Cigna Group: Form 10-Q for the period ended Mar 31, 2019

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide information to assist you in better understanding and evaluating our financial condition as of March 31, 2019 compared with December 31, 2018 and our results of operations for the three months ended March 31, 2019 compared with the same period last year. We encourage you to read this MD&A in conjunction with our Consolidated Financial Statements included in Part I, Item 1 of this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”), in particular the “Risk Factors” contained in Part I, Item 1A of that form.

Unless otherwise indicated, financial information in the MD&A is presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). See Note 2 to the Consolidated Financial Statements in our 2018 Form 10-K for additional information regarding the Company’s significant accounting policies and Note 2 to these Consolidated Financial Statements in the Form 10-Q for updates to those accounting policies resulting from adopting new accounting guidance. The preparation of interim consolidated financial statements necessarily relies heavily on estimates. This and certain other factors, such as the seasonal nature of portions of the health care and related pharmacy and other benefits businesses, as well as competitive and other market conditions, call for caution in estimating full-year results based on interim results of operations. In some of our financial tables in this MD&A, we present either percentage changes or “N/M” when those changes are so large as to become not meaningful. Changes in percentages are expressed in basis points (“bps”).

In this MD&A, our consolidated measures “adjusted income from operations,” earnings per share on that same basis, and “adjusted revenues” are not determined in accordance with GAAP and should not be viewed as substitutes for the most directly comparable GAAP measures “shareholders’ net income,” “earnings per share” and “total revenues.” As discussed in Note 18, we also use pre-tax adjusted income from operations and adjusted revenues to measure the results of our segments.

We use adjusted income from operations as our principal financial measure of operating performance because management believes it best reflects the underlying results of our business operations and permits analysis of trends in underlying revenue, expenses and profitability. We define adjusted income from operations as shareholders’ net income (or income before taxes for the segment metric) excluding realized investment gains and losses, amortization of acquired intangible assets, results of Anthem, Inc. and Coventry Health Care Inc. (“Coventry”) (collectively, the “transitioning clients”) (see the “Key Transactions and Developments” section of the MD&A for further discussion of transitioning clients) and special items. Cigna’s share of certain realized investment results of its joint ventures reported in the International Markets segment using the equity method of accounting are also excluded. Income or expense amounts excluded from adjusted income from operations because they are not indicative of underlying performance or the responsibility of operating segment management include:

• Realized investment gains (losses) including changes in market values of certain financial instruments between balance sheet dates, as well as gains and losses associated with invested asset sales.
• Amortization of acquired intangible assets because these relate to costs incurred for acquisitions.
• Results of transitioning clients because those results are not indicative of ongoing results.
• Special items, if any, that management believes are not representative of the underlying results of operations due to the nature or size of these matters. See Note 18 to the Consolidated Financial Statements for descriptions of special items.

Adjusted revenues is defined as total revenues excluding the following adjustments: revenue contributions from transitioning clients, special items and Cigna’s share of certain realized investment results of its joint ventures reported in the International Markets segment using the equity method of accounting.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on Cigna’s current expectations and projections about future trends, events and uncertainties. These statements are not historical facts. Forward-looking statements may include, among others, statements concerning future financial or operating performance, including our ability to deliver affordable, personalized and innovative solutions for our customers and clients; future growth, business strategy, strategic or operational initiatives; economic, regulatory or competitive environments, particularly with respect to the pace and extent of change in these areas; financing or capital deployment plans and amounts available for future deployment; our prospects for growth in the coming years; the merger (“Merger”) with Express Scripts Holding Company; and other statements regarding Cigna’s future beliefs, expectations, plans, intentions, financial condition or performance. You may identify forward-looking statements by the use of words such as “believe,” “expect,” “plan,” “intend,” “anticipate,” “estimate,” “predict,” “potential,” “may,” “should,” “will” or other words or expressions of similar meaning, although not all forward-looking statements contain such terms.

Forward-looking statements are subject to risks and uncertainties, both known and unknown, that could cause actual results to differ materially from those expressed or implied in forward-looking statements. Such risks and uncertainties include, but are not limited to: our ability to achieve our financial, strategic and operational plans or initiatives; our ability to predict and manage medical and pharmacy costs and price effectively; our ability to adapt to changes or trends in an evolving and rapidly changing industry; our ability to effectively differentiate our products and services from those of our competitors and maintain or increase market share; our ability to develop and maintain good relationships with physicians, hospitals, other health care providers and pharmaceutical manufacturers; changes in drug pricing; the impact of modifications to our operations and processes; our ability to identify potential strategic acquisitions or transactions and realize the expected benefits (including anticipated synergies) of such transactions in full or within the anticipated time frame, including with respect to the Merger, as well as our ability to integrate operations, resources and systems; the substantial level of government regulation over our business and the potential effects of new laws or regulations or changes in existing laws or regulations; the outcome of litigation, regulatory audits, investigations, actions and/or guaranty fund assessments; uncertainties surrounding participation in government-sponsored programs such as Medicare; the effectiveness and security of our information technology and other business systems; the impact of our debt service obligations on the availability of funds for other business purposes; unfavorable industry, economic or political conditions, including foreign currency movements; acts of war, terrorism, natural disasters or pandemics; as well as more specific risks and uncertainties discussed in Part I, Item 1A – Risk Factors and Part II, Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations of our 2018 Form 10-K and as described from time to time in our future reports filed with the Securities and Exchange Commission (the “SEC”).

You should not place undue reliance on forward-looking statements that speak only as of the date they are made, are not guarantees of future performance or results, and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Cigna undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as may be required by law.

EXECUTIVE OVERVIEW

Cigna Corporation, together with its subsidiaries (either individually or collectively referred to as “Cigna,” the “Company,” “we,” “our” or “us”) is a global health service organization dedicated to a mission of helping those we serve improve their health, well-being and peace of mind. Our evolved strategy in support of our mission is Go Deeper, Go Local, Go Beyond using a differentiated set of pharmacy, medical, dental, disability, life and accident insurance and related products and services offered by our subsidiaries. For further information on our business and strategy, see Item 1, “Business” in our 2018 Form 10-K.

As described more fully in Note 4 to our Consolidated Financial Statements, on December 20, 2018, we completed the acquisition of Express Scripts Holding Company (“Express Scripts”) and changed our segments effective in the fourth quarter of 2018. See Note 1 to our Consolidated Financial Statements for a description of our segments. As described further in Note 2 to the Consolidated Financial Statements, we adopted Article 5 of Regulation S-X issued by the SEC effective December 31, 2018. Prior year information presented in this Form 10-Q has been restated to reflect these changes. In addition, as discussed in Note 18 to our Consolidated Financial Statements, effective in the first quarter of 2019, compensation cost for stock options is now recorded by our segments. Prior year segment information has not been restated for this change. Results for the three months ended March 31, 2019 included the results of Express Scripts’ business, whereas results for the three months ended March 31, 2018 reflected Cigna’s stand-alone historical results. Unless otherwise specified, the commentary provided below describes our results for the three months ended March 31, 2019 compared with the same period in 2018.

Summarized below are certain key measures of our performance by segment for the three months ended March 31, 2019 and 2018:

Financial Highlights by Segment

(Dollars in millions, except per share amounts)

46

For further analysis and explanation of individual segment results, see the “Segment Reporting” section of this MD&A beginning on page 54.

Consolidated Results of Operations (GAAP basis)

(Dollars in millions)

Reconciliation of Shareholders’ Net Income to Adjusted Income from Operations

(In millions, except per share amounts)

47

Commentary: Three Months Ended March 31, 2019 versus Three Months Ended March 31, 2018

Earnings and Revenue

Shareholders’ net income increased, primarily driven by the earnings contribution from Express Scripts and higher adjusted income from operations in the Integrated Medical segment, partially offset by interest expense on debt issued to finance the Express Scripts acquisition. The decline on a per-share basis also reflects the dilution caused by shares issued in connection with the Express Scripts acquisition.

Adjusted income from operations increased, reflecting earnings from Express Scripts’ pharmacy benefits and medical management businesses reported in the Health Services segment. Improved results in Integrated Medical also contributed to the increase. These favorable results were partially offset by higher interest expense reported in Corporate from the debt issued to finance the acquisition and the debt assumed from Express Scripts. On a per-share basis, the decrease also reflects the dilution caused by shares issued in connection with the Express Scripts acquisition.

Medical customers increased, primarily attributable to growth in the select market segment. See the Integrated Medical segment section for additional discussion.

Revenue growth largely reflects the addition of Express Scripts and, to a lesser extent, business growth in the Integrated Medical segment. Detailed revenue items are discussed further below.

• Pharmacy revenues in 2019 reflect the Express Scripts pharmacy benefit management business. In 2018, Cigna’s home delivery business comprised the entire amount. See the Health Services section of this MD&A for further discussion of pharmacy revenues.
• Premiums were higher, primarily resulting from: 1) customer growth across all segments, predominantly Integrated Medical: 2) a contribution from Express Scripts’ Medicare Part D business, and 3) rate increases in Integrated Medical in line with medical cost trend.
• Fees and other revenues. The increase was primarily driven by contributions from Express Scripts’ medical management business reported in the Health Services segment. To a lesser extent, higher fees in our Integrated Medical segment contributed to the increase. The increases in Integrated Medical were due to growth in our specialty businesses and an increased customer base for our administrative services only (“ASO”) business.
• Net investment income was higher reflecting growth in average assets.

Other Components of Consolidated Results of Operations

• Pharmacy and other service costs. In 2019, this amount is largely comprised of Express Scripts’ pharmacy benefits and medical management businesses reported in the Health Services segment. In 2018, Cigna home delivery comprised the entire amount.
• Medical costs and other benefit expenses increased, largely attributable to the addition of Express Scripts’ Medicare Part D business along with customer growth and medical cost inflation in Integrated Medical.
• Selling, general and administrative expenses increased, primarily due to the addition of Express Scripts. To a lesser extent, volume-related expenses in Integrated Medical and increased integration and transaction-related costs (reported as a special item) also contributed to the expense growth. These increases were partially offset by suspension of the health insurance industry tax in 2019.
• Amortization of acquired intangible assets in 2019 primarily reflects the impact of the Express Scripts acquisition. See Note 3 in the Consolidated Financial Statements of our 2018 Form 10-K for additional information on the intangible assets identified in the Express Scripts acquisition.
• Interest expense and other increased significantly primarily due to interest incurred on debt issued in the third quarter of 2018 to finance the Express Scripts acquisition along with Express Scripts’ debt assumed upon closing of the acquisition.
• Realized investment gains (losses). We reported realized investment gains for the three months ended March, 31, 2019 compared with losses for the same period last year. The improvement largely results from favorable market value adjustments on equity securities and higher gains on sales of fixed maturities.
• The consolidated effective tax rate declined, due to suspension of the nondeductible health insurance industry tax in 2019.

Key Transactions and Developments

Acquisition of Express Scripts

As discussed in more detail in our 2018 Form 10-K, Cigna acquired Express Scripts on December 20, 2018 in a cash and stock transaction valued at $52.8 billion. The “Liquidity” section of this MD&A provides further discussion of the impact of the acquisition on our liquidity and capital resources.

We continue to incur costs related to this transaction. These costs are being reported in “integration and transaction-related costs” as a special item and excluded from adjusted income from operations. The results of the Express Scripts’ business were included in Cigna’s consolidated financial information for the three months ended March 31, 2019, whereas the three months ended March 31, 2018 reflected Cigna’s stand-alone historical results.

On January 30, 2019, Anthem exercised its early termination right and terminated the pharmacy benefit management services agreement with us, effective March 1, 2019. There is a twelve-month transition period ending March 1, 2020. The transition of Anthem’s customers is expected to occur at various dates, as informed by Anthem’s technology platform migration schedule. Over the next twelve months, we will focus on an effective transition of this relationship and related services over Anthem’s accelerated timeline. We exclude the results of Express Scripts’ contract with Anthem (and also Coventry) from our non-GAAP reporting metrics “adjusted revenues” and “adjusted income from operations.” We refer to these clients as “transitioning clients.”

Industry Developments and Other Matters Affecting Our Health Services and Integrated Medical Segments

Our 2018 Form 10-K provides a detailed description of The Patient Protection and Affordable Care Act (“ACA”) provisions and other legislative initiatives that impact our health care and pharmacy services businesses, including regulations issued by the Centers for Medicare & Medicaid Services (“CMS”) and the Departments of the Treasury and Health and Human Services (“HHS”). The health care and pharmacy services businesses continue to operate in a dynamic environment, and the laws and regulations applicable to these businesses, including the ACA, continue to be subject to legislative, regulatory and judicial challenges. The table presented below provides an update on the impact of these items and other matters affecting our Integrated Medical and Health Services segments as of March 31, 2019.

49

50

Risk Mitigation Programs – Individual ACA Business

In April of 2019, CMS published the final Notice of Benefit and Payment Parameters for the 2020 plan year that addressed the 2017 benefit year risk adjustment data validation program. CMS intends to publish 2017 benefit year data validation error rates in May and preliminary adjustments to risk adjustment transfers in August. Based on the information currently available, the Company is not able to reasonably estimate a potential adjustment from the data validation program. The Company does not expect the adjustment to have a material adverse impact to the Company’s results of operations, financial condition or liquidity for any particular period.

See the MD&A in our 2018 Form 10-K for background around legal actions related to the risk corridor and risk adjustment programs. During the first quarter of 2019, there have been no significant updates to these matters.

The following table presents our balances associated with the risk adjustment program as of March 31, 2019 and December 31, 2018.

(In millions)

(1) Receivables, net of allowances, are reported in accounts receivable in the Consolidated Balance Sheets.

(2) Payables are reported in accrued expenses and other liabilities (current) in the Consolidated Balance Sheets.

Charges for the risk adjustment program were $40 million pre-tax ($30 million after-tax) for the three months ended March 31, 2019 and $80 million pre-tax ($60 million after-tax) for the same period in 2018.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

We maintain liquidity at two levels: the subsidiary level and the parent company level.

Liquidity requirements at the subsidiary level generally consist of:

• medical costs, pharmacy and other benefit payments;
• expense requirements, primarily for employee compensation and benefits, information technology and facilities costs; and
• income taxes.

Our subsidiaries normally meet their operating requirements by:

• maintaining appropriate levels of cash, cash equivalents and short-term investments;
• using cash flows from operating activities;
• matching investment durations to those estimated for the related insurance and contractholder liabilities;
• selling investments; and
• borrowing from affiliates, subject to applicable regulatory limits.

Liquidity requirements at the parent company level generally consist of:

• debt service and dividend payments to shareholders;
• lending to subsidiaries as needed; and
• pension plan funding.

The parent company normally meets its liquidity requirements by:

• maintaining appropriate levels of cash and various types of marketable investments;
• collecting dividends from its subsidiaries;
• using proceeds from issuance of debt and common stock; and
• borrowing from its subsidiaries, subject to applicable regulatory limits.

Dividends from our insurance, Health Maintenance Organization (“HMO”) and foreign subsidiaries are subject to regulatory restrictions. Because most of Express Scripts’ subsidiaries are not subject to regulatory restrictions on paying dividends, Express Scripts’ operations provide significantly increased financial flexibility to Cigna.

Cash flows for the three months ended March 31 were as follows:

(In millions)

The following discussion explains variances in the various categories of cash flows for the three months ended March 31, 2019 compared with the same period in 2018.

Operating activities

Cash flows from operating activities consist principally of cash receipts and disbursements for pharmacy revenues and costs, premiums, fees, investment income, taxes, benefit costs and other expenses.

Cash flows from operating activities increased, primarily driven by higher net income adjusted for depreciation and amortization, the timing of pharmacy and services costs payables and reduction in inventories. These increases were partially offset by the absence of an early receipt of April payments from CMS in 2018 of approximately $730 million.

Investing and Financing activities

Cash flows from investing activities increased, primarily due to higher proceeds from investment sales coupled with lower investment purchases.

Cash used in financing activities increased, primarily due to a partial repayment of the term loan, net commercial paper activity and stock repurchase.

We maintain a share repurchase program authorized by our Board of Directors. Under this program, we may repurchase shares from time to time, depending on market conditions and alternate uses of capital. The timing and actual number of shares repurchased will depend on a variety of factors including price, general business and market conditions and alternate uses of capital. The share repurchase program may be effected through open market purchases or privately negotiated transactions in compliance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended, including through Rule 10b5-1 trading plans. The program may be suspended or discontinued at any time.

For the three months ended March 31, 2019, we repurchased 2.5 million shares for approximately $460 million. From April 1, 2019 through May 1, 2019 we repurchased 0.6 million shares for approximately $95 million. The remaining share repurchase authority as of May 1, 2019 was $390 million.

Capital Resources

Our capital resources (primarily cash flows from operating activities and proceeds from the issuance of debt and equity securities) provide protection for policyholders, furnish the financial strength to underwrite insurance risks and facilitate continued business growth.

Our acquisition of Express Scripts increased our debt and shareholders’ equity in 2018 as follows:

• Stock. Express Scripts’ shareholders received 0.2434 of a share of common stock of Cigna for every one share of Express Scripts’ common stock. Cigna issued 137.6 million additional shares to Express Scripts’ shareholders.
• Debt. See Note 6 to the Consolidated Financial Statements for further description of the debt issued to finance the acquisition.
• Assumption of Express Scripts’ Senior Notes. See Note 6 to the Consolidated Financial Statements for further description of the notes assumed in the acquisition of Express Scripts.

At March 31, 2019, our debt-to-capitalization ratio was 48.8%, a decline from 50.9% at December 31, 2018. We expect to deleverage to the upper 30s within 18 to 24 months of closing of the Express Scripts acquisition using cash flows from operating activities.

Cigna entered into a new Revolving Credit Agreement and Term Loan Credit Agreement in financing the Express Scripts acquisition. A select number of subsidiaries guarantee Cigna obligations under the Revolving Credit Agreement and the Term Loan Credit Agreement. See Note 6 to the Consolidated Financial Statements for further information on these guarantees, as well as information on our Revolving Credit Agreement and the Term Loan Credit Agreement. Cigna had $22 million of letters of credit outstanding under the Revolving Credit Agreement as of March 31, 2019.

Management, guided by regulatory requirements and rating agency capital guidelines, determines the amount of capital resources that we maintain. Management allocates resources to new long-term business commitments when returns, considering the risks, look promising and when the resources available to support existing business are adequate.

We prioritize our use of capital resources to:

• provide the capital necessary to support growth and maintain or improve the financial strength ratings of subsidiaries and to fund pension obligations;
• consider acquisitions that are strategically and economically advantageous; and
• return capital to investors primarily through share repurchases.

We continue to maintain a capital management strategy to retain overseas a significant portion of the earnings from our foreign operations. These undistributed earnings are deployed outside of the United States predominantly in support of the liquidity and regulatory capital requirements of our foreign operations as well as to support growth initiatives overseas. This strategy does not materially limit our ability to meet our liquidity and capital needs in the United States.

Liquidity and Capital Resources Outlook

At March 31, 2019, there was approximately $5.2 billion in cash and short-term investments, $2.4 billion of which was held by the parent company or subsidiaries with no regulatory or other restrictions on transferring cash to the parent via dividend or loan. In 2019, we expect to have $6.2 billion of capital available for deployment including $2.1 billion of dividends that our regulated insurance companies may pay without prior regulatory approval. The parent company’s cash obligations for the remainder of 2019 are expected to approximate $2.6 billion primarily for repayment of debt, interest and anticipated dividends and excluding commercial paper maturities that we expect to re-issue as needed to manage our parent company liquidity requirements.

We expect to have sufficient liquidity to meet the obligations discussed above, based on the cash currently available to the parent and current projections for subsidiary dividends and cash flows from the newly acquired Express Scripts operations. In addition, we actively monitor our debt obligations and engage in issuance or redemption activities as needed in accordance with our capital management strategy.

During the first quarter of 2019, our unfunded pension liability increased by approximately $140 million due to the settlement of the Amara litigation. Our required contributions for 2019 under the Pension Protection Act of 2006 remain unchanged and are still expected to be immaterial. See Note 13 to our Consolidated Financial Statements for additional information regarding our pension plans.

Our cash projections may not be realized and the demand for funds could exceed available cash if our ongoing businesses experience unexpected shortfalls in earnings or we experience material adverse effects from one or more risks or uncertainties described more fully in the Risk Factors section of our 2018 Form 10-K. In those cases, we expect to have the flexibility to satisfy liquidity needs through a variety of measures including intercompany borrowings. The parent company can borrow an additional $760 million from its insurance subsidiaries without additional state approval. We have additional liquidity available through short-term commercial paper borrowing capacity and the $3.25 billion revolving credit agreement discussed in Note 6 to the Consolidated Financial Statements.

Though we believe we have adequate sources of liquidity, significant disruption or volatility in the capital and credit markets could affect our ability to access those markets for additional borrowings or increase costs associated with borrowing funds.

Guarantees and Contractual Obligations

We are contingently liable for various contractual obligations entered into in the ordinary course of business. See Note 16 to the Consolidated Financial Statements for discussion of various guarantees.

We have updated the long-term debt and purchase obligations previously provided in our 2018 Form 10-K.

(In millions, on an undiscounted basis)

(1) Amounts reflect cash obligations for the remainder of 2019.

CRITICAL ACCOUNTING ESTIMATES

The preparation of Consolidated Financial Statements in accordance with GAAP requires management to make estimates and assumptions that affect reported amounts and related disclosures in the Consolidated Financial Statements. Management considers an accounting estimate to be critical if:

• it requires assumptions to be made that were uncertain at the time the estimate was made; and
• changes in the estimate or different estimates that could have been selected could have a material effect on our consolidated results of operations or financial condition.

Management has discussed how critical accounting estimates are developed and selected with the Audit Committee of our Board of Directors and the Audit Committee has reviewed the disclosures presented in our 2018 Form 10-K. We regularly evaluate items that may impact critical accounting estimates. Our most critical accounting estimates, as well as the effect of hypothetical changes in material assumptions used to develop each estimate, are described in the 2018 Form 10-K. As of March 31, 2019, there were no significant changes to the critical accounting estimates from what was reported in our 2018 Form 10-K.

SEGMENT REPORTING

The following section of this MD&A discusses the results of each of our segments. As a result of the Express Scripts acquisition, during the fourth quarter of 2018, we changed our segment reporting to reflect the new management and business reporting structure of the combined company. Prior year segment information presented in this Form 10-Q has been restated to conform to the new segment presentation. See Note 1 to our Consolidated Financial Statements for a description of our segments.

In segment discussions, we present adjusted revenues and “pre-tax adjusted income from operations,” defined as income before taxes excluding realized investment gains (losses), amortization of acquired intangible assets, results of transitioning clients and special items. Ratios presented in this segment discussion exclude the same items as adjusted income from operations. See Note 18 to our Consolidated Financial Statements for additional discussion of these metrics and a reconciliation of income before income taxes to pre-tax adjusted income from operations, as well as a reconciliation of total revenues to adjusted revenues. Note 18 to our Consolidated Financial Statements also explains two additional items that are important in understanding our segment results: 1) segment revenues include both external revenues and sales between segments that are eliminated in Corporate; and 2) beginning in the first quarter of 2019, compensation cost for stock options is recorded by the segments. Prior year segment information has not been restated for the change in stock option reporting.

In these segment discussions, we also present “pre-tax adjusted margin,” defined as adjusted income from operations before taxes divided by adjusted revenues.

See the MD&A Executive Overview beginning on page 46 for summarized financial results of each of our segments.

Health Services Segment

The Health Services segment includes the pharmacy benefit management, pharmacy home delivery and certain medical management services. This segment includes Express Scripts’ business from the December 20, 2018 date of acquisition with the exception of Express Scripts’ Medicare Part D business that is reported in the Government operating segment. This segment also includes Cigna’s legacy mail order pharmacy business. Due to the timing of the acquisition, first quarter 2018 results of operations and select financial information did not include results from the Express Scripts’ business. The main driver of period over period increases in the financial information presented below is the inclusion of results from the Express Scripts’ business in first quarter of 2019. As described in the introduction to Segment Reporting on page 54, performance of the Health Services segment is measured using pre-tax adjusted income from operations.

The key factors that impact Health Services revenues and costs of revenues are volume, mix and price. These key factors are discussed further below. See Note 2 to the Consolidated Financial Statements included in our 2018 Form 10-K for additional information on revenue and cost recognition policies for this segment.

• As our clients’ claim volumes increase or decrease, our resulting revenues and cost of revenues correspondingly increase or decrease. Our gross profit could also increase or decrease as a result of changes in purchasing discounts.
• The mix of claims generally considers the type of drug and distribution method used for dispensing and fulfilling. As our mix of drugs changes, our resulting pharmacy revenues and cost of revenues correspondingly may increase or decrease. The primary driver of fluctuations within our mix of claims is the generic fill rate. Generally, higher generic fill rates reduce revenues, as generic drugs are typically priced lower than the branded drugs they replace. However, as ingredient cost paid to pharmacies on generic drugs is incrementally lower than the price charged to our clients, higher generic fill rates generally have a favorable impact on our gross profit. The home delivery generic fill rate is currently lower than the network generic fill rate as fewer generic substitutions are available among maintenance medications (such as therapies for chronic conditions) commonly dispensed from home delivery pharmacies as compared to acute medications that are primarily dispensed by pharmacies in our retail networks.
• Our contract pricing is impacted by our ability to negotiate contracts for pharmacy network, pharmaceutical and wholesaler purchasing, and manufacturer rebates. We are able to reduce the rate of drug price increases and, in some cases, lower our clients’ prescription drug spend through our integrated set of solutions, including sharing significant amounts of pharmaceutical manufacturer rebates with our clients. We refer to this as “management of the supply chain.” Inflation also impacts our pricing because most of our contracts provide that we bill clients and pay pharmacies based on a generally recognized price index for pharmaceuticals. Therefore, the rate of inflation for prescription drugs and our efforts to manage this inflation for our clients can affect our revenues and cost of revenues.

In this MD&A, we present revenues, gross profit and pre-tax adjusted income from operations “excluding transitioning clients” in addition to those metrics including transitioning clients. See the “Key Transactions and Developments” section on page 49 of this MD&A for further discussion of transitioning clients and why we present this information.

Results of Operations

(In millions)

(Dollars and adjusted scripts in millions)

(1) Amounts exclude contributions from transitioning clients.

(2) Non-specialty network scripts filled through 90-day programs, and home delivery scripts are multiplied by three. All other network and specialty scripts are counted as one script.

Three Months Ended March 31, 2019 versus Three Months Ended March 31, 2018

This segment includes Express Scripts’ business from the date of acquisition with the exception of Express Scripts’ Medicare Part D business that is reported in the Government operating segment. The Company acquired Express Scripts on December 20, 2018. First quarter 2018 results of operations and select financial information reflect only Cigna’s legacy mail order pharmacy business.

The main driver of period over period increases in the financial information is the inclusion of results from the Express Scripts’ business in first quarter 2019. The Health Services segment reflects strong performance, including customer growth, adjusted pharmacy script volume and specialty pharmacy care.

Total pharmacy customers for the first quarter 2019 reflect strong new customer sales, retention and organic customer growth.

Integrated Medical Segment

The Integrated Medical segment includes the businesses previously reported in “Global Health Care” except as follows: 1) international health care products are now reported in the International Markets segment; 2) mail order pharmacy business is now reported in the Health Services segment; and 3) Medicare supplement business previously reported in “Global Supplemental Benefits” is now reported in Integrated Medical.

The business section of our 2018 Form 10-K (see the “Integrated Medical” section beginning on page 3) describes the various products and funding solutions offered by this segment, including the various revenue sources. As described in the introduction to Segment Reporting on page 54, performance of the Integrated Medical segment is measured using pre-tax adjusted income from operations. Key factors affecting profitability for this segment include:

• customer growth;
• revenues from integrated specialty products, including pharmacy services, sold to clients and customers across all funding solutions;
• percentage of Medicare Advantage customers in plans eligible for quality bonus payments;
• benefit expenses as a percentage of premiums (medical care ratio or “MCR”) for our insured commercial and government businesses; and
• selling, general and administrative expense as a percentage of adjusted revenues (expense ratio).

Results of Operations

(In millions)

Three Months Ended March 31, 2019 versus Three Months Ended March 31, 2018

Adjusted revenues increased, reflecting higher revenues in both our Commercial and Government operating segments. The increase in the Commercial segment reflected customer growth in our risk businesses as well as higher premium rates due to underlying medical cost trend. The increase in the Government segment reflected the addition of Express Scripts’ Medicare Part D business.

Pre-tax adjusted income from operations increased, reflecting strong ongoing performance in our Commercial segment including increased contributions from our commercial risk business and specialty products.

Medical care ratio. As expected, the medical care ratio increased for the three months ended March 31, 2019 compared with the same period in 2018, primarily reflecting the addition of Express Scripts’ Medicare Part D business with a seasonally higher loss ratio as well as the pricing impact of suspension of the health insurance industry tax in 2019.

Expense ratio. The expense ratio decreased for the three months ended March 31, 2019 compared to the same period in 2018, primarily reflecting higher risk revenues and suspension of the health insurance industry tax in 2019.

Other Items Affecting Integrated Medical Results

Unpaid Claims and Claim Expenses

Unpaid claims and claim expenses were higher as of March 31, 2019 compared with December 31, 2018, primarily due to seasonality in our stop loss products.

Medical Customers

Our medical customer base was higher at March 31, 2019 compared with the same period in 2018, primarily reflecting growth in our Select market segment.

A medical customer is defined as a person meeting any one of the following criteria:

• is covered under a medical insurance policy, managed care arrangement or service agreement issued by us;
• has access to our provider network for covered services under their medical plan; or
• has medical claims that are administered by us.

International Markets Segment

As described in the business section of our 2018 Form 10-K, the International Markets segment includes supplemental health, life and accident business previously reported in the “Global Supplemental Benefits” segment, except for Medicare Supplement business that is now reported in the Integrated Medical segment and certain international businesses in run-off that are now reported in Group Disability and Other. International Markets also includes health care products previously reported in the former “Global Health Care” segment.

As described in the introduction to Segment Reporting on page 54, performance of the International Markets segment is measured using pre-tax adjusted income from operations. Key factors affecting pre-tax adjusted income from operations for this segment are:

• premium growth, including new business and customer retention;
• benefit expenses as a percentage of premiums (loss ratio);
• selling, general and administrative expense and acquisition expense as a percentage of revenues (expense ratio and acquisition cost ratio); and
• the impact of foreign currency movements.

Results of Operations

(In millions)

58

Three Months Ended March 31, 2019 versus Three Months Ended March 31, 2018

Adjusted revenues increased mainly due to the acquisition of OnePath Life in New Zealand in the fourth quarter of 2018 and business growth in South Korea, the Middle East and China. These increases are partially offset by unfavorable foreign currency movements.

Pre-tax adjusted income from operations decreased primarily driven by higher operating expense and loss ratios and unfavorable foreign currency movements, partially offset by the acquisition of OnePath Life and business growth largely in China and South Korea.

The segment’s loss ratio was less favorable, largely resulting from higher benefit expense in Europe and South Korea.

The acquisition cost ratio was lower due to lower spending in certain markets and the acquisition of OnePath Life.

The increase in the expense ratio (excluding acquisition costs) was driven by strategic investments for long-term growth and integration of OnePath Life.

Other Items Affecting International Markets Results

South Korea is the single largest geographic market for our International Markets segment. South Korea generated 38% of the segment’s revenues and 58% of the segment’s first quarter 2019 pre-tax adjusted income from operations. For the three months ended March 31, 2019, our International Markets segment operations in South Korea represented 2% of our consolidated revenues and 6% of consolidated pre-tax adjusted income from operations.

Group Disability and Other

Group Disability and Other includes the results of the business previously reported in the “Group Disability and Life” segment and “Other Operations” comprising the corporate-owned life insurance (“COLI”) business along with run-off of the following businesses: 1) reinsurance; 2) settlement annuity; and 3) the sold individual life insurance and annuity and retirement benefits businesses. In addition, certain international run-off business previously reported in the “Global Supplemental Benefits” segment is now reported in Group Disability and Other.

As described in the introduction of Segment Reporting on page 54, performance of Group Disability and Other is measured using pre-tax adjusted income from operations. Key factors affecting pre-tax adjusted income from operations are:

• premium growth, including new business and customer retention;
• net investment income;
• benefit expenses as a percentage of premiums (loss ratio); and
• selling, general and administrative expense as a percentage of revenues excluding net investment income (expense ratio).

Results of Operations

(In millions)

59

Three Months Ended March 31, 2019 versus Three Months Ended March 31, 2018

Adjusted revenues increased, due to business growth in the group disability, life and voluntary businesses, partially offset by the continued run-off of international business.

Pre-tax adjusted income from operations and margin decreased, reflecting unfavorable disability claims experience, partially offset by favorable life claims experience.

Corporate

Corporate reflects amounts not allocated to operating segments, including net interest expense (defined as interest on corporate debt less net investment income on investments not supporting segment and other operations), certain litigation matters, expense associated with our frozen pension plans, charitable contributions, severance, certain overhead and project costs and intersegment eliminations for products and services sold between segments. As discussed in the introduction to Segment Reporting on page 54, beginning in the first quarter of 2019, compensation cost for stock options is now recorded by the segments. Prior year results for Corporate were not restated to reflect this change.

(In millions)

Three Months Ended March 31, 2019 versus Three Months Ended March 31, 2018

Pre-tax adjusted loss from operations was higher, reflecting interest expense on debt issued in the third quarter of 2018 to finance the Express Scripts acquisition and debt assumed from Express Scripts.

INVESTMENT ASSETS

The following table presents our investment asset portfolio excluding separate account assets as of March 31, 2019 and December 31, 2018. Additional information regarding our investment assets is included in Notes 9, 10, 11 and 12 to our Consolidated Financial Statements.

(In millions)

Debt Securities

Investments in debt securities include publicly traded and privately placed bonds, mortgage and other asset-backed securities and preferred stocks redeemable by the investor. These investments are classified as available for sale and are carried at fair value on our balance sheet. Additional information regarding valuation methodologies, key inputs and controls is included in Note 10 to our Consolidated Financial Statements. More detailed information about debt securities by type of issuer and maturity dates is included in Note 9 to our Consolidated Financial Statements.

The following table reflects our portfolio of debt securities by type of issuer as of March 31, 2019 and December 31, 2018.

(In millions)

60

Our debt securities portfolio increased during the first quarter of 2019 reflecting increased valuations due to decreases in market yields, partially offset by net sales and maturities. As of March 31, 2019, $20.7 billion, or 89% of the debt securities in our investment portfolio were investment grade (Baa and above, or equivalent) and the remaining $2.5 billion were below investment grade. The majority of the bonds that are below investment grade are rated at the higher end of the non-investment grade spectrum. These quality characteristics have not materially changed from the prior year and are consistent with our investment strategy. Investments in debt securities are diversified by issuer, geography and industry as appropriate.

Foreign government obligations are concentrated in Asia, primarily South Korea, consistent with our risk management practice and local regulatory requirements of our international business operations. Corporate debt securities include private placement assets of $7.0 billion. These investments are generally less marketable than publicly-traded bonds; however yields on these investments tend to be higher than yields on publicly-traded bonds with comparable credit risk. We perform a credit analysis of each issuer and require financial and other covenants that allow us to monitor issuers for deteriorating financial strength and pursue remedial actions, if warranted.

In addition to amounts classified in debt securities in our Consolidated Balance Sheets, we participate in an insurance joint venture in China with a 50% ownership interest. We account for this joint venture on the equity basis of accounting and report it in other assets. This entity had an investment portfolio of approximately $6.7 billion supporting its business that is primarily invested in Chinese corporate and government debt securities. There were no investments with a material unrealized loss as of March 31, 2019.

Commercial Mortgage Loans

Our commercial mortgage loans are fixed rate loans, diversified by property type, location and borrower. Loans are secured by high quality commercial properties and are generally made at less than 70% of the property’s value at origination of the loan. Property value, debt service coverage, quality, building tenancy and stability of cash flows are all important financial underwriting considerations. We hold no direct residential mortgage loans and do not originate or service securitized mortgage loans.

Commercial real estate capital markets remain very active for well-leased, quality commercial real estate located in strong institutional investment markets. The vast majority of properties securing the mortgages in our mortgage loan portfolio possess these characteristics.

As of March 31, 2019, the $1.9 billion commercial mortgage loan portfolio consisted of approximately 65 loans that are generally in good standing. Given the quality and diversity of the underlying real estate, positive debt service coverage and significant borrower cash investment generally ranging between 30 and 40%, we remain confident that borrowers will continue to perform as expected under their contract terms.

Other Long-term Investments

Other long-term investments of $2.0 billion included investments in securities limited partnerships and real estate limited partnerships as well as direct investments in real estate joint ventures. These entities typically invest in mezzanine debt or equity of privately held companies (securities partnerships) and equity real estate. Given our subordinate position in the capital structure of these underlying entities, we assume a higher level of risk for higher expected returns. To mitigate risk, these investments are diversified across approximately 140 separate partnerships and approximately 70 general partners who manage one or more of these partnerships. Also, the underlying investments are diversified by industry sector or property type and geographic region. No single partnership investment exceeded 4% of our securities and real estate partnership portfolio.

Problem and Potential Problem Investments

“Problem” bonds and commercial mortgage loans are either delinquent by 60 days or more or have been restructured as to terms, including concessions by us for modification of interest rate, principal payment or maturity date. “Potential problem” bonds and commercial mortgage loans are considered current (no payment is more than 59 days past due), but management believes they have certain characteristics that increase the likelihood that they may become problems.

The amounts of problem or potential problem investments as of March 31, 2019 and December 31, 2018 were not material.

Investment Outlook

Public equity markets rebounded in the first quarter of 2019, reflecting the continued strength of the U.S. economy. However, concerns related to trade and tariffs continue to contribute to financial market volatility. We continue to closely monitor global macroeconomic conditions and trends, including uncertainty caused by the United Kingdom’s process of exiting the European Union, and their potential impact on our investment portfolio. We expect continued volatility in certain sectors, such as retail, energy and natural gas. Future realized and unrealized investment results will be driven largely by market conditions that exist when a transaction occurs or at the reporting date. These future conditions are not reasonably predictable; however, we believe that the vast majority of our investments will continue to perform under their contractual terms. Based on our strategy to match the duration of invested assets to the duration of insurance and contractholder liabilities, we expect to hold a significant portion of these assets for the long term. Although future impairment losses resulting from interest rate movements and credit deterioration due to both investment-specific and the global economic uncertainties discussed above remain possible, we do not expect these losses to have a material adverse effect on our financial condition or liquidity.

MARKET RISK

Financial Instruments

Our assets and liabilities include certain financial instruments subject to the risk of potential losses from adverse changes in market rates and prices. Our primary market risk exposures are interest rate risk and foreign currency exchange rate risk. We encourage you to read this in conjunction with “Market Risk – Financial Instruments” included in the MD&A section of our 2018 Form 10-K. As of March 31, 2019, there were no material changes in our risk exposures from that reported in our 2018 Form 10-K.

Information responsive to this item is contained under the caption “Market Risk” in Item 2 above, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Based on an evaluation of the effectiveness of Cigna’s disclosure controls and procedures conducted under the supervision and with the participation of Cigna’s management, Cigna’s Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, Cigna’s disclosure controls and procedures are effective to ensure that information required to be disclosed by Cigna in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to Cigna’s management, including Cigna’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

On December 20, 2018, Cigna acquired Express Scripts (see Note 4 to the accompanying Consolidated Financial Statements for additional information). As of March 31, 2019, management is in the process of evaluating and integrating the internal controls of the acquired Express Scripts business into the Company’s existing operations. Other than the controls enhanced or implemented to integrate the Express Scripts business, there have been no changes in Cigna’s internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, Cigna’s internal controls over financial reporting.

Cigna’s Annual Report on Form 10-K for the year ended December 31, 2018 includes a detailed description of its risk factors.