Fair Value Measurements

6 Months Ended

Jun. 30, 2018

Note 9 ― Fair Value Measurements

The Company carries certain financial instruments at fair value in the financial statements including fixed maturities, certain 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 June 30, 2018 and December 31, 2017 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.

(In millions)	Quoted Prices in Active Markets for Identical Assets(Level 1)				Significant Other Observable Inputs(Level 2)				Significant Unobservable Inputs(Level 3)				Total
	As of June 30, 2018		As of December 31, 2017		As of June 30, 2018		As of December 31, 2017		As of June 30, 2018		As of December 31, 2017		As of June 30, 2018		As of December 31, 2017
Financial assets at fair value
Fixed maturities
Federal government and agency	$	271	$	253	$	509	$	526	$	-	$	-	$	780	$	779
State and local government		-		-		1,045		1,287		-		-		1,045		1,287
Foreign government		-		-		2,411		2,442		44		45		2,455		2,487
Corporate		-		-		18,478		17,658		307		430		18,785		18,088
Mortgage and other asset-backed		-		-		384		343		144		154		528		497
Total fixed maturities		271		253		22,827		22,256		495		629		23,593		23,138
Equity securities ⁽¹⁾		391		412		68		73		33		103		492		588
Subtotal		662		665		22,895		22,329		528		732		24,085		23,726
Short-term investments		-		-		220		199		-		-		220		199
GMIB assets		-		-		-		-		684		777		684		777
Other derivative assets		-		-		32		2		-		-		32		2
Total financial assets at fair value, excluding separate accounts and real estate funds	$	662	$	665	$	23,147	$	22,530	$	1,212	$	1,509	$	25,021	$	24,704
Real estate funds priced at NAV as a practical expedient ⁽²⁾														263		N/A
Financial liabilities at fair value
GMIB liabilities	$	-	$	-	$	-	$	-	$	653	$	762	$	653	$	762
Other derivative liabilities		-		-		54		25		-		-		54		25
Total financial liabilities at fair value, excluding separate accounts	$	-	$	-	$	54	$	25	$	653	$	762	$	707	$	787

(1) Beginning in 2018, certain private equity securities are no longer carried at fair value under the policy election of ASU 2016-01 (Recognition and Measurement of Financial Assets and Financial Liabilities). As of December 31, 2017, private equity securities of $70 million were included in the Level 3 amount. See Note 10 for additional information on this accounting policy change.
(2) Beginning in 2018 upon adopting ASU 2016-01, certain real estate funds are carried at fair value (previously carried at cost) based on the Company's ownership share of the equity of the investee (Net Asset Value ("NAV") as a practical expedient) including changes in the fair value of its underlying investments. The funds have a quarterly redemption frequency, 45-90 day redemption notice period and $65 million in unfunded commitments as of June 30, 2018. See Note 10 for additional information on this accounting policy change. Prior periods are designated as not applicable ("N/A") in this table.

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 95% of the Company’s investments in fixed maturities and equity securities are classified in Level 2 including most public and private corporate debt and hybrid 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 valuation 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 June 30, 2018 or December 31, 2017. The nature and use of these other derivatives are described in Note 11.

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 2% 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 June 30, 2018 and December 31, 2017. The range and weighted average basis point amounts (“bps”) for liquidity and credit 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.

	Fair Value as of				Unobservable Input	Unobservable AdjustmentRange (Weighted Average) as of
(Fair value in millions )	June 30, 2018		December 31, 2017		Unobservable Input	June 30, 2018	December 31, 2017
Fixed maturities
Mortgage and other asset-backed	$	144	$	154	Liquidity	60 - 350 (80) bps	60 - 370 (90) bps
securities					Weighting of credit spreads	190 - 300 (240) bps	180 - 290 (230) bps
Corporate and government fixed maturities		333		446	Liquidity	80 - 930 (240) bps	70 - 1,650 (300) bps
Total fixed maturities		477		600
Equity securities
Private equity securities ⁽¹⁾		N/A		70	Price-to-EBITDA multiples	N/A	5.0 - 12.0 (8.9)
Hybrid equity securities		33		33	Liquidity	230 bps⁽³⁾	270 bps⁽³⁾
Total equity securities		33		103
Subtotal		510		703
Securities not priced by the Company⁽²⁾		18		29
Total Level 3 securities	$	528	$	732

(1) Beginning in 2018, private equity securities are no longer carried at fair value under the policy election of ASU 2016-01 (Recognition and Measurement of Financial Assets and Financial Liabilities). Current periods are designated as N/A in this table.
(2) The fair values for these securities use single, unadjusted non-binding broker quotes not developed directly by the Company.
(3) The range and weighted average is equivalent for this security type.

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 8.

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 three months and six months ended June 30, 2018 and 2017. Separate account asset changes are reported separately 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 these tables 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
	2018		2017		2018		2017		2018		2017
Balance at April 1,	$	596	$	727	$	717	$	777	$	(682)	$	(761)
Gains (losses) included in shareholders' net income
GMIB fair value gain/(loss)		-		-		(27)		15		27		(15)
Other		(1)		1		1		-		(5)		(3)
Total gains (losses) included in shareholders' net income		(1)		1		(26)		15		22		(18)
Gains (losses) included in other comprehensive income		(5)		5		-		-		-		-
Gains (losses) required to adjust future policy benefits for settlement annuities⁽¹⁾		(2)		9		-		-		-		-
Purchases, sales, settlements
Purchases		6		65		-		-		-		-
Sales		-		(23)		-		-		-		-
Settlements		(13)		(12)		(7)		(15)		7		15
Total purchases, sales and settlements		(7)		30		(7)		(15)		7		15
Transfers into/(out of) Level 3
Transfers into Level 3		-		36		-		-		-		-
Transfers out of Level 3		(53)		(57)		-		-		-		-
Total transfers into/(out of) Level 3		(53)		(21)		-		-		-		-
Balance at June 30,	$	528	$	751	$	684	$	777	$	(653)	$	(764)
Total gains (losses) included in shareholders' net income attributable to instruments held at the reporting date	$	(1)	$	-	$	(26)	$	15	$	22	$	(18)

(In millions)	Fixed Maturities & Equity Securities				GMIB Assets				GMIB Liabilities
	2018		2017		2018		2017		2018		2017
Balance at January 1,	$	732	$	776	$	777	$	799	$	(762)	$	(780)
Gains (losses) included in shareholders' net income
GMIB fair value gain (loss)		-		-		(67)		4		69		(4)
Other		(21)		24		(2)		1		11		(7)
Total gains (losses) included in shareholders' net income		(21)		24		(69)		5		80		(11)
Losses included in other comprehensive income		(10)		(3)		-		-		-		-
Gains (losses) required to adjust future policy benefits for settlement annuities⁽¹⁾		(6)		9		-		-		-		-
Purchases, sales, settlements
Purchases		16		90		-		-		-		-
Sales		(11)		(70)		-		-		-		-
Settlements		(15)		(39)		(24)		(27)		29		27
Total purchases, sales and settlements		(10)		(19)		(24)		(27)		29		27
Transfers into/(out of) Level 3
Transfers into Level 3		20		76		-		-		-		-
Transfers out of Level 3 ⁽²⁾		(177)		(112)		-		-		-		-
Total transfers into/(out of) Level 3		(157)		(36)		-		-		-		-
Balance at June 30,	$	528	$	751	$	684	$	777	$	(653)	$	(764)
Total gains (losses) included in shareholders' net income attributable to instruments held at the reporting date	$	(8)	$	(6)	$	(69)	$	5	$	80	$	(11)

(1) Amounts do not accrue to shareholders.
(2) Beginning in 2018, certain private equity securities are no longer carried at fair value under the policy election of ASU 2016-01 (Recognition and Measurement of Financial Assets and Financial Liabilities). $70 million in private equity securities as of December 31, 2017 are included in the June 30, 2018 Transfers out of Level 3 amount.

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; 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 2018 and 2017, 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, electric, capital goods and consumer. As noted above, transfers out of Level 3 during 2018 also include $70 million of private equity securities that are no longer carried at fair value.

Separate Accounts

Fair values and changes in the fair values of separate account assets generally accrue directly to the policyholders and are excluded from the Company’s revenues and expenses. See Note 10 to the Consolidated Financial Statements contained in the Company’s 2017 Form 10-K for additional policy information related to separate accounts.

As of June 30, 2018 and December 31, 2017, 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
	June		December		June		December		June		December		June		December
	30,		31,		30,		31,		30,		31,		30,		31,
	2018		2017		2018		2017		2018		2017		2018		2017
Guaranteed separate accounts (see Note 16)	$	208	$	215	$	299	$	308	$	-	$	-	$	507	$	523
Non-guaranteed separate accounts ⁽¹⁾		1,392		1,536		5,356		5,298		256		292		7,004		7,126
Subtotal	$	1,600	$	1,751	$	5,655	$	5,606	$	256	$	292		7,511		7,649
Non-guaranteed separate accounts priced at NAV as a practical expedient⁽¹⁾														776		774
Total separate account assets													$	8,287	$	8,423

(1) Non-guaranteed separate accounts included $3.9 billion as of June 30, 2018 and December 31, 2017 in assets supporting the Company's pension plans, including $0.2 billion classified in Level 3 as of June 30, 2018 and $0.3 billion classified in Level 3 as of December 31, 2017.

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. The following tables summarize the changes in separate account assets reported in Level 3 for the periods ending June 30.

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(In millions)	2018		2017		2018		2017
Balance, beginning of period	$	262	$	330	$	292	$	331
Policyholder (losses) gains		(2)		10		43		37
Purchases, sales and settlements
Purchases		4		7		12		17
Sales		-		(17)		(72)		(52)
Settlements		(8)		-		(12)		(1)
Total purchases, sales and settlements		(4)		(10)		(72)		(36)
Transfers into (out of) Level 3
Transfers into Level 3		-		1		-		1
Transfers out of Level 3		-		(15)		(7)		(17)
Total transfers into (out of) Level 3		-		(14)		(7)		(16)
Balance, end of period	$	256	$	316	$	256	$	316

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 table below provides additional information on these investments.

	Fair Value as of				Unfunded Commitments as of June 30, 2018		Data as of June 30, 2018 and December 31, 2017
(In millions)	June 30, 2018		December 31, 2017		Unfunded Commitments as of June 30, 2018		Redemption Frequency (if currently eligible)	Redemption Notice Period
Securities Partnerships	$	485	$	458	$	302	Not applicable	Not applicable
Real Estate Funds		247		239		-	Quarterly	45-90 days
Hedge Funds		44		77		-	Up to Annually, varying by fund	30-90 days
Total	$	776	$	774	$	302

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 when they become impaired including real estate, partnership entities, commercial mortgage loans, and certain equity securities with no readily determinable fair value. There were no such impaired investments written down to fair value for the three and six months ended June 30, 2018. Impaired values for these asset types representing less than 1% of total investments, were written down to their fair values, resulting in immaterial realized losses for the three months and six months ended June 30, 2017.

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 June 30, 2018 and December 31, 2017. 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.

			June 30, 2018				December 31, 2017
(In millions)	Classification in the Fair Value Hierarchy		Fair Value		Carrying Value		Fair Value		Carrying Value
Commercial mortgage loans	Level 3	$	1,839	$	1,866	$	1,766	$	1,761
Long-term debt, including current maturities, excluding capital leases	Level 2	$	5,201	$	5,184	$	5,730	$	5,321

Fair values of off-balance sheet financial instruments were not material as of June 30, 2018 and December 31, 2017.

- 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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