IHC’s health insurance products serve niche sectors of the commercial market through multiple classes of business and varied distribution channels. Medical Stop-Loss is marketed to large employer groups that self-insure their medical risks; in 2011 the Company’s average case size was 250 covered employee lives. This niche is expected to grow as result of federal health care reform. The small-group major medical product is purchased by employers with between two and 50 covered lives. With regard to those persons in the growing individual market, IHC’s products offer major medical coverage for individuals and families and persons with short-term medical needs, and limited medical and scheduled benefit plans through select distribution partners. Beginning in 2012, Independence American entered the
On March 5, 2010, IHC acquired a controlling interest in AMIC. Upon achieving control AMIC’s income and expense amounts became consolidated with IHC’s results. Accordingly, the individual line items on the Consolidated Statement of Operations for 2011 and 2010 reflect the operations of AMIC with no corresponding amounts for 2009.
Released $2.3 million of deferred income taxes relative to its investment in AMIC based on the Company’s intention to adopt tax planning strategies to recover its investment in AMIC in a tax-free manner;
In the fourth quarter of 2011, Standard Security Life entered into a coinsurance agreement effective in January 2012 and transferred approximately $143 million of group annuity reserves in the first quarter of 2012. For the year ended December 31, 2011, net realized investment gains were $8.7 million of which a significant portion resulted from sales of invested assets in anticipation of the transfer of assets in accordance with the terms of such agreement in the first quarter of 2012. As a result of such agreement, the Company wrote-off $4.6 million of deferred acquisition costs at December 31, 2011, which was more than offset by these net realized investment gains.
The Medical Stop-Loss segment reported income from continuing operations before taxes of $9.0 million and $1.9 million for the years ended December 31, 2011 and 2010, respectively. The increase is primarily due to improved underwriting results in 2011 despite decrease in premiums earned;
Premiums earned decreased $6.7 million for the year ended December 31, 2011 when compared to 2010. The decrease in premiums earned is due to the cancellation of certain non-owned managing general underwriters in 2010;
The Fully Insured Health segment reported $7.7 million of income from continuing operations before taxes for the year ended December 31, 2011 as compared to $3.1 million for the year ended December 31, 2010;
The decrease in the loss ratio was primarily attributable to improved underwriting results due to a shift to more limited plans, lower utilization and claims and less exposure to large groups.
Income before taxes from the Individual life, annuities and other segment decreased $1.8 million for the year ended December 31, 2011 compared to the prior year primarily due to lower investment income;
Income before taxes from the Corporate segment decreased $29.0 million for the year ended December 31, 2011 compared to the prior year primarily due to the inclusion, in 2010, of a $27.8 million pre-tax gain as a result of the March 2010 acquired controlling interest in AMIC;
Net realized investment gains were $8.7 million for the year ended December 31, 2011 compared to $4.6 million in 2010. A significant portion of the net realized investment gains in 2011 resulted from sales of invested assets in anticipation of a transfer of assets in the first quarter of 2012 in accordance with the terms of a coinsurance agreement at December 31, 2011.
Management believes that the Company's methods of estimating the liabilities for insurance reserves provided appropriate levels of reserves at December 31, 2011. Changes in the Company's reserve estimates are recorded through a charge or credit to its earnings.
The Company has classified all of its investments as either available-for-sale or trading securities. These investments are carried at fair value with unrealized gains and losses reported in accumulated other comprehensive income (loss) in the Consolidated Balance Sheets for available-for-sale securities or as unrealized gains or losses in the Consolidated Statements of Operations for trading securities. Fixed maturities and equity securities available-for-sale totaled $880.4 million and $841.7 million at December 31, 2011 and 2010, respectively. Premiums and discounts on debt securities purchased at other than par value are amortized and accreted, respectively, to interest income in the Consolidated Statements of Operations, using the constant yield method over the period to maturity. Net realized gains and losses on investments are computed using the specific identification method and are reported in the Consolidated Statements of Operations.
Goodwill carrying amounts are evaluated for impairment, at least annually, at the reporting unit level which is equivalent to an operating segment. If the fair value of a reporting unit is less than its carrying amount, further evaluation is required to determine if a write-down of goodwill is required. In determining the fair value of each reporting unit, we used an income approach, applying a discounted
cash flow method which included a residual value. Based on historical experience, we make assumptions as to: (i) expected future performance and future economic conditions, (ii) projected operating earnings, (iii) projected new and renewal business as well as profit margins on such business, and (iv) a discount rate that incorporated an appropriate risk level for the reporting unit. Any impairment of goodwill would be charged to expense. No impairment charge for goodwill was required in 2011 or 2010. At December 31, 2009, the Company wrote-off $4.2 million of goodwill in connection with an other-than-temporary impairment loss related to its then equity method investment in AMIC. During 2010, the Company obtained a controlling interest in AMIC. See Note 2 in the Notes to Consolidated Financial Statements included in Item 8 of this report for further information.
Other intangible assets are amortized to expense over their estimated useful lives and are subject to impairment testing. Any impairment write-down of other intangible assets would be charged to expense. For the year ended December 31, 2009, selling, general and administrative expenses include the write-off of $5.1 million of previously capitalized software. See Note 11 in the Notes to Consolidated Financial Statements included in Item 8 of this report for further information regarding the impairment loss in 2009. No impairment charges for intangible assets were required in 2011 or 2010.
On March 5, 2010, IHC acquired a controlling interest in AMIC as a result of the purchase of AMIC common stock in the open market. In determining the bargain purchase gain with regard to the acquisition of the controlling interest in AMIC, IHC first recognized a gain of $2.2 million as a result of re-measuring its equity interest in AMIC to its fair value of $22.0 million immediately before the acquisition based on the closing market price of AMIC's common stock. Then, upon the acquisition of a controlling interest on March 5, 2010, the Company consolidated the net assets of AMIC. Accordingly, the Company determined the fair value of the identifiable assets acquired and liabilities assumed from AMIC on such date. The fair value of the net assets acquired exceeded the sum of: (i) the fair value of the consideration paid; (ii) the fair value of IHC’s equity investment prior to the acquisition; and (iii) the fair value of the noncontrolling interests in AMIC, resulting in a bargain purchase gain of $25.6 million. The total gain, amounting to $27.8 million pre-tax, is included in gain on bargain purchase of AMIC on the Company’s Consolidated Statement of Operations. This gain is a result of the quoted market price of AMIC being significantly less than the fair value of the net assets of AMIC. This disparity is due to the
low trading volume in AMIC shares, and a discount on the shares traded due to a lack of control by minority shareholders. The fair value of the noncontrolling interests in AMIC was based on the closing market price of AMIC’s common stock.
For the year ended December 31, 2011 and 2010, the Company recorded $1.5 million and $3.8 million, respectively, of other-than-temporary impairment losses in earnings, pre-tax. In 2011, other-than-temporary impairment losses recognized in earnings consist of $1.3 million of credit losses resulting from expected cash flows of debt securities that are less than the debt securities’ amortized cost and $.2 million of losses resulting from the Company’s intent to sell certain corporate debt securities prior to the recovery of their amortized cost bases. In 2010, other-than-temporary impairment losses recognized in earnings consist of $3.1million of credit losses resulting from expected cash flows of debt securities that are less than the debt securities’ amortized cost and $.7 million resulting from the Company’s intent to sell certain municipal debt securities prior to the recovery of their amortized cost bases.
In 2011, IHC eliminated $2.3 million of previously recorded deferred income taxes due to management’s intention to adopt tax planning strategies to recover its investment in AMIC in a tax-free manner. In addition, under the above assumptions, IHC did not record deferred taxes in 2011 relative to its share of earnings from its investment in AMIC, as it had in prior years, also resulting in a lower effective tax rate in the current year. Excluding this transaction, the effective tax rate for the year ended December 31, 2011 was 32.4% compared to 34.8% in 2010. The high effective tax rate in 2010 is
Results of Operations for the Year Ended December 31, 2010 Compared to the Year Ended December 31, 2009
Information by business segment for the years ended December 31, 2010 and 2009 is as follows:
Excluding amounts generated by AMIC, other income in 2010 decreased by $1.4 million compared to 2009. In 2009, other income includes income resulting from the commutation of a block of business.
As of December 31, 2011, the Company had $18.2 million of cash and cash equivalents compared with $11.4 million as of December 31, 2010.
The Company has $458.7 million of insurance reserves that it expects to ultimately pay out of current assets and cash flows from future business. If necessary, the Company could utilize the cash received from maturities and repayments of its fixed maturity investments if the timing of claim payments associated with the Company's insurance resources does not coincide with future cash flows. For the year ended December 31, 2011, cash received from the maturities and other repayments of fixed maturities was $158.7 million.
Financing activities for the year ended December 31, 2011 provided $3.1 million, primarily consisting of proceeds from debt and investment-type insurance contracts, net of dividends paid, repurchases of common stock and cash used to purchase additional noncontrolling interests in majority-owned subsidiaries, among other items.
The Company had net receivables from reinsurers of $119.7 million at December 31, 2011. All of such reinsurance receivables are either due from highly rated companies or are adequately secured. No allowance for doubtful accounts was necessary at December 31, 2011.
On December 31, 2011, the Company wrote-off $4.6 million of deferred acquisition costs in connection with a coinsurance agreement effective in the first quarter of 2012.
Other assets decreased $11.2 million primarily as a result of a decrease in tax assets.
Approximately 1.9% of fixed maturities, primarily municipal obligations, in our investment portfolio are insured by financial guaranty insurance companies. The purpose of this insurance is to increase the credit quality of the fixed maturities and their credit ratings. If the obligations of these financial guarantors ceased to be valuable, either through a credit rating downgrade or default, these debt securities would likely receive lower credit ratings by the rating agencies that would reflect the creditworthiness of the various obligors as if the fixed maturities were uninsured. The following table
summarizes the credit quality of our fixed maturity portfolio as rated, and as rated if the fixed maturities were uninsured, at December 31, 2011:
The following table summarizes the prior year net favorable amount incurred in 2011 according to the year to which it relates, together with the opening reserve balance (net of reinsurance recoverable) to which it relates (in thousands):
Due to the long-term nature of LTD, in establishing loss reserves the Company must make estimates for case reserves, incurred but not reported reserves (“IBNR”), and reserves for Loss Adjustment Expenses (“LAE”). Case reserves generally equal the actuarial present value of the liability for future benefits to be paid on claims incurred as of the balance sheet date. The IBNR reserve is established based upon historical trends of existing incurred claims that were reported after the balance sheet date. The LAE reserve is calculated based on an actuarial expense study. Since the LTD block of policies is relatively small, with the potential for very large claims on individual policies, results can vary from year to year. If a small number of claimants with large claim reserves were to recover or several very large claims were incurred, the results could distort the Company’s reserve estimates from year to year. However, there were no individual factors in 2011 that caused the favorable development in LTD. With respect to DBL, reserves for the most recent quarter of earned premium are established using a Net Loss Ratio methodology. The Net Loss Ratio is determined by applying the completed prior four quarters of historical Net Loss Ratios to the last quarter of earned premium. Reserves associated with the premium earned prior to the last quarter are established using a completion factor methodology. The
Adapting to health care reform by continuing to proactively adjust our distribution strategies and mix of Fully Insured Health products to take advantage of changing market demands.
coverage. This increase in net retained premiums has been made possible by our increased capital base.
The Company remained highly liquid in 2011 with a shorter duration portfolio. As a result, the yields on our investment portfolio were, and continue to remain, lower than in prior years and investment income may continue to be depressed for the balance of the year. IHC has approximately $273.3 million in highly rated shorter maturity securities earning on average 1.5%; our portfolio as a whole is rated, on average, AA. The low duration of our portfolio enables us, if we deem prudent, the flexibility to reinvest in much higher yielding longer-term securities, which would significantly increase investment income. A low duration portfolio such as ours also mitigates the adverse impact of potential inflation. IHC will continue to monitor the financial markets and invest accordingly.
We will continue to focus on our strategic objectives, including expanding our distribution network. However, the success of a portion of our Fully Insured Health business may be affected by the passage of the Patient Protection and Affordable Care and Education Reconciliation Act of 2010 signed by President Obama in March 2010, and its subsequent interpretations by state and federal regulators and its possible revision by the newly-elected Congress. The National Association of Insurance Commissioners has now issued its proposed regulations. The regulations proposed to-date (including those mandating minimum loss ratios) seem to have validated our strategy of pursuing niche lines of business across many states utilizing multiple carriers. We have begun a comprehensive review of all the options for IHC and we are continuing a thorough evaluation of our options for those health insurance products that may be affected. Although the law will generally require insurers to operate with a lower expense structure for major medical plans in the small employer and individual markets, the law appears to make exceptions for carriers, such as ours, that have a minimal presence in any one state. “Non-essential” lines of business and Medical Stop-Loss have been impacted by health care reform minimally or not at all.
See Index to Consolidated Financial Statements and Schedules on page 60.