Cigna 2010 Annual Report Download - page 63

CIGNA CORPORATION  2010 Form 10K 43
PART II
ITEM 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations
Balance Sheet Caption/Nature of Critical
Accounting Estimate Assumptions/Approach Used E ect if Di erent Assumptions Used
Health Care medical claims payable
Medical claims payable for the Health
Care segment include both reported
claims and estimates for losses incurred
but not yet reported.
Liabilities for medical claims payable as of
December 31 were as follows (in millions):
•2010— gross $1,246; net $1,010
•2009 — gross $921; net $715
 ese liabilities are presented above both
gross and net of reinsurance and other
recoverables.
 ese liabilities generally exclude amounts
for administrative services only business.
See Note 5 to the Consolidated Financial
Statements for additional information.
 e Company develops estimates for Health Care medical
claims payable using actuarial principles and assumptions
consistently applied each reporting period, and recognizes
the actuarial best estimate of the ultimate liability within
a level of confi dence, as required by actuarial standards of
practice, which require that the liabilities be adequate under
moderately adverse conditions.
 e liability is primarily calculated using “completion
factors” (a measure of the time to process claims), which
are developed by comparing the date claims were incurred,
generally the date services were provided, to the date claims
were paid.  e Company uses historical completion factors
combined with an analysis of current trends and operational
factors to develop current estimates of completion factors.
 e Company estimates the liability for claims incurred in
each month by applying the current estimates of completion
factors to the current paid claims data.  is approach
implicitly assumes that historical completion rates will be a
useful indicator for the current period. It is possible that the
actual completion rates for the current period will develop
diff erently from historical patterns, which could have a
material impact on the Company’s medical claims payable
and shareholders’ net income.
Completion factors are impacted by several key items
including changes in: 1) electronic (auto-adjudication) versus
manual claim processing, 2) provider claims submission
rates, 3) membership and 4) the mix of products.
In addition, for the more recent months, the Company also
relies on medical cost trend analysis, which refl ects expected
claim payment patterns and other relevant operational
considerations. Medical cost trend is primarily impacted by
medical service utilization and unit costs, which are aff ected
by changes in the level and mix of medical benefi ts off ered,
including inpatient, outpatient and pharmacy, the impact
of copays and deductibles, changes in provider practices
and changes in consumer demographics and consumption
behavior.
Despite refl ecting both historical and emerging trends in
setting reserves, it is possible that the actual medical trend for
the current period will develop diff erently from the expected,
which could have a material impact on the Company’s
medical claims payable and shareholders’ net income.
For each reporting period, the Company evaluates key
assumptions by comparing the assumptions used in
establishing the medical claims payable to actual experience.
When actual experience diff ers from the assumptions used in
establishing the liability, medical claims payable are increased
or decreased through current period shareholders’ net
income. Additionally, the Company evaluates expected future
developments and emerging trends which may impact key
assumptions.  e estimation process involves considerable
judgment, refl ecting the variability inherent in forecasting
future claim payments.  ese estimates are highly sensitive
to changes in the Company’s key assumptions, specifi cally
completion factors, and medical cost trends.
For the year ended December 31, 2010,
actual experience diff ered from the Company’s
key assumptions as of December 31, 2009,
resulting in $93 million of favorable incurred
claims related to prior years’ medical claims
payable or 1.3% of the current year incurred
claims as reported for the year ended
December 31, 2009. For the year ended
December 31, 2009, actual experience diff ered
from the Company’s key assumptions as of
December 31, 2008, resulting in $43 million
of favorable incurred claims related to prior
years’ medical claims, or 0.6% of the current
year incurred claims reported for the year
ended December 31, 2008. Specifi cally, the
favorable impact is due to faster than expected
completion factors and lower than expected
medical cost trends, both of which included an
assumption for moderately adverse experience.
 e impact of this favorable prior year
development was an increase to shareholders’
net income of $26 million after-tax
($39 million pre-tax) for the year ended
December 31, 2010.  e change in the
amount of the incurred claims related to prior
years in the medical claims payable liability
does not directly correspond to an increase
or decrease in shareholders’ net income as
explained in Note 5 to the Consolidated
Financial Statements.