Cigna Pins 80 Percent Dip on Fair Value

The health insurer applied FAS 157 to value one of its businesses and saw its first-quarter profits fall dramatically.

Cigna has partly attributed an 80 percent loss in its net income to a new accounting rule. For the first time, the health insurer valued the assets and liabilities of one of its businesses using FAS 157, the guidelines companies use to measure the fair value of financial instruments.

On Thursday, the health insurer reported earning $58 million, or 21 cents per share, during the first quarter, compared with earning $289 million, or 98 cents per share, during the same time last year. Cigna said the loss was partly due to an after-tax $131 million hit in its guaranteed minimum income benefits (GMIB) business.

The company began using FAS 157 on January 1 to value the assets and liabilities of this reinsurance business, which stopped operations eight years ago. GMIB used to sell contracts to cover guaranteed minimum death benefits that were issued by other insurance companies.

According to Cigna’s executives, the “volatility” created by the standard prompted the company to exclude its GMIB reporting for the first time from its adjusted income from operations (a non-GAAP measurement), which were calculated at $265 million for the first quarter of this year (compared to $279 million last year).

Cigna’s executives acknowledged during a morning conference call that using FAS 157 hasn’t been easy. Calling it a “very, very conservative accounting standard,” CFO Michael Bell lamented, “We have to hypothetically put ourselves in the shoes of a buyer of this business and try to say if there was a buyer out there for this book, how would they value it?”

In the past, Cigna would have considered historical cost averages rather than consider a hypothetical exit price, Bell said. The company’s executives said they do not believe the GMIB results represent the true economic reality of the business, and shouldn’t have a material effect on the company’s overall 2008 financial results.

The reliability of fair-value accounting has been questioned by many executives in recent months as the hurting financial markets have led to billions-dollar-plus write-downs for many financial services firms. Fair value critics say its use lead to volatile income statements.

Under the rules, companies measure their assets and liabilities based on an existing market or — in the case of assets that are traded thinly, or not at all — on unobservable estimates based on what value they believe a hypothetical third party would place on those assets. FAS 157 doesn’t force companies to use fair value; it merely tells them how to use it. Once a companies applies fair value to a particular asset, it can’t switch back to historical cost.

During their 2007 fourth-quarter earnings call, Cigna’s leaders warned that future results for their GMIB business would become more volatile because of FAS 157. They predicted a tax charge of between $125 million and $150 million.

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