IndependenceCare leases 6,900 square feet of office space in Minneapolis, Minnesota, which expires on May 31, 2008; 1,200 square feet in Franklin, Tennessee, which expires on June 30, 2007; and 3,100 square feet in Austin, Texas, which expires on September 30, 2008. The Tennessee lease will not be renewed and the Company is attempting to transfer the obligations under its Texas lease to a third party. RAS leases 4,200 square feet of office space in South Windsor, Connecticut, which expires on February 1, 2009. Marlton leases 6,000 square feet of office space in Voorhees, New Jersey, which expires on January 31, 2009.
The following is a summary of selected consolidated financial data of the Company for each of the last five years. The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes thereto and "Management's Discussions and Analysis of Financial Condition and Results of Operations" included elsewhere in this annual report on Form 10-K. (In thousands, except per share data)
All per share data has been restated to show the effect of the Company's one for three reverse split on February 13, 2003.
The Company is an insurance holding company engaged in the insurance and reinsurance business through its wholly owned insurance company, Independence American Insurance Company ("Independence American") and its managing general underwriter subsidiaries (the "MGUs") that currently specialize in medical stop-loss insurance. Since November 2002, AMIC has been affiliated with Independence Holding Company ("IHC"), which currently owns 48% of AMIC's stock, and IHC's senior management has provided direction to the Company through service agreements between the Company and IHC. Independence American’s primary source of revenue is reinsurance premiums. The majority of these premiums are ceded to Independence American from IHC under long-term reinsurance treaties to cede its gross medical stop-loss premiums written to Independence American. In addition, Independence American assumes fully insured health and short-term statutory disability benefit product in New York State ("DBL") premiums from IHC, and assumes medical stop-loss premiums from unaffiliated carriers. Independence American began writing medical stop-loss business in 2006 and will expand this line of business and begin writing two fully insured health products in 2007.
While management considers a wide range of factors in its strategic planning, the overriding consideration is underwriting profitability. Management's assessment of trends in healthcare and in the medical stop-loss market play a significant role in determining whether to expand Independence American's reinsurance participation percentage or the number of programs it reinsures. Since Independence American reinsures a portion of all of the business produced by the MGUs, and since the MGUs are also eligible to earn profit sharing commissions based on the profitability of the business they write, the MGUs also emphasize underwriting profitability. In addition, management focuses on controlling operating costs. By sharing employees with IHC and sharing resources among the MGUs and Independence American, AMIC strives to maximize its earnings.
2006 was negatively impacted by higher than expected claims from certain of Independence American's medical stop-loss programs. The Company recorded an overall Net Loss Ratio for medical stop-loss of 100.5%, 97.1% and 91.3% in 2006, 2005 and 2004, respectively. The Net Loss Ratio ("Net Loss Ratio") is defined as insurance benefits, claims and reserves, divided by (premiums earned less underwriting expenses). Based on currently available information, business incepting in 2006, of which a material portion will be earned and recorded in 2007, is projected to achieve a net loss ratio that is meaningfully lower than that of business incepting in 2005, just as the net loss ratio on business incepting in 2005 was meaningfully lower than that of business incepting in 2004.
Added six additional licenses in 2006, bringing total to 43 states and the District of Columbia.
Average percentage of gross medical stop-loss premiums written ceded from IHC to Independence American increased to 22.2% during 2006 from 21.9% during 2005.
In 2006, Independence American began writing medical stop-loss business and will, in 2007, write small group major medical business pursuant to an agreement entered into in 2006 (see Note 5 of Notes to Consolidated Financial Statements).
Agreed with a national, career agent marketing organization to begin marketing, in 2007, health plans to individuals and families utilizing Independence American as the carrier.
The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles ("GAAP"). The preparation of the Consolidated Financial Statements in conformity with GAAP requires the Company's management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. A summary of the Company's significant accounting policies and practices is provided in Note 1 of the Notes to the Consolidated Financial Statements included in Item 8. Management has identified the accounting policies described below as those that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of the Company's Consolidated Financial Statements and this Management's Discussion and Analysis
Major factors that affect the Projected Net Loss Ratio assumption in reserving for medical stop-loss relate to: (i) frequency and severity of claims; (ii) changes in medical trend resulting from the influences of underlying cost inflation, changes in utilization and demand for medical services, the impact of new medical technology and changes in medical treatment protocols; and (iii) the adherence by the MGUs that produce and administer this business to the Company’s underwriting guidelines. Changes in these underlying factors are what determine the reasonably likely changes in the Projected Net Loss Ratio as discussed above.
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 Employer Stop-Loss, as noted above, the Company maintains its reserves based on underlying pricing assumptions until it determines that an adjustment is appropriate based on emerging experience from its MGUs for prior underwriting years. Reserves for HMO Reinsurance and Provider Excess are adjusted on a policy by policy basis. Because of the small number of HMO Reinsurance and Provider Excess policies it writes, the Company is able to evaluate each policy individually for potential liability by reviewing open claims with each HMO or provider group and applying completion factors using historical data.
The primary assumption in the determination of fully insured reserves is that historical claim development patterns are representative of future claim development patterns. Factors which 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. The reserving analysis includes a review of claim processing statistical measures and large claim early notifications; the potential impact of any changes in these factors are minimal. The time delay in submission of claims tends to be stable over time and not subject to
significant volatility. The Company does not believe that any reasonably likely change in these factors will have a Material Effect.
Independence American is primarily a reinsurer, and currently derives most of its business from pro rata quota share reinsurance treaties with Standard Security Life and Madison National Life which are wholly owned subsidiaries of IHC. These treaties were entered into in 2002 and terminate on December 31, 2014, unless terminated sooner by Independence American. Standard Security Life and Madison National Life must cede at least 15% of their medical stop-loss business to Independence American under these treaties. Additionally, Standard Security Life, Madison National Life and Independence American have received regulatory approval to cede up to 30% to Independence American under most of IHC’s medical stop-loss programs. For the twelve months ended December 31, 2006 and 2005, Standard Security Life and Madison National Life ceded an average of 22.2% and 21.9%, respectively, of their medical stop-loss business to Independence American. Commencing in July 2004, Independence American began reinsuring 20% of Standard Security Life’s short-term statutory disability benefit product (“DBL”) business. In 2005, Standard Security Life and Madison National Life began ceding 10% of the majority of its fully insured business to Independence American.
IHC provides the Company with pro rata quota share reinsurance on business written by Independence American. This business accounted for approximately 2% of the Company’s total earned premiums at December 31, 2006. Commencing in January 2004, Independence American began ceding 30% of its provider excess insurance to Madison National Life. In January 2005, Independence American increased the amount ceded to Madison National Life to 55%. This treaty was entered into on January 1, 2004 and will remain in force for an indefinite period, unless terminated by either party as of any December 31. The Company is not aware of any regulatory or other restrictions on the ability of IHC to fund its obligations under agreements in which IHC reinsures such provider excess business. Any such restrictions would at this point have a minimal impact on the Company. In addition, in 2006 Independence American ceded 50% of its STM business to unrelated reinsurers.
The Company has net operating loss carryforwards for federal income tax purposes available to reduce future income subject to income taxes. The net operating loss carryforwards expire between 2019 and 2025.
Results of Operations for the Fiscal Year Ended December 31, 2006, Compared to the Fiscal Year Ended December 31, 2005
Premiums Earned. Premiums earned increased $1,659,000 (3% increase) to $67,777,000 for fiscal 2006, compared to $66,118,000 for fiscal 2005. The Company currently reinsures three lines of business from IHC. Premiums relating to medical stop-loss business were $56,179,000 and $57,732,000 for fiscal 2006 and fiscal 2005, respectively. The decline is due to a decrease in gross medical stop-loss premiums written by IHC as a result of stricter underwriting guidelines. Premiums relating to DBL were $3,913,000 and $4,187,000 for fiscal 2006 and fiscal 2005, respectively. The decline is due to a decrease in DBL premiums produced by IHC as a result of a reduction in premium rates. Premiums relating to group major medical and STM were $7,685,000 and $4,199,000 for fiscal 2006 and fiscal 2005, respectively. Independence American began reinsuring 10% of IHC’s group medical business effective January 1, 2005 and 10% of IHC’s STM in the second half of 2005. The increase is due to an increase in production of these lines at IHC and the lack of STM premiums in the first half of fiscal 2005.
MGU Fee Income. MGU fee income decreased $3,800,000 to $10,356,000 for fiscal 2006, compared to $14,156,000 for fiscal 2005. MGU fee income-administration decreased $2,046,000 to $10,238,000 for fiscal 2006, compared to $12,284,000 for fiscal 2005, as the MGUs have decreased their volume of business as a result of stricter underwriting guidelines. MGU fee income-profit commission decreased $1,754,000 to $118,000 for fiscal 2006, compared to $1,872,000 for fiscal 2005. Profit commissions for a given year are based primarily on the performance of business written during portions of the three preceding years. Therefore, profit commissions for 2006 are based on business written during portions of 2003, 2004 and 2005. Since certain of the MGUs experienced higher loss ratios on those years, profit commissions for 2007 and future fiscal years will continue to be adversely affected.
Selling, General and Administrative. Selling, general and administrative expenses decreased $925,000 to $30,267,000 for fiscal 2006, compared to $31,192,000 for fiscal 2005. This decrease is primarily due to lower commission expense of $780,000 incurred by Independence American resulting from a decrease in profit commissions due to non-owned MGUs resulting from higher loss ratios on certain treaties.
Amortization and Depreciation. Amortization and depreciation expense decreased $411,000 to $689,000 for fiscal 2006, compared to $1,100,000 for fiscal 2005. The expense mainly relates to the amortization of the intangible assets for the value of broker/TPA relationships of the MGUs. These assets were part of the purchase price adjustments for the acquisition of IAHC, Marlton, and IndependenceCare-MidAtlantic. Amortization expense for these intangible assets will decline over the useful lives of the assets.
Gain/Loss on Discontinued Operations. Loss on discontinued operations, net of tax was $54,000 for fiscal 2006, compared to $59,000 for fiscal 2005. The loss in both years was primarily the result of the re-estimation of lease costs related to the Company’s discontinued Intellicom operation.
Net Income. The Company had net income of $1,454,000, or $.17 per share, diluted, for fiscal 2006, compared to $5,460,000, or $.64 per share, diluted, for fiscal 2005.
Results of Operations for the Fiscal Year Ended December 31, 2005, Compared to the Fiscal Year Ended December 31, 2004
Premiums Earned. Premiums earned increased $5,915,000 to $66,118,000 for fiscal 2005, compared to $60,203,000 for fiscal 2004, an increase of 10%. The Company currently reinsures three lines of business from Independence Holding Company ("IHC"). Total premiums relating to medical stop-loss were $57,732,000 and $57,998,000 for the fiscal years ended December 31, 2005 and 2004, respectively. Premiums relating to DBL were $4,187,000 and $2,205,000 for 2005 and 2004, respectively. Independence American began reinsuring 20% of IHC’s DBL business effective July 1, 2004. Premiums relating to small group major medical were $4,199,000 and $0 for 2005 and 2004, respectively. Independence American began reinsuring 10% of IHC’s small group medical business effective January 1, 2005. Independence American generated $180,000 of STM premiums in 2005, which was the first year in which it wrote such business.
MGU Fee Income. The Company earned $14,156,000 of fee income from its MGUs for fiscal 2005 as compared to $17,597,000 for fiscal 2004, a decrease of $3,441,000. The reduction in fee income is due to lower volume of premiums written and lower profit commissions. Included in fee income is $1,872,000 and $2,749,000 of MGU profit commissions in 2005 and 2004, respectively. Profit commissions for a given year are based primarily on the performance of business written during portions of the two preceding years. Therefore, profit commissions for 2006 will be based on business written during portions of 2004 and 2005. Since certain of the MGUs experienced higher loss ratios in those years, profit commissions for the 2006 fiscal year and future years may be adversely affected.
Insurance Benefits, Claims and Reserves. Insurance benefits, claims and reserves amounted to $44,722,000 for fiscal 2005 as compared to $39,173,000 for fiscal 2004, an increase of $5,549,000 or 14%. The increase is mainly due to additional claims relating to increased earned premium volume from Independence American in 2005. Additionally, 2005 was negatively impacted by higher than expected claims from certain of Independence American's 2004 and 2005 medical stop-loss programs. The Company recorded an overall Net Loss Ratio of 95.1% in 2005 versus 90.9% in 2004. Insurance benefits, claims and reserves for 2005 includes a charge of $305,000 to reflect loss development from prior treaty years and a corresponding increase in reserves for the current treaty year. While management sets reserves based on its best estimate of ultimate claim settlement cost, the Company adjusts reserves as claims mature, approach settlement or are otherwise resolved.
Restructuring Expense. The Company recognized no restructuring expense for fiscal 2005 and no related expense for fiscal 2004. The Company reversed the remaining reserve of $67,000 related to the restructuring during fiscal 2005. At December 31, 2005 and December 31, 2004, a restructuring accrual of $0 and $300,000, respectively, remained outstanding.
Independence American principally derives cash flow from: (i) operations; (ii) the receipt of scheduled principal payments on its portfolio of fixed income securities; and (iii) earnings on investments. Such cash flow is partially used to finance liabilities for insurance policy benefits and reinsurance obligations.
Net cash used by investing activities of continuing operations for fiscal year ended December 31, 2006 was $11,546,000. This results from purchases of fixed maturities, equity securities, and short-term investments, net of sales of all such securities. Also, in February 2006, Independence American entered into an agreement to write group major medical and medical stop-loss insurance pursuant to which $2,500,000 was paid to EDH (see Note 5 of Notes to Consolidated Financial Statements).
Net cash provided by financing activities for the fiscal year ended December 31, 2006 was $52,000, resulting from the exercise of common stock options.
The Company believes it has sufficient cash to meet its currently anticipated business requirements over the next twelve months including the funding of discontinued operations, working capital requirements, and capital investments. The Company expects continued cash usage for its discontinued operations, which are primarily lease obligations, for the year ending December 31, 2007.
The nature and quality of insurance company investments must comply with all applicable insurance statutes and regulations which have been promulgated primarily for the protection of policyholders. Of the aggregate carrying value of the Company's investment assets, approximately 94.3% was invested in investment grade fixed income securities, resale agreements, and cash and cash equivalents at December 31, 2006. Also at such date, 99.6% of the Company's fixed maturities were investment grade. These investments carry less default risk and, therefore, lower interest rates than other types of fixed maturity investments. At December 31, 2006, 0.4% of the carrying value of fixed maturities was invested in diversified non-investment grade fixed income securities. 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 maturities.
The composition of the Company's fixed maturities at December 31, 2006, utilizing Standard and Poor's rating categories, was as follows:
The Company had receivables from reinsurers of $12,249,000 at December 31, 2006. Substantially all of the business ceded to such reinsurers is of short duration. All of such receivables are either due from related parties, highly rated companies or are adequately secured. No allowance for doubtful accounts was deemed necessary at December 31, 2006.
Independence American, which is domiciled in Delaware, is licensed to write property and/or casualty insurance in 43 states and the District of Columbia, and has a B++ (Good) rating from A.M. Best Company, Inc. ("A.M. Best"). An A.M. Best rating is assigned after an extensive quantitative and qualitative evaluation of a company's financial condition and operating performance, and is also based upon factors relevant to policyholders, agents, and intermediaries, and is not directed towards protection of investors. A.M. Best ratings are not recommendations to buy, sell or hold securities of the Company.
The gross medical stop-loss premiums written by IHC decreased in 2006 by 4.6% and such premiums produced by the AMIC MGUs decreased by 3.5% in 2006, as a result of writing and/or renewing fewer policies due to competitors' willingness to write business at profit margins lower than those acceptable to the Company, partially offset by increased rates on the policies retained. This resulted in a decrease in the gross amount of premium available to be ceded to Independence American. The AMIC MGUs do not anticipate materially increasing their production of medical stop-loss business in 2007. IHC has reported that it expects its gross DBL premiums to be relatively stable in 2006, however, it expects meaningful growth in its STM and CDHP premiums in 2007.
In February 2006, Independence American entered into an agreement with a marketing organization with a growing block of fully insured health business, including CDHPs, primarily sold to small employer groups, and medical stop-loss, to begin writing for Independence American. The organization that produces this business began writing employer medical stop-loss through Independence American in 2006, and will move the majority of its existing block of fully insured and stop-loss health insurance (currently approximately $29 million) to Independence American during 2007. This block, which is expected to have meaningful growth, has averaged 8% risk profit over the past five years, although there is no guaranty that such results will be maintained. Independence American will be the exclusive issuing carrier for business underwritten by this organization through December 31, 2011. Subject to certain conditions, the agreement will automatically extend until December 31, 2016, and this organization could be entitled to additional cash consideration (see Note 5 of Notes to Consolidated Financial Statements).
Consolidated Statements of Operations for the years ended December 31, 2006, 2005
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of American Independence Corp. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006, and our report dated March 15, 2007 expressed an unqualified opinion on those consolidated financial statements.
We have audited the accompanying consolidated balance sheets of American Independence Corp. and subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedules listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of American Independence Corp. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Due from reinsurers ($11,003 and $10,696, respectively, due from related parties)
MGU fee income ($7,793, $10,568 and $12,772 respectively, from related parties)
American Independence Corp. ("AMIC" or "the Company") is a holding company engaged in the insurance and reinsurance business through: a) its wholly owned insurance company, Independence American Insurance Company ("Independence American"); b) its managing general underwriter subsidiaries: IndependenceCare Holdings L.L.C. and its subsidiaries (collectively referred to as "IndependenceCare"); Risk Assessment Strategies, Inc. ("RAS"), and Marlton Risk Group LLC ("Marlton"); and c) its investment in Majestic Underwriters LLC ("Majestic"). IndependenceCare, RAS and Marlton are collectively referred to as the "MGU Subsidiaries."
Prior to November 14, 2002, the Company (then known as SoftNet Systems, Inc.) was a holding company principally engaged in providing Internet services. Four previously reported business segments, business center services, satellite-based Internet services, cable-based Internet services and document management, have ceased operations or have been sold, and accordingly are reported as discontinued operations (see Note 9 of Notes to Consolidated Financial Statements).
The Company's investment in Majestic Underwriters LLC (see Note 7 of Notes to Consolidated Financial Statements) is carried on the equity method with the Company's share of income or loss credited or charged, as appropriate, to net invested income in the Consolidated Statement of Operations with a corresponding charge to the Company's investment account. The
Company also reduces its investment account for its proportionate share of the amortization expense for the intangible assets recorded in the acquisition.
For goodwill, if the book value of a reporting unit exceeds its fair value, the implied fair value of goodwill is compared with the carrying amount of goodwill. If the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recorded in an amount equal to that excess.
Cash and cash equivalents consist of cash and highly liquid securities with maturities of three months or less from date of purchase. Restricted cash primarily consists of funds held by the MGUs for the benefit of their insurers and reinsurers. These funds are restricted and are to be used to facilitate expeditious payment of approved claims. The funds are replenished by the insurers and reinsurers as claims are paid by the MGUs.
(iv) The Company enters into derivative financial instruments, such as put and call option contracts and options on interest rate futures contracts, to minimize losses on portions of the Company's fixed income portfolio in a rapidly changing interest rate environment. Equity index options are entered into to offset price fluctuations in the equity markets. These derivative financial instruments are all readily marketable and are carried on the Consolidated Balance Sheets at their current fair value with changes in fair value (unrealized gains or losses), credited or charged, as appropriate, to net realized investment gains in the Consolidated Statements of Operations. All realized gains and losses are reflected currently in the Consolidated Statements of Operations. Losses on these instruments were $19,000, $90,000 and $27,000 during 2006, 2005 and 2004, respectively.
Liabilities for insurance reserves for fully insured medical business are established to provide for the liability for incurred but not paid claims. Reserves are calculated using standard actuarial methods and practices. Historical paid claim patterns are reviewed and estimated development factors are applied to immature incurred months to calculate these reserves. The primary assumption in the determination of fully insured reserves is that historical claim development patterns are representative of future claim development patterns. Factors which 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.
Management believes that the Company's methods of estimating the liabilities for insurance reserves provided appropriate levels of reserves at December 31, 2006 and December 31, 2005. Changes in the Company's reserve estimates are recorded through a charge or credit to its earnings.
The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial carrying amounts of existing assets and liabilities and their respective tax basis, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets where it is more likely than not that the deferred tax asset will not be realized (see Note 13 of Notes to Consolidated Financial Statements).
On November 14, 2002, the Company adopted certain provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 established a fair-value-based method of accounting for stock-based compensation plans. Pursuant to the transition provisions of SFAS 123, the Company applied the fair value method of accounting to all option grants issued on or after October 1, 2002. The fair value method was not applied to stock option awards granted prior to October 1, 2002. Such awards continue to be accounted for under the intrinsic value method pursuant to APB 25, except to the extent those prior years' awards are modified subsequent to October 1, 2002. At December 31, 2006 all such shares accounted for under APB 25 were fully vested or expired.
regarding the SEC's interpretation of SFAS No. 123 (R) and the valuation of share-based payments for public companies. The company has applied the provisions of SAB 107 in its adoption of SFAS No. 123 (R) and accordingly recorded share-based payment expense in selling, general and administrative expenses. Since the Company previously adopted the provisions of SFAS No. 123, effective November 14, 2002, the adoption of SFAS No. 123 (R) did not have a material impact on the Company's Consolidated Financial Statements.
In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109" ("Interpretation 48"), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The recognition threshold is based on a determination of whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. Only tax positions that meet the more-likely-than-not recognition threshold at the effective date may be recognized or continue to be recognized upon adoption of Interpretation 48. Interpretation 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Interpretation 48 is effective for fiscal years beginning after December 15, 2006. The cumulative effect of applying the provisions of Interpretation 48 is reported as an adjustment to retained earnings as of the beginning of the year of adoption. The amount of the cumulative-effect adjustment is the difference between the net amount of assets and liabilities recognized in the balance sheet prior to the application of Interpretation 48 and the net amount of assets and liabilities recognized as a result of applying Interpretation 48. Adoption of Interpretation 48 on January 1, 2007 is not expected to have a material effect on the Company's consolidated financial statements.
In September 2006, the staff of the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. The SEC staff believes that registrants should quantify errors using both a balance sheet and an income statement approach and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB 108 was effective for the year ended December 31, 2006 and did not affect the Company’s consolidated financial statements.
Intangible assets at December 31, 2006 and 2005 consist of the following (in thousands):
Expected amortization expense for the next five years is as follows (in thousands):
The EDH Agreement terminates on December 31, 2011; provided, it will automatically be extended to December 31, 2016, subject to satisfaction of certain conditions as to premium volume and profitability. Assuming these conditions are satisfied, EDH would be entitled to up to an additional $2,500,000 depending on the value of the IHC Stock as of December 31, 2011. The Company recorded a derivative liability (“EDH Derivative”) and an intangible asset on its balance sheet in the amount of $743,000 to account for the fair value of such contingent payment at
The Company had derivative instruments representing the value of the contingent payment due to EDH as of December 31, 2006 (see Note 5 of Notes to Consolidated Financial Statements). There were no derivative instruments as of December 31, 2005.
Gross gains of $115,000 and gross losses of $336,000 were realized on sales of available-for-sale securities for the year ended December 31, 2006.
Gross gains of $478,000 and gross losses of $481,000 were realized on sales of available-for-sale securities for the year ended December 31, 2005.
Gross gains of $876,000 and gross losses of $903,000 (including $134,000 from temporary impairment) were realized on sales of available-for-sale securities for the year ended December 31, 2004.
Fixed maturities with a carrying value of $4,444,946 are on deposit with various state insurance departments at December 31, 2006.
Future minimum lease payments under non-cancelable operating leases as of December 31, 2006, are as follows (in thousands):
The Company's net rent expense from continuing operations for fiscal years 2006, 2005, and 2004 were $649,000, $872,000 and $923,000, respectively.
The Company has additional obligations in regard to its agreement with EDH as further described in Note 5 of Notes to Consolidated Financial Statements.
The Company recorded an expense of approximately $235,000 and $227,000 for fiscal 2006 and 2005, respectively, related to options issued under the fair value based method. As of December 31, 2006, there was $305,000 of total unrecognized compensation expense related to non-vested options which will be recognized over the remaining requisite service periods.
The following table summarizes information regarding stock options outstanding at December 31, 2006:
The fair value of each stock option on the date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions for years 2006, 2005 and 2004:
No options were granted for the period ended December 31, 2006.
IHC provides the Company with pro rata quota share reinsurance on business written by Independence American. This business accounted for approximately 2% of the Company’s total earned premiums at December 31, 2006. Commencing in January 2004, Independence American began ceding 30% of its provider excess insurance to Madison National Life. In January 2005, Independence American increased the amount ceded to Madison National Life to 55%. This treaty was entered into on January 1, 2004 and will remain in force for an indefinite period, unless
terminated by either party as of any December 31. The Company is not aware of any regulatory or other restrictions on the ability of IHC to fund its obligations under agreements in which IHC reinsures such provider excess business. Any such restrictions would at this point have a minimal impact on the Company. In addition, in 2006 Independence American ceded 50% of its STM business to unrelated reinsurers.
AMIC and its subsidiaries incurred expense of $622,000, $564,000 and $550,000 for the twelve months ended December 31, 2006, 2005, and 2004 respectively, from its service agreements with IHC and its subsidiaries. These payments reimburse IHC and its subsidiaries, at agreed upon rates including an overhead factor, for management services provided to AMIC and its subsidiaries, including accounting, legal, compliance, underwriting, and claims.
Independence American assumes these premiums from Standard Security Life and Madison National Life, and records related insurance income, expenses, assets and liabilities. Independence American pays administrative fees and commissions to subsidiaries of IHC in connection with fully insured health business written by Independence American. Additionally, the MGU Subsidiaries market, underwrite and provide administrative services (including premium collection, medical management and claims adjudication) for a substantial portion of the medical stop-loss business written by the insurance subsidiaries of IHC and records related income, assets and liabilities in connection with that business. Such related party information is disclosed on the Consolidated Balance Sheets and Consolidated Statements of Operations. The Company also contracts for several types of insurance coverage (e.g. directors and officers and professional liability coverage) jointly with IHC. The cost of this coverage is split proportionally between the Company and IHC according to the type of risk and AMIC’s portion is recorded in Selling, General and Administrative Expenses.
The tax effect of temporary differences that give rise to significant portions of the net deferred tax assets at December 31, 2006 and 2005 are as follows:
During the year ended December 31, 2006 the Company increased its valuation allowance by $44,000 representing and increase of deferred tax on unrealized losses allocated to equity.
During the year ended December 31, 2005, the Company reduced its valuation allowance by $1,807,000. This reduction included $2,079,000 for the projected utilization of Federal operating losses which was allocated to operations and a $272,000 increase of deferred tax on unrealized losses allocated to equity.
The preceding schedule reflects (i) the due and unpaid, (ii) claims in the course of settlement, (iii) estimated incurred but not reported reserves and (iv) the present value of amounts not yet due on claims. The incurred and paid data above reflects all activity for the year. The amount incurred in 2006, 2005 and 2004 for prior years of $1,969,000, $305,000 and $1,730,000, respectively, is primarily a result of re-estimation of unpaid losses on medical stop-loss reserves. This increase (decrease) is generally the result of on-going analysis of recent loss development trends.
Independence American reinsures a portion of its provider excess loss business in order to limit the assumption of disproportionate risks. Amounts not retained are ceded to other companies on an automatic basis. Independence American is contingently liable with respect to reinsurance in the unlikely event that the assuming reinsurers are unable to meet their obligations. The ceding of reinsurance does not discharge the primary liability of the original insurer to the insured. At December 31, 2006, Independence American ceded to three highly rated reinsurers.
Dividends from Independence American to its parent, a subsidiary of AMIC, are subject to the prior notification to the Delaware Insurance Commissioner. If such dividends, together with the fair market value of other dividends or distributions made within the preceding twelve months, exceed the greater of (i) 10% of surplus as regards policyholders as of the preceding December 31 or (ii) net income, not including realized capital gains, for the twelve-month period ending the 31st day of December next preceding, such dividends may be paid so long as they have not been disapproved by the Delaware Insurance Commissioner within 30 days of its receipt of notice thereof. Independence American did not pay any dividends in 2006, 2005, and 2004.
The components of total comprehensive income, net of tax, include net income and certain amounts reported directly in equity, such as the after-tax unrealized gains and losses on investment securities available-for-sale. The components of other comprehensive income for fiscal years 2006, 2005 and 2004 are as follows (in thousands):