We own a seven story building located at 1441 F.D. Roosevelt Avenue, in San Juan, Puerto Rico, and two adjacent buildings, as well as the adjoining parking lot, which is mainly used by the Managed Care segment. In addition, we own five floors of a fifteen-story building located at 1510 F.D. Roosevelt Avenue, in Guaynabo, Puerto Rico, which is mainly used by the Property and Casualty segment. We also own land and a multi-segment customer service center in the municipalities of Mayagüez and Ponce, Puerto Rico. Through a health clinic we own land and a two-story medical facility in the municipality of Bayamón, Puerto Rico. These properties are subject to liens under our credit facilities. In connection with our entrance to the Costa Rican market, we acquired a two-story building located in the city of San José, Costa Rica, which is used by the Life segment. In addition to the properties described above, we or our subsidiaries are parties to operating leases that are entered into in the ordinary course of business. See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources”.
● Consolidated claims incurred for the year were $2.7 billion, up 5.5% over last year, mostly reflecting higher claims in the Managed Care segment by $254.2 million mostly driven higher enrollment, partially offset by the aforementioned $128.7 million unfavorable reserve development related to Hurricane Maria recognized by the Property and Casualty segment in 2018. The consolidated loss ratio decreased 400 basis points, to 82.0%. The Managed Care segment’s Medical Loss Ratio (“MLR”) was to 84.6%, up 10 basis points year over year.
Premiums on traditional life insurance policies are reported as earned when due. Premiums on accident and health and other short-term contracts are recognized as earned, primarily on a pro rata basis over the contract period. Premiums on credit life policies are recognized as earned in proportion to the amounts of insurance in force. Group insurance premiums are billed one month in advance and a grace period of one month is provided for premium payment. If the insured fails to pay within the one-month grace period, we may cancel the policy. We recognize premiums on property and casualty contracts as earned on a pro rata basis over the policy term. Property and casualty policies are subscribed through general agencies, which bill policy premiums to their clients in advance or, in the case of new business, at the inception date and remit collections to us, net of commissions. The portion of premiums related to the period prior to the end of coverage is recorded in the consolidated balance sheet as unearned premiums and is transferred to premium revenue as earned.
Other operating revenues. Other operating revenues primarily consist of revenues generated by the health clinics reporting unit.
Claims Incurred. Our largest expense is the Managed Care segment’s medical claims incurred, or the cost of medical services we arrange for our members. Medical claims incurred include the payment of benefits and losses, mostly to physicians, hospitals, pharmacies, and other service providers, and to policyholders. We generally pay our providers on one of three forms: (1) fee-for-service contracts based on negotiated fee schedules; (2) capitation arrangements, generally on a fixed PMPM payment basis, whereby the provider generally assumes some of the medical expense risk; and (3) risk-sharing arrangements, whereby we advance a PMPM payment and share the risk of certain medical costs of our members with the provider based on actual experience as measured against pre-determined sharing ratios. Claims incurred also include claims incurred in our Life and Property and Casualty segments. Each segment’s results of operations depend to a significant extent on our ability to accurately predict and effectively manage claims and losses. A portion of the claims incurred for each period consists of claims reported but not paid during the period, as well as a management and actuarial estimate of claims incurred but not reported during the period.
The following table sets forth our consolidated operating results for the years ended December 31, 2019, 2018, and 2017. Further details of the results of operations of each reportable segment are included in the analysis of operating results for the respective segments.
Premiums earned, net increased by $314.3 million, or 10.7%, to $3.3 billion. This increase primarily reflects higher premiums in the Managed Care segment by $298.4 million. The growth in managed care premiums reflects higher average premium rates across all lines of business and an increase in Medicare and Commercial fully-insured membership. The increase was partially offset by lower Medicaid membership.
Consolidated claims incurred increased by $138.7 million, or 5.5%, to $2.7 billion, mostly driven by an increase in the claims incurred in the Managed Care segment of $254.2 million, partially offset by lower claims incurred in the Property and Casualty segment of $128.7 million. The increase in managed care claims primarily reflects higher Medicare and Commercial fully-insured enrollment, offset in part by the decrease in Medicaid membership. The decrease in claims incurred in the Property and Casualty segment was due to prior year losses related to hurricane Maria. The consolidated loss ratio decreased by 400 basis points to 82.0%.
Administrative service fees decreased $1.8 million, or 10.9%, mainly due to lower membership enrolled in this business.
● Medical premiums generated by the Commercial business increased by $18.4 million, or 2.4%, to $801.2 million. This fluctuation primarily reflects higher fully-insured member months during the year by approximately 69,000 member months and higher average premium rates, offset in part by $12.1 million related to the suspension of the HIP fee pass-through in 2019.
Medical claims incurred increased by $254.2 million, or 11.2%, to $2.5 billion. The MLR of the segment increased 10 basis points during the 2019 period, to 84.6%. This fluctuation is primarily attributed to the net effect of the following:
● Medical premiums generated by the Commercial business decreased by $20.5 million, or 2.6%, to $782.8 million. This fluctuation primarily reflects lower fully-insured enrollment during the year of approximately 206,000 member months; offset in part by $12.1 million related to the reinstatement of the HIP fee pass-through in 2018 and higher average premium rates.
● The medical claims incurred of the Medicare business increased by $33.1 million, or 3.6%, during the 2018 period and its MLR decreased by 450 basis points, to 83.2%. The lower MLR reflects the higher premium rates in the 2018 period as well as cost containment initiatives implemented during the year; partially offset by the impact of the hurricane related decrease in utilization in 2017. The hurricane related decrease in utilization was estimated to lower 2017 claims by approximately $25.1 million, or 240 basis points of last year’s MLR.
● The medical claims incurred of the Commercial business increased by $22.3 million, or 3.6%, during the 2018 period and its MLR, at 82.4%, was 490 basis points higher than the same period last year primarily reflecting the decrease in utilization in the 2017 period caused by Hurricanes Irma and Maria and claim trends higher than premium trends. The hurricane related decrease in utilization was estimated to lower 2017 claims by approximately $27.8 million, or 340 basis points of last year’s MLR.
● The medical claims incurred of the Medicaid business decreased by $1.1 million, or 0.2%, during the 2018 period and its MLR decreased by 300 basis points, to 88.5%, mostly reflecting the impact of higher premium rates in 2018 and cost containment initiatives; partially offset by the impact of hurricane related decrease in utilization in 2017. The hurricane related decrease in utilization was estimated to lower 2017 claims by approximately $2.2 million, or 30 basis points of last year’s MLR.
Premiums earned, net increased by $13.6 million, or 8.1% to $182.2 million, mainly as the result of higher sales and improved policy retention in the Individual Life and Cancer lines of business.
Policy benefits and claims incurred increased by $6.9 million, or 7.0%, to $105.9 million, mostly resulting from higher volume of sales and actuarial reserves following improved portfolio persistency during the year. The segment’s loss ratio decreased 60 basis points, to 58.1%.
Increase in underwriting and other expenses of $6.4 million, or 8.5%, to $81.7 million mostly resulting from higher commission expense reflecting the segment’s higher volume of business and improved portfolio persistency. As a result, the segment’s operating expense ratio increased 10 basis points, to 44.8%.
Policy benefits and claims incurred increased by $11.7 million, or 13.4%, to $99.0 million, mostly resulting from higher number of deaths benefits paid in the Individual Life line of business, an increased average cost of claims in the Cancer line of business, and higher actuarial reserves following improved portfolio persistency. The segment’s loss ratio increased 470 basis points, to 58.7%.
The premiums ceded to reinsurers decreased by $8.1 million, or 13.4%, mostly reflecting a decrease in cessions in the Commercial quota share agreement from 35% in 2017 to 25% since April 2019, as well as the impact of the related incoming portfolio transfer. These decreases were offset in part by higher non-proportional reinsurance costs, mostly in property catastrophe reinsurance.
Total premiums written decreased by $4.0 million, or 2.8%, to $139.8 million, driven by lower sales of Commercial Package products, mostly the result of selective and disciplined underwriting of Commercial risks.
The $8.4 million increase in the change in unearned premiums reflects the segments lower premiums written in 2018.
Cash flows from operating activities decreased by $25.0 million during the year ended December 31, 2019 mostly due to higher claims paid by $296.6 million partially offset by an increase in premium collections of $223.6 million; both fluctuations reflecting the increased volume in 2019. In addition, cash paid to suppliers and employees decreased by $45.5 million when compared to the prior year.
In August 2017, the Company’s Board of Directors authorized a $30.0 million repurchase program of its Class B common stock (2017 Repurchase Program). In February 2018 the Company’s Board of Directors authorized a $25.0 million expansion of this program. In October 2019 the Company’s Board of Directors authorized an additional expansion to this program increasing its remaining balance up to a total of $25.0 million, effective November 2019. Repurchases were conducted through open-market purchases of Class B shares only, in accordance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. During the year 2019, the Company repurchased and retired 527,881 shares of our Class B Common Stock shares at an average per share price of $18.92, for an aggregate cost of $10.0 million.
Decrease in net purchases of investments in securities are part of our asset/liability management strategy using cash on hand.
TSM has $35.5 million credit agreement with a commercial bank in Puerto Rico. The agreement consists of three term loans: (i) Term Loan A in the principal amount of $11.2 million, (ii) Term Loan B in the principal amount of $20.2 million, and (iii) Term Loan C in the principal amount of $4.1 million. Term Loan A matures in October 2023 while Term Loans B and C mature in January 2024. Term Loan A was used to refinance a previous $41.0 million secured loan payable with the same commercial bank. Pursuant to the credit agreement, interest is payable on the outstanding balance of the Loan at the following annual rate: (i) 100 basis points over LIBOR for Term Loan A, (ii) 275 basis points over LIBOR for Term Loan B, and, (iii) 325 basis points over LIBOR for Term Loan C. The loan includes certain financial and non-financial covenants, which are customary for this type of facility, including negative covenants imposing certain restrictions on the Company’s business. Failure to meet these covenants may trigger the accelerated payment of the outstanding balance. As of December 31, 2019, we are in compliance with these covenants.
In July 2017, the Financial Conduct Authority (“FCA”) in the United Kingdom, which regulates LIBOR, announced that it would phase out this benchmark by the end of 2021. In response, the U.S. Federal Reserve convened the Alternative Reference Rates Committee (“ARRC”), a working group comprised of private market participants, to ensure a transition to a new reference rate.
For further details, see Note 13, Borrowings, of the Notes to the Consolidated Financial Statements, included in “Item 8, Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
● As of December 31, 2019, TSS has $60.0 of available credit under repurchase agreements with broker-dealers, which are short term borrowing facilities using securities as collateral. There are no outstanding short-term borrowings under these facilities as of December 31, 2019.
● TSA has a $10.0 million revolving loan agreement with a commercial bank in Puerto Rico. This line of credit has an interest rate of 30-day LIBOR plus 25 basis points and contains certain financial and non-financial covenants that are customary for this type of facility. This line of credit matures on April 30, 2020 and has no outstanding balance as of December 31, 2019.
● The table below describes the payments due under our contractual obligations, aggregated by type of contractual obligation, including the maturity profile of our debt, operating leases and other long-term liabilities, but excludes an estimate of the future cash outflows related to the following:
o Alternative investments - The Company has $72.2 million of unfunded capital commitments related to alternative investments. These commitments were excluded from this disclosure due to the undetermined timing of their cash flows.
o Unearned premiums - This amount accounts for the premiums collected prior to the end of coverage period and does not represent a future cash outflow. As of December 31, 2019, we had $93.3 million in unearned premiums.
o Policyholder deposits - The cash outflows related to these instruments are not included because they do not have defined maturities, such that the timing of payments and withdrawals is uncertain. There are currently no significant policyholder deposits in paying status. As of December 31, 2019, our policyholder deposits had a carrying amount of $189.1 million.
o Other long-term liabilities - Due to the indeterminate nature of their cash outflows, $92.6 million of other long-term liabilities are not reflected in the following table, consisting of $34.5 million of liability for pension benefits, $10.3 million in deferred tax liabilities, and $47.8 million in liabilities to the Federal Employees’ Health Benefits Plan Program.
(2) Purchase obligations represent payments required by us under material agreements to purchase goods or services that are enforceable and legally binding and where all significant terms are specified, including: quantities to be purchased, price provisions and the timing of the transaction. Other purchase orders made in the ordinary course of business for which we are not liable are excluded from the table above. Estimated pension plan contributions amounting to $2.0 million were included within the total purchase obligations. However, this amount is an estimate which may be subject to change in view of the fact that contribution decisions are affected by various factors such as market performance, regulatory and legal requirements and plan funding policy.
(3) Claim liabilities represent the amount of our claims processed and incomplete as well as an estimate of the amount of incurred but not reported claims and loss-adjustment expenses. This amount does not include an estimate of claims to be incurred subsequent to December 31, 2019. The expected claims payments are an estimate and may differ materially from the actual claims payments made by us in the future. Also, claim liabilities are presented gross, and thus do not reflect the effects of reinsurance under which $325.0 million of reserves had been ceded at December 31, 2019.
Given the inherent unpredictability of these matters, it is possible that an adverse outcome in certain matters could, from time to time, have an adverse effect on our operating results and/or cash flows. For a description of our legal proceedings, see Note 24, Contingencies, of the Notes to Consolidated Financial Statements, included in “Item 8, Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
To operate in Puerto Rico, insurance companies, such as our insurance subsidiaries, are required to participate in guarantee associations, which are organized to pay policyholders contractual benefits on behalf of insurers declared insolvent. These associations levy assessments, up to prescribed limits, on a proportional basis, to all member insurers in the line of business in which the insolvent insurer was engaged. In 2019, two local property and casualty insurance companies entered into a liquidation process, accordingly, the property and casualty guarantee fund initiated the process to settle unpaid claims and return unearned premiums of the insolvent insurers. In December 2019, the guarantee fund determined and imposed an assessment to cover claims and return premiums, payable in two installments during 2020 based on premiums written in 2018. TSP’s share in this assement was $912 thousand. Annual assessments are limited to 2% of direct premiums written, as defined. TSP has also accrued $716 thousand to cover its estimate of assements based in premiums written in 2019 and loss data made available by the guaranty fund. In accordance with insurance laws and regulations, assessments are recoverable through policy surcharges. During 2018 and 2017, no assessment or payment was made for this contingency. It is the opinion of management that any possible future guarantee association assessments will not have a material effect on our operating results and/or cash flows, although there is no ceiling on these payment obligations.
Claim liabilities by segment as of December 31, 2019 were as follows:
At December 31, 2019, claim liabilities for the Managed Care segment amounted to $340.2 million and represented 48.0% of our total consolidated claim liabilities and 18.1% of our total consolidated liabilities.
(2) Assumes (decrease) increase in the claims trend factors for the most recent twelve months.
The following table shows the variance between the segment’s incurred claims for current period insured events and the incurred claims for such years had they been determined retrospectively (the “Incurred claims related to current period insured events” for the year shown plus or minus the “Incurred claims related to prior period insured events” for the following year as included in Note 11, Claim Liabilities and Claim Adjustment Expenses, of the Notes to Consolidated Financial Statements, included in “Item 8, Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K). This table shows that the segments’ estimates of this liability have approximated the actual development.
● In the Commercial business we have the ability to increase the premium rates throughout the year in the monthly renewal process, when renegotiating the premiums for the following contract year of each group as they become due. We consider the actual claims trend of each group when determining the premium rates for the following contract year.
The key assumption with regard to claim liabilities for our life segment is related to claims incurred prior to the end of the year, but not yet reported to our subsidiary. A liability for these claims is estimated based upon experience with regards to amounts reported subsequent to the close of business in prior years. There are uncertainties in the development of these estimates; however, in recent years our estimates have resulted in immaterial redundancies or deficiencies.
Estimates of the ultimate cost of claims and loss-adjustment expenses of this segment are based largely on the assumption that past developments, with appropriate adjustments due to known or unexpected changes, are a reasonable basis on which to predict future events and trends, and involve a variety of actuarial techniques that analyze current experience, trends and other relevant factors. Property and casualty insurance claim liabilities are categorized and tracked by line of business. Medical malpractice policies are written on a claims-made basis. Policies written on a claims-made basis require that claims be reported during the policy period. Other lines of business are written on an occurrence basis. Hurricane losses initially include the use of models from industry recognized firms having data, historical and current information about the events, to estimate ultimate losses. These estimates are supplemented by internal estimates of other costs deemed necessary to develop the ultimate losses. As loss information emerges, claims are separated between those with solid estimates and the remained claims. Additional reserves are provided based on paid loss experience for unreported, potential development, and loss expenses.
At December 31, 2019, the claim liabilities of the Property and Casualty segment fall within the actuarial reserve range determined by the actuaries. Management reviews the results of the reserve estimates in order to determine any appropriate adjustments in the recording of reserves. Adjustments to reserve estimates are made after management’s consideration of numerous factors, including but not limited to the magnitude of the difference between the actuarial indication and the recorded reserves, improvement or deterioration of actuarial indications in the period, the maturity of the accident year, trends observed over the recent past and the level of volatility within a particular line of business. In general, changes are made more quickly to more mature accident years and less volatile lines of business. Varying the net expected loss ratio by +/-1% in all lines of business for the six most recent accident years would increase/decrease the claims incurred by approximately $5.1 million.
Liabilities for future policy benefits for whole life and term insurance products and active life reserves for accident and health products are computed by the net level premium method, using interest assumptions of 4.40% in 2019 and ranging from 3.90% to 5.75% in 2018 and 2017, and withdrawal, mortality, morbidity and maintenance expense assumptions appropriate at the time the policies were issued (or when a block of business was purchased, as applicable). Accident and health unpaid claim reserves are stated at amounts determined by estimates on individual claims and estimates of unreported claims based on past experience. Deferred annuity reserves are carried at the account value.
Impairment of an investment exists if a decline in the estimated fair value is below the amortized cost of the security. Management regularly monitors and evaluates the difference between the cost and estimated fair value of fixed maturity investments and other invested assets. For investments with a fair value below cost, the process includes evaluating: (1) the length of time and the extent to which the estimated fair value has been less than amortized cost for fixed maturity securities, or cost for equity securities, (2) the financial condition, near-term and long-term prospects for the issuer, including relevant industry conditions and trends, and implications of rating agency actions, (3) the Company’s intent to sell or the likelihood of a required sale prior to recovery, (4) the recoverability of principal and interest for fixed maturity securities, or cost for equity securities, and (5) other factors, as applicable. This process is not exact and further requires consideration of risks such as credit and interest rate risks. Consequently, if an investment’s cost exceeds its estimated fair value solely due to changes in interest rates, other-than temporary impairment may not be appropriate.
For our audited consolidated financial statements as of December 31, 2019 and 2018 and for each of the three years ended December 31, 2019, 2018, and 2017 see Index to consolidated financial statements in “Item 15. Exhibits and Financial Statements Schedules” to this Annual Report on Form 10-K.