We own a seven-story building located at 1441 F.D. Roosevelt Avenue, in San Juan, Puerto Rico, and two adjacent buildings, as well as the adjoining parking lot, which is mainly used by the Managed Care segment. We also own a neighboring ten-story building located at 1451 F.D. Roosevelt Avenue, in San Juan, Puerto Rico, and an adjacent multi-level parking, as a well as the adjoining parking lot, of which six floors are currently leased. In the near future the Company expects to move its Corporate operations to this building. In addition, we own five floors of a fifteen-story building located at 1510 F.D. Roosevelt Avenue, in Guaynabo, Puerto Rico, which is mainly used by the Property and Casualty segment. We also own land and a multi-segment customer service center in the municipalities of Mayagüez and Ponce, Puerto Rico. Through a health clinic we own land and a two-story medical facility in the municipality of Bayamón, Puerto Rico. These properties are subject to liens under our credit facilities. We also own a two-story building located in the city of San José, Costa Rica, which is used by the Life Insurance segment. In addition to the properties described above, we or our subsidiaries are parties to operating leases that are entered into in the ordinary course of business. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources.
• Net income for the year was $67.2 million, a decrease from a net income of $92.9 million for the prior year. The decrease in net income primarily reflects the recognition of a $32 million contingency reserve related to a legal proceeding in our Managed Care segment (see Note 25, Contingencies, of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, of this Annual Report on Form 10-K) and the impact of lower net unrealized gains on equity investments.
We participate in the managed care market through our subsidiaries, TSS, TSA, and TSB. TSS, TSA and TSB are BCBS licensees. As of December 31, 2020, we served approximately 979,000 managed care members across all regions of Puerto Rico.
The Commissioner of Insurance of the Government of Puerto recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the Puerto Rico insurance laws, and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the Commissioner of Insurance of Puerto Rico to financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) in making such determinations. See Note 26, Statutory Accounting of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Intersegment revenues and expenses are reported on a gross basis in each of the operating segments but eliminated in the consolidated results. Except as otherwise indicated, the numbers presented in this Annual Report on Form 10-K do not reflect intersegment eliminations. These intersegment revenues and expenses affect the amounts reported on the financial statement line items for each segment, but are eliminated in consolidation and do not change net income. The following table shows Premiums Earned, Net and Administrative Service Fees and Operating Income for each segment, as well as the intersegment premiums earned, service revenues and other intersegment transactions, which are eliminated in the consolidated results:
Premium Revenue. Our revenue primarily consists of premiums earned from the sale of managed care products to the Commercial, Medicare Advantage and Medicaid sectors. We receive a monthly payment from or on behalf of each member enrolled in our managed care plans (excluding ASO). We recognize all premium revenue in our Managed Care segment during the month in which we are obligated to provide services to an enrolled member. Premiums we receive in advance of that date are recorded as unearned premiums. See Note 2, Significant Accounting Policies - Revenue Recognition - of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Claims Incurred. Our largest expense is the Managed Care segment’s medical claims incurred, or the cost of medical services we arrange for our members. Medical claims incurred include the payment of benefits and losses, mostly to physicians, hospitals, pharmacies and other service providers, and to policyholders. We generally pay our providers on one of three forms: (1) fee-for-service contracts based on negotiated fee schedules; (2) capitation arrangements, generally on a fixed PMPM payment basis, whereby the provider generally assumes some of the medical expense risk; and (3) risk-sharing arrangements, whereby we advance a PMPM payment and share the risk of certain medical costs of our members with the provider based on actual experience as measured against pre-determined sharing ratios. Claims incurred also include claims incurred in our Life Insurance and Property and Casualty segments. Each segment’s results of operations depend to a significant extent on our ability to accurately predict and effectively manage claims and losses. A portion of the claims incurred for each period consists of claims reported but not paid during the period, as well as a management and actuarial estimate of claims incurred but not reported during the period.
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, the economy and general market conditions.
(1) Commercial membership includes corporate accounts, self-funded employers, individual accounts, Medicare Supplement, federal government employees and local government employees.
Consolidated premiums earned, net increased by $352.6 million, or 10.8%, to $3.6 billion during the year ended December 31, 2020. This increase primarily reflects higher premiums earned, net in the Managed Care segment by $334.8 million due to higher average premium rates and fully insured member months across all Managed Care businesses.
The $7.6 million in consolidated net unrealized investment gains on equity investments reflect the impact of changes in equity markets.
Consolidated operating expenses increased by $86.5 million, or 15.2%, to $655.9 billion. The increase in operating expenses mostly resulted from the reinstatement of the HIP fee in 2020 of $55.5 million, the recognition of a $32.0 million contingency reserve related to a legal proceeding in our Managed Care segment (see Note 25, Contingencies of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, of this Annual Report on Form 10-K), higher amortization of deferred acquisition costs and higher business promotion expenses, mainly related to COVID-19 relief efforts. These increases were partially offset by lower professional fees and provision for doubtful accounts. The consolidated operating expense ratio increased 60 basis points, to 18.1%.
Consolidated income tax expense for the year ended December 31, 2020 decreased by $14.9 million, to $24.5 million, primarily reflecting a lower taxable income in all segments in 2020.
Consolidated claims incurred increased by $138.7 million, or 5.5%, to $2.7 billion, mostly driven by an increase in the claims incurred in the Managed Care segment of $254.2 million, partially offset by lower claims incurred in the Property and Casualty segment of $128.7 million. The increase in Managed Care claims primarily reflects higher Medicare and Commercial fully insured enrollment, offset in part by the decrease in Medicaid membership. The decrease in claims incurred in the Property and Casualty segment was due to prior year losses related to hurricane Maria. The consolidated loss ratio decreased by 400 basis points to 82.0%.
Consolidated income tax expense for the year ended December 31, 2019 was $39.4 million, compared to a benefit of $29.8 million in 2018. The year over year change in income taxes primarily reflects higher taxable income in all segments and the 2018 loss before taxes in the Property and Casualty segment.
Managed Care claims incurred increased by $279.0 million, or 11.0%, to $2.8 billion when compared to the year ended December 31, 2019. The MLR of the segment decreased 10 basis points during 2020, to 84.5%. This fluctuation is primarily attributed to the net effect of the following:
• Claims incurred in the Medicare business increased by $132.2 million, or 11.8%, during the 2020 period and its MLR increased 110 basis points, to 80.9%. The increase in claims incurred is due to higher member months, improved benefits in product offerings, and unfavorable prior-period reserve development, partially offset by lower utilization of services as the result of the government-enforced lockdown during the COVID-19 pandemic.
• Medical premiums generated by the Commercial business increased by $18.4 million, or 2.4%, to $801.2 million. This fluctuation primarily reflects higher fully insured member months during the year by approximately 69,000 member months and higher average premium rates, offset in part by $12.1 million related to the suspension of the HIP fee pass-through in 2019.
• The medical claims incurred of the Medicare business increased by $183.1 million, or 19.5%, during the 2019 period mostly driven by higher enrollment. The MLR at 79.8% was 340 basis points lower than the same period last year, driven by favorable prior period reserve developments in 2019 and the impact of cost containment initiatives. These decreases were partially offset by improved benefits in the 2019 product offerings.
Policy benefits and claims incurred increased by $1.3 million, or 1.2%, to $107.2 million, mostly as the result of higher actuarial reserves following portfolio growth offset in part by a slowdown in claim trends in the Cancer and Accidental Death lines of business due to the COVID-19 lockdown. The segment’s loss ratio decreased 340 basis points, to 54.7%.
Policy benefits and claims incurred increased by $6.9 million, or 7.0%, to $105.9 million, mostly resulting from higher volume of sales and actuarial reserves following improved portfolio persistency during 2019. The segment’s loss ratio decreased 60 basis points, to 58.1%.
Underwriting and other expenses increased by $6.4 million, or 8.5%, to $81.7 million mostly resulting from higher commission expense reflecting the segment’s higher volume of business and improved portfolio persistency. As a result, the segment’s operating expense ratio increased 10 basis points, to 44.8%.
Total premiums written increased by $7.4 million, or 4.9%, to $157.9 million, mostly driven by higher premiums, particularly in Commercial Auto, Commercial Package and Personal Package products.
The premiums ceded to reinsurers increased by $8.8 million, or 16.8%, mostly due to approximately $3.0 million of reinsurance reinstatement premiums following losses recorded after the earthquakes in the southwest region of Puerto Rico in January 2020, as well as higher premiums written.
Claims incurred decreased by $4.5 million, or 11.4%, to $35.1 million because of better loss experience in the segment’s on-going business from the effects of the COVID-19 measures and lockdown, partially offset by the recognition of $5.0 million of earthquake losses after the January 2020 events. As a result, the loss ratio decreased by 700 basis points, to 38.2% during this period.
Underwriting and other operating expenses increased by $2.6 million, or 6.0%, to $46.0 million, mostly because of higher net commission expense following the increase in net premiums earned. Current year net commission expense is affected by a lower capitalization of deferred acquisition costs. The operating expense ratio was 50.0%, 50 basis points higher than prior year.
Total premiums written increased by $10.7 million, or 7.7%, to $150.5 million, driven by higher volume of Commercial and Personal Package, Commercial Auto and Commercial Liability products. This increase in volume was offset by lower sales of Commercial Property products, mostly resulting from the selective and disciplined underwriting of Commercial risks.
The $14.6 million decrease in the change in unearned premiums reflects the segments higher premiums written in 2019.
Claims incurred decreased by $120.3 million, or 75.2%, to $39.6 million driven by a $128.7 million unfavorable prior period reserve development in claims in prior year related to Hurricane Maria. As a result, the segment’s loss ratio decreased to 45.2%.
On June 19, 2020, TSM entered into a $31.4 million Credit Agreement (the Loan) with a commercial bank in Puerto Rico. The proceeds of the Loan were used by the Company to partially finance the acquisition of a building (the Building), which is included in Capital Expenditures in the Statement of Cash Flows. For further details, see Note 13, Borrowing of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
The increase in capital contribution reflects capital contributions in exchange for a participation in equity method investees.
The net change in short-term borrowings represents the repayment of short-term facilities available to address timing differences between cash receipts and disbursements.
Cash flows from operating activities decreased by $24.3 million during the year ended December 31, 2019, mostly due to higher claims paid by $296.6 million partially offset by an increase in premium collections of $223.6 million; both fluctuations reflected the increased volume in 2019. In addition, cash paid to suppliers and employees decreased by $45.5 million when compared to the prior year.
Increase in capital contribution reflects capital contributions in exchange for fifty percent participation in equity method investees.
The Company repurchases shares through open market transactions, in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended, under repurchase programs authorized by the Board of Directors. Shares purchased under share repurchase programs are retired and returned to authorized and unissued status. See Note 19, Stock Repurchase Program of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
TSM has a $35.5 million credit agreement with a commercial bank in Puerto Rico. The agreement consists of three term loans: (i) Term Loan A in the principal amount of $11.2 million, (ii) Term Loan B in the principal amount of $20.2 million, and (iii) Term Loan C in the principal amount of $4.1 million. Term Loan A matures in October 2023, while Term Loans B and C mature in January 2024. Term Loan A was used to refinance a previous $41.0 million secured loan payable with the same commercial bank. Pursuant to the credit agreement, interest is payable on the outstanding balance of the Loan at the following annual rate: (i) 100 basis points over LIBOR for Term Loan A, (ii) 275 basis points over LIBOR for Term Loan B, and, (iii) 325 basis points over LIBOR for Term Loan C. The loan includes certain financial and non-financial covenants, which are customary for this type of facility, including negative covenants imposing certain restrictions on the Company’s business. Failure to meet these covenants may trigger the accelerated payment of the outstanding balance. The Company was in compliance with these covenants as of December 31, 2020.
In July 2017, the Financial Conduct Authority (FCA) in the United Kingdom, which regulates LIBOR, announced that it would phase out this benchmark by the end of 2021. In response, the U.S. Federal Reserve convened the Alternative Reference Rates Committee (ARRC), a working group comprised of private market participants, to ensure a transition to a new reference rate.
The ARRC has recommended the use of the Secured Overnight Financing Rate (SOFR), which is an index based on the cost of borrowing overnight cash collateralized by U.S. Treasury securities. Currently, there is no definitive information regarding the future use of SOFR as a widely accepted benchmark or any other replacement rate.
For further details, see Note 13, Borrowings of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
We have several short-term facilities available to address timing differences between cash receipts and disbursements, consisting of collateralized advances from the Federal Home Loan Bank of New York (FHLBNY), repurchase agreements, and a revolving credit facility.
• In August 2019, TSS and TSV became members of the FHLBNY, which provides access to collateralized advances. The borrowing capacity of TSS and TSV is up to 30% of their admitted assets as disclosed in the most recent filing with the Commissioner of Insurance but is constrained by the amount of collateral held at the FHLBNY. See Note 3, Investment in Securities of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. As of December 31, 2020 and 2019, the borrowing capacity was approximately $200.3 million and $131.1 million, respectively. The outstanding balance as of December 31, 2020 and 2019 was $30.0 million and $54.0 million, respectively. The average interest rate of the outstanding balances was 0.33% and 1.79% as of December 31, 2020 and 2019, respectively.
• As of December 31, 2020, TSS has $35.0 million of available credit under repurchase agreements with broker-dealers, which are short-term borrowing facilities using securities as collateral. There were no outstanding short-term borrowings under these facilities as of December 31, 2020.
• Alternative investments - The Company has $52.6 million of unfunded capital commitments related to alternative investments. These commitments were excluded from this disclosure due to the undetermined timing of their cash flows.
• 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, 2020, we had $97.5 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, 2020, our policyholder deposits had a carrying amount of $206.1 million.
(2) Purchase obligations represent payments required by us under material agreements to purchase goods or services that are enforceable and legally binding and where all significant terms are specified, including: quantities to be purchased, price provisions and the timing of the transaction. Other purchase orders made in the ordinary course of business for which we are not liable are excluded from the table above. Estimated pension plan contributions amounting to $10.0 million were included within the total purchase obligations. However, this amount is an estimate which may be subject to change in view of the fact that contribution decisions are affected by various factors such as market performance, regulatory and legal requirements and plan funding policy.
(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, 2020. 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 $344.0 million of reserves had been ceded at December 31, 2020.
We have no off-balance-sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, revenues and expenses, results of operations, liquidity, capital expenditures or capital resources.
Pursuant to the Puerto Rico Insurance Code, our Property and Casualty subsidiary is a member of Sindicato de Aseguradores para la Suscripción Conjunta de Seguros de Responsabilidad Profesional Médico-Hospitalaria (SIMED). The syndicate was organized for the purpose of underwriting medical-hospital professional liability insurance. As a member, the Property and Casualty segment shares risks with other member companies and, accordingly, is contingently liable in the event the syndicate cannot meet their obligations. During 2020, 2019, and 2018, no assessment or payment was made for this contingency. It is the opinion of management that any possible future syndicate assessments will not have a material effect on our operating results and/or cash flows, although there is no ceiling on these payment obligations. In December 2018, SIMED declared a distribution to its members; the TSP’s share of this distribution was $2.9 million, which is presented with Other Income in the accompanying Consolidated Statement of Earnings.
In addition, our Property and Casualty insurance subsidiary is a member of the Compulsory Vehicle Liability Insurance Joint Underwriting Association (the Association). The Association was organized in 1997 to underwrite insurance coverage of motor vehicle property damage liability risks effective January 1, 1998. As a participant, the segment shares the risk proportionally with other members based on a formula established by the Insurance Code. During the years 2020, 2019 and 2018, the Association distributed to the Company $0.2 million each year, respectively, based on the good experience of the business. In June 2017, the Association declared a special dividend of $70.0 million as authorized by a recent amendment to the Act creating the Association. The distribution was subject to a unique and special tax rate of 50%. The dividend was paid net of its related tax in December 2018. The share of the Property and Casualty segment in this distribution was $2.4 million.
Our Consolidated Financial Statements and accompanying Notes included in this Annual Report on Form 10-K have been prepared in accordance with GAAP applied on a consistent basis. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We continually evaluate the accounting policies and estimates we use to prepare our consolidated financial statements. In general, management’s estimates are based on historical experience and various other assumptions it believes to be reasonable under the circumstances. The following is an explanation of our accounting policies considered most significant by management. These accounting policies require us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information is known. Actual results could differ materially from those estimates.
Claim liabilities by segment as of December 31, 2020 were as follows:
Management continually evaluates the potential impact of changes in the factors considered for its claim liabilities estimates, both positive and negative, and uses the results of these evaluations to adjust recorded claim liabilities and underwriting criteria. Our profitability depends in large part on our ability to accurately predict and effectively manage the amount of claims incurred, particularly those of the Managed Care segment and the losses arising from the Life Insurance and Property and Casualty segments. Management regularly reviews its premiums and benefits structure to reflect our underlying claims experience and revised actuarial data; however, several factors could adversely affect our underwriting results. Some of these factors are beyond management’s control and could adversely affect its ability to accurately predict and effectively control claims incurred. Examples of such factors include changes in health practices, economic conditions, change in utilization trends including those caused by epidemic conditions, health care costs, the advent of natural disasters and malpractice litigation. Costs in excess of those anticipated could have a material adverse effect on our results of operations.
Claim liabilities are determined employing actuarial methods that are commonly used by managed care actuaries and meet Actuarial Standards of Practice, which require that the claim liabilities be adequate under moderately adverse circumstances. The segment determines the amount of the liability by following a detailed actuarial process that entails using both historical claim payment patterns as well as emerging medical cost trends to project a best estimate of claim liabilities. Under this process, historical claims incurred dates are compared to actual dates of claims payment. This information is analyzed to create “completion” or “development” factors that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Completion factors are applied to claims paid through the consolidated financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the total expected claims incurred. The majority of unpaid claims, both reported and unreported, for any period, are those claims which are incurred in the final months of the period. Since the percentage of claims paid during the period with respect to claims incurred in those months is generally very low, the above-described completion factor methodology is less reliable for such months. In order to complement the analysis to determine the unpaid claims, historical completion factors and payment patterns are applied to incurred and paid claims for the most recent twelve months and compared to the prior twelve month period. Incurred claims for the most recent twelve months also take into account recent claims expense levels and health care trend levels (trend factors). Using all of the above methodologies, our actuaries determine based on the different circumstances the unpaid claims as of the end of period.
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 93% of the claims are paid within three months after the last day of the month in which they were incurred and about 4% 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.
Management regularly reviews its assumptions regarding claim liabilities and makes adjustments to claims incurred when necessary. If management’s assumptions regarding cost trends and utilization are significantly different than actual results, our Consolidated Statement of Earnings and Balance Sheets could be affected in future periods. Changes to prior year estimates may result in an increase in claims incurred or a reduction of claims incurred in the period the change is made. Further, due to the considerable variability of health care costs, adjustments to claims liabilities are made in each period and are sometimes significant as compared to the net income recorded in that period. Prior year development of claim liabilities is recognized immediately upon the actuary’s judgment that a portion of the prior year liability is no longer needed or that an additional liability should have been accrued. Health care trends are monitored in conjunction with the claim reserve analysis. Based on these analyses, rating trends are adjusted to anticipate future changes in health care cost or utilization. Thus, the Managed Care segment incorporates those trends as part of the development of premium rates in an effort to keep premium rating trends in line with claims trends.
Amounts incurred related to prior years vary from previously estimated liabilities as the claims are ultimately settled. Liabilities at any year-end are continually reviewed and re-estimated as information regarding actual claims payments or run-out becomes known. This information is compared to the originally established year-end liability. Negative amounts reported for incurred claims related to prior years result from claims being settled for amounts less than originally estimated. The reverse is true of reserve shortfalls. Medical claim liabilities are usually described as having a “short tail”, which means that they are generally paid within several months of the member receiving service from the provider. Accordingly, the majority, or approximately 93%, of any redundancy or shortfall relates to claims incurred in the previous calendar year-end, with the remaining 7% related to claims incurred prior to the previous calendar year-end. Management has not noted any significant emerging trends in claim frequency and severity and the normal fluctuations in enrollment and utilization trends from year to year.
The following table shows the variance between the segment’s incurred claims for current period insured events and the incurred claims for such years had they been determined retrospectively (the “Incurred claims related to current period insured events” for the year shown plus or minus the “Incurred claims related to prior period insured events” for the following year as included in Note 11, Claim Liabilities and Claim Adjustment Expenses of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. This table shows that the segments’ estimates of this liability have approximated the actual development.
• In the Commercial business we have the ability to increase the premium rates throughout the year in the monthly renewal process when renegotiating the premiums for the following contract year of each group as they become due. We consider the actual claims trend of each group when determining the premium rates for the following contract year.
• We have available short-term borrowing facilities to address differences between cash receipts and disbursements.
For additional information on our credit facilities, see section Financing and Financing Capacity of this Item.
At December 31, 2020, claim liabilities for the Life Insurance segment amounted to $49.9 million and represented 6.3% of total consolidated claim liabilities and 2.4% of our total consolidated liabilities.
The key assumption about claim liabilities for our Life Insurance segment is related to claims incurred prior to the end of the year but not yet reported to our subsidiary. A liability for these claims is estimated based upon experience with regards to amounts reported subsequent to the close of business in prior years. There are uncertainties in the development of these estimates; however, in recent years our estimates have resulted in immaterial redundancies or deficiencies.
Estimates of the ultimate cost of claims and loss-adjustment expenses of this segment are based largely on the assumption that past developments, with appropriate adjustments due to known or unexpected changes, are a reasonable basis on which to predict future events and trends, and involve a variety of actuarial techniques that analyze current experience, trends and other relevant factors. Property and Casualty insurance claim liabilities are categorized and tracked by line of business. Medical malpractice policies are written on a claims-made basis. Policies written on a claims-made basis require that claims be reported during the policy period. Other lines of business are written on an occurrence basis. Hurricane losses initially include the use of models from industry recognized firms having data, historical and current information about the events to estimate ultimate losses. These estimates are supplemented by internal estimates of other costs deemed necessary to develop the ultimate losses. As loss information emerges, claims are separated between those with solid estimates and those for which we cannot make a reasonable estimate of ultimate cost of claim. Additional reserves are provided based on paid loss experience for unreported, potential development, and loss expenses.
Individual case estimates for reported claims are established by a claims adjuster and are changed as new information becomes available during the course of handling the claim. Our Property and Casualty business, other than medical malpractice, is primarily a short-tailed business, where losses (e.g. paid losses and case reserves) are generally reported quickly.
At December 31, 2020, the claim liabilities of the Property and Casualty segment fall within the actuarial reserve range determined by the actuaries. Management reviews the results of the reserve estimates in order to determine any appropriate adjustments in the recording of reserves. Adjustments to reserve estimates are made after management’s consideration of numerous factors, including but not limited to the magnitude of the difference between the actuarial indication and the recorded reserves, improvement or deterioration of actuarial indications in the period, the maturity of the accident year, trends observed over the recent past and the level of volatility within a particular line of business. In general, changes are made more quickly to more mature accident years and less volatile lines of business. Varying the net expected loss ratio by +/-1% in all lines of business for the six most recent accident years would increase/decrease the claims incurred by approximately $5.2 million.
For deferred annuities and universal life products, the liability for future policy benefits is equal to total policy account values. The liabilities for all other products are based upon a variety of actuarial assumptions that are uncertain. The most significant of these assumptions is the level of anticipated death and health claims. Other assumptions that are less significant to the appropriate level of the liability for future policy benefits are anticipated policy persistency rates, investment yields and operating expense levels. Policy portfolio valuations are performed frequently by our subsidiary’s external actuaries, to assure that the current level of liabilities for future policy benefits is sufficient, in combination with anticipated future cash flows, to provide for all contractual obligations. For all products, except for deferred annuities and universal life products, the basis for the liability for future policy benefits is established at the time of issuance of each contract and would only change if our experience deteriorates to the point that the level of the liability is not adequate to provide for future policy benefits. We do not currently expect that level of deterioration to occur.
Certain costs incurred for acquiring life and property and casualty insurance business are deferred. Acquisition costs related to the Managed Care segment are expensed as incurred.
The property and casualty business acquisition costs consist of commissions net of reinsurance commissions, during the production of business and are deferred and amortized ratably over the terms of the policies. The method used in calculating deferred acquisition costs limits the amount of such deferred costs to actual costs or their estimated realizable value, whichever is lower.
An investment is considered to be impaired when the estimated fair value is below the amortized cost of the security and it is more likely than not the Company will have to sell the fixed-maturity security before the recovery of its amortized cost basis. Management regularly monitors and evaluates the difference between the amortized cost and estimated fair value of fixed-maturity investments and other invested assets. For fixed-maturity securities with a fair value below amortized cost, the process includes evaluating: (1) the extent to which the estimated fair value has been less than amortized cost, (2) the financial condition, near-term and long-term prospects for the issuer, including relevant industry conditions and trends, and implications of rating agency actions, (3) the Company’s intent to sell or the likelihood of a required sale prior to recovery, (4) the recoverability of principal and interest, and (5) other factors, as applicable. This process is not exact and requires further consideration of risks such as credit and interest rate risks. Consequently, if an investment’s cost exceeds its estimated fair value solely due to changes in interest rates, an allowance for credit losses is not recorded.
If a fixed-maturity security is in an unrealized loss position and the Company has the intent to sell the security, or it is more likely than not that the Company will have to sell the fixed-maturity security before recovery of its amortized cost basis, the Company will write off any previously recognized allowance for credit losses and will decrease the amortized cost basis of the security. If the allowance has been fully written off and the fair value is less than its amortized cost basis, the amortized cost basis is written down and an impairment loss is recognized in the Company’s Consolidated Statements of Earnings.
In addition, the Company considers the following factors when evaluating whether or not a credit loss exists: the reasons for the impairment, the severity of the impairment, market conditions, changes in the security’s rating, changes in value subsequent to year-end, forecasted performance of the investee, and the general market condition in the geographic area or industry in which the investee operates.
For our Audited Consolidated Financial Statements as of December 31, 2020 and 2019 and for each of the three years ended December 31, 2020, 2019 and 2018 see Index of the Consolidated Financial Statements in Item 15. Exhibits and Financial Statements Schedules of this Annual Report on Form 10-K.