Aetna 2006 Annual Report Download - page 27

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The discount rate is the interest rate at which future benefit cash flows are discounted to determine the present value
of those cash flows. The discount rate we select is a critical estimate, as higher discount rates result in lower
reserves. We determine the discount rate based on the current and estimated future yield of the asset portfolio
supporting our life and disability reserves. If the discount rate we select in estimating our reserves is lower (higher)
than our actual future portfolio returns, our reserves may be higher (lower) than necessary. Our discount rate for
life and disability reserves at December 31, 2006 decreased by .22% and .01%, respectively, when compared to the
rates used at December 31, 2005, and increased by .16% and .08%, respectively, when compared to the rates used
at December 31, 2004. The discount rates we selected for disability and life reserves at December 31, 2006 were
slightly lower than the rates we selected in the previous year as a result of declining investment yields on the
portfolio of assets supporting these reserves. The discount rates we selected for disability and life reserves at
December 31, 2005 were slightly higher than the rates we selected in the previous year as a result of improved
investment yields on the portfolio of assets supporting these reserves. Based on our historical experience, it is
reasonably possible that the assumed discount rates for our life and disability reserves may vary by plus or minus
.25% from year to year. A .25% decrease in the discount rates selected for our life and disability reserves would
have increased current and future life and disability benefit costs by approximately $12 million for 2006.
For disability claims and a portion of our life claims, we must estimate the timing of benefit payments, which takes
into consideration the maximum benefit period and the probabilities of recovery (i.e., recovery rate) or death (i.e.,
mortality rate) of the member. Benefit payments may also be affected by a change in employment status of a
disabled member, for example if the member returns to work on a part-time basis. Estimating the recovery and
mortality rates of our members is complex. Our actuaries evaluate our current and historical claim patterns, the
timing and amount of any Social Security offset (for disability only), as well as other factors including the relative
ages of covered members and the duration of each member’ s disability when developing these assumptions. For
disability reserves, if our actual recovery and mortality rates are lower (higher) than our estimates, our reserves will
be lower (higher) than required to cover future disability benefit payments. For certain life reserves, if the actual
recovery rates are lower (higher) than our estimates or the actual mortality rates are higher (lower) than our
estimates, our reserves will be lower (higher) than required to cover future life benefit payments. We use standard
industry tables and our historical claim experience to develop our estimated recovery and mortality rates. Claim
reserves for our disability and life claims are sensitive to these assumptions. Our historical experience has been that
our recovery or mortality rates for our life and disability reserves may vary by less than one percent during the
course of a year. A one percent less (more) favorable assumption for our recovery or mortality rates would have
increased (decreased) current and future life and disability benefit costs by approximately $5 million for 2006.
When establishing our reserves at December 31, 2006, we have adjusted our estimates of these rates based on recent
experience.
We estimate our reserve for claims incurred but not yet reported to us for life products largely based on completion
factors. The completion factors we use are based on our historical experience and reflect judgments and possible
adjustments based on data such as claim inventory levels, claim payment patterns, changes in business volume and
other factors. If claims are submitted or processed on a faster (slower) pace than historical periods, the actual
claims may be more (less) complete than originally estimated using our completion factors, which may result in
reserves that are higher (lower) than required to cover future life benefit payments. At December 31, 2006, we held
approximately $239 million in reserves for life claims incurred but not yet reported to us.
Long-term Care
We establish a reserve for future policy benefits for our long-term care products at the time each policy is issued
based on the present value of future benefit payments less the present value of future premiums. In establishing this
reserve, we must evaluate assumptions about mortality, morbidity, lapse rates and the rate at which new claims are
submitted to us. We estimate the future policy benefits reserve for long-term care products using these assumptions
and actuarial principles. For long-duration insurance contracts, we use our original assumptions throughout the life
of the policy and do not subsequently modify them unless we deem the reserves to be inadequate. A portion of our
reserves for long-term care products also reflect our estimates relating to future payments to members currently
receiving benefits. These reserves are estimated primarily using recovery and mortality rates, as described above.