IHC Carrier Solutions leases 11,297 square feet of office space in Phoenix, Arizona as its corporate headquarters.
While management considers a wide range of factors in its strategic planning and decision-making, underwriting profit is consistently emphasized as the primary goal in all decisions as to whether or not to increase our retention in a core line, expand into new products, acquire an entity or a block of business, or otherwise change our business model. Management's assessment of trends in healthcare and morbidity, with respect to specialty medical, disability and New York short-term disability (“DBL”); mortality rates with respect to life insurance; and changes in market conditions in general play a significant role in determining the rates charged, deductibles and attachment points quoted, and the percentage of business retained. IHC also seeks transactions that permit it to leverage its vertically integrated organizational structure by generating fee income from production and administrative operating companies as well as risk income for its carriers. Management has always focused on managing the costs of its operations.
Net income for the year ended December 31, 2015 includes a $6.7 million gain, net of tax, resulting from the deconsolidation of a subsidiary and corresponding joint venture transaction. See discussion on Gain on Sale of Subsidiary to Joint Venture.
Book value of $25.53 per common share at December 31, 2016 compared to $18.73 at December 31, 2015.
The Company has renamed its “Fully Insured” segment “Specialty Health”. Specialty Health more accurately reflects the niche nature of the products that IHC markets in this segment and continues to expand into since its exit from the major medical market. The Specialty Health segment reported $7.2 million of income before taxes for the year ended December 31, 2016 compared to $6.5 million for the comparable period in 2015. The increase was primarily the result of increases from broader marketing of our short-term medical, scheduled benefit and gap plans, and growth in the pet insurance line of business, partially offset by poor underwriting results in our occupational accident business.
Although the loss ratio for the year ended December 31, 2016 was slightly lower than the same period in 2015, the loss ratio would have been significantly lower (48.0%) excluding the occupational accident line of business. Poor performance of the business underwritten by its occupational accident agency led to the Company’s decision to sell such company and exit business produced by it. Expense ratios are higher for the year ended December 31, 2016 because of a change in the mix of business from major medical to specialty health products and a reallocation of certain fixed costs from the medical stop loss line to the specialty health segment.
Income before taxes from the Group disability, life and DBL segment increased $2.1 million in 2016 compared to prior year results. The overall increase is primarily due to increased volume;
The Company believes that its liability for policy benefits and claims is reasonable and adequate to satisfy its ultimate liability. The Company primarily uses its own loss development experience, but will also supplement that with data from its outside actuaries, reinsurers and industry loss experience as warranted. To illustrate the impact that Loss Ratios have on the Company’s loss reserves and related expenses, each hypothetical 1% change in the Loss Ratio for the health business (i.e., the ratio of insurance benefits, claims and settlement expenses to earned health premiums) for the year ended December 31, 2016, would increase reserves (in the case of a higher ratio) or decrease reserves (in the case of a lower ratio) by approximately $2.5 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the Consolidated Statement of Income. Depending on the circumstances surrounding a change in the Loss Ratio, other pre-tax amounts reported in the Consolidated Statement of Income could also be affected, such as amortization of deferred acquisition costs and commission expense.
For the Specialty Health business, incurred but not reported (“IBNR”) claims liabilities plus expected development on reported claims are calculated using standard actuarial methods and practices. The “primary” assumption in the determination of Specialty Health reserves is that historical Claim Development Patterns are representative of future Claim Development Patterns. Factors that may affect this assumption include changes in claim payment processing times and procedures, changes in time delay in submission of claims, and the incidence of unusually large claims. Liabilities for policy benefits and claims for specialty health medical and disability coverage are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data. The reserving analysis includes a review of claim processing statistical measures and large claim early
notifications; the potential impacts of any changes in these factors are not material. The Company has business that is serviced by third-party administrators. From time to time, there are changes in the timing of claims processing due to any number of factors including, but not limited to, system conversions and staffing changes during the year. These changes are monitored by the Company and the effects of these changes are taken into consideration during the claim reserving process. Other than these considerations, there have been no significant changes to methodologies and assumptions from the prior year.
The Company’s disability business is comprised of group disability and DBL. The two “primary” assumptions on which disability policy benefits and claims are based are: (i) morbidity levels; and (ii) recovery rates. If morbidity levels increase, for example due to an epidemic or a recessionary environment, the Company would increase reserves because there would be more new claims than expected. In regard to the assumed recovery rate, if disabled lives recover more quickly than anticipated then the existing claims reserves would be reduced; if less quickly, the existing claims reserves would be increased. Advancements in medical treatments could affect future recovery, termination, and mortality rates.
On March 31, 2016, the Company sold Risk Solutions, an MGU that was its principal source of medical stop-loss business. All of the in-force medical stop-loss business of Standard Security Life and Independence American produced by Risk Solutions was 100% co-insured as of January 1, 2016 and IHC’s block of medical stop-loss business is in run-off.
Liabilities for policy benefits and claims on medical stop-loss coverage are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data. Policy benefits and claims for medical stop-loss insurance are more volatile in nature than those for specialty health medical insurance. This is primarily due to the excess nature of medical stop-loss, with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. The level of these deductibles makes it more difficult to predict the amount and payment pattern of such claims. Furthermore, these excess claims are highly sensitive to changes in factors such as medical trend, provider contracts and medical treatment protocols, adding to the difficulty in predicting claim values and estimating reserves. Also, because medical stop-loss is in excess of an underlying benefit plan, there is an additional layer of claim reporting and processing that can affect claim payment patterns. Finally, changes in the distribution of business by effective month can affect reserve estimates due to the timing of claim occurrences and the time required to accumulate claims against the stop-loss deductible.
Predicting ultimate claims and estimating reserves in Medical Stop-Loss is more complex than specialty health medical and disability business due to the “excess of loss” nature of these products with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. The level of these deductibles makes it more difficult to predict the amount and payment pattern of such claims. Fluctuations in results for specific coverage are primarily due to the severity and frequency of individual claims, whereas fluctuations in aggregate coverage are largely attributable to frequency of underlying claims rather than severity. Liabilities for first dollar medical reserves and disability coverages are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data.
Due to the short-term nature of Medical Stop-Loss, redundancies or deficiencies will typically emerge during the course of the following year rather than over a number of years. For Medical Stop-Loss, as noted above, the Company maintains its reserves based on underlying assumptions until it determines that an adjustment is appropriate based on emerging experience from all of its prior underwriting years.
deposits received and interest credited to the benefit of the policyholder less surrenders and withdrawals, mortality charges and administrative expenses.
In 2016, premiums earned decreased $216.8 million over the comparable period of 2015. The decrease is primarily due to: (i) a decrease of $197.7 million in the Stop Loss segment as a result of the sale of Risk Solutions and exit from the medical stop-loss business, further described in Note 3; (ii) a decrease of $17.5 million in the Specialty Health segment principally as a result of a $26.8 million decrease in premiums from exiting the Major Medical line, a $11.9 million decrease in the fixed indemnity limited benefit line due to the cancellation of a distribution source, and a $1.4 million decrease in international medical business premiums due to lower retention, partially offset by premium increases in the short-term medical, pet and occupational accident lines of business of $17.7 million, $4.7 million and $1.6 million, respectively, as a result of higher volume; and (iii) a decrease of $11.8 million in the Individual life, annuities and other segment as a result of this business being in run-off; partially offset by
(iv) a $10.2 million increase in earned premiums from the Group disability, life, annuities and DBL segment primarily due to increased volume and retention in the LTD and group term life lines and increased volume in DBL business.
The Company had net realized investment gains of $4.5 million in 2016 compared to $3.1 million in 2015. These amounts include gains and losses from sales of fixed maturities and equity securities available-for-sale and other investments. Decisions to sell securities are based on management's ongoing evaluation of investment opportunities and economic and market conditions, thus creating fluctuations in gains and losses from period to period.
The Company recognized $1.5 million of other-than-temporary impairment losses on certain fixed maturities available-for-sale during 2016. The Company determined that it is more likely than not that we will sell the securities before recovery of their amortized cost basis. In 2015, the Company recognized $0.2 million of other-than-temporary impairment losses on equity securities available-for-sale due to the length of time and extent an equity security was below cost.
In the third quarter of 2015, the Company finalized a joint venture with Ebix, Inc. in which IHC sold its wholly owned administrative subsidiary, IHC Health Solutions (now known as Ebix Health Administration Exchange, Inc.), in exchange for a 60% ownership interest in Ebix Health Exchange and $6.0 million in cash proceeds. The transaction resulted in a loss of control over the subsidiary (due to a lack of the majority of the voting interest on the Board of Managers) and therefore the subsidiary was deconsolidated from the Company’s financial statements. The Company recognized a net gain of $9.9 million, pre-tax, on the transaction (see Note 7).
The Company recognized $0.2 million of other-than-temporary impairment losses on equity securities available-for-sale during 2015 due to the length of time and extent an equity security was below cost.
In 2015, insurance benefits, claims and reserves decreased $18.8 million over the comparable period in 2014. The decrease is primarily attributable to: (i) a decrease of $52.5 million in the Specialty Health segment, primarily due to lower loss ratios in 2015 and a decrease of $48.4 million in benefits, claims and reserves related to the run-off of the Major Medical; offset in part by increases in the volume of ancillary products, pet and occupational accident lines of business; (ii) a decrease of $7.9 million in the Individual life, annuities and other segment primarily as a result of a reinsurance transaction in the third quarter of 2015 whereby the Company ceded substantially all of its ordinary life and annuity business; partially offset by (iii) an increase of $31.5 million in benefits, claims and reserves in the Medical Stop-Loss segment as a result of an increase in premium volume and higher loss ratios; and (iv) an increase of $10.1 million in the group disability, life and DBL segment, primarily due to increased volume and retention in the group term life and LTD lines partially offset by lower loss ratios.
Total selling, general and administrative expenses decreased $3.7 million over the comparable period in 2014. The decrease is primarily attributable to: (i) a decrease of $9.1 million in the Specialty Health segment largely due to the run-off of the Major Medical and the deconsolidation of IHC Health Solutions, partially offset by increases in general expenses as a result of the higher volume of ancillary, pet and occupational accident business, which tends to have a higher expense structure than major medical; and (ii) a decrease of $6.0 million in Individual life, annuity and other segment primarily due to lower amortization of deferred costs in correlation with the assumptions of certain ceded life and annuity policies; partially offset by; (iii) an increase of $2.4 million in the Medical Stop-Loss segment primarily as a result of higher commission expenses; (iv) an increase of $9.0 million in the group disability, life and DBL segment primarily due to increased commission expense in the group term life and LTD lines as a result of new business and changes in retention levels.
The effective tax rate for 2015 was 36.2%. In 2014, the Company recorded a $2.5 million credit to federal income taxes as a result of the reduction in AMIC’s valuation allowance related to its deferred tax asset at December 31, 2014. Excluding this transaction, the effective tax rate for 2014 was 40.7%. The lower effective tax rate in 2015 was primarily due to: (i) a decrease in the amount of non-deductible expenses as a result of the Affordable Care Act as a percentage of income in 2015 compared to 2014; and (ii) a decrease in state taxes as a percentage of income in 2015; partially offset by (iii) a decrease in benefits from tax-advantaged securities as a percentage of income in 2015.
Cash and cash equivalents, including discontinued operations, as of December 30, 2016 and December 31, 2015 was $22.0 million and $19.2 million, respectively.
For year ended December 31, 2016, operating activities of the Company utilized $31.0 million of cash, $98.9 million was provided by investment activities and $65.0 million of cash was utilized for financing activities. The increase in cash from investing is primarily related to the proceeds from the sale of Risk Solutions net of amounts subsequently invested in short-term and available-for-sale securities. Financing activities include $18.1 million for the acquisition of AMIC shares in connection with taking AMIC private, $42.9 million utilized for the repayment of debt, $1.6 million for the payment of dividends and $3.5 million for treasury share purchases.
The $113.2 million increase in IHC’s stockholders' equity in 2016 is primarily due to the $123.3 million of net income attributable to IHC, partially offset by $3.6 million of other comprehensive loss attributable to IHC, $3.5 million of treasury stock purchases, a $2.2 million decrease related to the purchase of AMIC shares from noncontrolling interests and $1.8 million of common stock dividends. Noncontrolling interests in subsidiaries decreased primarily as a result of taking AMIC private in 2016.
The nature and quality of insurance company investments must comply with all applicable statutes and regulations, which have been promulgated primarily for the protection of policyholders. Although the Company's gross unrealized losses on available-for-sale securities totaled $12.3 million at December 31, 2016, more than 99.9% of the Company’s fixed maturities were investment grade and
continue to be rated on average AA. The Company marks all of its available-for-sale securities to fair value through accumulated other comprehensive income or loss. These investments tend to carry less default risk and, therefore, lower interest rates than other types of fixed maturity investments. At December 31, 2016, less than 0.1% (or $0.1 million) of the carrying value of fixed maturities was invested in non-investment grade fixed maturities (a commercial mortgage obligation). Investments in such securities have different risks than investment grade securities, including greater risk of loss upon default, and thinner trading markets. The Company does not have any non-performing fixed maturity investments at December 31, 2016.
Certain fixed maturities, primarily municipal obligations, in our investment portfolio are insured by financial guaranty insurance companies. The insurance, however, does not enhance the credit ratings on these securities. The following table summarizes the credit quality of our fixed maturity portfolio, as rated, at December 31, 2016:
The Company reviews its investments regularly and monitors its investments continually for impairments, as discussed in Note 1(G) (iv) of the Notes to Consolidated Financial Statements in Item 8 of this report. The Company recognized $1.5 million of other-than-temporary impairment losses on certain fixed maturities available-for-sale during 2016. The Company determined that it is more likely than not that we will sell the securities before recovery of their amortized cost basis. The Company recorded $0.2 million of other-than-temporary impairment losses on equity securities available-for-sale during 2015 due to the length of time and extent an equity security was below cost. At December 31, 2016, there were no securities with fair values less than 80% of their amortized cost.
All goodwill carrying amounts are evaluated for impairment at the reporting unit level which is equivalent to an operating segment. Goodwill was allocated to each reporting unit or operating segment at the time of acquisition. At December 31, 2016, total goodwill was $41.6 million, all of which was attributable to the Specialty Health segment.
Based upon the goodwill impairment testing performed at December 31, 2016, the fair value of each reporting unit exceeded its carrying value and no impairment charge was required. Fair value exceeded carrying value by more than 10% in the Specialty Health segment.
All other lines, primarily life and other individual health products, experienced favorable development of $1.7 million primarily due to a change in reserve factors and release of IBNR reserves.
The chart below reflects the maturity distribution of IHC’s contractual obligations at December 31, 2016 (in thousands):
Continue to show significant increases in specialty health premiums (including hospital indemnity, group limited medical and group gap and other supplemental health products, such as dental, accident medical, gap and critical illness products), although we may see a decrease in short term medical as a result of a regulation expected to take effect April 1, 2017.
On March 31, 2016, IHC and a subsidiary of AMIC sold the stock of Risk Solutions. In addition, under the purchase and sale agreement, all of the in-force stop-loss business of Standard Security Life and Independence American produced by Risk Solutions was co-insured by Westport as of January 1, 2016. The aggregate purchase price was $152.5 million in cash, subject to adjustments and settlements. This transaction resulted in a gain of $100.8 million, net of taxes and amounts attributable to noncontrolling interests. As a result, IHC is highly liquid and has excess capital; however its Medical Stop-Loss line of business is in run-off, which will have a negative impact on future earnings.
Our results depend on the adequacy of our product pricing, our underwriting, the accuracy of our reserving methodology, returns on our invested assets, and our ability to manage expenses. We will also need to be diligent with increased rate review scrutiny to effect timely rate changes and will need to stay focused on the management of medical cost drivers as medical trend levels cause margin pressures. Factors affecting these items, as well as unemployment and global financial markets, may have a material adverse effect on our results of operations and financial condition.
See Index to Consolidated Financial Statements and Schedules on page 80.