Investments

6 Months Ended

Jun. 30, 2017

Note 10 — Investments

Cigna's investment portfolio consists of a broad range of investments including fixed maturities and equity securities, commercial mortgage loans, other long-term investments and short-term investments. The sections below provide more detail regarding our investment balances, net investment income and realized investment gains and losses. See Note 9 for information about the valuation of the Company’s investment portfolio. See Note 11 to the Consolidated Financial Statements contained in the Company’s 2016 Form 10-K for accounting policies for each investment type.

Investment Portfolio

Fixed Maturities and Equity Securities

The amortized cost and fair value by contractual maturity periods for fixed maturities were as follows at June 30, 2017:

		Amortized		Fair
(In millions)		Cost		Value
Due in one year or less	$	1,393	$	1,407
Due after one year through five years		6,822		7,079
Due after five years through ten years		8,905		9,176
Due after ten years		3,649		4,368
Mortgage and other asset-backed securities		453		483
Total fixed maturities	$	21,222	$	22,513

Actual maturities of these securities could differ from their contractual maturities used in the table above. This could occur because issuers may have the right to call or prepay obligations, with or without penalties.

Gross unrealized appreciation (depreciation) on fixed maturities by type of issuer is shown below.

				Gross		Gross
				Unrealized		Unrealized
		Amortized		Appre-		Depre-		Fair
		Cost		ciation		ciation		Value
(In millions)	June 30, 2017
Federal government and agency	$	663	$	240	$	(3)	$	900
State and local government		1,277		106		(2)		1,381
Foreign government		2,202		125		(14)		2,313
Corporate		16,627		877		(68)		17,436
Mortgage and other asset-backed		453		32		(2)		483
Total fixed maturities	$	21,222	$	1,380	$	(89)	$	22,513

(In millions)	December 31, 2016
Federal government and agency	$	658	$	223	$	(4)	$	877
State and local government		1,342		99		(6)		1,435
Foreign government		1,998		129		(14)		2,113
Corporate		15,483		716		(149)		16,050
Mortgage and other asset-backed		461		29		(4)		486
Total fixed maturities	$	19,942	$	1,196	$	(177)	$	20,961

The above table includes investments with a fair value of $2.8 billion at June 30, 2017 and $2.7 billion at December 31, 2016 supporting liabilities of the Company’s run-off settlement annuity business. These investments had gross unrealized appreciation of $630 million and gross unrealized depreciation of $3 million at June 30, 2017, compared with gross unrealized appreciation of $539 million and gross unrealized depreciation of $15 million at December 31, 2016.

Review of declines in fair value. Management reviews fixed maturities with a decline in fair value from cost for impairment based on criteria that include:

length of time and severity of decline;

financial health and specific near term prospects of the issuer;
changes in the regulatory, economic or general market environment of the issuer’s industry or geographic region; and
the Company’s intent to sell or the likelihood of a required sale prior to expected recovery.

The table below summarizes fixed maturities in an unrealized loss position at June 30, 2017 by the length of time these securities have been in an unrealized loss position. These fixed maturities were primarily corporate securities with a decline in fair value that reflects an increase in market yields since purchase.

	June 30, 2017
	Fair		Amortized		Unrealized		Number
(Dollars in millions)	Value		Cost		Depreciation		of Issues
One year or less:
Investment grade	$	3,449	$	3,515	$	(66)	791
Below investment grade	$	399	$	408	$	(9)	401
More than one year:
Investment grade	$	220	$	229	$	(9)	40
Below investment grade	$	71	$	76	$	(5)	14

There are no available for sale equity securities with a significant unrealized loss reflected in accumulated other comprehensive income at June 30, 2017.

Equity securities include hybrid investments consisting of preferred stock with call features that are carried at fair value with changes in fair value reported in other realized investment gains (losses) and dividends reported in net investment income. As of June 30, 2017, fair values of these securities were $61 million and amortized cost was $75 million, compared with fair value of $36 million and amortized cost of $49 million as of December 31, 2016.

Commercial Mortgage Loans

Mortgage loans held by the Company are made exclusively to commercial borrowers and are diversified by property type, location and borrower. Loans are generally issued at a fixed rate of interest and are secured by high quality and substantially leased operating properties.

Credit quality. The Company regularly evaluates and monitors credit risk, beginning with the initial underwriting of a mortgage loan and continuing throughout the investment holding period. Mortgage origination professionals employ an internal credit quality rating system designed to evaluate the relative risk of the transaction at origination that is then updated each year as part of the annual portfolio loan review. The Company evaluates and monitors credit quality on an ongoing basis, classifying each loan as a loan in good standing, potential problem loan or problem loan.

The quality rating is based on our evaluation of a number of key inputs related to the loan including real estate market-related factors such as rental rates and vacancies, and property-specific inputs such as growth rate assumptions and lease rollover statistics. However, the two most significant contributors to the credit quality rating are the debt service coverage and loan-to-value ratios. The debt service coverage ratio measures the amount of property cash flow available to meet annual interest and principal payments on the debt, with a ratio below 1.0 indicating that there is not enough cash flow to cover the required loan payments. The loan-to-value ratio, commonly expressed as a percentage, compares the amount of the loan to the fair value of the underlying property collateralizing the loan.

The following tables summarize the credit risk profile of the Company’s commercial mortgage loan portfolio based on loan-to-value and debt service coverage ratios, as of June 30, 2017 and December 31, 2016:

(In millions)
		Debt Service Coverage Ratio
		1.30x or		1.20x to		1.10x to		1.00x to		Less than
Loan-to-Value Ratios		Greater		1.29x		1.19x		1.09x		1.00x		Total
As of June 30, 2017
Below 50%	$	354	$	15	$	-	$	-	$	30	$	399
50% to 59%		635		27		-		-		15		677
60% to 69%		541		-		-		-		-		541
70% to 79%		84		-		-		-		35		119
80% to 89%		-		-		-		-		-		-
90% to 100%		-		-		-		-		5		5
Total	$	1,614	$	42	$	-	$	-	$	85	$	1,741

As of December 31, 2016
Below 50%	$	335	$	15	$	-	$	-	$	-	$	350
50% to 59%		517		46		-		30		-		593
60% to 69%		624		14		-		-		-		638
70% to 79%		-		-		29		-		35		64
80% to 89%		-		-		-		-		-		-
90% to 100%		-		-		-		-		21		21
Total	$	1,476	$	75	$	29	$	30	$	56	$	1,666

The Company’s annual in-depth review of its commercial mortgage loan investments is the primary mechanism for identifying emerging risks in the portfolio. The most recent review was completed by the Company’s investment professionals in the second quarter of 2017 and included an analysis of each underlying property’s December 31, 2016 annual financial statements, rent rolls, operating plans and budgets for 2017, a physical inspection of the property and other pertinent factors. Based on historical results, current leases, lease expirations and rental conditions in each market, the Company estimates the current year and future stabilized property income and fair value and categorizes the investments as loans in good standing, potential problem loans or problem loans. Based on property values and cash flows estimated as part of this review, the portfolio’s average loan-to-value ratio remained at 57% at June 30, 2017 compared with December 31, 2016, primarily due to stable collateral values in the majority of underlying properties. The portfolio’s average debt service coverage ratio improved to 2.10 at June 30, 2017 compared with 1.95 at December 31, 2016, driven by loans paid off with lower debt service coverage ratios and new loans with higher debt service coverage ratios.

The Company will reevaluate a loan’s credit quality between annual reviews if new property information is received or an event such as delinquency or a borrower’s request for restructure causes management to believe that the Company’s estimate of financial performance, fair value or the risk profile of the underlying property has been impacted.

Potential problem mortgage loans are considered current (no payment is more than 59 days past due), but they exhibit certain characteristics that increase the likelihood of future default. The characteristics management considers include, but are not limited to, the deterioration of debt service coverage below 1.0, estimated loan-to-value ratios increasing to 100% or more, downgrade in quality rating and requests from the borrower for restructuring. In addition, loans are considered potential problems if principal or interest payments are past due by more than 30 but less than 60 days. Problem mortgage loans are either in default by 60 days or more or have been restructured as to terms that could include concessions on interest rate, principal payment or maturity date. The Company monitors each problem and potential problem mortgage loan on an ongoing basis, and updates the loan categorization and quality rating when warranted.

Problem and potential problem mortgage loans, net of valuation reserves, totaled $5 million at June 30, 2017 and $21 million at December 31, 2016.

Impaired commercial mortgage loans. A commercial mortgage loan is considered impaired when it is probable that the Company will not collect all amounts due according to the terms of the original loan agreement. These loans are included in either problem or potential problem loans. The Company monitors credit risk and assesses the impairment of loans individually and on a consistent basis for all loans in the portfolio. Impaired loans are carried at the lower of unpaid principal balance or the fair value of the underlying real estate. Certain commercial mortgage loans without valuation reserves are considered impaired because the Company will not collect all interest due according to the terms of the original agreements; however, the Company expects to recover the unpaid principal because it is less than the fair value of the underlying real estate. The Company recognizes interest income on impaired mortgage loans only when payment is actually received.

The carrying value of the Company’s impaired commercial mortgage loans and related valuation reserves were as follows:

		June 30, 2017					December 31, 2016
(In millions)		Gross		Reserves		Net		Gross		Reserves		Net
Impaired commercial mortgage loans with valuation reserves	$	6	$	(1)	$	5	$	26	$	(5)	$	21
Impaired commercial mortgage loans without valuation reserves		-		-		-		-		-		-
Total impaired commercial mortgage loans	$	6	$	(1)	$	5	$	26	$	(5)	$	21

For the six months ended June 30, 2017, the average recorded investment in impaired loans decreased to $14 million in 2017 compared with $102 million for the six months ended June 30, 2016, primarily due to the foreclosure of one impaired loan and the full payoff of another.

Changes in valuation reserves for commercial mortgage loans were not material for the six months ended June 30, 2017 and 2016.

Short-Term Investments and Cash Equivalents

Short-term investments and cash equivalents included the following types of issuers:.

		June 30,		December 31,
(In millions)		2017		2016
Corporate securities	$	1,700	$	2,234
Federal government securities	$	673	$	378
Foreign government securities	$	109	$	94
Money market funds	$	20	$	11

Realized Investment Gains and Losses

The following realized gains and (losses) on investments exclude amounts required to adjust future policy benefits for the run-off settlement annuity business.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(In millions)	2017		2016		2017		2016
Fixed maturities	$	14	$	6	$	16	$	(12)
Equity securities		1		11		34		1
Commercial mortgage loans		(1)		4		(1)		4
Other investments, including derivatives		37		46		48		42
Realized investment gains before income taxes		51		67		97		35
Less income taxes		17		23		32		12
Net realized investment gains	$	34	$	44	$	65	$	23

Included in these realized investment gains were pre-tax other-than-temporary impairments on debt securities and other asset write-downs of $13 million for the six months ended June 30, 2017 and $43 million for the six months ended June 30, 2016.

Realized gains reported in the above table in other investments, including derivatives for the three months and six months ended June 30, 2017 and 2016 primarily reflected sales of real estate investments.

The following table presents sales information for available-for-sale fixed maturities and equity securities. Gross gains on sales and gross losses on sales exclude amounts required to adjust future policy benefits for the run-off settlement annuity business.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(In millions)	2017		2016		2017		2016
Proceeds from sales	$	516	$	351	$	930	$	712
Gross gains on sales	$	12	$	22	$	59	$	34
Gross losses on sales	$	2	$	1	$	4	$	6

- Definition

The entire disclosure for investments in certain debt and equity securities.

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