The Company’s business segments for financial reporting purposes include (i) the Insurance segment (which includes the businesses of the Company’s Self-Employed Agency Division (“SEA”), the Life Insurance Division and Other Insurance); (ii) Other Key Factors (which includes investment income not allocated to the Insurance segment, realized gains or losses on sale of investments, interest expense on corporate debt, general expenses relating to corporate operations, merger transaction expenses, variable non-cash stock-based compensation and operations that do not constitute reportable operating segments); and (iii) Disposed Operations (which includes the Company’s former Star HRG Division and former Student Insurance Division).
During the second quarter of 2006, the Company utilized cash in the amount of approximately $120.9 million for professional fees and expenses associated with the Merger. Of this total cash expended, $47.3 million ($38.2 million, net of tax) was expensed and charged to income in the second quarter of 2006 (which expenses are reflected under the caption “Other expenses” on the Company’s Consolidated Statement of Operations), $31.7 million of fees and expenses related to raising equity in the Merger was reflected as a direct reduction in stockholders’ equity, and $41.9 million ($9.4 million of prepaid monitoring fees and $32.5 million of capitalized financing costs attributable to the issuance of the debt in the Merger) was capitalized (which capitalized financing costs are reflected under the caption “Other assets” on the Company’s Consolidated Balance Sheet). As of December 31, 2006 all of the prepaid monitoring fees and $6.3 million of the capitalized financing cost had been amortized. See Note I. The Company did not incur any additional Merger transaction costs through the remainder of 2006.
The Company maintains for the benefit of its independent agents various stock-based compensation plans, in connection with which it records non-cash variable stock-based compensation expense (benefit) in amounts that depend and fluctuate based upon the performance of the Company’s common stock. In 2006, the
In the second quarter of 2006, the Company determined that sufficient provision for large claims could be made within its normal reserve process, eliminating the need for a previously-established separate large claim reserve. This refinement resulted in a reduction in the claim liability of $10.8 million. Had this refinement been made at December 31, 2005, the claim liability estimate would have been reduced by $10.6 million.
Set forth below is certain summary financial and operating data for the Company’s Other Insurance division for each of the three most recent fiscal years:
Underwriting costs, policy acquisition costs and insurance expenses increased by 2% to $491.5 million in 2005 from $481.3 million in 2004. The increase was primarily due to the expenses incurred with the increased new sales at both the Life Insurance Division and ZON Re.
Total interest expense increased by 76%, to $6.0 million in 2005 from $3.4 million in 2004, primarily due to an increase in the interest rates associated with student loan indebtedness (consisting of borrowings incurred to fund student loan obligations under the Company’s College Fund Life Division program - see Note J of Notes to Consolidated Financial Statements).
In the first quarter of 2005, the Company recorded a favorable claim liability adjustment in the amount of $7.6 million attributable to a refinement of an estimate for the Company’s claim liability established with respect to a product rider that provides for catastrophic coverage on the SEA Division’s scheduled health insurance products. See discussion below under the caption “Change in Claims and Future Benefit Liability Estimates - Self-Employed Agency Division” for additional information with respect to this adjustment.
In the third quarter of 2005, the Company recorded an additional favorable claim liability adjustment in the amount of $33.3 million attributable to a refinement of the Company’s estimate for its claim liability on its health insurance products. The largest portion of this adjustment (approximately $21.0 million) was attributable to a refinement of the estimate of the unpaid claim liability for the most recent incurral months. The Company utilizes anticipated loss ratios to calculate the estimated claim liability for the most recent incurral months. Despite negligible premium rate increases implemented on its most popular
As a result of the favorable claims experience in 2005 associated with the SEA Division’s health insurance products, during the fourth quarter of 2005 the Company implemented reduced premium rates (average 15% reduction) on new business in a number of markets.
Prior approval by insurance regulatory authorities is required for the payment by a domestic insurance company of dividends that exceed certain limitations based on statutory surplus and net income. During 2007, the Company’s domestic insurance companies can pay, without prior approval of the regulatory authorities, aggregate dividends in the ordinary course of business to the holding company of approximately $71.2 million. However, as it has done in the past, the Company will assess the results of operations of the regulated domestic insurance companies to determine the prudent dividend capability of the subsidiaries, consistent with HealthMarkets’ practice of maintaining risk-based capital ratios at each of the Company’s domestic insurance subsidiaries significantly in excess of minimum requirements.
During 2006, the Company received $10.4 million of investment income on short-term investments and other invested assets held at the holding company.
The SEA Division also makes various refinements to the claim liabilities as appropriate. These refinements estimate liabilities for circumstances, such as an excess pending claims inventory (i.e., inventories of pending claims in excess of historical levels) and disputed claims. For example, the Company closely monitors the level of claims that are pending. When the level of pending claims appears to be in excess of “normal” levels, the Company typically establishes a liability for excess pending claims. The Company believes that such an “excess pending claims liability” is appropriate under such circumstances because of the operation of the developmental method used by the Company to calculate the principal claim liability, which method “develops” or “completes” paid claims to estimate the claim liability. When the pending claims inventory is higher than would ordinarily be expected, the level of paid claims is correspondingly lower than would ordinarily be expected. This lower level of paid claims, in turn, results in the developmental method yielding a smaller claim liability than would have been yielded with a normal level of paid claims, resulting in the need for an augmented claim liability.
The total favorable claims liability development experience for 2006 in the amount of $85.8 million represented 19.5% of total claim liabilities established for the SEA Division at December 31, 2005. Most of
The Company accounts for goodwill and other intangible assets under Financial Accounting Standards Board Statement 142, Goodwill and Other Intangible Assets. Statement 142 requires that goodwill and other intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually. Statement 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment. The Company has determined that it will review goodwill and other intangible assets for impairment as of November 1 of each year or more frequently if certain indicators arise. An impairment loss would be recorded in the period such determination was made. Following the Company’s annual review in 2006 for impairment of the goodwill and other intangible assets related to continuing operations, the Company recorded an impairment charge in the amount of $496,000 related to the HealthMarket customer list acquired in October 2004. See Note F of Notes to Consolidated Financial Statements.