OF THE PROPOSED AMENDMENT TO ARTICLE 11 OF
AETNA'S ARTICLES OF INCORPORATION REDUCING SHAREHOLDER VOTING REQUIREMENTS FOR
BUSINESS COMBINATIONS.
THE BOARD RECOMMENDS A VOTE FOR THE PROPOSED AMENDMENT TO ARTICLE 11 OF AETNA'S
ARTICLES OF INCORPORATION REDUCING SHAREHOLDER VOTING REQUIREMENTS FOR BUSINESS
COMBINATIONS. IF YOU COMPLETE THE ENCLOSED PROXY CARD, UNLESS YOU DIRECT TO THE
CONTRARY ON THAT CARD, THE SHARES REPRESENTED BY THAT PROXY CARD WILL BE VOTED
FOR APPROVAL OF THE PROPOSED AMENDMENT REDUCING SHAREHOLDER VOTING REQUIREMENTS
FOR BUSINESS COMBINATIONS.
IV. AMENDMENT TO AETNA'S ARTICLES OF INCORPORATION PERMITTING SHAREHOLDERS TO
CALL SPECIAL MEETINGS OF SHAREHOLDERS
The Board has approved and recommends shareholder approval of an amendment to
the Company's Articles of Incorporation to permit shareholders entitled to cast
at least two-thirds of the votes that all voting shareholders are entitled to
cast on the matter to be considered at a special meeting to call the special
meeting. In addition, if this proposal is approved, the Board will amend the
Company's By-Laws to specify the procedures shareholders must follow to call
special meetings and make them generally consistent with the existing
requirements for annual meetings. The text of the proposed amendment to the
Articles of Incorporation and the amendment to the Company's By-Laws that the
Board will adopt is attached to this Proxy Statement as Appendix B and is marked
to show changes from the Company's current Articles of Incorporation and
By-Laws.
Under the Company's Articles of Incorporation and By-Laws as currently in
effect, special meetings of shareholders may be called only by (i) the Board of
Directors, (ii) the Chairman or (iii) the President of the Company. If you
approve the proposed amendment, shareholders entitled to cast at least
two-thirds of the votes that all voting shareholders are entitled to cast on the
matter to be considered at a special meeting also will have the right to call
the special meeting. One effect of this proposal may be to accelerate the
consideration of a change-in-control of the Company or other significant
transaction by shareholders.
The Board urges each shareholder to read Appendix B carefully before voting on
this proposal. If the proposed amendment is approved by Aetna's shareholders, it
would become effective upon filing with the Secretary of the Commonwealth of
Pennsylvania.
The Board believes that it is appropriate for shareholders to have the ability
to call special meetings and has determined that at least two-thirds of the
votes that are entitled to be cast on the matter to be considered at a special
meeting is an appropriate threshold in these circumstances to ensure that
shareholder-called special meetings are undertaken only where supported by a
substantial majority of shareholders. Under Pennsylvania law, if this proposal
is approved it will require a vote of at least two-thirds of the votes that are
entitled to be cast on an amendment to the Company's Articles of Incorporation
to change the number of votes shareholders need to call a special meeting or to
eliminate shareholders' right to call special meetings.
The Board also believes that, to ensure a fair and orderly process at special
meetings, the procedural requirements currently in effect with respect to annual
meetings should apply to special meetings. Accordingly, if shareholders approve
this proposal the Board will amend the Company's By-Laws as described in
Appendix B. Once the Board has made that amendment, it will require a vote of
two-thirds of the
38
votes that all voting shareholders, voting as a single class, are entitled to
cast (or 80% of the Company's outstanding shares if Proposal V is not approved)
for shareholders to revise those procedural requirements.
THE AFFIRMATIVE VOTE OF AT LEAST A MAJORITY OF THE VOTES CAST AT THE ANNUAL
MEETING IS REQUIRED FOR APPROVAL OF THE PROPOSED AMENDMENT TO AETNA'S ARTICLES
OF INCORPORATION TO PERMIT SHAREHOLDERS TO CALL SPECIAL MEETINGS.
THE BOARD RECOMMENDS A VOTE FOR THE PROPOSED AMENDMENT PERMITTING SHAREHOLDERS
TO CALL SPECIAL MEETINGS OF SHAREHOLDERS. IF YOU COMPLETE THE ENCLOSED PROXY
CARD, UNLESS YOU DIRECT TO THE CONTRARY ON THAT CARD, THE SHARES REPRESENTED BY
THAT PROXY CARD WILL BE VOTED FOR APPROVAL OF THE PROPOSED AMENDMENT PERMITTING
SHAREHOLDERS TO CALL SPECIAL MEETINGS.
V. AMENDMENT TO AETNA'S BY-LAWS REDUCING THE SHAREHOLDER VOTING REQUIREMENTS
FOR CERTAIN BY-LAW AMENDMENTS
The Board has approved and recommends shareholder approval of an amendment to
the Company's By-Laws reducing the required shareholder vote from 80% of the
outstanding shares entitled to vote to two-thirds of the votes that all voting
shareholders are entitled to cast at a meeting of shareholders to approve an
amendment to the Company's By-Laws (or a repeal of a By-Law or an adoption of a
new By-Law) with respect to certain matters. The text of the proposed amendment
to the Company's By-Laws is attached to this Proxy Statement as Appendix C and
is marked to show changes from the Company's current By-Laws.
Under the Company's By-Laws as currently in effect, the By-Laws may be amended
or repealed, or new by-laws may be adopted by (i) except as stated in the
following sentence, shareholders representing a majority of the Company's
outstanding voting power, or (ii) with respect to those matters that are not, by
statute, committed exclusively to shareholders, Directors representing a
majority of the Directors then in office. If action is being taken by a vote of
shareholders on certain provisions of Aetna's By-Laws, the affirmative vote of
80% of the Company's outstanding shares is required to change these provisions
of the By-Laws, such as the rules for conducting annual meetings and nominating
Directors, setting the number of Directors, filling vacancies on the Board of
Directors and calling and conducting special meetings of shareholders and the
Board. The Board generally has the power to amend the Company's By-Laws without
shareholder approval. If you approve the proposed amendment, the 80% vote of the
outstanding shares required to change the By-Laws as to such matters will be
reduced to a required vote of two-thirds of the Company's outstanding voting
power.
The Board urges each shareholder to read Appendix C carefully before voting on
this proposal. This proposal will make it easier for shareholders to amend
certain portions of the Company's By-Laws. The proposed amendment would become
effective immediately if it is approved by Aetna's shareholders.
The Board believes that it is appropriate to allow shareholders to make changes
to the Company's By-Laws, subject to the requirements of the Pennsylvania
Business Corporation Law, and has determined that a voting requirement of at
least two-thirds of the Company's outstanding voting power is appropriate in
these circumstances to ensure that any shareholder-initiated changes to the
By-Laws are undertaken only where supported by a substantial majority of
shareholders.
THE AFFIRMATIVE VOTE OF AT LEAST 80% OF AETNA'S OUTSTANDING SHARES OF COMMON
STOCK IS REQUIRED FOR APPROVAL OF THE PROPOSED AMENDMENT TO SECTION 5.02 OF
AETNA'S BY-LAWS REDUCING CERTAIN BY-LAW AMENDMENT VOTING REQUIREMENTS.
THE BOARD RECOMMENDS A VOTE FOR THE PROPOSED AMENDMENT REDUCING CERTAIN BY-LAW
AMENDMENT VOTING REQUIREMENTS. IF YOU COMPLETE THE ENCLOSED PROXY CARD, UNLESS
YOU DIRECT TO THE CONTRARY ON THAT CARD, THE SHARES REPRESENTED BY THAT PROXY
CARD WILL BE VOTED FOR APPROVAL OF THE PROPOSED AMENDMENT REDUCING CERTAIN
BY-LAW AMENDMENT VOTING REQUIREMENTS.
39
VI. SHAREHOLDER PROPOSAL TO IMPLEMENT CUMULATIVE VOTING IN THE ELECTION OF
DIRECTORS
Evelyn Y. Davis, Watergate Office Building, 2600 Virginia Ave. N.W., Suite 215,
Washington, D.C. 20037 (owner of 200 shares of Common Stock), has advised Aetna
that she plans to present the following proposal at the Annual Meeting. The
proposal is included in this Proxy Statement pursuant to the rules of the SEC.
"RESOLVED: That the stockholders of Aetna, assembled in Annual Meeting in person
and by proxy, hereby request the Board of Directors to take the necessary steps
to provide for cumulative voting in the election of directors, which means each
stockholder shall be entitled to as many votes as shall equal the number of
shares he or she owns multiplied by the number of directors to be elected, and
he or she may cast all of such votes for a single candidate, or any two or more
of them as he or she may see fit."
"REASONS: Many states have mandatory cumulative voting, so do National Banks."
"In addition, many corporations have adopted cumulative voting."
"Last year the owners of 46,405,138 shares, representing approximately 43% of
shares voting, voted FOR this proposal."
"If you AGREE, please mark your proxy FOR this resolution."
THE AFFIRMATIVE VOTE OF A MAJORITY OF THE VOTES CAST IS REQUIRED FOR APPROVAL OF
THE FOREGOING PROPOSAL.
THE BOARD OF DIRECTORS WILL OPPOSE THIS PROPOSAL IF IT IS INTRODUCED AT THE 2003
ANNUAL MEETING AND RECOMMENDS A VOTE AGAINST THIS PROPOSAL FOR THE FOLLOWING
REASONS:
The Board continues to believe that the present system of voting for Directors
provides the best assurance that the decisions of the Directors will be in the
interests of all shareholders, as opposed to the interests of special interest
groups.
Cumulative voting is one of those issues that may favor special interest groups.
Cumulative voting could make it possible for such a group to elect one or more
Directors beholden to the group's narrow interests. This could increase the
likelihood of factionalism and discord within the Board, which may undermine its
ability to work effectively as a governing body on behalf of the common
interests of all shareholders. The present system of voting utilized by the
Company and by most leading corporations prevents the "stacking" of votes behind
potentially partisan Directors. The present system thus promotes the election of
a more effective Board in which each Director represents the shareholders as a
whole.
The Board would not be able to implement cumulative voting upon adoption of this
proposal by the shareholders, because cumulative voting is prohibited by Aetna's
Articles of Incorporation. Under Pennsylvania law and Aetna's Articles of
Incorporation, an amendment to Aetna's Articles of Incorporation to delete this
provision would require shareholder approval at a subsequent shareholder
meeting, following adoption of a resolution by the Board approving the proposed
amendment.
The Board continues to believe that this proposal is not in the best interests
of Aetna or its shareholders.
IF YOU COMPLETE THE ENCLOSED PROXY CARD, UNLESS YOU DIRECT TO THE CONTRARY ON
THAT CARD, THE SHARES REPRESENTED BY THAT PROXY CARD WILL BE VOTED AGAINST THE
FOREGOING PROPOSAL.
40
ADDITIONAL INFORMATION
Contact Information
If you have questions or need more information about the Annual Meeting, write
to:
Office of the Corporate Secretary
Aetna Inc.
151 Farmington Avenue, RC4A
Hartford, CT 06156
or call us at (860) 273-3945.
For information about your record holdings or DirectSERVICE Investment Program
account, call EquiServe Trust Company, N.A. at 1-800-446-2617 or access your
account via the Internet at www.equiserve.com. We also invite you to visit
Aetna's Web site at www.aetna.com. Web site materials are not part of this proxy
solicitation.
Financial Statements
The year 2002 consolidated financial statements and auditor's report,
management's discussion and analysis of financial condition and results of
operations, information concerning quarterly financial data for the past two
fiscal years and other information are provided in the Aetna 2002 Annual Report,
Financial Report that is included in this booklet.
SEC Form 10-K
SHAREHOLDERS MAY OBTAIN A COPY OF AETNA'S ANNUAL REPORT TO THE SECURITIES AND
EXCHANGE COMMISSION ON FORM 10-K WITHOUT CHARGE BY CALLING 1-800-AESHARE
(1-800-237-4273) OR BY VISITING AETNA'S WEB SITE AT WWW.AETNA.COM.
By order of the Board of Directors,
/s/ WILLIAM J. CASAZZA
WILLIAM J. CASAZZA
VICE PRESIDENT AND CORPORATE SECRETARY
MARCH [14], 2002
41
APPENDIX A
AMENDMENT TO AETNA'S ARTICLES OF INCORPORATION REDUCING THE SHAREHOLDER VOTING
REQUIREMENTS FOR BUSINESS COMBINATIONS
The following sets forth the proposed amendment to Article 11 of the Company's
Amended and Restated Articles of Incorporation:
11. REQUIRED VOTE OF SHAREHOLDERS. (a) A consolidation, merger, share exchange
or division to which the Corporation is a party, or a sale of all or
substantially all of the assets of the Corporation, any of which is required to
be adopted by the shareholders, [an] or any amendment or repeal of this Article
11(a), or any new provision of these articles of incorporation that is
inconsistent with this Article 11(a) shall be adopted only upon receiving the
affirmative vote of at least a majority of the votes that all voting
shareholders, voting as a single class, are entitled to cast thereon and, in
addition, the affirmative vote of such number or proportion of shares of any
class or series of the Corporation, if any, as shall be required at the time by
the express terms of any such class or series of shares of the Corporation.
(b) Any amendment or repeal of Article 5, 6, 7, 10, 12 or 13 or this
Article 11(b), or any new provision of these articles of incorporation that is
inconsistent with this Article 11(b), or a dissolution of the Corporation shall
be adopted only upon receiving the affirmative vote of at least two-thirds of
the votes that all voting shareholders, voting as a single class, are entitled
to cast thereon and, in addition, the affirmative vote of such number or
proportion of shares of any class or series of the Corporation, if any, as shall
be required at the time by the express terms of any such class or series of
shares of the Corporation.
Please note: New language is underlined and deleted language is in [brackets and
struck through].
A-1
APPENDIX B
AMENDMENT TO AETNA'S ARTICLES OF INCORPORATION PERMITTING
SHAREHOLDERS TO CALL SPECIAL MEETINGS OF SHAREHOLDERS
The following sets forth the proposed amendment to Article 8 of the Company's
Amended and Restated Articles of Incorporation;
8. ACTION BY SHAREHOLDERS. Special Meetings of Shareholders may be called at
any time by shareholders entitled to cast at least two-thirds of the votes that
all voting shareholders, voting as a single class, are entitled to cast at the
particular Special Meeting. The procedure to be followed by shareholders in
calling a Special Meeting shall be as set forth in the Corporation's by-laws.
Shareholders shall not have the right to propose amendments to these articles of
incorporation. Shareholder action may only be taken at an Annual or Special
Meeting of Shareholders and not by written consent.
The following sets forth the changes to Section 1.04 of the Company's Amended
and Restated By-Laws that the Board of Directors will adopt if the above
proposed amendment to the Company's Articles of Incorporation is approved by
shareholders:
Section 1.04. SPECIAL MEETINGS.
(a) General Rule. Special meetings of shareholders may be called (i) by
the shareholders to the extent permitted by the Corporation's articles
of incorporation or (ii) at any time by the Board of Directors, the
Chairman or the President of the Corporation. Each special meeting of
shareholders shall be held at such place, within the Commonwealth of
Pennsylvania or elsewhere, as may be fixed from time to time by the
Board of Directors. If no place is so fixed for a special meeting of
shareholders, it shall be held at the Corporation's then principal
executive office. The only [substantive] business to be conducted at a
special meeting of shareholders shall be that set forth in the notice of
such meeting.
(b) Shareholder Petition. Shareholders entitled to cast the number of
votes specified in the Corporation's articles of incorporation may call
a special meeting of shareholders by delivery, either by personal
delivery or by United States mail, postage pre-paid, to the Corporate
Secretary of a written petition signed by each of such shareholders that
includes (i) a brief description of the business to be conducted at a
special meeting and the reasons for conducting the business at a special
meeting; (ii) the name and address of each shareholder who has signed
the petition; (iii) evidence of the class and number of shares of
capital stock of the Corporation that are beneficially owned by each
shareholder who has signed the petition; and (iv) any material interest
of any shareholder who has signed the petition in the business described
in the petition. It shall be the duty of the Corporate Secretary to fix
the date and time of any shareholder-called special meeting, which shall
be held not more than 120 days after the Corporate Secretary's receipt
of a petition that complies with this Section 1.04(b).
(c) Shareholder Proposals. The business to be conducted at a special
meeting must be lawful and appropriate for consideration at the meeting
and must be (i) set forth in the notice of special meeting at the
direction of the Board of Directors or (ii) specified in a petition that
complies with Section 1.04(b).
B-1
(d) Determination of Propriety of Business. Notwithstanding anything in
these by-laws to the contrary, no business shall be conducted at a
special meeting except in accordance with the procedures set forth in
this Section 1.04. The chairman of each special meeting shall determine
whether each item of business satisfies the requirements of Section
1.04(c). If the chairman of a special meeting shall determine that an
item of business does not satisfy the requirements of Section 1.04(c),
the chairman shall so declare to the special meeting, and any such
business shall not be transacted at the special meeting.
Please note: New language is underlined and deleted language is in [brackets and
struck through].
B-2
APPENDIX C
AMENDMENT TO AETNA'S BY-LAWS REDUCING THE SHAREHOLDER VOTING REQUIREMENTS FOR
CERTAIN BY-LAW AMENDMENTS
The following sets forth the proposed amendment to Section 5.02 of the Company's
Amended and Restated By-Laws:
Section 5.02. AMENDMENTS. These by-laws may be amended or repealed, or new
by-laws may be adopted, either (i) by an affirmative vote of the holders of a
majority of the voting power of shares entitled to vote thereon, voting as a
single class, at a meeting of the shareholders in the call for which written
notice of the proposed action shall have been given, or (ii) with respect to
those matters that are not by statute committed exclusively to the shareholders
and regardless of whether the shareholders have previously adopted or approved
the by-law being amended or repealed, by the affirmative vote of a majority of
the Directors then in office, upon written notice to each Director of the action
proposed to be taken. Notwithstanding the preceding sentence, Sections 1.02,
1.03, 1.04, 2.01, 2.02 and 2.06 and this Section 5.02 may be amended or repealed
or a new by-law adopted that is inconsistent with any of those sections by vote
of the shareholders only if the amendment, repeal or adoption of a new by-law is
approved by [an] the affirmative vote of at least two-thirds of the [holders of
not less than 80% of the outstanding shares entitled to vote]votes that all
voting shareholders, voting as a single class, are entitled to cast thereon,[
voting as a single class,] at a meeting of the shareholders in the call for
which written notice of the proposed action shall have been given. Any change in
these by-laws shall take effect when adopted unless otherwise provided in the
resolution effecting the change. No provision of these by-laws shall vest any
property right in any shareholder as such.
Please note: New language is underlined and deleted language is in [brackets and
struck through].
C-1
ANNEX 1
AETNA INC.
CORPORATE GOVERNANCE GUIDELINES
ROLE OF THE BOARD OF DIRECTORS
1. Management is responsible for the day-to-day business operations of
Aetna Inc. (the "Company"). The Board of Directors (the "Board") oversees
and guides the Company's management and its business. The basic
responsibility of the Board is to exercise its business judgment to act in
what it reasonably believes to be in the best interests of the Company and
its shareholders. Within this framework, the Board also considers the
Company's ethical behavior and may consider the interests of other
constituents, including the Company's customers, employees and the
communities in which it functions.
In discharging their obligations, Directors are entitled to rely on the
honesty and integrity of the Company's executives, and its outside advisors
and auditors. The Directors also shall be entitled to have the Company
purchase reasonable directors' and officers' liability insurance on their
behalf, to the benefits of indemnification to the fullest extent permitted
by law and the Company's Articles of Incorporation and By-Laws, and to
exculpation as provided by applicable state law and the Company's Articles
of Incorporation.
2. The Board provides oversight with respect to the strategic direction and
key policies of the Company. It approves major initiatives, advises on key
financial and business objectives, and monitors progress with respect to
these matters.
3. The Board, directly and through its Audit Committee, provides oversight
of the integrity of the financial statements of the Company; the
independent accountants' qualifications and independence; the performance
of the Company's internal audit function and independent accountants; and
the compliance by the Company with legal and regulatory requirements.
4. The Board selects and annually evaluates the performance of the Chief
Executive Officer. Directly and through its Committee on Compensation and
Organization (the "Compensation Committee"), the Board also collaborates
with the Chief Executive Officer in the selection of senior management. The
Compensation Committee, on behalf of the Board, evaluates and determines
the compensation of the Company's executive officers; oversees compensation
and benefits plans, policies and programs of the Company; administers the
equity-based incentive compensation plans of the Company; and considers
from time to time and, when appropriate, makes recommendations to the Board
as to the development and succession plans for the senior management of the
Company.
5. The Company's By-Laws provide that the Chairman shall be the Chief
Executive Officer, unless the Board vests this position in another officer.
The Board may determine to separate these positions based on what is deemed
to be in the Company's best interest at any given point in time.
COMPOSITION OF THE BOARD AND SELECTION OF DIRECTORS
6. The size and composition of the Board should be appropriate for
effective deliberation of issues relevant to the Company's businesses and
related interests. A substantial majority of the members of the Board shall
be, in the business judgment of the Board, "independent" under the rules of
the New York Stock Exchange, Inc.
7. The credentials of prospective director candidates are reviewed by the
Nominating and Corporate Governance Committee (the "Nominating Committee").
Nominees are selected through a process
1-1
based on criteria set with the concurrence of the full Board and
re-evaluated periodically. The criteria weighed in the Director selection
process include: the relevance of the candidate's experience to the
business of the Company; enhancing the diversity of the Board; the
candidate's independence from conflict or direct economic relationship with
the Company; and the ability of the candidate to attend Board meetings
regularly and devote an appropriate amount of effort in preparation for
those meetings. It also is expected that outside Directors nominated by the
Board shall be individuals who possess a reputation and hold positions or
affiliations befitting a director of a large publicly held company, and are
actively engaged in their occupations or professions or are otherwise
regularly involved in the business, professional or academic community.
Honorary Directors shall not be appointed.
All new Directors must participate in the Company's Director Orientation
Program. This orientation includes presentations by senior management to
familiarize new Directors with the Company's strategic plans, its
significant financial, accounting and risk management issues, its
compliance programs, its code of business conduct and ethics, its principal
officers, and its internal and independent auditors. In addition, each
Board Committee also provides new Committee members with appropriate
background information about the workings of the Committee. The Board
encourages, but does not require, formal Board continuing education.
8. The Nominating Committee annually reviews Director suitability and the
continuing composition of the Board; it then recommends Director nominees
who are voted on by the full Board. The Board believes that, if this
evaluation is well done, it obviates the need for term limits, which could
unnecessarily deprive the Company of experienced Directors. Until the
Annual Meeting of Shareholders in 2004, the Board shall be divided into
three Classes, and the terms of each class shall be classified so that only
one Class will be elected each year. At and after the Annual Meeting in
2004, each Director nominee shall stand for election by the shareholders
annually.
9. Any significant change in circumstances that may relate to a Director's
qualifications as a Director is considered in determining suitability for
continued directorship. In addition, an analysis of potential conflicts and
review by the Nominating Committee and the Board are conducted for any
proposed additional director affiliation with a for-profit enterprise or
for any proposed transaction involving the Company (or a subsidiary of the
Company) in which any Director would have a direct economic or beneficial
interest. Directors shall give the Chairman of the Nominating Committee
notice of any such significant change in circumstances, proposed additional
for-profit or charitable director affiliation or proposed transaction
involving the Company.
10. As a general matter, a retiring Chief Executive Officer (or other
officer Director) will resign from the Board at the time of his/her
retirement from the Company. Outside Directors resign no later than the
Annual Shareholders Meeting coincident with or immediately following their
72nd birthdays.
FUNCTIONING OF THE BOARD
11. The Board sets the annual schedule of Board and Committee meetings.
Committee schedules are recommended by each Committee in order to meet the
responsibilities of that Committee.
12. Board agendas are generally set by the Chairman with ample opportunity
for suggestions from other Directors.
13. The Board is provided, in advance of meetings, with agendas and written
background information and data with respect to Board/Committee agenda
items, as well as other general information relevant to the Company's
businesses. As needed, the Board also is provided with information between
meetings.
14. The Chairman of the Company presides at Board meetings. In the event
that the Chairman of the Company is unable to attend a meeting of the Board
of Directors, the most senior Director (in terms of current consecutive
years of Board service) present shall, at the request of the Chairman of
this Company or the Corporate Secretary of this Company, chair the meeting.
Members of senior
1-2
management are included in open sessions of Board and Committee meetings,
as appropriate. The Board meets regularly in executive session with only
Directors present. The nonmanagement Directors of the Company meet at
regularly scheduled full executive sessions, without management. The
Director who presides at these full executive sessions is rotated annually
among the Chairmen of the principal Committees of the Board. In addition,
the Compensation Committee and the Board meet annually in full executive
session, without management, to assess the performance of the Chief
Executive Officer and consider the Chief Executive Officer's compensation.
15. Board members have full access to Company management. In addition, the
Board or any of its Committees have the authority to retain counsel and
other independent experts or consultants, as they may deem necessary,
without consulting or obtaining the approval of any officer of the Company
in advance.
16. The Board conducts a self-evaluation annually to determine whether it
and its Committees are functioning effectively. This review is overseen by
the Nominating Committee.
17. As a general matter, the Board believes that management speaks for the
Company.
COMMITTEES OF THE BOARD
18. Committees support the role of the Board on issues that benefit from
consideration by a smaller, more focused subset of Directors. The Board
will have at all times an Audit Committee, a Compensation Committee and a
Nominating Committee. All of the members of these Committees will, in the
business judgment of the Board, be "independent" Directors under the rules
of the New York Stock Exchange and meet the standards of independence
required under applicable law. The Board also has established an Investment
Committee to assist the Board in reviewing investment policies, strategies,
transactions, and performance of the Company and its subsidiaries. The
Board also has established an Executive Committee, which may act on behalf
of the full Board between regularly scheduled Board meetings, usually when
timing is critical. The Board may form other Committees from time to time
to deal with special issues. One or more Board members also serve on the
Board of the Aetna Foundation to oversee and coordinate the Company's
charitable giving programs.
19. The roles of the Committees are defined by the Company's By-Laws and by
Committee charters adopted by the Board.
20. At least annually, the Nominating Committee, in consultation with the
Chairman and the Chief Executive Officer, reviews Committee assignments
(members and chairs). In considering a Director for Committee membership,
the Committee takes into consideration any factors it deems appropriate,
including without limitation, the Director's experience and background, and
its relevance to the goals and responsibilities of the Committee and the
Director's Committee preferences. The Committee then makes Committee
assignment recommendations on which the full Board votes. It is the sense
of the Board that consideration should be given to rotating Committee
members and Committee chairs periodically, but the Board does not believe
that rotation should be mandated as a policy because the Board believes
that there are significant benefits attributable to the continuity and
experience gained in service on a particular Committee over time.
21. Committee agendas are set by the respective Committee chairs in
consultation with management and other Committee members. Committee chairs
report on each Committee meeting at the Board meeting following the
Committee meeting. Minutes of Committee meetings also are provided to each
Director. Each Committee chairman convenes, as appropriate, executive
sessions of outside Directors of the Committee to discuss its operations
and other related matters.
22. In the absence of a Committee chair, the most senior Committee member
(in terms of Committee service) chairs the Committee meeting.
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COMPENSATION OF DIRECTORS
23. At least annually, the Nominating Committee reviews competitive
compensation survey information, and considers the appropriateness of the
form and amount of Director compensation with a view toward attracting and
retaining qualified Directors.
24. The Nominating Committee, with the concurrence of the full Board, has
directed that a significant portion of Director compensation be delivered
in stock-based forms. In addition, a deferred compensation plan also allows
individual Directors voluntarily to defer cash compensation into deferred
stock units. The Board of Directors also has adopted Stock Ownership
Guidelines.
CONDUCT AND ETHICS STANDARDS FOR DIRECTORS
25. Directors are subject to applicable provisions of the Company's Code of
Conduct. Among other things, Directors must conduct themselves in a manner
that avoids actual or apparent conflicts of interest and that protects the
Company's business reputation. A conflict of interest occurs when a
Director's private interest interferes in any way -- or even appears to
interfere -- with the interest of the Company. Except as authorized by the
Board of Directors, no outside Director shall have a direct economic
relationship with the Company. Company loans to, or guarantees of
obligations of, Directors and their family members are prohibited.
26. Directors owe a duty to the Company to advance its legitimate interests
when the opportunity to do so arises. Accordingly, Directors are prohibited
from taking for themselves personally business opportunities that are
discovered through the use of Company property, information or position.
27. Directors, in the course of their Company duties, must comply fully
with all federal and state laws applicable to the Company's businesses, and
with applicable Company policies (including policies relating to use of
confidential information and insider trading).
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ANNEX 2
AETNA INC.
INDEPENDENCE STANDARDS FOR DIRECTORS
To be considered independent under the proposed New York Stock Exchange, Inc.
("NYSE") rules, the Board must determine that a Director does not have any
direct or indirect material relationship with Aetna. The Board has established
the following guidelines to assist it in determining Director independence in
accordance with that proposed rule:
(a) A Director will not be independent if, within the preceding five years:
(i) the Director was employed by Aetna; (ii) an immediate family member of
the Director was employed by Aetna as an officer; (iii) the Director was
employed by or affiliated with Aetna's independent auditor; (iv) an
immediate family member of the Director was employed by Aetna's independent
auditor as a partner, principal or manager; or (v) an Aetna executive
officer was on the compensation committee of the board of directors of a
company that concurrently employed the Aetna Director or employed an
immediate family member of the Director as an officer.
(b) The following commercial or charitable relationships will not be
considered to be material relationships that would impair a Director's
independence: (i) if an Aetna Director is an executive officer of another
company that does business with Aetna and the annual sales to, or purchases
from, Aetna are less than five percent of the annual revenues of the
company he or she serves as an executive officer; (ii) if an Aetna Director
is an executive officer of another company that is indebted to Aetna, or to
which Aetna is indebted, and the total amount of either company's
indebtedness to the other is less than five percent of the total
consolidated assets of the company he or she serves as an executive
officer; (iii) if an Aetna Director is an executive officer of another
company in which Aetna owns a common stock interest, and the amount of the
common stock interest is less than five percent of the total shareholders
equity of the company he or she serves as an executive officer; and (iv) if
an Aetna Director serves as an officer, director or trustee of a charitable
organization, and Aetna's discretionary charitable contributions to the
organization are less than five percent of that organization's total annual
charitable receipts. (Aetna's automatic matching of employee charitable
contributions will not be included in the amount of Aetna's contributions
for this purpose.) Also, a commercial relationship in which a Director is
an executive officer of another company that owns a common stock interest
in Aetna will not be considered to be a material relationship which would
impair a Director's independence. The Board will annually review commercial
and charitable relationships of Directors.
(c) For relationships not covered by the guidelines in (b) above, the
determinations of whether the relationship is material or not, and
therefore whether the Director would be independent or not, shall be made
by the Directors who satisfy the independence guidelines set forth in (a)
and (b) above. For example, if a Director is the executive officer of a
company that sells products and services to Aetna that are more than five
percent of that company's annual revenues, the independent Directors could
determine, after considering all of the relevant circumstances, whether
such a relationship was material or immaterial, and whether the Director
would therefore be considered independent under the proposed NYSE rules.
Aetna would explain in its proxy statement the basis for any Board
determination that a relationship was immaterial, despite the fact that it
did not meet the categorical standards of immateriality set forth in
subsection (b) above.
In addition, members of certain Board Committees, such as the Audit Committee,
are subject to heightened standards of independence under various rules and
regulations.
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ANNEX 3
AETNA INC.
AUDIT COMMITTEE CHARTER
PURPOSE OF COMMITTEE
The primary purpose of the Audit Committee (the "Committee") of the Board of
Directors (the "Board") of Aetna Inc. (the "Company") is to assist the Board in
its oversight of (1) the integrity of the financial statements of the Company;
(2) the independent accountants' qualifications and independence, (3) the
performance of the Company's internal audit function and independent
accountants, and (4) the compliance by the Company with legal and regulatory
requirements. The Committee shall also prepare the report required by the rules
of the Securities and Exchange Commission ("SEC") to be included in the
Company's annual proxy statement.
The Committee shall provide a forum for private and direct communications
between Committee members and the Company's independent accountants, Internal
Audit Department and senior financial management. The Committee shall serve as a
channel of communication to the Board for the Company's independent accountants
and Internal Audit Department. The Committee also shall, upon request, provide
prompt access for the independent accountants and Internal Audit Department to
meet directly with the Board. In addition, the Committee will establish
procedures to receive, retain and treat complaints received by the Company
regarding accounting, internal accounting controls or auditing matters, and for
the confidential, anonymous submission by Company employees of concerns
regarding questionable accounting or auditing matters.
The function of the Audit Committee is oversight. The management of the Company
is responsible for the preparation, presentation and integrity of the Company's
financial statements. Management and the Internal Audit Department are
responsible for maintaining appropriate accounting and financial reporting
principles and policies and internal controls and procedures designed to assure
compliance with accounting standards and applicable laws and regulations. The
independent accountants are responsible for planning and carrying out proper
annual audits and quarterly reviews of the Company's financial statements. In
fulfilling their responsibilities hereunder, it is recognized that members of
the Committee are not full-time employees of the Company and, as such, it is not
the duty or responsibility of the Committee or its members to conduct auditing
or accounting reviews or procedures. Each member of the Committee shall be
entitled to rely on information, opinions, reports or statements, including
financial statements and other financial data prepared or presented by officers
or employees of the Company, legal counsel, independent accountants or other
persons with professional or expert competence.
COMMITTEE MEMBERSHIP
The Committee shall be composed of at least three Directors, who shall satisfy
the applicable independence, experience and other membership requirements under
the rules of the New York Stock Exchange, Inc. (the "NYSE"), as such
requirements are interpreted by the Board in its business judgment, and under
applicable law.
All new Committee members also participate in an Audit Committee Orientation
Program where they are provided with appropriate background information about
the Company and the workings of the Committee.
The members of the Committee shall be appointed annually and may be replaced by
the Board.
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COMMITTEE STRUCTURE AND OPERATIONS
The Board shall designate one member of the Committee as its Chairman. The
Committee shall meet as often as necessary to carry out its responsibilities
under this Charter, but at least five times a year. The Committee shall make
regular reports to the Board.
The Committee is empowered, to the extent it deems necessary or appropriate, to
retain outside legal, accounting or other advisers having special competence as
necessary to assist it in fulfilling its responsibilities and duties.
COMMITTEE AUTHORITY AND RESPONSIBILITIES
The Committee is directly responsible for the appointment, compensation and
oversight of the work of the independent accountants, including the resolution
of any disagreements between management and the independent accountants
regarding financial reporting. The independent accountants will report directly
to the Committee.
The Committee is authorized to perform each of the specific duties set forth
herein and any other duties it considers necessary or advisable to carry out its
purpose, responsibilities and its specific duties. To the extent relevant to
carrying out its purpose, responsibilities and duties, the Committee is
empowered to recommend that any activity of the Company be investigated and, in
appropriate circumstances, the Committee is empowered to investigate any
activity of the Company.
The Committee Chairman sets the meeting agendas in consultation with management
and other Committee members. Among other things, an assessment of potential
risks of the Company conducted by management, the independent accountants and
the Internal Audit Department is taken into account in setting the Committee's
agendas.
SPECIFIC DUTIES
In discharging its responsibilities, the Committee shall perform the following
duties, as well as any other additional duties as may be required by NYSE rule
or applicable law:
Relationship with Independent Accountants
a. The Committee will annually review the qualifications, performance and
independence of the independent accountants. The Committee's evaluation
shall also include the review and evaluation of the lead partner of the
independent accountants. In conducting this review, the Committee shall
obtain and review a report from the independent accountants regarding (a)
the independent accountants' internal quality-control procedures, (b) any
material issues raised by the most recent internal quality-control review,
or peer review, of the firm, or by any inquiry or investigation by
governmental or professional authorities within the preceding five years
respecting one or more independent audits carried out by the firm, and any
steps taken to deal with any such issues, (c) any significant litigation
against the firm, and (d) all relationships between the independent
accountants and the Company. The Committee will actively engage in a
dialogue with the independent accountants with respect to any disclosed
relationships or services that may impact the objectivity and independence
of the independent accountants. The Committee shall discuss with the
independent accountants the rotation of the lead audit partner or other
members of the independent accountants' audit team. The Committee
periodically shall consider whether it is appropriate to rotate the
independent accountants. The Committee will also confer with management and
the internal auditors in reviewing the qualifications, performance and
independence of the independent accountants. The Committee shall present
its conclusions to the Board.
b. The Committee shall approve all audit engagement fees and terms and all
non-audit engagements with the independent accountants. The Chairman of the
Committee may approve any proposed non-
3-2
audit engagements that arise between Committee meetings, provided that any
such decision is presented to the full Committee at its next scheduled
meeting.
c. Meet in private session with the independent accountants at each
regularly scheduled in-person meeting of the Committee.
d. Review with the independent accountants the planning, staffing and scope
of their examination with emphasis on accounting and financial areas where
the Committee, management or the accountants believe special attention
should be directed.
e. Review with the independent accountants:
1. results of their audit, including their opinion on the financial
statements,
2. their consideration of the internal control structure and their
evaluation regarding the adequacy of those controls over the financial
reporting process, including computer controls and security, as well as
special audit steps, if any, adopted in light of material control
issues,
3. alternative GAAP methods discussed with management, ramifications of
alternative disclosures and treatment preferred by the independent
accountants,
4. critical accounting policies and practices,
5. any audit problems or difficulties and management's response,
including
- accounting adjustments noted or proposed by the independent
accountants but not recorded,
- issues discussed with the independent accountants' national office,
- any management or internal control letter issued or proposed by the
independent accountants to the Company,
- significant disagreements, if any, with management,
- cooperation received from management in the conduct of the audit,
- time constraints on the independent accountants, and
- any restrictions on the scope of activities or on access to requested
information,
6. any other material written communication between the independent
accountants and management, and
7. other matters related to the conduct of the annual audit or the
review of quarterly financial results required to be communicated to the
Committee under applicable law, auditing standards or other professional
accounting standards.
Relationship with Internal Audit Department
a. Review and consult with management in management's appointment,
replacement, reassignment and dismissal of the Director of Internal Audit.
b. Meet in private session with the Director of Internal Audit at each
regularly scheduled in-person meeting of the Committee.
c. Review the Internal Audit Department's objectives, resources and
effectiveness, its organizational position, objectivity and status within
the Company, and its annual audit plan, including its coordination with the
examination performed by the independent accountants.
d. Review the results of the Internal Audit activities for the year. Review
their consideration of the internal control structure and their evaluation
regarding the adequacy of those controls over the financial reporting
process, including computer controls and security.
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e. Review periodically the Internal Audit Department's written Charter and
inquire whether the Department is in compliance with relevant professional
standards.
Relationship with Management
a. Meet in private session with management at each regularly scheduled
in-person meeting of the Committee.
b. Review their consideration of the internal control structure and their
evaluation regarding the adequacy of those controls over the financial
reporting process, including computer controls and security. Review and
discuss management's annual report required by applicable law with respect
to the Company's internal controls, and the process by which the report is
produced.
c. Before publication, review and discuss with management and the
independent accountants the annual financial statements and quarterly
financial statements, related footnotes and related disclosures, including
the accompanying management's discussion and analysis of financial
condition and results of operations. Review and discuss the Chief Executive
Officer's and Chief Financial Officer's quarterly certification required by
applicable law with respect to the Company's financial statements and
reports and other matters filed with the SEC, as well as management's
annual certification required by NYSE rule with respect to compliance with
listing standards, and the process by which these certifications are
produced. Discuss earnings press releases, including the use of "pro forma"
or "adjusted" non-GAAP information, as well as financial information and
earnings guidance provided to analysts and rating agencies.
d. Discuss all critical accounting policies and practices, and any
significant changes in selection or application of accounting principles
proposed by management.
e. Discuss significant accounting accruals, reserves or other estimates
made by management, including reviewing the actuarial reports concerning
the annual actuarial opinions.
f. Discuss any other analyses prepared by management and/or the independent
accountants setting forth significant financial reporting issues and
judgments made in connection with the preparation of the financial
statements, including analyses of the effects of alternative GAAP methods
on the financial statements.
g. Discuss the significant accounting, reporting, regulatory and other
developments affecting the Company's annual and quarterly financial
statements, related footnotes and related disclosures.
h. Review the effect of any off-balance sheet structures on the Company's
annual and quarterly financial statements, related footnotes and related
disclosures.
i. Inquire whether a second opinion regarding a significant accounting
matter had been sought and, if so, discuss the accounting method selected.
j. Review management letter comments received and management's response
to/implementation of those comments.
k. Periodically review with the General Counsel significant litigation and
regulatory matters involving the Company and review with the General
Counsel and independent accountants related disclosures made in the annual
financial statements and related footnotes.
Other
a. Discuss periodically management's policies with respect to risk
assessment and risk management, and discuss periodically with the
independent accountants, management and Internal Audit Department
significant financial risk exposures and the steps management has taken to
monitor, control and report such exposures.
3-4
b. Consider whether there are any emerging issues which the Committee
should become involved with in the future.
c. Review transactions or courses of dealing with parties related to the
Company which are significant in size or involve terms or other aspects
that differ from those that would likely be negotiated with independent
parties and that are relevant to an understanding of the Company's
financial statements.
d. Discuss periodically with management the program that management
establishes to monitor compliance with the Company's code of conduct and
laws and regulations.
e. Meet in executive session at each regularly scheduled in-person meeting
of the Committee.
f. Establish Company policies for the hiring of employees or former
employees of the independent accountants.
g. Review and reassess the adequacy of this Charter annually and recommend
any proposed changes to the Board for approval.
h. Evaluate the Committee's performance annually.
i. Perform any other responsibilities delegated to the Committee by the
Board from time to time.
3-5
ANNEX 4
AETNA INC.
COMMITTEE ON COMPENSATION AND ORGANIZATION CHARTER
PURPOSE OF COMMITTEE
The primary purpose of the Committee on Compensation and Organization (the
"Committee") of the Board of Directors (the "Board") of Aetna Inc. (the
"Company") is to discharge the Board's responsibilities relating to compensation
of the Company's executives. In doing so, the Committee shall:
1. evaluate and determine the compensation of the Company's executive
officers and such other key executives or executive positions as identified
by the Committee;
2. oversee compensation and benefits plans, policies and programs of the
Company;
3. administer the equity-based incentive compensation plans of the Company
and the Company's Section 162m Annual Incentive Plan; and
4. consider from time to time and, when appropriate, make recommendations
to the Board as to the development and succession plans for the senior
management of the Company.
The Committee shall prepare an annual report on executive compensation for
inclusion in the Company's Proxy Statement in accordance with applicable rules
and regulations.
COMMITTEE MEMBERSHIP
The Committee shall be composed solely of at least three members of the Board,
each of whom is, in the business judgment of the Board, "independent" under the
rules of the New York Stock Exchange, Inc.
The members of the Committee shall be appointed annually and replaced by the
Board.
COMMITTEE STRUCTURE AND OPERATIONS
The Board shall designate one member of the Committee as its chairperson. The
Committee shall meet as often as necessary to carry out its responsibilities
under this Charter, but at least three times a year. The Committee shall make
regular reports to the Board. Except for grants and awards to executive
officers, the Committee may, in its discretion, delegate all or a portion of its
duties and responsibilities to a subcommittee of the Committee.
The Committee shall have the resources and authority appropriate to discharge
its responsibilities, including the authority to retain counsel and other
experts or consultants. Further, the Committee shall have the sole authority to
select, retain and terminate any compensation consultant to be used to assist
the Committee in the evaluation of Chief Executive Officer ("CEO") and senior
executive compensation, and shall have sole authority to approve the
consultant's fees and other retention terms.
COMMITTEE RESPONSIBILITIES AND AUTHORITY
The following are the goals and responsibilities of the Committee:
1. To annually review and approve corporate goals and objectives relevant
to CEO and other executive officer compensation, evaluate their performance
in light of those goals and objectives, and establish their compensation
levels based on this evaluation. In determining the long-term incentive
component of CEO and other executive officer compensation, the Committee
will consider the Company's performance, the value of similar incentive
awards to CEOs and other executive officers at comparable
4-1
companies, and the awards given to the CEO and other executive officers in
past years. The Committee also shall take into account the need to attract
and retain high-performing executives. The Company's CEO should not attend
any portion of a meeting where the CEO's performance or compensation are
discussed, unless specifically invited by the Committee.
2. To review and approve, for the CEO and the executive officers of the
Company, (a) the annual base salary level, (b) the annual incentive
opportunity level, (c) the long-term incentive level, (d) employment
agreements, severance arrangements, and change-in-control
agreements/provisions, in each case as, when and if appropriate, and (e)
any special or supplemental benefits, arrangements or agreements, including
perquisites.
3. To develop principles and process for selection of CEO and key
executives, including succession in the event of an emergency or
retirement, for consideration by the Board, and to oversee the creation of
development plans for such executives.
4. To review and recommend to the Board proposed business affiliations of
executive officers of the Company.
5. To review and reassess the adequacy of this Charter annually and
recommend any proposed changes to the Board for approval.
6. To evaluate its own performance annually.
7. To perform any other responsibilities delegated to the Committee by the
Board from time to time.
4-2
ANNEX 5
AETNA INC.
EXECUTIVE COMMITTEE CHARTER
PURPOSE OF COMMITTEE
The primary purpose of the Executive Committee (the "Committee") of the Board of
Directors (the "Board") of Aetna Inc. (the "Company") is to act on behalf of the
full Board between regularly scheduled Board meetings, usually when timing is
critical. The Committee has and may exercise all of the powers and authority of
the Board, subject to such limitations as the Board and/or applicable law may
from time to time impose.
COMMITTEE MEMBERSHIP
The Committee shall be composed of at least three members of the Board,
including the Chairman of the Board (the "Chairman").
The members of the Committee shall be appointed annually and replaced by the
Board.
COMMITTEE STRUCTURE AND OPERATIONS
The Chairman shall be the chairperson of the Committee. The Committee shall meet
at the call of the Chairman. The Committee shall report its actions to the
Board.
The Committee shall have the resources and authority appropriate to discharge
its responsibilities, including the authority to retain counsel and other
experts or consultants.
5-1
ANNEX 6
AETNA INC.
INVESTMENT COMMITTEE CHARTER
PURPOSE OF COMMITTEE
The primary purpose of the Investment Committee (the "Committee") of the Board
of Directors (the "Board") of Aetna Inc. (the "Company") is to assist the Board
in reviewing investment policies, strategies, transactions, and performance of
the Company and its subsidiaries.
COMMITTEE MEMBERSHIP
The Committee shall be composed of at least three members of the Board.
The members of the Committee shall be appointed annually and replaced by the
Board.
COMMITTEE STRUCTURE AND OPERATIONS
The Board shall designate one member of the Committee as its chairperson. The
Committee shall meet at least three times a year. The Committee shall make
regular reports to the Board. The Committee may, in its discretion, delegate all
or a portion of its duties and responsibilities to a subcommittee of the
Committee.
The Committee shall have the resources and authority appropriate to discharge
its responsibilities, including the authority to retain counsel and other
experts or consultants.
COMMITTEE GOALS AND RESPONSIBILITIES
The following are the goals and responsibilities of the Committee:
1. To review the investment policies, strategies, and programs of the
Company and its subsidiaries.
2. To direct the sale of securities and other property of the Company,
except real property owned and occupied by the Company for the conduct of
its business, as it may deem best.
3. To direct the investment of the funds of the Company (including the
incurrence of indebtedness and other liabilities in connection therewith)
in such amounts and in such securities or other property as the Committee
shall consider for the best interest of the Company.
4. To delegate authority to management to execute individual investment
transactions on behalf of the Company within policies and limits approved
by the Committee.
5. To review investment transactions made on behalf of the Company and its
subsidiaries, whether pursuant to standing authority granted by the board
of directors of each legal entity, or pursuant to specific authority for
transactions that exceed authority delegated to management.
6. To review the performance of the investment portfolios of the Company
and its subsidiaries.
7. To review and reassess the adequacy of this Charter annually and
recommend any proposed changes to the Board for approval.
8. To evaluate its own performance annually.
9. To perform any other responsibilities delegated to the Committee by the
Board from time to time.
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ANNEX 7
AETNA INC.
MEDICAL AFFAIRS COMMITTEE CHARTER
PURPOSE OF COMMITTEE
The primary purpose of the Medical Affairs Committee (the "Committee") of Aetna
Inc. (the "Company") is to assist the Company's Board of Directors (the "Board")
in the general oversight of Company policies and practices that relate to
providing members with access to cost-effective quality health care.
COMMITTEE MEMBERSHIP
The Committee shall be composed of the Chairman of the Board and at least two
additional outside members of the Board. The members of the Committee shall be
appointed annually and replaced by the Board.
The Company's Chief Medical Officer shall support the Committee in identifying
the issues and policies to be reviewed by the Committee, and in coordinating
presentations and the distribution of information to the Committee.
COMMITTEE STRUCTURE AND OPERATIONS
The Board shall designate one member of the Committee as its chairperson. The
Committee shall meet as often as necessary to carry out its responsibilities
under this Charter, but at least three times a year. The Committee shall make
regular reports to the Board. The Committee may, in its discretion, delegate all
or a portion of its duties and responsibilities to a subcommittee of the
Committee.
The Committee shall have the resources and authority appropriate to discharge
its responsibilities, including the authority to retain counsel and other
experts or consultants.
COMMITTEE GOALS AND RESPONSIBILITIES
Among the Committee's goals and responsibilities are the following:
1. To review significant Company strategies and initiatives relating to the
objective of promoting access to cost-effective quality health care and to
consider the impact of those strategies and initiatives on members and
participating physicians, hospitals and other health care providers.
2. To review Company strategies that have been designed to enhance the
effectiveness of the Company's interaction with physicians and which
thereby assist in the promotion of access to quality health care for
members.
3. To review the scope and effectiveness of the Company's disease
management and case management programs.
4. To oversee the Company's development of an integrated medical management
model that utilizes medical, pharmacy, laboratory and behavioral/mental
health data to assist in the promotion of appropriate health care to
members.
5. To review Company initiatives designed to address socioeconomic, racial
and ethnic disparities in health care.
6. To review and reassess the adequacy of this Charter annually and to
recommend any proposed changes to the Board for approval.
7. To evaluate its own performance annually.
8. To perform any other responsibilities delegated to the Committee by the
Board from time to time.
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ANNEX 8
AETNA INC.
NOMINATING AND CORPORATE GOVERNANCE
COMMITTEE CHARTER
PURPOSE OF COMMITTEE
The primary purpose of the Nominating and Corporate Governance Committee (the
"Committee") of the Board of Directors (the "Board") of Aetna Inc. (the
"Company") is to assist the Board in identifying and recommending individuals to
the Board for nomination as members of the Board and its committees, and in
developing and recommending to the Board corporate governance principles
applicable to the Company.
COMMITTEE MEMBERSHIP
The Committee shall be composed solely of at least three members of the Board,
each of whom is, in the business judgment of the Board, "independent" under the
rules of the New York Stock Exchange, Inc.
The members of the Committee shall be appointed annually and replaced by the
Board.
COMMITTEE STRUCTURE AND OPERATIONS
The Board shall designate one member of the Committee as its chairperson. The
Committee shall meet as often as necessary to carry out its responsibilities
under this Charter, but at least three times a year. The Committee shall make
regular reports to the Board. The Committee may, in its discretion, delegate all
or a portion of its duties and responsibilities to a subcommittee of the
Committee.
The Committee shall have the resources and authority appropriate to discharge
its responsibilities, including the authority to retain counsel and other
experts or consultants. Further, the Committee shall have the sole authority to
select, retain and terminate any search firm to be used to identify Director
candidates and to approve the search firm's fees and other retention terms.
COMMITTEE GOALS AND RESPONSIBILITIES
The following are the goals and responsibilities of the Committee:
1. To identify candidates believed to be qualified to become Board members,
and to recommend to the Board the nominees to stand for election as
Directors of the Company at the annual meeting of shareholders. In
nominating candidates, the Committee shall take into consideration the
criteria set with the concurrence of the full Board and re-evaluated
periodically. The criteria weighed in the Director selection process
include:
the relevance of the candidate's experience to the business of the Company;
enhancing the diversity of the Board; the candidate's independence from conflict
or direct economic relationship with the Company; and the ability of the
candidate to attend Board meetings regularly and devote an appropriate amount of
effort in preparation for those meetings. It also is expected that outside
Directors nominated by the Board shall be individuals who possess a reputation
and hold positions or affiliations befitting a director of a large publicly held
company, and are actively engaged in their occupations or professions or are
otherwise regularly involved in the business, professional or academic
community. Honorary Directors shall not be appointed.
2. To recommend to the Board the structure, composition and functions of
the committees of the Board and to identify, in consultation with the
Chairman and Chief Executive Officer of the Company, Board members
qualified to become members of the committees of the Board (including this
Committee). In
8-1
nominating a Director for committee membership, the Committee shall take
into consideration any factors it deems appropriate, including without
limitation, the Director's experience and background, and its relevance to
the goals and responsibilities of the committee and the Director's
committee preferences.
3. To develop and recommend to the Board corporate governance principles
applicable to the Company, and to review those principles periodically.
4. To review the compensation of, and benefits for, Directors; the
retirement policy for Directors; any waiver and interpretation of the code
of business conduct and ethics applicable to Directors; and potential
conflicts of interest or other issues arising as a result of other
positions held or proposed to be held by, or any change in circumstances
of, a Director.
5. To oversee the annual evaluation of the Board.
6. To review and reassess the adequacy of this Charter annually and
recommend any proposed changes to the Board for approval.
7. To evaluate its own performance annually.
8. To perform any other responsibilities delegated to the Committee by the
Board from time to time.
8-2
Aetna
2002 Annual Report,
Financial Report
AETNA ANNUAL REPORT,
FINANCIAL REPORT 2002
--------------------------------------------------------------------------------
Management's Discussion and Analysis........................
Overview.................................................... 1
Health Care................................................. 3
Group Insurance............................................. 9
Large Case Pensions......................................... 12
Corporate Interest.......................................... 17
Severance and Facilities Charges............................ 18
Results of Discontinued Operations.......................... 20
Total Investments........................................... 21
Liquidity and Capital Resources............................. 26
Critical Accounting Policies................................ 30
Goodwill and Other Acquired Intangible Assets............... 33
New Accounting Standards.................................... 34
Regulatory Environment...................................... 34
Forward-Looking Information/Risk Factors.................... 41
Selected Financial Data..................................... 47
Consolidated Financial Statements........................... 48
Notes to Consolidated Financial Statements.................. 52
Management's Responsibility for Financial Statements........ 105
Independent Auditors' Report................................ 106
Quarterly Data.............................................. 107
Board of Directors and Management........................... 108
Shareholder Information..................................... 109
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 as of December 31, 2002 and 2001, and its results of operations for
2002, 2001 and 2000. This Management's Discussion and Analysis should be read in
its entirety, since it contains detailed information that is important to
understanding Aetna Inc. and its subsidiaries' results and financial condition.
The information herein is as of February 26, 2003.
OVERVIEW
GENERAL
The consolidated financial statements include Aetna Inc. (a Pennsylvania
corporation) ("Aetna") and its subsidiaries (collectively, the "Company"). The
Company's operations include three business segments: Health Care, Group
Insurance and Large Case Pensions. Health Care consists of health and dental
plans offered on both a risk basis (where the Company assumes all or a majority
of the risk for health and dental care costs) ("Risk") and an employer-funded
basis (where the plan sponsor under an administrative service contract, and not
the Company, assumes all or a majority of this risk) ("ASC"). Health plans
include health maintenance organization ("HMO"), point-of-service ("POS"),
preferred provider organization ("PPO") and indemnity benefit products
("Indemnity"). The Group Insurance segment includes group life insurance
products offered on a risk basis, as well as group disability and long-term care
insurance products offered on both a risk and an employer-funded basis. Large
Case Pensions manages a variety of retirement products (including pension and
annuity products) primarily for defined benefit and defined contribution plans.
These products provide a variety of funding and benefit payment distribution
options and other services. The Large Case Pensions segment includes certain
discontinued products.
TURNAROUND INITIATIVES
During 2002, the Company continued to implement strategic and operational
initiatives aimed at improving the performance of its business. These
initiatives included, among other things, implementing a new customer market
approach, improving the efficiency of operations, addressing rising medical
costs, improving relations with health care providers and withdrawing certain
products within markets. Specific actions taken included significant price
increases, withdrawal from certain unprofitable Commercial HMO and Medicare
products within markets, changes to underwriting practices, initiatives to
improve the efficiency of claims payment and other member services processes,
and initiatives to reduce expenses, including significant staff reductions.
For various reasons, including premium rate increases and withdrawal from
certain unprofitable Commercial HMO and Medicare products within markets, the
Company's membership has decreased significantly. Total medical membership at
December 31, 2002 was 13.7 million members, compared to 17.2 million members at
December 31, 2001.
The Company has also continued to reduce its cost structure as its membership
has decreased. The Company recorded severance and facilities charges of $105
million after tax during 2002 and a severance and facilities charge of $125
million after tax in the fourth quarter of 2001. Refer to "Severance and
Facilities Charges" and Note 11 of Notes to Consolidated Financial Statements
for more information.
Page 1
Consolidated Results
The Company reported a net loss of $2.5 billion in 2002, a net loss of $280
million in 2001 and net income of $127 million in 2000. The Company reported
income from continuing operations of $393 million in 2002 and losses from
continuing operations of $292 million in 2001 and $127 million in 2000. Income
from continuing operations per diluted common share was $2.57 in 2002 compared
to losses from continuing operations per basic common share of $2.03 in 2001 and
$.90 in 2000. The net loss in 2002 includes income from discontinued operations
of $50 million and a cumulative effect charge of approximately $3.0 billion
related to the Company's adoption of Financial Accounting Standard ("FAS") No.
142, Goodwill and Other Intangible Assets, as discussed below. The loss in 2001
includes an $11 million benefit from the reduction of the reserve for costs
relating to the sale of certain discontinued operations and a cumulative effect
benefit of $.5 million related to the Company's adoption of the amended FAS No.
133, Accounting for Derivative Instruments and Hedging Activities. The net
income in 2000 includes income from discontinued operations of $255 million.
(Refer to "Results of Discontinued Operations" for more information.)
For 2002, income from continuing operations includes severance and facilities
charges of $105 million, a benefit from the reduction of the reserve for
anticipated future losses on discontinued products in the Large Case Pensions
segment of $5 million and net realized capital gains of $22 million. The loss
from continuing operations in 2001 includes a severance and facilities charge of
$125 million, a benefit from the reduction of the reserve for anticipated future
losses on discontinued products in Large Case Pensions of $61 million and net
realized capital gains of $74 million. The loss from continuing operations in
2000 includes a charge of $238 million related to the write-off of goodwill
primarily associated with Medicare service area exits effective January 1, 2001,
a severance and facilities charge of $93 million, costs of $38 million resulting
from change in control-related payments and other costs required to effect the
spin-off of the Company from its predecessor, a benefit from the reduction of
the reserve for anticipated future losses on discontinued products in Large Case
Pensions of $95 million and net realized capital losses of $14 million.
Excluding these items, income from continuing operations would have been $470
million in 2002 compared to a loss from continuing operations of $302 million in
2001, and income from continuing operations of $161 million in 2000.
Pharmacy Strategy
In October 2002, the Company announced that, following a review of strategic
options related to its pharmacy benefits management operations, the Company
decided to retain and expand upon its existing capabilities. In February 2003,
the Company completed the purchase of a mail order pharmacy facility from Eckerd
Health Services. The Company also expects to expand its existing clinical and
sales capabilities relating to its pharmacy benefits management operations.
New Accounting Standard On Goodwill and Other Acquired Intangible Assets
On January 1, 2002, the Company adopted FAS No. 142. As a result, the Company
recorded an impairment of goodwill of approximately $3.0 billion in the first
quarter of 2002 which is recorded as a cumulative effect adjustment in the
Consolidated Statement of Income. Refer to "Critical Accounting Policies" and
"Goodwill and Other Acquired Intangible Assets" within this MD&A and Notes 2 and
6 of Notes to Consolidated Financial Statements for further discussion.
Page 2
HEALTH CARE
Operating Summary
(MILLIONS) 2002 2001 2000
---------------------------------------------------------------------- --------- --------- ---------
Premiums:
Commercial HMO (1)................................................. $10,858.5 $14,345.8 $14,164.4
Medicare HMO....................................................... 1,013.1 1,995.7 4,051.3
Other (2).......................................................... 3,164.5 3,598.9 3,530.9
--------- --------- ---------
Total premiums........................................................ 15,036.1 19,940.4 21,746.6
--------- --------- ---------
Administrative services contract fees................................. 1,806.6 1,802.9 1,903.2
Net investment income................................................. 295.7 373.9 428.5
Other income.......................................................... 15.6 50.6 45.1
Net realized capital gains............................................ 56.0 102.2 2.6
--------- --------- ---------
Total revenue................................................... 17,210.0 22,270.0 24,126.0
--------- --------- ---------
Health care costs (3)................................................. 12,452.8 17,938.8 18,884.1
Salaries and related benefits......................................... 2,150.1 2,188.4 2,384.6
Other operating expenses.............................................. 1,884.4 2,130.0 2,261.4
Amortization of goodwill.............................................. -- 198.1 204.9
Amortization of other acquired intangible assets...................... 130.8 218.5 230.7
Goodwill write-off.................................................... -- -- 310.2
Severance and facilities charges...................................... 156.0 192.5 142.5
--------- --------- ---------
Total benefits and.............................................. 16,774.1 22,866.3 24,418.4
expenses
--------- --------- ---------
Income (loss) before income taxes (benefit) and cumulative effect
adjustments........................................................... 435.9 (596.3) (292.4)
Income taxes (benefit)................................................ 119.5 (157.3) .4
Cumulative effect adjustments, net of tax............................. (2,965.7) .5 --
--------- --------- ---------
Net loss.............................................................. $(2,649.3) $ (438.5) $ (292.8)
========= ========= =========
Net realized capital gains, net of tax (included above)............... $ 36.4 $ 77.4 $ 13.1
========= ========= =========
--------------
(1) Commercial HMO includes premiums related to POS members who access primary
care physicians and referred care through an HMO network.
(2) Includes POS, PPO, Indemnity, Medicaid HMO and Dental products.
(3) The percentage of health care costs related to capitated arrangements (a fee
arrangement where the Company pays providers a monthly fixed fee for each
member, regardless of the medical services provided to the member) was 11.3%
for 2002, compared to 11.7% for 2001 and 14.1% for 2000.
The table presented below identifies certain items which, although they may
recur, are excluded from net loss to arrive at operating earnings or loss.
Management believes this provides a comparison more reflective of Health Care's
underlying business performance. The table reconciles operating earnings or loss
to net loss reported in accordance with accounting principles generally accepted
in the United States of America.
(MILLIONS) 2002 2001 2000
----------------------------------------------------- --------- -------- -------
Net loss............................................. $(2,649.3) $(438.5) $(292.8)
Other items included in net loss:
Net realized capital gains........................ (36.4) (77.4) (13.1)
Amortization of goodwill.......................... -- 195.3 200.4
Amortization of other acquired intangible assets.. 85.0 142.4 150.0
Goodwill write-off................................ -- -- 238.3
Severance and facilities charges.................. 101.4 125.1 92.6
Release of state income tax reserves (1).......... (19.8) -- --
Change in control-related costs................... -- -- 37.7
Cumulative effect adjustments..................... 2,965.7 (.5) --
--------- ------- -------
Operating earnings (loss)............................ $ 446.6 $ (53.6) $ 413.1
========= ======= =======
--------------
(1) During the first quarter of 2002, the Company released $19.8 million of
state income tax related reserves as a result of the favorable conclusion of
several state tax audits.
Page 3
2002 Compared to 2001
Operating earnings for 2002 reflect an increase of $500 million from the
operating loss in 2001, which decreased $467 million from the operating earnings
in 2000. For 2002 and 2001, membership levels were lower than in the prior year
periods, resulting in both lower overall premiums and medical costs. For 2002,
the increase in operating earnings was due primarily to significant premium rate
increases and reductions of membership with historically higher medical cost
ratios (including withdrawal of products within certain markets), partially
offset by higher per member medical costs for Commercial HMO products and, to a
lesser extent, for PPO, POS and Indemnity products. Premiums for 2002 also
reflect a benefit of approximately $21 million after tax ($32 million pretax)
from the favorable resolution of prior period contract matters for a large
customer. Medical costs for 2002 reflect the favorable development of prior
period medical cost estimates of approximately $26 million after tax ($40
million pretax) for Commercial HMO products and approximately $23 million after
tax ($35 million pretax) for Medicare HMO. Medical costs for 2001 reflect the
unfavorable development of prior period medical cost estimates of approximately
$42 million after tax ($65 million pretax), primarily related to Medicare
service areas that the Company exited, effective January 1, 2001. The increase
in 2002 operating earnings was also attributable to a decrease in total
operating expenses, including salaries and related benefits, resulting from
expense reduction initiatives related to lower membership levels, including
workforce reductions, lower broker commissions and sales compensation expense,
offset partially by higher performance-based compensation, due to the Company's
improved results, and higher pension costs. Operating earnings for 2002 were
adversely affected by a decrease in net investment income due primarily to lower
average yields on debt securities, mortgage loans and short-term investments as
well as lower average assets, partially offset by higher limited partnership
income, and a decrease in other income primarily due to proceeds in the third
quarter of 2001, not present in 2002, of approximately $13 million after tax
($20 million pretax) from the sale of the Company's New Jersey Medicaid
membership (discussed in more detail below).
2001 Compared to 2000
The decrease in operating earnings for 2001 reflects lower results for
Commercial HMO products and, to a lesser extent, lower results for Indemnity,
PPO and POS medical products, partially offset by higher results for Medicare
HMO products. The decline in results for Commercial HMO products resulted from
significantly higher per member medical costs outpacing per member premium rate
increases, partially offset by a decrease in operating expenses, including
salaries and related benefits, resulting from expense reduction initiatives. The
decline in results for Indemnity, PPO and POS products was due primarily to
higher per member medical costs outpacing per member premium rate increases. The
operating loss for 2001 was partially offset by higher results for Medicare HMO
products due to the Company's exit of a number of Medicare service areas on
January 1, 2001 and per member premium rate increases on renewing business,
partially offset by significantly higher per member medical costs. 2001 results
also reflect a decrease in net investment income primarily due to lower income
from limited partnerships and lower yields on debt securities and short-term
investments, partially offset by higher asset balances. Results in 2001 also
include a charge of $15 million after tax ($23 million pretax) for prior period
claim surcharges, and a benefit of $13 million after tax ($20 million pretax)
related to the net settlement of a reinsurance agreement with The Prudential
Insurance Company of America, as well as a benefit of approximately $13 million
after tax ($20 million pretax) relating to the sale of the Company's New Jersey
Medicaid membership. Results for Risk Products in 2000 also reflect a favorable
development related to a government plan arrangement included in Indemnity, PPO
and POS products, almost entirely offset by unfavorable development related to
the resolution or termination of certain provider contracts included in Medicare
HMO products.
Page 4
Commercial HMO
Commercial HMO premiums decreased approximately $3.5 billion in 2002, when
compared to 2001, and increased $181 million in 2001, when compared to 2000.
This decrease for 2002 primarily reflects significant membership reductions,
offset in part by significant premium rate increases on renewing business. The
increase in 2001 was due to premium rate increases on renewing business,
partially offset by a shift in the geographic mix of membership, customers
selecting lower premium plans and by membership reductions.
The Commercial HMO medical cost ratio was 83.2% for 2002, 90.3% for 2001 and
86.3% for 2000. The decrease in 2002, compared to 2001, was the result of
significant per member premium rate increases outpacing per member medical cost
increases and reductions of membership with historically higher medical cost
ratios (including withdrawal of products within certain markets). Premiums for
2002 also include a benefit of approximately $32 million pretax from the
favorable resolution of prior period contract matters for a large customer. Per
member medical cost increases in 2002 were partially offset by favorable
development of prior period medical cost estimates of approximately $40 million
pretax. Excluding the favorable resolution of prior period contract matters for
a large customer and the favorable development of prior period medical cost
estimates, the Commercial HMO medical cost ratio was 83.8% for 2002. Higher per
member medical costs were primarily due to higher utilization related to 2002
services and also reflect the impact of certain unit cost increases. While the
specific factors vary in importance by local market, the major drivers of the
increase in utilization include an increase in physician services (including
specialists), inpatient services, pharmacy and outpatient services (particularly
ambulatory surgeries and radiology). The increase in 2001, compared to 2000, was
the result of significantly increased per member medical costs outpacing per
member premium increases. Higher per member medical costs were primarily due to
higher utilization.
Medicare HMO
The Company's Medicare+Choice contracts with the federal government are renewed
for a one-year period each January 1. In September 2002, the Company notified
the Centers for Medicare and Medicaid Services ("CMS") of its intent not to
renew its Medicare+Choice contracts for 2003 for individuals in a number of
Medicare service areas affecting approximately 9,000 members, or approximately
8% of the Company's total Medicare membership at December 31, 2002. Employer
groups offering Aetna's Medicare+Choice coverage in these service areas will
continue to be able to do so. As part of a new CMS Medicare+Choice Demonstration
Project, the Company is offering an open access Medicare+Choice plan (the Aetna
Golden Choice plan) for 2003 in certain service areas, including certain service
areas where the Company decided not to renew its Medicare+Choice contracts for
individuals. This new Aetna Golden Choice plan will not require referrals or the
selection of a primary care physician.
In September 2001, the Company notified CMS of its intent to exit a number of
Medicare service areas, affecting approximately 95,000 members, or approximately
37% of the Company's total Medicare membership at December 31, 2001. The
termination of these Medicare+Choice contracts became effective on January 1,
2002. The medical cost ratio for the exited Medicare service areas, effective
January 1, 2002, was approximately 100% for 2001. In June 2000, the Company
notified CMS of its intent to exit a number of Medicare service areas affecting
approximately 260,000 members, or approximately 47% of the Company's total
Medicare membership at December 31, 2000. The termination of these
Medicare+Choice contracts became effective on January 1, 2001.
Medicare HMO premiums decreased $983 million in 2002, when compared to 2001, and
decreased $2.1 billion in 2001, when compared to 2000. The decrease in 2002 was
substantially due to the Company exiting a number of Medicare service areas on
January 1, 2002, discussed above. The decrease in 2001, compared to 2000, was
due to the exit of a number of Medicare service areas on January 1, 2001,
partially offset by increases in supplemental premiums and rate increases by
CMS.
Page 5
The Medicare HMO medical cost ratio for 2002 was 82.2%, compared to 93.7%
(excluding premiums and medical costs relating to Medicare service areas that
the Company exited, effective January 1, 2001 ("2001 exited markets")) for 2001
and 91.6% for 2000 excluding 2001 exited markets. The decrease for 2002,
compared to 2001, primarily reflects the Company's exit from certain Medicare
service areas on January 1, 2002 that had high medical cost ratios, premium rate
increases outpacing medical cost increases and the favorable development of
prior period medical cost estimates discussed previously. Excluding the
favorable development of prior period medical cost estimates for 2002 of
approximately $35 million pretax, the Medicare HMO medical cost ratio was 85.6%.
The increase for 2001, compared to 2000, reflects increased per member medical
costs which outpaced the increases in supplemental premiums and CMS rate
increases. The increases in per member medical costs were primarily a result of
higher utilization and, to a lesser extent, unit cost increases mostly due to a
shift from capitation to fee-for-service arrangements in certain markets.
Excluding premiums and medical costs relating to Medicare service areas that the
Company exited, effective January 1, 2002, the Medicare HMO medical cost ratio
would have been approximately 91.0% for 2001. Medical costs for 2001 reflect the
unfavorable development of prior period medical cost estimates of approximately
$56 million pretax, primarily related to those Medicare service areas that the
Company exited, effective January 1, 2001. For 2001 and 2000, the Medicare HMO
medical cost ratio (including 2001 exited markets) was 95.7% and 97.0%,
respectively.
MEDICAID SALE
On August 1, 2001, the Company completed the sale of its New Jersey Medicaid and
New Jersey Family Care membership to AmeriChoice. The agreement covered
approximately 118,000 New Jersey Medicaid beneficiaries and members of the New
Jersey Family Care program for uninsured children and adults. Proceeds from this
sale of approximately $20 million pretax are included in other income for 2001.
The operating results of the Medicaid business sold, which include the proceeds
from the sale, were not material to the Company's results of operations.
HEALTH CARE COSTS PAYABLE
Health care costs payable reflects estimates of the ultimate cost of claims that
have been incurred but not yet reported or reported but not yet paid. Health
care costs payable is estimated periodically, and any resulting adjustments are
reflected in the current-period operating results within health care costs.
Health care costs payable is based on a number of factors, including those
derived from historical claim experience. A large portion of health care claims
are not submitted to the Company until after the end of the quarter in which
services are rendered by providers to members. As a result, an extensive degree
of judgment is used in this estimation process, considerable variability is
inherent in such estimates, and the adequacy of the estimates 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 health care
costs payable at December 31, 2002 would cause these estimates to change in the
near term, and such a change could be material. For example, a 100 basis point
change in the estimated medical cost trend for Commercial HMO Risk products
would have changed annual after tax results for 2002 by approximately $50
million. This estimation process is a critical accounting policy for the
Company. Refer to "Critical Accounting Policies" for more information.
OTHER REVENUE
ASC fees for 2002 remained relatively consistent with 2001. This reflects
overall lower ASC membership levels, offset by an increase in rates. The
decrease in ASC fees for 2001 of approximately $100 million, when compared to
2000, is primarily due to lower overall membership levels, partially offset by
higher Commercial HMO fees due to higher Commercial HMO membership and rate
increases.
Page 6
Net realized capital gains for 2002 include a capital gain of $39 million after
tax related to the Company's 1997 sale of its behavioral health subsidiary,
Human Affairs International ("HAI") and net gains from the sale of debt
securities resulting from the Company's rebalancing of its investment portfolio
in a low interest rate environment. The Company records capital gains relating
to the HAI sale as they become realizable. Refer to "Total Investments - Capital
Gains and Losses" for further discussion of the $60 million pretax that was
scheduled to be paid to the Company by the purchaser of HAI, Magellan Health
Services, Inc. ("Magellan"), and Magellan's current financial condition. These
gains were partially offset by capital losses primarily due to the write-down of
certain debt and equity securities, the final resolution of matters related to
the prior year sale of NYLCare Texas, the sale of the Company's investment in an
internet technology-based connectivity company and losses from futures
contracts. Net realized capital gains for 2001 primarily reflect a capital gain
of $38 million after tax related to the HAI sale, net gains from the sale of
debt securities resulting from the Company's rebalancing of its investment
portfolio and capital gains resulting from collections of previously charged-off
mortgage loans. These gains in 2001 were partially offset by capital losses
resulting primarily from the write-down of certain debt securities. Net realized
capital gains for 2000 primarily reflect a capital gain of $38 million after tax
related to the HAI sale. During 2000, the Company incurred capital losses due to
the rebalancing of its investment portfolio in a then rising interest rate
environment, the write-down of certain debt securities and on the sale of
certain corporate real estate, which almost entirely offset the HAI capital
gain.
Income Taxes
Results for 2002 included approximately $20 million of state income tax related
reserves released in the first quarter of 2002 as a result of the favorable
conclusion of several state tax audits. Results for 2000 included a charge of
$238 million after tax related to the write-off of goodwill, primarily
associated with Medicare service area exits effective January 1, 2001. Excluding
the state income tax reserve release in 2002, the goodwill write-off in 2000,
amortization of goodwill for 2001 and 2000, and net realized capital gains and
amortization of other acquired intangible assets for all periods, the effective
tax rates were 32.4%, 36.6% and 37.3% for 2002, 2001 and 2000, respectively.
Fluctuations in the effective tax rates primarily reflect a change in the mix of
state income taxes that apply to pretax income or loss. This mix of state income
taxes depends on the states in which the Company's earnings or losses are
incurred and the level of such earnings or losses, due to differing tax rates
and/or limitations of allowed losses in various states.
Membership
Health Care's membership was as follows:
DECEMBER 31, 2002 DECEMBER 31, 2001
------------------------ -------------------------
(THOUSANDS) RISK ASC TOTAL RISK ASC TOTAL
----------------------- ----- ----- ------ ----- ----- ------
Commercial
HMO (1)............. 3,948 1,349 5,297 6,712 1,086 7,798
PPO................. 753 3,171 3,924 907 3,168 4,075
POS................. 101 2,514 2,615 183 2,820 3,003
Indemnity........... 106 1,517 1,623 204 1,691 1,895
----- ----- ------ ----- ----- ------
Total Commercial
Membership.......... 4,908 8,551 13,459 8,006 8,765 16,771
Medicare HMO........... 117 -- 117 255 -- 255
Medicaid HMO........... -- 102 102 15 129 144
----- ----- ------ ----- ----- ------
Total Medical
Membership.......... 5,025 8,653 13,678 8,276 8,894 17,170
===== ===== ====== ===== ===== ======
Dental................. 4,740 7,027 11,767 5,704 7,755 13,459
----- ----- ------ ----- ----- ------
--------------
(1) Commercial HMO in thousands includes POS members who access primary care
physicians and referred care through an HMO network of 1,067 at December 31,
2002 and 1,475 at December 31, 2001.
Page 7
Total medical and dental membership as of December 31, 2002 decreased by
approximately 3.5 million members and 1.7 million members, respectively,
compared to December 31, 2001, resulting from the Company's strategic and
operational initiatives, including significant price increases, the withdrawal
of under-performing Commercial HMO products in certain markets and the exit from
certain Medicare service areas. Substantially all of the medical membership
decrease relates to Risk membership and as a result, ASC membership at December
31, 2002 represents approximately 63% of Health Care's total medical membership,
compared to approximately 52% at December 31, 2001.
Outlook
The Company continues to implement its strategic and operational initiatives
which are designed to improve profitability and competitiveness. As a result,
certain key actions and the Company's success in implementing them are expected
to be significant drivers of the Company's 2003 financial performance. A key
goal for the Company in 2003 is to begin to grow membership levels, as discussed
below.
Medical Costs/Pricing Actions. The Company continues to take certain actions
designed to improve its medical cost ratios. The Company attempts to improve
profitability through price increases and, where appropriate, through improved
underwriting and more effective contracting, benefit plan designs and medical
management programs. Premiums for Risk health plans are generally fixed for
one-year periods and, accordingly, cost levels in excess of medical cost
projections reflected in pricing cannot be recovered in the contractual year
through higher premiums. The Company has sought significant price increases for
2003 renewals to further improve profitability. A majority of the Company's
Health Risk business will renew during the first quarter of 2003. As a result,
the Company's results for 2003 are particularly sensitive to the price increases
it achieves for business renewing in the early part of the year. There can be no
assurances regarding the accuracy of medical cost projections assumed for
pricing purposes and if the rate of increase in medical costs in 2003 were to
exceed the levels projected for pricing purposes, our results would be
materially adversely affected.
Membership/Revenue. Premium increases for 2002 renewals and other actions
resulted in significantly reduced membership for 2002. Actions affecting
membership also included the exit of certain Medicare service areas and the
withdrawal of under-performing Commercial HMO products in certain markets.
Further premium increases for 2003 renewals have resulted in additional
membership reductions during the first quarter of 2003. If membership declines
more than we expect or if we lose accounts with favorable medical cost
experience while retaining accounts with unfavorable medical cost experience,
our business and results of operations may be adversely affected in 2003. First
quarter 2003 medical membership is expected to be approximately 13.0 million
members. However, the Company is taking steps to begin to increase membership
and expects growth beginning in the second quarter of 2003 and that medical
membership at December 31, 2003 will be approximately 13.2 million members.
Lower levels of membership are projected to result in lower revenue in 2003,
compared to 2002.
Page 8
Expenses. To improve operating margins, the Company will need to continue to
reduce operating expenses, particularly if membership continues to decrease. The
Company continues to implement initiatives designed to improve the efficiency of
its operations, while at the same time attempting to improve customer service
and comply with important new privacy and other regulations. The Company
recorded severance and facilities charges for Health Care of $28 million after
tax in the fourth quarter of 2002, $56 million after tax in the third quarter of
2002 and $18 million after tax in the second quarter of 2002 relating to actions
to reduce its workforce and vacate certain leased facilities. The charge in the
fourth quarter of 2002 includes the elimination of approximately 607 positions
and is expected to be completed by December 31, 2003. The charge in the third
quarter of 2002 includes the elimination of approximately 2,600 positions and is
expected to be completed by September 30, 2003. The charge in the second quarter
of 2002 was substantially completed by December 31, 2002. (Refer to "Severance
and Facilities Charges" later for additional details.) The Company expects that
its 2003 pension costs will increase by approximately $110 million pretax due to
continued or sustained declines in equity markets and the resulting impact on
the fair value of pension plan assets (refer to "Critical Accounting Policies --
Defined Benefit Pension and Other Post-Retirement Benefit Plans").
Internal Revenue Service Audits. The Internal Revenue Service is currently
auditing certain issues related to the Company and the Company's predecessor,
former Aetna, and the Company has established reserves to cover adverse outcomes
of such audits. The Company is currently negotiating the settlement of certain
of these audits and as a result, the Company expects to conclude certain of
these audits in 2003. Refer to Note 13 of Notes to Consolidated Financial
Statements for more information.
The future performance of the Company will depend in large part on its ability
to continue to implement its strategic and operational initiatives. If these
initiatives do not achieve their objectives, or result in unanticipated
increases in medical cost trends or other adverse affects, the Company's results
in future periods would be materially adversely affected.
Refer to "Forward-Looking Information/Risk Factors" for information regarding
other important factors that may materially affect the Company.
GROUP INSURANCE
OPERATING SUMMARY
(MILLIONS) 2002 2001 2000
------------------------------------------------------------------ ----------- ----------- ----------
Premiums:
Life.......................................................... $ 1,093.0 $ 1,052.1 $ 1,045.5
Disability.................................................... 300.0 267.4 238.7
Long-term care................................................ 64.4 59.1 44.4
----------- ----------- ---------
Total premiums................................................... 1,457.4 1,378.6 1,328.6
Administrative services contract fees............................ 36.0 32.3 34.3
Net investment income............................................ 269.5 286.0 300.9
Other income..................................................... 4.0 4.0 4.1
Net realized capital gains (losses).............................. (21.6) .4 (49.0)
----------- ----------- ---------
Total revenue.............................................. 1,745.3 1,701.3 1,618.9
----------- ----------- ---------
Current and future benefits...................................... 1,380.5 1,303.6 1,216.2
Salaries and related benefits.................................... 79.4 85.0 79.3
Other operating expenses......................................... 97.8 90.1 79.5
Severance and facilities charge.................................. 5.0 -- --
----------- ----------- ---------
Total benefits and expenses................................ 1,562.7 1,478.7 1,375.0
----------- ----------- ---------
Income before income taxes....................................... 182.6 222.6 243.9
Income taxes..................................................... 57.6 71.2 82.6
----------- ----------- ---------
Net income....................................................... $ 125.0 $ 151.4 $ 161.3
=========== =========== =========
Net realized capital gains (losses), net of tax (included above). $ (14.0) $ .3 $ (31.8)
=========== =========== =========
Page 9
RESULTS
Net income for 2002 reflects a decrease of $26 million, when compared to 2001,
which decreased $10 million when compared to 2000. Net income for 2001 includes
$9 million for life insurance claims resulting from the events of September 11,
2001. Excluding the severance and facilities charges in 2002 of $3 million after
tax, the impact from the events of September 11, 2001 and net realized capital
gains or losses, operating earnings for 2002 decreased $18 million, compared to
2001, and operating earnings for 2001 decreased $33 million, when compared to
2000. The decrease in operating earnings for 2002 is due primarily to an
increase in the benefit cost ratio (current and future benefits divided by
premiums) and lower net investment income. Lower net investment income is
primarily due to lower average yields on mortgage loans, bonds and short-term
investments as well as lower mortgage loan equity participation and prepayment
income, partially offset by higher average assets and higher limited partnership
and real estate income. The decrease in operating earnings for 2002 also
reflects an increase in other operating expenses due primarily to higher broker
commission expenses, partially offset by a decrease in salaries and related
benefits due primarily to lower sales compensation expense. The decrease in
operating earnings for 2001 is due primarily to increases in the benefit cost
ratio and operating expenses as well as a decrease in net investment income. The
benefit cost ratios, excluding the events of September 11, 2001, were 94.7% for
2002, 93.6% for 2001 and 91.5% for 2000.
Net realized capital losses for 2002 primarily reflect losses due to the
write-down of certain investments in debt and equity securities and losses on
futures contracts. These losses were partially offset by capital gains from debt
securities resulting from the Company's rebalancing of its investment portfolio
in a low interest rate environment. Net realized capital gains for 2001
primarily reflect collections of previously charged-off mortgage loans,
partially offset by capital losses resulting primarily from the write-down of
certain bonds and capital losses on Treasury futures contracts used for managing
the maturities of invested assets with the payment of expected liabilities. Net
realized capital losses for 2000 primarily reflect the Company's rebalancing of
its investment portfolio in a then rising interest rate environment and the
write-down of certain debt securities.
The table presented below identifies certain items which, although they may
recur, are excluded from net income to arrive at operating earnings. Management
believes this provides a comparison more reflective of Group Insurance's
underlying business performance. The table reconciles operating earnings to net
income reported in accordance with accounting principles generally accepted in
the United States of America.
(MILLIONS) 2002 2001 2000
----------------------------------------------- ------ ------ ------
Net income .................................... $125.0 $151.4 $161.3
Other items included in net income:
Net realized capital (gains) losses 14.0 (.3) 31.8
Severance and facilities charges .......... 3.2 -- --
Impact from events of September 11, 2001... -- 9.0 --
------ ------ ------
Operating earnings ............................ $142.2 $160.1 $193.1
====== ====== ======
Operating earnings:
Life products ............................. $112.2 $116.5 $136.0
Disability and Long-term care products .... 30.0 43.6 57.1
------ ------ ------
Total Group Insurance ......................... $142.2 $160.1 $193.1
====== ====== ======
Page 10
Life Products
Life products include Basic Term Group Life Insurance, Group Universal Life,
Supplemental or Voluntary programs and Accidental Death and Dismemberment
coverage. Operating earnings for Life products decreased for 2002, when compared
to 2001, primarily due to lower net investment income discussed previously.
Operating earnings for Life products decreased for 2001, when compared to 2000,
primarily due to a decrease in net investment income as a result of lower
limited partnership income, partially offset by mortgage loan prepayment fees in
the first quarter of 2001. The decrease in operating earnings for 2001 also
reflects increases in operating expenses and the benefit cost ratio.
Disability and Long-term Care Products
Disability and Long-term care products consist primarily of short-term and
long-term disability insurance (and products which combine both), as well as
long-term care products, which provide benefits offered to cover the cost of
care in private home settings, adult day care, assisted living or nursing
facilities. Operating earnings for 2002 decreased, when compared to 2001,
primarily due to an increase in the combined benefit cost ratio for Disability
and Long-term care products and, to a lesser extent, lower net investment income
discussed previously. Operating earnings for 2001 decreased, when compared to
2000, primarily due to an increase in the combined benefit cost ratio for
Disability and Long-term care products and, to a lesser extent, increases in
operating expenses. The decrease in 2001 operating earnings was partially offset
by an increase in net investment income primarily resulting from an increase in
mortgage loan prepayment fees. The 2001 increase in the Disability benefit cost
ratio reflects an increase in current and future benefits resulting from less
favorable reserve developments than those in 2000, partially offset by selective
premium rate increases on renewing business.
MEMBERSHIP
Group Insurance's membership was as follows:
(THOUSANDS) 2002 2001
-------------------------- ------ ------
Life products............. 9,274 9,211
Disability products....... 2,210 2,140
Long-term care products... 180 129
------ ------
Total..................... 11,664 11,480
====== ======
Total Group Insurance membership as of December 31, 2002 increased by 184,000
members, when compared to December 31, 2001. This increase reflects the addition
of approximately 1,768,000 members, offset by lapses of approximately 1,584,000
members during 2002. Total Group Insurance membership as of December 31, 2001
decreased 204,000 members, when compared to December 31, 2000. This decrease
reflects the addition of approximately 2,196,000 members, offset by lapses of
approximately 2,400,000 members during 2001.
Outlook
The Company projects operating earnings in 2003 from Group Insurance products to
be slightly lower than 2002 operating earnings. The Company also expects
membership for Group Insurance to increase for 2003, compared to 2002.
Refer to "Forward-Looking Information/Risk Factors" for information regarding
important factors that may materially affect the Company.
Page 11
LARGE CASE PENSIONS
Operating Summary
(MILLIONS) 2002 2001 2000
------------------------------------------------------------------------------- --------- --------- ---------
Premiums....................................................................... $ 219.2 $ 453.0 $ 139.7
Net investment income.......................................................... 685.5 751.7 902.2
Other income................................................................... 18.8 21.3 25.8
Net realized capital gains (losses)............................................ (.1) (6.5) 6.3
--------- --------- ---------
Total revenue......................................................... 923.4 1,219.5 1,074.0
--------- --------- ---------
Current and future benefits.................................................... 865.0 1,154.7 937.3
Salaries and related benefits.................................................. 15.7 17.0 16.8
Other operating expenses....................................................... 5.2 4.5 8.2
Reductions of reserve for anticipated future losses on discontinued products... (8.3) (94.5) (146.0)
--------- --------- ---------
Total benefits and expenses........................................... 877.6 1,081.7 816.3
--------- --------- ---------
Income before income taxes..................................................... 45.8 137.8 257.7
Income taxes................................................................... 16.3 48.9 92.3
--------- --------- ---------
Net income..................................................................... $ 29.5 $ 88.9 $ 165.4
========= ========= =========
Net realized capital gains (losses), net of tax (included above)............... $ (.1) $ (4.1) $ 4.5
========= ========= =========
Assets under management: (1)
Fully guaranteed discontinued products...................................... $ 4,784.2 $ 5,246.2 $ 5,490.0
Experience-rated............................................................ 5,764.2 6,476.3 7,008.5
Non-guaranteed.............................................................. 7,916.5 8,364.7 11,294.1
--------- --------- ---------
Total assets under management......................................... $18,464.9 $20,087.2 $23,792.6
========= ========= =========
--------------
(1) Excludes net unrealized capital gains of $511.0 million at December 31,
2002, $176.0 million at December 31, 2001 and $108.1 million at December 31,
2000.
Results
Large Case Pensions' net income decreased $59 million in 2002, compared to 2001,
which decreased $77 million from 2000. Net income for 2002 includes a benefit
from the reduction of the reserve for anticipated future losses on discontinued
products for Large Case Pensions of $5 million due primarily to favorable
mortality and retirement experience and certain reductions in administrative
expenses, partially offset by lower investment portfolio returns. Net income for
2001 includes a benefit from the reduction of the reserve for anticipated future
losses on discontinued products of $61 million primarily as a result of
favorable investment performance that included equity gains and mortgage loan
prepayment penalty income, as well as favorable mortality and retirement
experience. Net income for 2000 includes a benefit from the reduction of the
reserve for anticipated future losses on discontinued products of $95 million
primarily resulting from favorable investment performance as well as favorable
mortality and retirement experience. Excluding the discontinued products reserve
releases and net realized capital gains and losses, operating earnings were $24
million in 2002, $32 million in 2001 and $66 million in 2000.
The decreases in results for 2002 and 2001 continue to reflect the run off of
underlying liabilities and related assets. Premiums, along with current and
future benefits, decreased for 2002, compared to 2001, primarily due to less
activity relating to the funding of retirement incentive programs by an existing
customer and also the 2001 transfer of cash from separate accounts to the
general account to purchase annuities for another large customer. Premiums,
along with current and future benefits, increased for 2001, compared to 2000,
due to the funding of a retirement incentive program by an existing customer and
a transfer of cash from separate accounts to the general account to purchase
annuities for another large customer.
Page 12
General account assets supporting experience-rated products (where the
contractholder, not the Company, assumes investment and other risks subject to,
among other things, certain minimum guarantees) may be subject to participant or
contractholder withdrawal. Experience-rated contractholder and participant
withdrawals were as follows:
(MILLIONS) 2002 2001 2000
---------------------------------------------------------- ------ ------ ------
Scheduled contract maturities and benefit payments (1).... $793.6 $929.3 $870.7
Contractholder withdrawals other than scheduled
contract maturities and benefit payments (2)............ 104.6 218.1 220.4
Participant-directed withdrawals (2)...................... 22.9 20.7 44.1
--------------
(1) Includes payments made upon contract maturity and other amounts distributed
in accordance with contract schedules.
(2) Approximately $674 million and $679 million at December 31, 2002 and 2001,
respectively, of experience-rated pension contracts allowed for unscheduled
contractholder withdrawals, subject to timing restrictions and formula-based
market value adjustments. Further, approximately $1.1 billion and $1.4
billion at December 31, 2002 and 2001, respectively, of experience-rated
contracts supported by general account assets could be withdrawn or
transferred to other plan investment options at the direction of plan
participants, without market value adjustment, subject to plan, contractual
and income tax provisions.
Outlook
Large Case Pensions operating earnings are projected to be lower for 2003,
compared to operating earnings in 2002, as the business continues to run off.
Refer to "Forward-Looking Information/Risk Factors" for information regarding
other important factors that may materially affect Large Case Pensions.
DISCONTINUED PRODUCTS
The Company discontinued the sale of its fully guaranteed large case pension
products (single-premium annuities ("SPAs") and guaranteed investment contracts
("GICs")) in 1993. The Company established a reserve for anticipated future
losses on these products based on the present value of the difference between
the expected cash flows from the assets supporting these products and the cash
flows expected to be required to meet the product obligations.
Results of operations of discontinued products, including net realized capital
gains or losses, are credited or charged to the reserve for anticipated future
losses. The Company's results of operations would be adversely affected to the
extent that future losses on the products are greater than anticipated and
positively affected to the extent future losses are less than anticipated.
The factors contributing to changes in the reserve for anticipated future losses
are: operating income or loss, realized capital gains or losses and mortality
gains or losses. Operating income or loss is equal to revenue less expenses.
Realized capital gains or losses reflect the excess (deficit) of sales price
over (below) the carrying value of assets sold. Mortality gains or losses
reflect the mortality and retirement experience related to SPAs. A mortality
gain (loss) occurs when an annuitant or a beneficiary dies sooner (later) than
expected. A retirement gain will occur on some contracts if an annuitant retires
later than expected (a loss if an annuitant retires earlier than expected).
Page 13
The results of discontinued products were as follows:
(MILLIONS) 2002 2001 2000
----------------------------------------------------------- ------ ------ ------
Interest deficit (1)...................................... $(12.2) $(17.0) $(10.2)
Net realized capital gains (losses)....................... (37.2) 13.8 (18.3)
Interest earned on receivable from continuing products.... 17.4 17.7 19.6
Other, net................................................ 10.8 13.4 9.7
------ ------ ------
Results of discontinued products, after tax............... $(21.2) $ 27.9 $ 0.8
====== ====== ======
Results of discontinued products, pretax.................. $(33.7) $ 40.0 $ (2.2)
====== ====== ======
Net realized capital gains (losses) from bonds, after
tax (included above).................................... $(53.3) $ 29.9 $(58.3)
====== ====== ======
--------------
(1) The interest deficit is the difference between earnings on invested assets
and interest credited to contractholders.
Net realized capital losses in 2002 are due primarily to debt securities sales
and the write-down of certain debt and equity securities, partially offset by
the sale of an equity investment and the collection of previously charged-off
mortgage loans. Net realized capital gains in 2001 were due primarily to gains
on the sale of bonds in a declining interest rate environment, partially offset
by capital losses on Treasury futures contracts used for duration management and
the sale of equity securities. Net realized capital losses in 2000 are due
primarily to losses on the sale of bonds in a then rising interest rate
environment, partially offset by gains on 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 $357 million at December 31, 2002, $345
million at December 31, 2001 and $389 million at December 31, 2000.
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. Since 1997, a
bond default assumption has been 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
declines 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.
Page 14
The activity in the reserve for anticipated future losses on discontinued
products was as follows (pretax):
(MILLIONS)
---------------------------------
Reserve at December 31, 1999..... $1,147.6
Operating income................. 16.1
Net realized capital losses...... (31.1)
Mortality and other.............. 12.8
Reserve reduction................ (146.0)
--------
Reserve at December 31, 2000..... 999.4
Operating income................. 3.2
Net realized capital gains....... 18.9
Mortality and other.............. 17.9
Reserve reduction................ (94.5)
--------
Reserve at December 31, 2001..... 944.9
Operating income................. 8.2
Net realized capital losses...... (57.5)
Mortality and other.............. 15.6
Reserve reduction................ (8.3)
--------
Reserve at December 31, 2002..... $ 902.9
========
Management reviews the adequacy of the discontinued products reserve quarterly
and, as a result, $5 million ($8 million pretax) of the reserve was released in
2002 primarily due to favorable mortality and retirement experience and certain
reductions in administrative expenses, partially offset by lower portfolio
returns. For 2001, $61 million ($95 million pretax) of the reserve was released
primarily due to favorable investment performance that included equity gains and
mortgage loan prepayment penalty income, as well as favorable mortality and
retirement experience. For 2000, $95 million ($146 million pretax) of the
reserve was released primarily due to favorable investment performance related
to certain equity investments, favorable mortality and retirement experience and
the decrease in size of the overall bond portfolio, which decreased default
risk. The current reserve reflects management's best estimate of anticipated
future losses.
The anticipated run off of the December 31, 2002 reserve balance is as follows:
(MILLIONS)
--------------
2003.......... $ 30.8
2004.......... 31.2
2005.......... 31.5
2006.......... 31.7
2007.......... 31.8
2008 - 2012 163.2
2013 - 2017 155.2
2018 - 2022 133.1
2023 - 2027 104.2
Thereafter.... 190.2
-------------- ------
The above table assumes that assets are held until maturity and that the reserve
run off is proportional to the liability run off.
The expected liability (as of December 31, 1993) and actual balances for the GIC
and SPA liabilities at December 31 are as follows:
EXPECTED ACTUAL
------------------ ------------------
(MILLIONS) GIC SPA GIC SPA
---------- ------ -------- ------ --------
2000...... $690.7 $4,357.9 $548.8 $4,462.5
2001...... 352.9 4,238.9 261.5 4,512.6
2002...... 169.5 4,114.6 82.9 4,361.1
------ -------- ------ --------
Page 15
The GIC balances were lower than expected in each period, as several
contractholders redeemed their contracts prior to contract maturity. The SPA
balances in each period were higher than expected because of additional amounts
received under existing contracts. The increase in the 2001 actual SPA balance,
when compared to 2000, is due to the transfer of funds from separate accounts to
purchase guaranteed annuities in the Company's general account, under an
existing contract.
The discontinued products investment portfolio is as follows:
(MILLIONS) DECEMBER 31, 2002 DECEMBER 31, 2001
----------------------------- -------------------- --------------------
CLASS AMOUNT PERCENT AMOUNT PERCENT
----------------------------- -------- ------- -------- -------
Debt securities available for
sale....................... $3,481.0 68.4% $3,573.8 66.8%
Loaned securities (1)........ 167.1 3.3 131.9 2.5
-------- ----- -------- -----
Total debt securities........ 3,648.1 71.7 3,705.7 69.3
Mortgage loans............... 763.2 15.0 822.1 15.4
Investment real estate....... 95.0 1.9 130.4 2.4
Equity securities............ 73.4 1.4 211.0 3.9
Other (2).................... 505.7 10.0 481.4 9.0
-------- ----- -------- -----
Total........................ $5,085.4 100.0% $5,350.6 100.0%
======== ===== ======== =====
--------------
(1) Refer to Note 2 of Notes to Consolidated Financial Statements for further
discussion of the Company's securities lending program.
(2) Amount includes restricted debt securities on deposit as required by
regulatory authorities of $68.3 million at December 31, 2002 and $55.7
million at December 31, 2001 included in long-term investments on the
Consolidated Balance Sheets.
The investment portfolio has declined from 2001, as assets were used to pay off
contractual liabilities. As mentioned above, the investment portfolio has
changed since inception. Mortgage loans have decreased from $5.4 billion (37% of
the investment portfolio) at December 31, 1993 to their current level. This was
a result of maturities, prepayments and the securitization and sale of
commercial mortgages. Also, real estate decreased from $.5 billion (4% of the
investment portfolio) at December 31, 1993 to its current level, primarily as a
result of sales. The resulting proceeds were reinvested in debt and equity
securities.
The change in the composition of the overall investment portfolio resulted in a
change in the quality of the portfolio since 1993. As the Company's exposure to
commercial mortgage loans and real estate has diminished, additional investment
return has been achieved by increasing the risk in the bond portfolio. At
December 31, 1993, 60% of the debt securities had a quality rating of AAA or AA,
and at December 31, 2002, 29% of the debt securities had a quality rating of AAA
or AA. However, management believes the level of risk in the total portfolio of
assets supporting discontinued products was lower at December 31, 2002 when
compared to December 31, 1993 due to the reduction of the portfolio's exposure
to mortgage loan and real estate investments.
Distributions on discontinued products were as follows:
(MILLIONS) 2002 2001 2000
--------------------------------------------- ------ ------ ------
Scheduled contract maturities, settlements
and benefit payments...................... $704.0 $835.7 $917.8
Participant-directed withdrawals............ 3.6 5.6 9.6
------ ------ ------
Page 16
Cash required to fund these distributions was provided by earnings and scheduled
payments on, and sales of, invested assets.
At December 31, 2002, scheduled maturities, future benefit payments and other
expected payments, including future interest, were as follows:
(MILLIONS)
--------------
2003.......... $ 575.9
2004.......... 529.6
2005.......... 505.2
2006.......... 493.4
2007.......... 482.0
2008 - 2012... 2,232.3
2013 - 2017... 1,846.9
2018 - 2022... 1,431.1
2023 - 2027... 1,034.3
Thereafter.... 1,605.5
-------------- --------
Refer to Note 12 of Notes to Consolidated Financial Statements and "Total
Investments" for additional information.
CORPORATE INTEREST
Beginning in 2001, overhead costs previously included in Corporate were
integrated into the business segments and are reported in operating expenses,
including salaries and related benefits. Corresponding information for 2000 has
been restated to reflect this change. Corporate interest expense represents
interest incurred on the Company's short-term and long-term debt and is not
recorded in the Company's business segments.
After-tax interest expense was $78 million for 2002, $93 million for 2001 and
$161 million for 2000. The decrease in interest expense for 2002, when compared
to 2001, is primarily a result of lower interest rates and a benefit from the
Company's interest rate swap agreement entered into in December 2001. The
decrease in interest expense for 2001, when compared to 2000, is primarily a
result of lower levels of debt as a result of the spin-off of the Company from
its predecessor, as well as lower short-term rates.
Outlook
Interest expense is expected to be approximately level in 2003, compared to
2002. Refer to "Liquidity and Capital Resources" for more information on the
Company's interest rate swap agreements entered into in December 2002 and
December 2001.
Refer to "Forward-Looking Information/Risk Factors" for information regarding
important factors that may materially affect the Company.
Page 17
Severance and Facilities Charges
The Company has taken a number of actions during the last three years to reduce
operating costs including, among other actions, significant staff reductions and
vacating certain leased facilities. During 2002 and 2001, the Company recorded
severance and facilities charges of $105 million after tax and $125 million
after tax, respectively. As a result of actions related to these charges, the
Company eliminated approximately 7,000 positions and expects to make 2003
severance payments for employee positions eliminated prior to December 31, 2003
and rental payments on facilities to be partially or fully vacated prior to
December 31, 2003, net of anticipated sublease rentals and related costs, of
approximately $89 million after tax. During 2003, as a result of these actions,
the Company also expects a reduction in salary and related benefits and other
operating expenses totaling approximately $283 million after tax and an increase
in after tax cash flows from operating activities of approximately $196 million.
See information below for more details on each charge taken during 2002 and
2001.
Fourth Quarter 2002 Severance and Facilities Charge
In the fourth quarter of 2002, the Company recorded a severance and facilities
charge of $45 million pretax ($29 million after tax) relating to the
implementation of ongoing initiatives that are intended to improve the Company's
overall future performance. The initiatives included further reductions to
operating expenses and the continued reorganization and realignment of Health
Care and Group Insurance operations. This charge included $20 million after tax
for severance activities relating to the planned elimination of approximately
680 employee positions (primarily customer service, information technology and
Group Insurance related positions) and $9 million after tax representing the
present value of the difference between rent required to be paid by the Company
and future sublease rentals expected to be received by the Company relating to
certain leased facilities, or portions of such facilities, that will be vacated.
Severance actions and the vacating of leased facilities relating to the fourth
quarter of 2002 charge are expected to be completed by December 31, 2003.
As a result of these actions, the Company eliminated 321 positions and used
approximately $22 million pretax of reserves through December 31, 2002. Refer to
Note 11 of Notes to Consolidated Financial Statements for more details.
The Company expects to make severance payments for employee positions eliminated
prior to December 31, 2003 of approximately $17 million after tax in 2003 and
approximately $3 million after tax in 2004. Rental payments on facilities to be
partially or fully vacated prior to December 31, 2003, net of anticipated
sublease rentals and related costs, is expected to be approximately $2 million
after tax in 2003 and approximately $9 million after tax in 2004 through 2009.
As a result of these actions, the Company expects a reduction in salary and
related benefit costs of approximately $21 million after tax in 2003 and
approximately $30 million after tax in 2004 and annually thereafter, as well as
a reduction in other operating expenses due to reduced rent expense of
approximately $2 million after tax in 2003 and approximately $9 million after
tax in 2004 through 2009.
The Company expects an after tax increase in future cash flows from operating
activities as a result of the actions being taken in connection with the fourth
quarter charge of approximately $3 million in 2003, approximately $27 million in
2004 and approximately $30 million annually thereafter, reflecting expected cost
savings, net of termination payments.
Page 18
Third Quarter 2002 Severance and Facilities Charge
In the third quarter of 2002, the Company recorded a severance and facilities
charge of $89 million pretax ($58 million after tax) relating to the
implementation of ongoing initiatives intended to improve the Company's overall
future performance. These initiatives included further reductions to operating
expenses and the continued reorganization and realignment of Health Care and
Group Insurance operations. This charge included $53 million after tax for
severance activities relating to the planned elimination of approximately 2,750
employee positions (primarily customer service, plan sponsor services, patient
management, sales, network management and Group Insurance) and $5 million after
tax representing the present value of the difference between rent required to be
paid by the Company and future sublease rentals expected to be received by the
Company relating to certain leased facilities, or portions of such facilities,
that will be vacated. Severance actions and the vacating of leased facilities
relating to the third quarter of 2002 charge are expected to be completed by
September 30, 2003.
As a result of these actions, the Company eliminated 1,805 positions from July
1, 2002 through December 31, 2002 and used approximately $73 million pretax of
reserves through December 31, 2002. Refer to Note 11 of Notes to Consolidated
Financial Statements for more details.
The Company expects to make severance payments for employee positions eliminated
prior to September 30, 2003 relating to the third quarter charge of
approximately $42 million after tax in 2003 and $2 million after tax in 2004.
Rental payments on facilities to be partially or fully vacated prior to
September 30, 2003, net of anticipated sublease rentals and related costs, are
expected to be approximately $2 million after tax in 2003 and approximately $3
million after tax in 2004 through completion in 2009.
As a result of these actions, the Company expects to reduce salary and related
benefit costs by approximately $79 million after tax in 2003 and approximately
$93 million after tax annually thereafter, as well as a reduction in other
operating expenses due to reduced rent expense of approximately $1 million after
tax in 2003 and approximately $3 million after tax in 2004 through 2009.
The Company expects an after tax increase in future cash flows from operating
activities as a result of the actions being taken in connection with the third
quarter charge of approximately $37 million in 2003, approximately $91 million
in 2004 and approximately $93 million annually thereafter, reflecting expected
cost savings, net of termination payments.
Second Quarter 2002 Severance Charge
In the second quarter of 2002, the Company recorded a severance charge of $27
million pretax ($18 million after tax) relating to the implementation of ongoing
initiatives that are intended to improve the Company's overall future
performance. These initiatives include further reductions to operating expenses
and the continued reorganization and realignment of Health Care operations. As a
result of these initiatives, the Company eliminated 527 positions (primarily
regional field management, information technology and medical service functions)
from April 1, 2002 through December 31, 2002 resulting in a reduction of the
severance reserve of approximately $27 million pretax. Severance actions
relating to the second quarter of 2002 severance charge were substantially
completed by December 31, 2002. Refer to Note 11 of Notes to Consolidated
Financial Statements for more details.
As a result of these actions, the Company expects to make severance payments for
employee positions eliminated of approximately $5 million after tax in 2003.
The Company expects to reduce salary and related benefit costs by approximately
$26 million after tax in 2003 and annually thereafter.
Page 19
As a result of these actions, the Company expects an after tax increase in
future cash flows from operating activities of approximately $21 million in 2003
and approximately $26 million annually thereafter, reflecting expected cost
savings, net of termination payments.
2001 Severance and Facilities Charge
In the fourth quarter of 2001, the Company recorded a severance and facilities
charge of $193 million pretax ($125 million after tax) relating to the
implementation of initiatives that are intended to improve the Company's overall
future performance. These initiatives included seeking to reduce 2002 expenses,
reorganization and realignment of Health Care operations to better align our
business resources with our customer market-focused approach, business process
improvements, product market withdrawals, continued migration off the Prudential
Health Care systems and vacating certain facilities (primarily customer
service-related locations). This charge included $85 million after tax for
severance activities relating to the planned elimination of approximately 4,400
employee positions (primarily customer service and regional field management
functions) and $40 million after tax representing the present value of the
difference between rent required to be paid by the Company and future sublease
rentals expected to be received by the Company relating to certain leased
facilities, or portions of such facilities, that were vacated. As a result of
these actions, the Company eliminated 3,487 positions and used approximately
$143 million pretax of reserves in 2002 and eliminated 757 positions and used
approximately $50 million pretax of reserves in 2001. Severance actions and the
vacating of leased facilities relating to the fourth quarter of 2001 severance
and facilities charge, as aligned to better reflect service operations
consistent with its customer market approach, were completed by December 31,
2002. Refer to Note 11 of Notes to Consolidated Financial Statements for more
details.
Results of Discontinued Operations
In December 2000, the Company was spun off from its predecessor, former Aetna,
and is considered the successor for accounting purposes. Accordingly, the
account balances and activities of former Aetna's financial services and
international businesses for periods prior to December 13, 2000 have been
segregated and reported as discontinued operations. The Company reported income
from discontinued operations of $255 million in 2000. Income from discontinued
operations in 2000 includes a charge for the reserve for net costs associated
with the transaction of approximately $174 million after tax. These costs, which
were directly associated with the sale of former Aetna's financial services and
international businesses, were included in the results of discontinued
operations for 2000 and related to certain compensation-related arrangements,
costs for outside financial and legal advisors, income taxes related to legal
entity realignment, payments for the settlement of certain former Aetna employee
stock options held by employees of the sold businesses and various other
expenses related to the change in control of former Aetna. During the fourth
quarter of 2001, the Company reduced the reserve for such costs by approximately
$11 million after tax, which management determined were no longer necessary.
Included in the cost associated with the transaction was the release of
approximately $53 million of previously established reserves in connection with
prior dispositions of businesses reflected as discontinued operations. Refer to
Note 21 of Notes to Consolidated Financial Statements for more details on the
results of discontinued operations.
The Company released $50 million of federal income tax reserves resulting from
the resolution of several Internal Revenue Service audit issues during the first
quarter of 2002 that related to the property and casualty insurance business of
former Aetna, which was sold in 1996.
Page 20
TOTAL INVESTMENTS
Investments disclosed in this section relate to the Company's total portfolio
(including assets supporting discontinued products and experience-rated
products).
Total investments at December 31 were as follows:
(MILLIONS) 2002 2001
----------------------------------- --------- ---------
Debt securities available for sale. $13,379.1 $13,446.0
Loaned securities.................. 948.2 608.1
--------- ---------
Total debt securities.............. 14,327.3 14,054.1
Mortgage loans..................... 1,773.2 2,045.0
Equity securities.................. 93.2 242.1
Other investment securities........ 605.3 689.2
Investment real estate............. 308.8 359.7
Other (1).......................... 1,790.5 1,472.9
--------- ---------
Total investments.................. $18,898.3 $18,863.0
========= =========
--------------
(1) Amount includes restricted debt securities on deposit as required by
regulatory authorities of $747.5 million at December 31, 2002 and $691.6
million at December 31, 2001 included in long-term investments on the
Consolidated Balance Sheets.
DEBT AND EQUITY SECURITIES
Debt securities represented 76% at December 31, 2002 and 75% at December 31,
2001 of the Company's total general account invested assets and supported the
following types of products:
(MILLIONS) 2002 2001
---------------------------------------- --------- ---------
Supporting discontinued products........ $ 3,648.1 $ 3,705.7
Supporting experience-rated products.... 2,303.2 2,167.4
Supporting remaining products........... 8,376.0 8,181.0
--------- ---------
Total debt securities................... $14,327.3 $14,054.1
========= =========
The debt securities in the Company's portfolio are generally rated by external
rating agencies and, if not externally rated, are rated by the Company on a
basis believed to be similar to that used by the rating agencies. The Company's
investments in debt securities had an average quality rating of A+ at December
31, 2002 and 2001 (34% and 32% were AAA at December 31, 2002 and 2001,
respectively). "Below investment grade" debt securities carry a rating of below
BBB-/Baa3 and represented 5% and 7% of the portfolio at December 31, 2002 and
December 31, 2001, respectively, of which 22% at December 31, 2002 and 23% at
December 31, 2001, support discontinued and experience-rated products. Refer to
Note 7 of Notes to Consolidated Financial Statements for disclosures related to
debt securities by market sector.
The Company has classified its debt and equity securities as available for sale
and carries them at fair value. Fair values for such securities are based on
quoted market prices. Non-traded debt securities are priced independently by a
third-party vendor and non-traded equity securities are priced based on an
internal analysis of the investment's financial statements and cash flow
projections. The carrying value of non-traded debt and equity securities as of
December 31, 2002 and 2001 were as follows.
DECEMBER 31, 2002 DECEMBER 31, 2001
------------------------------ ------------------------------
DEBT EQUITY DEBT EQUITY
(MILLIONS) SECURITIES SECURITIES TOTAL SECURITIES SECURITIES TOTAL
------------------------- ---------- ---------- ------ ---------- ---------- ------
Supporting discontinued
and experience-rated
products............... $531.8 $11.2 $543.0 $759.6 $15.8 $775.4
Supporting remaining
products............... 19.9 7.3 27.2 31.3 10.1 41.4
Total non-traded
securities............. $551.7 $18.5 $570.2 $790.9 $25.9 $816.8
Page 21
Debt securities reflect net unrealized capital gains of $859 million (comprised
of gross unrealized capital gains of $949 million and gross unrealized losses of
$90 million) at December 31, 2002 compared with net unrealized capital gains of
$266 million (comprised of gross unrealized capital gains of $470 million and
gross unrealized losses of $204 million) at December 31, 2001. Of the net
unrealized capital gains at December 31, 2002, $295 million relate to assets
supporting discontinued products and $159 million relate to experience-rated
products. Of the net unrealized capital gains at December 31, 2001, $107 million
relate to assets supporting discontinued products and $64 million relate to
experience-rated products.
Equity securities reflect net unrealized capital gains of $2 million (comprised
of gross unrealized capital gains of $7 million and gross unrealized losses of
$5 million) at December 31, 2002 compared with net unrealized capital gains of
$8 million (comprised of gross unrealized capital gains of $24 million and gross
unrealized losses of $16 million) at December 31, 2001.
If management believes a decline in the value of a particular investment is
temporary, the decline is recorded as an unrealized loss in Shareholders'
Equity, consistent with the guidance of FAS No. 115, Accounting for Certain
Investments in Debt and Equity Securities. If the decline is
"other-than-temporary", the carrying value of the investment is written down and
a realized loss is recorded in the Consolidated Statement of Income. The
Company's impairment analysis is discussed in more detail in Capital Gains and
Losses below. As of December 31, 2002 and 2001, the amount of gross unrealized
losses and related fair value, by investment type included in our Shareholders'
Equity were as follows:
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------------------- -----------------------------
(MILLIONS) FAIR VALUE UNREALIZED LOSSES FAIR VALUE UNREALIZED LOSSES
---------------------------------- ---------- ----------------- ---------- -----------------
Debt securities:
Supporting discontinued and
experienced-rated products... $ 495.4 $54.3 $1,697.0 $ 97.6
Supporting remaining
products..................... 804.9 35.8 2,347.3 106.4
-------- ----- -------- ------
Total............................. $1,300.3 $90.1 $4,044.3 $204.0
======== ===== ======== ======
Equity securities:
Supporting discontinued and
experienced-rated products... $ 7.5 $ 4.2 $ 38.5 $ 3.8
Supporting remaining
products..................... 1.2 .4 16.2 11.9
-------- ----- -------- ------
Total............................. $ 8.7 $ 4.6 $ 54.7 $ 15.7
======== ===== ======== ======
At December 31, 2002 and 2001, debt and equity securities which were
non-investment grade and non-rated represented approximately 2.3% and 3.5%,
respectively, of the total debt and equity security portfolio (.7% related to
non-investment grade and non-rated debt and equity securities supporting
experience-rated and discontinued products at December 31, 2002 and 2001) and
approximately 54.0% and 54.2%, respectively, of total unrealized losses related
to securities which were non-investment grade and non-rated (30.8% and 20.5%,
respectively, related to securities supporting experience-rated and discontinued
products).
Page 22
As of December 31, 2002 and 2001, the amount of unrealized losses and related
fair value for debt and equity securities in an unrealized loss position for
greater than nine months were as follows:
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------------------- -----------------------------
(MILLIONS) FAIR VALUE UNREALIZED LOSSES FAIR VALUE UNREALIZED LOSSES
---------------------------------- ---------- ----------------- ---------- -----------------
Debt and equity securities:
Supporting discontinued and
experienced-rated products... $321.4 $41.8 $ 685.4 $ 63.3
Supporting remaining
products..................... 218.3 26.2 405.0 72.9
------ ----- -------- ------
Total (1)......................... $539.7 $68.0 $1,090.4 $136.2
====== ===== ======== ======
--------------
(1) At December 31, 2002, securities with a fair value of less than 80% of
amortized costs had a fair value of $24.0 million and unrealized losses of
$9.2 million (includes securities supporting discontinued and
experience-rated products with a fair value of $7.1 million and unrealized
losses of $2.0 million). At December 31, 2001, securities with a fair value
of less than 80% of amortized cost had a fair value of $85.5 million and
unrealized losses of $79.3 million (includes securities supporting
discontinued and experience-rated products with a fair value of $40.9
million and unrealized losses of $29.5 million).
The Company had no material unrealized losses on individual debt or equity
securities at December 31, 2002 or 2001.
The maturity dates for debt securities in an unrealized loss position as of
December 31, 2002 and 2001 were as follows:
DECEMBER 31, 2002
-----------------------------------------------------------------
SUPPORTING
DISCONTINUED
AND EXPERIENCE-RATED SUPPORTING REMAINING
PRODUCTS PRODUCTS TOTAL
-------------------- -------------------- ---------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
(MILLIONS) VALUE LOSSES VALUE LOSSES VALUE LOSSES
----------------------------- ------ ----------- ------ ----------- -------- ----------
Due to mature:
Less than one year........ $ 25.5 $ 4.6 $ 27.9 $ 1.7 $ 53.4 $ 6.3
One year through five 30.5 3.6 216.9 5.3 247.4 8.9
years...................
After five years through 47.7 5.4 198.9 9.5 246.6 14.9
ten years
Greater than ten years.... 391.7 40.7 350.7 19.3 742.4 60.0
Mortgage-backed -- -- 10.5 -- 10.5 --
securities..............
------ ----- ------ ----- -------- -----
Total........................ $495.4 $54.3 $804.9 $35.8 $1,300.3 $90.1
====== ===== ====== ===== ======== =====
DECEMBER 31, 2001
-----------------------------------------------------------------
SUPPORTING
DISCONTINUED
AND EXPERIENCE-RATED SUPPORTING REMAINING
PRODUCTS PRODUCTS TOTAL
-------------------- -------------------- ---------------------
FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED
(MILLIONS) VALUE LOSSES VALUE LOSSES VALUE LOSSES
----------------------------- -------- ---------- -------- ---------- -------- ----------
Due to mature:
Less than one year........ $ 3.0 $ -- $ 5.9 $ 0.1 $ 8.9 $ 0.1
One year through five
years................... 119.4 6.5 344.0 27.0 463.4 33.5
After five years
through ten years....... 322.7 33.0 886.1 34.7 1,208.8 67.7
Greater than ten years.... 1,146.8 57.0 751.3 41.3 1,898.1 98.3
Mortgage-backed
securities.............. 105.1 1.1 360.0 3.3 465.1 4.4
-------- ----- -------- ------ -------- ------
Total........................ $1,697.0 $97.6 $2,347.3 $106.4 $4,044.3 $204.0
======== ===== ======== ====== ======== ======
Page 23
Capital Gains and Losses
The Company periodically reviews its debt and equity securities to determine
whether a decline in fair value below the carrying value is other than
temporary. If a decline in market value is considered other than temporary, the
cost basis/carrying amount of the security is written down and the amount of the
write-down is included in earnings. The Company analyzes all relevant facts and
circumstances for each investment when performing this analysis, in accordance
with the guidance of FAS No. 115 and the Securities and Exchange Commission's
Staff Accounting Bulletin No. 59, Accounting for Noncurrent Marketable Equity
Securities. The available guidance on the determination of whether a decline in
the value of an investment is other-than-temporary requires management to
exercise significant diligence and judgment in the consideration of whether an
unrealized loss is other-than-temporary.
Among the factors considered in evaluating whether a decline is
other-than-temporary, management considers whether the decline in fair value
results from a change in the quality of the investment security itself, whether
the decline results from a downward movement in the market as a whole, the
prospects for realizing the carrying value of the security based on the
investee's current and short-term prospects for recovery and other factors. For
unrealized losses deemed to be the result of market conditions (e.g., increasing
interest rates, volatility due to conditions in the overall market, etc.) or
industry-related events, the Company determines if there exists an expectation
for a reasonable market recovery and whether management has the intent and
ability to hold the investment until maturity or market recovery is realized. In
such a case, an other-than-temporary impairment is generally not recognized.
The Company measures other-than-temporary losses based on the valuation of an
investment, including in-house credit analyst expectations of future
performance, the current market environment and current market values. Based on
the Company's evaluation, if any factors reviewed, individually or in
combination, indicate that a decline in fair value below its carrying value is
other-than-temporary, the Company records an impairment charge in earnings.
The risks inherent in assessing the impairment of an investment include the risk
that market factors may differ from the Company's expectations; facts and
circumstances factored into our assessment may change with the passage of time;
or the Company may decide to subsequently sell the investment.
For 2002, net realized capital gains were $34 million ($22 million after tax)
and included net investment write-downs of $83 million ($54 million after tax).
The majority of these impairments were taken in the telecommunications and
transportation sectors. Throughout 2002, the market values of telecommunication
companies and assets declined precipitously, resulting in the bankruptcy of
numerous companies, resulting in the Company's decision to impair these
investments. Also, during 2002, impairments were taken in the transportation
sector as the market values of companies in the airline industry declined
significantly as a result of widespread financial difficulties. For 2001, net
realized capital gains were $96 million ($74 million after tax) and included net
investment write-downs of $49 million ($32 million after tax). In 2001, the
majority of the impairment losses recognized were taken in the
telecommunications sector as the market values of high-yield telecommunication
companies declined primarily as a result of their inability to raise capital.
For the year ended December 31, 2000, net realized capital losses were $40
million ($14 million after tax) and include net investment write-downs of $58
million ($38 million after tax). In 2000, the majority of the impairments were
taken in the banking/finance and telecommunications sectors. The factors
contributing to the impairment losses recognized in 2002, 2001 and 2000 did not
impact other material investments held at the time. The Company had no material
realized losses on individual debt or equity securities during 2002 or 2001.
Page 24
The Company has been able to earn contingent consideration under a long-term
strategic provider relationship with Magellan, the purchaser of HAI. The Company
recognized the final installment of this contingent consideration under this
agreement of approximately $60 million pretax during the second quarter of 2002.
This amount was due in February 2003, but was not paid and Magellan has
announced that it is experiencing financial difficulties. Based on the Company's
discussions with Magellan regarding their plans to address these issues, the
Company currently believes it will ultimately recover the full amount due.
Mortgage Loans
The Company's mortgage loan investments, net of impairment reserves, supported
the following types of products:
(MILLIONS) 2002 2001
---------------------------------------- -------- --------
Supporting discontinued products ... $ 763.2 $ 822.1
Supporting experience-rated products 387.6 563.1
Supporting remaining products ...... 622.4 659.8
-------- --------
Total mortgage loans ............... $1,773.2 $2,045.0
======== ========
The mortgage loan portfolio balance represented 9% and 11% of the Company's
total invested assets at December 31, 2002 and 2001, respectively. Problem,
restructured and potential problem loans included in mortgage loans were $51
million at December 31, 2002 and $174 million at December 31, 2001, of which 82%
at December 31, 2002 and 92% at December 31, 2001 support discontinued and
experience-rated products. Specific impairment reserves on these loans were $11
million at December 31, 2002 and $26 million at December 31, 2001. Refer to
Notes 2 and 7 of Notes to Consolidated Financial Statements for additional
information.
At December 31, 2002 scheduled mortgage loan principal repayments were as
follows:
(MILLIONS)
------------
2003........ $261.0
2004........ 156.6
2005........ 81.5
2006........ 136.8
2007........ 251.1
Thereafter.. 897.5
---------- ------
Outlook
Net investment income is projected to be lower for 2003, compared to 2002, due
primarily to lower yields.
Risk Management and Market-sensitive Instruments
The Company manages interest rate risk by seeking to maintain a tight duration
band where appropriate, while credit risk is managed by seeking to maintain high
average quality ratings and diversified sector exposure within the debt
securities portfolio. In connection with its investment and risk management
objectives, the Company also uses financial instruments whose market value is at
least partially determined by, among other things, levels of or changes in
interest rates (short-term or long-term), duration, prepayment rates, equity
markets or credit ratings/spreads. The Company's use of derivatives is generally
limited to hedging purposes and has principally consisted of using interest rate
swap agreements, forward contracts and futures contracts. These instruments,
viewed separately, subject the Company to varying degrees of interest rate,
equity price and credit risk. However, when used for hedging, the expectation is
that these instruments would reduce overall risk. Refer to "Liquidity and
Capital Resources - Long-term Debt" and Note 8 of Notes to Consolidated
Financial Statements for additional information.
Page 25
The Company regularly evaluates the risk of market-sensitive instruments by
examining, among other things, levels of or changes in interest rates
(short-term or long-term), duration, prepayment rates, equity markets or credit
ratings/spreads. The Company also regularly evaluates the appropriateness of
investments relative to its management-approved investment guidelines (and
operates within those guidelines) and the business objective of the portfolios.
The risks associated with investments supporting experience-rated pension and
annuity products in the Large Case Pensions business are assumed by those
contractholders and not by the Company (subject to, among other things, certain
minimum guarantees). Anticipated future losses associated with investments
supporting discontinued fully guaranteed large case pension products are
provided for in the reserve for anticipated future losses (refer to "Large Case
Pensions - Discontinued Products").
Management also reviews, on a quarterly basis, the impact of hypothetical net
losses in the Company's consolidated near-term financial position, results of
operations and cash flows assuming certain reasonably possible changes in market
rates and prices were to occur. The potential effect of interest rate risk on
near-term net income, cash flow and fair value was determined based on commonly
used models. The models project the impact of interest rate changes on a wide
range of factors, including duration, prepayment, put options and call options.
Fair value was estimated based on the net present value of cash flows or
duration estimates using a representative set of likely future interest rate
scenarios. The assumptions used were as follows: an immediate increase of 100
basis points in interest rates (which the Company believes represents a
moderately adverse scenario and is approximately equal to the historical annual
volatility of interest rate movements for the Company's intermediate-term
available-for-sale debt securities) and an immediate decrease of 25% in prices
for domestic equity securities.
Based on the Company's overall exposure to interest rate risk and equity price
risk, the Company believes that these changes in market rates and prices would
not materially affect the consolidated near-term financial position, results of
operations or cash flows of the Company as of December 31, 2002.
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. The
Company monitors the duration of its debt securities portfolio (which is highly
marketable) and mortgage loans, and executes its purchases and sales of these
investments with the objective of having adequate funds available to satisfy the
Company's maturing liabilities. Overall cash flows are used primarily for claim
and benefit payments, contract withdrawals and operating expenses.
Cash flows provided by (inflow) operating activities were approximately $306
million for 2002. Excluding the impact of changes in insurance reserves related
to the Large Case Pensions business segment which are included in operating
activities but are funded from sales of investments, cash flows provided by
operating activities were approximately $579 million. Uses of operating cash
reflect the payment of approximately $974 million from estimated reserves the
Company held for members that lapsed during 2002. This was partially offset by
the collection of an estimated $170 million of premiums receivable for these
lapsed members. Cash flows provided by operating activities also reflect
approximately $176 million for payments related to actions covered by severance
and facilities reserves. Refer to the "Consolidated Statements of Cash Flows"
for additional information.
In 2003, the Company expects cash flows from operations to be significantly less
than income levels due primarily to continued medical claim payments for lapsed
members and payments on severance and facilities reserves.
Page 26
Dividends
On September 27, 2002, the Board declared an annual cash dividend of $.04 per
common share to shareholders of record at the close of business on November 15,
2002. The dividend was paid on November 29, 2002. The Board reviews the
Company's common stock dividend annually. Among the factors considered by the
Board in determining the amount of the dividend are the Company's results of
operations and the capital requirements, growth and other characteristics of its
businesses.
Financings, Financing Capacity and Capitalization
At December 31, 2002, the Company's borrowings were $1.6 billion of long-term
senior notes and there was no short-term debt outstanding. The Company's total
debt to capital ratio (total debt divided by total debt and shareholders'
equity, adjusted for unrealized gains or losses on available-for-sale investment
securities) was 19.6% at December 31, 2002. Refer to Note 15 of Notes to
Consolidated Financial Statements for additional information.
The ratings of Aetna Inc. and its subsidiaries follow:
RATING AGENCIES
------------------------------------------------------
MOODY'S
INVESTORS STANDARD
A.M.BEST FITCH** SERVICE & POOR'S
-------- ------- ---------- ---------
Aetna Inc. (senior debt)
October 30, 2002 .................. * BBB+ Baa3 BBB
February 27, 2003 (1) ............. * BBB+ Baa3 BBB
Aetna Inc. (commercial paper)
October 30, 2002 .................. * F2 P3 A2
February 27, 2003 (1) ............. * F2 P3 A2
Aetna Life Insurance Company ("ALIC")
(financial strength)
October 30, 2002 .................. A- A+ A3 A-
February 27, 2003 (1) ............. A- A+ A3 A-
--------------
* Nonrated by the agency.
** Formerly known as Duff & Phelps.
(1) A.M. Best has the ALIC rating on outlook-positive. Fitch has the Aetna Inc.
senior debt and ALIC ratings on outlook-stable. Moody's has the Aetna Inc.
senior debt and commercial paper and ALIC ratings on outlook-stable.
Standard & Poor's has the Aetna Inc. senior debt and ALIC ratings on
outlook-stable.
On February 13, 2002, Moody's Investors Service downgraded the Company's senior
debt rating from Baa2 to Baa3, the Company's commercial paper rating from P2 to
P3 and ALIC's financial strength rating from A2 to A3. This downgrade has not
materially affected either the Company's ability to borrow or the cost of
borrowing. The Company's ability to borrow under its commercial paper program,
as well as the cost of such borrowings, could be adversely affected if its
ratings were downgraded further, however a ratings downgrade would not affect
the Company's ability to borrow under its revolving credit facilities as an
alternative. On January 14, 2003, Fitch improved its ratings outlook from
negative to stable for the Company's senior debt rating and ALIC's financial
strength rating. On January 30, 2003, A.M. Best improved its ratings outlook
from stable to positive for ALIC's financial strength rating.
The Company continually monitors existing and alternative financing sources to
support its capital and liquidity needs, including, but not limited to, debt
issuance, preferred or common stock issuance and pledging or selling of assets.
Page 27
Long-term Debt
On February 14, 2001, the Company filed a shelf registration statement with the
Securities and Exchange Commission to sell debt securities, from time to time,
up to a total of $2 billion, with the amount, price and terms to be determined
at the time of the sale. On March 2, 2001, the Company issued $900 million of
senior notes under this shelf registration statement consisting of $450 million
of 7.375% senior notes due in 2006 and $450 million of 7.875% senior notes due
in 2011. On June 18, 2001, the Company issued, under this shelf registration
statement, an additional $700 million of 8.5% senior notes due in 2041. Net
proceeds from these issuances totaled approximately $1.6 billion and were used
to reduce outstanding commercial paper borrowings.
In December 2001, the Company entered into an interest rate swap agreement to
convert the fixed rate of 8.5% on $350 million of its senior notes to a variable
rate of three-month LIBOR plus 159.5 basis points (approximately 3.02% at
December 31, 2002). In December 2002, the Company also entered into an interest
rate swap agreement to convert the fixed rate of 8.5% on an additional $200
million of its senior notes to a variable rate of three-month LIBOR plus 254.0
basis points (approximately 3.95% at December 31, 2002). As a result of these
swap agreements, the Company's effective interest rate on its long-term debt was
6.99% during 2002. In accordance with the Company's accounting policy for fair
value hedges, the change in the fair value of the interest rate swaps and the
loss or gain on the hedged senior notes attributable to the hedged interest rate
risk are recorded in current period earnings. No material changes in value
occurred during the period ended December 31, 2002. Because the terms of the
interest rate swap agreements match the terms of the senior notes, the gain or
loss on the swaps and the senior notes will generally be offsetting. The swap
agreements contain bilateral credit protection covenants which, depending on
credit ratings, obligates each party to post collateral equal to the fair value
of the swaps. As of February 26, 2003, the Company was not required to post
collateral for the $350 million interest rate swap, but did post $2 million for
the $200 million interest rate swap.
Short-term Debt
The Company has significant short-term liquidity supporting its businesses. The
Company uses short-term borrowings from time to time to address timing
differences between cash receipts and disbursements. The maximum amount of
domestic short-term borrowings outstanding during 2002 was $145 million. The
Company's short-term borrowings consist of a commercial paper program that
relies on backup revolving credit facilities, which together provide for an
aggregate borrowing capacity of $800 million. The Company's credit facilities
consist of a $300 million credit facility which terminates in November 2003 and
a $500 million credit facility which terminates in November 2005.
These facilities contain financial covenants. Under the terms of its credit
facilities, the Company is required to maintain a minimum level of shareholders'
equity, excluding net unrealized capital gains and losses, as of each fiscal
quarter end. The required minimum level is increased by 50% of the Company's
consolidated net income each quarter beginning with the quarter ending March 31,
2003, and is decreased by up to $150 million for certain non-recurring after-tax
charges ("excluded charges"). At December 31, 2002, the Company met its required
minimum level of approximately $5 billion. The Company is also required to
maintain its ratio of total debt to consolidated earnings as of each fiscal
quarter end at or below 3.0. For this purpose, consolidated earnings equals, for
the period of four consecutive quarters, net income plus interest expense,
income tax expense, depreciation expense, amortization expense, certain excluded
charges, the goodwill impairment resulting from the adoption of FAS No. 142 and
any extraordinary gains or losses. The Company met this requirement at December
31, 2002. Failure to meet the financial covenants would affect both the
Company's ability to borrow under the facilities and the commercial paper
program.
Page 28
Common Stock Transactions
During the second quarter of 2002, the Company repurchased approximately 2.1
million shares of common stock at a cost of approximately $104 million,
completing a previous share repurchase program. On June 28, 2002, the Board
authorized a new share repurchase program for the repurchase of up to 5 million
shares of common stock (not to exceed an aggregate purchase price of $250
million). During the remainder of 2002, the Company repurchased approximately
1.5 million shares of common stock at a cost of approximately $61 million. Also,
during 2002, the Company issued approximately 9.3 million shares of common stock
for benefit plans, including approximately 8.4 million shares related to stock
option exercises. Refer to Note 16 of Notes to Consolidated Financial Statements
for further discussion related to the Company's stock option grant to eligible
employees and Note 14 of Notes to Consolidated Financial Statements for
information on the shareholder approved Employee Stock Purchase Plan.
For the full year 2002, the Company had weighted average common shares,
including common share equivalents, of approximately 153 million (refer to Note
5 of Condensed Notes to Consolidated Financial Statements).
Financing Obligations
The Company's financing obligations generally include debt, lease payment
obligations and commitments to fund certain of its investments in equity limited
partnership investments and commercial mortgage loans. At December 31, 2002,
annual payments required by the Company, through 2007, relating to these
financing obligations were as follows:
(MILLIONS) 2003 2004 2005 2006 2007
---------------------------------------------- ------ ------ ------ ------ ------
Long-term debt (1)............................ $128.1 $128.1 $128.1 $550.4 $ 94.9
Noncancelable leases.......................... 181.8 147.5 112.1 81.8 67.6
Funding requirements for equity limited
partnership investments..................... 151.7 51.1 32.0 30.0 14.4
Funding requirements for commercial mortgage
loans....................................... 44.0 -- -- -- --
------ ------ ------ ------ ------
Total......................................... $505.6 $326.7 $272.2 $662.2 $176.9
====== ====== ====== ====== ======
--------------
(1) The interest payments for each of the periods presented do not consider the
Company's interest rate swap agreements.
Noncancelable lease payments in the table above include approximately $11
million in 2003 declining to approximately $7 million in 2007 relating to a
leasing program with an independent third party grantor trust primarily for the
lease of a corporate aircraft and certain office furniture. The total value of
the assets under this leasing program at December 31, 2002 was approximately $54
million. For 2002, this arrangement was classified as an operating lease and
therefore the related assets and liabilities are not included in the Company's
Consolidated Balance Sheet. Beginning with the third quarter of 2003, the
Company will consolidate this entity in accordance with Financial Accounting
Standards Board Interpretation No. 46, Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51 (refer to Note 2 of Notes to
Consolidated Financial Statements for more information). The Company may
terminate the lease program at any time by purchasing the assets at cost or
dissolving the grantor trust through liquidation. If the assets were sold to a
third party at less than cost to the grantor trust, the Company's maximum
exposure under a residual value guarantee was approximately $48 million as of
December 31, 2002.
The Company also uses derivative instruments, generally limited to hedging
purposes, principally consisting of interest rate swap agreements, forward
contracts and futures contracts. These derivative instruments are not expected
to materially adversely affect the near-term financial position or cash flows of
the Company. Refer to "Total Investments - Risk Management and Market-Sensitive
Investments" for more information.
Page 29
Other than as noted above, the Company does not have any material off-balance
sheet arrangements, trading activities involving non-exchange traded contracts
accounted for at fair value or relationships with persons or entities that
derive benefits from a non-independent relationship with the Company or the
Company's related parties.
Restrictions On Certain Payments by the Company
In addition to general state law restrictions on payments of dividends and other
distributions to shareholders applicable to all corporations, HMOs and insurance
companies are subject to further state regulations that, among other things, may
require those companies to maintain certain levels of equity, and restrict the
amount of dividends and other distributions that may be paid to their parent
corporations. These regulations are not directly applicable to Aetna Inc., as a
holding company, since it is not an HMO or insurance company. The additional
regulations applicable to Aetna Inc.'s HMO and insurance company subsidiaries
are not expected to affect the ability of Aetna Inc. to service its debt, meet
its other financing obligations or pay dividends, or the ability of any of Aetna
Inc.'s subsidiaries to service debt or other financing obligations, if any.
Under regulatory requirements, the amount of dividends that may be paid to Aetna
Inc. by its domestic insurance and HMO subsidiaries at December 31, 2002 without
prior approval by state regulatory authorities is approximately $505 million in
the aggregate.
Solvency Regulation
The National Association of Insurance Commissioners ("NAIC") utilizes risk-based
capital ("RBC") standards for life insurance companies that are designed to
identify weakly capitalized companies by comparing each company's adjusted
surplus to its required surplus ("RBC ratio"). The RBC ratio is designed to
reflect the risk profile of life insurance companies. Within certain ratio
ranges, regulators have increasing authority to take action as the RBC ratio
decreases. There are four levels of regulatory action, ranging from requiring
insurers to submit a comprehensive plan to the state insurance commissioner to
requiring the state insurance commissioner to place the insurer under regulatory
control. At December 31, 2002, the RBC ratio of each of the Company's primary
insurance subsidiaries was above the level that would require regulatory action.
The RBC framework described above for insurers has been extended by the NAIC to
health organizations, including HMOs. Although not all states had adopted these
rules at December 31, 2002, at that date, each of the Company's active HMOs had
a surplus that exceeded either the applicable state net worth requirements or,
where adopted, the levels that would require regulatory action under the NAIC's
RBC rules. Refer to Note 17 of Notes to Consolidated Financial Statements for
information relating to the rules on codification of statutory accounting
principles. External rating agencies use their own RBC standards as part of
determining a company's rating.
Critical Accounting Policies
The accounting policies described below are those the Company considers critical
in preparing its Consolidated Financial Statements. These policies include
significant estimates made by management using information available at the time
the estimates are made. However, as described below, these estimates could
change materially if different information or assumptions were used. Also, these
estimates may not ultimately reflect the actual amounts of the final
transactions that occur. The descriptions below are summarized and have been
simplified for clarity. A more detailed description of the significant
accounting policies used by the Company in preparing its financial statements is
included in Note 2 of Notes to the Consolidated Financial Statements.
Page 30
Revenue Recognition (Allowance for Estimated Terminations and Uncollectable
Accounts)
The Company's revenue is principally derived from premiums and fees billed to
customers in the Health Care and Group Insurance businesses. In Health Care,
revenue is recognized based on customer billings, which reflect contracted rates
per employee and the number of covered employees recorded in Company records at
the time the billings are prepared. Billings are generally sent monthly for
coverage during the following month. In Group Insurance, premium for group life
and disability products is recognized as revenue, net of allowances for
uncollectable accounts, over the term of coverage. Amounts received before the
period of coverage begins are recorded as unearned premiums.
Health Care billings may be subsequently adjusted to reflect changes in the
number of covered employees due to terminations, etc. These adjustments are
known as retroactivity adjustments. The Company estimates the amount of future
retroactivity each period and adjusts the billed revenue accordingly. The
estimates are based on historical trends, premiums billed, the amount of
contract renewal activity during the period and other relevant information. As
information regarding actual retroactivity becomes known, the Company refines
its estimates and records any required adjustments at that time. A significant
change in the level of retroactivity would have a significant effect on Health
Care's results of operations.
The Company also estimates the amount of uncollectable receivables each period
and establishes an allowance for uncollectable amounts. The amount of the
allowance is based on the age of unpaid amounts, information about the
creditworthiness of customers, and other relevant information. Estimates of
uncollectable amounts are revised each period, and changes are recorded in the
period they become known. A significant change in the level of uncollectable
amounts would have a significant effect on the Company's results of operations.
Health Care and Insurance Liabilities
The Company establishes health care and insurance liabilities for benefit claims
that have been reported but not paid, claims that have been incurred but not
reported and future policy benefits earned under insurance contracts. These
reserves and the related benefit expenses are developed using actuarial
principles and assumptions which consider a number of factors, including
historical claim payment patterns and seasonality, which are described in the
Notes to the Consolidated Financial Statements. For Health Care, the factor that
has the greatest impact on the Company's financial results is the medical cost
trend, which is the rate of increase in health care costs. For Group Insurance,
the important factors considered are the level of interest rates, expected
investment returns, mortality rates, the rate that covered individuals suffer
disability, and the recovery rate of those with disabilities.
Each period, the Company estimates the relevant factors, based primarily on
historical data and uses this information to determine the assumptions
underlying its reserve calculations. An extensive degree of judgment is used in
this estimation process. For health care costs payable, the reserve balances and
the related benefit expenses are highly sensitive to changes in the assumptions
used in the reserve calculations. For example, a 100 basis point change in the
estimated medical cost trend for Commercial HMO Risk products would have changed
annual after-tax results by approximately $50 million for 2002. Any adjustments
to prior period reserves are included in the benefit expense of the period in
which the need for the adjustment becomes known. Due to the considerable
variability of health care costs, adjustments to health reserves occur each
quarter and are sometimes significant. For Group Insurance, and specifically
disability reserves, a 100 basis point change in interest rates would result in
approximately a 10 basis point change in the portfolio return rate for assets
supporting these liabilities, due to the long-term nature of disability
liabilities and related assets supporting these liabilities. A 10 basis point
change in the portfolio rate would have changed after-tax results by
approximately $2 million for 2002.
Page 31
The Company discontinued certain Large Case Pensions products in 1993 and
established a reserve to cover losses expected during the runoff period. Since
1993, there have been several adjustments to reduce this reserve that have
increased net income. These adjustments occurred primarily because investment
experience as well as mortality and retirement experience have been better than
was projected at the time the products were discontinued. There can be no
assurance that adjustments to the discontinued products reserve will occur in
the future or that they will increase net income.
In cases where estimated health care and group insurance costs are so high that
future losses on a given product are expected, the Company establishes premium
deficiency reserves for the amount of the expected loss in excess of expected
future premiums. Any such reserves established would normally cover expected
losses until the next policy renewal dates for the related policies.
Investment Securities
Investment securities are classified as available for sale and recorded at fair
value, and unrealized investment gains and losses are reflected in shareholders'
equity. Investment income is recorded when earned, and capital gains and losses
are recognized when investments are sold. Investments are reviewed periodically
to determine if they have suffered an impairment of value that is considered
other than temporary. If investments are determined to be impaired, a capital
loss is recognized at the date of determination.
Testing for impairment of investments also requires significant management
judgment. The identification of potentially impaired investments, the
determination of their fair value and the assessment of whether any decline in
value is other than temporary are the key judgment elements. The discovery of
new information and the passage of time can significantly change these
judgments. Revisions of impairment judgments are made when new information
becomes known, and any resulting impairment adjustments are made at that time.
The current economic environment and recent volatility of securities markets
increase the difficulty of determining fair value and assessing investment
impairment. The same influences tend to increase the risk of potentially
impaired assets.
Defined Benefit Pension and Other Post-Retirement Benefit ("OPEB") Plans
The Company sponsors defined benefit pension and other postretirement plans.
Refer to Note 14 of Notes to Consolidated Financial Statements. Major
assumptions used in the accounting for these plans include the expected return
on pension plan assets and the discount rate. Assumptions are determined based
on Company information and market indicators, and are evaluated at each annual
measurement date. A change in any of these assumptions would have an effect on
the Company's pension and postretirement plan costs.
The expected return on pension plan assets considers expected capital market
returns over a long term horizon (i.e., 20 years), inflation rate assumptions
and actual returns on an asset allocation of approximately 65% equity
securities, 28% fixed income securities and 7% private real estate investments.
Lower market interest rates and plan asset returns have resulted in declines in
pension plan asset performance and funded status. As a result, the expected
return on plan assets was reduced to 9.00% (from 9.25% for 2002 expense
recognition) and the discount rate was reduced to 6.75% (from 7.50% at the
previous measurement date). Pension and postretirement expense in 2003 is
expected to increase by approximately $110 million as a result of these changes,
as well as the continued decline in equity markets and the resulting impact on
the fair value of pension plan assets. These changes will not impact required
cash contributions to the pension plan, as the Company has met all minimum
funding requirements as set forth by the Employee Retirement Income Security Act
of 1974 ("ERISA") and further, will not have a minimum funding requirement in
2003.
Page 32
As part of expected 2003 operating cost savings initiatives, the Company expects
to reduce the approximate $110 million increase in pension and postretirement
expense discussed above through actions intended to bring overall benefit costs
more in line with industry peers, both in terms of costs and benefit levels. In
January 2003, the Company amended its postretirement plans, eliminating the
medical subsidy provided to active employees who terminate employment subsequent
to January 1, 2007 and eliminating the dental subsidy for active employees who
terminate employment on or after January 1, 2003. As a result of these plan
amendments, the Company expects to record a curtailment benefit of approximately
$35 million pretax in the first quarter of 2003.
Goodwill and Other Acquired Intangible Assets
The Company has made previous acquisitions that included a significant amount of
goodwill and other intangible assets. Effective January 1, 2002, goodwill is no
longer amortized but was subject to a transitional impairment test upon adoption
of FAS No. 142 as well as an annual (or under certain circumstances more
frequent) impairment test based on its estimated fair value. Other intangible
assets that meet certain criteria continue to be amortized over their useful
lives and are also subject to an impairment test, based on estimated fair value.
For these evaluations, the Company is using an implied fair value approach,
which uses a discounted cash flow analysis and other valuation methodologies.
These evaluations use many assumptions and estimates in determining an
impairment loss, including certain assumptions and estimates related to future
earnings to be derived from the Company's ongoing turnaround initiatives
previously discussed. If these turnaround initiatives do not achieve their
earnings objectives, the assumptions and estimates underlying these goodwill
impairment evaluations could be adversely affected.
GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS
An impairment of approximately $3.0 billion resulting from the initial
application of FAS No. 142 has been classified as a cumulative effect adjustment
for 2002. Subsequent impairments, if any, would be classified as an operating
expense. During the fourth quarter of 2002, the Company performed an annual
impairment test, in conjunction with its annual planning process, and determined
there were no additional impairment losses.
Upon adoption of FAS No. 142, the transition provisions of FAS No. 141, Business
Combinations, also became effective. These transition provisions specify
criteria for determining whether an acquired intangible asset should be
recognized separately from goodwill. Intangible assets that meet certain
criteria will qualify for recording on the Consolidated Balance Sheet and will
continue to be amortized over their useful lives in the Consolidated Statement
of Income. Such intangible assets are subject to a periodic impairment test
based on estimated fair value. As a result, the Company reclassified its work
force acquired intangible asset of $25.3 million at December 31, 2001 to
goodwill. Refer to Notes 2 and 6 of Condensed Notes to Consolidated Financial
Statements for more information on the Company's goodwill and other acquired
intangible assets.
Under accounting principles generally accepted in the United States of America
in effect through December 31, 2001, these assets were amortized over their
estimated useful lives, and were tested periodically to determine if they were
recoverable from operating earnings on an undiscounted basis over their useful
lives and to evaluate the related amortization periods. The Company wrote off
goodwill of approximately $310 million ($238 million after tax) in the fourth
quarter of 2000 under its accounting policy for goodwill recoverability in
effect at that time, primarily related to its Medicare market exits, as well as
to an investment in a medical information services business, given a
re-evaluation of its strategy for this business.
Page 33
NEW ACCOUNTING STANDARDS
Refer to Note 2 of Notes to Consolidated Financial Statements for a discussion
of recently issued accounting standards.
REGULATORY ENVIRONMENT
General
Our operations are subject to comprehensive and detailed state and federal
regulation throughout the United States in the jurisdictions in which we do
business. Supervisory agencies, including (depending on the state) state health,
insurance, managed care and securities departments, have broad authority to:
o Grant, suspend and revoke licenses to transact business;
o Regulate many aspects of the products and services we offer;
o Assess fines, penalties and/or sanctions;
o Monitor our solvency and reserve adequacy; and
o Regulate our investment activities on the basis of quality,
diversification and other quantitative criteria.
Our operations and accounts are subject to examination at regular intervals by
these agencies. In addition, our current and past business practices are subject
to review by other state and federal authorities. These reviews may result in
changes to or clarifications of our business practices, and may result in fines,
penalties or other sanctions.
In addition, the federal and state governments continue to enact and seriously
consider many legislative and regulatory proposals that have or would materially
impact various aspects of the health care system. Many of these changes are
described below. While certain of these measures would adversely affect us, at
this time we cannot predict the extent of this impact.
Page 34
HEALTH CARE REGULATION
General
The federal government and the governments of the states in which we conduct our
health operations have adopted laws and regulations that govern our business
activities in various ways. These laws and regulations may restrict how we
conduct our businesses and may result in additional burdens and costs to us.
Areas of governmental regulation include:
o Licensure
o Policy forms, including plan design and disclosures
o Premium rates and rating methodologies
o Underwriting rules and procedures
o Benefit mandates
o Eligibility requirements
o Service areas
o Market conduct
o Utilization review activities
o Payment of claims, including timeliness and accuracy of payment
o Member rights and responsibilities
o Sales and marketing activities
o Quality assurance procedures
o Disclosure of medical and other information
o Provider rates of payment
o Surcharges on provider payments
o Provider contract forms
o Delegation of risk and other financial arrangements
o Agent licensing
o Financial condition (including reserves) and
o Corporate governance
These laws and regulations are subject to amendments and changing
interpretations in each jurisdiction.
States generally require health insurers and HMOs to obtain a certificate of
authority prior to commencing operations. To establish a health insurance
company or an HMO in any state where we do not presently operate, we generally
would have to obtain such a certificate. The time necessary to obtain such a
certificate varies from state to state. Each health insurer and HMO must file
periodic financial and operating reports with the states in which it does
business. In addition, health insurers and HMOs are subject to state examination
and periodic license renewal.
GROUP PRICING AND UNDERWRITING RESTRICTIONS
Pricing and underwriting regulation by states includes various statutes that
limit the flexibility of Aetna and other health insurers relative to their
underwriting and rating practices, particularly for small employer groups. These
laws vary by state. In general they apply to certain business segments and limit
the ability of the Company to set prices or renew business, or both, based on
specific characteristics of the group or the group's prior claim experience.
Page 35
Many of these laws limit the differentials in rates carriers may charge between
new and renewal business, and/or between groups based on differing
characteristics. They may also require that carriers disclose to customers the
basis on which the carrier establishes new business and renewal rates, restrict
the application of pre-existing condition exclusions and limit the ability of a
carrier to terminate coverage of an employer group.
The federal Health Insurance Portability and Accountability Act of 1996, known
as HIPAA, generally requires carriers that write small business in any market to
accept for coverage any small employer group applying for a basic and standard
plan of benefits. HIPAA also mandates guaranteed renewal of health care coverage
for most employer groups, subject to certain defined exceptions, and provides
for specified employer notice periods in connection with product and market
withdrawals. The law further limits exclusions based on preexisting conditions
for individuals covered under group policies to the extent the individuals had
prior creditable coverage within a specified time frame. HIPAA is structured as
a "floor" requirement, allowing states latitude to enact more stringent rules
governing each of these restrictions. For example, certain states have modified
HIPAA's small group definition (2-50 employees) to include groups of one.
In addition, a number of states provide for a voluntary reinsurance mechanism to
spread small group risk among participating carriers. In a small number of
states, participation in this pooling mechanism is mandatory for all small group
carriers. In general Aetna has elected not to participate in voluntary pools,
but even in these states the Company may be subject to certain supplemental
assessments related to the state's small group experience.
Hipaa Administrative and Privacy Regulation; Gramm-leach-bliley Act
HIPAA and its regulations also impose a number of additional obligations on
issuers of health insurance coverage and health benefit plan sponsors. The law
authorizes the United States Department of Health and Human Services, known as
HHS, to issue standards for administrative simplification, as well as privacy
and security of medical records and other individually identifiable patient
data. HIPAA requirements apply to self-funded group health plans, health
insurers and HMOs and health care clearinghouses and health care providers that
transmit member health information electronically. Regulations adopted to
implement HIPAA also require that business associates acting for or on behalf of
these HIPAA-covered entities be contractually obligated to meet HIPAA standards.
HIPAA regulations establish significant criminal penalties and civil sanctions
for noncompliance.
Although HIPAA was intended ultimately to reduce administrative expenses and
burdens faced within the health care industry, we believe the law will initially
bring about significant and, in some cases, costly changes. We expect that we
will incur additional expenses to comply with, and that our business could be
adversely affected by, these regulations in future periods.
HHS has released rules mandating the use of new standard formats with respect to
certain health care transactions (e.g., health care claims information, plan
eligibility, referral certification and authorization, claims status, plan
enrollment and disenrollment, payment and remittance advice, plan premium
payments and coordination of benefits). HHS also has published rules requiring
the use of standardized code sets and unique employer identifiers. We are
required to comply with the transaction and code set requirements by October 16,
2003. We are required to comply with the employer identifier rules by July 30,
2004.
Page 36
HHS also has developed new standards relating to the privacy of individually
identifiable health information. In general, these regulations restrict the use
and disclosure of medical records and other individually identifiable health
information held by health plans and other affected entities in any form,
whether communicated electronically, on paper or orally, subject only to limited
exceptions. In addition, the regulations provide patients with new rights to
understand and control how their health information is used. These regulations
do not preempt more stringent state laws and regulations that may apply to us.
We have to comply with the new privacy standards by April 14, 2003. HHS recently
published final security regulations designed to protect member health
information from unauthorized use or disclosure. We are required to comply with
these security regulations by April 21, 2005.
In addition, provisions of the Gramm-Leach-Bliley Act generally require insurers
to provide customers with notice regarding how their personal health and
financial information is used and the opportunity to "opt out" of certain
disclosures before the insurer shares non-public personal information with a
non-affiliated third party. Like HIPAA, this law sets a "floor" standard,
allowing states to adopt more stringent requirements governing privacy
protection. The Gramm-Leach-Bliley Act also gives banks and other financial
institutions the ability to affiliate with insurance companies, which may lead
to new competitors in the insurance and health benefits fields.
LEGISLATIVE AND REGULATORY INITIATIVES
There has been a continuing trend of increased health care regulation at both
the federal and state levels. The federal government or many states, or both,
including states in which we have substantial health care membership, have
enacted or are considering additional legislation or regulation related to
health care plans. Legislation, regulation and initiatives relating to this
trend include among other things, the following:
o Amending or supplementing the Employee Retirement Income Security Act of
1974 ("ERISA") to impose greater requirements on the administration of
employer-funded benefit plans or limit the scope of current ERISA
pre-emption, which would among other things expose health plans to expanded
liability for punitive and other extra-contractual damages
o Imposing assessments on health plans or health carriers, such as assessments
for insolvency or high-risk pools, assessments for uncompensated care, or
assessments to defray provider medical malpractice insurance costs
o Extending malpractice and other liability exposure for decisions made by
health plans
o Mandating coverage for certain conditions and/or specified procedures, drugs
or devices (e.g. infertility treatment, experimental pharmaceuticals)
o Prohibiting or limiting certain types of financial arrangements with
providers, including among other things incentives based on utilization of
services
o Imposing substantial penalties for failure to pay claims within specified
time periods
o Regulating the composition of provider networks, such as any willing
provider and pharmacy laws (which generally provide that providers and
pharmacies cannot be denied participation in a managed care plan where the
providers and pharmacies are willing to abide by the terms and conditions of
that plan)
o Imposing payment levels for out-of-network care
o Exempting physicians from the antitrust laws that prohibit price fixing,
group boycotts and other horizontal restraints on competition
Page 37
o Mandating direct access to specialists for patients with chronic conditions,
and direct access to OB/GYNs, chiropractors or other practitioners
o Mandating expanded consumer disclosures and notices
o Mandating expanded coverage for emergency services
o Mandating liberalized definitions of medical necessity
o Mandating internal and external grievance and appeal procedures (including
expedited decision making and access to external claim review)
o Enabling the creation of new types of health plans or health carriers, which
in some instances would not be subject to the regulations or restrictions
that govern our operations
o Allowing individuals and small groups to collectively purchase health care
coverage without any other affiliations
o Restricting health plan claim and related procedures
o Requiring the application of treatment and financial parity between mental
health benefits and medical benefits within the same health plan
o Extending benefits available to workers who lose their jobs and other
uninsureds
o Restricting or eliminating the use of formularies for prescription drugs
o Making health plans responsible for provider payments in the event of
financial failure by a capitated physician group or other intermediary
o Creating or expanding state-sponsored health benefit purchasing pools, in
which we may be required to participate
o Creating a single payer system where the government oversees or manages the
provision of health care coverage
o Imposing employer or individual health coverage mandates
It is uncertain whether we can recoup, through higher premiums or other
measures, the increased costs of mandated benefits or other increased costs
caused by potential legislation or regulation.
We also may be adversely impacted by court and regulatory decisions that expand
the interpretations of existing statutes and regulations or impose medical
malpractice or bad faith liability. Among other issues, the courts, including
the United States Supreme Court and Federal and state courts, continue to
consider cases addressing the preemptive effect of ERISA on state laws. In
general, limitations to this pre-emption have the effect of increasing our costs
or our liability exposures, or both. Legislative initiatives discussed above
include state legislative activity in several states that, should it result in
enacted legislation that is not preempted by ERISA, could increase our liability
exposure and could result in greater state regulation of our operations.
Patients' Bill of Rights Legislation
The U.S. Congress and various state legislatures continue to debate legislation
containing various patient protection initiatives, including provisions that
could expose the Company to unlimited economic damages, and certain punitive
damages, for making a determination denying benefits or for delaying members'
receipt of benefits as a result of "medical necessity" and other coverage
determinations. The Company cannot predict whether these measures will be
enacted into law in 2003 or what form any such legislation might take.
Page 38
ERISA
The provision of services to certain employee benefit plans, including certain
health, group insurance and large case pensions benefit plans, is subject to
ERISA, a complex set of laws and regulations subject to interpretation and
enforcement by the Internal Revenue Service and the Department of Labor (the
"DOL"). ERISA regulates certain aspects of the relationships between us and
employers who maintain employee benefit plans subject to ERISA. Some of our
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.
In 2001 the DOL promulgated extensive new regulations under ERISA setting out
standards for claim payment and member appeals along with associated notice and
disclosure requirements. These rules took affect for employers with plan years
beginning on or after January 1, 2002 for disability plans, and on or after July
1, 2002 for health plans. The company has invested significant time and
attention to compliance with these new standards, which represent an additional
regulatory burden for the Company.
Large Case Pensions' products and services are also subject to potential issues
raised by certain judicial interpretations relating to 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 DOL issued final regulations as required by the Act on
January 5, 2000. The regulations provide that insurers generally will not have
ERISA fiduciary duties with respect to general account assets held under
contracts that are not guaranteed benefit policies based on claims that those
assets are plan assets provided certain disclosures are made to policyholders
annually. The relief afforded extends to conduct that occurred before July 5,
2001. 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. We are not currently able to predict how these
matters may ultimately affect our businesses.
Page 39
Medicare
In 1997, the federal government passed legislation establishing the
Medicare+Choice program 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 us compared to the old method, although the
level and extent of the reductions varies by geographic market and depends on
other factors. The legislation also requires us to pay a "user fee." Since 1997
the government has made a number of modifications to the payment levels, risk
adjustment methodology and user fees under the Medicare+Choice program. The
changes began to be phased in on January 1, 1998. As a result of these changes,
as well as other factors including certain Medicare+Choice regulations issued by
CMS, we decided to reduce contract service areas in certain markets effective
January 1, 2003. We also had not renewed our Medicare+Choice contracts or
reduced service areas in certain other areas effective January 1, 2002, January
1, 2001 and January 1, 2000. Refer to "Health Care" for more information.
Uncertainty regarding future reimbursement levels and other requirements under
the Medicare+Choice program make it difficult to predict whether the Company can
continue to participate profitably in the program at its current level after
2003.
In 2003, Congress may add out-patient pharmaceutical products as a benefit under
Medicare. We cannot predict whether Congress will add such a benefit in 2003,
what form any such benefit might take or how any such benefit may ultimately
affect our businesses.
HMO and Insurance Holding Company Laws
A number of states, including Pennsylvania and Connecticut, regulate affiliated
groups of HMOs and insurers such as us under holding company statutes. These
laws may require us and our subsidiaries to maintain certain levels of equity.
Holding company laws and regulations generally require insurance companies and
HMOs within an insurance holding company system to register with the insurance
department of each state where they are domiciled and to file reports with those
states' insurance departments regarding capital structure, ownership, financial
condition, intercompany transactions and general business operations. In
addition, various notice or prior regulatory approval requirements apply to
transactions between insurance companies, HMOs and their affiliates within an
insurance holding company system, depending on the size and nature of the
transactions. For information regarding restrictions on certain payments of
dividends or other distributions by HMO and insurance company subsidiaries of
our company, refer to "Liquidity and Capital Resources."
The holding company laws for the states of domicile of Aetna and its
subsidiaries also restrict the ability of any person to obtain control of an
insurance company or HMO without prior regulatory approval. Under those
statutes, without such approval (or an exemption), no person may acquire any
voting security of an insurance holding company (such as our parent company,
Aetna Inc.) that controls an insurance company or HMO, or merge with such a
holding company, if as a result of such transaction such person would "control"
the insurance holding company. "Control" is generally defined as the direct or
indirect power to direct or cause the direction of the management and policies
of a person and is presumed to exist if a person directly or indirectly owns or
controls 10% or more of the voting securities of another person.
Page 40
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. Assessments
generally are based on a formula relating to the Company's premiums in the state
compared to the premiums of other insurers. While we historically have recovered
more than half of guaranty fund assessments through statutorily permitted
premium tax offsets, significant increases in assessments could jeopardize
future recovery of these assessments. Some states have similar laws relating to
HMOs. In 2000, the Company incurred a $15 million after tax ($23 million pretax
assessment) related to its New Jersey business. There were no material charges
to earnings for guaranty fund obligations during 2002 or 2001.
FORWARD-LOOKING INFORMATION/RISK FACTORS
The Private Securities Litigation Reform Act of 1995 (the "1995 Act") provides a
"safe harbor" for forward-looking statements, so long as (1) those statements
are identified as forward-looking, and (2) the statements are accompanied by
meaningful cautionary statements that identify important factors that could
cause actual results to differ materially from those discussed in the statement.
We want to take advantage of these safe harbor provisions.
Certain information contained in this Management's Discussion and Analysis is
forward-looking within the meaning of the 1995 Act or Securities and Exchange
Commission rules. This information includes, but is not limited to: (1) the
information that appears under the headings "Outlook" in the discussion of
results of operations of each of our businesses and (2) "Total Investments -
Risk Management and Market-Sensitive Instruments". In writing this Management's
Discussion and Analysis, where we use the following words, or variations of
these words and similar expressions, we intend to identify forward-looking
statements:
o Expects o Anticipates o Plans o Seeks
o Projects o Intends o Believes o Estimates
Forward-looking statements rely on a number of assumptions concerning future
events, and are subject to a number of significant uncertainties and other
factors, many of which are outside our control, that could cause actual results
to differ materially from those statements. You should not put undue reliance on
forward-looking statements. We disclaim any intention or obligation to update or
revise forward-looking statements, whether as a result of new information,
future events or otherwise.
RISK FACTORS
You should carefully consider each of the following risks and all of the other
information set forth in this Management's Discussion and Analysis or elsewhere
in this Report. These risks and other factors may affect forward-looking
statements, including those in this Management's Discussion and Analysis or made
elsewhere, and/or our business generally. The risks and uncertainties described
below are not the only ones facing our Company. Additional risks and
uncertainties not presently known to us or that we currently believe to be
immaterial may also adversely affect our business.
If any of the following risks and uncertainties develops into actual events,
this could have a material adverse effect on our business, financial condition
or results of operations. In that case, the trading price of our common stock
could decline materially.
Page 41
WE ARE SEEKING TO CONTINUE TO IMPROVE THE PERFORMANCE OF OUR HEALTH CARE
BUSINESS BY IMPLEMENTING A NUMBER OF INITIATIVES; IF THESE INITIATIVES DO NOT
ACHIEVE THEIR OBJECTIVES, OUR RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.
Our operating earnings improved significantly in 2002, following significant
declines in 2001 and 2000, and we continue to implement a number of strategic
and operational initiatives with the goal of further improving the performance
of our business. These initiatives include, among other things, addressing
rising medical costs, the new customer market approach we implemented in 2002,
further improving the efficiency of operations, and improving relations with
health care providers. The future performance of our business will depend in
large part on our ability to design and implement these initiatives. If these
initiatives do not achieve their objectives or result in increased medical
costs, our results could be adversely affected. Refer to "Overview" for more
information.
OUR ABILITY TO ADDRESS HEALTH CARE COSTS, IMPLEMENT INCREASES IN PREMIUM RATES
AND THE RESULTING EFFECTS ON OUR MEMBERSHIP AFFECT OUR PROFITABILITY.
Our profitability depends in large part on accurately predicting health care
costs and on our ability to appropriately manage future health care costs
through underwriting criteria, product design, negotiation of favorable provider
contracts and medical management programs. The aging of the population and other
demographic characteristics, advances in medical technology and other factors
continue to contribute to rising health care costs. Government-imposed
limitations on Medicare and Medicaid reimbursement have also caused the private
sector to bear a greater share of increasing health care costs. Changes in
health care practices, inflation, new technologies, the cost of prescription
drugs and direct to consumer marketing by pharmaceutical companies, clusters of
high cost cases, changes in the regulatory environment and numerous other
factors affecting the cost of health care are beyond any health plan's control
and may adversely affect our ability to predict and manage health care costs, as
well as our business, financial condition and results of operations.
We have taken and are taking several actions to address this situation. We are
increasing premiums for business renewing in 2003. Premiums in the health
business are generally fixed for one-year periods. Accordingly, future cost
increases in excess of medical cost projections reflected in pricing cannot be
recovered in the contract year through higher premiums. As a result, the
Company's results are particularly sensitive to the price increases it projects
are necessary in advance of renewal of the business. There can be no assurances
regarding the accuracy of medical cost projections assumed for pricing purposes
and if the rate of increase in medical costs in 2003 were to exceed the levels
projected for pricing purposes, our results would be materially adversely
affected.
In addition to the challenge of managing health care costs, we face pressure to
contain premium prices. Our customer contracts are subject to negotiation as
customers seek to contain their costs. Alternatively, our customers may move to
a competitor to obtain more favorable premiums.
Page 42
Premium increases for 2003 renewals and other actions have reduced membership
for 2003, compared to membership at December 31, 2002. The Company is taking
steps to begin to increase its membership in 2003, although it expects that
during the year its membership will be lower than membership at December 31,
2002. If membership declines more than expected or we lose accounts with
favorable medical cost experience while retaining accounts with unfavorable
medical cost experience, our business and results of operations may be adversely
affected. The expected membership reductions will materially affect our revenue
for 2003, and underscore our need to continue to seek to reduce our level of
administrative expenses. In addition to premium increases, other factors that
could contribute to a reduction in enrollment include: failure to obtain new
customers; benefit changes; other market withdrawals; general economic downturn
that results in reductions in workforce by existing customers or business
failures; negative publicity and news coverage; and failure to attain or
maintain nationally-recognized accreditations for health plans (such as
accreditation by the National Committee for Quality Assurance). Refer to "Health
Care - Outlook" for more information.
WE HOLD RESERVES FOR EXPECTED CLAIMS, WHICH ARE ESTIMATED, AND THESE ESTIMATES
ARE HIGHLY JUDGMENTAL; IF ACTUAL CLAIMS EXCEED RESERVE ESTIMATES (AS THEY HAVE
IN CERTAIN PRIOR PERIODS), OUR RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.
Health care costs payable reflect estimates of the ultimate cost of claims that
have been incurred but not yet reported or reported but not yet paid. Health
care costs payable are estimated periodically, and any resulting adjustments are
reflected in the current-period operating results within health care costs.
Health care costs payable are based on a number of factors, including those
derived from historical claim experience. Most health care claims are not
submitted to the Company until after the end of the quarter in which services
are rendered by providers to members. As a result, 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 used in estimating health care costs
payable at December 31, 2002 would cause these estimates to change in the near
term, and such a change could be material. For example, a 100 basis point change
in the estimated medical cost trend for Commercial HMO Risk products would have
changed annual after tax results for 2002 by approximately $50 million. This
estimation process is a critical accounting policy for the Company. Refer to
"Health Care" and "Critical Accounting Policies" for more information.
OUR PROFITABILITY MAY BE ADVERSELY AFFECTED IF WE ARE UNABLE TO CONTRACT WITH
PROVIDERS ON FAVORABLE TERMS.
Our profitability is dependent in part upon our ability to contract on favorable
terms with hospitals, physicians and other health benefits providers. The
failure to maintain or to secure new cost-effective health care provider
contracts may result in a loss in membership or higher medical costs. In
addition, our inability to contract with providers, or the inability of
providers to provide adequate care, could adversely affect our business.
THE HEALTH BENEFITS INDUSTRY IS SUBJECT TO NEGATIVE PUBLICITY, WHICH CAN
ADVERSELY AFFECT OUR PROFITABILITY.
The health benefits industry is subject to negative publicity. Negative
publicity may result in increased regulation and legislative review of industry
practices, which may further increase our costs of doing business and adversely
affect our profitability by:
o Adversely affecting our ability to market our products and services;
o Requiring us to change our products and services; or
o Increasing the regulatory burdens under which we operate.
Page 43
WE ARE PARTY TO A SUBSTANTIAL AMOUNT OF LITIGATION; THESE CASES AND FUTURE CASES
MAY HAVE A MATERIAL ADVERSE EFFECT ON US.
We are party to a number of class action lawsuits and other litigation. The
majority of these cases relate to the conduct of our health care business and
allege various violations of law. Many of these cases seek substantial damages
(including punitive damages) and far-ranging changes in our practices. We may
also be subject to additional litigation in the future. This litigation could
materially adversely affect us, because of the costs of defending these cases,
costs of settlement or judgments against us, or because of changes in our
operations that could result from this litigation. Refer to Note 20 of Notes to
Consolidated Financial Statements.
OUR BUSINESS ACTIVITIES ARE HIGHLY REGULATED AND THERE ARE A NUMBER OF CURRENT
AND PLANNED INITIATIVES BEING CONSIDERED BY FEDERAL AND STATE GOVERNMENTS;
GOVERNMENT REGULATION LIMITS US IN THE CONDUCT OF OUR BUSINESS AND ALSO SUBJECTS
US TO ADDITIONAL COSTS IN COMPLYING WITH THE REQUIREMENTS OF GOVERNMENTAL
AUTHORITIES; FURTHER REGULATION COULD ALSO MATERIALLY ADVERSELY AFFECT OUR
BUSINESS.
Our business is subject to extensive regulation by state and federal
governmental authorities. For example, there are a number of federal and state
requirements restricting operations of health care plans (particularly HMOs).
The federal and many state governments have enacted or are actively considering
legislative and regulatory changes related to health products. At this time, we
are unable to predict the impact of future changes, although we anticipate that
some of these measures, if enacted, could adversely affect health operations
through:
o Affecting premium rates,
o Reducing our ability to manage medical costs,
o Increasing medical costs and operating expenses,
o Increasing our exposure to lawsuits,
o Regulating levels and permitted lines of business,
o Imposing financial assessments, and
o Regulating business practices.
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 one of the largest national managed care
organizations, we are regularly the subject of such reviews and several such
reviews currently are pending, some of which may be resolved during 2003. These
regulatory reviews could result in changes to or clarifications of our business
practices, and also could result in material fines, penalties or other
sanctions. Our 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. For
example, a federal appeals court recently held that in some circumstances ERISA
does not preempt state law medical malpractice claims against health plans
arising out of coverage denials on grounds of medical necessity.
It is uncertain whether we can recoup, through higher premiums or other
measures, the increased costs of mandated benefits or the other increased costs
that may be caused by this legislation or regulation, or by court and regulatory
decisions. For more information regarding the Patients' Bill of Rights, other
important regulatory initiatives and related judicial developments, see
"Regulatory Environment".
WE MUST COMPLY WITH THE REQUIREMENTS OF THE HEALTH INSURANCE PORTABILITY AND
ACCOUNTABILITY ACT OF 1996, ALSO KNOWN AS HIPAA, OR FACE POTENTIAL ADDITIONAL
LIABILITY.
Page 44
The Department of Health and Human Services, known as HHS, has promulgated
certain regulations under HIPAA related to the privacy of individually
identifiable health information, or protected health information. The new
regulations require self-funded group health plans, health insurers and HMO's,
health care clearinghouses and certain providers to:
o Comply with various requirements and restrictions related to the use,
storage and disclosure of protected health information;
o Adopt rigorous internal procedures to protect protected health
information; and
o Enter into specific written agreements with business associates to
whom protected health information is disclosed.
HHS also has recently published final security regulations designed to protect
member health information from unauthorized use or disclosure. HIPAA establishes
significant criminal penalties and civil sanctions for noncompliance.
For more information regarding these regulations, refer to "Regulatory
Environment".
DOWNGRADES IN OUR RATINGS MAY ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
Claims paying ability and financial strength ratings by recognized rating
organizations have become an increasingly important factor in establishing the
competitive position of insurance companies. Rating organizations continue to
review the financial performance and condition of insurers, including Aetna Life
Insurance Company and our other regulated subsidiaries. We believe our ratings
are an important factor in marketing our products to certain of our customers,
since ratings information is broadly disseminated and generally used throughout
the industry. Certain of our businesses, particularly our Group Insurance
business, would experience some run off of existing business or have the level
of new business negatively impacted if the major rating agencies do not give a
financial strength rating to the relevant subsidiary in the "A" rating category.
In addition to claims paying and financial strength ratings of Aetna's
subsidiaries, rating organizations also provide ratings of Aetna Inc.'s senior
debt and commercial paper. These ratings are broadly disseminated and used
throughout the market place for debt instruments, and any decrease in these
ratings could affect both the cost and availability of future borrowings. Each
of the rating agencies reviews its ratings periodically and there can be no
assurance that current ratings will be maintained in the future. Our ratings
reflect each rating agency's opinion of our financial strength, operating
performance and ability to meet our debt obligations or obligations to
policyholders, and are not evaluations directed toward the protection of
investors in our common stock and should not be relied upon as such. For
information regarding recent rating actions and the availability of borrowing,
refer to "Liquidity and Capital Resources--Financings, Financing Capacity and
Capitalization".
TERRORISM OR THE CONTINUED THREAT OF TERRORISM COULD INCREASE HEALTH CARE
UTILIZATION AND PHARMACY COSTS AND GROUP INSURANCE LIFE AND DISABILITY CLAIMS,
ALTHOUGH THE COMPANY CANNOT PREDICT WHETHER ANY SUCH INCREASES WILL OCCUR.
Beyond obtaining coverage for the Company's facilities, and some limited
coverage for Group Insurance claims, there are few, if any, commercial options
through which to transfer the exposure from terrorism away from the Company. For
Group Insurance claims, the Company has certain reinsurance in place for certain
types of catastrophic claims (and only if the losses are in excess of certain
amounts, and subject to limits). However, following the events of September 11,
2001, reinsurers have generally sought to exclude many types of potential
terrorism from coverage, and the Company's reinsurance coverage excludes most
types of terrorism while the Company's Group Insurance policies generally do not
contain similar exclusions. In addition, the Company's Group Insurance members
are concentrated in certain large, metropolitan areas.
Page 45
GENERAL MARKET CONDITIONS AFFECT OUR INVESTMENTS IN DEBT AND EQUITY SECURITIES,
MORTGAGE LOANS AND OTHER INVESTMENTS, OUR INCOME ON THOSE INVESTMENTS AND OUR
PENSION EXPENSES.
Generally lower levels of interest rates on investments, such as those currently
being experienced in United States financial markets, have negatively impacted
the level of investment income earned by the Company in recent periods, and such
lower levels of investment income would continue if these lower interest rates
continue. We also expect our pension costs to increase in 2003 due to recent
financial market conditions. For information regarding our expected pension
costs for 2003, please refer to "Health Care - Outlook."
IN RECENT YEARS, CERTAIN THIRD PARTIES TO WHICH WE DELEGATE SELECTED FUNCTIONS,
SUCH AS LARGE PHYSICIAN PRACTICE MANAGEMENT COMPANIES, HAVE EXPERIENCED
FINANCIAL DIFFICULTIES, INCLUDING BANKRUPTCY, WHICH MAY SUBJECT US TO INCREASED
CREDIT RISK RELATED TO PROVIDER GROUPS AND IN SOME CASES CAUSE US TO INCUR
DUPLICATIVE CLAIMS EXPENSE.
IN CONNECTION WITH THE DECEMBER 2000 SPIN-OFF OF OUR COMPANY FROM ITS
PREDECESSOR, FORMER AETNA, AND MERGER OF FORMER AETNA'S INTERNATIONAL AND
FINANCIAL SERVICES BUSINESSES WITH A SUBSIDIARY OF ING GROEP N.V., WE HAVE
AGREED TO BE LIABLE FOR, AND TO INDEMNIFY ING FOR, CERTAIN FORMER AETNA
LIABILITIES, INCLUDING LIABILITIES NOT RELATED TO OUR HEALTH CARE BUSINESS.
In connection with the spin-off, we generally assumed all liabilities related to
former Aetna's health care and large case pensions businesses. In addition, we
generally are responsible for former Aetna's liabilities other than those
arising out of former Aetna's financial services or international businesses.
These liabilities generally include the post-retirement pension and other
benefits payable to all previous employees of former Aetna, liabilities arising
out of significant litigation to which former Aetna is a party, all liabilities
arising out of certain divestiture transactions consummated by former Aetna
before the spin-off and tax liabilities relating to, or resulting from the
treatment of, the spin-off. We have agreed to indemnify ING for all of these
liabilities. Although management believes that it has established reserves
and/or obtained insurance sufficient to cover such liabilities as we consider
appropriate, we cannot assure you that these liabilities will not be materially
in excess of these reserves and insurance. In that case, these liabilities may
be materially adverse to our business and results of operations.
GOVERNMENT PAYORS CAN DETERMINE PREMIUMS.
Although we have withdrawn from certain Medicare markets, we will still have
operations in a number of Medicare markets. In government-funded health programs
such as Medicare and Medicaid, the government payor determines the premium
levels. If the government payor reduces the premium levels or increases premiums
by less than our costs increase and we cannot offset these with supplemental
premiums and changes in benefit plans, then we could be materially adversely
affected. In addition, premiums for certain federal government employee groups
are subject to retroactive adjustments by the federal government. These
adjustments could materially adversely affect us.
SUCCESS OF OUR BUSINESS INITIATIVES DEPENDS IN PART ON CONTINUING TO DEVELOP AND
IMPLEMENT IMPROVEMENTS IN TECHNOLOGY.
Our businesses depend in large part on our systems for processing claims and
interacting with providers, employer plan sponsors and members, and our business
strategy involves providing customers with easy to use products that leverage
information to meet the needs of those customers. Our success is dependent in
large part on implementing improvements and continuing to develop and enhance
information systems that support our business processes in a cost efficient
manner.
Page 46
SELECTED FINANCIAL DATA
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------------
(MILLIONS, EXCEPT PER COMMON SHARE DATA) 2002 2001 2000 1999 1998
------------------------------------------------------- --------- --------- --------- --------- ---------
Total revenue.......................................... $19,878.7 $25,190.8 $26,818.9 $22,109.7 $16,589.0
--------- --------- --------- --------- ---------
Income (loss) from continuing operations............... 393.2 (291.5) (127.4) 399.4 450.4
--------- --------- --------- --------- ---------
Net income (loss)...................................... (2,522.5) (279.6) 127.1 716.5 846.8
--------- --------- --------- --------- ---------
Net realized capital gains (losses), net of tax
(included above)..................................... 22.3 73.6 (14.2) 21.4 189.0
--------- --------- --------- --------- ---------
Total assets........................................... 40,047.5 43,196.7 47,673.0 52,667.6 53,355.2
--------- --------- --------- --------- ---------
Total short-term debt.................................. -- 109.7 1,592.2 1,725.0 1,370.1
--------- --------- --------- --------- ---------
Total long-term debt................................... 1,633.2 1,591.3 -- 2,093.9 1,593.3
--------- --------- --------- --------- ---------
Aetna-obligated mandatorily redeemable preferred
securities of subsidiary limited liability company
holding primarily debentures guaranteed by former
Aetna................................................ -- -- -- -- 275.0
--------- --------- --------- --------- ---------
Shareholders' equity................................... 6,980.0 9,890.3 10,127.1 10,703.2 11,429.5
--------- --------- --------- --------- ---------
Per common share data: (1)
Dividends declared (2)................................. $ .04 $ .04 $ -- $ -- $ --
Earnings (loss) per common share: (3)
Income (loss) from continuing operations:
Basic............................................... 2.64 (2.03) (.90) 2.56 2.74
Diluted (4)......................................... 2.57 (2.03) (.90) 2.54 2.72
Net income (loss):
Basic............................................... (16.94) (1.95) .90 4.76 5.49
Diluted (4)......................................... (16.49) (1.95) .90 4.72 5.40
========= ========= ========= ========= =========
--------------
(1) Per common share data is based on former Aetna common shares and share
equivalents through December 13, 2000 and Aetna Inc. thereafter. (Refer to
Notes 1, 5 and 21.)
(2) Prior to December 13, 2000, dividends were declared and paid by former
Aetna to its shareholders and therefore such dividends are not included
herein.
(3) For 1999 (through the redemption date of July 19, 1999) and 1998, preferred
stock dividends of former Aetna are deducted from income from continuing
operations and net income as the preferred stock issued by former Aetna was
for the acquisition of U.S. Healthcare, Inc. in 1996.
(4) Since the Company reported a loss from continuing operations in 2001 and
2000, the effect of common stock equivalents has been excluded from
earnings per common share computations for those years since including such
securities would be anti-dilutive. As a result, diluted and basic per
common share amounts for 2001 and 2000 are the same.
See Notes to Consolidated Financial Statements and Management's Discussion and
Analysis of Financial Condition and Results of Operations for significant events
affecting the comparability of results as well as material uncertainties.
Page 47
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
(MILLIONS, EXCEPT PER COMMON SHARE DATA) 2002 2001 2000
----------------------------------------------------------------------------- --------- --------- ------------
Revenue:
Health care premiums..................................................... $15,036.1 $19,940.4 $21,746.6
Other premiums........................................................... 1,676.6 1,831.6 1,468.3
Administrative services contract fees.................................... 1,842.6 1,835.2 1,925.9
Net investment income.................................................... 1,250.7 1,411.6 1,631.6
Other income............................................................. 38.4 75.9 86.6
Net realized capital gains (losses)...................................... 34.3 96.1 (40.1)
--------- --------- ---------
Total revenue............................................................... 19,878.7 25,190.8 26,818.9
--------- --------- ---------
Benefits and expenses:
Health care costs........................................................ 12,452.8 17,938.8 18,884.1
Current and future benefits.............................................. 2,245.5 2,458.3 2,153.5
Operating expenses:
Salaries and related benefits......................................... 2,245.2 2,290.4 2,328.7
Other................................................................. 1,987.4 2,224.6 2,501.1
Interest expense......................................................... 119.5 142.8 248.2
Amortization of goodwill................................................. -- 198.1 204.9
Amortization of other acquired intangible assets......................... 130.8 218.5 230.7
Goodwill write-off....................................................... -- -- 310.2
Severance and facilities charges......................................... 161.0 192.5 142.5
Reductions of reserve for anticipated future losses on
discontinued products.................................................. (8.3) (94.5) (146.0)
--------- --------- ---------
Total benefits and expenses................................................. 19,333.9 25,569.5 26,857.9
--------- --------- ---------
Income (loss) from continuing operations before income taxes (benefits)..... 544.8 (378.7) (39.0)
Income taxes (benefits):
Current.................................................................. 193.8 (13.6) 242.1
Deferred................................................................. (42.2) (73.6) (153.7)
--------- --------- ---------
Total income taxes (benefits)............................................... 151.6 (87.2) 88.4
--------- --------- ---------
Income (loss) from continuing operations.................................... 393.2 (291.5) (127.4)
Discontinued operations, net of tax (Note 21):
Income from operations................................................... 50.0 -- 428.5
Sale and spin-off related benefits (costs)............................... -- 11.4 (174.0)
--------- --------- ---------
Income (loss) before cumulative effect adjustments.......................... 443.2 (280.1) 127.1
Cumulative effect adjustments, net of tax (Note 2).......................... (2,965.7) .5 --
--------- --------- ---------
Net income (loss)........................................................... $(2,522.5) $ (279.6) $ 127.1
========= ========= =========
Earnings (loss) per common share (Note 5):
Basic:
Income (loss) from continuing operations................................. $ 2.64 $ (2.03) $ (.90)
Income from discontinued operations, net of tax.......................... .34 .08 1.80
--------- --------- ---------
Income (loss) before cumulative effect adjustments....................... 2.98 (1.95) .90
Cumulative effect adjustments, net of tax................................ (19.92) -- --
--------- --------- ---------
Net income (loss)........................................................ $ (16.94) $ (1.95) $ .90
========= ========= =========
Diluted (1):
Income (loss) from continuing operations................................. $ 2.57 $ (2.03) $ (.90)
Income from discontinued operations, net of tax.......................... .33 .08 1.80
--------- --------- ---------
Income (loss) before cumulative effect adjustments....................... 2.90 (1.95) .90
Cumulative effect adjustments, net of tax................................ (19.39) -- --
--------- --------- ---------
Net income (loss)........................................................ $ (16.49) $ (1.95) $ .90
========= ========= =========
--------------
(1) Since the Company reported a loss from continuing operations in 2001 and
2000, the effect of common stock equivalents has been excluded from per
common share computations for those years since including such securities
would be anti-dilutive. As a result, diluted and basic per common share
amounts for 2001 and 2000 are the same.
See Notes to Consolidated Financial Statements.
Page 48
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31,
----------------------
(MILLIONS, EXCEPT SHARE DATA) 2002 2001
-------------------------------------------------------------- --------- ---------
Assets
Current assets:
Cash and cash equivalents............................... $ 1,802.9 $ 1,398.2
Investment securities................................... 14,013.5 14,260.1
Other investments....................................... 358.0 171.7
Premiums receivable, net................................ 392.0 572.7
Other receivables, net.................................. 286.2 528.0
Accrued investment income............................... 214.3 232.3
Collateral received under securities loan agreements.... 969.0 621.7
Loaned securities....................................... 948.2 608.1
Deferred income taxes................................... 201.3 114.1
Other current assets.................................... 163.9 185.9
--------- ---------
Total current assets.......................................... 19,349.3 18,692.8
--------- ---------
Long-term investments......................................... 1,754.9 1,575.6
Mortgage loans................................................ 1,514.9 1,887.8
Investment real estate........................................ 308.8 359.7
Reinsurance recoverables...................................... 1,251.8 1,269.7
Goodwill, net................................................. 3,618.4 6,583.8
Other acquired intangible assets, net......................... 546.9 703.0
Property and equipment, net................................... 244.8 327.0
Deferred income taxes......................................... 582.5 360.5
Other long-term assets........................................ 211.0 146.8
Separate Accounts assets...................................... 10,664.2 11,290.0
--------- ---------
Total assets.................................................. $40,047.5 $43,196.7
========= =========
Liabilities and shareholders' equity
Current liabilities:
Health care costs payable............................... $ 2,194.1 $ 2,986.7
Future policy benefits.................................. 778.1 800.5
Unpaid claims........................................... 590.0 544.4
Unearned premiums....................................... 184.1 208.0
Policyholders' funds.................................... 1,072.2 1,052.8
Collateral payable under securities loan agreements..... 969.0 621.7
Short-term debt......................................... -- 109.7
Income taxes payable.................................... 322.5 147.4
Accrued expenses and other current liabilities.......... 1,608.8 1,316.1
--------- ---------
Total current liabilities..................................... 7,718.8 7,787.3
--------- ---------
Future policy benefits........................................ 8,333.3 8,621.5
Unpaid claims................................................. 1,177.8 1,203.6
Policyholders' funds.......................................... 1,867.3 2,245.1
Long-term debt................................................ 1,633.2 1,591.3
Other long-term liabilities................................... 1,672.9 567.6
Separate Accounts liabilities................................. 10,664.2 11,290.0
--------- ---------
Total liabilities............................................. 33,067.5 33,306.4
--------- ---------
Commitments and contingent liabilities (Notes 8 and 20)
Shareholders' equity:
Common stock and additional paid-in capital ($.01 4,070.9 3,913.8
par value, 756,277,772 shares authorized,
149,966,082 issued and outstanding in 2002 and $.01
par value, 759,900,000 shares authorized,
144,265,912 issued and outstanding in 2001)
Accumulated other comprehensive income (loss)........... (470.4) 68.5
Retained earnings....................................... 3,379.5 5,908.0
--------- ---------
Total shareholders' equity.................................... 6,980.0 9,890.3
--------- ---------
Total liabilities and shareholders' equity.................... $40,047.5 $43,196.7
========= =========
See Notes to Consolidated Financial Statements.
Page 49
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
ACCUMULATED OTHER
COMMON COMPREHENSIVE INCOME (LOSS)
STOCK AND ----------------------------------------------
ADDITIONAL UNREALIZED MINIMUM
PAID-IN GAINS (LOSSES) FOREIGN PENSION RETAINED
(MILLIONS, EXCEPT SHARE DATA) TOTAL CAPITAL ON SECURITIES CURRENCY DERIVATIVE LIABILITY EARNINGS
----------------------------------- --------- ---------- ------------- -------- ---------- --------- ---------
Balances at December 31, 1999.............. $10,703.2 $3,719.3 $(206.1) $(449.5) $ -- $ -- $ 7,639.5
--------- -------- ------- ------- ----- ------ ---------
Comprehensive income:
Net income.............................. 127.1 127.1
Other comprehensive income, net of tax:
Net unrealized gains on securities
($486.5 pretax)(1)................. 316.2 316.2
Foreign currency ($(50.9) pretax).... (39.9) (39.9)
---------
Other comprehensive income.............. 276.3
---------
Total comprehensive income................. 403.4
=========
Capital contributions from former Aetna.... 118.9 118.9
Dividends to former Aetna.................. (216.0) (216.0)
Outstanding shares cancelled
(1,100 shares)........................... -- --
Sale and spin-off related transaction
(141,670,551 shares issued) (Note 21).... (904.2) 38.7 (80.7) 495.1 (1,357.3)
Common shares issued for benefit plans
(948,000 share issued)................... 21.8 21.8
--------- -------- ------- ------- ----- ------ ---------
Balances at December 31, 2000.............. 10,127.1 3,898.7 29.4 5.7 -- -- 6,193.3
--------- -------- ------- ------- ----- ------ ---------
Comprehensive income:
Net loss................................ (279.6) (279.6)
Other comprehensive income, net of tax:
Net unrealized gains on securities
($57.2 pretax) (1)................ 37.2 37.2
Foreign currency ($(1.1) pretax)..... (.7) (.7)
Derivative losses
($(4.8) pretax) (1)............... (3.1) (3.1)
---------
Other comprehensive income.............. 33.4
---------
Total comprehensive loss................... (246.2)
=========
Common shares issued for benefit plans
(4,247,361 shares)....................... 110.7 110.7
Repurchase of common shares (2,600,000
shares).................................. (95.6) (95.6)
Common stock dividends..................... (5.7) (5.7)
--------- -------- ------- ------- ----- ------ ---------
Balances at December 31, 2001.............. 9,890.3 3,913.8 66.6 5.0 (3.1) -- 5,908.0
--------- -------- ------- ------- ----- ------ ---------
Comprehensive income:
Net loss................................ (2,522.5) (2,522.5)
Other comprehensive loss, net of tax:
Net unrealized gains on securities
($331.4 pretax) (1)............ 215.4 215.4
Foreign currency ($.7 pretax)..... .5 .5
Derivative gains ($.6 pretax) (1). .4 .4
Minimum pension liability
adjustment ($(1,161.8) pretax). (755.2) (755.2)
---------
Other comprehensive loss................ (538.9)
---------
Total comprehensive loss................... (3,061.4)
=========
Common shares issued for benefit plans
(9,320,601 shares)....................... 322.3 322.3
Repurchase of common shares (3,620,431
shares).................................. (165.2) (165.2)
Common stock dividends..................... (6.0) (6.0)
--------- -------- ------- ------- ----- ------ ---------
Balances at December 31, 2002.............. $ 6,980.0 $4,070.9 $ 282.0 $ 5.5 $(2.7) $(755.2 $ 3,379.5
========= ======== ======= ======= ===== ======= =========
--------------
(1) Net of reclassification adjustments (Refer to Note 10).
See Notes to Consolidated Financial Statements.
Page 50
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
(MILLIONS) 2002 2001 2000
------------------------------------------------------------------------------------- ------------- ------------- ----------
Cash flows from operating activities:
Net income (loss)................................................................. $ (2,522.5) $ (279.6) $ 127.1
Adjustments to reconcile net income (loss) to net cash provided by (used for)
operating activities:
Cumulative effect adjustments.................................................. 2,965.7 (.7) --
Income from discontinued operations............................................ (50.0) (11.4) (254.5)
Severance and facilities charges............................................... 161.0 192.5 142.5
Goodwill write-off............................................................. -- -- 310.2
Amortization of goodwill....................................................... -- 198.1 204.9
Amortization of other acquired intangible assets............................... 130.8 218.5 230.7
Depreciation and other amortization............................................ 170.7 181.0 190.1
Amortization (accretion) of net investment premium (discount).................. 11.3 (26.3) (37.8)
Net realized capital (gains) losses............................................ (34.3) (96.1) 40.1
Changes in assets and liabilities:
Decrease in accrued investment income....................................... 18.0 28.0 9.2
Decrease in premiums due and other receivables.............................. 352.9 495.8 115.2
Net change in income taxes.................................................. 218.4 (230.8) (13.9)
Net change in other assets and other liabilities............................ (64.8) (271.0) (231.9)
Net decrease in health care and insurance liabilities....................... (1,046.7) (432.0) (762.3)
Other, net.................................................................. (4.1) -- --
Discontinued operations, net......................................................... -- -- 1,457.0
------------- ------------- -------------
Net cash provided by (used for) operating activities................................. 306.4 (34.0) 1,526.6
------------- ------------- -------------
Cash flows from investing activities:
Proceeds from sales and investment maturities of:
Debt securities available for sale............................................. 15,679.9 17,561.8 13,093.9
Equity securities.............................................................. 251.2 239.5 358.8
Mortgage loans................................................................. 602.3 400.8 534.6
Investment real estate......................................................... 74.3 6.3 29.5
Other investments.............................................................. 3,321.0 4,866.5 5,166.8
NYLCare Texas.................................................................. -- -- 420.0
Cost of investments in:
Debt securities available for sale............................................. (15,452.3) (16,930.7) (12,081.3)
Equity securities.............................................................. (114.9) (288.1) (235.7)
Mortgage loans................................................................. (296.3) (226.4) (364.8)
Investment real estate......................................................... (47.6) (17.9) (15.7)
Other investments.............................................................. (3,251.4) (5,145.3) (5,395.6)
Increase in property and equipment................................................ (155.5) (142.6) (36.9)
Other, net........................................................................ -- -- 7.3
Discontinued operations, net......................................................... -- -- (445.1)
------------- ------------- -------------
Net cash provided by investing activities............................................ 610.7 323.9 1,035.8
------------- ------------- -------------
Cash flows from financing activities:
Deposits and interest credited for investment contracts........................... 127.1 170.4 237.2
Withdrawals of investment contracts............................................... (592.1) (795.0) (931.9)
Issuance of long-term debt........................................................ -- 1,566.1 --
Repayment of short-term debt...................................................... (109.7) (1,482.5) (132.8)
Capital contributions from former Aetna........................................... -- -- 118.9
Dividends paid to former Aetna.................................................... -- -- (216.0)
Common shares issued under benefit plans.......................................... 233.5 98.1 21.8
Common shares repurchased......................................................... (165.2) (95.6) --
Dividends paid to shareholders.................................................... (6.0) (5.7) --
Other, net........................................................................ -- -- (304.4)
Discontinued operations, net......................................................... -- -- (296.4)
------------- ------------- -------------
Net cash used for financing activities............................................... (512.4) (544.2) (1,503.6)
------------- ------------- -------------
Net increase in cash and cash equivalents of discontinued operations................. -- -- (715.5)
------------- ------------- -------------
Net increase (decrease) in cash and cash equivalents of continuing operations........ 404.7 (254.3) 343.3
Cash and cash equivalents, beginning of year......................................... 1,398.2 1,652.5 1,309.2
------------- ------------- -------------
Cash and cash equivalents, end of year............................................... $ 1,802.9 $ 1,398.2 $ 1,652.5
============= ============= =============
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Page 51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
The accompanying consolidated financial statements include Aetna Inc. (a
Pennsylvania corporation) ("Aetna") and its subsidiaries (collectively, the
"Company"). As of December 31, 2002, the Company's operations included three
business segments: Health Care, Group Insurance and Large Case Pensions. Health
Care consists of health and dental plans offered on both a risk basis (where the
Company assumes all or a majority of the risk for health and dental care costs)
and an employer-funded basis (where the plan sponsor under an administrative
services contract ("ASC"), and not the Company, assumes all or a majority of
this risk). Health plans include health maintenance organization ("HMO"),
point-of-service ("POS"), preferred provider organization ("PPO") and indemnity
benefit products. The Group Insurance segment includes group life insurance
products offered on a risk basis, as well as group disability and long-term care
insurance products offered on both a risk and an employer-funded basis. Large
Case Pensions manages a variety of retirement products (including pension and
annuity products) primarily for defined benefit and defined contribution plans.
These products provide a variety of funding and benefit payment distribution
options and other services. The Large Case Pensions segment includes certain
discontinued products. (Refer to Note 12 for additional information.)
The three segments are distinct businesses that offer different products and
services. The Company's chief operating decision maker evaluates financial
performance and makes resource allocation decisions at these segment levels. The
accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance of
these business segments based on operating earnings (net income or loss,
excluding net realized capital gains and losses and any other items, such as
severance and facilities charges and reductions of the reserve for anticipated
future losses on discontinued products).
Prior to December 13, 2000, the Company (formerly Aetna U.S. Healthcare Inc. and
its subsidiaries) was a subsidiary of a Connecticut corporation named Aetna Inc.
("former Aetna"). On December 13, 2000, former Aetna spun off shares of the
Company to shareholders and, as part of the same transaction, sold former
Aetna's financial services and international businesses to ING Groep N.V.
("ING") (collectively, the "Transaction"). The sale was accomplished by the
merger of former Aetna with a subsidiary of ING. The businesses sold to ING are
reflected as discontinued operations, since the Company is the successor of
former Aetna for accounting purposes. (Refer to Note 21 for additional
information.)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
These consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America. All
significant intercompany balances have been eliminated. Certain
reclassifications have been made to the 2001 and 2000 financial information to
conform to the 2002 presentation.
As a result of the Transaction, the consolidated financial statements for 2000
have been prepared using the historical basis of the assets and liabilities and
historical results of operations of the Health Care, Group Insurance and Large
Case Pensions businesses as if the Company were a separate entity for this
period. Changes in shareholders' equity prior to December 13, 2000 represented
the net income of the Company plus (less) net cash transfers from (to) former
Aetna. Additionally, the consolidated financial statements for 2000 include
allocations of certain assets and liabilities (including prepaid pension assets,
debt and benefit obligations and pension and post-retirement benefits) and
expenses (including interest), previously recorded by former Aetna, to the
Health Care, Group Insurance and Large Case Pensions businesses of the Company,
as well as to those businesses presented as discontinued operations. Management
believes these allocations are reasonable. Accordingly, the 2000 financial
information included herein may not necessarily reflect the consolidated results
of operations, financial position, changes in shareholders' equity and cash
flows of the Company had it been a separate, independent company.
Page 52
NEW ACCOUNTING STANDARDS
Goodwill and Other Intangible Assets
As of January 1, 2002, the Company adopted Financial Accounting Standard ("FAS")
No. 142, Goodwill and Other Intangible Assets. This standard eliminated goodwill
amortization from the Consolidated Statement of Income and required an
evaluation of goodwill for impairment (at the reporting unit level) upon
adoption of this standard, as well as an annual test, or more frequently if
circumstances indicate a possible impairment. This impairment test is comprised
of two steps. The initial step is designed to identify potential goodwill
impairment by comparing an estimate of the fair value of the applicable
reporting unit to its carrying value, including goodwill. If the carrying value
exceeds fair value, a second step is performed, which compares the implied fair
value of the applicable reporting unit's goodwill with the carrying amount of
that goodwill, to measure the amount of goodwill impairment, if any. The
Company's only reporting unit with goodwill and acquired intangible assets is
its Health Care business, which is also a reportable segment. Upon adoption, the
Company performed a transitional impairment test on its Health Care reporting
unit. As a result of this impairment test, the Company recorded an impairment of
approximately $3 billion during the first quarter of 2002, which is classified
as a cumulative effect adjustment for the year ended December 31, 2002.
Subsequent impairments, if any, would be classified as an operating expense.
During the fourth quarter of 2002, the Company performed an annual impairment
test, in conjunction with its annual planning process, and determined there were
no impairment losses related to goodwill and other acquired intangible assets.
The Company's measurement of fair value, utilized in its transitional impairment
test, was based on an evaluation of future discounted cash flows, public company
trading multiples and merger and acquisition transaction multiples. The
Company's fourth quarter 2002 annual impairment test was based on an evaluation
of future discounted cash flows. These evaluations utilized the best information
available in the circumstances, including reasonable and supportable assumptions
and projections. The discounted cash flow evaluations considered several
earnings scenarios and the likelihood of possible outcomes. Collectively, these
evaluations were management's best estimates of projected future cash flows. The
Company's discounted cash flow evaluations used a range of discount rates that
corresponds to the Company's weighted-average cost of capital. These discount
rate ranges are consistent with that used for investment decisions and take into
account the specific and detailed operating plans and strategies of the Health
Care reporting unit. Certain other key assumptions utilized, including changes
in membership, revenue, medical costs, operating expenses and effective tax
rates, are based on reasonable estimates related to the Company's turnaround
initiatives. Such assumptions also are consistent with those utilized in the
Company's annual planning process. If the Company's turnaround initiatives do
not achieve their earnings objectives, the assumptions and estimates underlying
these goodwill impairment evaluations could be adversely affected.
Upon adoption of FAS No. 142, the transition provisions of FAS No. 141, Business
Combinations, also became effective. FAS No. 141 specified criteria for
determining whether an acquired intangible asset should be recognized separately
from goodwill. Intangible assets that meet certain criteria qualify for
recording on the balance sheet and continue to be amortized over their useful
lives in the Consolidated Statement of Income. Such intangible assets are
subject to a periodic impairment test based on estimated fair value. As a result
of adopting FAS No. 141, the Company reclassified the carrying value of its work
force acquired intangible asset of $25.3 million at December 31, 2001 to
goodwill. Refer to Note 6 for more detail on the Company's goodwill and other
acquired intangible assets.
Page 53
Prior to the Company's adoption of FAS No. 142, goodwill and other intangible
assets were amortized over their estimated useful lives, and were tested
periodically to determine if they were recoverable from operating earnings on an
undiscounted basis over their useful lives and to evaluate the related
amortization periods. If it was probable that undiscounted projected operating
income (before amortization of goodwill and other acquired intangible assets)
was not sufficient to recover the carrying value of the asset, the carrying
value was written down through results of operations and, if necessary, the
amortization period was adjusted. Operating income considered in such an
analysis was either that of the entity acquired, if separately identifiable, or
the business segment that acquired the entity.
Accounting for the Impairment or Disposal of Long-Lived Assets
Effective January 1, 2002, the Company adopted FAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. This standard supercedes previous
related accounting standards. It addresses the accounting and reporting for
impairment of long-lived assets to be held and used, as well as long-lived
assets to be disposed of. It also broadens the presentation of discontinued
operations on the income statement to include a component of an entity (rather
than a segment of a business). This standard requires that long-lived assets to
be held and used be written down to fair value when they are considered
impaired. Long-lived assets to be disposed of are to be carried at the lower of
carrying value or fair value less estimated cost to sell. The adoption of this
standard did not have a material effect on the Company's financial position or
results of operations.
Accounting and Disclosure of Guarantees
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others ("FIN 45"), modifying the recognition and disclosure
requirements of a company's guarantee arrangements. Effective January 1, 2003,
FIN 45 requires a company that enters into or modifies existing guarantee
arrangements to recognize a liability for the fair value of the obligation
undertaken in issuing the guarantee. FIN 45 also requires disclosure of all
guarantees, regardless of when the guarantee originated, effective December 31,
2002 (Refer to Note 20). The adoption of the accounting provisions of FIN 45 is
not expected to have a material effect on the Company's financial position or
results of operations.
Accounting for Stock-Based Compensation
In December 2002, the FASB issued FAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of FASB Statement No.
123, which amends FAS No. 123, Accounting for Stock Based Compensation. FAS No.
148 provides transition alternatives to companies that have elected to account
for stock options under the fair value expense recognition model prescribed by
FAS No. 123. FAS No. 148 also amends the required disclosure of a company's
accounting policy regarding stock compensation to employees as well as requiring
additional annual and quarterly footnote disclosure regarding unvested stock
options. The Company does not account for stock-based compensation under the
fair value expense recognition model, but rather under the intrinsic value
method as permitted by FAS No. 123.
FUTURE APPLICATION OF ACCOUNTING STANDARDS
Accounting for Costs Associated with Exit or Disposal Activities
In July 2002, the Financial Accounting Standards Board ("FASB") issued FAS No.
146, Accounting for Costs Associated with Exit or Disposal Activities. This
standard supercedes the accounting guidance provided by Emerging Issues Task
Force Issue No. 94-3, Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring). FAS No. 146 requires companies to recognize costs
associated with exit activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan. The adoption of FAS No. 146 will
impact the timing of recognition for severance and facilities charges for
actions initiated after December 31, 2002.
Page 54
Accounting for Variable Interest Entities ("VIE")
In January 2002, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). This interpretation will require a
company to consolidate its VIE (formerly referred to as special purpose
entities) if the entities meet certain criteria and is considered the primary
beneficiary of the VIE (such as a direct or indirect ability to make significant
decisions of that entity or the obligation to absorb a majority of the entity's
expected losses). FIN 46 also requires additional disclosure of an entity's
relationship with a VIE. The consolidation provisions of this interpretation are
required for all VIE's created after January 31, 2003. For VIE's in existence
prior to January 31, 2003, the consolidation provisions of FIN 46 are effective
July 1, 2003.
As of December 31, 2002, the Company had a leasing program with an independent
third party grantor trust primarily for the lease of a corporate aircraft and
certain office furniture. The total value of the assets owned by the trust under
this leasing program at December 31, 2002 was approximately $54 million. For
2002, this arrangement was classified as an operating lease under existing
accounting requirements and therefore the related assets and liabilities are not
included in the Company's Consolidated Balance Sheet. The Company may terminate
the lease program at any time by purchasing the assets at cost or dissolving the
grantor trust through liquidation. If the assets were sold to a third party at
less than cost, the Company's maximum exposure under a residual value guarantee
was approximately $48 million at December 31, 2002 (Refer to Note 20 for further
information). Upon adoption of FIN 46, on July 1, 2003, the Company expects it
will consolidate this VIE as it is the primary beneficiary of these assets. The
adoption of this Interpretation is expected to increase reported assets and
liabilities on the Company's Consolidated Balance Sheets, but is not expected to
have any effect on the Company's results of operations.
USE OF ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from reported
results using those estimates. The Company considers the following accounting
policies, requiring significant estimates, critical when preparing its
consolidated financial statements: Revenue Recognition (Allowance for Estimated
Terminations and Uncollectable Accounts), Health Care and Insurance Liabilities,
Investments, Goodwill and Other Acquired Intangible Assets, and Defined Benefit
Pension and Other Post-Retirement Benefit Plans.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand and other debt securities with a
maturity of 90 days or less when purchased. The carrying value of cash
equivalents approximates fair value due to the short-term maturity of these
instruments.
Page 55
INVESTMENTS
Investment Securities
Investment securities consist primarily of U.S. Treasury and agency securities,
mortgage-backed securities, corporate and foreign bonds, money market
instruments and other debt and equity securities. The Company has determined
that its investment securities are available for use in current operations and,
accordingly, has classified such securities as current without regard to
contractual maturity dates. The cost for mortgage-backed and other asset-backed
securities is adjusted for unamortized premiums and discounts, which are
amortized using the interest method over the estimated remaining term of the
securities, adjusted for anticipated prepayments. The Company regularly reviews
its debt and equity securities to determine whether a decline in fair value
below the carrying value is other than temporary. If a decline in fair value is
considered other than temporary, the cost basis/carrying amount of the security
is written down and the amount of the write-down is included in earnings. The
Company does not accrue interest on debt securities when management believes the
collection of interest is unlikely.
Long-Term Investments
Long-term investments consist primarily of equity securities subject to
restrictions on disposition, limited partnerships and restricted assets. Limited
partnerships are generally carried on an equity basis. Restricted assets consist
of debt securities on deposit as required by regulatory authorities.
Fair Value of Investments
The Company has classified its investment securities as available for sale and
carries them at fair value. Fair values for such securities are based on quoted
market prices or dealer quotes. Non traded debt securities are priced
independently by a third party vendor and non traded equity securities are
priced based on an internal analysis of the investment's financial statements
and cash flow projections.
Securities Lending
The Company engages in securities lending whereby certain securities from its
portfolio are loaned to other institutions for short periods of time. Such
securities are classified as loaned securities on the Consolidated Balance
Sheets. The fair value of the loaned securities is monitored on a daily basis,
with additional collateral obtained or refunded as the market value of the
loaned securities fluctuates. Initial collateral, primarily cash, is required at
a rate of 102% of the market value of a loaned domestic security and 105% of the
market value of a loaned foreign security. The collateral is deposited by the
borrower with an independent lending agent, and retained and invested by the
lending agent according to the Company's guidelines to generate additional
income.
Mortgage Loans
Mortgage loans are carried at unpaid principal balances, net of impairment
reserves. A mortgage loan may be impaired when it is a problem loan (i.e., more
than 60 days delinquent, in bankruptcy or in process of foreclosure), a
potential problem loan (i.e., high probability of default within 3 years) or a
restructured loan. For impaired loans, a specific impairment reserve is
established for the difference between the recorded investment in the loan and
the estimated fair value of the collateral. The Company applies its loan
impairment policy individually to all loans in the portfolio and does not
aggregate loans for the purpose of applying such policy. The Company records
full or partial charge-offs of loans at the time an event occurs affecting the
legal status of the loan, typically at the time of foreclosure or upon a loan
modification giving rise to forgiveness of debt. The Company accrues interest
income on impaired loans to the extent it is deemed collectible and the loan
continues to perform under its original or restructured terms. Interest income
on problem loans is generally recognized on a cash basis. Cash payments on loans
in the process of foreclosure are generally treated as a return of principal.
Mortgage loans with a maturity date of less than one year from the balance sheet
date are reported in other investments on the Consolidated Balance Sheets.
Page 56
Mortgage Loan Securitizations
The Company may, from time to time, securitize and sell certain commercial
mortgage loans and retain an interest in the securitized mortgage loans. Gains
or losses on the sale of these loans would depend on the previous carrying
amount of the transferred loans, allocated between the portion of the loans sold
and the retained interests based on their relative fair value at the date of
transfer. Fair values are based on quoted market prices or dealer quotes.
Investment Real Estate
Investment real estate, which the Company intends to hold for the production of
income, is carried at depreciated cost, including capital additions, net of
write-downs for other than temporary declines in fair value. Depreciation is
generally calculated using the straight-line method based on the estimated
useful life of each asset. Properties held for sale (primarily acquired through
foreclosure) are carried at the lower of carrying value or fair value less
estimated selling costs. Adjustments to the carrying value of properties held
for sale are recorded in a valuation reserve when the fair value less estimated
selling costs is below carrying value. Fair value is generally estimated using a
discounted future cash flow analysis in conjunction with comparable sales
information. Property valuations are reviewed by the Company's investment
management group. At the time of the sale, the difference between the sales
price and the carrying value is recorded as a realized capital gain or loss.
NET INVESTMENT INCOME AND REALIZED CAPITAL GAINS AND LOSSES
Net investment income and realized capital gains and losses on investments
supporting Group Insurance and Health Care's liabilities and Large Case
Pensions' non-experience-rated products are reflected in the Company's results
of operations. Realized capital gains and losses are determined on a specific
identification basis. Unrealized capital gains and losses are computed on a
specific identification basis and are reflected in shareholders' equity, net of
related income taxes, as a component of accumulated other comprehensive income.
Purchases and sales of debt and equity securities are recorded on the trade
date. Sales of mortgage loans and investment real estate are recorded on the
closing date. Net investment income supporting Large Case Pensions
experience-rated products is included in net investment income, which is
credited to contractholders in current and future benefits.
Realized and unrealized capital gains and losses on investments supporting
experience-rated products in the Large Case Pensions business are reflected in
policyholders' funds and are determined on a specific identification basis.
Experience-rated products are products in the Large Case Pensions business where
the contract holder, not the Company, assumes investment (including realized
capital gains and losses) and other risks, subject to, among other things,
minimum guarantees provided by the Company in some instances. The effect of
investment performance is allocated to contractholders' accounts daily, based on
the underlying investment's experience and, therefore, does not impact the
Company's results of operations (as long as minimum guarantees are not
triggered).
When the Company discontinued the sale of its fully guaranteed large case
pensions products, it established a reserve for anticipated future losses from
these products and segregated the related investments. These investments are
managed as a separate portfolio. Investment income and net realized capital
gains and losses on this separate portfolio are ultimately credited/charged to
the reserve and, therefore, do not impact the Company's results of operations.
Unrealized capital gains or losses on this separate portfolio are reflected in
other current assets or other current liabilities on the Consolidated Balance
Sheets. (Refer to Note 12)
Page 57
DERIVATIVE INSTRUMENTS
The Company's Use of Derivatives
The Company uses derivative instruments ("derivatives") in order to manage
interest rate and price risk (collectively, "market risk"). By using derivatives
to manage market risk, the Company exposes itself to credit risk and additional
market risk.
Credit risk is the exposure to loss if a counterparty fails to perform under the
terms of the derivative contract. The Company generally does not require
collateral or other security for its derivatives, but may be required to post
collateral under certain circumstances. However, the Company minimizes its
credit risk by entering into transactions with counterparties that maintain high
credit ratings, as well as by limiting single counterparty exposure and
monitoring the financial condition of counterparties. Market risk is the
exposure to changes in the market price of the underlying instrument and the
related derivative. Such price changes result from movements in interest rates
and equity markets, and as a result, assets and liabilities will appreciate or
depreciate in market value.
The Company uses primarily futures contracts, forward contracts, interest rate
swap agreements and warrants to manage market risk.
Futures contracts represent commitments either to purchase or to sell securities
at a specified future date and specified price. Futures contracts trade on
organized exchanges and therefore, have minimal credit risk. Forward contracts
are agreements to exchange fixed amounts of two different financial instruments
or currencies at a specified future date and specified price. Interest rate swap
agreements are contracts to exchange interest payments on a specified principal
(notional) amount for a specified period.
From time to time, the Company uses option contracts for the purpose of
increasing net investment income. Option contracts grant the purchaser, for a
fee, the right, but not the obligation, to buy or sell a financial instrument at
a given price during a specified period.
Effective January 1, 2001, with the implementation of FAS No. 133, Accounting
for Derivative Instruments and Hedging Activities, as amended and interpreted,
derivatives are recognized on the Company's Consolidated Balance Sheets in other
investments at fair value. The fair value of derivatives is estimated based on
quoted market prices, dealer quotes or internal price estimates believed to be
comparable to dealer quotes. These fair value amounts reflect the estimated
amounts that the Company would have to pay or would receive if the contracts
were terminated.
When the Company enters into a derivative contract, if certain criteria are met,
it may designate the derivative as one of the following: (i) a hedge of the fair
value of a recognized asset or liability or of an unrecognized firm commitment
("fair value hedge"); (ii) a hedge of a forecasted transaction or of the
variability of cash flows to be received or paid related to a recognized asset
or liability ("cash flow hedge"); or (iii) a foreign currency fair value or cash
flow hedge ("foreign currency hedge").
At hedge inception, the Company formally documents all relationships between
hedging instruments and hedged items, as well as its risk management objective
and strategy for the hedge transactions. This process includes linking all
derivatives that are designated as fair value or cash flow hedges to specific
assets and liabilities on the Company's Consolidated Balance Sheets or to
specific firm commitments or forecasted transactions. The Company also formally
assesses, both at inception and on an ongoing basis, whether the derivatives
used in hedging transactions are highly effective in offsetting changes in fair
values or cash flows of hedged items. If it is determined that a derivative is
not highly effective as a hedge, the Company discontinues hedge accounting
prospectively, as discussed below.
Page 58
For a derivative designated as a fair value hedge, changes in the fair value,
along with the gain or loss on the related hedged asset or liability, are
recorded in current period earnings. For a derivative designated as a cash flow
hedge, the effective portion of changes in the fair value of the derivative are
recorded in accumulated other comprehensive income and are recognized in the
Consolidated Statements of Income when the hedged item affects earnings. Any
amounts excluded from the assessment of hedge effectiveness, as well as the
ineffective portion of the gain or loss are reported in earnings immediately. If
the derivative is not designated as a hedge, the gain or loss is recognized in
earnings in the period of change.
The Company's financial instruments and insurance products are reviewed to
determine whether a derivative may be "embedded" in such instruments or
products. The Company assesses whether the economic characteristics of the
embedded derivative are clearly and closely related to the remaining component
of the financial instrument or insurance product (that is, the host contract).
If it is determined that the embedded derivative is not clearly and closely
related to the host contract and that a separate instrument with the same terms
would qualify as a derivative, the embedded derivative is separated from the
host contract and carried at fair value.
The Company discontinues hedge accounting prospectively when it is determined
that one of the following has occurred: (i) the derivative is no longer highly
effective in offsetting changes in the fair value or cash flows of a hedged
item; (ii) the derivative expires or is sold, terminated, or exercised; (iii)
the derivative is undesignated as a hedge instrument because it is unlikely that
a forecasted transaction will occur; (iv) a hedged firm commitment no longer
meets the definition of a firm commitment; or (v) management determines that the
designation of the derivative as a hedge instrument is no longer appropriate.
If hedge accounting is discontinued, the derivative will continue to be carried
on the Company's Consolidated Balance Sheets at its fair value. When hedge
accounting is discontinued because the derivative no longer qualifies as an
effective fair value hedge, the related hedged asset or liability will no longer
be adjusted for fair value changes. When hedge accounting is discontinued
because it is probable that a forecasted transaction will not occur, the
accumulated gains and losses included in accumulated other comprehensive income
will be recognized immediately in earnings. When hedge accounting is
discontinued because the hedged item no longer meets the definition of a firm
commitment, any asset or liability that was recorded pursuant to the firm
commitment will be removed from the balance sheet and recognized as a gain or
loss in current period earnings. In all other situations in which hedge
accounting is discontinued, changes in the fair value of the derivative are
recognized in current period earnings.
REINSURANCE
The Company utilizes reinsurance agreements to reduce its exposure to large
losses in certain aspects of its insurance business as well as the acquisition
or disposition of certain insurance contracts. These reinsurance agreements
permit recovery of a portion of losses from reinsurers, although they do not
discharge the Company's primary liability as direct insurer of the risks
reinsured. Only those reinsurance recoverables deemed probable of recovery are
reflected as assets. In the normal course of business, the Company enters into
agreements with other insurance companies to assume reinsurance, primarily
related to its health and group life products (Refer to Note 18). The Company
does not transfer any portion of the financial risk associated with our HMO
business to third parties.
Page 59
PROPERTY AND EQUIPMENT AND OTHER ACQUIRED INTANGIBLE ASSETS
Property and equipment and other acquired intangible assets are reported at
historical cost net of accumulated depreciation/amortization. At December 31,
2002 and 2001, historical cost of property and equipment was approximately $.9
billion, and the related accumulated depreciation was approximately $.7 billion.
Depreciation and amortization is calculated using the straight-line method over
the estimated useful lives of the respective assets ranging from three to forty
years.
The Company regularly evaluates whether events or changes in circumstances
indicate that the carrying amount of property and equipment and other acquired
intangible assets may not be recoverable. If it is determined that an asset may
not be recovered, the Company estimates the future undiscounted cash flows
(grouped at the lowest level for which identifiable cash flows are largely
independent of cash flows of other assets and liabilities) expected to result
from future use of the asset and its eventual disposition. If the sum of the
expected undiscounted future cash flows is less than the carrying amount of the
asset, an impairment loss will be recognized for the amount by which the
carrying amount of the asset exceeds its fair value.
SEPARATE ACCOUNTS
Separate Accounts assets and liabilities in the Large Case Pensions business
generally represent funds maintained to meet specific investment objectives of
contract holders who bear the investment risk. Investment income and investment
gains and losses generally accrue directly to such contractholders. The assets
of each account are legally segregated and are not subject to claims that arise
out of any other business of the Company. These assets and liabilities are
carried at market value. Deposits, net investment income and realized capital
gains and losses on Separate Accounts assets are not reflected on the
Consolidated Statements of Income. Management fees charged to contractholders
are included in other income and recognized over the period earned.
HEALTH CARE AND INSURANCE LIABILITIES
Health care costs payable consist principally of unpaid fee-for-service health
care and pharmacy claims, capitation costs and other amounts due to health care
providers pursuant to risk-sharing arrangements related to Health Care's HMO,
POS, PPO and traditional indemnity plans. Unpaid health care claims include
estimates of payments to be made on claims reported but not yet paid and health
care services rendered but not yet reported to the Company as of the balance
sheet date. Also included in these estimates is the cost of services that will
continue to be rendered after the balance sheet date if the Company is obligated
to pay for such services in accordance with contractual or regulatory
requirements. Such estimates are developed using actuarial principles and
assumptions which consider, among other things, contractual requirements,
historical utilization trends, persistency of membership and payment patterns,
medical inflation, product mix, seasonality, membership and other relevant
factors. Changes in estimates are recorded in health care costs on the
Consolidated Statements of Income in the period they are determined. Capitation
costs represent contractual monthly fees paid to participating physicians and
other medical providers for providing medical care. Amounts due under
risk-sharing arrangements are based on the terms of the underlying contracts
with the providers and consider experience under the contracts through the
balance sheet date.
Page 60
Unpaid claims consist primarily of reserves associated with certain
short-duration group disability and term life insurance contracts, including an
estimate for claims incurred but not reported as of the balance sheet date.
Reserves associated with certain short-duration group disability and term life
insurance contracts are based upon the present value of future benefits, which
is based on assumed investment yields and assumptions regarding mortality,
morbidity and recoveries from government programs. Reserves for claims incurred
but not reported are developed using actuarial principles and assumptions which
consider, among other things, contractual requirements, historical payment
patterns, seasonality and other relevant factors. The Company discounts certain
claim liabilities related to group long-term disability and premium waiver
contracts. The discounted unpaid claim liabilities were $1.3 billion as of
December 31, 2002 and $1.4 billion as of December 31, 2001. Generally, the
discount rates reflect the expected investment returns for the asset portfolios
that support these liabilities and ranged from 6.3% to 6.9% in 2002 (except for
experience-rated contracts where the discount rates are set at contractually
specified levels). The estimates of unpaid claims are subject to change due to
changes in the underlying experience of the contracts, changes in investment
yields or other factors, and these changes are recorded in current and future
benefits on the Consolidated Statements of Income in the period they are
determined.
Future policy benefits consist primarily of reserves for limited payment pension
and annuity contracts in the Large Case Pensions business and long-duration
group paid-up life and long-term care insurance contracts in the Group Insurance
business. Reserves for limited payment contracts are computed in accordance with
actuarial principles and are based upon assumptions reflecting anticipated
mortality, retirement, expense and interest rate experience. Such assumptions
generally vary by plan, year of issue and policy duration. Assumed interest
rates on such contracts ranged from 2.0% to 15.9% in 2002. Mortality assumptions
are periodically reviewed against both industry standards and experience.
Reserves for group paid-up life and long-term care contracts represent the
present value of future benefits to be paid to or on behalf of policyholders
less the present value of future net premiums. Assumed interest rates on such
contracts ranged from 2.5% to 9.5% in 2002. The present value of future benefits
is based upon mortality, morbidity and interest rate assumptions.
Policyholders' funds consist primarily of reserves for pension and annuity
investment contracts in the Large Case Pensions business and customer funds
associated with group life and health contracts in the Health Care and Group
Insurance businesses. Reserves on such contracts are equal to cumulative
deposits less withdrawals and charges plus credited interest thereon, net of
adjustments for investment experience that the Company is entitled to reflect in
future credited interest. In 2002, interest rates for pension and annuity
investment contracts ranged from 1.6% to 15.9% and rates for group life and
health contracts ranged from 1.3% to 6.8%. Reserves on contracts subject to
experience rating reflect the rights of policyholders, plan participants and the
Company.
Health care and insurance liabilities are reviewed periodically, with any
necessary adjustments reflected during the current period in results of
operations. While the ultimate amount of claims and related expenses are
dependent on future developments, it is management's opinion that the
liabilities that have been established are adequate to cover such costs. The
health care and insurance liabilities that are expected to be paid within one
year from the balance sheet date are classified as current liabilities on the
Consolidated Balance Sheets.
DEFERRED ACQUISITION COSTS
Acquisition costs related to the Company's prepaid health care and health
indemnity contracts are expensed as incurred. The Company defers certain
acquisition costs related to its long-term care products. Such deferred costs
were not material to the Company's financial position or results of operations
as of December 31, 2002 or 2001 and are included in Other long-term assets in
the Company's Consolidated Balance Sheets.
Page 61
PREMIUM DEFICIENCY
The Company evaluates its health care and insurance contracts to determine if it
is probable that a loss will be incurred. A premium deficiency loss is
recognized when it is probable that expected future claims, including
maintenance costs (e.g. claim processing costs), will exceed existing reserves
plus anticipated future premiums and reinsurance recoveries on existing
contracts. Anticipated investment income is considered in the calculation of
premium deficiency losses for short-duration contracts. For purposes of
determining premium deficiency losses, contracts are grouped in a manner
consistent with the Company's method of acquiring, servicing and measuring the
profitability of such contracts. For all periods presented, no deficiency losses
were recorded.
REVENUE RECOGNITION
Health care premiums associated with the Company's prepaid and other health care
plans are recognized as income in the month in which the enrollee is entitled to
receive health care services. Health care premiums are reported net of an
allowance for estimated terminations (retroactivity adjustments) and
uncollectable amounts. Other premium revenue for group life, long-term care and
disability products is recognized as income, net of allowances for termination
and uncollectable accounts, over the term of the coverage. Other premium revenue
for Large Case Pensions' limited payment pension and annuity contracts is
recognized as revenue in the period received. Premiums related to unexpired
contractual coverage periods are reported as unearned premiums on the
Consolidated Balance Sheets.
The balance of the allowance for estimated terminations and uncollectable
accounts on premiums receivable was $127 million and $172 million at December
31, 2002 and 2001, respectively, and is included in premiums receivable on the
Consolidated Balance Sheets. The balance of the allowance for uncollectable
accounts on other receivables was $91 million and $104 million at December 31,
2002 and 2001, respectively, and is included in other receivables on the
Consolidated Balance Sheets.
Some group contracts allow for premiums to be adjusted to reflect actual
experience. Such adjustments are reasonably estimable (based on actual
experience of the customer emerging under the contract and the terms of the
underlying contract) and are recognized as the experience emerges.
ASC fees are received in exchange for performing certain claims processing and
member services for self-insured health and disability members and are
recognized as revenue over the period the service is provided. Some of the
Company's contracts include guarantees with respect to certain functions such as
customer service response time, claim processing accuracy and claim processing
turnaround time, as well as certain guarantees that claim expenses to be
incurred by plan sponsors will fall within a certain range. With any of these
guarantees, the Company is financially at risk if the conditions of the
arrangements are not met, although the maximum amount at risk is typically
limited to a percentage of fees for the customer involved.
Other income includes charges assessed against contractholders' funds for
contract fees, participant fees and asset charges related to pension and annuity
products in the Large Case Pensions business. Other amounts received on pension
and annuity contracts are reflected as deposits and are not recorded as revenue.
When annuities with life contingencies are purchased under contracts that were
initially investment contracts, the accumulated balance related to the purchase
is treated as a single premium and reflected as an offsetting amount in both
other premiums and current and future benefits on the Consolidated Statements of
Income.
Page 62
ALLOCATION OF EXPENSES
The Company allocates to the business segments centrally incurred costs
associated with specific internal goods or services provided to the Company,
such as employee services, technology services and rent, based on a reasonable
method for each specific cost (such as usage, headcount, compensation or square
footage occupied). Interest expense on third-party borrowings is not allocated
to the reporting segments since it is not used as a basis for measuring the
operating performance of the segments. Such amounts are reflected in Corporate
Interest. (Refer to Note 19).
INCOME TAXES
The Company is taxed at regular corporate rates after adjusting income reported
for financial statement purposes for certain items. The Company was included in
the consolidated federal income tax returns of former Aetna through December 13,
2000. As a result of the Transaction, for the period December 14 through
December 31, 2000 and the years ended December 31, 2001 and 2002, the Company is
responsible for filing two separate consolidated and various standalone federal
income tax returns. The results of these separate tax filings are combined for
financial reporting purposes.
Deferred income tax assets and liabilities are recognized for the differences
between the financial and income tax reporting basis of assets and liabilities
based on enacted tax rates and laws. Valuation allowances are provided when it
is considered unlikely that deferred tax assets will be realized. Deferred
income tax expense or benefit primarily reflects the net change in deferred
income tax assets and liabilities during the year. The current income tax
provision reflects the tax results of revenues and expenses currently taxable or
deductible.
STOCK-BASED COMPENSATION
At December 31, 2002, the Company had various stock-based employee incentive
plans, which are described more fully in Note 14. The Company uses the intrinsic
value method of accounting for stock-based awards granted to employees.
Accordingly, compensation cost is not recognized when the exercise price of an
employee stock option equals or exceeds the fair market value of the stock on
the date the option is granted. The following table illustrates the pro forma
net income (loss) and pro forma earnings per share as if the Company had applied
the fair value based method of accounting to all awards of stock-based employee
compensation.
(MILLIONS, EXCEPT PER COMMON SHARE DATA) 2002 2001 2000
------------------------------------------------------ ------------ ---------- -------
Net income (loss), as reported........................ $ (2,522.5) $ (279.6) $ 127.1
Add: Stock-based employee compensation expense
included in reported net income (loss), net of
related tax effects................................... 27.4 2.1 13.9
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects................................... (59.4) (13.0) (136.4)
------------ -------- -------
Pro forma net income (loss)........................... $ (2,554.5) $ (290.5) $ 4.6
============ ======== =======
Earnings (loss) per common share (1):
Basic - as reported................................ $ (16.94) $ (1.95) $ .90
Basic - pro forma.................................. (17.15) (2.03) .03
Diluted - as reported.............................. (16.49) (1.95) .90
Diluted - pro forma................................ (16.88) (2.03) .03
------------ -------- -------
(1) Since the Company reported a loss from continuing operations in 2001 and
2000, the effect of common stock equivalents has been excluded from per
common share computations for those years since including such securities
would be anti-dilutive. As a result, diluted and basic per common share
amounts for 2001 and 2000 are the same.
Page 63
The fair value of the stock options included in the pro forma amounts was
estimated as of the grant date using the Black-Scholes option-pricing model with
the following weighted-average assumptions:
2002 2001 2000
------ ------ -------
Dividend yield .1% .1% 1%
Expected volatility 40% 40% 39%
Risk-free interest 4% 5% 7%
rate...............
Expected life...... 5 years 5 years 4 years
------- ------- -------
The weighted-average grant date fair values for the Company's options granted in
2002 and 2001 and former Aetna options granted in 2000 were $15.06, $11.68, and
$16.43, respectively.
3. DISPOSITIONS
EXIT OF CERTAIN MEDICARE SERVICE AREAS
The Company's Medicare+Choice contracts with the federal government are renewed
for a one-year period each January 1. In September 2002, the Company notified
the Centers for Medicare and Medicaid Services ("CMS") of its intent not to
renew its Medicare+Choice contracts for 2003 for individuals in a number of
Medicare service areas affecting approximately 9,000 members, or approximately
8% of the Company's total Medicare membership prior to this exit. The
termination of these Medicare+Choice contracts became effective on January 1,
2003. In September 2001, the Company notified CMS of its intent to exit a number
of Medicare service areas affecting approximately 95,000 members, or
approximately 37% of the Company's total Medicare membership prior to this exit.
The termination of these Medicare+Choice contracts became effective on January
1, 2002. Effective January 1, 2001, the Company exited a number of Medicare
service areas affecting approximately 260,000 members, or approximately 47% of
the Company's total Medicare membership prior to this exit. In the fourth
quarter of 2000, the Company recorded an after-tax charge of approximately $194
million ($266 million pretax) for the write-off of goodwill that was still
separately identifiable with such service areas.
SALE OF CERTAIN MEDICAID MEMBERSHIP
On August 1, 2001, the Company completed the sale of its New Jersey Medicaid and
New Jersey Family Care membership to AmeriChoice. The agreement covered
approximately 118,000 New Jersey Medicaid beneficiaries and members of the New
Jersey Family Care program for uninsured children and adults. Proceeds from this
sale of approximately $20 million pretax were included in other income for 2001.
The operating results of these Medicaid markets sold, which include the proceeds
from the sale, were not material to the Company's results of operations.
SALE OF NYLCARE TEXAS
In connection with the acquisition of the Prudential health care business
("PHC") from The Prudential Insurance Company of America ("Prudential"), 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") that
had been 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, the Company completed the sale of NYLCare Texas to Blue Cross
and Blue Shield of Texas, a division of Health Care Service Corporation
("HCSC"), 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. In March 2001, HCSC provided the Company with a letter
demanding arbitration of claims arising from its acquisition of NYLCare Texas.
In May 2002, the Company and HCSC settled this action. The settlement amount was
not material to the financial condition of the Company. The results of
operations of NYLCare Texas were not material to the Health Care segment or to
the Company's consolidated results of operations.
Page 64
4. HEALTH CARE COSTS PAYABLE
The following table shows the components of the change in health care costs
payable.
(MILLIONS) 2002 2001 2000
----------------------------------------------------- -------------- -------------- -----------
Health care costs payable, beginning of the period.. $ 2,986.7 $ 3,171.1 $ 3,238.7
Less: Reinsurance recoverables.. 10.3 32.8 66.2
----------- ----------- -----------
Health care costs payable, beginning of the period 2,976.4 3,138.3 3,172.5
-- net..............................................
Less: Disposition of NYLCare Texas.................. -- -- (71.9)
Add: components of incurred health care costs
Current period health care costs................. 12,523.7 17,894.9 18,861.5
Changes in prior periods' (70.9)(2) 43.9(3) 22.6
estimates (1)
---------- ----------
Total incurred health care costs 12,452.8 17,938.8 18,884.1
----------- ----------- -----------
Less: claims paid
Current period............... 10,668.2 15,266.3 15,935.9
Prior periods................ 2,573.6 2,834.4 2,910.5
----------- ----------- -----------
Total claims paid............... 13,241.8 18,100.7 18,846.4
----------- ----------- -----------
Health care costs payable, end of period -- net..... 2,187.4 2,976.4 3,138.3
Add: Reinsurance recoverables... 6.7 10.3 32.8
----------- ----------- -----------
Health care costs payable, end of period............ $ 2,194.1 $ 2,986.7 $ 3,171.1
=========== =========== ===========
(1) Changes in prior periods' estimates represents the effect of unfavorable
(favorable) development of prior period medical cost estimates on current
year results of operations, at each financial statement date.
(2) Reflects favorable development of prior period medical cost estimates of
approximately $40 million ($26 million after tax) for Commercial HMO and
approximately $35 million ($23 million after tax) for Medicare HMO.
(3) Reflects primarily unfavorable development of prior period medical cost
estimates related to certain Medicare markets the Company exited on January
1, 2001.
5. EARNINGS PER COMMON SHARE
A reconciliation of the numerator and denominator of the basic and diluted
earnings per common share ("EPS") is as follows:
INCOME (LOSS) SHARES PER COMMON
(MILLIONS, EXCEPT EPS DATA) (NUMERATOR) (DENOMINATOR) SHARE AMOUNT
---------------------------------------------- ------------- ------------- -------------
2002
Basic EPS:
Income from continuing operations......... $ 393.2 148.9 $ 2.64
========= ========
Effect of dilutive securities:
Stock options and 4.0
other (1)
------
Diluted EPS:
Income from continuing operations and..... $ 393.2 152.9 $ 2.57
assumed conversions
========= ======
2001
Basic and Diluted EPS:
Loss from continuing operations (2)....... $ (291.5) 143.2 $ (2.03)
========= ====== ========
2000
Basic and Diluted EPS:
Loss from continuing operations (3)....... $ (127.4) 141.3 $ (.90)
========= ====== ========
(1) Options to purchase shares of common stock for 2002 of 7.2 million shares
(with exercise prices ranging from $40.90 to $54.21) were not included in
the calculation of diluted earnings per common share because the options'
exercise prices were greater than the average market price of common shares
during such period.
(2) Since the Company reported a loss from continuing operations for 2001,
options to purchase 30.0 million shares (with exercise prices ranging from
$12.89 to $54.21) were not included in per common share calculations, since
including such securities would be anti-dilutive. As a result, diluted and
basic per common share amounts for 2001 are the same.
(3) Since the Company reported a loss from continuing operations for 2000,
options to purchase 31.7 million shares (with exercise prices ranging from
$7.14 to $54.21) were not included in per common share calculations, since
including such securities would be anti-dilutive. As a result, diluted and
basic per common share amounts for 2000 are the same.
Page 65
As a result of the Transaction, the former Aetna stock options held by employees
of the Company and retirees of former Aetna were converted into options to
purchase shares of the Company with adjustments made to both the number of
options and the exercise prices to maintain the intrinsic in- or
out-of-the-money value immediately before the spin-off. The in-the-money former
Aetna stock options held by employees of the sold businesses were settled for
cash while the out-of-the-money former Aetna stock options for such employees
were cancelled. (Refer to Note 14)
For the period January 1, 2000 through December 13, 2000, the common stock
outstanding and the dilutive effect of all outstanding stock options, where
appropriate, of former Aetna are reflected in the weighted average share
calculation. For the period from December 14, 2000 through December 31, 2000 and
the years ended December 31, 2001 and 2002, only the common stock outstanding of
the Company is reflected in the weighted average share calculation.
6. GOODWILL AND OTHER ACQUIRED INTANGIBLE ASSETS
On January 1, 2002, the Company adopted FAS No. 142 and the transition
provisions of FAS No. 141, as discussed in more detail in Note 2. As a result,
the Company recorded an impairment loss, ceased amortizing goodwill and
reclassified the December 31, 2001 carrying value of its work force acquired
intangible asset to goodwill. The Company's only reporting unit with goodwill
and other acquired intangible assets is its Health Care business, which also is
a reportable segment. Changes in the carrying amount of goodwill were as
follows:
(MILLIONS)
------------
Balance at December 31, 2000..... $ 6,781.9
Amortization..................... (198.1)
------------
Balance at December 31, 2001..... 6,583.8
Impairment loss.................. (2,965.7)
Reclassification of work force... 25.3
Goodwill adjustment (1).......... (25.0)
------------
Balance at December 31, 2002..... $ 3,618.4
===========
(1) Represents the post-acquisition adjustment of deferred tax liabilities
established in purchase accounting relating to former Aetna's 1996
acquisition of U.S. Healthcare, Inc. This post-acquisition adjustment was
the result of the conclusion of several Internal Revenue Service audit
issues during the first quarter of 2002.
Page 66
For comparative purposes, the following table adjusts net loss and basic and
diluted EPS for the year ended December 31, 2001, as if the work force asset
were reclassified and amortization of goodwill had ceased at the beginning of
2001.
(MILLIONS, EXCEPT EPS DATA) 2002 2001
--------------------------------------- ------------ ----------
Reported net loss..................... $ (2,522.5)$ (279.6)
Add back: Goodwill amortization....... -- 195.3
Add back: Work force amortization..... -- 8.1
----------- ----------
Adjusted net loss..................... $ (2,522.5)$ (76.2)
============ ==========
Basic EPS:
Reported net loss..................... $ (16.94) $ (1.95)
Add back: Goodwill amortization....... -- 1.36
Add back: Work force amortization..... -- .06
----------- ---------
Adjusted net loss..................... $ (16.94) $ (.53)
=========== =========
Diluted EPS: (1)
Reported net loss..................... $ (16.49) $ (1.95)
Add back: Goodwill amortization....... -- 1.36
Add back: Work force amortization..... -- .06
----------- ---------
Adjusted net loss..................... $ (16.49) $ (.53)
=========== =========
(1) Since the Company reported a loss from continuing operations for 2001, the
effect of common stock equivalents has been excluded from per common share
computations, since including such securities would be anti-dilutive. As a
result, diluted and basic per common share amounts for 2001 are the same.
Other acquired intangible assets at December 31, 2002 and December 31, 2001 were
as follows:
ACCUMULATED AMORTIZATION
DECEMBER 31, 2002 (MILLIONS) COST AMORTIZATION NET BALANCE PERIOD (YEARS)
--------------------------- ---------- ------------ ----------- --------------
Other acquired intangible
assets:
Provider networks........ $ 677.2 $ 169.3 $ 507.9 20-25
Customer lists........... 919.0 880.2 38.8 5-7
Other.................... 69.2 69.0 .2 3-5
---------- --------- --------
Total other acquired
intangible $ 1,665.4 $ 1,118.5 $ 546.9
========== ========= ========
assets......................
DECEMBER 31, 2001
Other acquired intangible
assets:
Provider networks........ $ 677.2 $ 141.5 $ 535.7 20-25
Customer lists........... 919.0 784.4 134.6 5-7
Work force............... 88.0 62.7 25.3 3-6
Other.................... 69.2 61.8 7.4 3-5
---------- --------- --------
Total other acquired
intangible $ 1,753.4 $ 1,050.4 $ 703.0
========== ========= ========
assets......................
Annual pretax amortization for other acquired intangible assets over the next
five calendar years is estimated to be as follows:
(MILLIONS)
-----------
2003.. $ 50.8
2004.. 42.5
2005.. 29.4
2006.. 27.8
2007.. 27.8
---- --------
Page 67
7. INVESTMENTS
Investment securities at December 31 were as follows:
(MILLIONS) 2002 2001
----------------------------------- ------------ ------------
Debt securities available for sale. $ 13,379.1 $ 13,446.0
Equity securities.................. 29.1 124.9
Other investment securities........ 605.3 689.2
------------ ------------
Total investment securities........ $ 14,013.5 $ 14,260.1
============ ============
Page 68
Debt securities available for sale (including loaned securities) at December 31
were as follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
2002 (MILLIONS) COST GAINS LOSSES VALUE
----------------------------------------------------------------- ------------ ---------- ---------- ---------
Bonds:
U.S. government and government agencies and authorities....... $ 991.7 $ 13.9 $ -- $ 1,005.6
States, municipalities and political subdivisions............. 1,033.5 44.7 .4 1,077.8
U.S. corporate securities:
Utilities.................................................. 610.0 35.8 18.8 627.0
Financial.................................................. 1,697.5 118.6 6.7 1,809.4
Transportation/Capital goods............................... 835.6 82.7 15.5 902.8
Health care/Consumer products.............................. 808.1 63.3 10.8 860.6
Natural resources.......................................... 851.6 87.5 1.2 937.9
Other corporate securities................................. 1,463.3 130.4 8.9 1,584.8
------------ -------- -------- ------------
Total U.S. corporate securities......................... 6,266.1 518.3 61.9 6,722.5
------------ -------- -------- ------------
Foreign:
Government, including political subdivisions............... 609.4 30.3 4.8 634.9
Utilities.................................................. 28.2 .7 .6 28.3
Other...................................................... 1,281.5 122.2 5.7 1,398.0
------------ -------- -------- ------------
Total foreign securities................................ 1,919.1 153.2 11.1 2,061.2
------------ -------- -------- ------------
Residential mortgage-backed securities:
Pass-throughs.............................................. 1,572.5 64.0 -- 1,636.5
Collateralized mortgage obligations........................ 20.8 .2 -- 21.0
------------ -------- -------- ------------
Total residential....................................... 1,593.3 64.2 -- 1,657.5
mortgage-backed securities
------------ -------- --------
Commercial/Multifamily mortgage-backed securities (1)(2)...... 1,199.5 127.8 11.1 1,316.2
Other asset-backed securities................................. 309.8 10.9 3.3 317.4
------------ -------- -------- ------------
Total bonds...................................................... 13,313.0 933.0 87.8 14,158.2
Redeemable preferred stocks...................................... 154.9 16.5 2.3 169.1
------------ -------- -------- ------------
Total available-for-sale debt securities (3)..................... $ 13,467.9 $ 949.5 $ 90.1 $ 14,327.3
============ ======== ======== ============
2001
Bonds:
U.S. government and government agencies and authorities....... $ 782.7 $ .3 $ 9.5 $ 773.5
States, municipalities and political subdivisions............. 882.1 12.6 5.5 889.2
U.S. corporate securities:
Utilities.................................................. 743.8 24.1 13.6 754.3
Financial.................................................. 1,777.9 62.1 15.3 1,824.7
Transportation/Capital goods............................... 1,156.3 66.8 39.6 1,183.5
Health care/Consumer products.............................. 798.0 34.3 8.5 823.8
Natural resources.......................................... 794.8 32.8 10.2 817.4
Other corporate securities................................. 1,494.3 57.6 32.4 1,519.5
------------ -------- -------- ------------
Total U.S. securities................................... 6,765.1 277.7 119.6 6,923.2
------------ -------- -------- ------------
Foreign:
Government, including political subdivisions............... 458.9 19.3 4.2 474.0
Utilities.................................................. 61.2 1.3 3.5 59.0
Other...................................................... 1,245.8 57.5 25.6 1,277.7
------------ -------- -------- ------------
Total foreign securities................................ 1,765.9 78.1 33.3 1,810.7
------------ -------- -------- ------------
Residential mortgage-backed securities:
Pass-throughs.............................................. 1,781.5 32.6 4.4 1,809.7
Collateralized mortgage obligations........................ 72.5 3.7 .1 76.1
------------ -------- -------- ------------
Total residential....................................... 1,854.0 36.3 4.5 1,885.8
mortgage-backed securities
------------ -------- --------
Commercial/Multifamily mortgage-backed securities (1)(2)...... 1,270.0 45.2 28.8 1,286.4
Other asset-backed securities................................. 256.2 9.4 .6 265.0
------------ -------- -------- ------------
Total bonds...................................................... 13,576.0 459.6 201.8 13,833.8
Redeemable preferred stocks...................................... 212.5 10.0 2.2 220.3
------------ -------- -------- ------------
Total available-for-sale debt securities (3)..................... $ 13,788.5 $ 469.6 $ 204.0 $ 14,054.1
============ ======== ======== ============
(1) Includes approximately $154.2 million and $151.2 million of subordinate and
residual certificates at December 31, 2002 and 2001, respectively, from a
1997 commercial mortgage loan securitization which were retained by the
Company.
(2) Includes approximately $89.8 million and $85.2 million of subordinate and
residual certificates at December 31, 2002 and 2001, respectively, from a
1995 commercial mortgage loan securitization which were retained by the
Company.
(3) Includes approximately $948.2 million and $608.1 million of loaned
securities at December 31, 2002 and 2001, respectively.
Page 69
Debt securities available for sale (including loaned securities) supporting
discontinued, experience-rated and remaining products at December 31 were as
follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
2002 (MILLIONS) COST GAINS LOSSES VALUE
----------------------------------------- ------------ ---------- ---------- ---------
Supporting discontinued products........ $ 3,353.5 $ 333.3 $ 38.7 $ 3,648.1
Supporting experience-rated products.... 2,144.7 174.1 15.6 2,303.2
Supporting remaining products........... 7,969.7 442.1 35.8 8,376.0
------------ -------- ------- ------------
Total available-for-sale debt securities $ 13,467.9 $ 949.5 $ 90.1 $ 14,327.3
============ ======== ======= ============
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
2001 (MILLIONS) COST GAINS LOSSES VALUE
----------------------------------------- ------------ ---------- ---------- ---------
Supporting discontinued products........ $ 3,598.7 $ 179.6 $ 72.6 $ 3,705.7
Supporting experience-rated products.... 2,103.2 89.2 25.0 2,167.4
Supporting remaining products........... 8,086.6 200.8 106.4 8,181.0
------------ -------- -------- ------------
Total available-for-sale debt securities $ 13,788.5 $ 469.6 $ 204.0 $ 14,054.1
============ ======== ======== ============
At December 31, 2002 and 2001, net unrealized appreciation on debt securities
included $295 million and $107 million, respectively, related to discontinued
products (refer to Note 12) and $159 million and $64 million, respectively,
related to experience-rated contracts, which were not reflected in shareholders'
equity.
The carrying and fair value of debt securities is shown below by contractual
maturity. Actual maturities may differ from contractual maturities because
securities may be restructured, called or prepaid.
AMORTIZED FAIR
2002 (MILLIONS) COST VALUE
--------------------------------------- ---------- ------------
Due to mature:
One year or less.................... $ 760.1 $ 782.5
After one year through five years... 2,356.9 2,461.5
After five years through ten years.. 2,982.2 3,150.0
After ten years..................... 4,266.1 4,642.2
Mortgage-backed securities.......... 2,792.8 2,973.7
Other asset-backed securities....... 309.8 317.4
------------ ------------
Total.................................. $ 13,467.9 $ 14,327.3
============ ============
At December 31, 2002 and 2001, debt securities carried at $748 million and $692
million, respectively, were on deposit as required by regulatory authorities.
These securities are considered restricted assets and were included in long-term
investments on the Consolidated Balance Sheets.
Investments in equity securities at December 31 were as follows:
(MILLIONS) 2002 2001
------------------------------------------------------- -------- -------
Cost.................................................. $ 91.3 $ 234.3
Gross unrealized capital gains........................ 6.5 23.5
Gross unrealized capital losses....................... (4.6) (15.7)
-------- ---------
Fair value............................................ 93.2 242.1
Less: amount included in long-term investments........ 64.1 117.2
-------- ---------
Equity securities (included in investment securities). $ 29.1 $ 124.9
======== =========
Page 70
Investment real estate holdings at December 31 were as follows:
(MILLIONS) 2002 2001
------------------------------------- --------- --------
Properties held for sale............. $ 25.9 $ 232.7
Investment real estate............... 356.2 192.3
--------- ---------
Gross carrying value of real estate.. 382.1 425.0
Valuation reserve.................... (73.3) (65.3)
--------- ---------
Investment real estate............... $ 308.8 $ 359.7
========= =========
Accumulated depreciation for investment real estate was $67 million and $18
million at December 31, 2002 and 2001, respectively.
Total real estate write-downs included in the net carrying value of the
Company's real estate holdings at December 31, 2002 and 2001 were $117 million
and $122 million, respectively (including $100 million and $102 million
attributable to assets supporting discontinued products for 2002 and 2001,
respectively).
At December 31, 2002 and 2001, the Company's mortgage loan balances, net of
specific impairment reserves, by geographic region and property type were as
follows:
(MILLIONS) 2002 2001
----------------------------------------------- ----------- ---------
South Atlantic................................ $ 456.0 $ 395.6
Middle Atlantic............................... 601.6 599.8
New England................................... 91.1 158.1
South Central................................. 64.8 45.5
North Central................................. 247.4 237.4
Pacific and Mountain.......................... 311.9 615.2
Non-U.S .4 .5
----------- ---------
Total......................................... 1,773.2 2,052.1
Less: general impairment reserve.............. -- 7.1
----------- ---------
Net mortgage loan balance..................... 1,773.2 2,045.0
Less: amount included in other investments.... 258.3 157.2
----------- ---------
Mortgage loans................................ $ 1,514.9 $ 1,887.8
=========== =========
(MILLIONS) 2002 2001
------------------------------------ ----------- ---------
Office............................. $ 673.6 $ 960.8
Retail............................. 382.9 453.1
Apartment.......................... 205.3 118.4
Hotel/Motel........................ 151.3 143.7
Industrial......................... 315.7 339.7
Mixed Use.......................... 32.3 32.8
Other.............................. 12.1 3.6
----------- ---------
Total.............................. 1,773.2 2,052.1
Less: general impairment reserve... -- 7.1
----------- ---------
Net mortgage loan balance.......... 1,773.2 2,045.0
Less: amount included in other
investments........................ 258.3 157.2
----------- ---------
Mortgage loans..................... $ 1,514.9 $ 1,887.8
=========== =========
At December 31, 2002 and 2001, the total recorded investment in mortgage loans
that are considered to be impaired (including problem, restructured and
potential problem loans) and related specific reserves were as follows:
2002 2001
------------------- ------------------
TOTAL TOTAL
RECORDED SPECIFIC RECORDED SPECIFIC
(MILLIONS) INVESTMENT RESERVES INVESTMENT RESERVES
---------- -------- ---------- --------
Supporting discontinued products........ $ 18.3 $ -- $ 104.2 $ 14.9
Supporting experience-rated products.... 23.4 6.9 55.4 5.9
Supporting remaining products........... 9.2 4.5 14.7 4.7
------- ------- --------- -------
Total impaired loans (1)................ $ 50.9 $ 11.4 $ 174.3 $ 25.5
======= ======= ========= =======
(1) Includes impaired loans at December 31, 2002 and 2001 of $31.3 million and
$60.2 million, respectively, for which no specific reserves are considered
necessary.
Page 71
The activity in the specific and general mortgage loan impairment reserves for
the periods indicated is summarized below:
SUPPORTING
SUPPORTING EXPERIENCE SUPPORTING
DISCONTINUED RATED REMAINING
(MILLIONS) PRODUCTS PRODUCTS PRODUCTS TOTAL
------------------------------------- ------------ ---------- ---------- -----
Balance at December 31, 1999......... $ 28.9 $ 13.6 $ 3.4 $ 45.9
Principal write-offs................. (.5) (.8) (.6) (1.9)
-------- ------- ------- --------
Balance at December 31, 2000......... $ 28.4 $ 12.8 $ 2.8 $ 44.0
Provision (charged to realized
capital loss) .2 -- 5.4 5.6
Principal write-offs................. (13.7) (.4) (2.9) (17.0)
-------- ------- ------- --------
Balance at December 31, 2001 (1) $ 14.9 $ 12.4 $ 5.3 $ 32.6
Provision (charged to realized
capital loss)........................ -- .3 .3 .6
Recoveries of previously
charged off amounts.................. (6.2) (4.5) (.7) (11.4)
Principal write-offs................. (8.7) (1.3) (.4) (10.4)
-------- ------- ------- --------
Balance at December 31, 2002 (1) $ -- $ 6.9 $ 4.5 $ 11.4
======== ======= ======= ========
(1) Total reserves at December 31, 2001 include $25.5 million of specific
reserves and $7.1 million of general reserves. There was no general reserve
at December 31, 2002.
Income earned (pretax) and cash received on the average recorded investment in
impaired loans for the years ended December 31 were as follows:
2002 2001 2000
------------------------- ------------------------- ------------------------
AVERAGE AVERAGE AVERAGE
IMPAIRED INCOME CASH IMPAIRED INCOME CASH IMPAIRED INCOME CASH
(MILLIONS) LOANS EARNED RECEIVED LOANS EARNED RECEIVED LOANS EARNED RECEIVED
-------- ------ -------- -------- ------- -------- ------- ------- --------
Supporting
discontinued
products....... $ 20.4 $ 1.6 $ 1.6 $ 118.1 $ 10.6 $ 12.2 $ 149.9 $ 9.4 $ 8.7
Supporting
experience-rated
products....... 41.1 2.9 2.6 44.7 3.9 4.3 65.3 6.0 6.0
Supporting
remaining 13.4 .8 .6 29.6 1.6 3.0 42.1 9.6 9.8
------- ----- ----- ------- ------- ------ ------- ------- ------
products.......
Total.......... $ 74.9 $ 5.3 $ 4.8 $ 192.4 $ 16.1 $ 19.5 $ 257.3 $ 25.0 $ 24.5
======= ===== ===== ======= ======= ====== ======= ======= ======
Significant non-cash investing and financing activities include the acquisition
of real estate through foreclosures of mortgage loans amounting to $7 million
and $20 million for 2002 and 2001, respectively. There were also certain
significant noncash activities related to the Transaction. (Refer to Note 21.)
Page 72
8. FINANCIAL INSTRUMENTS
ESTIMATED FAIR VALUE
The carrying values and estimated fair values of certain of the Company's
financial instruments at December 31, 2002 and 2001 were as follows:
2002 2001
-------------------------- -------------------------
COST BASIS/ COST BASIS/
CARRYING ESTIMATED FAIR CARRYING ESTIMATED FAIR
(MILLIONS) VALUE VALUE VALUE VALUE
----------------------------------- ----------- -------------- ---------- ---------------
Assets:
Debt securities................. $ 14,170.9 $ 15,074.8 $ 14,476.6 $ 14,745.7
Equity securities............... 91.3 93.2 234.3 242.1
Mortgage loans.................. 1,773.2 1,806.2 2,045.0 2,071.7
Derivatives..................... 82.9 82.9 14.4 14.4
Liabilities:
Investment contract liabilities:
With a fixed................. 887.4 904.5 1,365.3 1,386.7
maturity
Without a fixed.............. 765.5 675.0 793.0 678.0
maturity
Derivatives..................... -- -- 4.0 4.0
Long-term debt.................. 1,633.2 1,769.0 1,591.3 1,571.1
------------ ------------ ------------ ------------
Fair value estimates are made at a specific point in time, based on available
market information and judgments about a given financial instrument, such as
estimates of timing and amount of future cash flows. Such estimates do not
reflect any premium or discount that could result from offering for sale at one
time the Company's entire holdings of a particular financial instrument, and do
not consider the tax impact of the realization of unrealized capital gains or
losses. In many cases, the fair value estimates cannot be substantiated by
comparison to independent markets, and the disclosed value cannot be realized
upon immediate settlement of the instrument. In evaluating the Company's
management of interest rate, price and liquidity risks, the fair values of all
financial instruments are taken into consideration.
The following valuation methods and assumptions were used by the Company in
estimating the fair value of the financial instruments included in the table
above:
Debt and equity securities: Fair values are based on quoted market prices or
dealer quotes. Non-traded debt securities are priced independently by a third
party vendor and non-traded equity securities are priced based on an internal
analysis of the investment's financial statements and cash flow projections.
Cost for mortgage-backed securities is adjusted for unamortized premiums and
discounts, which are amortized using the interest method over the estimated
remaining term of the securities, adjusted for anticipated prepayments and any
collateral shortfall issues.
Mortgage loans: Fair values are estimated by discounting expected mortgage loan
cash flows at market rates that reflect the rates at which similar loans would
be made to similar borrowers. These rates reflect management's assessment of the
credit quality and the remaining duration of the loans. The fair value estimates
of mortgage loans of lower credit quality, including problem and restructured
loans, are based on the estimated fair value of the underlying collateral.
Derivatives: Fair values are estimated based on quoted market prices, dealer
quotes or internal price estimates believed to be comparable to dealer quotes.
Page 73
Investment contract liabilities:
o With a fixed maturity: Fair value is estimated by discounting cash flows at
interest rates currently being offered by, or available to, the Company for
similar contracts.
o Without a fixed maturity: Fair value is estimated as the amount payable to
the contractholder upon demand. However, the Company has the right under
such contracts to delay payment of withdrawals that may ultimately result in
paying an amount different than that determined to be payable on demand.
Long-term debt: Fair values are based on quoted market prices for the same or
similar issued debt or, if no quoted market prices were available, on the
current rates estimated to be available to the Company for debt of similar terms
and remaining maturities.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company is using interest rate swap agreements to manage certain exposures
related to changes in interest rates on investments supporting experience-rated
and discontinued products in the Large Case Pensions business. The use of these
derivatives does not impact the Company's results of operations.
In December 2002, the Company entered into an interest rate swap agreement to
convert the fixed rate of 8.5% on $200 million of its senior notes to a variable
rate of three-month LIBOR plus 254.0 basis points (approximately 3.95% at
December 31, 2002). In December 2001, the Company entered into an interest rate
swap agreement to convert the fixed rate of 8.5% on $350 million of its senior
notes to a variable rate of three-month LIBOR plus 159.5 basis points
(approximately 3.02% at December 31, 2002). As a result of these swap
agreements, the Company's effective interest rate on its long-term debt was
6.99% during 2002. The change in the fair value of the interest rate swaps and
the loss or gain on the hedged senior notes attributable to the hedged interest
rate risk are recorded in current period earnings. Because the terms of the
interest rate swap agreements match the terms of the senior notes, the gain or
loss on the swaps and the senior notes will generally be offsetting (no material
change in value occurred during the periods ended December 31, 2002 or 2001).
The swap agreements contain bilateral credit protection covenants which,
depending on credit ratings, obligate each party to post collateral equal to the
fair value of the swap. As of February 26, 2003, the Company was not required to
post collateral for the $350 million interest rate swap, but did post $2 million
for the $200 million interest rate swap.
During the first quarter of 2001, the Company expected to issue approximately $1
billion of five- and ten-year fixed-rate debt securities to replace a portion of
its outstanding commercial paper. Prior to the transaction, the Company's risk
management objective was to secure financing based on the then five- and
ten-year U.S. Treasury rates. Accordingly, the Company entered into certain
forward contracts on U.S. Treasury securities prior to the actual issuance of
long-term debt of approximately $900 million, which were designated as cash flow
hedges in anticipation of the debt offering and determined to be highly
effective under the Company's accounting policy.
Upon issuance of the long-term debt (refer to Note 15) and termination of these
forward contracts, the Company recognized a loss of approximately $5 million
pretax related to these derivatives, which is included in accumulated other
comprehensive income. During 2002 and 2001, the amount of the loss that was
reclassified from accumulated other comprehensive income and recognized as part
of interest expense was not material.
Page 74
9. NET INVESTMENT INCOME
Sources of net investment income were as follows:
(MILLIONS) 2002 2001 2000
------------------------------ ----------- --------- ---------
Debt securities.............. $ 954.4 $ 1,104.8 $ 1,161.6
Mortgage loans............... 224.0 184.9 208.2
Other........................ 115.4 147.8 189.9
Investment real estate (1)... 66.6 62.8 63.8
Cash equivalents............. 28.3 26.2 26.7
Equity securities............ 14.6 2.3 6.8
Other investment securities.. 14.6 69.9 104.7
----------- --------- ---------
Gross investment income...... 1,417.9 1,598.7 1,761.7
Less: investment expenses.... 167.2 187.1 130.1
----------- --------- ---------
Net investment income (2).... $ 1,250.7 $ 1,411.6 $ 1,631.6
=========== ========= =========
(1) Includes $16.4 million and $14.0 million from real estate held for sale
during 2001 and 2000, respectively.
(2) Includes amounts related to experience-rated contractholders of $221.5
million, $237.5 million and $293.6 million during 2002, 2001 and 2000,
respectively. Interest credited to contractholders is included in current
and future benefits.
10. CAPITAL GAINS AND LOSSES ON INVESTMENTS AND OTHER
Net realized capital gains (losses), excluding amounts related to
experience-rated contractholders and discontinued products, on investments were
as follows:
(MILLIONS) 2002 2001 2000
------------------------------------------ --------- -------- ----------
Debt securities.......................... $ 25.6 $ 30.6 $ (110.3)
Equity securities........................ (15.1) (.6) 15.7
Mortgage loans........................... 4.8 29.8 .7
Investment real estate................... (10.5) (4.7) (.2)
Sales of subsidiaries (1)................ 46.0 59.0 78.8
Other.................................... (16.5) (18.0) (24.8)
-------- -------- --------
Pretax realized capital gains (losses)... $ 34.3 $ 96.1 $ (40.1)
======== ======== ========
After-tax realized capital gains (losses) $ 22.3 $ 73.6 $ (14.2)
======== ======== ========
(1) Includes a pretax realized capital gain of approximately $60.0 million in
2002, 2001 and 2000 related to contingent consideration earned by the
Company following the sale of its behavioral health subsidiary, Human
Affairs International, in 1997.
Net realized capital gains (losses) of $8 million, $11 million and $(44) million
for 2002, 2001 and 2000, respectively, related to experience-rated
contractholders were deducted from net realized capital gains (losses) and an
offsetting amount was reflected in policyholders' funds. Net realized capital
gains (losses) of $(58) million, $19 million and $(31) million for 2002, 2001
and 2000, respectively, related to discontinued products were deducted from net
realized capital gains (losses) and an offsetting amount was reflected in the
reserve for anticipated future losses on discontinued products.
Proceeds from the sale of debt securities and the related gross gains and losses
were as follows:
(MILLIONS) 2002 2001 2000
-------------------- ------------ ----------- ----------
Proceeds on sales.. $ 15,679.9 $ 17,561.8 $ 13,093.9
Gross gains........ 225.2 225.6 70.2
Gross losses....... 129.0 133.5 120.8
------------ ------------ ----------
Page 75
Changes in shareholders' equity related to changes in accumulated other
comprehensive income (loss) (excluding those related to experience-rated
contractholders and discontinued products) were as follows:
(MILLIONS) 2002 2001 2000
------------------------------------------------------- ------------ ---------- -------
Net unrealized gains on debt securities............... $ 339.0 $ 109.3 $ 543.4
Net unrealized losses on equity securities and other.. (7.6) (52.1) (152.8)
Foreign currency .7 (1.1) (39.9)
Derivatives .6 (4.8) --
Minimum pension liability adjustment.................. (1,161.8) -- --
------------ --------- ----------
Subtotal.............................................. (829.1) 51.3 350.7
Less: changes in deferred income taxes................ 290.2 (17.9) 74.4
------------ --------- ----------
Subtotal.............................................. (538.9) 33.4 276.3
Sale and spin-off transaction......................... -- -- 414.4
----------- --------- ----------
Net changes in accumulated other comprehensive
income (loss)......................................... $ (538.9)$ 33.4 $ 690.7
============ ========= ==========
Shareholders' equity included the following accumulated other comprehensive
income (loss) (excluding amounts related to experience-rated contractholders and
discontinued products) at December 31:
(MILLIONS) 2002 2001
--------------------------------------------------------------- ------------ ----------
Debt securities:
Gross unrealized capital gains............................. $ 477.3 $ 211.2
Gross unrealized capital losses............................ (35.8) (108.7)
------------ ----------
Net unrealized capital gains on debt securities............... 441.5 102.5
------------ ----------
Equity securities and other:
Gross unrealized capital gains............................. 12.3 27.8
Gross unrealized capital losses............................ (20.0) (27.9)
------------ ----------
Net unrealized capital losses on equity securities and other.. (7.7) (.1)
------------ ----------
Foreign currency.............................................. 8.5 7.8
Derivatives................................................... (4.2) (4.8)
Minimum pension liability adjustment.......................... (1,161.8) --
Deferred income taxes......................................... 253.3 (36.9)
------------ ----------
Net accumulated other comprehensive income (loss)............. $ (470.4)$ 68.5
============ ==========
Changes in accumulated other comprehensive income (loss) related to changes in
unrealized gains (losses) on securities (excluding those related to
experience-rated contractholders and discontinued products) were as follows:
(MILLIONS) 2002 2001 2000
-------------------------------------------------------------- ----------------- -------
Net unrealized holding gains arising during the period (1)... $ 214.9 $ 76.7 $ 293.0
Less: reclassification adjustment for gains (losses) and
other items included in net income (loss) (2) (.5) 39.5 (23.2)
--------- -------- -------
Net unrealized gains on securities........................... $ 215.4 $ 37.2 $ 316.2
========= ======== =======
(1) Pretax net unrealized holding gains arising during the period were $330.6
million, $118.0 million and $450.8 million for 2002, 2001 and 2000,
respectively.
(2) Pretax reclassification adjustments for gains (losses) and other items
included in net income were $(.8) million, $60.8 million and $(35.7) million
for 2002, 2001 and 2000, respectively.
Page 76
11. SEVERANCE AND FACILITIES CHARGES
In the fourth quarter of 2001, the Company recorded an after-tax severance and
facilities charge of $125 million ($193 million pretax) related to the
implementation of initiatives intended to improve the Company's overall future
performance (the "2001 Charge"). These initiatives included reductions to
operating expenses, reorganization and realignment of Health Care operations to
better align our business resources with our customer market-focused approach,
business process improvements, product market withdrawals, continued migration
off the Prudential health care systems and vacating certain facilities
(primarily customer service related locations). The 2001 Charge consisted of two
types of costs: those related to actions under a plan for the involuntary
termination of employees and those related to an exit plan with respect to
certain leased facilities. The severance portion of $130 million pretax was
based on a plan to eliminate 4,395 positions (primarily customer service and
regional field management functions). The facilities portion of $63 million
pretax represented the present value of the difference between rent required to
be paid by the Company and future sublease rentals expected to be received by
the Company related to certain leased facilities, or portions of such
facilities, that were vacated. Severance actions and the vacating of leased
facilities relating to the 2001 Charge, as aligned to better reflect service
operations consistent with the Company's customer market approach, were
completed as of December 31, 2002. The remaining lease payments (net of expected
sublease rentals) on these vacated facilities are payable over approximately the
next six years.
In the second quarter of 2002, the Company recorded an after-tax severance
charge of $18 million ($27 million pretax) related to the implementation of
ongoing initiatives intended to improve the Company's overall future performance
(the "Second Quarter 2002 Charge"). The initiatives included further reductions
to operating expenses and the continued reorganization and realignment of Health
Care operations. This charge consisted of costs that related to actions under a
plan of involuntary termination of employees and included the elimination of
approximately 600 employee positions (primarily regional field management,
information technology and medical service functions). Severance actions related
to the Second Quarter 2002 Charge were substantially completed by December 31,
2002.
In the third quarter of 2002, the Company recorded an after-tax severance and
facilities charge of $58 million ($89 million pretax) related to the
implementation of ongoing initiatives intended to improve the Company's overall
future performance (the "Third Quarter 2002 Charge"). These initiatives included
further reductions to operating expenses and the continued reorganization and
realignment of Health Care and Group Insurance operations. This charge consisted
of two types of costs: those that relate to actions under a plan for the
involuntary termination of approximately 2,750 employee positions (primarily
customer service, plan sponsor services, patient management, sales, network
management and certain Group Insurance related positions) representing
approximately $81 million pretax of this charge and those actions that relate to
an exit plan with respect to certain leased facilities representing
approximately $8 million pretax of this charge. The facilities portion
represents the present value of the difference between rent required to be paid
by the Company and future sublease rentals expected to be received by the
Company related to certain leased facilities, or portions of such facilities,
that will be vacated. Severance actions and the vacating of leased facilities
relating to the Third Quarter Charge 2002 are expected to be completed by
September 30, 2003. The remaining lease payments (net of expected sublease
rentals) on these vacated facilities are payable over approximately the next
seven years.
Page 77
In the fourth quarter of 2002, the Company recorded an after-tax severance and
facilities charge of $29 million ($45 million pretax) related to the
implementation of ongoing initiatives intended to improve the Company's overall
future performance (the "Fourth Quarter 2002 Charge"). These initiatives include
further reductions to operating expenses and the continued reorganization and
realignment of Health Care and Group Insurance operations. This charge consists
of two types of costs: those that relate to actions under a plan for the
involuntary termination of approximately 680 employee positions (primarily
customer service, information technology and certain Group Insurance related
positions) representing approximately $31 million pretax of this charge and
those actions that relate to an exit plan with respect to certain leased
facilities representing approximately $14 million pretax of this charge. The
facilities portion represents the present value of the difference between rent
required to be paid by the Company and future sublease rentals expected to be
received by the Company related to certain leased facilities, or portions of
such facilities, that will be vacated. Severance actions and the vacating of
leased facilities relating to the Fourth Quarter Charge 2002 are expected to be
completed by December 31, 2003. The remaining lease payments (net of expected
sublease rentals) on these vacated facilities are payable over approximately the
next seven years.
The activity within the severance and facilities reserves and the related number
of positions eliminated were as follows:
SECOND QUARTER THIRD QUARTER FOURTH QUARTER
2001 CHARGE 2002 CHARGE 2002 CHARGE 2002 CHARGE
----------------------- --------------------------- ------------------------- ----------------------
(MILLIONS, PRETAX) RESERVE POSITIONS RESERVE POSITIONS RESERVE POSITIONS RESERVE POSITIONS
------------------ ---------- ------------ -------------- ----------- ---------- ------------ ----------- ----------
Balance at
December $ 142.6 3,638 $ -- -- $ -- -- $ -- --
31, 2001........
Reserve additions -- -- 27.0 598 89.0 2,744 45.0 678
Actions taken (1) (142.6) (3,487) (27.0) (527) (72.8) (1,805) (21.6) (321)
-------- ------ ------- ---- ------- ------ ------- ----
Balance at
December $ -- 151(2) $ -- 71(2) $ 16.2 939 $ 23.4 357
======== ===== ====== === ======= ===== ======= ===
31, 2002........
(1) Actions taken relating to the 2001 Charge include $103.3 million of
severance-related actions and $39.3 million related to vacating certain
leased facilities. Actions taken relating to the Second Quarter 2002 Charge
were all severance related. Actions taken relating to the Third Quarter 2002
Charge include $70.6 million of severance-related actions and $2.2 million
related to vacating certain leased facilities. Actions taken relating to the
Fourth Quarter 2002 Charge were all severance related.
(2) The Company eliminated substantially all of the positions expected under the
Company's plans for involuntary termination related to the 2001 Charge and
the Second Quarter 2002 Charge and considers these plans now complete.
12. 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
future losses are less than anticipated. The current reserve reflects
management's best estimate of anticipated future losses.
The factors contributing to changes in the reserve for anticipated future losses
are: operating income or loss, realized capital gains or losses and mortality
gains or losses. Operating income or loss is equal to revenue less expenses.
Realized capital gains or losses reflect the excess (deficit) of sales price
over (below) the carrying value of assets sold. Mortality gains or losses
reflect the mortality and retirement experience related to SPAs. A mortality
gain (loss) occurs when an annuitant or a beneficiary dies sooner (later) than
expected. A retirement gain (loss) occurs when an annuitant retires later
(earlier) than expected.
Page 78
At the time of discontinuance, a receivable from Large Case Pensions' continuing
products equivalent to the net present value of the anticipated cash flow
shortfalls was established for the discontinued products. Interest on the
receivable is accrued at the discount rate that was used to calculate the
reserve. The offsetting payable, on which interest is similarly accrued, is
reflected in continuing products. Interest on the payable generally offsets the
investment income on the assets available to fund the shortfall. At December 31,
2002, the receivable from continuing products, net of related deferred taxes
payable of $96 million on the accrued interest income, was $357 million. At
December 31, 2001, the receivable from continuing products, net of the related
deferred taxes payable of $87 million on the accrued interest income, was $345
million. These amounts were eliminated in consolidation.
Results of discontinued products were as follows (pretax):
CHARGED (CREDITED)
TO RESERVE
(MILLIONS) RESULTS FUTURE LOSSES NET(1)
---------------------------------------- --------- ---------------- ---------
Net investment income ................. $ 375.2 $ -- $ 375.2
Net realized capital losses ........... (57.5) 57.5 --
Interest earned on receivable from
continuing products ................ 26.8 -- 26.8
Other income .......................... 28.4 -- 28.4
-------- ------- --------
Total revenue ................ 372.9 57.5 430.4
-------- ------- --------
Current and future benefits ........... 393.9 23.8 417.7
Operating expenses .................... 12.7 -- 12.7
-------- ------- --------
Total benefits and ........... 406.6 23.8 430.4
expenses
-------- ------- --------
Results of discontinued products ...... $ (33.7) $ 33.7 --
======== ======= ========
Net investment income ................. $ 397.6 $ -- $ 397.6
Net realized capital gains ............ 18.9 (18.9) --
Interest earned on receivable from
continuing products ................. 27.2 -- 27.2
Other income .......................... 32.2 -- 32.2
-------- ------- --------
Total revenue ................ 475.9 (18.9) 457.0
-------- ------- --------
Current and future benefits ............ 423.7 21.1 444.8
Operating expenses ..................... 12.2 -- 12.2
Total benefits and ........... 435.9 21.1 457.0
expenses
Results of discontinued products ....... $ 40.0 $ (40.0) $ --
======== ======= ========
Net investment income .................. $ 438.0 $ -- $ 438.0
Net realized capital losses ............ (31.1) 31.1 --
Interest earned on receivable from
continuing products .................. 30.2 -- 30.2
Other income ........................... 27.2 -- 27.2
-------- ------- --------
Total revenue .............. 464.3 31.1 495.4
-------- ------- --------
Current and future benefits ............ 453.7 28.9 482.6
Operating expenses ..................... 12.8 -- 12.8
-------- ------- --------
Total benefits and ......... 466.5 28.9 495.4
expenses
-------- ------- --------
Results of discontinued products ....... $ (2.2) $ 2.2 --
======== ======= ========
(1) Amounts are reflected in the 2002, 2001 and 2000 Consolidated Statements of
Income, except for interest earned on the receivable from continuing
products, which was eliminated in consolidation.
Net realized capital gains (losses) from the sale of bonds supporting
discontinued products were $(82) million, $46 million and $(90) million (pretax)
for 2002, 2001 and 2000, respectively.
Page 79
Assets and liabilities supporting discontinued products at December 31 were as
follows: (1)
(MILLIONS) 2002 2001
----------------------------------------------------------------- ---------- ----------
Assets:
Debt securities available for sale ........................... $ 3,481.0 $ 3,573.8
Equity securities ............................................ 73.4 211.0
Mortgage loans ............................................... 763.2 822.1
Investment real estate ....................................... 95.0 130.4
Loaned securities ............................................ 167.1 131.9
Other investments (2) ........................................ 505.7 481.4
---------- ----------
Total investments ............................................ 5,085.4 5,350.6
Collateral received under securities loan agreements ......... 170.8 135.2
Current and deferred income taxes ............................ 94.4 93.0
Receivable from continuing products (3) ...................... 453.1 431.7
---------- ----------
Total assets .................................................... $ 5,803.7 $ 6,010.5
========== ==========
Liabilities:
Future policy benefits ....................................... $ 4,361.1 $ 4,512.6
Policyholders' funds ......................................... 82.9 261.5
Reserve for anticipated future losses on discontinued products 902.9 944.9
Collateral payable under securities loan agreements .......... 170.8 135.2
Other liabilities ............................................ 286.0 156.3
Total liabilities ............................................... $ 5,803.7 $ 6,010.5
========== ==========
(1) Assets supporting the discontinued products are distinguished from assets
supporting continuing products.
(2) Includes debt securities on deposit as required by regulatory authorities
of $68.3 million and $55.7 million at December 31, 2002 and 2001,
respectively. These securities are considered restricted assets and were
included in long-term investments on the Consolidated Balance Sheets.
(3) The receivable from continuing products is eliminated in consolidation.
At December 31, 2002 and 2001, net unrealized capital gains on
available-for-sale debt securities are included above in other liabilities and
are not reflected in consolidated shareholders' equity. The reserve for
anticipated future losses is included in future policy benefits on the
Consolidated Balance Sheets.
The reserve for anticipated future losses on discontinued products represents
the present value (at the risk-free rate at the time of discontinuance,
consistent with the duration of the liabilities) of the difference between the
expected cash flows from the assets supporting discontinued products and the
cash flows expected to be required to meet the obligations of the outstanding
contracts. Calculation of the reserve for anticipated future losses requires
projection of both the amount and the timing of cash flows over approximately
the next 30 years, including consideration of, among other things, future
investment results, participant withdrawal and mortality rates and the cost of
asset management and customer service. 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. Since 1997, a
bond default assumption has been 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 80
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 the Company has 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.
The activity in the reserve for anticipated future losses on discontinued
products was as follows (pretax):
(MILLIONS)
-----------
Reserve at December 31,1999 $ 1,147.6
Operating income ........... 16.1
Net realized capital losses (31.1)
Mortality and other ........ 12.8
reserve reduction .......... (146.0)
----------
Reserve at December 31, 2000 999.4
Operating income ........... 3.2
Net realized capital gains . 18.9
Mortality and other ........ 17.9
reserve reduction .......... (94.5)
----------
Reserve at December 31, 2001 944.9
Operating income ........... 8.2
Net realized capital losses (57.5)
Mortality and other ........ 15.6
reserve reduction .......... (8.3)
----------
Reserve at December 31, 2002 $ 902.9
==========
Management reviews the adequacy of the discontinued products reserve quarterly
and, as a result, $8 million ($5 million after tax) of the reserve was released
in the second quarter of 2002, primarily due to favorable mortality and
retirement experience and certain reductions in administrative expenses,
partially offset by lower portfolio returns. For 2001, $95 million ($61 million
after tax) of the reserve was released primarily due to favorable investment
performance that included equity gains and mortgage loan prepayment penalty
income, as well as favorable mortality and retirement experience. For 2000, $146
million pretax ($95 million after tax) of the reserve was released primarily due
to favorable investment performance related to certain equity investments,
favorable mortality and retirement experience and the decrease in size of the
overall bond portfolio, which decreased default risk. The current reserve
reflects management's best estimate of anticipated future losses.
The anticipated run off of the December 31, 2002 reserve balance (assuming that
assets are held until maturity and that the reserve run off is proportional to
the liability run off) is as follows:
(MILLIONS)
---------
2003.......... $ 30.8
2004.......... 31.2
2005.......... 31.5
2006.......... 31.7
2007.......... 31.8
2008 - 2012 163.2
2013 - 2017 155.2
2018 - 2022 133.1
2023 - 2027 104.2
Thereafter.... 190.2
---------- ---------
Page 81
The expected (as of December 31, 1993) and actual liability balances for the GIC
and SPA liabilities at December 31 are as follows:
EXPECTED ACTUAL
--------------------- ------------------
(MILLIONS) GIC SPA GIC SPA
---------- --------- ----------- ------- ----------
2000...... $ 690.7 $ 4,357.9 $ 548.8 $ 4,462.5
2001...... 352.9 4,238.9 261.5 4,512.6
2002...... 169.5 4,114.6 82.9 4,361.1
--------- ----------- ------- -----------
The GIC balances were lower than expected in each period as several
contractholders redeemed their contracts prior to contract maturity. The SPA
balances in each period were higher than expected because of additional amounts
received under existing contracts. The increase in the 2001 actual SPA balance,
when compared to 2000, is due to the transfer of funds from separate accounts to
purchase guaranteed annuities in the Company's general account, under an
existing contract.
13. INCOME TAXES
Income taxes (benefits) consist of the following:
(MILLIONS) 2002 2001 2000
-------------------------------- ---------- --------- -------
Current taxes (benefits):
Federal..................... $ 216.6 $ (43.9) $ 194.9
State....................... (22.8) 30.3 47.2
--------- -------- ----------
Total current taxes (benefits). 193.8 (13.6) 242.1
--------- -------- ----------
Deferred taxes (benefits):
Federal..................... (43.1) (74.7) (152.8)
State .9 1.1 (.9)
--------- -------- ----------
Total deferred tax benefits.... (42.2) (73.6) (153.7)
--------- -------- ----------
Total income taxes (benefits).. $ 151.6 $ (87.2) $ 88.4
========= ======== ==========
Income taxes were different from the amount computed by applying the federal
income tax rate to income before income taxes as follows:
(MILLIONS) 2002 2001 2000
------------------------------------------------------------------ ----------- --------------------
Income (loss) from continuing operations before income taxes...... $ 544.8 $ (378.7) $ (39.0)
Tax rate.......................................................... 35% 35% 35%
--------- ---------- ---------
Application of the tax rate....................................... 190.7 (132.5) (13.7)
Tax effect of:
Tax-exempt interest............................................ (10.5) (10.3) (10.1)
Goodwill amortization and...................................... -- 66.9 103.6
write-off
State income taxes............................................. (14.2) 20.4 30.1
Sale of subsidiaries........................................... -- (11.6) (10.8)
Tax credits.................................................... (18.5) (17.1) (14.4)
Other, net..................................................... 4.1 (3.0) 3.7
--------- ---------- ---------
Income taxes (benefits)........................................... $ 151.6 $ (87.2) $ 88.4
========= ========== =========
Page 82
The tax effects of temporary differences that give rise to deferred tax assets
and deferred tax liabilities at December 31 are as follows:
(MILLIONS) 2002 2001
---------------------------------------------------------------------- ----------- ---------
Deferred tax assets:
Reserve for anticipated future losses on discontinued products.... $ 176.2 $ 263.6
Employee and retirement benefits (including minimum pension....... 552.4 123.5
liability)
Severance and facilities reserve.................................. 54.4 90.2
Deferred income................................................... 20.5 20.5
Expenses not currently deductible................................. 21.0 33.9
Allowance for doubtful accounts................................... 6.4 28.0
Deferred policy costs............................................. 37.4 33.1
Investments, net.................................................. 85.0 37.4
Depreciation and amortization..................................... 9.5 1.5
Net operating loss carry forwards................................. 33.9 17.4
Insurance reserves................................................ 86.7 6.8
Other............................................................. 18.8 20.4
----------- ---------
Total gross assets................................................... 1,102.2 676.3
Less: valuation allowance............................................ 33.9 16.2
----------- --------
Assets, net of valuation allowance.................................. 1,068.3 660.1
----------- ---------
Deferred tax liabilities:
Amortization of goodwill and other acquired intangible assets.... 103.0 117.6
Accumulated other comprehensive income........................... 153.4 36.9
Other............................................................ 28.1 31.0
----------- ---------
Total gross liabilities............................................. 284.5 185.5
----------- ---------
Net deferred tax asset.............................................. $ 783.8(1) $ 474.6(1)
(1) Includes $201.3 million and $114.1 million classified as current assets in
2002 and 2001, respectively, and $582.5 million and $360.5 million
classified as noncurrent assets in 2002 and 2001, respectively.
Valuation allowances are provided when it is considered unlikely that deferred
tax assets will be realized. Management believes that it is more likely than not
that the Company will realize its net deferred tax asset of $784 million, net of
a valuation allowance of $34 million. The valuation allowance is principally on
acquired net operating losses and state net operating losses, which are subject
to limitations as to future utilization. The Company has recognized $384 million
of net deferred tax assets on Aetna Life Insurance Company (which is not
consolidated for tax purposes) and $400 million on the remaining consolidated
group. Management's beliefs are based on historic and anticipated taxable income
for each group. However, the amount of the deferred tax asset considered
realizable could be adjusted in the future if estimates of taxable income are
revised.
The "Policyholders' Surplus Account", which arose under prior tax law, is
generally that portion of a life insurance company's statutory income that has
not been subject to taxation. As of December 31, 1983, no further additions
could be made to the Policyholders' Surplus Account for tax return purposes
under the Deficit Reduction Act of 1984. The balance in such account was $918
million at December 31, 2002, adjusted for Internal Revenue Service (the
"Service") audits finalized to date. This amount would be taxed only under
certain conditions. No income taxes have been provided on this amount, since
management believes under current tax law the conditions under which such taxes
would become payable are remote.
Page 83
In 2002, the Service completed its audit of the consolidated federal income tax
returns of former Aetna and its affiliates for the years 1979 through 1983. The
Service is presently completing its audit of former Aetna's 1984 through 1997
returns. As a result of these audits, the Service proposed certain adjustments.
The majority of these adjustments have been agreed to by the Company, and as a
result, in 2002 the Company reduced liabilities held for potential tax exposure
by $50 million for federal taxes associated with the discontinued Property and
Casualty insurance operations and by $25 million related to its acquisition of
U.S. Healthcare, Inc. in 1996, which was credited to goodwill. However, several
key issues have not yet been resolved, although the Company expects to resolve
these issues during 2003. In addition, several state audits were also completed
during 2001, resulting in the reduction of related liabilities by $20 million.
The Service recently began its audit of former Aetna's 1998 through 2000 (prior
to December 13, 2000) and the Company's 2000 (subsequent to December 13, 2000)
through 2001 returns. The Company expects to receive any proposed adjustments
for these years in late 2003 (as the audits progress to completion).
The Company believes that it has established adequate reserves for additional
taxes and interest that may result from the ultimate resolution of the audits
noted above. These reserves will be adjusted as necessary upon the resolution of
the related issues with the Service.
The Company paid (received refunds of) net income taxes of $(65) million, $106
million and $196 million in 2002, 2001 and 2000, respectively.
14. BENEFIT PLANS
The Company is responsible for pension and post-retirement benefits for actively
employed individuals, as well as retired or inactive United States employees of
the Company and former Aetna. (Refer to Note 21). For periods prior to December
13, 2000, accrued pension cost has been allocated to continuing and discontinued
operations (for those businesses sold by former Aetna) under an allocation
method based on eligible salaries. As of the Transaction date, data on a
separate company basis regarding the proportionate share of the projected
benefit obligation and plan assets for pension and post-retirement plans was not
available.
DEFINED BENEFIT PENSION PLANS
The Company's noncontributory defined benefit pension plans cover substantially
all of its employees. Effective January 1, 1999, the Company, in conjunction
with former Aetna, changed the formula from the previous final average pay
formula to a cash balance formula, which will credit employees annually with an
amount equal to a percentage of eligible pay based on age and years of service,
as well as an interest credit based on individual account balances. The formula
also provides for a transition period until December 31, 2006, which allows
certain employees to receive vested benefits at the higher of the previous final
average pay or cash balance formula. For employees hired after January 1, 2002,
the Company changed the cash balance formula to provide greater initial credits
and make the benefit less dependent on length of service. Existing employees
will receive the larger of the pension credit under the previous formula or this
new formula. These changes did not have a material effect on the Company's
results of operations, liquidity or financial condition.
Page 84
Components of the net periodic benefit income (cost) of the Company's (former
Aetna, prior to December 13, 2000) noncontributory defined benefit pension plan
were as follows:
(MILLIONS) 2002 2001 2000
--------------------------------------- ---------- ---------- ----------
Service cost.......................... $ (74.3)$ (82.0)$ (93.1)
Interest cost......................... (259.9) (263.8) (258.0)
Expected return on plan assets........ 295.6 375.4 350.7
Amortization of prior service cost.... (4.0) (4.5) (5.8)
Recognized net actuarial gain (loss).. (6.9) 11.9 7.5
---------- ---------- ----------
Net periodic benefit income (cost).... $ (49.5)$ 37.0 $ 1.3
========== ========== ==========
The allocated pretax benefit to operations for the pension plan (based on the
Company's total salary cost as a percentage of former Aetna's total salary cost)
was approximately $6 million for 2000.
As of the measurement date (September 30), the status of the Company's defined
benefit pension plans was as follows:
(MILLIONS) 2002 2001
------------------------------------------------------------------------- ------------ -----------
Projected benefit obligation, beginning of year.......................... $ 3,580.6 $ 3,519.4
Service cost............................................................. 74.3 82.0
Interest cost............................................................ 259.9 263.8
Actuarial loss (gain).................................................... 261.2 (66.7)
Benefits paid............................................................ (230.3) (217.9)
------------ -----------
Projected benefit obligation, end of year................................ $ 3,945.7 $ 3,580.6
------------ -----------
Fair value of plan assets, beginning of year............................. $ 3,301.5 $ 4,163.9
Actual return on plan assets............................................. (246.3) (662.1)
Employer contributions................................................... 118.3 17.6
Benefits paid............................................................ (230.3) (217.9)
------------ -----------
Fair value of plan assets, end of year................................... $ 2,943.2 $ 3,301.5
------------ -----------
Fair value of plan assets less than projected benefit obligation......... $ (1,002.5) $ (279.1)
Unrecognized net loss.................................................... 1,230.7 441.3
Unrecognized prior service cost.......................................... 41.5 38.7
------------ -----------
Net amount recognized.................................................... $ 269.7 $ 200.9
============ ===========
Amounts recognized in the statement of financial position consist of:
Prepaid pension asset.................................................... $ -- $ 200.9
Accrued pension liability (934.5) --
Intangible asset 42.4 --
Accumulated other comprehensive income 1,161.8 --
------------ -----------
Net amount recognized.................................................... $ 269.7 $ 200.9
============ ===========
Weighted average discount rate........................................... 6.75% 7.50%
Expected return on plan assets........................................... 9.00% 9.25%
Rate of compensation increase............................................ 3.75% 4.50%
----------- ----------
For 2002 and 2001, defined benefit plans included above with benefit obligations
in excess of assets had accumulated benefit obligations of approximately $3.9
billion and $3.5 billion, respectively. The above projected benefit and
accumulated benefit obligations reflect revised assumptions made as of the 2001
measurement date related to cost of living adjustments, average retirement age
and the form of payment elections, including deferral options. These revised
assumptions reflect the Company's experience and plan design, and reduced the
2001 projected benefit obligation by $212 million and the accumulated benefit
obligation by $208 million.
Page 85
OTHER POST-RETIREMENT BENEFIT PLANS
In addition to providing pension benefits, the Company currently provides
certain health care, dental and life insurance benefits for retired employees,
including those of former Aetna. A comprehensive medical and dental plan is
offered to all full-time employees, who terminate employment at age 45 or later
with 10 or more years of service. The Company provides subsidized benefits to
certain employees as of December 31, 2002 whose sum of age and service is at
least equal to 65 (due to a plan amendment, employees hired after January 1,
2002 and all employees under the age of 35 at that date are not eligible for
subsidized retiree health benefits). There is a cap on the portion of the cost
paid by the Company relating to medical and dental benefits. The plan assets are
held in trust and administered by Aetna Life Insurance Company ("ALIC").
In January 2003, the Company amended this plan, reducing the subsidy provided to
individuals retiring subsequent to January 1, 2004. Beginning January 1, 2004,
the Company will begin to phase-out the retiree medical subsidy for active
employees (and eligible dependents) who terminate employment after December 31,
2003. The subsidy will decrease 25% each year until it is eliminated for
employees terminating employment on or after January 1, 2007. Beginning January
1, 2004, the Company will eliminate the retiree dental subsidy for active
employees who terminate employment on or after January 1, 2003. However, Company
employees who terminate employment at age 45 or later with at least 10 years of
service will be eligible to participate in the Company's group health plans at
their own cost. As a result of these plan amendments announced in January of
2003, the Company expects to record a curtailment benefit of approximately $35
million pretax in the first quarter of 2003.
Components of the net periodic benefit cost of the Company's (former Aetna,
prior to December 13, 2000) postretirement plans were as follows:
(MILLIONS) 2002 2001 2000
------------------------------------- ------------- --------- -------
Service cost........................ $ (7.8) $ (6.7) $ (7.4)
Interest cost....................... (31.8) (31.7) (32.0)
Expected return on plan assets...... 4.8 4.8 4.4
Curtailment benefit................. 11.8 (1) -- --
Amortization of prior service cost.. 4.4 15.7 23.0
Recognized net actuarial gain....... -- .3 .8
-------- -------- --------
Net periodic benefit cost........... $ (18.6) $ (17.6) $ (11.2)
======== ======== ========
(1) Reflects a plan amendment, effective January 1, 2002, whereby the Company no
longer provides subsidized benefits to employees who had not reached age 35
by this date.
Allocated pre-tax charges to the Company associated with the postretirement
plans of former Aetna were $(10) million in 2000.
Page 86
As of the measurement date (September 30), the status of the Company's
postretirement benefit plans (other than pensions) was as follows:
(MILLIONS) 2002 2001
---------------------------------------------------------- --------- ---------
Accumulated benefit obligation, beginning of year........ $ 469.9 $ 425.9
Service cost............................................. 7.8 6.7
Interest cost............................................ 31.8 31.7
Actuarial (gain) loss.................................... 71.8 43.7
Curtailment benefit...................................... (1.4) --
Benefits paid............................................ (38.7) (38.1)
--------- ---------
Accumulated benefit obligation, end of year.............. $ 541.2 $ 469.9
--------- ---------
Fair value of plan assets, beginning of year............. $ 78.2 $ 78.4
Actual return on plan assets............................. -- 1.8
Employer contribution.................................... 37.3 36.1
Benefits paid............................................ (38.7) (38.1)
--------- ---------
Fair value of plan assets, end of year................... $ 76.8 $ 78.2
--------- ---------
Accumulated benefit obligation in excess of fair value
of plan assets........................................... $ 464.4 $ 391.6
Unrecognized net gain (loss)............................. (96.6) 4.8
Prior service cost....................................... 29.0 19.0
--------- ---------
Accrued postretirement benefit costs..................... $ 396.8 $ 415.4
--------- ---------
Weighted average discount rate........................... 6.75% 7.50%
Expected return on plan assets........................... 7.00% 7.00%
--------- ---------
The health care cost trend rate for the 2002 valuation decreased gradually from
9.0% for pre-65 and 11% for post-65 for 2003 to 5.0% by the year 2007 for pre-65
and 5.0% by the year 2009 for post-65. For the 2001 valuation, the rates
decreased gradually from 7.0% for 2002 to 5.5% by the year 2005. This assumption
reflects the Company's historical as well as expected future trend rates. In
addition, trend assumption reflects factors specific to the Company's retiree
medical plan, such as plan design, cost-sharing provisions, benefits covered,
and the presence of subsidy caps. As a result of the Transaction (refer to Note
21), the Company retained the postretirement benefit obligation for all Company
employees and existing retirees of former Aetna, except for a specific plan that
was retained by former Aetna.
A one-percentage-point change (increase or decrease) in assumed health care cost
trend rates would have the following effects:
(MILLIONS) INCREASE DECREASE
-------------------------------------------- -------- --------
Effect on total of service and interest cost
components................................... $ 1.0 $ (.7)
Effect on postretirement benefit obligation.. 11.3 (10.0)
------- -----
Page 87
Incentive Savings Plans - Substantially all of the Company's employees are
eligible to participate in a savings plan under which designated contributions,
which may be invested in common stock of the Company or certain other
investments, are matched by the Company. On January 1, 2002, the Company changed
its match to 50% of the first 6% of eligible pay contributed to the plan.
Effective January 2003, matching contributions by the Company are made in cash
and invested according to each participant's investment elections. For the
period August 2001 through December 2002, matching contributions by the Company
were made in Aetna Common Stock instead of being contributed in cash. In
addition, the plan provides for an annual performance-based contribution by the
Company of up to 3% of eligible pay (up to a maximum of $6,000), provided the
Company exceeds specified performance targets for the year. The
performance-based contribution may be made in cash, stock, or a combination of
both at the election of the Company. Based on the Company's results for 2002, a
performance-based contribution of 3% of eligible pay (up to a maximum of $6,000)
was contributed by the Company in February of 2003. Prior to January 1, 2002,
the Company provided for a match of up to 100% on the first 5% of eligible pay
contributed. The costs to the Company (allocated costs for 2000) associated with
these plans, including the performance-based contribution for 2002, were $79
million, $65 million and $67 million for 2002, 2001 and 2000, respectively. The
plan trustee held 5,383,324, 5,206,210 and 4,889,945 shares of the Company's
common stock for plan participants at December 31, 2002, 2001 and 2000,
respectively.
STOCK-BASED EMPLOYEE INCENTIVE PLANS
Stock-based Employee Incentive Plans - The Company's Stock-based Employee
Incentive Plans (the "Plans") provide for stock option awards (see "Stock
Options" below), deferred contingent common stock (see "Performance Units"
below), restricted stock awards to employees and the ability for employees to
purchase common stock at a discount. At December 31, 2002, 17,404,769 shares
were available for grant under the Plans.
Stock Options - Executive, middle management and nonmanagement employees may be
granted options to purchase common stock of the Company at or above the market
price on the date of grant. Options generally become 100% vested three years
after the grant is made, with one-third of the options vesting each year. From
time to time, the Company has issued options with different vesting provisions.
Vested options may be exercised at any time during the 10 years after grant,
except in certain circumstances, generally related to employment termination or
retirement. At the end of the 10-year period, any unexercised options expire.
Page 88
Prior to December 13, 2000, the Company's employees participated in former
Aetna's stock option plan. Since the Company is the successor of former Aetna
for accounting purposes, the following table reflects stock option transactions
of former Aetna for periods prior to December 13, 2000 and for the Company
subsequent to that date.
2002 2001 2000
--------------------- --------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE
OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE
---------- -------- ----------- -------- ---------- ---------
Outstanding, beginning of year 32,256,675 $ 30.72 31,709,870 $ 30.42 15,581,995 $ 68.30
Granted...................... 5,280,044 $ 36.28 5,299,825 $ 28.21 5,425,592 $ 44.32
Exercised.................... (8,393,059) $ 27.82 (3,558,748) $ 22.90 (619,027) $ 44.04
Expired or forfeited......... (865,709) $ 31.77 (1,194,272) $ 34.91 (1,526,884) $ 59.48
-------- ------- ---------- ------- ---------- -------
Outstanding at December 13, 18,861,676 $ 63.20
2000.........................
Settlement of stock options
held (3,207,604) --
by employees of sold
businesses...................
Conversion to Company stock 16,824,872 --
options......................
Granted...................... 207,744 $ 35.01
Exercised.................... (948,000) $ 23.15
Expired or forfeited......... (28,818) $ 24.32
-------- ------- -------- ------- -------- -------
Outstanding, end of year..... 28,277,951 $ 32.55 32,256,675 $ 30.72 31,709,870 $ 30.42
========== ======= ========== ======= ========== =======
Options exercisable, end of 20,535,382 $ 32.21 26,126,828 $ 31.23 30,352,471 $ 30.42
========== ======= ========== ======= ========== =======
year.........................
As a result of the Transaction, the former Aetna stock options held by employees
of the Company and existing retirees of former Aetna were converted into options
to purchase shares of the Company with adjustments made to both the number of
options and the exercise prices to maintain the intrinsic in- or
out-of-the-money value immediately before the spin-off. As a result of the
change in control of former Aetna, substantially all prior stock option grants
became fully vested during 2000. The in-the-money former Aetna stock options
held by employees of the sold businesses were settled for cash while the
out-of-the-money former Aetna stock options for such employees were cancelled.
The following is a summary of information regarding options outstanding and
options exercisable at December 31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- ------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE PRICE
----------------- -------------- ------------ -------- ------------ ----------
$12.89 - $16.26 25,694 .7 $ 15.66 25,694 $ 15.66
$16.26 - $21.69 2,409,442 6.7 $ 19.70 2,409,442 $ 19.70
$21.69 - $27.11 9,083,021 6.8 $ 25.37 7,039,310 $ 25.05
$27.11 - $32.53 1,188,042 6.7 $ 29.46 801,629 $ 29.72
$32.53 - $37.95 7,818,072 6.9 $ 35.34 2,872,159 $ 34.65
$37.95 - $43.37 4,981,766 3.4 $ 41.68 4,843,000 $ 41.66
$43.37 - $48.79 2,487,100 5.5 $ 43.93 2,259,334 $ 43.51
$48.79 - $54.21 284,814 3.3 $ 53.16 284,814 $ 53.16
-------- --- ------- -------- -------
28,277,951 20,535,382
========== ==========
Page 89
Performance Units - During 2002 and 2001, the Company granted performance stock
units to certain executives as part of a long-term incentive program. The value
of the performance stock units is equal to the Company's stock price, although
the units are not actual shares of stock and do not pay dividends (but may be
paid in shares of stock or cash, except as discussed below). The performance
stock units granted in 2002 and 2001 were established with the ability to vest
as early as December 31, 2003 and December 31, 2002, respectively, ("accelerated
vesting") if the Company meets or exceeds performance goals set by the Board of
Directors. If performance does not meet the accelerated vesting goal, the
performance measurement period for these grants may be as long as four and
one-half years from the grant date. The Board of Director's Committee on
Compensation and Organization determines if the performance goals have been
achieved and resets the performance goal each year, if it is not achieved in the
prior year. The number of performance stock units that may vest at the end of
the performance measurement period is dependent upon the degree to which the
Company achieves the performance goals. The vesting may go as high as 200% of
target for 2002 and 2001 grants, if operating earnings, as defined, are 25%
above performance goals. If performance accelerated vesting is not obtained, 50%
of the grant will vest, regardless of performance, at the end of the four and
one-half year measurement period if the participant is actively employed by the
Company on such date. Performance stock units which vest pursuant to time
vesting (rather than solely performance vesting) will be payable solely in
shares. The compensation expense related to time vested performance stock awards
will be amortized over the vesting period. For the 50% of the performance stock
units subject solely to performance goals, compensation expense is recognized
over the vesting period based on the Company's stock price.
In 2002, the Company determined that accelerated vesting at 200% of target
applied to grants made in 2001 as the Company exceeded performance goals set by
the Board of Directors. Accordingly, the Company recognized all remaining
compensation expense associated with these grants in 2002. Distributions to
participants occurred after approval by the Board of Director's Committee on
Compensation and Organization in the first quarter of 2003.
Incentive Units - Prior to December 13, 2000, the Company's executives
participated in former Aetna's incentive unit plan. These incentive units were
rights to receive common stock or an equivalent value in cash. Of the two cycles
of former Aetna incentive unit grants outstanding during 2000, each cycle was
due to vest at the end of a four-year vesting period (2000 and 2002),
conditioned upon the employee's continued employment during that period and
achievement of specified performance goals related to the total return to
shareholders over the four-year measurement period. Incentive units could vest
within a range from 0% to 175% at the end of the four-year period based on the
attainment of these performance goals. Interim measurements of compensation
expense were made at each reporting period based on the estimated periodic stock
price and estimated forfeitures, over the four-year vesting period. Compensation
expense was recognized over the four-year vesting period and no compensation
expense was recognized at the date of grant. The incentive unit holders were not
entitled to dividends during the vesting period. On December 13, 2000, as a
result of the change in control of former Aetna (refer to Note 21), the cycle
which ended on December 31, 2000 became fully vested while the cycle which would
have ended on December 31, 2002 became vested on a pro-rated basis. These awards
were paid in cash. As a result, there were no incentive units outstanding as of
December 31, 2000.
Page 90
The Company's (former Aetna prior to December 13, 2000) performance and
incentive unit transactions are as follows:
NUMBER OF INCENTIVE UNITS
------------------------------------------
2002 2001 2000
-------- -------- ---------
Outstanding, beginning
of year 442,325 -- 708,275
Granted............... 531,140 444,250 16,800
Vested................ (482,665) -- (382,834)
Expired or forfeited.. (24,400) (1,925) (342,241)
-------- ------ --------
Outstanding, end of 466,400 442,325 --
======== ======= ========
year..................
The weighted-average grant date fair values for incentive units granted in 2002,
2001 and 2000 were $46.48, $26.55 and $56.01, respectively.
The costs to the Company associated with the Company's (former Aetna, prior to
December 13, 2000) performance and incentive units for 2002, 2001 and 2000 were
$39 million, $2 million and $9 million, respectively.
Employee Stock Purchase Plan - The Company's shareholders approved the Aetna
Inc. Employee Stock Purchase Plan (the "ESPP") at the Company's Annual Meeting
on April 26, 2002. Under the ESPP, 6.5 million of the Company's common shares
are authorized for purchase by eligible employees in accordance with the ESPP's
provisions. All employees of the Company are eligible to participate in the ESPP
if employed immediately prior to the first day of the offering period. Employees
may contribute a percentage of their base salary through payroll deductions.
Contributions are accumulated for a six-month period and used to purchase stock
at the end of the offering period (the "Purchase Date"). On the Purchase Date,
stock is purchased for all participating employees based on the contributions
accumulated (subject to a $25,000 annual limit per employee). The purchase price
of the stock is based on a discounted percentage (such discount may not exceed
15%) of the lesser of the stock price at the beginning or the end of the
offering period. The first six-month accumulation period commenced July 5, 2002
and ended December 20, 2002. The purchase price for this offering was at a 10%
discount from the lesser of the stock's fair market value on July 5, 2002 or
December 20, 2002. For the period ended December 31, 2002, approximately 136,000
shares of common stock were purchased under the ESPP at the purchase price of
$36.85 per share. On January 3, 2003, the second six-month accumulation period
commenced. This accumulation period ends on June 20, 2003 and the purchase price
for this offering is at a 10% discount from the lesser of the stock's fair
market value on January 3, 2003 or June 20, 2003.
Page 91
15. Debt
The carrying value of long-term debt at December 31, was as follows:
(MILLIONS) 2002 2001
------------------------------------- ----------- -----------
Long-term debt:
Senior notes, 7.375% due 2006.... $ 449.1 $ 448.8
Senior notes, 7.875% due 2011.... 446.9 446.6
Senior notes, 8.50% due 2041..... 737.2 695.9
----------- -----------
Total............................... $ 1,633.2 $ 1,591.3
=========== ===========
On February 14, 2001, the Company filed a shelf registration statement with the
Securities and Exchange Commission to sell debt securities, from time to time,
up to a total of $2 billion, with the amount, price and terms to be determined
at the time of the sale. On March 2, 2001, the Company issued $900 million of
senior notes under this shelf registration statement consisting of $450 million
of 7.375% senior notes due in 2006 and $450 million of 7.875% senior notes due
in 2011. On June 18, 2001, the Company issued, under this shelf registration
statement, an additional $700 million of 8.5% senior notes due in 2041 (Refer to
Note 8 for information on the Company's interest rate swap agreements and
effective interest rate for 2002 relating to these senior notes). Net proceeds
from these issuances totaled approximately $1.6 billion and were used to reduce
outstanding commercial paper borrowings.
During 2002, the maximum amount of domestic short-term borrowings outstanding
was $145 million. The Company's short-term borrowings consist of a commercial
paper program that relies on backup revolving credit facilities, which together
provide for an aggregate borrowing capacity of $800 million. The Company's
credit facilities consist of a $300 million credit facility which terminates in
November 2003 and a $500 million credit facility which terminates in November
2005. Various interest rate options are available under these facilities. Any
revolving borrowings mature on the termination date of the applicable credit
facility, however the Company may convert any amounts outstanding under the $300
million facility when it terminates into a term loan that matures in November
2004 upon the satisfaction of certain conditions. The Company pays facility fees
on each facility ranging from .1% to .5% per annum, depending upon its long-term
senior unsecured debt rating. The facility fee at December 31, 2002 is at an
annual rate of .18% for the credit facility terminating in 2003 and .23% for the
credit facility terminating in 2005. There were no borrowings under these
facilities as of December 31, 2002.
Under the terms of its revolving credit facilities, the Company is required to
maintain a minimum level of shareholders' equity, excluding net unrealized
capital gains and losses, as of each fiscal quarter end. The required minimum
level is increased by 50% of the Company's consolidated net income each quarter
beginning with the quarter ending March 31, 2003, and is decreased by up to $150
million for certain non-recurring after-tax charges ("excluded charges"). At
December 31, 2002, the Company met its required minimum level of approximately
$5 billion. The Company is also required to maintain its ratio of total debt to
consolidated earnings as of each fiscal quarter end at or below 3.0. For this
purpose, consolidated earnings equals, for the period of four consecutive
quarters, net income plus interest expense, income tax expense, depreciation
expense, amortization expense, certain excluded charges, the goodwill impairment
resulting from the adoption of FAS No. 142 and any extraordinary gains or
losses. The Company met this requirement at December 31, 2002.
Total interest paid by the Company was $119 million, $118 million and $333
million in 2002, 2001 and 2000, respectively.
Page 92
16. Capital Stock
On October 25, 2002, the Company's Board of Directors ("the Board") voted to
terminate the Company's shareholder rights plan. The plan was terminated by
changing its 2010 expiration date to October 31, 2002, although the Board
retained the right to adopt a new plan at a future date in the event of changed
circumstances.
On September 27, 2002, the Board declared an annual cash dividend of $.04 per
common share to shareholders of record at the close of business on November 15,
2002. The dividend was paid on November 29, 2002.
In addition to the capital stock disclosed on the Consolidated Balance Sheets,
Aetna has authorized 7,625,000 shares of Class A voting preferred stock, $.01
par value per share. There are also 61,222,228 undesignated shares that the
Board has the power to divide into such classes and series, with such voting
rights, designations, preferences, limitations and special rights as the Board
determines. At December 31, 2002, 39,799,877 common shares of Aetna were
reserved for issuance under its stock option plans and 8,542,369 common shares
were reserved for issuance under its incentive savings plan.
In December 2000, the Board had authorized the repurchase of up to 5 million
shares of common stock (not to exceed an aggregate purchase price of $200
million). The Company repurchased 2.6 million shares of common stock at a cost
of approximately $96 million during the first quarter of 2001 pursuant to this
authorization, and then suspended repurchases until April 2002. In April 2002,
the Company re-initiated share repurchases pursuant to this authorization, and
during the second quarter of 2002, the Company repurchased approximately 2.1
million shares of common stock at a cost of approximately $104 million,
completing this share repurchase program. On June 28, 2002, the Board authorized
a new share repurchase program for the repurchase of up to 5 million shares of
common stock (not to exceed an aggregate purchase price of $250 million). During
the remainder of 2002, the Company repurchased approximately 1.5 million shares
of common stock at a cost of approximately $61 million under this new share
repurchase program.
On January 25, 2002, the Board authorized the issuance of approximately 7.5
million of the Company's common shares to eligible employees in accordance with
the 2002 Stock Incentive Plan. On January 25, 2002, the Board of Directors'
Committee on Compensation and Organization approved a grant of approximately 5
million stock options to purchase common shares of the Company at $35.78 per
share. During 2002, the Company issued approximately 9.3 million shares of
common stock for benefit plans (approximately 8.4 million shares related to
stock option exercises).
17. Dividend Restrictions and Shareholders' Equity
The Company's business operations are conducted through subsidiaries that
principally consist of HMOs and insurance companies. In addition to general
state law restrictions on payments of dividends and other distributions to
shareholders applicable to all corporations, HMOs and insurance companies are
subject to further state regulations that, among other things, may require such
companies to maintain certain levels of equity, and restrict the amount of
dividends and other distributions that may be paid to their parent corporations.
These regulations generally are not directly applicable to Aetna, as a holding
company, since it is not an HMO or insurance company. The additional regulations
applicable to Aetna's HMO and insurance company subsidiaries are not expected to
affect Aetna's ability to service its debt or to pay dividends or the ability of
any of Aetna's subsidiaries to service its debt or other financing obligations,
if any.
Under regulatory requirements, the amount of dividends that may be paid during
2003 to Aetna by its domestic insurance and HMO subsidiaries without prior
approval by state regulatory authorities as calculated at December 31, 2002 is
approximately $505 million in the aggregate. There are no such restrictions on
distributions from Aetna to its shareholders.
Page 93
The combined statutory net income for the years ended and statutory surplus as
of December 31 for the domestic insurance and HMO subsidiaries of the Company,
reflecting intercompany eliminations, were as follows:
(MILLIONS) 2002 2001 2000
----------------------- ----------- -------- --------
Statutory net income... $ 689.2 $ 20.9 $ 382.3
Statutory surplus...... 3,606.7 3,598.6 3,371.3
----------- -------- --------
Effective January 1, 2001, the Company's insurance and HMO subsidiaries were
required to prepare their statutory financial statements in accordance with the
National Association of Insurance Commissioners' (the "NAIC") Statements of
Statutory Accounting Principles ("Codification"), subject to the adoption of
Codification by their respective domicilary states.
As of December 31, 2002, the Company does not have state prescribed or permitted
statutory accounting practices which would result in reported statutory surplus
being materially different from the statutory surplus that would have been
reported had Codification been followed.
18. Reinsurance
The Company utilizes reinsurance agreements primarily to reduce its exposure to
large losses in certain aspects of its insurance business. These reinsurance
agreements permit recovery of a portion of losses from reinsurers, although they
do not discharge the Company's primary liability as direct insurer of the risks
reinsured. Failure of reinsurers to indemnify the Company could result in
losses, however, management does not expect charges for unrecoverable
reinsurance to have a material effect on the Company's results of operations or
financial position. The Company evaluates the financial condition of its
reinsurers and monitors concentrations of credit risk arising from similar
geographic regions, activities or economic characteristics of its reinsurers. As
of December 31, 2002, reinsurance recoverables consisted primarily of amounts
due from third parties that maintain independent agency ratings that are
consistent with those companies that are considered to have a strong ability to
meet their obligations.
Page 94
Earned premiums for the years ended December 31 were as follows:
PERCENTAGE
CEDED TO ASSUMED OF AMOUNT
DIRECT OTHER FROM OTHER NET ASSUMED
(MILLIONS) AMOUNT COMPANIES COMPANIES AMOUNT TO NET
--------------------------- ----------- -------- ---------- ------ ----------
2002 (1)
Accident and Health
Insurance $ 11,876.5 $ -- $ 3.6 $ 11,880.1 --
-- HMO (2).................
Accident and Health
Insurance 3,482.3 28.8 67.0 3,520.5 1.9%
-- Other (3)...............
Life Insurance............. 1,318.7 68.7 62.1 1,312.1 4.7%
----------- ------- --------- ----------- -----
Total premiums.......... $ 16,677.5 $ 97.5 $ 132.7 $ 16,712.7 .8%
=========== ======= ========= =========== =====
2001 (1)
Accident and Health
Insurance $ 16,210.6 $ -- $ 276.1 $ 16,486.7 1.7%
-- HMO (2).................
Accident and Health
Insurance 3,121.3 43.7 702.6 3,780.2 18.6%
-- Other (3)...............
Life Insurance............. 1,547.6 98.9 56.4 1,505.1 3.7%
----------- ------- --------- ----------- -----
Total premiums.......... $ 20,879.5 $ 142.6 $ 1,035.1 $ 21,772.0 4.8%
=========== ======= ========= =========== =====
2000 (1)
Accident and Health
Insurance $ 17,041.0 $ -- $ 1,373.3 $ 18,414.3 7.5%
-- HMO (2).................
Accident and Health
Insurance 2,657.9 38.7 994.4 3,613.6 27.5%
-- Other (3)...............
Life Insurance............. 1,195.5 61.4 52.9 1,187.0 4.5%
----------- ------- --------- ----------- -----
Total premiums.......... $ 20,894.4 $ 100.1 $ 2,420.6 $ 23,214.9 10.4%
=========== ======= ========= =========== =====
(1) Excludes intercompany transactions.
(2) Includes Commercial HMO (includes premiums related to POS members who access
primary care physicians and referred care through an HMO network), Medicare
HMO and Medicaid HMO Business. Earned premiums assumed from other companies
includes Commercial HMO premiums of $3.6 million, $276.1 million and $847.3
million in 2002, 2001 and 2000, respectively assumed from PHC pursuant to
the Coinsurance Agreement discussed below and $526 million in 2000 of
Medicare premium assumed from Health Care Services Corporation related to
the NYLCare Texas transaction.
(3) Includes all other Medical, Dental and Group Insurance products offered by
the Company. Earned premiums assumed from other companies includes $33.8
million, $676.8 million and $975.1 million of premium assumed from PHC
pursuant to the Coinsurance Agreement discussed below in 2002, 2001 and
2000, respectively.
Prior to the Company's acquisition of PHC, certain of PHC's medical and dental
contracts were underwritten directly by Prudential and HMO contracts were
underwritten by Prudential's HMO legal entities. The Company acquired
Prudential's HMO legal entities, but did not acquire Prudential, the legal
entity that wrote certain of PHC's medical and dental business. Concurrent with
the acquisition, ALIC entered into a reinsurance agreement (in the form of a
coinsurance agreement) in order to assume the business underwritten by
Prudential (the "Coinsured Business"). In order to provide for an orderly
transition of the Coinsured Business to products underwritten by legal entities
of the Company, the terms of the coinsurance agreement permitted the Company to
renew such business in Prudential's name until August 2001.
Effective November 1, 1999, the Company reinsured certain policyholder
liabilities and obligations related to paid-up group life insurance. Effective
October 1, 1998, the Company reinsured certain policyholder liabilities and
obligations related to individual life insurance (in conjunction with former
Aetna's sale of this business). These transactions were in the form of indemnity
reinsurance arrangements, whereby the assuming companies contractually assumed
certain policyholder liabilities and obligations, although the Company remains
directly obligated to policyholders. The liability related to the Company's
obligation is recorded in future policy benefits. Assets related to and
supporting these policies were transferred to the assuming companies and the
Company recorded a reinsurance recoverable. Reinsurance recoverables related to
these obligations were approximately $1.1 billion and approximately $1.2 billion
at December 31, 2002 and 2001, respectively.
There is not a material difference between premiums on a written basis versus an
earned basis. Reinsurance recoveries were approximately $120 million, $154
million and $134 million in 2002, 2001 and 2000, respectively. At December 31,
2002, reinsurance recoverables with a carrying value of approximately $1.1
billion were associated with three reinsurers.
Page 95
19. Segment Information
Summarized financial information for the Company's principal operations was as
follows:
GROUP LARGE CASE CORPORATE DISCONTINUED TOTAL
2002 (MILLIONS) HEALTH CARE INSURANCE PENSIONS INTEREST OPERATIONS COMPANY
--------------------------------- ------------ ---------- ----------- ---------- ---------- -----------
Revenues from external customers(1) $ 16,858.3 $ 1,497.4 $ 238.0 $ -- $ -- $ 18,593.7
Net investment income ............. 295.7 269.5 685.5 -- -- 1,250.7
----------- ---------- ----------- ----------- -------- -----------
Total revenue excluding realized
capital gains (losses) ............ $ 17,154.0 $ 1,766.9 $ 923.5 $ -- $ -- $ 19,844.4
=========== ========== =========== ========== ======= ===========
Interest expense .................. $ -- $ -- $ -- $ 119.5 $ -- $ 119.5
----------- ---------- ----------- ----------- -------- -----------
Amortization of other intangible
assets ............................ $ 130.8 $ -- $ -- $ -- $ -- $ 130.8
----------- ---------- ----------- ----------- -------- -----------
Income taxes (benefits) ........... $ 119.5 $ 57.6 $ 16.3 $ (41.8) $ -- $ 151.6
Operating earnings (losses) from
continuing operations (2) ......... $ 361.6 $ 142.2 $ 2 $ ($7.7) $ -- $ 450.3
Other items (3) ................... (81.6) (3.2) 5.4 -- -- (79.4)
Realized capital gains (losses),
net of tax ........................ 36.4 (14.0) (.1) -- -- 22.3
----------- ---------- ----------- ----------- -------- -----------
Income (loss) from continuing
operations ........................ 316.4 125.0 29.5 (77.7) -- 393.2
Discontinued operations, net of
tax(4) -- -- -- -- 50.0 50.0
----------- ---------- ----------- ----------- -------- -----------
Cumulative effect adjustment, net
of tax ............................ (2,965.7) -- -- -- -- (2,965.7)
Net income (loss) ................. $ (2,649.3) $ 125 $ 29.5 $ (77.7) $ 50 $ (2,522.5)
=========== ========== =========== ========== ======= ===========
Segment assets (5) ................ $ 13,805.6 $ 5,409.0 $ 20,832.9 $ -- $ -- $ 40,047.5
----------- ---------- ----------- ----------- -------- -----------
Expenditures for long-lived assets $ 39.6 $ -- $ 2.9 $ -- $ -- $ 42.5
----------- ---------- ----------- ----------- -------- -----------
(1) Revenues from external customers include revenues earned from one major
customer (the federal government, primarily CMS) amounting to 9.4% of total
revenue from external customers.
(2) Operating earnings (loss) from continuing operations is comprised of income
(loss) from continuing operations excluding net realized capital gains or
losses, any other items and the cumulative effect adjustment. 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 net income (loss) as a measure of profitability.
(3) The following other items were excluded from operating earnings (losses)
from continuing operations: a $19.8 million income tax benefit resulting
from the release of state income tax related reserves in connection with
the favorable conclusion of several state tax audits in the Health Care
segment, severance and facilities charges of $104.6 million after tax
consisting of $101.4 million after tax in the Health Care segment and $3.2
million after tax in the Group Insurance segment and $5.4 million after tax
from reductions of the reserve for anticipated future losses on
discontinued products in the Large Case Pensions segment.
(4) As discussed in more detail in Note 21, the Company released $50.0 million
of federal income tax reserves resulting from the resolution of several
Internal Revenue Service audit issues during the first quarter of 2002 that
related to the property and casualty insurance business of one of Aetna's
predecessors, which was sold in 1996.
(5) Large Case Pensions assets include $5.4 billion attributable to
discontinued products.
Page 96
GROUP LARGE CASE CORPORATE DISCONTINUED TOTAL
2001 (MILLIONS) HEALTH CARE INSURANCE PENSIONS INTEREST OPERATIONS COMPANY
--------------- ----------- --------- ------------ ---------- ----------- -------------
Revenues from external customers (1)... $ 21,793.9 $ 1,414.9 $ 474.3 $-- $-- $ 23,683.1
Net investment income.................. 373.9 286.0 751.7 -- -- 1,411.6
----------- ---------- ----------- ------- ----- -----------
Total revenue excluding realized
capital gains $ 22,167.8 $ 1,700.9 $ 1,226.0 $-- $-- $ 25,094.7
=========== ========== =========== ======= ===== ===========
(losses)...............................
Interest expense....................... $ -- $ -- $ -- $142.8 $-- $ 142.8
----------- ---------- ----------- ------- ----- -----------
Amortization of goodwill and other
intangible $ 416.6 $ -- $ -- $-- $-- $ 416.6
----------- ---------- ----------- ------- ----- -----------
assets.................................
Income taxes (benefits)................ $ (157.3) $ 71.2 $ 48.9 $(50.0) $-- $ (87.2)
----------- ---------- ----------- ------- ----- -----------
Operating earnings (losses) from
continuing $ (365.3) $ 160.1 $ 31.6 $(92.8) $-- $ (266.4)
operations (2).........................
Other items (3)........................ (151.1) (9.0) 61.4 -- -- (98.7)
Realized capital gains (losses), net of 77.4 .3 (4.1) -- -- 73.6
=========== ========== =========== ======= ===== ===========
tax....................................
Income (loss) from continuing operations (439.0) 151.4 88.9 (92.8) -- (291.5)
Discontinued operations, net of tax:
Reduction of the.................... -- -- -- -- 11.4 11.4
reserve for sale and
spin-off related
costs (4)
Cumulative effect adjustment, net of tax .5 -- -- -- -- .5
----------- ---------- ----------- ------- ----- -----------
Net income (loss)...................... $ (438.5) $ 151.4 $ 88.9 $(92.8) $11.4 $ (279.6)
=========== ========== =========== ======= ===== ===========
Segment assets (5)..................... $ 16,593.4 $ 4,683.5 $ 21,919.8 $-- $-- $ 43,196.7
----------- ---------- ----------- ------- ----- -----------
Expenditures for long-lived assets..... $ 29.1 $ -- $ 33.7 $-- $-- $ 62.8
----------- ---------- ----------- ------- ----- -----------
(1) Revenues from external customers include revenues earned from one major
customer (the federal government, primarily CMS) amounting to 12.6% of
total revenue from external customers.
(2) Operating earnings (loss) from continuing operations is comprised of income
(loss) from continuing operations excluding net realized capital gains or
losses, any other items and the cumulative effect adjustment. 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 net income (loss) as a measure of profitability.
(3) The following other items were excluded from operating earnings (losses)
from continuing operations: a $125.1 million after-tax severance and
facilities charge, $26.0 million after-tax charge for unfavorable reserve
developments related to exited Medicare markets in the Health Care segment,
an after-tax charge of $9.0 million for events of September 11, 2001 in the
Group Insurance segment; and a $61.4 million after-tax benefit from
reductions of the reserve for anticipated future losses on discontinued
products in the Large Case Pensions segment.
(4) In connection with the Transaction, as more fully described in Note 21, the
Company recorded a reserve of approximately $174 million for net costs
associated with this transaction. In the fourth quarter of 2001, the
Company reduced the reserve for such costs by approximately $11 million.
(5) Large Case Pensions assets include $5.6 billion attributable to
discontinued products.
Page 97
GROUP LARGE CASE CORPORATE DISCONTINUED TOTAL
2000 (MILLIONS) HEALTH CARE INSURANCE PENSIONS INTEREST OPERATIONS COMPANY
--------------- ------------ ---------- ----------- --------- ----------- -----------
Revenues from external customers (1).. $ 23,694.9 $ 1,367.0 $ 165.5 $-- $-- $ 25,227.4
Net investment income................. 428.5 300.9 902.2 -- -- 1,631.6
----------- ---------- ----------- -------- ------ -----------
Total revenue excluding realized
capital $ 24,123.4 $ 1,667.9 $ 1,067.7 $-- $-- 26,859.0
=========== ========== =========== ======== ====== ===========
gains (losses)........................
Interest expense...................... $ -- $ -- $ -- $248.2 $-- $ 248.2
----------- ---------- ----------- -------- ------ -----------
Amortization of goodwill and other
intangible assets..................... $ 435.6 $ -- $ -- $-- $-- $ 435.6
----------- ---------- ----------- -------- ------ -----------
Income taxes (benefits)............... $ .4 $ 82.6 $ 92.3 $(86.9) $-- $ 88.4
----------- ---------- ----------- -------- ------ -----------
Operating earnings (losses) from
continuing $ 95.5 $ 193.4 $ 66.0 $(161.3) $-- $ 193.6
operations (2)........................
Other items (3)....................... (401.4) (.3) 94.9 -- -- (306.8)
Realized capital gains (losses), net 13.1 (31.8) 4.5 -- -- (14.2)
----------- ---------- ----------- -------- ------ -----------
of tax................................
Income (loss) from continuing (292.8) 161.3 165.4 (161.3) -- (127.4)
operations............................
Discontinued operations, net of tax:
Income from........................ -- -- -- -- 428.5 428.5
operations
Sale and spin-off.................. -- -- -- -- (174.0) (174.0)
related costs
----------- ---------- ----------- -------- ------ -----------
Net income (loss)..................... $ (292.8) $ 161.3 $ 165.4 $(161.3) $254.5 $ 127.1
=========== ========== =========== ======== ====== ===========
Segment assets (4).................... $ 17,114.9 $ 4,788.5 $ 25,769.6 $-- $-- $ 47,673.0
----------- ---------- ----------- -------- ------ -----------
Expenditures for long-lived assets.... $ 34.8 $ -- $ 82.8 $-- $-- $ 117.6
----------- ---------- ----------- -------- ------ -----------
(1) Revenues from external customers include revenues earned from one major
customer (the federal government, primarily CMS) amounting to 20.3% of
total revenue from external customers.
(2) Operating earnings (loss) from continuing operations is comprised of income
(loss) from continuing operations excluding net realized capital gains or
losses and any other items. While operating earnings is the measure of
profit or loss used by the Company's management when assessing performance
or making operating decisions, it does not replace net income (loss) as a
measure of profitability.
(3) The following other items were excluded from operating earnings (losses)
from continuing operations: an after-tax charge of $238.3 million from the
write-off of goodwill, a $92.6 million after-tax severance and facilities
charge, a $14.6 million after-tax charge related to the New Jersey
insolvency assessment, a $5.2 million after-tax charge related to a
shareholder litigation settlement agreement and an after-tax charge of
$50.7 million, primarily change-in-control related costs, in the Health
Care segment; an after-tax charge of $.3 million for change-in-control
related costs in the Group Insurance segment; and a $94.9 million after-tax
benefit from reductions of the reserve for anticipated future losses on
discontinued products in the Large Case Pensions segment.
(4) Large Case Pensions assets include $5.8 billion attributable to
discontinued products.
Revenues from external customers (all within the United States) by product were
as follows:
(MILLIONS) 2002 2001 2000
------------------------------- ------------ ---------- ----------
Health risk................... $ 15,039.4 $ 19,972.5 $ 21,756.2
Health ASC.................... 1,818.9 1,821.4 1,938.7
Group life.................... 1,097.0 1,056.1 1,050.4
Group disability.............. 336.0 299.7 272.1
Group long-term care.......... 64.4 59.1 44.5
Large case pensions........... 238.0 474.3 165.5
------------ ---------- ----------
Total revenue from external
customers..................... $ 18,593.7 $ 23,683.1 $ 25,227.4
============ ========== ==========
Long-lived assets, all within the United States, were $245 million and $327
million at December 31, 2002 and 2001, respectively.
Page 98
20. Commitments and Contingent Liabilities
The Company has entered into operating leases for office space and certain
computer and other equipment. Rental expenses for these items were $168 million,
$217 million and $273 million for 2002, 2001 and 2000, respectively. The future
net minimum payments under noncancelable leases for 2003 through 2007 are
estimated to be $182 million, $148 million, $112 million, $82 million and $68
million, respectively.
The Company also has funding obligations relating to equity limited partnership
investments and commercial mortgage loans. The funding requirements for equity
limited partnership investments for 2003 through 2007 are estimated to be $152
million, $51 million, $32 million, $30 million and $14 million, respectively.
The funding requirements for commercial mortgage loans for 2003 are estimated to
be $44 million. At December 31, 2002, the Company was not obligated to fund any
commercial loans beyond 2003.
As discussed in Aetna Inc.'s 2002 Annual Report on Form 10-K, the Company has
been able to earn contingent consideration under a long-term strategic provider
relationship with Magellan Health Services Inc. ("Magellan"), the purchaser of
HAI. The Company recognized the final installment of this contingent
consideration under this agreement of approximately $60 million pretax during
the second quarter of 2002. This amount was due in February 2003 but was not
paid, and Magellan announced that it is experiencing financial difficulties.
Based on the Company's discussions with Magellan regarding their plans to
address these issues, the Company currently believes it will ultimately recover
the full amount due.
GUARANTEES
The Company has the following guarantee arrangements as of December 31, 2002.
Mortgage-Backed Securities Obligation - In June of 1992, the Company securitized
98 apartment mortgage loans totaling $325 million into 21 FNMA ("Fannie Mae")
mortgage-backed securities ("MBS"). The Company subsequently sold those MBSs for
cash. Fannie Mae required that the Company continue to retain a portion of the
risk of default of the underlying loans, and therefore the Company guaranteed
the first $59 million of such losses. As of December 31, 2002, $50 million of
the original mortgage loans were outstanding. Therefore, the maximum exposure
the Company had on its guarantee to Fannie Mae for loans default, as of December
31, 2002 was $50 million. The Company has no recourse for this guarantee.
Operating Lease Residual Value Guarantee - The Company has a leasing program
with an independent third party grantor trust primarily for the lease of a
corporate aircraft and certain office furniture. The total value of the assets
under lease as of December 31, 2002 was $54 million. Under current accounting
guidance, this arrangement is an operating lease, and therefore the related
assets and liabilities are not recorded on the Company's Consolidated Balance
Sheet. However, under the guidance of FIN 46 (see Note 2 for a discussion of new
accounting standards) the Company will consolidate this VIE beginning with its
third quarter 2003 interim financial statements. The Company may terminate the
lease program at any time by purchasing the assets at cost or dissolving the
grantor trust through liquidation. If the assets were sold to a third party at
less than the cost to the grantor trust, the Company's maximum exposure under a
residual value guarantee was approximately $48 million as of December 31, 2002.
ASC Claim Funding Accounts - The Company has arrangements with certain banks for
the processing of claim payments for its ASC customers. The banks maintain
accounts to fund ASC customer's claims. The customer is responsible to fund the
amount paid by the bank each day. In these arrangements, the Company guarantees
that the banks will not sustain losses if the responsible ASC customer does not
properly fund their account. The aggregate maximum exposure under these
arrangements is $258 million. The Company could limit its exposure to this
guarantee by suspending the payment of claims for ASC customers that have not
adequately funded the amount paid by the bank.
Page 99
Indemnification Agreements - In connection with certain acquisitions and
dispositions of assets and/or businesses (e.g., the Transaction), the Company
has incurred certain customary indemnification obligations to the applicable
seller or purchaser, respectively. In general, the Company has agreed to
indemnify the other party for certain losses relating to the assets or business
that the Company purchased or sold. Certain portions of the Company's
indemnification obligations are capped at the applicable purchase price, while
other arrangements are not subject to such a limit. As of December 31, 2002, the
Company believes it has established reserves and/or obtained insurance
sufficient to cover such potential losses. Refer to Notes 13 and 21 for more
information and the Company's indemnification obligations related to the
Transaction.
Intercompany Obligations - The Company has guaranteed certain of the obligations
of certain of its HMO and dental maintenance organizations ("DMO") subsidiaries.
For certain HMOs and DMOs, Aetna guarantees the payment of substantially all the
legal entities' expenses and claims in the event of that legal entity's
insolvency. The Company's maximum exposure under these arrangements is the
payment of such expense and claim obligations of the applicable legal entities,
which totaled approximately $800 million as of December 31, 2002. These
obligations are reflected on the applicable legal entity's balance sheets and
are included in the Consolidated Balance Sheet. Aetna also has agreed to
maintain the capital of certain HMOs at or above the minimum level required by
law. The aggregate of all such minimum capital requirements at December 31, 2002
was $11 million; however, the capital of each of these HMOs exceeded the
required level at December 31, 2002. There are no recourse provisions to offset
payments made under either of these types of arrangements.
GUARANTY FUND ASSESSMENTS, MARKET STABILIZATION AND OTHER NON-VOLUNTARY RISK
SHARING POOLS
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. Assessments
generally are based on a formula relating to the Company's premiums in the state
compared to the premiums of other insurers. While we historically have recovered
more than half of guaranty fund assessments through statutorily permitted
premium tax offsets, significant increases in assessments could jeopardize
future recovery of these assessments. Some states have similar laws relating to
HMOs. HMOs in certain states in which the Company does business are subject to
assessments, including market stabilization and other risk sharing pools for
which the Company is assessed charges based on incurred claims, demographic
membership mix and other factors. The Company establishes liabilities for these
assessments based on applicable laws and regulations. In certain states, the
ultimate assessments to be paid by the Company are dependent upon the Company's
experience relative to other entities subject to the assessment and the ultimate
liability is not known at the balance sheet date. While the ultimate amount of
the assessment is dependent upon the experience of all pool participants, the
Company has adequate reserves to cover such assessments. There were no material
charges to earnings for guaranty fund and other assessments during 2002 or 2001.
LITIGATION
Managed Care Class Action Litigation Since 1999, the Company has been involved
in purported class action lawsuits that are part of a wave of similar actions
targeting the health care payor industry and, in particular, the conduct of
business by managed care companies (the "Managed Care Class Action Litigation").
Page 100
The Judicial Panel on Multi-district Litigation has transferred all of the
federal actions, including several actions originally filed in state courts, to
the United States District Court for the Southern District of Florida (the
"Florida Federal Court") for consolidated pretrial proceedings. The Florida
Federal Court has divided these cases into two tracks - one for cases brought on
behalf of subscribers (collectively, the "Subscriber Cases") and the other for
cases brought on behalf of health care providers (collectively, the "Provider
Cases").
Twelve Subscriber Cases currently are pending in the Florida Federal Court. The
Subscriber Cases seek various forms of relief, including unspecified damages,
treble damages, injunctive relief and restitutionary relief for unjust
enrichment, for alleged violations of the Racketeer Influenced and Corrupt
Organizations Act ("RICO") and the Employee Retirement Income Security Act of
1974 ("ERISA"), and seek similar relief under common law theories and/or state
unfair trade statutes. Each of former Aetna, the Company (including certain
health maintenance organizations that Aetna acquired from Prudential) and
Richard L. Huber (the former chairman of former Aetna) are named as defendants
in one or more of the Subscriber Cases. The Subscriber Case complaints allege
generally that defendants failed to adequately inform members about defendants'
managed care practices, including capitated payments to providers and
utilization management practices. Certain Subscriber Cases also contain charges
relating to the disclosure and determination of usual, customary and reasonable
charges for claims and related claims payment practices.
On September 26, 2002, the Florida Federal Court denied the plaintiffs' motion
to certify a class for the Subscriber Cases. Merits discovery on the Subscriber
Cases commenced in September 2002, and the Florida Federal Court has scheduled
trial for the Subscriber Cases commencing September 22, 2003. The Company
intends to continue to defend the Subscriber Cases vigorously.
Eleven Provider Cases currently are pending in the Florida Federal Court, and a
similar action is pending in Louisiana state court. The Provider Cases allege
generally that the Company and each of the other defendant managed care
organizations employ coercive economic power to force physicians to enter into
economically unfavorable contracts, impose unnecessary administrative burdens on
providers and improperly deny claims in whole or in part, and that the
defendants do not pay claims timely or do not pay claims at proper rates. The
Provider Cases further charge that the Company and the other defendant managed
care organizations conspired and aided and abetted one another in the alleged
wrongdoing. In addition, a Provider Case brought on behalf of the American
Dental Association alleges improper disclosure and determination of usual,
customary and reasonable charges for dental claims and related claims payment
practices. The Provider Cases allege violations of RICO, ERISA, state unfair
trade statutes, state consumer fraud statutes, state laws regarding the timely
payment of claims, and various common law doctrines. The Provider Cases seek
various forms of relief, including unspecified damages, treble damages, punitive
damages and injunctive relief.
The plaintiffs in the Provider Cases generally seek to represent purported
nationwide classes and subclasses of physicians and other providers who
currently or formerly provided services to members of the Company and/or
Prudential. Certain Provider Cases also purport to bring class actions on behalf
of physicians and/or other providers in a particular state, and plaintiffs in
cases originally filed in state courts seek to have those cases remanded to
state courts for separate trial. On September 26, 2002, the Florida Federal
Court issued an order certifying a global RICO class and certain sub-classes in
the matter it has designated as the lead Provider Case. That order is the
subject of a pending appeal before the United States Court of Appeals for the
Eleventh Circuit. Merits discovery on the Provider Cases commenced in September
2002, and the Florida Federal Court has scheduled the Provider Cases for trial
commencing December 8, 2003. The Company intends to continue to defend
vigorously the Provider Cases and similar state court actions.
Page 101
In addition to the Subscriber and Provider Cases consolidated before the Florida
Federal Court, a complaint was filed in the Superior Court of the State of
California, County of San Diego (the "California Superior Court") 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, as amended, seeks injunctive relief
against former Aetna, Aetna, Aetna Health 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 the Company's HMO
members and the general public and for alleged unfair practices relating to
contracting of doctors. This action is in the discovery phase, and trial
currently is scheduled to begin on December 5, 2003. Defendants intend to
continue to defend this action vigorously.
Securities Class Action Litigation Laborers Tri-County Pension Fund, Goldplate
Investment Partners Ltd. and Sheila Shafran filed a consolidated and amended
purported class action complaint ("Securities Complaint") on June 7, 2002 in the
United States District Court for the Southern District of New York. The
Securities Complaint supplanted several complaints, filed beginning November 6,
2001, which have been voluntarily dismissed or consolidated. Plaintiffs contend
that the Company and two of its current or former officers and directors,
William H. Donaldson and John W. Rowe, M.D., violated federal securities laws.
Plaintiffs allege misrepresentations and omissions regarding, among other
things, the Company's ability to manage and control medical costs and the
appropriate reserve for medical costs as of December 31, 2000, for which they
seek unspecified damages, among other remedies. On October 15, 2002, the Court
heard argument on defendants' motion to dismiss the Securities Complaint.
Defendants intend to continue vigorously defending this action, which is in its
preliminary stages.
The Company is unable to predict at this time the ultimate outcome of the
Managed Care Class Action Litigation or Securities Class Action Litigation. It
is reasonably possible that their outcome could be material to the Company.
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 employment litigation and 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.
In addition, the Company's current and past business practices are subject to
review by various state insurance and health care regulatory authorities and
other state and federal authorities. There continues to be heightened review by
these authorities of the managed health care industry's business practices,
including utilization management, delegated arrangements and claim payment
practices. As a leading national managed care organization, the Company
regularly is the subject of such reviews. 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 this other litigation and these regulatory
proceedings 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 102
21. Discontinued Operations
As discussed in Note 13, in the first quarter of 2002 the Company released $50
million of federal income tax reserves resulting from the resolution of Service
audit issues that related to the property and casualty insurance business of
former Aetna, which was sold in 1996.
On December 13, 2000, former Aetna sold its financial services and international
businesses to ING in a transaction valued at approximately $7.7 billion. Under
the terms of the agreement and in an integrated transaction, former Aetna spun
off to its shareholders the shares of the Company, which is comprised primarily
of the Health Care, Group Insurance and Large Case Pensions businesses.
Simultaneously, former Aetna, which then was comprised of Aetna Financial
Services and Aetna International, was merged with a newly formed subsidiary of
ING. In exchange for each share of former Aetna, shareholders received one share
of the Company and $35.33 per share in cash. When ING acquired former Aetna,
that entity included approximately $3.0 billion of net liabilities, primarily
comprised of $2.7 billion of long-term debt. As part of the sale consideration
and the spin-off transaction, these net liabilities were acquired by ING.
In December 2000, the Company established a reserve for the net costs associated
with the Transaction of approximately $174 million after tax. These costs, which
were directly associated with the sale of the financial services and
international businesses, were included in the results of discontinued
operations for 2000 and related to certain compensation-related arrangements,
costs for outside financial and legal advisors, income taxes related to legal
entity realignment, payments for the settlement of certain former Aetna employee
stock options held by employees of the sold businesses and various other
expenses related to the change in control of former Aetna. During the fourth
quarter of 2001, the Company reduced the reserve for such costs by approximately
$11 million after tax, which management determined were no longer necessary.
Included in the cost associated with the Transaction was the release of
approximately $53 million of previously established reserves in connection with
prior dispositions of businesses reflected as discontinued operations.
In connection with its spin-off from former Aetna, the Company assumed all
liabilities related to the Health Care, Group Insurance and Large Case Pensions
businesses. In addition, the Company generally is responsible for the
liabilities of former Aetna other than those arising out of the financial
services and international businesses sold to ING. Those liabilities include the
post-retirement pension and other benefits payable to all former employees of
former Aetna, liabilities arising out of health litigation and certain
corporate-level litigation to which former Aetna is a party, and all liabilities
arising out of certain divestiture transactions consummated by former Aetna
prior to the closing of the Company's spin-off. The Company also provided
certain administrative services on behalf of ING through June 2002.
Page 103
The Company is the successor of former Aetna for accounting purposes and,
accordingly, the account balances and activities of the financial services and
international businesses have been segregated and reported as discontinued
operations. Operating results of these discontinued operations for the year
ended December 31, 2000 were as follows:
(MILLIONS) 2000
---------- -----------
Revenue:
Premiums.................................................................... $ 3,105.2
Total net investment income................................................. 1,370.4
Fees and other income....................................................... 727.2
Net realized capital gains.................................................. 280.5
-----------
Total revenue.................................................................. 5,483.3
-----------
Benefits and expenses:
Current and future benefits................................................. 3,255.4
Operating expenses:
Salaries and related..................................................... 481.8
benefits
Other.................................................................... 665.2
Interest expense............................................................ 49.7
Amortization of goodwill and other acquired intangible...................... 28.6
assets
Amortization of deferred policy acquisition costs........................... 224.3
-----------
Total benefits and expenses.................................................... 4,705.0
-----------
Income before taxes............................................................ 778.3
Income taxes:
Current..................................................................... 210.6
Deferred.................................................................... 139.2
-----------
Total income taxes............................................................. 349.8
-----------
Income from discontinued operations before sale and spin-off related costs..... 428.5
Sale and spin-off related costs, net of $16.0 million of income taxes.......... (174.0)
-----------
Income from discontinued operations............................................ $ 254.5
===========
Page 104
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
Management is responsible for the financial statements of Aetna Inc., which have
been prepared in accordance with accounting principles generally accepted in the
United States of America. The financial statements are the products of a number
of processes that include the gathering of financial data developed from the
records of the Company's day-to-day business transactions. Informed judgments
and estimates are used for those transactions not yet complete or for which the
ultimate effects cannot be measured precisely. The Company emphasizes the
selection and training of personnel who are qualified to perform these
functions. In addition, Company personnel are subject to rigorous standards of
ethical conduct that are widely communicated throughout the organization.
The Company's internal controls are designed to reasonably assure that Company
assets are safeguarded from unauthorized use or disposition and that Company
transactions are authorized, executed and recorded properly. Company personnel
maintain and monitor these internal controls on an ongoing basis. In addition,
the Company's internal auditors review and report upon the functioning of these
controls with the right of full access to all Company personnel.
The Company engages KPMG LLP as independent auditors to audit its financial
statements and express their opinion thereon. Their audits include reviews and
tests of the Company's internal controls to the extent they believe necessary to
determine and conduct the audit procedures that support their opinion. Members
of that firm also have the right of full access to each member of management in
conducting their audits. The report of KPMG LLP appears below.
The Company's Board of Directors has an Audit Committee composed solely of
independent directors. The Committee meets regularly with management, the
internal auditors and KPMG LLP to oversee and monitor the work of each and to
inquire of each as to their assessment of the performance of the others in their
work relating to the Company's financial statements. Both the independent and
internal auditors have, at all times, the right of full access to the Audit
Committee, without management present, to discuss any matter they believe should
be brought to the attention of the Committee.
Page 105
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Directors Aetna Inc.:
We have audited the accompanying consolidated balance sheets of Aetna Inc. and
subsidiaries as of December 31, 2002 and 2001, and the related consolidated
statements of income, shareholders' equity and cash flows for each of the years
in the three-year period ended December 31, 2002. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Aetna Inc. and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States of America.
/S/ KPMG LLP
HARTFORD, CONNECTICUT
FEBRUARY 10, 2003
Page 106
QUARTERLY DATA (UNAUDITED)
2002 (MILLIONS, EXCEPT PER COMMON SHARE DATA) FIRST (1) SECOND (2) THIRD (3) FOURTH (4)
----------------------------------------------------- ----------- ---------- --------- ----------
Total revenue........................................ $ 5,264.7 $ 5,064.2 $ 4,832.1 $ 4,717.7
------------ --------- --------- ---------
Income from continuing operations before income
taxes................................................ $ 97.7 $ 159.6 $ 143.5 $ 144.0
Income taxes......................................... 9.7 51.4 44.7 45.8
------------ --------- --------- ---------
Income from continuing operations.................... 88.0 108.2 98.8 98.2
Income from discontinued operations.................. 50.0 -- -- --
Cumulative effect adjustment, net of tax............. (2,965.7) -- -- --
------------ --------- --------- ---------
Net income (loss).................................... $ (2,827.7) $ 108.2 $ 98.8 $ 98.2
============ ========= ========= =========
Per common share results: (5)
Net income (loss)
Basic............................................. $ (19.50) $ .73 $ .66 $ .65
Diluted........................................... (19.00) .70 .64 .63
------------ --------- --------- ---------
Common stock data:
Dividends declared................................ $ -- $ -- $ .04 $ --
Common stock prices, 38.82 51.76 47.04 43.97
high
Common stock prices, 30.76 38.66 35.81 31.69
low
------------ --------- --------- ---------
(1) First quarter includes a release of $19.8 million of state income taxes
related reserves.
(2) Second quarter includes an after-tax severance and facilities charge of
$17.5 million ($27.0 million pretax) (refer to Note 11) and a $5.4 million
after tax benefit ($8.3 million pretax) from a reduction of the reserve for
loss on discontinued products.
(3) Third quarter includes an after-tax severance and facilities charge of
$57.9 million ($89.0 million pretax) (refer to Note 11).
(4) Fourth quarter includes an after-tax severance and facilities charge of
$29.2 million ($45.0 million pretax) (refer to Note 11).
(5) Calculation of the earnings per share is based on weighted average shares
outstanding during each quarter and, accordingly, the sum may not equal the
total for the year.
2001 (MILLIONS, EXCEPT PER COMMON SHARE DATA) FIRST SECOND (1) THIRD FOURTH (2)
---------------------------------------------------- ----------- ------------ ---------- -----------
Total revenue...................................... $ 6,428.7 $ 6,536.4 $ 6,183.2 $ 6,042.5
----------- ----------- ----------- -----------
Income (loss) from continuing operations before
income taxes (benefits)............................ $ (48.5)$ 43.6 $ (62.0)$ (311.8)
Income taxes (benefits) .2 33.0 (7.6) (112.8)
----------- ----------- ----------- -----------
Income (loss) from continuing operations........... (48.7) 10.6 (54.4) (199.0)
Income from discontinued operations................ -- -- -- 11.4
Cumulative effect adjustment, net of tax .5 -- -- --
----------- ----------- ----------- -----------
Net income (loss).................................. $ (48.2)$ 10.6 $ (54.4)$ (187.6)
=========== =========== =========== ===========
Per common share results: (3)(4)
Net income (loss)
Basic........................................... $ (.34) $ .07 $ (.38) $ (1.30)
Diluted......................................... (.34) .07 (.38) (1.30)
---------- ---------- ---------- ----------
Common stock data:
Dividends declared.............................. $ -- $ -- $ .04 $ --
Common stock prices, high....................... 41.50 36.55 30.05 33.71
Common stock prices, low........................ 33.81 23.23 24.68 27.64
---------- ---------- ---------- ----------
(1) Second quarter includes a $61.4 million after-tax benefit ($94.5 million
pretax) from a reduction of the reserve for loss on discontinued products.
(2) Fourth quarter includes an after-tax severance and facilities charge of
$125.1 million ($192.5 million pretax) (refer to Note 11).
(3) Calculation of the earnings per share is based on weighted average shares
outstanding during each quarter and, accordingly, the sum may not equal the
total for the year.
(4) Since the Company reported a loss from continuing operations in the first,
third and fourth quarters, the effect of common stock equivalents has been
excluded from per common share computations for these quarters, since
including such securities would be anti-dilutive. As a result, diluted and
basic per common share amounts for these quarters are the same.
107
BOARD OF DIRECTORS
Betsy Z. Cohen
Chairman and Chief Executive Officer
Resource Asset Investment Trust
Barbara Hackman Franklin
President and Chief Executive Officer
Barbara Franklin Enterprises
Former U.S. Secretary of Commerce
Jeffrey E. Garten
Dean
Yale School of Management
Earl G. Graves
Chairman and Chief Executive Officer
Earl G. Graves, Ltd.
Publisher, Black Enterprise magazine
Gerald Greenwald
Founding Principal of
Greenbriar Equity Group
Retired Chairman and
Chief Executive Officer
UAL Corporation
Ellen M. Hancock
Former Chairman and
Chief Executive Officer
Exodus Communications, Inc.
Michael H. Jordan
Retired Chairman and
Chief Executive Officer
CBS Corporation
Jack D. Kuehler
Retired Vice Chairman
International Business Machines Corporation
Joseph P. Newhouse
John D. MacArthur Professor of Health Policy and Management
Harvard University
Judith Rodin
President
University of Pennsylvania
John W. Rowe, M.D.
Chairman and Chief Executive Officer
Aetna Inc.
Ronald A. Williams
President
Aetna Inc.
R. David Yost
Chief Executive Officer
AmerisourceBergen Corporation
COMMITTEES OF THE BOARD
Audit
Barbara Hackman Franklin*
Jeffrey E. Garten
Earl G. Graves
Ellen M. Hancock
Joseph P. Newhouse
Compensation and Organization
Betsy Z. Cohen
Gerald Greenwald
Michael H. Jordan*
Jack D. Kuehler
R. David Yost
Executive
Barbara Hackman Franklin
Earl G. Graves
Michael H. Jordan
Jack D. Kuehler
Judith Rodin
John W. Rowe, M.D.*
Investment
Betsy Z. Cohen
Gerald Greenwald
Jack D. Kuehler*
Judith Rodin
Ronald A. Williams
R. David Yost
Medical Affairs Committee
Jeffrey E. Garten
Joseph P. Newhouse
Judith Rodin*
John W. Rowe, M.D.
Nominating and Corporate Governance
Barbara Hackman Franklin
Earl G. Graves
Gerald Greenwald*
Ellen M. Hancock
Michael H. Jordan
*Committee Chairman
MANAGEMENT
John W. Rowe, M.D.
Chairman and Chief Executive Officer
Ronald A. Williams
President
David B. Kelso
Executive Vice President
Strategy and Finance
L. Edward Shaw, Jr.
Executive Vice President and
General Counsel
Dong H. Ahn
Senior Vice President
Group Insurance
Andrew Allocco
Senior Vice President
Network Contracting and Strategy
Alan M. Bennett
Senior Vice President and
Chief Financial Officer
John J. Bermel
Vice President and Business Operations Chief Financial Officer
Mark T. Bertolini
Senior Vice President
Specialty Products
Roger Bolton
Senior Vice President
Communications
C. Timothy Brown
Senior Vice President
Middle Market Accounts and
Health Care Delivery
William J. Casazza
Vice President Deputy General Counsel and Corporate Secretary
Wei-Tih Cheng
Senior Vice President and
Chief Information Officer
Eric S. Elliott
Vice President
Pharmacy Management
Patricia A. Farrell
Senior Vice President
Strategic Planning
Russell D. Fisher
Senior Vice President
National Accounts and Aetna Global Benefits
Mary Fox
Vice President
Operational Excellence Group
Patricia Hassett
Chief of Staff
Office of the Chairman
Paul B. Hebert
Vice President, Internal Audit
Timothy A. Holt
Senior Vice President and
Chief Investment Officer
Charles Klippel
Vice President and
Deputy General Counsel
Vanda B. McMurtry
Senior Vice President
Federal Government Relations
Dennis Oakes
Vice President
Investor Relations
Ronald M. Olejniczak
Vice President and Controller
William C. Popik, M.D.
Senior Vice President and
Chief Medical Officer
Alfred P. Quirk, Jr.
Vice President, Finance and Treasurer
Arthur J. Redmond
Senior Vice President
Strategic Marketing
William H. Roth
Senior Vice President
Small Group Business and Retiree Markets
Scott A. Schnuckle
Vice President
Dental and Behavioral Health Operations
Diane D. Souza
Vice President
National Customer Operations
Thomas C. Strohmenger
Vice President and
Chief Compliance Officer
Robyn S. Walsh
Vice President
Elease E. Wright
Senior Vice President
Human Resources
SHAREHOLDER INFORMATION
CORPORATE HEADQUARTERS
151 Farmington Avenue
Hartford, Connecticut 06156
860-273-0123
ANNUAL MEETING
The annual meeting of shareholders of Aetna Inc. will be held on Friday, April
25, 2003 at 9:30 a.m. at the company's headquarters in Hartford, Connecticut.
STOCK EXCHANGE LISTING
Aetna's common shares are listed on the New York Stock Exchange. The NYSE symbol
for the common shares is AET. As of January 31, 2003, there were 14,241 record
holders of Aetna's common shares.
WEB SITE ACCESS TO AETNA'S PERIODIC AND CURRENT REPORTS AND CORPORATE GOVERNANCE
MATERIALS
Aetna makes available free of charge through its Web site at
http://www.aetna.com its Annual Report on Form 10-K, Forms 10-Q, current reports
on Form 8-K and all amendments to those reports as soon as reasonably
practicable after Aetna electronically files or furnishes such material with the
Securities and Exchange Commission. Aetna also makes available free of charge
through its Web site the company's Annual Report, Financial Report and Proxy
Statement. Shareholders may request printed copies of these reports free of
charge by calling 1-800-237-4273.
Aetna's report to the Securities and Exchange Commission on Form 10-K provides
additional details about the company's business, as well as other financial
information not included in this Annual Report. TO RECEIVE A COPY OF THE ANNUAL
REPORT ON FORM 10-K WITHOUT CHARGE, PLEASE FOLLOW THE ABOVE INSTRUCTIONS.
Also available on Aetna's Web site at http://www.aetna.com are the following
Aetna corporate governance materials: Articles of Incorporation and By-Laws;
Code of Conduct for Directors, officers and employees (and information regarding
any amendments or waivers relating to Aetna's Directors, executive officers and
principal financial and accounting officers or persons performing similar
functions); Independence Standards for Directors; Corporate Governance
Guidelines; and Charters for the Committees of the Board of Directors (Audit
Committee, Committee on Compensation and Organization, Executive Committee,
Investment Committee, Medical Affairs Committee, and Nominating and Corporate
Governance Committee). These materials also are available in print to
shareholders free of charge by calling 1-800-237-4273.
Section 16 reports are filed with the Securities and Exchange Commission by
Aetna's Directors and those officers subject to Section 16 to reflect a change
in their beneficial ownership of Aetna's securities and are available through
Aetna's Web site at http://www.aetna.com.
The Audit Committee can be confidentially contacted by those wishing to raise
concerns or complaints about the Company's accounting, internal accounting
controls or auditing matters by calling AlertLine(R), an independent toll-free
service, at 1-888-891-8910 (available seven days a week, 24 hours a day), or by
writing to: Corporate Compliance, P.O. Box 370205, West Hartford, CT 06137-0205.
Anyone wishing to make their concerns known to Aetna's nonmanagement Directors
may contact the Aetna Director who leads the nonmanagement Directors session at
Board meetings (currently Gerald Greenwald) by writing to Mr. Greenwald at P.O.
Box 370205, West Hartford, CT 06137-0205.
Aetna mails quarterly financial results only to those shareholders who request
copies. Shareholders may call 1-800-237-4273 to listen to the company's
quarterly earnings release and dividend information, and to request faxed or
mailed copies of the quarterly results.
INVESTOR RELATIONS
Securities analysts and institutional investors should contact:
Dennis Oakes, Vice President
860-273-6184
FAX: 860-273-3971
Internet mail: oakesd@aetna.com
SHAREHOLDER SERVICES
EquiServe Trust Company, N.A. maintains a telephone response center to service
registered shareholder accounts. Registered owners may contact the center to
inquire about replacement dividend checks, address changes, stock transfers and
other account matters.
EquiServe Trust Company, N.A.
P.O. Box 43069
Providence, RI 02940-3069
1-800-446-2617
For direct deposit of dividends, registered shareholders may call EquiServe at
1-800-870-2340.
Registered shareholders with e-mail addresses can send account inquiries
electronically to EquiServe at http://www.equiserve.com.
Additionally, registered shareholders now have available online access to their
accounts through the Internet at EquiServe's Web site at
http://www.equiserve.com.
DirectSERVICE Investment Program
Current shareholders and new investors can purchase common shares of Aetna and
reinvest cash dividends through EquiServe Trust Company, N.A. All inquiries for
materials or information about this program should be directed to EquiServe at
1-800-446-2617.
Other Shareholder Inquiries
Office of the Corporate Secretary
Aetna Inc.
151 Farmington Avenue, RC4A
Hartford, Connecticut 06156-3215
860-273-3945
AETNA STOCK OPTION PARTICIPANTS
AETNA EMPLOYEE STOCK PURCHASE PLAN PARTICIPANTS
Employees with outstanding stock options should address all questions to UBS
PaineWebber regarding their accounts, outstanding options or shares received
through option exercises. Employees participating in the Employee Stock Purchase
Plan also should contact UBS PaineWebber with questions on their accounts.
UBS PaineWebber Inc.
Corporate Employee Financial Services
300 Lighting Way, 6th Floor
Secaucus, New Jersey 07094-3672
1-888-793-7631, or 1-800-238-6247
Online access
http://www.cefs.ubspainewebber.com/aet
151 Farmington Avenue
Hartford, Connecticut 06156
Printed on recycled paper.
31.05.901.1
AETNA INC.
TO: PARTICIPANTS IN THE AETNA INCENTIVE SAVINGS PLAN
Mellon Bank, N.A., the Trustee under the Aetna Incentive Savings Plan (the
Plan), has been instructed to solicit your instructions on how to vote the Aetna
Common Shares held by the Trustee on your behalf in accordance with the terms of
the Plan and to vote those shares in accordance with your instructions at the
Annual Meeting of Shareholders of Aetna Inc. to be held on April 25, 2003 and at
any adjournment or postponement thereof. Please indicate by checking the
appropriate box how you want these shares voted by the Trustee and return this
card to the Trustee in the envelope provided. We would like to remind you that
your individual voting instructions are held in strictest confidence and will
not be disclosed to the Corporation. IF YOU FAIL TO PROVIDE VOTING INSTRUCTIONS
TO THE TRUSTEE BY 4:00 P.M., EASTERN TIME, ON APRIL 18, 2003 EITHER BY TELEPHONE
OR BY COMPLETING, SIGNING AND RETURNING THIS CARD, YOUR SHARES WILL BE VOTED BY
THE TRUSTEE IN THE SAME MANNER AND PROPORTION AS THOSE SHARES FOR WHICH THE
TRUSTEE RECEIVES PROPER AND TIMELY INSTRUCTIONS.
TO VOTE BY TELEPHONE, PLEASE SEE THE REVERSE SIDE OF THIS CARD. TO VOTE BY MAIL,
PLEASE SIGN AND DATE THIS CARD ON THE REVERSE SIDE, TEAR OFF AT THE PERFORATION,
AND MAIL PROMPTLY IN THE ENCLOSED POSTAGE-PAID ENVELOPE.
--------------------------------------------------------------------------------
FOLD AND DETACH HERE
VOTE BY PHONE
QUICK - EASY - IMMEDIATE
IF YOU VOTED BY TELEPHONE DO NOT MAIL YOUR INSTRUCTION CARD
Note: Participants who received the 2003 Aetna Inc. Proxy Statement and Aetna
2002 Annual Report, Financial Report over the Internet and who would
like a printed copy of this document may call 1-800-237-4273.
THANK YOU FOR VOTING.
PLEASE MARK
YOUR VOTES AS [X]
INDICATED IN
THIS EXAMPLE
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR ITEMS 1, 2, 3, 4 AND 5.
FOR WITHHELD
--- --------
1. Election of Directors [ ] [ ]
01 Betsy Z. Cohen
02 Jeffrey E. Garten
03 Jack D. Kuehler
04 John W. Rowe
05 Ronald A. Williams
For, except vote withheld from the following nominee(s):
--------------------------------------------------------
FOR AGAINST ABSTAIN
--- ------- -------
2. Approval of KPMG LLP as [ ] [ ] [ ]
Independent Auditors
FOR AGAINST ABSTAIN
--- ------- -------
3. Amend Articles of [ ] [ ] [ ]
Incorporation -- Business
Combinations Voting
FOR AGAINST ABSTAIN
--- ------- -------
4. Amend Articles of [ ] [ ] [ ]
Incorporation -- Special
Shareholders Meetings
FOR AGAINST ABSTAIN
--- ------- -------
5. Amend By-Laws -- Voting [ ] [ ] [ ]
Requirements
THE BOARD OF DIRECTORS RECOMMENDS A VOTE AGAINST ITEM 6.
FOR AGAINST ABSTAIN
--- ------- -------
6. Shareholder Proposal on [ ] [ ] [ ]
Cumulative Voting
Mark this box if you plan to attend the Annual Meeting. [ ]
THIS INSTRUCTION CARD IS SOLICITED ON
BEHALF OF MELLON BANK, N.A.
SIGNATURE DATE
------------------------------------------ -------------------
NOTE: PLEASE SIGN EXACTLY AS NAME APPEARS HEREON. JOINT OWNERS SHOULD EACH SIGN.
WHEN SIGNING AS ATTORNEY, EXECUTOR, ADMINISTRATOR, TRUSTEE OR GUARDIAN, PLEASE
GIVE YOUR FULL TITLE AS SUCH. IF A CORPORATION OR OTHER FORM OF ENTITY, PLEASE
SIGN IN THE FULL NAME OF THE ENTITY, BY A DULY AUTHORIZED OFFICER. THE SIGNER
HEREBY REVOKES ALL VOTING INSTRUCTIONS HERETOFORE GIVEN TO THE TRUSTEE BY THE
SIGNER TO VOTE AT THE 2003 ANNUAL MEETING OF AETNA INC. AND ANY ADJOURNMENT OR
POSTPONEMENT THEREOF.
--------------------------------------------------------------------------------
FOLD AND DETACH HERE
VOTE BY TELEPHONE 24 HOURS A DAY, 7 DAYS A WEEK
TELEPHONE VOTING IS AVAILABLE THROUGH 11PM EASTERN TIME ON APRIL 18, 2003.
YOUR TELEPHONE VOTE AUTHORIZES THE NAMED TRUSTEE TO VOTE YOUR SHARES
IN THE SAME MANNER AS IF YOU MARKED, SIGNED AND RETURNED YOUR PROXY CARD.
TELEPHONE MAIL
1-800-435-6710
Use any touch-tone telephone to Mark, sign and date
vote your voting instruction card. OR your voting instruction card
Have your voting instruction card in and
hand when you call. You will be return it in the
prompted to enter your control enclosed postage-paid
number, located in the box below, envelope.
and then follow the directions given.
IF YOU VOTE BY TELEPHONE, YOU DO NOT NEED TO MAIL BACK
YOUR VOTING INSTRUCTION CARD.
YOUR VOTE IS IMPORTANT. PLEASE MARK, SIGN, DATE AND PROMPTLY RETURN
THIS VOTING INSTRUCTION CARD.
TO ATTEND THE ANNUAL MEETING: If you plan to attend the Annual Meeting, you
should mark the box provided on the above voting instruction card. An admission
card will then be mailed to you.
THANK YOU FOR VOTING.
PROXY
AETNA INC.
The undersigned hereby appoints Barbara Hackman Franklin, Gerald Greenwald and
Michael H. Jordan, and each of them, the proxies of the undersigned, with full
power of substitution, to vote the shares of the undersigned at the Annual
Meeting of Shareholders of Aetna Inc. to be held April 25, 2003 and at any
adjournment or postponement thereof, and directs said proxies to vote as
specified herein on the six items specified in this Proxy, and in their
discretion on any other matters that may properly come before the meeting or any
adjournment or postponement thereof.
NOMINEES FOR TERMS EXPIRING AT 2004 ANNUAL MEETING:
01. Betsy Z. Cohen 04. John W. Rowe
02. Jeffrey E. Garten 05. Ronald A. Williams
03. Jack D. Kuehler
THIS PROXY IS SOLICITED ON BEHALF OF AETNA'S BOARD OF DIRECTORS.
--------------------------------------------------------------------------------
To vote by telephone or internet, please see the reverse of this card. To vote
by mail, please sign and date the above proxy card on the reverse, tear off at
the perforation, and mail promptly in the enclosed postage-paid envelope.
SHAREHOLDER ACCOUNT INQUIRIES
Aetna Inc.'s Transfer Agent, EquiServe Trust Company, N.A., maintains a
telephone response center to service shareholder accounts. Registered owners of
Aetna shares may call the center at 1-800-446-2617 to inquire about replacement
dividend checks, address changes, stock transfers and other account matters or
to inquire about EquiServe's DirectSERVICE Investment Program.
For direct deposit of dividends, registered shareholders may call EquiServe at
1-800-870-2340.
Registered shareholders with e-mail addresses can send account inquiries
electronically to EquiServe at equiserve@equiserve.com.
Registered shareholders can also access their Aetna accounts via the Internet
through EquiServe's web site at http://www.equiserve.com.
[X] PLEASE MARK YOUR 8988
VOTES AS IN THIS
EXAMPLE.
THIS PROXY, WHEN PROPERLY EXECUTED, WILL BE VOTED IN THE MANNER DIRECTED HEREIN
BY THE SHAREHOLDER. IF NO DIRECTION IS MADE, THIS PROXY WILL BE VOTED FOR ITEMS
1, 2, 3, 4 AND 5 AND AGAINST ITEM 6.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR ITEMS 1, 2, 3, 4 AND 5.
FOR WITHHELD FOR AGAINST ABSTAIN FOR AGAINST ABSTAIN
1. Election of [ ] [ ] 2. Approval of KPMG [ ] [ ] [ ] 4. Amend Articles of [ ] [ ] [ ]
Directors LLP as Independent Incorporation -- Special
(See reverse Auditors Shareholders Meetings
side)
For, except vote withheld from 3. Amend Articles 5. Amend By-Laws --
the following nominee(s): of Incorporation -- [ ] [ ] [ ] Voting Requirements [ ] [ ] [ ]
Business Combinations
Voting
---------------------------
THE BOARD OF DIRECTORS RECOMMENDS A VOTE AGAINST ITEM 6.
--------------------------------------------------------
FOR AGAINST ABSTAIN
6. Shareholder Proposal on [ ] [ ] [ ]
Cumulative Voting
MARK THIS BOX IF YOU HAVE [ ]
MORE THAN ONE ACCOUNT AND
WANT TO DISCONTINUE
RECEIVING MULTIPLE COPIES
OF FUTURE ANNUAL REPORTS.
MARK THIS BOX IF YOU PLAN [ ]
TO ATTEND THE ANNUAL MEETING.
SIGNATURE(S) DATE
----------------------------------- ---------------------------
NOTE: PLEASE SIGN EXACTLY AS NAME APPEARS HEREON. JOINT OWNERS SHOULD EACH SIGN.
WHEN SIGNING AS ATTORNEY, EXECUTOR, ADMINISTRATOR, TRUSTEE OR GUARDIAN, PLEASE
GIVE YOUR FULL TITLE AS SUCH. IF A CORPORATION OR OTHER FORM OF ENTITY, PLEASE
SIGN IN THE FULL NAME OF THE ENTITY, BY A DULY AUTHORIZED OFFICER. THE SIGNER
HEREBY REVOKES ALL PROXIES HERETOFORE GIVEN BY THE SIGNER TO VOTE AT THE 2003
ANNUAL MEETING OF AETNA INC. AND ANY ADJOURNMENT OR POSTPONEMENT THEREOF.
--------------------------------------------------------------------------------
PLEASE SIGN AND DATE HERE, DETACH AND RETURN IN ENCLOSED ENVELOPE OR VOTE BY
TELEPHONE OR THE INTERNET.
NOW YOU CAN VOTE YOUR SHARES BY TELEPHONE OR INTERNET!
QUICK * EASY * IMMEDIATE * AVAILABLE 24 HOURS A DAY * 7 DAYS A WEEK
Your telephone or Internet vote authorizes the named proxies to vote your shares
in the same manner as if you marked, signed, and returned your proxy card. To
vote by phone or Internet, please follow these easy steps:
TO VOTE BY PHONE
Call toll free 1-877-PRX-VOTE (1-877-779-8683) on a touch tone telephone.
Shareholders residing outside the United States, Canada and Puerto Rico should
call 1-201-536-8073. Telephone voting will be available until 11:59 p.m.,
Eastern time, on April 24, 2003.
Use the Control Number located in the box above, just below the perforation.
Enter the Control Number and pound signs (#) exactly as they appear.
Follow the recorded instructions.
TO VOTE BY INTERNET
Log onto http://www.eproxyvote.com/aet which will be available until 11:59 p.m.,
Eastern time, on April 24, 2003.
Follow the instructions on the screen.
You can also elect to receive future shareholder materials electronically at
this web site.
TO ATTEND THE ANNUAL
MEETING
If you plan to attend the Annual Meeting, you should either mark the box
provided on the above proxy card or signify your intention to attend when you
access the telephone or Internet voting system.
An admission card will then be mailed to you.
THANK YOU FOR VOTING!