(1) Further details of the calculation of basic earnings per share are set forth in notes 2 and 21 of the audited consolidated financial statements for the years ended December 31, 2014, 2013 and 2012.
We participate in the managed care market through our subsidiaries, TSS and TSA. TSS, TSA and TSB are BCBSA licensees, which provide us with exclusive use of the Blue Cross and Blue Shield name and mark throughout Puerto Rico, the U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla.
We participate in the life insurance market through our subsidiary, TSV, and in the property and casualty insurance market through our subsidiary, TSP. TSV and TSP represented 6.7% and 4.3%, respectively, of our consolidated premiums earned, net for the year ended December 31, 2014 and 41.2% and 18.2%, respectively, of our operating income for that period.
In December 2014, Triple-S Salud, Inc. (“TSS”) and Triple-S Advantage, Inc. (“TSA”) entered into a novation agreement after obtaining approval from Centers for Medicare and Medicaid Services (“CMS”), whereby all the assets and liabilities of TSS’s Medicare Advantage business were transferred to TSA and TSA assumed all the obligations of the policies and all obligations that may exist under the contracts.
On November 7, 2013, our subsidiary TSV completed the acquisition of 100% of the outstanding capital stock of ASICO (effective March 27, 2014 this entity changed its name from ASICO to Triple-S Blue, Inc. ,“Triple-S Blue” or “TSB”), a life insurance company authorized to do business in Puerto Rico, Costa Rica, Anguilla and the British Virgin Islands. The cost of this acquisition was approximately $9.4 million and was funded with unrestricted cash. Our consolidated results of operations and financial condition included in this Annual Report on Form 10-K reflect TSB’s acquisition in periods subsequent to the effective date of the transaction and were included within the Life Insurance segment.
Our results of operations depend in large part on our ability to maintain or grow our membership. In addition to driving revenues, membership growth is necessary to successfully introduce new products, maintain an extensive network of providers and achieve economies of scale. Our ability to maintain or grow our membership is affected principally by the competitive environment and general market conditions.
TSS has a contract with the Government of Puerto Rico to administer the provision of the physical health component of the Medicaid program (similar to Medicaid) in designated service regions in Puerto Rico. On July 1, 2013, TSS extended this contract for a 12-month period. This amendment also transferred the administration of the three remaining service regions to TSS upon completion of a transition period, which ended on October 1, 2013.
(1) Commercial membership includes corporate accounts, self-funded employers, individual accounts, Medicare Supplement, Federal government employees and local government employees.
Consolidated premiums earned, net decreased by $74.4 million, or 3.4%, to $2.1 billion during the year ended December 31, 2014 compared to the year ended December 31, 2013. The decrease was mostly the result of lower member month enrollment in the Commercial and Medicare businesses and the receipt of lower risk score adjustments from CMS in 2014 as compared to 2013.
The consolidated administrative service fees increased by $10.6 million, or 9.8%, to $119.3 million for the year ended December 31, 2014 when compared with the year ended December 31, 2013, mostly as the result of the increased enrollment after the addition of the three new Medicaid regions effective October 1, 2013.
Consolidated other income decreased by $13.0 million during the year ended December 31, 2014 when compared to the year ended December 31, 2013, mostly due to a special distribution received the year ended December 31, 2013 from the Puerto Rico Joint Underwriting Association (“JUA”) in the Property and Casualty segment of $12.8 million, net of a special tax.
Consolidated income tax expense during the year ended December 31, 2014 decreased by $1.6 million, or 69.6%, to $0.7 million when compared to the income tax expense during the year ended December 31, 2013. This decrease is primarily due to an income tax benefit of $17.0 million that principally results from the enactment of a local law that provided a temporary preferential tax rate in capital asset transactions during the last quarter of 2014, together with the execution of a Closing Agreement between TSM and its subsidiaries and the Puerto Rico Treasury Department in connection with this law. These events allowed the Company to benefit from the enacted lower taxable rate and to reassess deferred taxes upon the changes in the tax bases of some assets and tax attributes that became realizable. This benefit was offset by an additional tax expense of $6.3 million resulting from the increase in the corporate tax rate over long-term capital gains from 15% to 20% for all transactions occurring after June 30, 2014.
Year ended December 31, 2013 compared with the year ended December 31, 2012
Consolidated net realized investment gains of $2.6 million during the year ended December 31, 2013 are the result of net realized gains from the sale of debt and equity securities classified as available for sale, following our asset/liability management and tax planning strategies. The net realized gains were partially offset by a $1.0 million other-than-temporary impairments related to certain equity securities that have been at an unrealized loss for a period exceeding six months.
Consolidated income tax expense during the year ended December 31, 2013 decreased by $10.2 million, or 81.6%, to $2.3 million as compared to the income tax expense during the year ended December 31, 2012. This decrease is primarily due to the effect of a $7.7 million adjustment to the consolidated net deferred tax assets after an increase in the enacted tax rate from 30% to 39% and the lower income before taxes during the year 2013, net of additional tax expense due to the aforementioned tax rate increase that was effective January 1, 2013. The effective tax rate decreased from 18.8% in 2012 to 4.0% in 2013 primarily reflecting the net effect of the change in the enacted tax rate.
We offer our products in the managed care segment to three distinct market sectors in Puerto Rico: Commercial, Medicare (including Medicare Advantage and PDP) and Medicaid. For the year ended December 31, 2014, the Commercial sector represented 41.4% and 28.2% of our consolidated premiums earned, net and operating income, respectively. Premiums earned, net and operating income generated from our Medicare contracts (including PDP) during the year ended December 31, 2014 represented 47.5% and -11.2%, respectively, of our consolidated earned premiums, net and operating income, respectively. The operating income of the Medicaid sector represented 35.7% of the consolidated operating income for the year ended December 31, 2014.
Administrative service fees increased by $10.8 million, or 9.6%, to $123.6 million during the year ended December 31, 2014. This is primarily a result of higher Medicaid enrollment after the addition of three regions effective October 1, 2013.
Medical claims incurred during the year ended December 31, 2014 decreased by $83.8 million, or 4.9%, to $1.6 billion, when compared to the prior year. The MLR of the segment was 85.9%, decreasing by 80 basis points during the year ended December 31, 2014. These fluctuations are primarily attributed to the effect of the following:
• The medical claims incurred of the commercial business decreased by $85.6 million, or 10.2%, during the 2014 period mostly reflecting a lower fully-insured member month enrollment. The 2014 Commercial MLR was 85.3%, which is 430 basis points lower than the prior year. Excluding the effect of prior period reserve developments in 2014 and 2013, the MLR would have increased by 100 basis points, mostly reflecting higher cost trends, particularly for pharmacy benefits.
Medical operating expenses for the year ended December 31, 2014 increased by $19.4 million, or 5.5%, to $374.2 million when compared to the year ended December 31, 2013. The operating expense ratio increased by 150 basis points, from 17.0% in 2013 to 18.5% in 2014. This increase is mainly related to $27.7 million of Health Insurance Providers Fee that became effective January 1, 2014, increase of $3.3 million of premium taxes that became effective July 1, 2013 and incremental expenses related to the administration of the three new service regions of the Medicaid program effective October 1, 2013. The effect of new taxes and fees and the increased Medicaid enrollment was partially offset by the impact of cost containment initiatives in place during the 2014 period.
• Medical premiums generated by the Medicare business decreased by $34.6 million, or 3.2%, to $1.0 billion. This fluctuation is the result of an overall decrease in the member month enrollment of this business by 83,828, or 5.8%, when compared with the same period in 2012. Decrease in member month enrollment was attributed to lower sales of our non-dual offerings. This fluctuation also results from the receipt of a lower risk score adjustments from CMS in 2013 as compared to 2012. The 2013 and 2012 periods include the net effect of approximately $2.9 million and $12.6 million, respectively, related to CMS final risk scores adjustments corresponding to prior periods.
• Medical premiums generated by the Commercial business decreased by $24.2 million, or 2.5%, to $935.8 million during the year ended December 31, 2013 as compared to the year ended December 31, 2012. This fluctuation is primarily the result of a decrease in member month enrollment by 313,728, or 5.4%, which was partially offset by an increase in average premium rates of approximately 3.0%. The decrease in member month enrollment is mostly due to the non-renewal of one large commercial account and a higher level of attrition, due to the prevailing economic conditions in the island.
Medical claims incurred during the year ended December 31, 2013 decreased by $93.5 million, or 5.2%, to $1.7 billion, when compared to the year ended December 31, 2012. The MLR of the segment was 86.7%, decreasing by 210 basis points during the year ended December 31, 2013. These fluctuations are primarily attributed to the effect of the following:
• The medical claims incurred of the Medicare business decreased by $79.9 million, or 8.4%, during the 2013 period and its MLR was 84.0%, which is 480 basis points lower than the MLR for the prior year. The lower member month enrollment in this sector contributed to the decrease in claims incurred. Excluding the effect of risk-score premium adjustments and prior period reserve developments in the 2013 and 2012 periods, the MLR decreased by 460 basis points, mostly as the result of lower utilization and cost trends. The decrease also reflects improved drug costs after the new PBM contract in TSA and the impact of changes in 2013 product design.
• The medical claims incurred of the Commercial business decreased by $12.6 million, 1.5%, during the 2013 period mostly reflecting a lower fully-insured member month enrollment. The Commercial MLR was 89.5%, which is 90 basis points higher than the MLR for the prior year. Excluding the effect of prior period reserve developments in 2013 and 2012, the MLR would have increased by 170 basis points, mostly reflecting higher utilization, plus a higher loss ratio in our USVI operation, principally as a result of higher cost and utilization trends during the year.
Medical operating expenses for the year ended December 31, 2013 increased by $43.5 million, or 14.0%, to $354.8 million when compared to the year ended December 31, 2012. The operating expense ratio increased by 250 basis points, from 14.5% in 2012 to 17.0% in 2013. This increase is mainly related to on-going special project initiatives related to TSS’s core system upgrade to QNXT 5.0, the implementation of a new financial system, expenses related to the reorganization of the Medicare business, higher payroll and related expenses mostly as a result of recruitment of additional Medicare sales force, an increase in professional services related to our Medicare risk scoring and CMS star ratings efforts, consultants’ fees for the Medicare integration process, premium taxes amounting to $3.8 million, and incremental expenses related to the administration of the three new service regions of the Medicaid program effective October 1, 2013. These premium taxes became effective on July 1, 2013.
Lower volume of premiums written in the current year generated lower unearned premiums resulting in a favorable change in unearned premiums of $3.1 million. Prior year change in unearned premium was $5.6 million. As a result of the above fluctuations net premiums earned for the year ended December 31, 2014 decreased by $8.2 million, or 8.2%, to $92.1 million.
Cash flows from operating activities decreased by $74.9 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013, principally due to the effect of a decrease in premiums collected of $79.9 million and higher cash paid to suppliers and employees of $57.3 million, offset in part by lower claims paid of $46.0 million. The increase in payments to suppliers and employees is primarily related to the higher Medicaid ASO enrollment, the Health Insurance Providers Fee Assessment of approximately $27.7 million that was paid for the first time during the 2014 period and the collection in 2013 of the $12.8 million JUA special distribution. The decrease in premiums collected is principally the result of lower Managed Care membership enrollment. The decrease in claims mostly results from the lower enrollment in the Managed Care membership.
Net capital expenditures decreased by $7.0 million for the year ended December 31, 2014, as compared to the year ended December 31, 2013, principally due to special projects initiatives related to information technology during 2013.
Payments of short-term borrowings decreased by $30.0 million during the year ended December 31, 2014.
During the year ended December 31, 2014, we had $4.9 million of other uses of cash, while in the 2013 period we had a net balance of other sources of cash of $15.1 million. The fluctuation in the other uses/sources of cash is attributed to changes in the amount of outstanding checks over bank balances.
During the year ended December 31, 2013 we received $9.2 million in policyholder deposits. This represents a decrease of $30.5 million when compared to the prior year and is the result of lower sales of annuity products. The Corporation has reduced the pricing for this product due to the current interest rate scenario.
On November 7, 2013, we completed the acquisition of 100% of the outstanding shares of capital stock of TSB for an aggregate purchase price of approximately $4.8 million, net of $4.6 million of cash acquired. On January 18, 2012, we acquired a controlling stake in a health clinic in Puerto Rico at a cost of $2.7 million, net of $0.8 million of cash acquired. On February 7, 2011, we acquired TSA at a cost of $54.0 million, net of $30.1 million of cash acquired.
On March 6, 2013, the Company’s Board authorized the repurchase of up to $30.0 million of Class B shares concurrent with the conversion of 7 million Class A shares into Class B shares and the public offering of a substantial majority of such convertible shares. As part of the Offering, on May 17, 2013, the Company repurchased and retired 1,000,000 shares at a price of $18.25 per share.
In addition, we are a party to a secured term loan with a commercial bank in Puerto Rico. This secured loan, with original principal balance of $41.0 million, bears interest at a rate equal to the London Interbank Offered Rate (LIBOR) plus 100 basis points and requires monthly principal repayments of $0.1 million. As of December 31, 2014, this secured loan had an outstanding balance of $14.5 million and average annual interest rate of 1.24%. This secured loan is guaranteed by a first lien on our land, buildings and substantially all leasehold improvements, as collateral for the term of the agreements under a continuing general security agreement. This secured loan contains certain non-financial covenants which are customary for this type of facility, including, but not limited to, restrictions on the granting of certain liens, limitations on acquisitions and limitations on changes in control. As of December 31, 2014, we are in compliance with these covenants. Failure to meet these non-financial covenants may trigger the accelerated payment of the secured loan’s outstanding balances.
The federal regulations that require that we begin using a new set of standardized diagnostic codes, known as ICD-10, were postponed to October 01, 2015. This delayed some of the tasks and investments associated with this project, as well as required investment to implement the additional changes incorporated to existing software during the course of 2014-2015. The task of mapping ICD-9 codes to ICD-10 and uploading them to the system was completed in 2014, save for the ongoing maintenance which is to be done through October 2015. In order to become ICD-10 compliant, in September 2013 TSS upgraded the versions of its core business applications that were previously implemented in the third quarter of 2012. The cost of the core business application upgrade and ICD-10 compliance efforts was approximately $6.0 million. Additional software and efforts have and are being invested in defining the mapping of current ICD-9 codes to ICD-10 in order to load that mapping in the recently-upgraded systems. The Company believes that these additional efforts to comply with ICD-10 requirements will represent an additional investment of approximately $1.4 million.
• Unearned premiums - This amount accounts for the premiums collected prior to the end of coverage period and does not represent a future cash outflow. As of December 31, 2014, we had $82.7 million in unearned premiums.
• Policyholder deposits - The cash outflows related to these instruments are not included because they do not have defined maturities, such that the timing of payments and withdrawals is uncertain. There are currently no significant policyholder deposits in paying status. As of December 31, 2014, our policyholder deposits had a carrying amount of $118.9 million.
(3) Claim liabilities represent the amount of our claims processed and incomplete as well as an estimate of the amount of incurred but not reported claims and loss-adjustment expenses. This amount does not include an estimate of claims to be incurred subsequent to December 31, 2014. The expected claims payments are an estimate and may differ materially from the actual claims payments made by us in the future. Also, claim liabilities are presented gross, and thus do not reflect the effects of reinsurance under which $41.2 million of reserves had been ceded at December 31, 2014.
(4) Our life insurance segment establishes, and carries as liabilities, actuarially determined amounts that are calculated to meet its policy obligations when a policy matures or surrenders, an insured dies or becomes disabled or upon the occurrence of other covered events. A significant portion of the estimated obligation for future policy benefits to be paid included in this table considers contracts under which we are currently not making payments and will not make payments until the occurrence of an insurable event not under our control, such as death, illness, or the surrender of a policy. We have estimated the timing of the cash flows related to these contracts based on historical experience as well as expectations of future payment patterns. The amounts presented in the table above represent the estimated cash payments for benefits under such contracts based on assumptions related to the receipt of future premiums and assumptions related to mortality, morbidity, policy lapses, renewals, retirements, disability incidence and other contingent events as appropriate for the respective product type. All estimated cash payments included in this table are not discounted to present value nor do they take into account estimated future premiums on policies in-force as of December 31, 2014 and are gross of any reinsurance recoverable. The $396.1 million total estimated cash flows for all years in the table is different from the liability of future policy benefits of $328.3 million included in our audited consolidated financial statements principally due to the time value of money. Actual cash payments to policyholders could differ significantly from the estimated cash payments as presented in this table due to differences between actual experience and the assumptions used in the estimation of these payments.
Our insurance subsidiaries are subject to the regulations of the Commissioner of Insurance of Puerto Rico. These regulations, among other things, require insurance companies to maintain certain levels of capital, thereby restricting the amount of earnings that can be distributed by the insurance subsidiaries to TSM.
To monitor the solvency of the operations, the BCBSA requires us, TSS and TSA to comply with certain specified levels of RBC. RBC is designed to identify weakly capitalized companies by comparing each company’s adjusted surplus to its required surplus (RBC ratio). The RBC ratio reflects the risk profile of insurance companies. At December 31, 2014, TSM and TSS estimated RBC ratio was above the minimum BCBSA RBC requirement of 200% and the 375% of RBC level required by the BCBSA to avoid monitoring. At December 31, 2014, TSA estimated RBC ratio was above the minimum BCBSA RBC requirement of 100% for smaller controlled affiliate.
Starting 2015, BCBSA’s primary licensees could be subject to monitoring if, over a 6 or 12 month period, its RBC ratio declines by 80 or more points and which results in a level that is below 500%.
The property and casualty segment is also member of the Puerto Rico Fire and Allied Lines Underwriting Association and the Puerto Rico Auto Assign Plan. These entities periodically impose assessments to cover operations and other charges. The assessments recorded from these entities were $1 thousand and $3 thousand in 2014 and 2013, respectively. No assessment was received in 2012.
Circumstances to be considered in developing our best estimate of reserves include changes in enrollment, utilization levels, unit costs, mix of business, benefit plan designs, provider reimbursement levels, processing system conversions and changes, claim inventory levels, regulatory and legislative requirements, claim processing patterns, and claim submission patterns. A comparison or prior period liabilities to re-estimated claim liabilities based on subsequent claims development is also considered in making the liability determination. In the actuarial process, the methods and assumptions are not changed as reserves are recalculated, but rather the availability of additional paid claims information drives our changes in the re-estimate of the unpaid claim liability. Changes in such development are recorded as a change to current period benefit expense. The re-estimates or recasts are done monthly for the previous four calendar quarters. On average, about 90% of the claims are paid within three months after the last day of the month in which they were incurred and about 7% are within the next three months, for a total of 97% paid within six months after the last day of the month in which they were incurred.
(1) Includes total claims incurred less adjustments for prior year reserve development.
Management expects that substantially all of the development of the 2014 estimate of medical claims payable will be known during 2015 and that the variance of the total incurred claims on a retrospective basis when compared to reported incurred claims will be similar to the prior years.
• We have available short-term borrowing facilities that from time to time address differences between cash receipts and disbursements.
At December 31, 2014, claim liabilities for the life insurance segment amounted to $43.7 million and represented 11.2% of total consolidated claim liabilities and 3.4% of our total consolidated liabilities.
Liabilities for future policy benefits for whole life and term insurance products and active life reserves for accident and health products are computed by the net level premium method, using interest assumptions ranging from 4.90% to 5.75% and withdrawal, mortality, morbidity and maintenance expense assumptions appropriate at the time the policies were issued (or when a block of business was purchased, as applicable). Accident and health unpaid claim reserves are stated at amounts determined by estimates on individual claims and estimates of unreported claims based on past experience. Liabilities for universal life policies are stated at policyholder account values before surrender charges. Deferred annuity reserves are carried at the account value.
The costs of acquiring new life business, principally commissions, and certain variable underwriting, agency and policy issue expenses of our life insurance segment, have been deferred. These costs, including value of business acquired (“VOBA”) recorded upon our acquisitions of GA Life (now TSV) and TSB, are amortized to income over the premium-paying period of the related whole life and term insurance policies in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue, and over the anticipated lives of universal life policies in proportion to the ratio of the expected annual gross profits to the expected total gross profits. The expected premiums revenue and gross profits are based upon the same mortality and withdrawal assumptions used in determining the liability for future policy benefits. For universal life and deferred annuity policies, changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on the amortization of deferred policy acquisition costs of revisions to estimated gross profits is reported in earnings in the period such estimated gross profits are revised.
• Determination of the status of each analyzed security as other-than-temporary or not, with documentation of the rationale for the decision.
Management continues to review the investment portfolios under our impairment review policy. Given the current market conditions and the significant judgments involved, there is a continuing risk that further declines in fair value may occur and additional material other-than-temporary impairments may be recorded in future periods.
During the year ended December 31, 2014, we recognized other-than-temporary impairments amounting to $1.2 million on fixed income securities issued by the Commonwealth of Puerto Rico. During the year ended December 31, 2013, we recognized other-than-temporary impairments amounting to $1.0 million on equity securities classified as available for sale that had been in an unrealized loss position for a period longer than six months. During the year ended December 31, 2012, there were no realized losses associated with other-than-temporary impairments.
As of December 31, 2014, the investment in securities of approximately $1.3 billion is classified as either available-for-sale or held-to-maturity and consists of high-quality investments. Our investment portfolio is predominantly comprised of obligations of U.S. government-sponsored enterprises, U.S. Treasuries, U. S. agency-backed mortgage securities and U.S. municipal bonds. These investments comprise approximately 67.1% of the total portfolio value as of December 31, 2014. Obligations of the Commonwealth of Puerto Rico represent 2.7% of the total portfolio. Corporate bonds and private label mortgage securities account for 15.0%. The remaining balance of the investment portfolio consists of mutual funds (14.0%) and investments in partnerships (1.2%). The gross unrealized gains and losses as of December 31, 2014 of the available-for-sale and held-to-maturity portfolios amounted to $118.2 million and $1.2 million, respectively.
The impairment analysis as of December 31, 2014 indicated that, other than those securities for which an other-than-temporary impairment was recognized, none of the securities whose carrying amount exceeded its estimated fair value was considered other-than-temporarily impaired as of that date; however, several factors are beyond management’s control, such as the following: financial condition of the issuers, movement of interest rates, specific situations within corporations, among others. Over time, the economic and market environment may provide additional insight regarding the estimated fair value of certain securities, which could change management’s judgment regarding impairment. This could result in realized losses related to other-than-temporary declines being charged against future income.