Document


    
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
    
FORM 10-Q

(Mark One)
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2019
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: 001-01011
cvshealtha08.jpg
CVS HEALTH CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)
05-0494040
(I.R.S. Employer Identification No.)
One CVS Drive, Woonsocket, Rhode Island
(Address of principal executive offices)
02895
(Zip Code)
(401) 765-1500
 (Registrant’s telephone number, including area code)

Former name, former address and former fiscal year, if changed since last report: N/A

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. þ Yes o No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).      þ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ
 
Accelerated filer o
Non-accelerated filer o  
Smaller reporting company o
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

There were 1,299,092,100 shares of the registrant’s voting common stock with a par value of $0.01 per share outstanding at April 23, 2019.



TABLE OF CONTENTS
Page
 
 
 
Part I
Financial Information
 
 
 
 
Item 1.
Item 2.
Item 3.
Item 4.
 
 
 
Part II
Other Information
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3
Item 4.
Item 5.
Item 6.
 
 
 
 
 


Form 10-Q Table of Contents

Part I.
Financial Information

Item 1.
Financial Statements

Index to Condensed Consolidated Financial Statements

 
 
 
Page
Condensed Consolidated Statements of Operations (Unaudited) for the three months ended March 31, 2019 and 2018
 
 
Condensed Consolidated Statements of Comprehensive Income (Unaudited) for the three months ended March 31, 2019 and 2018
 
 
Condensed Consolidated Balance Sheets (Unaudited) as of March 31, 2019 and December 31, 2018
 
 
Condensed Consolidated Statements of Cash Flows (Unaudited) for the three months ended March 31, 2019 and 2018
 
 
Condensed Consolidated Statements of Shareholders' Equity (Unaudited) for the three months ended March 31, 2019 and 2018
 
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
 
 
Report of the Independent Registered Public Accounting Firm
 
 



1
Index to Consolidated Financial Statements

CVS Health Corporation
Condensed Consolidated Statements of Operations
(Unaudited)
 
Three Months Ended
March 31,
In millions, except per share amounts
2019
 
2018
Revenues:
 
 
 
Products
$
43,343

 
$
44,049

Premiums
16,282

 
1,306

Services
1,772

 
338

Net investment income
249

 
50

Total revenues
61,646

 
45,743

Operating costs:
 
 
 
Cost of products sold
37,247

 
37,505

Benefit costs
13,459

 
1,329

Operating expenses
8,250

 
4,913

Total operating costs
58,956

 
43,747

Operating income
2,690

 
1,996

Interest expense
782

 
523

Other expense (income)
(31
)
 
3

Income before income tax provision
1,939

 
1,470

Income tax provision
512

 
472

Net income
1,427

 
998

Net income attributable to noncontrolling interests
(6
)
 
—

Net income attributable to CVS Health
$
1,421

 
$
998

 
 
 
 
Net income per share attributable to CVS Health:
 
 
 
Basic
$
1.09

 
$
0.98

Diluted
$
1.09

 
$
0.98

Weighted average shares outstanding:
 
 
 
Basic
1,298

 
1,016

Diluted
1,302

 
1,019

Dividends declared per share
$
0.50

 
$
0.50

 
 
 
 

See accompanying notes to condensed consolidated financial statements (unaudited).

2
Index to Consolidated Financial Statements

CVS Health Corporation
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
 
 
 
 
 
Three Months Ended
March 31,
In millions
2019
 
2018
Net income
$
1,427

 
$
998

Other comprehensive income (loss), net of tax:
 
 
 
Net unrealized investment gains
334

 
—

Foreign currency translation adjustments
1

 
1

Net cash flow hedges
(4
)
 
343

Other comprehensive income
331

 
344

Comprehensive income
1,758

 
1,342

Comprehensive income attributable to noncontrolling interests
(6
)
 
—

Comprehensive income attributable to CVS Health
$
1,752

 
$
1,342

 
 
 
 

See accompanying notes to condensed consolidated financial statements (unaudited).

3
Index to Consolidated Financial Statements

CVS Health Corporation
Condensed Consolidated Balance Sheets
(Unaudited)
In millions, except per share amounts
March 31,
2019
 
December 31,
2018
Assets:
 
 
 
Cash and cash equivalents
$
5,896

 
$
4,059

Investments
2,426

 
2,522

Accounts receivable, net
19,509

 
17,631

Inventories
15,448

 
16,450

Other current assets
4,578

 
4,581

Total current assets
47,857

 
45,243

Long-term investments
16,410

 
15,732

Property and equipment, net
11,348

 
11,349

Operating lease right-of-use assets
20,992

 
—

Goodwill
79,075

 
78,678

Intangible assets, net
35,147

 
36,524

Separate accounts assets
4,074

 
3,884

Other assets
4,865

 
5,046

Total assets
$
219,768

 
$
196,456

 
 
 
 
Liabilities:
 
 
 
Accounts payable
$
8,290

 
$
8,925

Pharmacy claims and discounts payable
11,827

 
11,365

Health care costs payable
6,701

 
6,147

Policyholders’ funds
2,732

 
2,939

Accrued expenses
10,443

 
10,711

Other insurance liabilities
1,937

 
1,937

Current portion of operating lease liabilities
1,803

 
—

Short-term debt
3,005

 
720

Current portion of long-term debt
3,893

 
1,265

Total current liabilities
50,631

 
44,009

Long-term operating lease liabilities
18,961

 
—

Long-term debt
67,888

 
71,444

Deferred income taxes
7,540

 
7,677

Separate accounts liabilities
4,074

 
3,884

Other long-term insurance liabilities
8,052

 
8,119

Other long-term liabilities
2,616

 
2,780

Total liabilities
159,762

 
137,913

 
 
 
 
Shareholders’ equity:
 
 
 
Preferred stock, par value $0.01: 0.1 shares authorized; none issued or outstanding
—

 
—

Common stock, par value $0.01: 3,200 shares authorized; 1,722 shares issued and 1,298 shares outstanding at March 31, 2019 and 1,720 shares issued and 1,295 shares outstanding at December 31, 2018
45,615

 
45,440

Treasury stock, at cost: 424 shares at March 31, 2019 and 425 shares at December 31, 2018
(28,221
)
 
(28,228
)
Retained earnings
41,859

 
40,911

Accumulated other comprehensive income
433

 
102

Total CVS Health shareholders’ equity
59,686

 
58,225

Noncontrolling interests
320

 
318

Total shareholders’ equity
60,006

 
58,543

Total liabilities and shareholders’ equity
$
219,768

 
$
196,456

 
 
 
 

See accompanying notes to condensed consolidated financial statements (unaudited).

4
Index to Consolidated Financial Statements

CVS Health Corporation
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
Three Months Ended
March 31,
In millions
2019
 
2018
Cash flows from operating activities:
 
 
 
Cash receipts from customers
$
58,873

 
$
43,369

Cash paid for inventory and prescriptions dispensed by retail network pharmacies
(35,645
)
 
(35,102
)
Insurance benefits paid
(12,951
)
 
(1,093
)
Cash paid to other suppliers and employees
(7,403
)
 
(4,271
)
Interest and investment income received
250

 
50

Interest paid
(1,123
)
 
(545
)
Income taxes paid
(53
)
 
(53
)
Net cash provided by operating activities
1,948

 
2,355

 
 
 
 
Cash flows from investing activities:
 
 
 
Proceeds from sales and maturities of investments
1,986

 
10

Purchases of investments
(2,047
)
 
(33
)
Purchases of property and equipment
(716
)
 
(482
)
Acquisitions (net of cash acquired)
(124
)
 
(353
)
Proceeds from sale of subsidiary
—

 
725

Other
10

 
2

Net cash used in investing activities
(891
)
 
(131
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Net borrowings (repayments) of short-term debt
2,285

 
(1,276
)
Proceeds from issuance of long-term debt
—

 
39,376

Repayments of long-term debt
(882
)
 
(1
)
Derivative settlements
—

 
446

Dividends paid
(649
)
 
(508
)
Proceeds from exercise of stock options
101

 
107

Payments for taxes related to net share settlement of equity awards
(44
)
 
(4
)
Other
5

 
—

Net cash provided by financing activities
816

 
38,140

Net increase in cash, cash equivalents and restricted cash
1,873

 
40,364

Cash, cash equivalents and restricted cash at the beginning of the period
4,295

 
1,900

Cash, cash equivalents and restricted cash at the end of the period
$
6,168

 
$
42,264

 
 
 
 


5
Index to Consolidated Financial Statements

CVS Health Corporation
Condensed Consolidated Statements of Cash Flows
(Unaudited)


 
 
 
 
 
Three Months Ended
March 31,
In millions
2019
    
2018
Reconciliation of net income to net cash provided by operating activities:
 
 
 
Net income
$
1,427

 
$
998

Adjustments required to reconcile net income to net cash provided by operating activities:
 
 
Depreciation and amortization
1,111

 
644

Stock-based compensation
114

 
55

Deferred income taxes and other noncash items
153

 
62

Change in operating assets and liabilities, net of effects from acquisitions:
 
 
 
Accounts receivable, net
(1,989
)
 
(857
)
Inventories
1,001

 
464

Other assets
(389
)
 
(57
)
Accounts payable and pharmacy claims and discounts payable
(22
)
 
(178
)
Health care costs payable and other insurance liabilities
553

 
236

Other liabilities
(11
)
 
988

Net cash provided by operating activities
$
1,948

 
$
2,355

 
 
 
 

See accompanying notes to condensed consolidated financial statements (unaudited).


6
Index to Consolidated Financial Statements

CVS Health Corporation
Condensed Consolidated Statements of Shareholders’ Equity
(Unaudited)
 
 
 
Attributable to CVS Health
 
 
 
Number of shares outstanding
 
Common
 
 
Accumulated
Total
 
 
 
 
Stock and
 
 
Other
CVS Health
 
 
 
Common
Treasury
 
Capital
Treasury
Retained
Comprehensive
Shareholders’
Noncontrolling
Total
In millions
Shares
Shares (1)
 
Surplus (2)
Stock (1)
Earnings
Income (Loss)
Equity
Interests
Equity
Three Months Ended March 31, 2019
 
 
 
 
 
 
 
 
 
Balance at December 31, 2018
1,720

(425
)
 
$
45,440

$
(28,228
)
$
40,911

$
102

$
58,225

$
318

$
58,543

Adoption of new accounting standard (Note 1)
—

—

 
—

—

178

—

178

—

178

Net income
—

—

 
—

—

1,421

—

1,421

6

1,427

Other comprehensive income (Note 8)
—

—

 
—

—

—

331

331

—

331

Stock option activity, stock awards and other
2

—

 
175

—

—

—

175

—

175

Purchase of treasury shares, net of ESPP issuances
—

1

 
—

7

—

—

7

—

7

Common stock dividends
—

—

 
—

—

(651
)
—

(651
)
—

(651
)
Other decreases in noncontrolling interests
—

—

 
—

—

—

—

—

(4
)
(4
)
Balance at March 31, 2019
1,722

(424
)
 
$
45,615

$
(28,221
)
$
41,859

$
433

$
59,686

$
320

$
60,006

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
1,712

(698
)
 
$
32,096

$
(37,796
)
$
43,556

$
(165
)
$
37,691

$
4

$
37,695

Adoption of new accounting standards (3)
—

—

 
—

—

(6
)
(7
)
(13
)
—

(13
)
Net income
—

—

 
—

—

998

—

998

—

998

Other comprehensive income (Note 8)
—

—

 
—

—

—

344

344

—

344

Stock option activity, stock awards and other
2

—

 
112

—

—

—

112

—

112

Purchase of treasury shares, net of ESPP issuances
—

—

 
—

49

—

—

49

—

49

Common stock dividends
—

—

 
—

—

(508
)
—

(508
)
—

(508
)
Balance at March 31, 2018
1,714

(698
)
 
$
32,208

$
(37,747
)
$
44,040

$
172

$
38,673

$
4

$
38,677

 
 
 
 
 
 
 
 
 
 
 
_____________________________________________ 
(1)
Treasury shares include 1 million shares held in trust as of March 31, 2019 and 2018 and December 31, 2018 and 2017. Treasury stock includes $29 million related to shares held in trust as of March 31, 2019 and December 31, 2018, and $31 million related to shares held in trust as of March 31, 2018 and December 31, 2017.
(2)
Common stock and capital surplus includes the par value of common stock of $17 million as of March 31, 2019 and 2018 and December 31, 2018 and 2017.
(3)
Reflects the adoption of ASU 2014-09, Revenue from Contracts with Customers, which resulted in a reduction to retained earnings of $13 million and the adoption of ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which resulted in a reduction to accumulated other comprehensive income and an increase to retained earnings of $7 million.


See accompanying notes to condensed consolidated financial statements (unaudited).


7
Index to Consolidated Financial Statements

Notes to Condensed Consolidated Financial Statements

1.
Significant Accounting Policies

Description of business 

CVS Health Corporation, together with its subsidiaries (collectively, “CVS Health,” the “Company,” “we,” “our” or “us”), is the nation’s premier health innovation company helping people on their path to better health. Whether in one of its pharmacies or through its health services and plans, CVS Health is pioneering a bold new approach to total health by making quality care more affordable, accessible, simple and seamless. CVS Health is community-based and locally focused, engaging consumers with the care they need when and where they need it. The Company has more than 9,900 retail locations, approximately 1,100 walk-in medical clinics, a leading pharmacy benefits manager with approximately 94 million plan members, a dedicated senior pharmacy care business serving more than one million patients per year and expanding specialty pharmacy services. CVS Health also serves an estimated 38 million people through traditional, voluntary and consumer-directed health insurance products and related services, including rapidly expanding Medicare Advantage offerings and a leading standalone Medicare Part D prescription drug plan (“PDP”). The Company believes its innovative health care model increases access to quality care, delivers better health outcomes and lowers overall health care costs.

On November 28, 2018 (the “Aetna Acquisition Date”), the Company acquired Aetna Inc. (“Aetna”). As a result of the acquisition of Aetna (the “Aetna Acquisition”), the Company added the Health Care Benefits segment. Certain aspects of Aetna’s operations, including products for which the Company no longer solicits or accepts new customers, such as large case pensions and long-term care insurance products, are included in the Company’s Corporate/Other segment.

Effective for the first quarter of 2019, the Company realigned the composition of its segments to correspond with changes to its operating model and reflect how its Chief Operating Decision Maker (the “CODM”) reviews information and manages the business. As a result of this realignment, the Company’s SilverScript® PDP moved from the Pharmacy Services segment to the Health Care Benefits segment. In addition, the Company moved Aetna’s mail order and specialty pharmacy operations from the Health Care Benefits segment to the Pharmacy Services segment. Segment financial information for the three months ended March 31, 2018, has been retrospectively adjusted to reflect these changes.

The Company has four reportable segments: Pharmacy Services, Retail/LTC, Health Care Benefits and Corporate/Other, which are described below.

Pharmacy Services Segment
The Pharmacy Services segment provides a full range of pharmacy benefit management (“PBM”) solutions, including plan design offerings and administration, formulary management, retail pharmacy network management services, mail order pharmacy, specialty pharmacy and infusion services, clinical services, disease management services and medical spend management. The Pharmacy Services segment’s clients are primarily employers, insurance companies, unions, government employee groups, health plans, PDPs, Medicaid managed care plans, plans offered on public health insurance exchanges (“Public Exchanges”) and private health insurance exchanges, other sponsors of health benefit plans and individuals throughout the United States. The Pharmacy Services segment operates retail specialty pharmacy stores, specialty mail order pharmacies, mail order dispensing pharmacies, compounding pharmacies and branches for infusion and enteral nutrition services.

Retail/LTC Segment
The Retail/LTC segment sells prescription drugs and a wide assortment of general merchandise, including over-the-counter drugs, beauty products, cosmetics and personal care products, provides health care services through its MinuteClinic® walk-in medical clinics and conducts long-term care (“LTC”) pharmacy operations, which distribute prescription drugs and provide related pharmacy consulting and other ancillary services to chronic care facilities and other care settings. As of March 31, 2019, the Retail/LTC segment operated more than 9,900 retail locations, approximately 1,100 MinuteClinic® locations as well as online retail pharmacy websites, LTC pharmacies and onsite pharmacies.

Health Care Benefits Segment
The Health Care Benefits segment is one of the nation’s leading diversified health care benefits providers, serving an estimated 38 million people as of March 31, 2019. The Health Care Benefits segment has the information and resources to help members, in consultation with their health care professionals, make more informed decisions about their health care. The Health Care Benefits segment offers a broad range of traditional, voluntary and consumer-directed health insurance products and related services, including medical, pharmacy, dental, behavioral health, medical management capabilities, Medicare Advantage and Medicare Supplement plans, PDPs, Medicaid health care management services, workers’ compensation administrative services

8

and health information technology products and services. The Health Care Benefits segment’s customers include employer groups, individuals, college students, part-time and hourly workers, health plans, health care providers (“providers”), governmental units, government-sponsored plans, labor groups and expatriates. The Company refers to insurance products (where it assumes all or a majority of the risk for medical and dental care costs) as “Insured” and administrative services contract products (where the plan sponsor assumes all or a majority of the risk for medical and dental care costs) as “ASC.”

Corporate/Other Segment
The Company presents the remainder of its financial results in the Corporate/Other segment, which consists of:

•
Management and administrative expenses to support the overall operations of the Company, which include certain aspects of executive management and the corporate relations, legal, compliance, human resources, information technology and finance departments and acquisition-related transaction and integration costs; and
•
Products for which the Company no longer solicits or accepts new customers such as its large case pensions and long-term care insurance products.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of CVS Health Corporation and its subsidiaries have been prepared in accordance with the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”) regarding interim financial reporting. In accordance with such rules and regulations, certain information and accompanying note disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted, although the Company believes the disclosures included herein are adequate to make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto, which are included in Exhibit 13.1 to the Company’s Annual Report on Form 10‑K for the year ended December 31, 2018 (the “2018 Form 10‑K”).
 
In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the interim periods presented. Because of the influence of various factors on the Company’s operations, including business combinations, certain holidays and other seasonal influences, net income for any interim period may not be comparable to the same interim period in previous years or necessarily indicative of income for the full year.

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts of CVS Health Corporation and its majority-owned subsidiaries and the variable interest entities (“VIEs”) for which the Company is the primary beneficiary. All material intercompany balances and transactions have been eliminated.
 
The Company continually evaluates its investments to determine if they represent variable interests in a VIE. If the Company determines that it has a variable interest in a VIE, the Company then evaluates if it is the primary beneficiary of the VIE. The evaluation is a qualitative assessment as to whether the Company has the ability to direct the activities of a VIE that most significantly impact the entity’s economic performance. The Company consolidates a VIE if it is considered to be the primary beneficiary.

Assets and liabilities of VIEs for which the Company is the primary beneficiary were not significant to the Company’s unaudited condensed consolidated financial statements. VIE creditors do not have recourse against the general credit of the Company.

Reclassifications

Certain prior year amounts have been reclassified to conform with the current year presentation.

Restricted Cash

Restricted cash included in other current assets in the unaudited condensed consolidated balance sheets represents amounts held in escrow accounts in connection with certain recent acquisitions. Restricted cash included in other assets in the unaudited condensed consolidated balance sheets represents amounts held in a trust in one of the Company’s captive insurance companies

9

to satisfy collateral requirements associated with the assignment of certain insurance polices. All restricted cash is invested in time deposits, money market funds or commercial paper. The following represents a reconciliation of cash and cash equivalents in the unaudited condensed consolidated balance sheets to total cash, cash equivalents and restricted cash in the unaudited condensed consolidated statements of cash flows:
In millions
March 31,
2019
    
December 31,
2018
Cash and cash equivalents
$
5,896

 
$
4,059

Restricted cash (included in other current assets)
6

 
6

Restricted cash (included in other assets)
266

 
230

Total cash, cash equivalents and restricted cash in the statements of cash flows
$
6,168

 
$
4,295

 
 
 
 

Accounts Receivable

Accounts receivable are stated net of allowances for doubtful accounts, customer credit allowances, contractual allowances and estimated terminations. Accounts receivable, net is composed of the following:
In millions
March 31,
2019
    
December 31,
2018
Trade receivables
$
7,158

 
$
6,896

Vendor and manufacturer receivables
8,901

 
7,655

Premium receivables
2,582

 
2,259

Other receivables
868

 
821

   Total accounts receivable, net
$
19,509

 
$
17,631

 
 
 
 

Revenue Recognition

The following is a discussion of the Company’s revenue recognition policies by segment.

Pharmacy Services Segment

The Pharmacy Services segment sells prescription drugs directly through its mail service dispensing pharmacies and indirectly through the Company’s retail pharmacy network. The Company’s pharmacy benefit arrangements are accounted for in a manner consistent with a master supply arrangement as there are no contractual minimum volumes and each prescription is considered a separate purchasing decision and distinct performance obligation transferred at a point in time. PBM services performed in connection with each prescription claim are considered part of a single performance obligation which culminates in the dispensing of prescription drugs.

The Company recognizes revenue using the gross method at the contract price negotiated with its clients when the Company has concluded it controls the prescription drug before it is transferred to the client plan members. The Company controls prescriptions dispensed indirectly through its retail pharmacy network because it has separate contractual arrangements with those pharmacies, has discretion in setting the price for the transaction and assumes primary responsibility for fulfilling the promise to provide prescription drugs to its client plan members while also performing the related PBM services.

Revenues include (i) the portion of the price the client pays directly to the Pharmacy Services segment, net of any discounts earned on brand name drugs or other discounts and refunds paid back to the client (see “Drug Discounts” and “Guarantees” below), (ii) the price paid to the Pharmacy Services segment by client plan members for mail order prescriptions and the price paid to retail network pharmacies by client plan members for retail prescriptions (“Retail Co-Payments”), and (iii) claims based administrative fees for retail pharmacy network contracts. Sales taxes are not included in revenue.

The Company recognizes revenue when control of the prescription drugs is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to receive in exchange for those prescription drugs. The following revenue recognition policies have been established for the Pharmacy Services segment:

•
Revenues generated from prescription drugs sold by mail service dispensing pharmacies are recognized when the prescription drug is delivered to the client plan member. At the time of delivery, the Company has performed substantially

10

all of its performance obligations under its client contracts and does not experience a significant level of returns or reshipments.
•
Revenues generated from prescription drugs sold by third-party pharmacies in the Company’s retail pharmacy network and associated administrative fees are recognized at the Company’s point-of-sale, which is when the claim is adjudicated by the Company’s online claims processing system and the Company has transferred control of the prescription drug and performed all of its performance obligations.

For contracts under which the Pharmacy Services segment acts as an agent or does not control the prescription drugs prior to transfer to the client plan member, revenue is recognized using the net method.

Drug Discounts
The Pharmacy Services segment records revenue net of manufacturers’ rebates earned by its clients based on their plan members’ utilization of brand name formulary drugs. The Pharmacy Services segment estimates these rebates at period-end based on actual and estimated claims data and its estimates of the manufacturers’ rebates earned by its clients. The estimates are based on the best available data at period-end and recent history for the various factors that can affect the amount of rebates due to the client. The Pharmacy Services segment adjusts its rebates payable to clients to the actual amounts paid when these rebates are paid or as significant events occur. Any cumulative effect of these adjustments is recorded against revenues as identified. Adjustments generally result from contract changes with clients or manufacturers that have retroactive rebate adjustments, differences between the estimated and actual product mix subject to rebates, or whether the brand name drug was included in the applicable formulary. The effect of adjustments between estimated and actual manufacturers’ rebate amounts has not been material to the Company’s operating results or financial condition.

Guarantees
The Pharmacy Services segment also adjusts revenues for refunds owed to clients resulting from pricing guarantees and performance against defined service and performance metrics. The inputs to these estimates are not subject to a high degree of subjectivity or volatility. The effect of adjustments between estimated and actual pricing and performance refund amounts has not been material to the Company’s operating results or financial condition.

Retail/LTC Segment

Retail Pharmacy
The Company’s retail drugstores recognize revenue at the time the customer takes possession of the merchandise. For pharmacy sales, each prescription claim is its own arrangement with the customer and is a performance obligation, separate and distinct from other prescription claims under other retail network arrangements. Revenues are adjusted for refunds owed to third party payers for pricing guarantees and performance against defined value-based service and performance metrics. The inputs to these estimates are not subject to a high degree of subjectivity or volatility. The effect of adjustments between estimated and actual pricing and performance refund amounts has not been material to the Company’s operating results or financial condition.

Revenue from Company gift cards purchased by customers is deferred as a contract liability until goods or services are transferred. Any amounts not expected to be redeemed by customers (i.e., breakage) are recognized based on historical redemption patterns.

Customer returns are not material to the Company’s operating results or financial condition. Sales taxes are not included in revenue.

Loyalty Program
The Company’s customer loyalty program, ExtraCare®, consists of two components, ExtraSavingsTM and ExtraBucks® Rewards. ExtraSavings are coupons that are recorded as a reduction of revenue when redeemed as the Company has concluded that they do not represent a promise to the customer to deliver additional goods or services at the time of issuance because they are not tied to a specific transaction or spending level.

ExtraBucks Rewards are accumulated by customers based on their historical spending levels. Thus, the Company has determined that there is an additional performance obligation to those customers at the time of the initial transaction. The Company allocates the transaction price to the initial transaction and the ExtraBucks Rewards transaction based upon the relative standalone selling price, which considers historical redemption patterns for the rewards. Revenue allocated to ExtraBucks Rewards is recognized as those rewards are redeemed. At the end of each period, unredeemed rewards are reflected as a contract liability.


11

Long-term Care
Revenue is recognized when control of the promised goods or services is transferred to customers in an amount that reflects the consideration the Company expects to be entitled to receive in exchange for those goods or services. Each prescription claim represents a separate performance obligation of the Company, separate and distinct from other prescription claims under customer arrangements. A significant portion of Long-term Care revenue from sales of pharmaceutical and medical products is reimbursed by the federal Medicare Part D program and, to a lesser extent, state Medicaid programs. The Company monitors its revenues and receivables from these reimbursement sources, as well as other third-party insurance payors, and reduces revenue at the revenue recognition date to properly account for the variable consideration due to anticipated differences between billed and reimbursed amounts. Accordingly, the total revenues and receivables reported in the Company’s unaudited condensed consolidated financial statements are recorded at the amount expected to be ultimately received from these payors.

Patient co-payments associated with Medicare Part D, certain state Medicaid programs, Medicare Part B and certain third-party payors are typically not collected at the time products are delivered or services are rendered, but are billed to the individuals as part of normal billing procedures and subject to normal accounts receivable collections procedures.

Walk-In Medical Clinics
For services provided by the Company’s walk-in medical clinics, revenue recognition occurs for completed services provided to patients, with adjustments taken for third-party payor contractual obligations and patient direct bill historical collection rates.

Health Care Benefits Segment

Premium Revenue
Premiums are recognized as revenue in the month in which the enrollee is entitled to receive health care services. Premiums are reported net of an allowance for estimated terminations and uncollectible amounts. Additionally, premium revenue subject to the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010’s (as amended, collectively, the “ACA’s”) minimum medical loss ratio (“MLR”) rebate requirements is recorded net of the estimated minimum MLR rebates for the current calendar year. Premiums related to unexpired contractual coverage periods (unearned premiums) are reported as other insurance liabilities on the unaudited condensed consolidated balance sheets and recognized as revenue when earned.

Some of the Company’s contracts allow for premiums to be adjusted to reflect actual experience or the relative health status of Insured members. Such adjustments are reasonably estimable at the outset of the contract, and adjustments to those estimates are made based on actual experience of the customer emerging under the contract and the terms of the underlying contract.

Services Revenue
Services revenue relates to contracts that can include various combinations of services or series of services which generally are capable of being distinct and accounted for as separate performance obligations. Health Care Benefits segment services revenue consists of the following components:

•
ASC fees are received in exchange for performing certain claim processing and member services for ASC members. ASC fee revenue is recognized over the period the service is provided. Some of the Company’s administrative services contracts include guarantees with respect to certain functions, such as customer service response time, claim processing accuracy and claim processing turnaround time, as well as certain guarantees that a plan sponsor’s benefit claim experience will fall within a certain range. With any of these guarantees, the Company is financially at risk if the conditions of the arrangements are not met, although the maximum amount at risk is typically limited to a percentage of the fees otherwise payable to the Company by the customer involved. Each period the Company estimates its obligations under the terms of these guarantees and records its estimate as an offset to service revenues.
•
Workers’ compensation administrative services consist of fee-based managed care services. Workers’ compensation administrative services revenue is recognized once the service is provided.


12

Disaggregation of Revenue
The following table disaggregates the Company’s revenue by major source in each segment for the three months ended March 31, 2019 and 2018:
 
Pharmacy
 
Retail/
 
Health Care
 
Corporate/
 
Intersegment
 
Consolidated
In millions
Services
    
LTC
    
Benefits
 
Other
 
Eliminations
    
Totals
Three Months Ended March 31, 2019
 
 
 
 
 
 
 
 
 
 
 
Major goods/services lines:
 
 
 
 
 
 
 
 
 
 
 
Pharmacy
$
33,413

 
$
16,118

 
$
—

 
$
—

 
$
(11,007
)
 
$
38,524

Front Store
—

 
4,799

 
—

 
—

 
—

 
4,799

Premiums
—

 
—

 
16,259

 
23

 
—

 
16,282

Net investment income
—

 
—

 
164

 
85

 
—

 
249

Other
145

 
198

 
1,447

 
2

 
—

 
1,792

Total
$
33,558

 
$
21,115

 
$
17,870

 
$
110

 
$
(11,007
)
 
$
61,646

 
 
 
 
 
 
 
 
 
 
 
 
Pharmacy Services distribution channel:
 
 
 
 
 
 
 
 
 
 
Pharmacy network (1)
$
21,574

 
 
 
 
 
 
 
 
 
 
Mail choice (2)
11,839

 
 
 
 
 
 
 
 
 
 
Other
145

 
 
 
 
 
 
 
 
 
 
Total
$
33,558

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended March 31, 2018
 
 
 
 
 
 
 
 
 
 
 
Major goods/services lines:
 
 
 
 
 
 
 
 
 
 
 
Pharmacy
$
32,406

 
$
15,500

 
$
—

 
$
—

 
$
(8,601
)
 
$
39,305

Front Store
—

 
4,726

 
—

 
—

 
—

 
4,726

Premiums
—

 
—

 
1,306

 
—

 
—

 
1,306

Net investment income
—

 
—

 
2

 
48

 
—

 
50

Other
140

 
206

 
10

 
—

 
—

 
356

Total
$
32,546

 
$
20,432

 
$
1,318

 
$
48

 
$
(8,601
)
 
$
45,743

 
 
 
 
 
 
 
 
 
 
 
 
Pharmacy Services distribution channel:
 
 
 
 
 
 
 
 
 
 
Pharmacy network (1)
$
21,198

 
 
 
 
 
 
 
 
 
 
Mail choice (2)
11,208

 
 
 
 
 
 
 
 
 
 
Other
140

 
 
 
 
 
 
 
 
 
 
Total
$
32,546

 
 
 
 
 
 
 
 
 
 
_____________________________________________ 
(1)
Pharmacy Services pharmacy network is defined as claims filled at retail and specialty retail pharmacies, including the Company’s retail pharmacies and LTC pharmacies, but excluding Maintenance Choice® activity, which is included within the mail choice category.
(2)
Pharmacy Services mail choice is defined as claims filled at a Pharmacy Services mail facility, which includes specialty mail claims inclusive of Specialty Connect® claims picked up at a CVS Pharmacy retail store, as well as prescriptions filled at the Company’s retail pharmacies under the Maintenance Choice program, which permits eligible client plan members to fill their maintenance prescriptions through mail order delivery or at a CVS Pharmacy retail store for the same price as mail order.

Contract Balances
Contract liabilities primarily represent the Company’s obligation to transfer additional goods or services to a customer for which the Company has received consideration, for example ExtraBucks® Rewards and unredeemed Company gift cards. The consideration received remains a contract liability until goods or services have been provided to the customer. In addition, the Company recognizes breakage on Company gift cards based on historical redemption patterns.


13

The following table provides information about receivables and contract liabilities from contracts with customers:
 
 
 
 
In millions
March 31,
2019
    
December 31,
2018
Trade receivables (included in accounts receivable, net)
$
7,158

 
$
6,896

Contract liabilities (included in accrued expenses)
75

 
67

 
 
 
 

During the three months ended March 31, 2019, the contract liabilities balance includes increases related to customers’ earnings in ExtraBucks Rewards or issuances of Company gift cards and decreases for revenues recognized during the period as a result of the redemption of ExtraBucks Rewards or Company gift cards and breakage of Company gift cards. Below is a summary of such changes:
 
 
In millions
 
Balance at December 31, 2018
$
67

Loyalty program earnings and gift card issuances
90

Redemption and breakage
(82
)
Balance at March 31, 2019
$
75

 
 

Related Party Transactions

The Company has an equity method investment in SureScripts, LLC (“SureScripts”), which operates a clinical health information network. The Company utilizes this clinical health information network in providing services to its client plan members and retail customers. The Company expensed fees for the use of this network of approximately $10 million and $22 million in the three months ended March 31, 2019 and 2018, respectively. The Company’s investment in and equity in the earnings of SureScripts for all periods presented is immaterial.

The Company has an equity method investment in Heartland Healthcare Services (“Heartland”). Heartland operates several LTC pharmacies in four states. Heartland paid the Company approximately $25 million and $35 million for pharmaceutical inventory purchases during the three months ended March 31, 2019 and 2018, respectively. Additionally, the Company performs certain collection functions for Heartland and then passes those customer cash collections back to Heartland. The Company’s investment in and equity in the earnings of Heartland for all periods presented is immaterial.

New Accounting Pronouncements Recently Adopted

Leases
In February 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU 2016-02, Leases (Topic 842). Lessees are required to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). The liability is equal to the present value of lease payments. The asset is based on the liability, subject to certain adjustments, such as for initial direct costs. For income statement purposes, a dual model was retained, requiring leases to be classified as either operating or finance leases. Operating leases result in straight-line expense (similar to operating leases under the prior accounting standard) while finance leases result in a front-loaded expense pattern (similar to capital leases under the prior accounting standard). Lessor accounting is similar to the prior model, but updated to align with certain changes to the lessee model (e.g., certain definitions, such as initial direct costs, have been updated) and the new revenue recognition standard that was adopted in 2018.

The Company adopted this new accounting standard on January 1, 2019 on a modified retrospective basis and applied the new standard to all leases through a cumulative-effect adjustment to beginning retained earnings. As a result, comparative financial information has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company elected the package of practical expedients permitted under the transition guidance within the new standard, which includes, among other things, the ability to carry forward the existing lease classification. On January 1, 2019, the Company recorded an after-tax transition adjustment to increase retained earnings by approximately $178 million ($241 million prior to tax effect). The new standard had a material impact on the unaudited condensed consolidated balance sheet, but did not materially impact the Company’s consolidated operating results and had no impact on the Company’s cash flows.


14

The following is a discussion of the Company’s lease policy under the new lease accounting standard:

The Company determines if an arrangement contains a lease at the inception of a contract. Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Right-of-use assets and lease liabilities are recognized at the commencement date based on the present value of the remaining future minimum lease payments. As the interest rate implicit in the Company’s leases is not readily determinable, the Company utilizes its incremental borrowing rate, determined by class of underlying asset, to discount the lease payments. The operating lease right-of-use assets also include lease payments made before commencement and exclude lease incentives.

The Company’s real estate leases typically contain options that permit renewals for additional periods of up to five years each. For real estate leases, the options to extend are not considered reasonably certain at lease commencement because the Company reevaluates each lease on a regular basis to consider the economic and strategic incentives of exercising the renewal options, and regularly opens or closes stores to align with its operating strategy. Generally, the renewal option periods are not included within the lease term and the associated payments are not included in the measurement of the right-of-use asset and lease liability. Similarly, renewal options are not included in the lease term for non-real estate leases because they are not considered reasonably certain of being exercised at lease commencement. Leases with an initial term of 12 months or less are not recorded on the balance sheets and lease expense is recognized on a straight-line basis over the term of the short-term lease.

For real estate leases, the Company accounts for lease components and nonlease components as a single lease component. Certain real estate leases require additional payments based on sales volume, as well as reimbursement for real estate taxes, common area maintenance and insurance, which are expensed as incurred as variable lease costs. Other real estate leases contain one fixed lease payment that includes real estate taxes, common area maintenance and insurance. These fixed payments are considered part of the lease payment and included in the right-of-use assets and lease liabilities.

See Note 5 ‘‘Leases’’ for additional information.


15

Impact of New Lease Standard on Balance Sheet Line Items
As a result of applying the new lease standard using a modified retrospective method, the following adjustments were made to accounts on the condensed consolidated balance sheet as of January 1, 2019:
 
 
Impact of Change in Accounting Policy
 
    
As Reported
    
 
    
Adjusted
In millions
 
December 31, 2018
 
Adjustments
 
January 1, 2019
Condensed Consolidated Balance Sheets:
 
 
 
 
 
 
Other current assets
 
$
4,581

 
$
(48
)
 
$
4,533

Total current assets
 
45,243

 
(48
)
 
45,195

Property and equipment, net
 
11,349

 
11

 
11,360

Operating lease right-of-use assets
 
—

 
20,987

 
20,987

Intangible assets, net
 
36,524

 
(217
)
 
36,307

Other assets
 
5,046

 
(521
)
 
4,525

Total assets
 
196,456

 
20,212

 
216,668

Accrued expenses
 
10,711

 
(52
)
 
10,659

Current portion of operating lease liabilities
 
—

 
1,803

 
1,803

Current portion of long-term debt
 
1,265

 
2

 
1,267

Total current liabilities
 
44,009

 
1,753

 
45,762

Long-term operating lease liabilities
 
—

 
18,832

 
18,832

Long-term debt
 
71,444

 
(96
)
 
71,348

Deferred income taxes
 
7,677

 
63

 
7,740

Other long-term liabilities
 
2,780

 
(518
)
 
2,262

Total liabilities
 
137,913

 
20,034

 
157,947

Retained earnings
 
40,911

 
178

 
41,089

Total CVS Health shareholders’ equity
 
58,225

 
178

 
58,403

Total shareholders’ equity
 
58,543

 
178

 
58,721


Accounting for Interest Associated with the Purchase of Callable Debt Securities
In March 2017, the FASB issued ASU 2017-08, Accounting for Interest Associated with the Purchase of Callable Debt Securities (Topic 310). Under this standard, premiums on callable debt securities are amortized to the earliest call date rather than to the contractual maturity date. Callable debt securities held at a discount will continue to be amortized to the contractual maturity date. The Company adopted this new accounting guidance on January 1, 2019 on a modified retrospective basis and recorded an immaterial cumulative effect adjustment from accumulated other comprehensive income to retained earnings on the condensed consolidated balance sheet.

New Accounting Pronouncements Not Yet Adopted

Measurement of Credit Losses on Financial Instruments
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326). This standard requires the use of a forward-looking expected loss impairment model for trade and other receivables, held-to-maturity debt securities, loans and other instruments. This standard also requires impairments and recoveries for available-for-sale debt securities to be recorded through an allowance account and revises certain disclosure requirements. The standard is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The Company is currently evaluating the effect that implementation of this standard will have on the Company’s consolidated operating results, cash flows, financial condition and related disclosures.

Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and other - Internal-Use Software (Topic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract. This standard requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in Topic 350-40 to determine which implementation costs to capitalize as assets. The standard is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is

16

permitted. The Company is currently evaluating the effect that implementation of this standard will have on the Company’s consolidated operating results, cash flows, financial condition and related disclosures.

Targeted Improvements to the Accounting for Long-Duration Insurance Contracts
In August 2018, the FASB issued ASU 2018-12, Targeted Improvements to the Accounting for Long-Duration Contracts (Topic 944). This standard requires the Company to review cash flow assumptions for its long-duration insurance contracts at least annually and recognize the effect of changes in future cash flow assumptions in net income. This standard also requires the Company to update discount rate assumptions quarterly and recognize the effect of changes in these assumptions in other comprehensive income. The rate used to discount the Company’s liability for future policy benefits will be based on an estimate of the yield for an upper-medium-grade fixed-income instrument. In addition, this standard changes the amortization method for deferred acquisition costs and requires additional disclosures regarding the long duration insurance contract liabilities in the Company’s interim and annual financial statements. The standard is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. The Company is currently evaluating the effect that implementation of this standard will have on the Company’s consolidated operating results, cash flows, financial condition and related disclosures.

2.
Acquisition of Aetna

On the Aetna Acquisition Date, the Company acquired 100% of the outstanding shares and voting interests of Aetna for a combination of cash and stock. Under the terms of the merger agreement, Aetna shareholders received $145.00 in cash and 0.8378 CVS Health shares for each Aetna share. The transaction valued Aetna at approximately $212 per share or approximately $70 billion. Including the assumption of Aetna’s debt, the total value of the transaction was approximately $78 billion. The Company financed the cash portion of the purchase price through a combination of cash on hand and by issuing approximately $45 billion of new debt, including senior notes and term loans. Aetna is a leading health care benefits company that offers a broad range of traditional, voluntary, and consumer-directed health insurance products and related services. The Company acquired Aetna to help improve the consumer health care experience by combining Aetna’s health care benefits products and services with CVS Health’s more than 9,900 retail locations, approximately 1,100 walk-in medical clinics and integrated pharmacy capabilities with the goal of becoming the new, trusted front door to health care.

The transaction has been accounted for using the acquisition method of accounting which requires, among other things, the assets acquired and liabilities assumed to be recognized at their fair values at the date of acquisition. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition:
In millions
 
Cash and cash equivalents
$
6,565

Accounts receivable
4,089

Other current assets
3,896

Investments (current and long-term)
17,984

Goodwill
47,082

Intangible assets
23,086

Other long-term assets
8,249

Total assets acquired
110,951

Health care costs payable
5,293

Other current liabilities
9,982

Debt (current and long-term)
8,098

Deferred income taxes
4,414

Other long-term liabilities
13,078

Total liabilities assumed
40,865

Noncontrolling interests
320

Total consideration transferred
$
69,766


The assessment of fair value is preliminary and is based on information that was available to management at the time the unaudited condensed consolidated financial statements were prepared. The most significant open items included the valuation of certain intangible assets, the accounting for income taxes and the accounting for contingencies as management is awaiting

17

additional information to complete its assessment of these matters. Measurement period adjustments will be recorded in the period in which they are determined, as if they had been completed at the acquisition date. Measurement period adjustments to assets acquired and liabilities assumed during the three months ended March 31, 2019 primarily related to additional information received related to certain valuations and contingencies and the related impact on the accounting for income taxes and goodwill. There were no material income statement measurement period adjustments recorded during the three months ended March 31, 2019.

Unaudited pro forma financial information
The following unaudited pro forma information presents a summary of the Company’s combined operating results for the three months March 31, 2018 as if the Aetna acquisition and the related financing transactions had occurred on January 1, 2017. The following pro forma financial information is not necessarily indicative of the Company’s operating results as they would have been had the acquisition been effected on the assumed date, nor is it necessarily an indication of trends in future results for a number of reasons, including, but not limited to, differences between the assumptions used to prepare the pro forma information, basic shares outstanding and dilutive equivalents, cost savings from operating efficiencies, potential synergies, and the impact of incremental costs incurred in integrating the businesses.
In millions, except per share amounts
 
 
Total revenues
 
$
59,093

Net income attributable to CVS Health
 
1,807

Net income per share attributable to CVS Health:
 
 
Basic
 
$
1.40

Diluted
 
$
1.39

 
 
 

The pro forma results for the three months ended March 31, 2018 include adjustments related to the following purchase accounting and acquisition-related items:

•
Elimination of intercompany transactions between CVS Health and Aetna;
•
Elimination of estimated foregone interest income associated with (i) cash assumed to have been used to partially fund the Aetna Acquisition and (ii) adjusting the amortized cost of Aetna’s investment portfolio to fair value as of the completion of the Aetna Acquisition;
•
Elimination of historical intangible asset, deferred acquisition cost and capitalized software amortization expense and addition of amortization expense based on the current preliminary values of identified intangible assets;
•
Additional interest expense from (i) the long-term debt issued to partially fund the Aetna Acquisition and (ii) the amortization of the fair value adjustment to assumed long-term debt.
•
Additional depreciation expense related to the adjustment of Aetna’s property and equipment to fair value;
•
Adjustments to align CVS Health’s and Aetna’s accounting policies;
•
Elimination of transaction related costs; and
•
Tax effects of the adjustments noted above.

3.
Investments

Total investments at March 31, 2019 and December 31, 2018 were as follows:
 
March 31, 2019
 
December 31, 2018
In millions
Current
 
Long-term
 
Total
 
Current
 
Long-term
 
Total
Debt securities available for sale
$
2,286

 
$
13,611

 
$
15,897

 
$
2,359

 
$
12,896

 
$
15,255

Mortgage loans
123

 
1,215

 
1,338

 
145

 
1,216

 
1,361

Other investments
17

 
1,584

 
1,601

 
18

 
1,620

 
1,638

Total investments
$
2,426

 
$
16,410

 
$
18,836

 
$
2,522

 
$
15,732

 
$
18,254



18

Debt Securities
Debt securities available for sale at March 31, 2019 and December 31, 2018 were as follows:
In millions
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
March 31, 2019
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
U.S. government securities
$
1,704

 
$
40

 
$
—

 
$
1,744

States, municipalities and political subdivisions
2,246

 
71

 
—

 
2,317

U.S. corporate securities
6,777

 
288

 
(1
)
 
7,064

Foreign securities
2,243

 
110

 
—

 
2,353

Residential mortgage-backed securities
577

 
18

 
—

 
595

Commercial mortgage-backed securities
608

 
29

 
—

 
637

Other asset-backed securities
1,148

 
8

 
(7
)
 
1,149

Redeemable preferred securities
32

 
6

 
—

 
38

Total debt securities (1)
$
15,335

 
$
570

 
$
(8
)
 
$
15,897

 
 
 
 
 
 
 
 
December 31, 2018
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

U.S. government securities
$
1,662

 
$
26

 
$
—

 
$
1,688

States, municipalities and political subdivisions
2,370

 
30

 
(1
)
 
2,399

U.S. corporate securities
6,444

 
61

 
(16
)
 
6,489

Foreign securities
2,355

 
31

 
(3
)
 
2,383

Residential mortgage-backed securities
567

 
10

 
—

 
577

Commercial mortgage-backed securities
594

 
11

 
—

 
605

Other asset-backed securities
1,097

 
3

 
(15
)
 
1,085

Redeemable preferred securities
30

 
—

 
(1
)
 
29

Total debt securities (1)
$
15,119

 
$
172

 
$
(36
)
 
$
15,255

 
 
 
 
 
 
 
 
_____________________________________________ 
(1)
Investment risks associated with the Company’s experience-rated products generally do not impact the Company’s consolidated operating results. At March 31, 2019, debt securities with a fair value of $939 million, gross unrealized capital gains of $45 million and no gross unrealized capital losses and at December 31, 2018, debt securities with a fair value of $916 million, gross unrealized capital gains of $12 million and gross unrealized capital losses of $2 million were included in total debt securities, but support experience-rated products. Changes in net unrealized capital gains (losses) on these securities are not reflected in accumulated other comprehensive income.

The fair value of debt securities at March 31, 2019 is shown below by contractual maturity. Actual maturities may differ from contractual maturities because securities may be restructured, called or prepaid, or the Company intends to sell a security prior to maturity.
In millions
Amortized
Cost
 
Fair
Value
Due to mature:
 
 
 
Less than one year
$
990

 
$
993

One year through five years
5,511

 
5,630

After five years through ten years
2,991

 
3,125

Greater than ten years
3,510

 
3,768

Residential mortgage-backed securities
577

 
595

Commercial mortgage-backed securities
608

 
637

Other asset-backed securities
1,148

 
1,149

Total
$
15,335

 
$
15,897


19

Summarized below are the debt securities the Company held at March 31, 2019 and December 31, 2018 that were in an unrealized capital loss position:
In millions, except number of securities
Number of Securities
 
Fair Value
 
Unrealized Losses
March 31, 2019
 
 
 
 
 
Debt securities:
 
 
 
 
 
U.S. government securities
12

 
$
30

 
$
—

States, municipalities and political subdivisions
26

 
39

 
—

U.S. corporate securities
70

 
94

 
1

Foreign securities
39

 
47

 
—

Residential mortgage-backed securities
23

 
—

 
—

Commercial mortgage-backed securities
1

 
2

 
—

Other asset-backed securities
487

 
486

 
7

Redeemable preferred securities
1

 
6

 
—

Total debt securities
659

 
$
704

 
$
8

 
 
 
 
 
 
December 31, 2018
 
 
 

 
 

Debt securities:
 
 
 

 
 

U.S. government securities
8

 
$
26

 
$
—

States, municipalities and political subdivisions
54

 
86

 
1

U.S. corporate securities
1,399

 
1,431

 
16

Foreign securities
243

 
314

 
3

Residential mortgage-backed securities
45

 
1

 
—

Other asset-backed securities
516

 
528

 
15

Redeemable preferred securities
14

 
23

 
1

Total debt securities
2,279

 
$
2,409

 
$
36

 
 
 
 
 
 

Since Aetna’s investment portfolio was measured at fair value as of the Aetna Acquisition Date, each of the securities in the table above were in an unrealized loss position for less than 12 months. The Company reviewed the securities in the tables above and concluded that these are performing assets generating investment income to support the needs of the Company’s business. In performing this review, the Company considered factors such as the quality of the investment security based on research performed by the Company’s internal credit analysts and external rating agencies and the prospects of realizing the carrying value of the security based on the investment’s current prospects for recovery. As of March 31, 2019, the Company did not intend to sell these securities, and did not believe it was more likely than not that it would be required to sell these securities prior to anticipated recovery of their amortized cost basis.


20

The maturity dates for debt securities in an unrealized capital loss position at March 31, 2019 were as follows:
 
Supporting
experience-rated products
 
Supporting remaining
products
 
Total
In millions
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Due to mature:
 
 
 
 
 
 
 
 
 
 
 
Less than one year
$
1

 
$
—

 
$
20

 
$
—

 
$
21

 
$
—

One year through five years
—

 
—

 
43

 
1

 
43

 
1

After five years through ten years
6

 
—

 
82

 
—

 
88

 
—

Greater than ten years
4

 
—

 
60

 
—

 
64

 
—

Residential mortgage-backed securities
—

 
—

 
—

 
—

 
—

 
—

Commercial mortgage-backed securities
—

 
—

 
2

 
—

 
2

 
—

Other asset-backed securities
—

 
—

 
486

 
7

 
486

 
7

Total
$
11

 
$
—

 
$
693

 
$
8

 
$
704

 
$
8

 
 
 
 
 
 
 
 
 
 
 
 

Mortgage Loans
The Company’s mortgage loans are collateralized by commercial real estate. The Company did not have any mortgage loans during the three months ended March 31, 2018. During the three months ended March 31, 2019, the Company had the following activity in its mortgage loan portfolio:
In millions
 
New mortgage loans
$
41

Mortgage loans fully repaid
52

Mortgage loans foreclosed
—

 
 

The Company assesses mortgage loans on a regular basis for credit impairments, and annually assigns a credit quality indicator to each loan. The Company’s credit quality indicator is internally developed and categorizes its portfolio on a scale from 1 to 7. These indicators are based upon several factors, including current loan to value ratios, property condition, market trends, creditworthiness of the borrower and deal structure. The vast majority of the Company’s mortgage loans fall into categories 2 to 4.

•
Category 1 - Represents loans of superior quality.
•
Categories 2 to 4 - Represent loans where credit risk is minimal to acceptable; however, these loans may display some susceptibility to economic changes.
•
Categories 5 and 6 - Represent loans where credit risk is not substantial, but these loans warrant management’s close attention.
•
Category 7 - Represents loans where collections are potentially at risk; if necessary, an impairment is recorded.

Based upon the most recent assessments at March 31, 2019 and December 31, 2018, the Company’s mortgage loans were given the following credit quality indicators:
In millions, except credit ratings indicator
March 31,
2019
 
December 31,
2018
1
$
41

 
$
42

2 to 4
1,283

 
1,301

5 and 6
14

 
18

7
—

 
—

Total
$
1,338

 
$
1,361

 
 
 
 
 


21

Net Investment Income
Sources of net investment income for the three months ended March 31, 2019 and 2018 were as follows:
 
Three Months Ended
March 31,
In millions
2019
 
2018
Debt securities
$
156

 
$
50

Mortgage loans
17

 
—

Other investments
26

 
—

Gross investment income
199

 
50

Investment expenses
(9
)
 
—

Net investment income (excluding net realized capital gains or losses)
190

 
50

Net realized capital gains (1)
59

 
—

Net investment income (2)
$
249

 
$
50

 
 
 
 
_____________________________________________ 
(1)
Other-than-temporary impairment (“OTTI”) losses on debt securities recognized in the unaudited condensed consolidated statements of operations were $7 million for the three months ended March 31, 2019. There were no OTTI losses on debt securities for the three months ended March 31, 2018.
(2)
Net investment income includes $11 million for the three months ended March 31, 2019 related to investments supporting experience-rated products. The Company had no investments supporting experience-rated products during the three months ended March 31, 2018.

The portion of unrealized capital gains and losses recognized during the three months ended March 31, 2019 related to investments in equity securities held as of the reporting date was not material.

The Company did not have any material proceeds from the sale of available for sale debt securities or related gross realized capital gains or losses for the three months ended March 31, 2018. Excluding amounts related to experience-rated products, proceeds from the sale of available for sale debt securities and the related gross realized capital gains and losses for the three months ended March 31, 2019 were as follows:
In millions
 
Proceeds from sales
$
1,489

Gross realized capital gains
35

Gross realized capital losses
2

 
 

4.
Fair Value

The preparation of the Company’s condensed consolidated financial statements in accordance with GAAP requires certain assets and liabilities to be reflected at their fair value and others to be reflected on another basis, such as an adjusted historical cost basis. The Company’s assets and liabilities carried at fair value have been classified within one of three levels of a hierarchy established by GAAP. The following are the levels of the hierarchy and a brief description of the type of valuation information (“valuation inputs”) that qualifies a financial asset or liability for each level:

•
Level 1 – Unadjusted quoted prices for identical assets or liabilities in active markets.
•
Level 2 – Valuation inputs other than Level 1 that are based on observable market data.  These include: quoted prices for similar assets in active markets, quoted prices for identical assets in inactive markets, valuation inputs that are observable that are not prices (such as interest rates and credit risks) and valuation inputs that are derived from or corroborated by observable markets.
•
Level 3 – Developed from unobservable data, reflecting the Company’s assumptions.

For a description of the methods and assumptions that are used to estimate the fair value and determine the fair value hierarchy classification of each class of financial instrument, see Note 4 “Fair Value” of Notes to Consolidated Financial Statements in Exhibit 13.1 to the 2018 Form 10-K.


22

There were no financial liabilities measured at fair value on a recurring basis on the condensed consolidated balance sheets at March 31, 2019 or December 31, 2018. Financial assets measured at fair value on a recurring basis on the condensed consolidated balance sheets at March 31, 2019 and December 31, 2018 were as follows:
 
 
 
 
 
 
 
 
In millions
Level 1
 
Level 2
 
Level 3
 
Total
March 31, 2019
 
 
 
 
 
 
 
Debt securities:
 
 
 
 
 
 
 
U.S. government securities
$
1,665

 
$
79

 
$
—

 
$
1,744

States, municipalities and political subdivisions
—

 
2,317

 
—

 
2,317

U.S. corporate securities
—

 
7,006

 
58

 
7,064

Foreign securities
—

 
2,350

 
3

 
2,353

Residential mortgage-backed securities
—

 
595

 
—

 
595

Commercial mortgage-backed securities
—

 
637

 
—

 
637

Other asset-backed securities
—

 
1,149

 
—

 
1,149

Redeemable preferred securities
—

 
27

 
11

 
38

Total debt securities
1,665

 
14,160

 
72

 
15,897

Equity securities
9

 
—

 
71

 
80

Total
$
1,674

 
$
14,160

 
$
143

 
$
15,977

 
 
 
 
 
 
 
 
December 31, 2018
 

 
 

 
 

 
 

Debt securities:
 

 
 

 
 

 
 

U.S. government securities
$
1,597

 
$
91

 
$
—

 
$
1,688

States, municipalities and political subdivisions
—

 
2,399

 
—

 
2,399

U.S. corporate securities
—

 
6,422

 
67

 
6,489

Foreign securities
—

 
2,380

 
3

 
2,383

Residential mortgage-backed securities
—

 
577

 
—

 
577

Commercial mortgage-backed securities
—

 
605

 
—

 
605

Other asset-backed securities
—

 
1,085

 
—

 
1,085

Redeemable preferred securities
—

 
22

 
7

 
29

Total debt securities
1,597

 
13,581

 
77

 
15,255

Equity securities
19

 
—

 
54

 
73

Total
$
1,616

 
$
13,581

 
$
131

 
$
15,328


There were no transfers between Levels 1 and 2 during the three months ended March 31, 2019 or 2018. During the three months ended March 31, 2019 and 2018, there were no transfers into or out of Level 3.


23

The carrying value and estimated fair value classified by level of fair value hierarchy for financial instruments carried on the condensed consolidated balance sheets at adjusted cost or contract value at March 31, 2019 and December 31, 2018 were as follows:
 
Carrying
Value
 
 Estimated Fair Value
In millions
 
Level 1
 
Level 2
 
Level 3
 
Total
March 31, 2019
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
Mortgage loans
$
1,338

 
$
—

 
$
—

 
$
1,350

 
$
1,350

Equity securities (1)
135

 
N/A

 
N/A

 
N/A

 
N/A

Liabilities:
 
 
 
 
 
 
 
 
 
Investment contract liabilities:
 
 
 
 
 
 
 
 
 
With a fixed maturity
5

 
—

 
—

 
5

 
5

Without a fixed maturity
377

 
—

 
—

 
364

 
364

Long-term debt
71,781

 
72,376

 
—

 
—

 
72,376

 
 
 
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
Mortgage loans
$
1,361

 
$
—

 
$
—

 
$
1,366

 
$
1,366

Equity securities (1)
140

 
N/A

 
N/A

 
N/A

 
N/A

Liabilities:
 

 
 
 
 
 
 
 
 

Investment contract liabilities:
 

 
 
 
 
 
 
 
 

With a fixed maturity
5

 
—

 
—

 
5

 
5

Without a fixed maturity
382

 
—

 
—

 
357

 
357

Long-term debt
72,709

 
71,252