XNYS:UNH UnitedHealth Group Inc Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

XNYS:UNH Fair Value Estimate
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XNYS:UNH Consider Buying
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XNYS:UNH Consider Selling
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________________________ 
Form 10-Q
__________________________________________________________ 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2012
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _______
Commission file number: 1-10864
__________________________________________________________ 
    
UnitedHealth Group Incorporated
(Exact name of registrant as specified in its charter)
 __________________________________________________________ 
Minnesota
 
41-1321939
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
UnitedHealth Group Center
9900 Bren Road East
Minnetonka, Minnesota
 
55343
(Address of principal executive offices)
 
(Zip Code)
(952) 936-1300
(Registrant’s telephone number, including area code)
__________________________________________________________  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
 
Accelerated filer
o
 
Non-accelerated filer
o
 
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o No x
As of July 31, 2012, there were 1,032,705,691 shares of the registrant’s Common Stock, $.01 par value per share, issued and outstanding.
 
 
 
 
 



UNITEDHEALTH GROUP
Table of Contents
 
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.




PART I. FINANCIAL INFORMATION 

ITEM 1.    FINANCIAL STATEMENTS
UnitedHealth Group
Condensed Consolidated Balance Sheets
(Unaudited)
(in millions, except per share data)
 
June 30,
2012
 
December 31,
2011
Assets
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
11,578

 
$
9,429

Short-term investments
 
2,852

 
2,577

Accounts receivable, net
 
2,648

 
2,294

Other current receivables, net
 
1,887

 
2,255

Assets under management
 
2,628

 
2,708

Deferred income taxes
 
461

 
472

Prepaid expenses and other current assets
 
673

 
615

Total current assets
 
22,727

 
20,350

Long-term investments
 
16,698

 
16,166

Property, equipment and capitalized software, net
 
2,589

 
2,515

Goodwill
 
26,191

 
23,975

Other intangible assets, net
 
3,141

 
2,795

Other assets
 
2,119

 
2,088

Total assets
 
$
73,465

 
$
67,889

Liabilities and shareholders’ equity
 
 
 
 
Current liabilities:
 
 
 
 
Medical costs payable
 
$
10,491

 
$
9,799

Accounts payable and accrued liabilities
 
6,460

 
6,853

Other policy liabilities
 
5,358

 
5,063

Current maturities of long-term debt
 
1,461

 
982

Unearned revenues
 
3,853

 
1,225

Total current liabilities
 
27,623

 
23,922

Long-term debt, less current maturities
 
11,156

 
10,656

Future policy benefits
 
2,441

 
2,445

Deferred income taxes and other liabilities
 
2,870

 
2,574

Total liabilities
 
44,090

 
39,597

Commitments and contingencies (Note 9)
 
 
 


Shareholders’ equity:
 
 
 
 
Preferred stock, $0.001 par value - 10 shares authorized; no shares issued or outstanding
 

 

Common stock, $0.01 par value - 3,000 shares authorized;
1,024 and 1,039 issued and outstanding
 
10

 
10

Retained earnings
 
28,896

 
27,821

Accumulated other comprehensive income
 
469

 
461

Total shareholders’ equity
 
29,375

 
28,292

Total liabilities and shareholders’ equity
 
$
73,465

 
$
67,889


See Notes to the Condensed Consolidated Financial Statements

1


UnitedHealth Group
Condensed Consolidated Statements of Operations
(Unaudited)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions, except per share data)
 
2012
 
2011
 
2012
 
2011
Revenues:
 
 
 
 
 
 
 
 
Premiums
 
$
24,609

 
$
22,813

 
$
49,240

 
$
45,816

Services
 
1,800

 
1,656

 
3,591

 
3,254

Products
 
678

 
605

 
1,366

 
1,254

Investment and other income
 
178

 
160

 
350

 
342

Total revenues
 
27,265

 
25,234

 
54,547

 
50,666

Operating costs:
 
 
 
 
 
 
 
 
Medical costs
 
20,013

 
18,578

 
39,952

 
37,303

Operating costs
 
4,080

 
3,733

 
8,176

 
7,350

Cost of products sold
 
620

 
554

 
1,254

 
1,153

Depreciation and amortization
 
326

 
270

 
622

 
540

Total operating costs
 
25,039

 
23,135

 
50,004

 
46,346

Earnings from operations
 
2,226

 
2,099

 
4,543

 
4,320

Interest expense
 
(153
)
 
(119
)
 
(301
)
 
(237
)
Earnings before income taxes
 
2,073

 
1,980

 
4,242

 
4,083

Provision for income taxes
 
(736
)
 
(713
)
 
(1,517
)
 
(1,470
)
Net earnings
 
$
1,337

 
$
1,267

 
$
2,725

 
$
2,613

Basic net earnings per common share
 
$
1.30

 
$
1.18

 
$
2.64

 
$
2.42

Diluted net earnings per common share
 
$
1.27

 
$
1.16

 
$
2.59

 
$
2.38

Basic weighted-average number of common shares outstanding
 
1,028

 
1,075

 
1,034

 
1,079

Dilutive effect of common stock equivalents
 
21

 
19

 
20

 
17

Diluted weighted-average number of common shares outstanding
 
1,049

 
1,094

 
1,054

 
1,096

Anti-dilutive shares excluded from the calculation of dilutive effect of common stock equivalents
 
10

 
44

 
17

 
52

Cash dividends declared per common share
 
$
0.2125

 
$
0.1625

 
$
0.3750

 
$
0.2875


See Notes to the Condensed Consolidated Financial Statements

2



UnitedHealth Group
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions)
 
2012
 
2011
 
2012
 
2011
 
 
 
 
 
 
 
 
 
Net earnings
 
$
1,337

 
$
1,267

 
$
2,725

 
$
2,613

Other comprehensive income:
 
 
 
 
 
 
 
 
Gross unrealized holding gains on investment securities during the period
 
81

 
198

 
111

 
161

Income tax expense
 
(35
)
 
(73
)
 
(46
)
 
(59
)
Total unrealized gains, net of tax
 
46

 
125

 
65

 
102

Gross reclassification adjustment for net realized gains included in net earnings
 
(50
)
 
(21
)
 
(89
)
 
(69
)
Income tax effect
 
19

 
8

 
33

 
25

Total reclassification adjustment, net of tax
 
(31
)
 
(13
)
 
(56
)
 
(44
)
Foreign currency translation adjustments
 
(4
)
 
13

 
(1
)
 
22

Other comprehensive income
 
11

 
125

 
8

 
80

Comprehensive income
 
$
1,348

 
$
1,392

 
$
2,733

 
$
2,693


See Notes to the Condensed Consolidated Financial Statements

3


UnitedHealth Group
Condensed Consolidated Statements of Changes in Shareholders’ Equity
(Unaudited)
 
 
 
 
 
 
 
 
 
 
Accumulated Other Comprehensive Income (Loss)
 
 
 
 
 
 
 
 
Additional Paid-In Capital
 
Retained Earnings
 
 
Total Shareholders' Equity
 
 
Common Stock
 
 
 
Net Unrealized Gains on Investments
 
Foreign Currency Translation (Losses) Gains
 
(in millions)
 
Shares
 
Amount
 
 
 
 
 
Balance at January 1, 2012
 
1,039

 
$
10

 
$

 
$
27,821

 
$
476

 
$
(15
)
 
$
28,292

Net earnings
 
 
 
 
 
 
 
2,725

 

 

 
2,725

Other comprehensive income (loss)
 
 
 
 
 
 
 
 
 
9

 
(1
)
 
8

Issuances of common stock, and related tax effects
 
18

 

 
194

 
 
 

 

 
194

Share-based compensation, and related tax benefits
 
 
 
 
 
351

 
 
 

 

 
351

Common stock repurchases
 
(33
)
 

 
(545
)
 
(1,264
)
 
 
 
 
 
(1,809
)
Common stock dividends
 
 
 
 
 
 
 
(386
)
 

 

 
(386
)
Balance at June 30, 2012
 
1,024

 
$
10

 
$

 
$
28,896

 
$
485

 
$
(16
)
 
$
29,375

 
 
 
 
 
 
 
 
 
 

 

 
 
Balance at January 1, 2011
 
1,086

 
$
11

 
$

 
$
25,562

 
$
280

 
$
(28
)
 
$
25,825

Net earnings
 
 
 
 
 
 
 
2,613

 

 

 
2,613

Other comprehensive income
 
 
 
 
 
 
 
 
 
58

 
22

 
80

Issuances of common stock, and related tax effects
 
11

 

 
153

 
 
 

 

 
153

Share-based compensation, and related tax benefits
 
 
 
 
 
256

 
 
 

 

 
256

Common stock repurchases
 
(28
)
 

 
(409
)
 
(846
)
 
 
 
 
 
(1,255
)
Common stock dividends
 
 
 
 
 
 
 
(309
)
 

 

 
(309
)
Balance at June 30, 2011
 
1,069

 
$
11

 
$

 
$
27,020

 
$
338

 
$
(6
)
 
$
27,363


See Notes to the Condensed Consolidated Financial Statements

4


UnitedHealth Group
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
Six Months Ended June 30,
(in millions)
 
2012
 
2011
Operating activities
 
 
 
 
Net earnings
 
$
2,725

 
$
2,613

Noncash items:
 
 
 
 
Depreciation and amortization
 
622

 
540

Deferred income taxes
 
108

 
264

Share-based compensation
 
242

 
218

Other, net
 
(163
)
 
(62
)
Net change in other operating items, net of effects from acquisitions and changes in AARP balances:
 
 
 
 
Accounts receivable
 
(188
)
 
(843
)
Other assets
 
(27
)
 
(281
)
Medical costs payable
 
298

 
120

Accounts payable and other liabilities
 
23

 
(128
)
Other policy liabilities
 
(365
)
 
37

Unearned revenues
 
2,496

 
(59
)
Cash flows from operating activities
 
5,771

 
2,419

Investing activities
 
 
 
 
Purchases of investments
 
(4,946
)
 
(4,479
)
Sales of investments
 
2,090

 
1,985

Maturities of investments
 
2,322

 
1,901

Cash paid for acquisitions, net of cash assumed
 
(2,404
)
 
(827
)
Cash received from dispositions
 

 
378

Purchases of property, equipment and capitalized software
 
(465
)
 
(516
)
Cash flows used for investing activities
 
(3,403
)
 
(1,558
)
Financing activities
 
 
 
 
Common stock repurchases
 
(1,809
)
 
(1,255
)
Proceeds from common stock issuances
 
410

 
225

Dividends paid
 
(386
)
 
(309
)
Proceeds from commercial paper, net
 

 
154

Proceeds from issuance of long-term debt
 
995

 
747

Repayments of long-term debt
 

 
(955
)
Customer funds administered
 
1,108

 
1,228

Checks outstanding in excess of bank deposits
 
(290
)
 
(88
)
Other, net
 
(247
)
 
44

Cash flows used for financing activities
 
(219
)
 
(209
)
Increase in cash and cash equivalents
 
2,149

 
652

Cash and cash equivalents, beginning of period
 
9,429

 
9,123

Cash and cash equivalents, end of period
 
$
11,578

 
$
9,775


See Notes to the Condensed Consolidated Financial Statements

5


UNITEDHEALTH GROUP
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Basis of Presentation
UnitedHealth Group Incorporated (also referred to as “UnitedHealth Group” and the “Company”) is a diversified health and well-being company dedicated to helping people live healthier lives and making health care work better. We offer a broad spectrum of products and services through two distinct platforms: UnitedHealthcare, which provides health care coverage and benefits services; and Optum, which provides information and technology-enabled health services.
The Company has prepared the Condensed Consolidated Financial Statements according to U.S. Generally Accepted Accounting Principles (GAAP) and has included the accounts of UnitedHealth Group and its subsidiaries. The Company has eliminated intercompany balances and transactions. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. In accordance with the rules and regulations of the U.S. Securities and Exchange Commission (SEC), the Company has omitted certain footnote disclosures that would substantially duplicate the disclosures contained in its annual audited Consolidated Financial Statements. Therefore, these Condensed Consolidated Financial Statements should be read together with the Consolidated Financial Statements and the Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC (2011 10-K). The accompanying Condensed Consolidated Financial Statements include all normal recurring adjustments necessary to present the interim financial statements fairly.
Use of Estimates
These Condensed Consolidated Financial Statements include certain amounts based on the Company’s best estimates and judgments. The Company’s most significant estimates relate to medical costs payable and medical costs, premium rebates and risk-sharing provisions related to revenues, valuation and impairment analysis of goodwill and other intangible assets, estimates of other policy liabilities and other current receivables, valuations of investments, income taxes and contingent liabilities. These estimates require the application of complex assumptions and judgments, often because they involve matters that are inherently uncertain and will likely change in subsequent periods. The impact of any changes in estimates is included in earnings in the period in which the estimate is adjusted.
Accounting Policies
Following is an expanded portion of the Company's revenue policy related to premium rebates. All other accounting policies disclosed in Note 2 of Notes to the Consolidated Financial Statements in the 2011 10-K remain unchanged.
The Company's fully insured commercial premium revenues are generally subject to the minimum medical loss ratio requirements of the Patient Protection and Affordable Care Act and the associated reconciliation measure, the Health Care and Education Reconciliation Act of 2010 (Health Reform Legislation). Premium revenues are recognized based on the estimated premiums earned net of projected rebates because the Company is able to reasonably estimate the ultimate premiums of these contracts. Each period, the Company estimates premium rebates based on the expected financial performance of the applicable contracts within each defined aggregation set (e.g., by state, group size and licensed subsidiary). The most significant factors in estimating the financial performance are current and future premiums and medical claim experience, effective tax rates and expected changes in business mix. The estimated ultimate premium is revised each period to reflect current and projected experience.
Recently Adopted Accounting Standards
In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs” (ASU 2011-04). This update provides guidance on how fair value measurement should be applied where existing GAAP already requires or permits fair value measurements. In addition, ASU 2011-04 requires expanded disclosures regarding fair value measurements. ASU 2011-04 became effective for the Company's fiscal year 2012. The adoption of the measurement guidance of ASU 2011-04 did not have a material impact on the Condensed Consolidated Financial Statements. The new disclosures have been included with the Company's fair value disclosures in Note 3 of Notes to the Condensed Consolidated Financial Statements.
In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income” (ASU 2011-05). ASU 2011-05 requires entities to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements and eliminates the option to present the components of other comprehensive

6


income as a part of the statement of equity. ASU 2011-05 became effective for the Company's fiscal year 2012. The Company presented separate Condensed Consolidated Statements of Comprehensive Income, which appear consecutive to the Condensed Consolidated Statements of Operations.
The Company has determined that there have been no other recently adopted or issued accounting standards that had or will have a material impact on its Condensed Consolidated Financial Statements.
2.
Investments
A summary of short-term and long-term investments is as follows:
(in millions)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
June 30, 2012
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
2,474

 
$
51

 
$

 
$
2,525

State and municipal obligations
 
6,352

 
379

 
(2
)
 
6,729

Corporate obligations
 
6,109

 
226

 
(8
)
 
6,327

U.S. agency mortgage-backed securities
 
2,351

 
80

 

 
2,431

Non-U.S. agency mortgage-backed securities
 
445

 
32

 

 
477

Total debt securities - available-for-sale
 
17,731

 
768

 
(10
)
 
18,489

Equity securities - available-for-sale
 
587

 
22

 
(3
)
 
606

Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
172

 
7

 

 
179

State and municipal obligations
 
26

 

 

 
26

Corporate obligations
 
257

 

 
(3
)
 
254

Total debt securities - held-to-maturity
 
455

 
7

 
(3
)
 
459

Total investments
 
$
18,773

 
$
797

 
$
(16
)
 
$
19,554

December 31, 2011
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
2,319

 
$
54

 
$

 
$
2,373

State and municipal obligations
 
6,363

 
403

 
(1
)
 
6,765

Corporate obligations
 
5,825

 
205

 
(23
)
 
6,007

U.S. agency mortgage-backed securities
 
2,279

 
74

 

 
2,353

Non-U.S. agency mortgage-backed securities
 
476

 
28

 

 
504

Total debt securities - available-for-sale
 
17,262

 
764

 
(24
)
 
18,002

Equity securities - available-for-sale
 
529

 
23

 
(8
)
 
544

Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
166

 
7

 

 
173

State and municipal obligations
 
13

 

 

 
13

Corporate obligations
 
18

 

 

 
18

Total debt securities - held-to-maturity
 
197

 
7

 

 
204

Total investments
 
$
17,988

 
$
794

 
$
(32
)
 
$
18,750


Included in the Company’s investment portfolio were securities collateralized by sub-prime home equity lines of credit with fair values of $2 million at both June 30, 2012 and December 31, 2011. Also included were Alt-A securities with fair values of $7 million and $9 million at June 30, 2012 and December 31, 2011.


7


The fair values of the Company’s mortgage-backed securities by credit rating (when multiple credit ratings are available for an individual security, the average of the available ratings is used) and origination as of June 30, 2012 were as follows:
(in millions)
 
AAA
 
AA
 
Non-Investment
Grade
 
Total Fair
Value
2012
 
$
15

 
$

 
$

 
$
15

2011
 
26

 

 

 
26

2010
 

 
3

 

 
3

2007
 
84

 

 
2

 
86

2006
 
155

 

 
9

 
164

Pre - 2006
 
177

 

 
6

 
183

U.S. agency mortgage-backed securities
 
2,431

 

 

 
2,431

Total
 
$
2,888

 
$
3

 
$
17

 
$
2,908

The amortized cost and fair value of available-for-sale debt securities as of June 30, 2012, by contractual maturity, were as follows:
(in millions)
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
2,929

 
$
2,942

Due after one year through five years
 
5,906

 
6,106

Due after five years through ten years
 
4,380

 
4,693

Due after ten years
 
1,720

 
1,840

U.S. agency mortgage-backed securities
 
2,351

 
2,431

Non-U.S. agency mortgage-backed securities
 
445

 
477

Total debt securities - available-for-sale
 
$
17,731

 
$
18,489

The amortized cost and fair value of held-to-maturity debt securities as of June 30, 2012, by contractual maturity, were as follows:
(in millions)
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
77

 
$
77

Due after one year through five years
 
124

 
127

Due after five years through ten years
 
193

 
191

Due after ten years
 
61

 
64

Total debt securities - held-to-maturity
 
$
455

 
$
459


8


The fair value of available-for-sale investments with gross unrealized losses by investment type and length of time that individual securities have been in a continuous unrealized loss position were as follows:
 
 
Less Than 12 Months
 
12 Months or Greater
 
Total
(in millions)
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
State and municipal obligations
 
$
448

 
$
(2
)
 
$

 
$

 
$
448

 
$
(2
)
Corporate obligations
 
1,034

 
(7
)
 
48

 
(1
)
 
1,082

 
(8
)
Total debt securities - available-for-sale
 
$
1,482

 
$
(9
)
 
$
48

 
$
(1
)
 
$
1,530

 
$
(10
)
Equity securities - available-for-sale
 
$
29

 
$
(2
)
 
$
4

 
$
(1
)
 
$
33

 
$
(3
)
December 31, 2011
 
 
 
 
 
 
 
 
 
 
 
 
Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
 
State and municipal obligations
 
$
85

 
$
(1
)
 
$
21

 
$

 
$
106

 
$
(1
)
Corporate obligations
 
1,496

 
(22
)
 
28

 
(1
)
 
1,524

 
(23
)
Total debt securities - available-for-sale
 
$
1,581

 
$
(23
)
 
$
49

 
$
(1
)
 
$
1,630

 
$
(24
)
Equity securities - available-for-sale
 
$
24

 
$
(7
)
 
$
3

 
$
(1
)
 
$
27

 
$
(8
)
The unrealized losses from all securities as of June 30, 2012 were generated from 1,900 positions out of a total of 16,900 positions. The Company believes that it will collect the principal and interest due on its investments that have an amortized cost in excess of fair value. The unrealized losses were primarily caused by interest rate increases and not by unfavorable changes in the credit ratings associated with these securities. At each reporting period, the Company evaluates securities for impairment when the fair value of the investment is less than its amortized cost. The Company evaluated the underlying credit quality and credit ratings of the issuers, noting neither a significant deterioration since purchase nor other factors leading to an other-than-temporary impairment (OTTI). As of June 30, 2012, the Company did not have the intent to sell any of the securities in an unrealized loss position.
As of June 30, 2012, the Company’s holdings of non-U.S. agency mortgage-backed securities included $7 million of commercial mortgage loans in default. These loans represented less than 1% of the Company’s total mortgage-backed security holdings as of June 30, 2012.
A portion of the Company’s investments in equity securities and venture capital funds consists of investments held in various public and nonpublic companies concentrated in the areas of health care services and related information technologies. Market conditions that affect the value of health care and related technology stocks will likewise impact the value of the Company’s equity portfolio. The equity securities and venture capital funds were evaluated for severity and duration of unrealized loss, overall market volatility and other market factors.
Net realized gains included in Investment and Other Income on the Condensed Consolidated Statements of Operations were from the following sources:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions)
 
2012
 
2011
 
2012
 
2011
Total OTTI
 
$
(1
)
 
$
(2
)
 
$
(4
)
 
$
(6
)
Portion of loss recognized in other comprehensive income
 

 

 

 

Net OTTI recognized in earnings
 
(1
)
 
(2
)
 
(4
)
 
(6
)
Gross realized losses from sales
 
(2
)
 
(3
)
 
(3
)
 
(4
)
Gross realized gains from sales
 
53

 
26

 
96

 
79

Net realized gains
 
$
50

 
$
21

 
$
89

 
$
69



9


3.
Fair Value
Certain assets and liabilities are measured at fair value in the Condensed Consolidated Financial Statements or have fair values disclosed in the Notes to the Condensed Consolidated Financial Statements. These assets and liabilities are classified into one of three levels of a hierarchy defined by GAAP. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement is categorized in its entirety based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.
The fair value hierarchy is summarized as follows:
Level 1 — Quoted prices (unadjusted) for identical assets/liabilities in active markets.
Level 2 — Other observable inputs, either directly or indirectly, including:
Quoted prices for similar assets/liabilities in active markets;
Quoted prices for identical or similar assets/liabilities in non-active markets (e.g., few transactions, limited information, non-current prices, high variability over time);
Inputs other than quoted prices that are observable for the asset/liability (e.g., interest rates, yield curves, implied volatilities, credit spreads); and
Inputs that are corroborated by other observable market data.
Level 3 — Unobservable inputs that cannot be corroborated by observable market data.
Transfers between levels, if any, are recorded as of the beginning of the reporting period in which the transfer occurs; there were no transfers between Levels 1, 2 or 3 of any financial assets or liabilities during 2012 or 2011.
Non-financial assets and liabilities or financial assets and liabilities that are measured at fair value on a nonrecurring basis are subject to fair value adjustments only in certain circumstances, such as when the Company records an impairment. There were no significant fair value adjustments for these assets and liabilities recorded during the three and six months ended June 30, 2012 and 2011.
The following methods and assumptions were used to estimate the fair value and determine the fair value hierarchy classification of each class of financial instrument included in the tables below:
Cash and Cash Equivalents. The carrying value of cash and cash equivalents approximates fair value as maturities are less than three months. Fair values of cash equivalent instruments that do not trade on a regular basis in active markets are classified as Level 2.
Debt and Equity Securities. Fair values of debt and equity securities are based on quoted market prices, where available. The Company obtains one price for each security primarily from a third-party pricing service (pricing service), which generally uses quoted or other observable inputs for the determination of fair value. The pricing service normally derives the security prices through recently reported trades for identical or similar securities, making adjustments through the reporting date based upon available observable market information. For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, benchmark yields, credit spreads, default rates, prepayment speeds and non-binding broker quotes. As the Company is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Company compares the prices received from the pricing service to a secondary pricing source, prices reported by its custodian, its investment consultant and third-party investment advisors. Additionally, the Company compares changes in the reported market values and returns to relevant market indices to test the reasonableness of the reported prices. The Company’s internal price verification procedures and reviews of fair value methodology documentation provided by independent pricing services have not historically resulted in adjustment in the prices obtained from the pricing service.
Fair values of debt securities that do not trade on a regular basis in active markets but are priced using other observable inputs are classified as Level 2.
Fair value estimates for Level 1 and Level 2 equity securities are based on quoted market prices for actively traded equity securities and/or other market data for the same or comparable instruments and transactions in establishing the prices.
The Company's Level 3 equity securities are primarily investments in venture capital securities. The fair values of Level 3 investments in venture capital portfolios are estimated using a market valuation technique that relies heavily on management assumptions and qualitative observations. Under the market approach, the fair values of the Company's various venture capital

10


investments are computed using limited quantitative and qualitative observations of activity for similar companies in the current market. The Company's market modeling utilizes, as applicable, transactions for comparable companies in similar industries and having similar revenue and growth characteristics; and similar preferences in their capital structure. Key significant unobservable inputs in the market technique include implied earnings before interest, taxes, depreciation and amortization (EBITDA) multiples and revenue multiples. Additionally, the fair value of certain of the Company's venture capital securities are based off of recent transactions in inactive markets for identical or similar securities. Significant changes in any of these inputs could result in significantly lower or higher fair value measurements.
Throughout the procedures discussed above in relation to the Company's processes for validating third party pricing information, the Company validates the understanding of assumptions and inputs used in security pricing and determines the proper classification in the hierarchy based on that understanding.
AARP Program-related Investments. AARP Program-related investments consist of debt and equity securities held to fund costs associated with the AARP Program and are priced and classified using the same methodologies as the Company’s other securities.
Interest Rate Swaps. Fair values of the Company’s interest rate swaps are estimated using the terms of the swaps and publicly available market yield curves. Because the swaps are unique and not actively traded but are valued using other observable inputs, the fair values are classified as Level 2.
Senior Unsecured Notes. The fair values of the senior unsecured notes are estimated and classified using the same methodologies as the Company's investments in debt securities.
AARP Program-related Other Liabilities. AARP Program-related other liabilities consist of liabilities that represent the amount of net investment gains and losses related to AARP Program-related investments that accrue to the benefit of the AARP policyholders.

11


The following table presents a summary of fair value measurements by level and carrying values for items measured at fair value on a recurring basis in the Condensed Consolidated Balance Sheets excluding AARP related assets and liabilities, which are discussed below:
(in millions)
 
Quoted Prices
in Active
Markets
(Level 1)
 
Other
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
 
Total
Fair
Value
 
Total Carrying Value
June 30, 2012
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
10,193

 
$
1,385

 
$

 
$
11,578

 
$
11,578

Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
1,721

 
804

 

 
2,525

 
2,525

State and municipal obligations
 

 
6,729

 

 
6,729

 
6,729

Corporate obligations
 
1

 
6,326

 

 
6,327

 
6,327

U.S. agency mortgage-backed securities
 

 
2,431

 

 
2,431

 
2,431

Non-U.S. agency mortgage-backed securities
 

 
470

 
7

 
477

 
477

Total debt securities - available-for-sale
 
1,722

 
16,760

 
7

 
18,489

 
18,489

Equity securities - available-for-sale
 
376

 
2

 
228

 
606

 
606

Interest rate swap assets
 

 
12

 

 
12

 
12

Total assets at fair value

$
12,291

 
$
18,159

 
$
235

 
$
30,685

 
N/A

Percentage of total assets at fair value
 
40
%
 
59
%
 
1
%
 
100
%
 
N/A

December 31, 2011
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
8,569

 
$
860

 
$

 
$
9,429

 
$
9,429

Debt securities - available-for-sale:
 
 
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
1,551

 
822

 

 
2,373

 
2,373

State and municipal obligations
 

 
6,750

 
15

 
6,765

 
6,765

Corporate obligations
 
16

 
5,805

 
186

 
6,007

 
6,007

U.S. agency mortgage-backed securities
 

 
2,353

 

 
2,353

 
2,353

Non-U.S. agency mortgage-backed securities
 

 
497

 
7

 
504

 
504

Total debt securities - available-for-sale
 
1,567

 
16,227

 
208

 
18,002

 
18,002

Equity securities - available-for-sale
 
333

 
2

 
209

 
544

 
544

Total assets at fair value
 
$
10,469

 
$
17,089

 
$
417

 
$
27,975

 
N/A

Percentage of total assets at fair value
 
37
%
 
61
%
 
2
%
 
100
%
 
N/A


12


The following table presents a summary of fair value measurements by level and carrying values for certain financial instruments not measured at fair value on a recurring basis in the Condensed Consolidated Balance Sheets:
(in millions)
 
Quoted Prices
in Active
Markets
(Level 1)
 
Other
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
 
Total
Fair
Value
 
Total Carrying Value
June 30, 2012
 
 
 
 
 
 
 
 
 
 
Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
179

 
$

 
$

 
$
179

 
$
172

State and municipal obligations
 

 
2

 
24

 
26

 
26

Corporate obligations
 
9

 
12

 
233

 
254

 
257

Total debt securities - held-to-maturity
 
$
188

 
$
14

 
$
257

 
$
459

 
$
455

Senior unsecured notes
 
$

 
$
14,490

 
$

 
$
14,490

 
$
12,617

December 31, 2011
 
 
 
 
 
 
 
 
 
 
Debt securities - held-to-maturity:
 
 
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
$
173

 
$

 
$

 
$
173

 
$
166

State and municipal obligations
 

 
1

 
12

 
13

 
13

Corporate obligations
 
9

 
9

 

 
18

 
18

Total debt securities - held-to-maturity
 
$
182

 
$
10

 
$
12

 
$
204

 
$
197

Senior unsecured notes
 
$

 
$
13,149

 
$

 
$
13,149

 
$
11,638

The carrying amounts reported in the Condensed Consolidated Balance Sheets for accounts and other current receivables, unearned revenues, commercial paper, accounts payable and accrued liabilities approximate fair value because of their short-term nature. These assets and liabilities are not listed in the table above.
A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level 3 inputs is as follows:
 
 
Three Months Ended
 
Six Months Ended
(in millions)
 
Debt
Securities
 
Equity
Securities
 
Total
 
Debt
Securities
 
Equity
Securities
 
Total
June 30, 2012
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
7

 
$
204

 
$
211

 
$
208

 
$
209

 
$
417

Purchases
 

 
33

 
33

 

 
51

 
51

Sales
 

 
(7
)
 
(7
)
 

 
(9
)
 
(9
)
Net unrealized losses in accumulated other comprehensive income
 

 
(3
)
 
(3
)
 

 
(3
)
 
(3
)
Net realized gains in investment and other income
 

 
1

 
1

 

 
1

 
1

Transfers to held-to-maturity
 

 

 

 
(201
)
 
(21
)
 
(222
)
Balance at end of period
 
$
7

 
$
228

 
$
235

 
$
7

 
$
228

 
$
235

 
 
 
 
 
 
 
 
 
 
 
 
 
June 30, 2011
 
 
 
 
 
 
 
 
 
 
 
 
Balance at beginning of period
 
$
135

 
$
201

 
$
336

 
$
141

 
$
208

 
$
349

Purchases
 
9

 
27

 
36

 
9

 
31

 
40

Sales
 

 
(5
)
 
(5
)
 

 
(14
)
 
(14
)
Settlements
 
(4
)
 

 
(4
)
 
(10
)
 

 
(10
)
Net unrealized losses in accumulated other comprehensive income
 

 
(1
)
 
(1
)
 

 
(3
)
 
(3
)
Balance at end of period
 
$
140

 
$
222

 
$
362

 
$
140

 
$
222


$
362


13


The following table presents quantitative information regarding unobservable inputs that were significant to the valuation of assets measured at fair value on a recurring basis using Level 3 inputs:
 
 
 
 
 
 
 
 
Range
(in millions)
 
Fair Value
 
Valuation Technique
 
Unobservable Input
 
Low
 
High
June 30, 2012
 
 
 
 
 
 
 
 
 
 
Equity securities - available-for-sale
 
 
 
 
 
 
 
 
 
 
Venture capital portfolios
 
$
199

 
Market approach - comparable companies
 
Revenue multiple
 
1.0
 
10.0
 
 
 
 
 
 
EBITDA multiple
 
8.0
 
10.0
 
 
29

 
Market approach - recent transactions
 
Inactive market transactions
 
N/A
 
N/A
Total equity securities
     available-for-sale
 
$
228

 
 
 
 
 
 
 
 
Also included in the Company's assets measured at fair value on a recurring basis using Level 3 inputs were $7 million of available-for-sale debt securities at June 30, 2012, which were not significant.
The Company provides health insurance products and services to members of AARP under a Supplemental Health Insurance Program (the AARP Program). The Company elected to measure the entirety of the AARP Assets Under Management at fair value pursuant to the fair value option. See Note 2 of Notes to the Consolidated Financial Statements in the Company’s 2011 10-K for further detail on AARP. The following table presents fair value information about the AARP Program-related financial assets and liabilities:
(in millions)
 
Quoted Prices
in Active
Markets
(Level 1)
 
Other
Observable
Inputs
(Level 2)
 
Unobservable
Inputs
(Level 3)
 
Total
Fair
Value
June 30, 2012
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
116

 
$
10

 
$

 
$
126

Debt securities:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
544

 
251

 

 
795

State and municipal obligations
 

 
43

 

 
43

Corporate obligations
 

 
1,086

 

 
1,086

U.S. agency mortgage-backed securities
 

 
430

 

 
430

Non-U.S. agency mortgage-backed securities
 

 
146

 

 
146

Total debt securities
 
544

 
1,956

 

 
2,500

Equity securities - available-for-sale
 

 
2

 

 
2

Total assets at fair value
 
$
660

 
$
1,968

 
$

 
$
2,628

Other liabilities
 
$
27

 
$
54

 
$

 
$
81

Total liabilities at fair value
 
$
27

 
$
54

 
$

 
$
81

December 31, 2011
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
257

 
$
10

 
$

 
$
267

Debt securities:
 
 
 
 
 
 
 
 
U.S. government and agency obligations
 
566

 
214

 

 
780

State and municipal obligations
 

 
25

 

 
25

Corporate obligations
 

 
1,048

 

 
1,048

U.S. agency mortgage-backed securities
 

 
436

 

 
436

Non-U.S. agency mortgage-backed securities
 

 
150

 

 
150

Total debt securities
 
566

 
1,873

 

 
2,439

Equity securities - available-for-sale
 

 
2

 

 
2

Total assets at fair value
 
$
823

 
$
1,885

 
$

 
$
2,708

Other liabilities
 
$
27

 
$
49

 
$

 
$
76

Total liabilities at fair value
 
$
27

 
$
49

 
$

 
$
76


14


4.
CMS Prepayments and Medicare Part D Pharmacy Benefits

CMS Prepayments

On June 29, 2012, the Company received approximately $2.7 billion for its July monthly premium payment and approximately $500 million for the Catastrophic Reinsurance and Low-Income Member Cost Sharing Subsidies (Subsidies) and drug discount from the Centers for Medicare & Medicaid Services (CMS). CMS generally pays on the first calendar day of the applicable month. If the first calendar day of the month falls on a weekend or a holiday, CMS has typically paid the Company on the last business day of the preceding calendar month. The Company recorded the premium payment as unearned revenues in both its Condensed Consolidated Balance Sheets and Condensed Consolidated Statements of Cash Flows. The treatment of the Subsidies and drug discount is described below.
Medicare Part D Pharmacy Benefits Contract
The Condensed Consolidated Balance Sheets include the following amounts associated with the Medicare Part D program:
 
 
June 30, 2012
 
December 31, 2011
(in millions)
 
Subsidies
 
Drug Discount
 
Risk-Share
 
Subsidies
 
Drug Discount
 
Risk-Share
Other current receivables
 
$

 
$
159

 
$

 
$

 
$
509

 
$

Other policy liabilities
 
824

 
383

 
2

 
70

 
649

 
170

The Subsidies and drug discount represent cost reimbursements under the Medicare Part D program. The Company is fully reimbursed by CMS for costs incurred for these contract elements and, accordingly, there is no insurance risk to the Company. Amounts received for these Subsidies are not reflected as premium revenues, but rather are accounted for as a reduction of receivables and/or increase in deposit liabilities. The drug discount is ultimately funded by the pharmaceutical manufacturers. CMS provides prospective payments, which the Company records as liabilities when received. The Company bills the pharmaceutical manufacturers for claims under the program, which are recorded as receivables. Related cash flows are presented as customer funds administered within financing activities in the Condensed Consolidated Statements of Cash Flows.
Premiums from CMS are subject to risk-sharing provisions based on a comparison of the Company’s annual bid estimates of prescription drug costs and the actual costs incurred. Variances may result in CMS making additional payments to the Company or require the Company to remit funds to CMS subsequent to the end of the year. The Company records risk-share adjustments to premium revenue and other current receivables or other policy liabilities in the Condensed Consolidated Balance Sheets.

5.
Medical Costs and Medical Costs Payable
The following table provides details of the Company's net favorable medical cost development:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in millions)
 
2012
 
2011
 
2012
 
2011
Related to Prior Years
 
$
90