Fair Value Measurements

12 Months Ended

Dec. 31, 2017

Note 10 – Fair Value Measurements

The Company carries certain financial instruments at fair value in the financial statements including fixed maturities, equity securities, short-term investments and derivatives. Other financial instruments are measured at fair value only under certain conditions, such as when impaired.

Fair value is defined as the price at which an asset could be exchanged in an orderly transaction between market participants at the balance sheet date. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a market participant, not the amount that would be paid to settle the liability with the creditor.

The Company’s financial assets and liabilities carried at fair value have been classified based upon a hierarchy defined by GAAP. The hierarchy gives the highest ranking to fair values determined using unadjusted quoted prices in active markets for identical assets and liabilities (Level 1) and the lowest ranking to fair values determined using methodologies and models with unobservable inputs (Level 3). An asset’s or a liability’s classification is based on the lowest level of input that is significant to its measurement. For example, a financial asset or liability carried at fair value would be classified in Level 3 if unobservable inputs were significant to the instrument’s fair value, even though the measurement may be derived using inputs that are both observable (Levels 1 and 2) and unobservable (Level 3).

The Company estimates fair values using prices from third parties or internal pricing methods. Fair value estimates received from third-party pricing services are based on reported trade activity and quoted market prices when available, and other market information that a market participant may use to estimate fair value. The internal pricing methods are performed by the Company’s investment professionals and generally involve using discounted cash flow analyses, incorporating current market inputs for similar financial instruments with comparable terms and credit quality, as well as other qualitative factors. In instances where there is little or no market activity for the same or similar instruments, fair value is estimated using methods, models and assumptions that the Company believes a hypothetical market participant would use to determine a current transaction price. These valuation techniques involve some level of estimation and judgment that becomes significant with increasingly complex instruments or pricing models.

The Company is responsible for determining fair value, as well as for assigning the appropriate level within the fair value hierarchy, based on the significance of unobservable inputs. The Company reviews methodologies, processes and controls of third-party pricing services and compares prices on a test basis to those obtained from other external pricing sources or internal estimates. The Company performs ongoing analyses of both prices received from third-party pricing services and those developed internally to determine that they represent appropriate estimates of fair value. The controls executed by the Company include evaluating changes in prices and monitoring for potentially stale valuations. The Company also performs sample testing of sales values to confirm the accuracy of prior fair value estimates. The minimal exceptions identified during these processes indicate that adjustments to prices are infrequent and do not significantly impact valuations. Annually, we conduct an on-site visit of the most significant pricing service to review their processes, methodologies and controls. This on-site review includes a walk-through of inputs for a sample of securities held across various asset types to validate the documented pricing process.

Financial Assets and Financial Liabilities Carried at Fair Value

The following table provides information as of December 31, 2017 and 2016 about the Company’s financial assets and liabilities carried at fair value. Separate account assets that are also recorded at fair value on the Company’s Consolidated Balance Sheets are reported separately in the Separate Accounts section as gains and losses related to these assets generally accrue directly to policyholders.

As of December 31,
(In millions)	Quoted Prices in Active Markets for Identical Assets(Level 1)				Significant Other Observable Inputs(Level 2)				Significant Unobservable Inputs(Level 3)				Total
	2017		2016		2017		2016		2017		2016		2017		2016
Financial assets at fair value
Fixed maturities
Federal government and agency	$	253	$	374	$	526	$	503	$	-	$	-	$	779	$	877
State and local government		-		-		1,287		1,435		-		-		1,287		1,435
Foreign government		-		-		2,442		2,066		45		47		2,487		2,113
Corporate		-		-		17,658		15,552		430		498		18,088		16,050
Mortgage and other asset-backed		-		-		343		329		154		157		497		486
Total fixed maturities		253		374		22,256		19,885		629		702		23,138		20,961
Equity securities		412		396		73		113		103		74		588		583
Subtotal		665		770		22,329		19,998		732		776		23,726		21,544
Short-term investments		-		-		199		691		-		-		199		691
GMIB assets		-		-		-		-		777		799		777		799
Other derivative assets		-		-		2		10		-		-		2		10
Total financial assets at fair value, excluding separate accounts	$	665	$	770	$	22,530	$	20,699	$	1,509	$	1,575	$	24,704	$	23,044
Financial liabilities at fair value
GMIB liabilities	$	-	$	-	$	-	$	-	$	762	$	780	$	762	$	780
Other derivative liabilities		-		-		25		5		-		-		25		5
Total financial liabilities at fair value, excluding separate accounts	$	-	$	-	$	25	$	5	$	762	$	780	$	787	$	785

Level 1 Financial Assets

Inputs for instruments classified in Level 1 include unadjusted quoted prices for identical assets in active markets accessible at the measurement date. Active markets provide pricing data for trades occurring at least weekly and include exchanges and dealer markets.

Assets in Level 1 include actively-traded U.S. government bonds and exchange-listed equity securities. Given the narrow definition of Level 1 and the Company's investment asset strategy to maximize investment returns, a relatively small portion of the Company’s investment assets are classified in this category.

Level 2 Financial Assets and Financial Liabilities

Inputs for instruments classified in Level 2 include quoted prices for similar assets or liabilities in active markets, quoted prices from those willing to trade in markets that are not active, or other inputs that are market observable or can be corroborated by market data for the term of the instrument. Such other inputs include market interest rates and volatilities, spreads and yield curves. An instrument is classified in Level 2 if the Company determines that unobservable inputs are insignificant.

Fixed maturities and equity securities. Approximately 94% of the Company’s investments in fixed maturities and equity securities are classified in Level 2 including most public and private corporate debt and equity securities, federal agency and municipal bonds, non-government mortgage-backed securities and preferred stocks. Because many fixed maturities do not trade daily, third-party pricing services and internal methods often use recent trades of securities with similar features and characteristics. When recent trades are not available, pricing models are used to determine these prices. These models calculate fair values by discounting future cash flows at estimated market interest rates. Such market rates are derived by calculating the appropriate spreads over comparable U.S. Treasury securities, based on the credit quality, industry and structure of the asset. Typical inputs and assumptions to pricing models include, but are not limited to, a combination of benchmark yields, reported trades, issuer spreads, liquidity, benchmark securities, bids, offers, reference data, and industry and economic events. For mortgage-backed securities, inputs and assumptions may also include characteristics of the issuer, collateral attributes, prepayment speeds and credit rating.

Nearly all of these instruments are valued using recent trades or pricing models. Less than 1% of the fair value of investments classified in Level 2 represents foreign bonds that are valued using a single unadjusted market-observable input derived by averaging multiple broker-dealer quotes, consistent with local market practice.

Short-term investments are carried at fair value which approximates cost. On a regular basis, the Company compares market prices for these securities to recorded amounts to validate that current carrying amounts approximate exit prices. The short-term nature of the investments and corroboration of the reported amounts over the holding period support their classification in Level 2.

Other derivatives classified in Level 2 represent over-the-counter instruments such as interest rate and foreign currency swap contracts. Fair values for these instruments are determined using market observable inputs including forward currency and interest rate curves and widely published market observable indices. Credit risk related to the counterparty and the Company is considered when estimating the fair values of these derivatives. However, the Company is largely protected by collateral arrangements with counterparties and determined that no adjustment for credit risk was required as of December 31, 2017 or 2016. Level 2 also includes exchange-traded interest rate swap contracts. Credit risk related to the clearinghouse counterparty and the Company is considered minimal when estimating the fair values of these derivatives because of upfront margin deposits and daily settlement requirements. The nature and use of these other derivatives are described in Note 12.

Level 3 Financial Assets and Financial Liabilities

Certain inputs for instruments classified in Level 3 are unobservable (supported by little or no market activity) and significant to their resulting fair value measurement. Unobservable inputs reflect the Company’s best estimate of what hypothetical market participants would use to determine a transaction price for the asset or liability at the reporting date.

The Company classifies certain newly issued, privately-placed, complex or illiquid securities, as well as assets and liabilities relating to GMIB, in Level 3. Approximately 3% of fixed maturities and equity securities are priced using significant unobservable inputs and classified in this category.

Fair values of mortgage and other asset-backed securities, corporate and government fixed maturities are primarily determined using pricing models that incorporate the specific characteristics of each asset and related assumptions including the investment type and structure, credit quality, industry and maturity date in comparison to current market indices, spreads and liquidity of assets with similar characteristics. For mortgage and other asset-backed securities, inputs and assumptions for pricing may also include collateral attributes and prepayment speeds. Recent trades in the subject security or similar securities are assessed when available, and the Company may also review published research in its evaluation, as well as the issuer’s financial statements.

Quantitative Information about Unobservable Inputs

The following table summarizes the fair value and significant unobservable inputs used in pricing the following securities that were developed directly by the Company as of December 31, 2017 and 2016. The range and weighted average basis point amounts (“bps”) for fixed maturity spreads (adjustment to discount rates) and price-to-earnings multiples for equity investments reflect the Company’s best estimates of the unobservable adjustments a market participant would make to calculate these fair values.

Mortgage and other asset-backed securities. The significant unobservable inputs used to value the following mortgage and other asset-backed securities are liquidity and weighting of credit spreads. When there is limited trading activity for the security, an adjustment for liquidity is made as of the measurement date that considers current market conditions, issuer circumstances and complexity of the security structure. An adjustment to weight credit spreads is needed to value a more complex bond structure with multiple underlying collateral and no standard market valuation technique. The weighting of credit spreads is primarily based on the underlying collateral’s characteristics and their proportional cash flows supporting the bond obligations.

Corporate and government fixed maturities. The significant unobservable input used to value the following corporate and government fixed maturities is an adjustment for liquidity. When there is limited trading activity for the security, an adjustment is needed to reflect current market conditions and issuer circumstances.

Private equity securities. The significant unobservable input used to value the following private equity securities is a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”). These securities are comprised of private equity investments with limited trading activity and therefore a ratio of EBITDA is used to estimate value based on company circumstances and relative risk characteristics.

Hybrid equity securities. The significant unobservable input used to value the following hybrid equity securities is an adjustment for liquidity due to limited trading activity. These cumulative preferred shares are deemed likely to exercise certain call options and the Company estimates an adjustment used to discount cash flows based on current market conditions and issuer circumstances.

As of December 31,
	Fair Value				Unobservable Input	Unobservable Adjustment Range (Weighted Average)
(Fair value in millions )	2017		2016		Unobservable Input	2017	2016

Fixed maturities
Mortgage and other asset-backed securities	$	154	$	157	Liquidity	60 - 370 (90) bps	60 - 330 (90) bps
					Weighting of credit spreads	180 - 290 (230) bps	160 - 470 (230) bps
Corporate and government fixed maturities		446		490	Liquidity	70 - 1,650 (300) bps	80 - 1,300 (340) bps
Total fixed maturities		600		647
Equity securities
Private equity securities		70		74	Price-to-EBITDA multiples	5.0 - 12.0 (8.9)	4.2 - 11.6 (8.5)
Hybrid equity securities		33		-	Liquidity	270 - 270 (270) bps
Total equity securities		103		74
Subtotal		703		721
Securities not priced by the Company⁽¹⁾		29		55
Total Level 3 securities	$	732	$	776
(1) The fair values for these securities use single, unadjusted non-binding broker quotes not developed directly by the Company.

Significant increases in liquidity or credit spreads would result in lower fair value measurements while decreases in these inputs would result in higher fair value measurements. Significant decreases in equity price-to-EBITDA multiples would result in lower fair value measurements while increases in these inputs would result in higher fair value measurements. Generally, the unobservable inputs are not interrelated and a change in the assumption used for one unobservable input is not accompanied by a change in the other unobservable input.

GMIB contracts. See discussion in Note 9.

Changes in Level 3 Financial Assets and Financial Liabilities Carried at Fair Value

The following table summarizes the changes in financial assets and financial liabilities classified in Level 3 for the years ended December 31, 2017 and 2016. Separate account asset changes are reported in the Separate Accounts section as the changes in fair values of these assets generally accrue directly to the policyholders. Gains and losses reported in this table may include net changes in fair value that are attributable to both observable and unobservable inputs.

(In millions)	Fixed Maturities & Equity Securities				GMIB Assets				GMIB Liabilities
	2017		2016		2017		2016		2017		2016
Balance at January 1,	$	776	$	726	$	799	$	907	$	(780)	$	(885)
Gains (losses) included in shareholders' net income
GMIB fair value gain/(loss)		-		-		31		(47)		(31)		47
Other		25		(18)		1		-		(5)		(3)
Total gains (losses) included in shareholders' net income		25		(18)		32		(47)		(36)		44
Losses included in other comprehensive income		(11)		(1)		-		-		-		-
Gains required to adjust future policy benefits for settlement annuities⁽¹⁾		7		29		-		-		-		-
Purchases, sales, settlements
Purchases		133		96		-		-		-		-
Sales		(95)		(140)		-		-		-		-
Settlements		(74)		(74)		(54)		(61)		54		61
Total purchases, sales and settlements		(36)		(118)		(54)		(61)		54		61
Transfers into/(out of) Level 3
Transfers into Level 3		275		338		-		-		-		-
Transfers out of Level 3		(304)		(180)		-		-		-		-
Total transfers into/(out of) Level 3		(29)		158		-		-		-		-
Balance at December 31,	$	732	$	776	$	777	$	799	$	(762)	$	(780)
Total gains (losses) included in shareholders' net income attributable to instruments held at the reporting date	$	(9)	$	(18)	$	32	$	(47)	$	(36)	$	44

(1) Amounts do not accrue to shareholders.

As noted in the preceding tables, total gains and losses included in shareholders’ net income are reflected in the following captions in the Consolidated Statements of Income:

Realized investment gains (losses) and net investment income for amounts related to fixed maturities and equity securities and realized investment gains (losses) for the impact of changes in non-performance risk related to GMIB assets and liabilities, similar to hedge ineffectiveness; and
Other operating expenses for amounts related to GMIB assets and liabilities (GMIB fair value gain/loss), except for the impact of changes in non-performance risk.

In the tables above, gains and losses included in other comprehensive income are reflected in net unrealized appreciation (depreciation) on securities in the Consolidated Statements of Comprehensive Income.

Reclassifications impacting Level 3 financial instruments are reported as transfers into or out of the Level 3 category as of the beginning of the quarter in which the transfer occurs. Therefore gains and losses in income only reflect activity for the period the instrument was classified in Level 3.

Transfers into or out of the Level 3 category occur when unobservable inputs, such as the Company’s best estimate of what a market participant would use to determine a current transaction price, become more or less significant to the fair value measurement. During 2017 and 2016, transfers between Level 2 and Level 3 primarily reflected changes in liquidity and credit risk estimates for certain private placement issuers across several sectors including metals, mining, energy, utilities, capital goods, consumer products and transportation services.

Separate Accounts

Accounting policy. Separate account assets and liabilities are contractholder funds maintained in accounts with specific investment objectives. The assets of these accounts are legally segregated and are not subject to claims that arise out of any of the Company’s other businesses. These separate account assets are carried at fair value with equal amounts recorded for related separate account liabilities. The investment income and fair value gains and losses of these accounts generally accrue directly to the contractholders and, together with their deposits and withdrawals, are excluded from the Company’s Consolidated Statements of Income and Cash Flows. Fees and charges earned for mortality risks, asset management or administrative services are reported in either premiums or fees and other revenues. Investments that are measured using the practical expedient of Net Asset Value (“NAV”) are excluded from the fair value hierarchy.

At December 31, fair values of separate account assets were as follows:

(In millions)	Quoted Prices in Active Markets for Identical Assets(Level 1)				Significant Other Observable Inputs(Level 2)				Significant Unobservable Inputs(Level 3)				Total
	2017		2016		2017		2016		2017		2016		2017		2016
Guaranteed separate accounts (See Note 21)	$	215	$	238	$	308	$	262	$	-	$	-	$	523	$	500
Non-guaranteed separate accounts ⁽¹⁾		1,536		1,368		5,298		4,885		292		331		7,126		6,584
Subtotal	$	1,751	$	1,606	$	5,606	$	5,147	$	292	$	331		7,649		7,084
Non-guaranteed separate accounts priced at NAV as a practical expedient⁽¹⁾														774		856
Total separate account assets													$	8,423	$	7,940

(1) Non-guaranteed separate accounts included $3.9 billion as of December 31, 2017 and $3.7 billion as of December 31, 2016 in assets supporting the Company's pension plans, including $0.3 billion classified in Level 3 for both periods and $0.8 billion as of December 31, 2017 and $0.9 billion as of December 31, 2016 priced at NAV as a practical expedient for each year.

Separate account assets in Level 1 primarily include exchange-listed equity securities. Level 2 assets primarily include:

corporate and structured bonds valued using recent trades of similar securities or pricing models that discount future cash flows at estimated market interest rates as described above; and
actively-traded institutional and retail mutual fund investments.

Separate account assets classified in Level 3 primarily support Cigna’s pension plans, and include certain newly issued, privately-placed, complex, or illiquid securities that are priced using methods discussed above, as well as commercial mortgage loans that are valued according to the methodologies discussed below. The following tables summarize the changes in separate account assets reported in Level 3 for the years ended December 31, 2017 and 2016.

(In millions)		2017		2016
Balance at January 1	$	331	$	297
Policyholder gains (losses)		34		2
Purchases, issuances, settlements
Purchases		33		22
Sales		(53)		(11)
Settlements		(13)		(18)
Total purchases, sales and settlements		(33)		(7)
Transfers into/(out of) Level 3
Transfers into Level 3		7		65
Transfers out of Level 3		(47)		(26)
Total transfers into/(out of) Level 3:		(40)		39
Balance at December 31	$	292	$	331

Separate account investments in securities partnerships, real estate, and hedge funds are generally valued based on the separate account’s ownership share of the equity of the investee (NAV as a practical expedient), including changes in the fair values of its underlying investments. Substantially all of these assets support the Cigna Pension Plans. The following table provides additional information on these investments.

						Unfunded	Data as of December 31, 2017 and 2016
						Commitments	Redemption Frequency
	Fair Value as of					as of	(if currently	Redemption Notice
(In millions)	December 31, 2017		December 31, 2016		December 31, 2017		eligible)	Period
Securities partnerships	$	458	$	424	$	365	Not applicable	Not applicable
Real estate funds		239		231		-	Quarterly	45-90 days
Hedge funds		77		201		-	Up to annually, varying by fund	30-90 days
Total	$	774	$	856	$	365

Assets and Liabilities Measured at Fair Value under Certain Conditions

Some financial assets and liabilities are not carried at fair value each reporting period, but may be measured using fair value only under certain conditions, such as investments in real estate, partnership entities and commercial mortgage loans when they become impaired. Impaired values for these asset types classified as Level 3 representing less than 1% of total investments, were written down to their fair values, resulting in immaterial realized investment losses in 2017 and 2016.

Fair Value Disclosures for Financial Instruments Not Carried at Fair Value

The following table includes the Company’s financial instruments not recorded at fair value that are subject to fair value disclosure requirements at December 31, 2017 and 2016. In addition to universal life products and capital leases, financial instruments that are carried in the Company’s Consolidated Financial Statements at amounts that approximate fair value are excluded from the following table.

(In millions)			December 31, 2017				December 31, 2016
	Classification in Fair Value Hierarchy		Fair Value		Carrying Value		Fair Value		Carrying Value
Commercial mortgage loans	Level 3	$	1,766	$	1,761	$	1,682	$	1,666
Contractholder deposit funds, excluding universal life products	Level 3	$	1,121	$	1,119	$	1,215	$	1,212
Long-term debt, including current maturities, excluding capital leases	Level 2	$	5,730	$	5,321	$	5,460	$	4,991

The fair values for all financial instruments presented in the table above have been estimated using market information when available. The following valuation methodologies and inputs are used by the Company to determine fair value.

Commercial mortgage loans. The Company estimates the fair value of commercial mortgage loans generally by discounting the contractual cash flows at estimated market interest rates that reflect the Company’s assessment of the credit quality of the loans. Market interest rates are derived by calculating the appropriate spread over comparable U.S. Treasury rates based on the property type, quality rating and average life of the loan. The quality ratings reflect the relative risk of the loan considering debt service coverage, the loan-to-value ratio and other factors. Fair values of impaired mortgage loans are based on the estimated fair value of the underlying collateral generally determined using an internal discounted cash flow model. The fair value measurements were classified in Level 3 because the cash flow models incorporate significant unobservable inputs.

Contractholder deposit funds, excluding universal life products. Generally, these funds do not have stated maturities. Approximately 70% of these balances can be withdrawn by the customer at any time without prior notice or penalty. The fair value for these contracts is the amount estimated to be payable to the customer as of the reporting date, which is generally the carrying value. Most of the remaining contractholder deposit funds are reinsured by the buyers of the individual life and annuity and retirement benefits businesses. The fair value for these contracts is determined using the fair value of these buyers’ assets supporting these reinsured contracts. The Company had reinsurance recoverables equal to the carrying value of these reinsured contracts. These instruments were classified in Level 3 because certain inputs are unobservable (supported by little or no market activity) and significant to their resulting fair value measurement.

Long-term debt, including current maturities, excluding capital leases. The fair value of long-term debt is based on quoted market prices for recent trades. When quoted market prices are not available, fair value is estimated using a discounted cash flow analysis and the Company’s estimated current borrowing rate for debt of similar terms and remaining maturities. These measurements were classified in Level 2 because the fair values are based on quoted market prices or other inputs that are market observable or can be corroborated by market data.

Fair values of off-balance sheet financial instruments were not material as of December 31, 2017 and 2016.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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