We are an insurance holding company engaged in the insurance and reinsurance business through our wholly owned insurance company, Independence American Insurance Company ("Independence American"), our full service direct writer of medical-stop insurance for self-insured employer groups IHC Risk Solutions, LLC (“Risk Solutions”), and our two insurance and marketing agencies Independent Producers of America, LLC (“IPA”) and HealthInsurance.org (“HIO”). Since November 2002, AMIC has been affiliated with Independence Holding Company ("IHC"), which owned 78.5% of AMIC's stock as of December 31, 2011. In March 2010, upon approval of the AMIC Board of Directors, IHC acquired control of AMIC through the purchase of approximately 28,000 shares of common stock of AMIC in the open market. As of December 31, 2011, IHC had acquired an additional 2,235,000 shares of AMIC, bringing its aggregate ownership to 78.5%. IHC's senior management has provided direction to us through service agreements between us and IHC. In 2011, a significant amount of Independence American’s revenue was from 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 group major medical, medical stop-loss, major medical plans for individuals and families, and short-term medical in 2007, and added dental in 2009. Given its A- (Excellent) rating from A.M. Best, Independence American expects to expand the distribution of its medical stop-loss products, and slightly increase the business written on its paper, especially major medical plans for individuals and families and pet insurance.
At December 31, 2011, 98.6% of the Company's fixed maturities were investment grade.
Premiums earned decreased 2% to $72.4 million for the year ended December 31, 2011 from $73.9 million for the year ended December 31, 2010, primarily due to lower assumed medical stop-loss premiums and lower group major medical premiums written.
For the years ended December 31, 2011 and 2010, Independence American wrote $13.1 million and $14.1 million, respectively, of individual health business produced by our marketing organization IPA. The Company increased its retention in this business to 70% from 50% in 2011.
The Company recorded a decrease in the loss ratio in the medical stop-loss line of business for the year ended December 31, 2011 due to improved profitability of both direct and assumed business. The medical stop-loss results have begun to show improved profit margins primarily as a result of business written in 2010 performing better than that written in the comparable period of 2009, and the run-out of poorly performing business by non-owned managing general underwriters (“MGUs”) which were previously cancelled.
The Company’s medical stop-loss business is comprised of employer stop-loss and HMO Reinsurance. The two “primary” or “key” assumptions underlying the calculation of loss reserves for medical stop-loss business are (i) projected net loss ratio, and (ii) claim development patterns. The projected net loss ratio is set at expected levels consistent with the underlying assumptions (“Projected Net Loss Ratio”). Claim development patterns are set quarterly as reserve estimates are developed and are based on recent claim development history (“Claim Development Patterns”). The Company uses the Projected Net Loss Ratio to establish reserves until developing losses provide a better indication of ultimate results and it is feasible to set reserves based on Claim Development Patterns. The Company has concluded that a reasonably likely change in the Projected Net Loss Ratio assumption could have a material effect on the Company’s financial condition, results of operations, or liquidity (“Material Effect”) but a reasonably likely change in the Claim Development Pattern would not have a Material Effect.
While the Company establishes a best estimate of the Projected Net Loss Ratio, actual experience may deviate from this estimate. This was the case with the 2008, 2009 and 2010 underwriting years that increased (decreased) by (0.5), 3.3, and (0.9) Loss Ratio points, respectively. While the Company believes that larger variations are possible, based on the Company’s experience to date, it is reasonably likely that the actual experience will fall within a range up to five Net Loss Ratio points above or below the expected Projected Net Loss Ratio for the 2011 underwriting year at December 31, 2011. The impact of these reasonably likely changes at December 31, 2011, would be an increase in net reserves (in the case of a higher ratio) or a decrease in net reserves (in the case of a lower ratio) of up to approximately $0.9 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the 2011 Consolidated Statement of Operations.
Amounts recoverable or paid for under reinsurance contracts are included in total assets or total liabilities as due from reinsurers or due to reinsurers. In 2011, Independence American derived a significant amount 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 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 each of the twelve months ended December 31, 2011 and 2010, Standard Security Life and Madison National Life ceded an average of approximately 20% of their medical stop-loss business to Independence American. Independence American reinsures 20% of Standard Security Life’s DBL business. Standard Security Life and Madison National Life also ceded approximately 9% of the majority of their fully insured health business lines to Independence American. In addition, in 2011, Independence American ceded 30% of the majority of its fully insured health business lines to an unaffiliated reinsurer.
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 2029.
The Company has classified all of its investments as available-for-sale securities. These investments are carried at fair value with unrealized gains and losses reported in accumulated other comprehensive income (loss) in the Consolidated Balance Sheets. Fixed maturities and equity securities available-for-sale totaled $61.7 million and $57.7 million at December 31, 2011 and 2010, respectively. Premiums and discounts on debt securities purchased at other than par value are amortized and accreted, respectively, to interest income in the Consolidated Statements of Operations, using the constant yield method over the period to maturity. Net realized gains and losses on investments are computed using the specific identification method and are reported in the Consolidated Statements of Operations.
Equity securities may experience other-than-temporary impairment in the future based on the prospects for full recovery in value in a reasonable period of time and the Company’s ability and intent to hold the security to recovery. If a decline in fair value is judged by management to be other-than-temporary or management does not have the intent or ability to hold a security, a loss is recognized by a charge to total other-than-temporary impairment losses in the Consolidated Statements of Operations for the difference between the carrying value and the fair value of the securities. For the purpose of other-than-temporary impairment evaluations, preferred stocks with maturities are treated in a manner similar to debt securities. Declines in the creditworthiness of the
issuer of debt securities with both debt and equity-like features requires the use of the equity model in analyzing the security for other-than-temporary impairment.
Premiums Earned. Premiums earned decreased 2%, or $1,411,000 from 2010 to 2011. The Company currently has three lines of business. Premiums relating to medical stop-loss business decreased $678,000. This is due to a decrease in medical stop-loss premiums assumed by Independence American ($2,597,000), offset by an increase in medical stop-loss premiums written by Independence American ($1,919,000). Premiums relating to fully insured health consisting of group major medical, limited medical, short-term medical, dental, vision, hospital indemnity, and individual health decreased $481,000. The decrease is primarily due to a decrease in group major medical premiums written by Independence American ($1,600,000) and a decrease in fully insured premiums assumed from IHC ($428,000), offset by an increase in hospital indemnity premiums
($734,000) and individual health premiums ($547,000) written by Independence American. Premiums relating to DBL decreased $252,000 primarily due to a premium rate reduction mandated by the State of New York. For the year ended December 31, 2011, Independence American assumed 10% of IHC’s short-term medical business, approximately 9% of certain of IHC’s group major medical business, 20% of IHC’s DBL business and approximately 20% of IHC’s medical stop-loss business. There were no significant changes to these percentages from the prior year.
Fee and Agency Income. Fee and agency income decreased $778,000 from 2010 to 2011. Risk Solutions fee income-administration increased $457,000 to $4,950,000 for 2011, compared to $4,493,000 for 2010. Risk Solutions fee income-profit commission decreased $248,000 to $671,000 for 2011, compared to $919,000 for 2010. 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 2011 are based on business written during portions of 2008, 2009 and 2010. In 2011, income from our Agencies consisted of commission income and other fees of $4,852,000 from IPA and revenue of $2,174,000 from HIO. In 2010, income from our Agencies consisted of commission income and other fees of $5,752,000 from IPA and revenue of $2,261,000 from HIO.
Net Income attributable to American Independence Corp. The net income attributable to the Company increased to $2,494,000, or $.29 per share, diluted, for 2011, compared to $2,099,000, or $.25 per share, diluted, for 2010.
Premiums Earned. Premiums earned decreased 14%, or $11,656,000 from 2009 to 2010. The Company currently has three lines of business. Premiums relating to medical stop-loss business decreased $7,131,000. This is due to a decrease in medical stop-loss premiums assumed by Independence American ($9,285,000), offset by an increase in medical stop-loss premiums written by Independence American ($2,154,000). Premiums relating to fully insured health consisting of group major medical, limited medical, short-term medical, dental, vision, and individual health decreased $4,440,000. The decrease is primarily due to a decrease in group major medical premiums written by Independence American ($4,193,000) and a decrease in group major medical premiums assumed from IHC ($2,347,000), offset by an increase in individual health premiums written by Independence American ($1,608,000). Premiums relating to DBL decreased $85,000. For 2010, Independence American assumed 10% of IHC’s short-term medical business, approximately 9% of certain
Fee and Agency Income. Fee and agency income decreased $1,915,000 from 2009 to 2010. Risk Solutions fee income-administration decreased $1,599,000 to $4,493,000 for 2010, compared to $6,092,000 for 2009, as Risk Solutions has decreased its volume of business as a result of market conditions. Risk Solutions fee income-profit commission decreased $102,000 to $919,000 for 2010, compared to $1,021,000 for 2009. 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 2010 are based on business written during portions of 2007, 2008 and 2009. In 2010, income from our Agencies consisted of commission income and other fees of $5,752,000 from IPA, and revenue of $2,261,000 from HIO. In 2009, income from our Agencies consisted of commission income and other fees of $6,772,000 from IPA and revenue of $1,455,000 from HIO.
Other Income. Other income decreased $168,000 from 2009 to 2010. Included in 2009 is income of $205,000 representing a decrease in the fair value of the derivative liability relating to the agreement with Employers Direct Health, Inc. (“EDH”) (see Note 19 of Notes to Consolidated Financial Statements).
Selling, General and Administrative. Selling, general and administrative expenses decreased $4,865,000 from 2009 to 2010. This decrease is primarily due to (i) a decrease in commission and brokerage expenses of $3,847,000 incurred by Independence American, which resulted, in large part, from a decrease in assumed medical stop-loss premiums, assumed fully insured premiums, and direct group major medical premiums written, offset slightly by higher profit commission expense and administration fees, and (ii) lower expenses at IndependenceCare of $683,000, primarily due to lower payroll expenses as a result of closing the operation, and lower expenses at IPA of $893,000, primarily due to lower agent commissions and expenses.
Amortization and Depreciation. Amortization and depreciation expense increased $19,000 from 2009 to 2010.
Income Taxes. The provision for income taxes decreased $381,000 to $1,091,000, an effective rate of 34.2%, for 2010, compared to $1,472,000, an effective rate of 36.0%, for 2009. Net income for 2010 and 2009 includes a non-cash provision for federal income taxes of $1,023,000 and $1,311,000, respectively. The state tax effective rate decreased to 1.0% for 2010, compared to 3.1% for 2009. As compared to Risk Solutions, Independence American pays a nominal amount of state income tax; therefore, the Company’s state tax effective rate will decrease relative to an increase in Independence American’s pre-tax income or a decrease in Risk Solutions’ pre-tax income. For as long as AMIC utilizes its NOL carryforwards, it will not pay any income taxes, except for federal alternative minimum taxes and state income taxes.
Corporate derives cash flow funds principally from: dividends and tax payments from its subsidiaries and investment income from corporate liquidity. The ability of Independence American to pay dividends to its parent company is governed by Delaware insurance laws and regulations; otherwise, there are no regulatory constraints on the ability of any of our subsidiaries to pay dividends to its parent company. For the twelve months ended December 31, 2011, Independence American, Risk Solutions, and our Agencies paid $1,935,000 in dividends and $1,900,000 in tax payments to Corporate.
Net cash provided by operating activities for the year ended December 31, 2011 was $3,127,000.
Net cash used by investing activities for the year ended December 31, 2011 was $2,740,000.
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.
The $1,929,000 increase in AMIC’s stockholders' equity is primarily due to net income of $2,494,000, an increase of $1,175,000 in net unrealized gains on investments, offset by an increase in treasury stock of $1,131,000 due to share repurchases.
Approximately 2.6% of fixed maturities, primarily municipal obligations, in our investment portfolio are insured by financial guaranty insurance companies. The purpose of this insurance is to increase the credit quality of the fixed maturities and their credit ratings. If the obligations of these financial guarantors ceased to be valuable, either through a credit rating downgrade or default, these debt securities would likely receive lower credit ratings by the rating agencies that would reflect the creditworthiness of the various obligors as if the fixed maturities were uninsured. The following table summarizes the credit quality of our fixed maturity portfolio as rated, and as rated if the fixed maturities were uninsured, at December 31, 2011:
With respect to the IHC Treaties, the Company’s operating results are affected by the following factors: (i) the percentage of business ceded to Independence American pursuant to the IHC Treaties; (ii) the amount of gross premium written by Standard Security Life or Madison National Life that is ceded to the IHC Treaties; and (iii) the amount of gross premium produced by the MGUs and other distribution sources written by carriers other than Standard Security Life or Madison National Life that is ceded to Independence American. The profitability of the business ceded will also impact our operating results. Independence American assumes medical stop-loss, fully insured health and DBL premiums from IHC under the IHC Treaties.
Independence American reinsures 20% of Standard Security Life’s DBL product. Standard Security Life is not contractually obligated to continue to cede this business to Independence American after termination of the current treaty year. Standard Security Life and Madison National Life ceded approximately 9% of their fully insured health business to Independence American. Standard Security Life and Madison National Life are not contractually obligated to continue to cede this business to Independence American after termination of the current treaty years.
The gross medical stop-loss premiums written by IHC decreased in 2011 by approximately 8% and such premiums produced by Risk Solutions decreased by approximately 2% in 2011 as a result of termination of unprofitable programs. This resulted in a decrease in the gross amount of premium available to be ceded to Independence American in 2011. Risk Solutions anticipates increasing its production of medical stop-loss business in 2012. Therefore, Independence American anticipates reinsuring a higher amount of medical-stop loss premium ceded by IHC in 2012. IHC has reported that it expects its fully insured premiums to increase slightly and its DBL premiums to remain steady in 2012.
Our results depend on the adequacy of our product pricing, our underwriting and the accuracy of our reserving methodology, returns on our invested assets and our ability to manage expenses. Therefore, factors affecting these items, including unemployment and global financial markets, may have a material adverse effect on our results of operations and financial condition.
In 2007, Independent Producers of America, LLC (“IPA”), a national career-agent marketing organization, began marketing health plans to individuals and families utilizing Independence American as the carrier. Gross premiums of $13,114,000 and $14,122,000 were written under this program in 2011 and 2010, respectively. The program is administered by IHC Health Solutions, LLC, a wholly owned subsidiary of IHC. AMIC purchased a 51% interest in IPA in April 2008 and increased its interest to 79% in September 2011. On December 31, 2011, the Company acquired an additional 10.6% ownership interest in IPA from non-controlling interests, thereby increasing its ownership in IPA to 89.6%. See Note 20 of Notes to Consolidated Financial Statements.
Consolidated Balance Sheets as of December 31, 2011 and December 31, 2010
Consolidated Statements of Operations for the years ended December 31, 2011, 2010
Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010
We have audited the accompanying consolidated balance sheets of American Independence Corp. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2011. In connection with our audits of the consolidated financial statements, we have also audited financial statement schedules I to III and V. These consolidated financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and 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, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011 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.
As used in this report, unless otherwise required by the context, AMIC and its subsidiaries are sometimes collectively referred to as the "Company" or "AMIC", or are implicit in the terms "we", "us" and "our".
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 Risk Solutions for the benefit of its 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 Risk Solutions.
(ii) Financial instruments sold, but not yet purchased, represent obligations to replace borrowed securities that have been sold. Such transactions occur in anticipation of declines in the fair value of the securities. The Company's risk is an increase in the fair value of the securities sold in excess of the consideration received, but that risk is mitigated as a result of relationships to certain securities owned. Unrealized gains or losses on open transactions are credited or charged, as appropriate, to net realized investment gains in the Consolidated Statements of Operations. While the transaction is open, the Company will also incur an expense for any accrued dividends or interest payable to the lender of the securities. When the transaction is closed, the Company realizes a gain or loss in an amount equal to the difference between the price at which the securities were sold and the cost of replacing the borrowed securities. There were no such transactions outstanding at December 31, 2011 and 2010.
The Company periodically reviews and assesses the vendor’s qualifications and the design and appropriateness of its pricing methodologies. Management will on occasion challenge pricing information on certain individual securities and, through communications with the vendor, obtain information about the assumptions, inputs and methodologies used in pricing those securities, and corroborate it against documented pricing methodologies. Validation procedures are in place to determine completeness and accuracy of pricing information, including, but not limited to: (i) review of exception reports that (a) identify any zero or un-priced securities; (b) identify securities with no price change; and (c) identify securities with significant price changes; (ii) performance of trend analyses; (iii) periodic comparison of pricing to alternative pricing sources; and (iv) comparison of pricing changes to expectations based on rating changes, benchmarks or control groups. In certain circumstances, pricing is unavailable from the vendor and broker pricing information is used to determine fair value. In these instances, management will assess the quality of the data sources, the underlying assumptions and the reasonableness of the broker quotes based on the current market information available. To determine if an exception represents an error, management will often have to exercise judgment. Procedures to resolve an exception vary depending on the significance of the security and its related class, the frequency of the exception, the risk of material misstatement, and the availability of information for the security. These procedures include, but are not limited to; (i) a price challenge process with the vendor; (ii) pricing from a different vendor; (iii) a reasonableness review; (iv) a change in price based on better information, such as an actual market trade, among other things. Management considers all facts and relevant information
obtained during the above procedures to determine the proper classification of each security in the Fair Value Hierarchy.
Subsequent increases and decreases, if not an other-than-temporary impairment, in the fair value of available-for-sale securities that were previously impaired, are included in other comprehensive income in the Consolidated Balance Sheet.
The two “primary” or “key” assumptions underlying the calculation of loss reserves for medical stop-loss business are (i) projected net loss ratio, and (ii) claim development patterns. The projected net loss ratio is set at expected levels consistent with the underlying assumptions (“Projected Net Loss Ratio”). Claim development patterns are set quarterly as reserve estimates are developed and are based on Claim Development Patterns. The Company uses the Projected Net Loss Ratio to establish reserves until developing losses provide a better indication of ultimate results and it is feasible to set reserves based on Claim Development Patterns. The Company has concluded that a reasonably likely change in the Projected Net Loss Ratio assumption could have a material effect on the Company’s financial condition, results of operations, or liquidity (“Material Effect”) but a reasonably likely change in the Claim Development Pattern would not have a Material Effect.
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 typically maintains its reserves based on underlying assumptions until it determines that an adjustment is appropriate based on emerging experience from all of its MGUs for prior underwriting years. Reserves for HMO reinsurance are adjusted on a policy by policy basis. Because of the small number of HMO reinsurance policies it writes or reinsures, the Company is able to evaluate each policy individually for potential liability by reviewing open claims with each HMO and applying completion factors using historical data.
Amounts recoverable or paid for under reinsurance contracts are included in total assets or total liabilities as due from reinsurers or due to reinsurers. In 2011, Independence American derived a significant amount 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.
In December 2010, the Financial Accounting Standards Board ("FASB") issued guidance that amends existing goodwill impairment test guidance to include a requirement that entities perform Step 2 of the goodwill impairment test for reporting units with zero or negative carrying amounts if it is more likely than not that an impairment exists. This guidance was effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The adoption of this guidance, effective January 1, 2011, did not have a material effect on the Company's consolidated financial statements.
In January 2010, the FASB issued standards requiring entities to provide the activity of Level 3 security purchases, sales, issuances, and settlements on a gross basis, which were be effective for fiscal years beginning after December 15, 2010. The adoption of this guidance did not have a material effect on the Company's consolidated financial statements.
In December 2011, the FASB issued guidance to amend the disclosure requirements on offsetting financial instruments and related derivatives. Entities are required to provide both net and gross information for these assets and liabilities in order to enhance comparability between those entities that prepare their financial statements on the basis of U.S. GAAP and those entities that prepare their financial statements on the basis of International Financial Reporting Standards (“IFRS”). The amendments in this Update are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of this guidance is not expected to have a material effect on the Company’s consolidated financial statements.
In April 2011, the FASB issued guidance that amends existing standards with regards to transfers of financial assets under repurchase and other agreements that entitle and obligate the transferor to repurchase or redeem the assets prior to maturity. Specifically, with respect to assessing effective control in such agreements, the criteria that the transferor must have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even upon the transferee's default, has been eliminated; as has the corresponding criterion calling for the transferor to have obtained cash or other sufficient collateral to purchase replacement assets from a third party, which was required to demonstrate such ability. This guidance is effective for the first interim or annual period beginning after December 15, 2011. The adoption of this guidance is not expected to have a material effect on the Company’s consolidated financial statements.
In October 2010, the FASB issued guidance that specifies the accounting treatment for the costs incurred by insurance entities when acquiring new and renewal insurance contracts. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and should be applied prospectively upon adoption. The adoption of this guidance is not expected to have a material effect on the Company’s consolidated financial statements.
Intangible assets at December 31, 2011 and 2010 consist of the following (in thousands):
Securities purchased under agreements to resell are utilized to invest excess funds on a short-term basis. At December 31, 2011, the Company had $2,679,000 in resale agreements outstanding, all of which settled on January 3, 2012 and were subsequently reinvested. The Company maintains control of securities purchased under resale agreements, values the collateral on a daily basis and obtains additional collateral, if necessary, to protect the Company in the event of default by the counterparties.
The unrealized gains (losses) on certain available-for-sale securities (residential CMO’s and certain preferred stocks with maturities) at December 31, 2011 and 2010 include $140,000 and $99,000, respectively, of the non-credit related component of other-than-temporary impairment losses recognized in accumulated other comprehensive income.
penalties. The average life of mortgage backed securities is affected by prepayments on the underlying loans and, therefore, is materially shorter than the original stated maturity.
At December 31, 2011, a total of 9 fixed maturities and 6 equity securities were in a continuous unrealized loss position for less than 12 months. Also, at December 31, 2011, a total of
Substantially all of the unrealized losses on fixed maturities at December 31, 2011 and December 31, 2010 were attributable to changes in market interest rates and general disruptions in the credit market subsequent to purchase. The unrealized losses on corporate securities and state and political subdivisions are due to wider spreads. Spreads have widened in recent years as investors shifted funds to US Treasuries in response to the current market turmoil. Because the Company does not intend to sell, nor is it more likely than not that the Company will have to sell, such investments before recovery of their amortized cost bases, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2011.
Major categories of net investment income for years 2011, 2010 and 2009 are summarized as follows:
Net realized investment gains (losses) for years 2011, 2010 and 2009 are as follows (in thousands):
For the twelve months ended December 31, 2011, the Company recorded realized gross gains of $1,042,000 and gross losses of $522,000 on sales of available-for-sale securities. For the twelve months ended December 31, 2010, the Company recorded realized gross gains of $1,312,000 and gross losses of $290,000 on sales of available-for-sale securities. For the twelve months ended December 31, 2009, the Company recorded realized gross gains of $581,000 and gross losses of $306,000 on sales of available-for-sale securities.
At December 31, 2011 and December 31, 2010, the Company had an equity investment in Majestic with a carrying value of $797,000 and $788,000, respectively. For years 2011, 2010 and 2009, the Company recorded $9,000, ($45,000) and ($29,000), respectively, for its share of income (loss) from its investment in other income in the Consolidated Statements of Operations.
The Company's net rent expense for years 2011, 2010, and 2009 were $222,000, $355,000, and $482,000, respectively.
and incentive stock options, stock appreciation rights, restricted stock awards, performance shares, and other awards to officers, employee and other individuals. Under the terms of the 2009 Plan, stock options have a maximum term of ten years from the date of grant, and have various vesting criteria depending on the grant with most grants vesting 25% on the first year anniversary date of the grant and ratably over the next 36 months. The 1998 Plan, which expired by its terms on October 7, 2008, had reserved for issuance a total of 7,154,198 common stock shares. At December 31, 2011, stock options for 333,956 common stock shares were outstanding, stock options for 310,622 common stock shares were vested, and 6,517,221 common stock shares that had not been issued remained available for future stock options grants and other awards. Awards made under the 1998 Plan prior to its expiration are still in effect.
Total share-based compensation expense was $43,000, $74,000 and $99,000 for the twelve months ended December 31, 2011, 2010 and 2009, respectively. Related tax benefits of $15,000, $26,000 and $35,000 were recognized for the twelve months ended December 31, 2011, 2010 and 2009, respectively.
The following table summarizes information regarding outstanding and exercisable options as of December 31, 2011:
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 2011 and 2010:
The following table summarizes restricted stock activity for the year ended December 31, 2011:
Independence American derives a significant amount 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 and Madison National Life 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, 2011 and 2010, Standard Security Life and Madison National Life ceded an average of approximately 20%, respectively, of their medical stop-loss business to Independence American. Commencing in July 2004, Independence American began reinsuring 20% of Standard Security Life’s DBL business. Standard Security Life and Madison National Life ceded approximately 9% of the majority of its fully insured health business to Independence American in 2011 and 2010.
The Company and its subsidiaries file a consolidated federal income tax return on a September 30 fiscal tax year. The provision for income taxes for the periods ended December 31, 2011, 2010 and 2009 are as follows:
Taxes computed at the federal statutory rate of 35% for the years ended December 31, 2011, 2010 and 2009 are reconciled to the Company's actual income tax expense as follows:
The current federal income tax provision for the periods ending December 31, 2010 and 2009 represents only federal alternative minimum tax due to the Company’s federal net operating loss carryforwards.
The tax effect of temporary differences that give rise to significant portions of the net deferred tax assets at December 31, 2011 and 2010 are as follows:
During the year ended December 31, 2011 and 2010 the Company decreased its valuation allowance by $1,394,000 and $325,000, respectively. The valuation allowance at December 31, 2011 and 2010 was primarily related to net operating loss carryforwards that, in the judgment of management, were not considered realizable.
At December 31, 2011, the Company also had NOL carryforwards of approximately $25,814,000 for state income tax purposes, primarily in the State of California. Management believes that it is more likely than not that the state tax benefit of these net operating loss carryforwards will not be realized and has provided a valuation allowance against the full amount.
The Internal Revenue Service ("IRS") is currently auditing the Company’s 2009 consolidated income tax return. The IRS has previously audited the Company’s 2003 and 2004 consolidated income tax returns and made no changes to the reported tax for those periods. Management believes that it has made adequate provision for all income tax uncertainties, such that the outcome of any unresolved issues or claims will not result in a material change to our financial position or results of operations.
Interest expense and penalties for the years ended December 31, 2011, 2010 and 2009 are insignificant.
As of December 31, 2011, AMIC believes there were no material uncertain tax positions that would require disclosure under GAAP.
The preceding schedule reflects (i) due and unpaid claims, (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 2011 for prior years of $(1,250,000) is a result of a redundancy of $788,000 of fully insured health reserves, $225,000 of DBL reserves and $237,000 of medical stop-loss reserves. The amount incurred in 2010 for prior years of $(809,000) is a result of a redundancy of $1,355,000 of fully insured health reserves and of $340,000 of DBL reserves, offset by the re-estimation of unpaid losses on medical stop-loss reserves of $886,000. Fluctuations are generally the result of on-going analysis of recent loss development trends.
Independence American reinsures a portion of its direct 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, 2011, Independence American ceded to 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 December 31 next preceding. Such dividends may be paid as long as they have not been disapproved by the Delaware Insurance Commissioner within 30 days of its receipt of notice thereof. Independence American paid dividends of $1,000,000 in 2011 and of $1,500,000 in 2010.
In February 2006, Independence American entered into an agreement (the “EDH Agreement”) with Employers Direct Health, Inc. (“EDH”). Under the EDH Agreement, EDH began writing employer medical stop-loss for Independence American in 2006, and moved the majority of its existing block of employer-sponsored group major medical and medical stop-loss to Independence American during 2007. The employer-sponsored group major medical product is part of the Company’s fully insured health line of business. As part of the EDH Agreement, an affiliate of EDH and Independence American agreed to a profit/loss sharing arrangement whereby Independence American will pay to, or receive from, such affiliate 35% of the underwriting profit or loss associated with the fully insured and medical stop-loss business written by Independence American through treaty year 2009. For treaty year 2010, the profit/loss sharing percentage remained at 35% for fully insured business and increased to 50% for medical stop-loss business. For treaty year 2011, the profit/loss sharing percentage remained at 35% for fully insured business and increased to 65% for medical stop-loss business. Accordingly, the Company has recorded a profit sharing commission expense on the business underwritten in the twelve months period ended December 31, 2011. For treaty year 2012, the profit/loss sharing percentage increased to 65% for fully insured business and remained at 65% for medical stop-loss business.
As a result of an actuarial evaluation of certain performance thresholds of EDH’s block of business, the Company determined that such thresholds were not achieved. Therefore, the fair value of the derivative liability representing the contingent payment to EDH was $0 as of December 31, 2011 and 2010.
The gain recognized on the derivative for the twelve months ended December 31, 2011, 2010 and 2009 are as follows (in thousands):