The book value of the Company decreased to $9.75 per share at December 31, 2008 compared to $9.96 per share at December 31, 2007, primarily due to the unrealized losses on the Company’s investment portfolio.
Of the aggregate carrying value of the Company’s investment assets, approximately 94.0% was invested in investment grade fixed maturities, securities purchased under resale agreements, and cash and cash equivalents at December 31, 2008. Also at such date, 99.6% of the Company's fixed maturities were investment grade.
For the year ended December 31, 2008, Independence American wrote $5.2 million of medical stop-loss business and $22.4 million of group major medical business pursuant to the Company’s agreement with EDH.
In 2008, our MGUs and Agencies generated revenues of $15.0 million compared to $9.8 million in 2007, an increase of 53%, primarily due to income earned by HIO, IPA, and higher profit commissions, offset by lower fee income due to the lower volume of premium underwritten.
In 2008, our MGUs wrote an aggregate of $73.3 million of annualized gross premium compared to $87.2 million in 2007. This reduction in premiums was due, in part, to stricter underwriting guidelines and the continuing generally "soft" market.
The Company formed Excess Claims Administrators, Inc. (“ECA”) during 2008 to provide medical management services and adjudicate claims for our MGUs and independent managing general underwriters.
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.
maintained at levels that are estimated in accordance with GAAP. The Company’s estimate of loss reserves represents management’s best estimate of the Company’s liability at the balance sheet date.
All of the Company’s policies are short-duration and are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims or open claims from prior periods, including losses incurred for claims that have not been reported (“IBNR”). Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
Subsequent to the first twelve months of an underwriting year, the Company’s developing losses provide a better indication of ultimate losses. At this point, claims have developed to a level where Claim Development Patterns can be applied to generate reasonably reliable estimates of ultimate claim levels. Development factors based on historical patterns are applied to paid and reported claims to estimate fully developed claims. Claim
Development Patterns are reviewed quarterly as reserve estimates are developed and are based on recent claim development history. The Company must determine whether changes in development represent true indications of emerging experience or are simply due to random claim fluctuations.
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 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, 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 2008, Independence American derived 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 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, 2008 and 2007, Standard Security Life and Madison National Life ceded an average of approximately 23% 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 8.9% of the majority of their fully insured health business to Independence American. In addition, in 2008, Independence American ceded 50% of its short-term medical (“STM”) and major medical for individuals and families business to unaffiliated reinsurers.
The Company accounts for its investments in debt and equity securities under SFAS No. 115 ("SFAS 115"), Accounting for Certain Investments in Debt and Equity Securities. The Company has classified all of its investments as available-for-sale or trading securities. These investments are carried at fair value with unrealized gains and losses reported in either accumulated other comprehensive income (loss) in the Consolidated Balance Sheets for available-for-sale securities or as unrealized gains or losses in the Consolidated Statements of Operations for trading securities. Fixed maturities and equity securities available-for-sale totaled $48.9 million and $49.4 million at December 31, 2008 and 2007, 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.
current expected cash flows; whether the decline in fair value appears to be issuer specific or, alternatively, a reflection of general market or industry conditions (including, in the case of fixed maturities, the effect of changes in market interest rates); and the Company's intent and ability to hold the security for a period of time sufficient to allow for a recovery in fair value. For the twelve months ended December 31, 2008, the Company recorded a loss of $1.0 million for other-than-temporary impairments from bonds and preferred stocks.
At December 31, 2008, the Company had $1.9 million invested in whole loan CMOs backed by Alt-A mortgages. Of this amount, 46.3% were in CMOs that originated in 2005 or earlier and 53.7% were in CMOs that originated in 2006. The Company’s mortgage security portfolio has no direct exposure to sub-prime mortgages. The unrealized loss for the equity securities was primarily due to wider spreads for preferred stocks issued by financial institutions following the disruption in credit markets in late 2007 and continuing in 2008. Some of these financial institutions have exposure to sub-prime mortgages. The unrealized loss for CMO securities is primarily attributable to Alt-A mortgages as described above. The unrealized losses on corporate securities are due to wider spreads. Spreads have widened as investors shifted funds to US Treasuries in response to the current market turmoil.
Premiums Earned. Premiums earned decreased 9%, or $9,116,000, to $96,984,000 for 2008, compared to $106,100,000 for 2007. The Company currently has three lines of business. Premiums relating to medical stop-loss business were $54,574,000 and $63,483,000 for 2008 and 2007, respectively. This change is primarily due to a decrease in medical stop-loss premiums assumed by Independence American ($9,239,000), partially offset by an increase in medical stop-loss written by Independence American ($330,000). Premiums relating to group major medical, STM and individual health were $38,975,000 and $39,136,000 for 2008 and 2007,
Other Income (Loss). Other income was $1,164,000 for 2008 compared to a loss of $388,000 for 2007. Included in 2008 is income of $1,043,000 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). Included in 2007 is a loss of $409,000 representing an increase in the fair value of the derivative liability relating to the agreement with EDH. The unrealized gain for 2008 reflects the probability of a lower future payment due to EDH as a result of less favorable loss ratios on this business.
Insurance Benefits, Claims and Reserves. Insurance benefits claims and reserves decreased 11%, or $8,504,000, to $70,114,000 for 2008, compared to $78,618,000 for 2007. The decrease of $8,504,000 is primarily comprised of a $9,729,000 decrease in medical stop-loss due to a decrease in volume of business written and improved loss ratios (the Company recorded $4,500,000 of reserve strengthening in the prior year), partially offset by a $1,540,000 increase in fully insured health as a result of higher claims and an overestimation of a PPO discount on business from the group major medical program, and higher losses on group major medical business assumed from IHC.
of $3,134,000 incurred by Independence American primarily resulting from a decrease in premiums assumed in medical stop-loss business.
Amortization and Depreciation. Amortization and depreciation expense decreased $178,000 to $793,000 for 2008, compared to $971,000 for 2007. The decrease in amortization is the result of the Company fully amortizing the intangible asset associated with previous broker/TPA relationships in the prior year, offset by additional amortization expense as a result of the acquisition of the remaining 20% interest in Marlton and the acquisition of 51% of IPA (see Note 4 of Notes to Consolidated Financial Statements).
Minority Interest. The Company recorded minority interest expense of $471,000 for 2008 and $215,000 for 2007. The 2008 expense relates to the 49% minority interest in IPA, the 49% minority interest in HIO, and the 20% minority interest in Marlton for the first quarter ended March 31, 2008. The 2007 expense relates to the 20% minority interest in Marlton.
Gain (loss) on Discontinued Operations. Loss on discontinued operations, net of tax was $75,000 for 2008, compared to $0 for 2007. The loss of $75,000 was due to the loss of rental income associated with the sublease of a property located in Livermore, California, and a re-estimation of expected expenses related to the lease (see Note 9 of Notes to Consolidated Financial Statements).
Corporate derives cash flow funds principally from dividends and tax payments from its subsidiaries and investment income from corporate liquidity. Other than Independence American, there are no regulatory constraints on the ability of any of our subsidiaries to pay dividends to its parent company. Delaware insurance laws and regulations govern the ability of Independence American to pay dividends to its parent company. For the twelve months ended December 31, 2008, our MGUs and agencies paid $3,025,000 in dividends to Corporate.
Net cash used by investing activities of continuing operations for the year ended December 31, 2008 was $4,338,000. This resulted from purchases of ownership interests in IPA and Marlton (see Note 3 of Notes to Consolidated Financial Statements).
At December 31, 2008, the Company had $32,760,000 of insurance reserves that it expects to pay out of current assets and cash flows from future business. If necessary, the Company could utilize the cash received from maturities and repayments of its fixed maturity investments if the timing of claim payments associated with the Company's insurance resources does not coincide with future cash flows.
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 similar to the amount used in 2008 for its discontinued operations, which are primarily lease obligations, for the year ending December 31, 2009.
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 94.0% was invested in investment grade fixed income securities, securities purchased under resale agreements, and cash and cash equivalents at December 31, 2008. The Company's gross unrealized losses on available-for-sale securities totaled $4,620,000 and $1,459,000 at December 31, 2008 and 2007, respectively. Substantially all of these securities were investment grade. The Company holds all fixed maturities and preferred stock as available-for-sale and accordingly marks all of its securities to market through accumulated other comprehensive income (loss). The Company does not have any non-performing fixed maturities at December 31, 2008.
At December 31, 2008, the Company had $1.9 million invested in whole loan collateralized mortgage obligations (“CMOs”) backed by Alt-A mortgages. Of this amount, 46.3% were in CMOs that originated in 2005 or earlier and 53.7% were in CMOs that originated in 2006. While these mortgages have seen lower market values recently, we believe that the unrealized losses on these securities are not necessarily indicative of their ultimate performance. The Company's mortgage security portfolio has no direct exposure to sub-prime mortgages. The decline in fair value for the equity securities was primarily due to wider spreads for preferred stocks issued by financial institutions following the disruption in credit markets in late 2007. Some of these financial institutions have exposure to sub-prime mortgages. The unrealized loss for CMO securities is primarily attributable to Alt-A mortgages as described above. The unrealized losses on corporate securities are due to wider spreads. Spreads have widened as investors shifted funds to US Treasuries in response to the current market turmoil. Further deterioration in credit quality of the companies backing the securities, further deterioration in the condition of the financial services industry, a continuation of the current imbalances in liquidity that exist in the marketplace, a continuation or worsening of the current economic recession, or additional declines in real estate values may further affect the fair value of these securities and increase the
potential that certain unrealized losses be designated as other-than-temporary in future periods and the Company may incur additional write-downs.
The Company reviews its investments regularly and monitors its investments continually for impairments. For 2008, the Company recorded a loss of $1,006,000 for other-than-temporary impairments from bonds and preferred stocks.
The following table summarizes the carrying value of securities with fair values less than 80% of their amortized cost at December 31, 2008 by the length of time the fair values of those securities were below 80% of their amortized cost (in thousands):
The Company has chosen to carry its fixed maturity securities as available-for-sale. The unrealized losses on all available-for-sale securities have been evaluated in accordance with the Company's impairment policy (as disclosed in Note 2 of Notes to Consolidated Financial Statements) and were determined to be temporary in nature at December 31, 2008. In 2008, the Company experienced an increase in unrealized losses of $2,853,000 million which decreased stockholders' equity by $2,853,000 million (reflecting unrealized losses of $4,057,000 million at December 31, 2008 compared to unrealized losses of $1,204,000 million at December 31, 2007). From time to time, as warranted, the Company may employ investment strategies to mitigate interest rate and other market exposures.
The Company had receivables from reinsurers of $9,386,000 at December 31, 2008. 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, 2008.
Independence American, which is domiciled in Delaware, is licensed to write property and/or casualty insurance in 49 states and the District of Columbia, and has an A- (Excellent) 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.
Since its acquisition by AMIC in 2002, Independence American’s primary source of revenue has been reinsurance premiums. During 2008, we began to become less dependent on reinsurance premiums as we increased the amount of business written by Independence American. During 2008, Independence American wrote group major medical, medical stop-loss, major medical plans for individuals and families, and a small amount of short-term medical. Given its A- (Excellent) rating from A.M. Best, Independence American expects to expand the distribution of its products. In late 2008, Independence American appointed a second MGU, which is expected to meaningfully increase the amount of medical stop-loss business written by Independence American in 2009, and we continue to seek additional production sources. With respect to major medical plans for individuals and families, the acquisition of a controlling interest in IPA, should meaningfully increase the amount of this line of business written by Independence American in 2009.
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 8.9% of the majority of their fully insured health business to Independence American. Standard Security Life and Madison National
If Independence American, Standard Security Life, and Madison National Life had agreed to increase the average percentage ceded to Independence American by 1% (from the approximately 23% ceded for the twelve months ended December 31, 2008) and Standard Security Life’s and Madison National Life’s gross written premium had remained unchanged, Independence American’s premium would have increased by approximately $1.8 million, which is approximately 1.8% of total net premiums earned for the year ended December 31, 2008. That increase in premium, however, would not have flowed directly to pre-tax operating income because of corresponding changes in insurance benefits, claims and reserves and other expenses attributable to the increase in premiums.
The medical stop-loss market is generally cyclical in nature. When a product experiences several consecutive years of underwriting profitability, it is not unusual for there to be more competitors entering that line which can increase pressure on pricing and create a “softer” market. The medical stop-loss market began to “soften” in 2003 and less favorable conditions continued through 2008. As a result of these market conditions, the rate that the carriers that cede business to the Company were able to charge for medical stop-loss increased at a lesser rate in recent years although increases in medical trend have also been held in check to a greater extent and deductibles and attachment points have increased. This reduces the risk taker’s overall risk exposure. Fully insured health business tends to be less volatile and less cyclical than excess insurance.
Consolidated Balance Sheets as of December 31, 2008 and December 31, 2007
Consolidated Statements of Cash Flows for the years ended December 31, 2008 and 2007
Statements of Cash Flows - Valuation and Qualifying Accounts (Schedule V)
We have audited the accompanying consolidated balance sheets of American Independence Corp. and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for the years then ended. 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 are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
Due from reinsurers ($7,115 and $9,242, respectively, due from related parties)
Accrued fee income ($480 and $782, respectively, due from related parties)
Since November 2002, AMIC has been affiliated with Independence Holding Company ("IHC"), an insurance holding company, which held 49.7% of AMIC’s outstanding common stock at December 31, 2008. The senior management of IHC provides direction to the Company through a service agreement between the Company and IHC. IHC has also entered into long-term reinsurance treaties through its wholly owned subsidiaries, Standard Security Life Insurance Company of New York (“Standard Security Life”) and Madison National Life Insurance Company, Inc. (“Madison National Life”), whereby the Company assumes reinsurance premiums from the following lines of business: medical stop-loss, New York statutory disability (“DBL”), short-term medical (“STM”) and group major medical.
Goodwill and intangible assets with indefinite lives, which consist of licenses, are not amortized but are evaluated for impairment in the aggregate at the end of the third quarter of each year, or more frequently if indicators arise. If the fair value of a reporting unit is less than its carrying amount (including goodwill), further evaluation is required to determine if a write-down of goodwill is required. Any impairment write-down of goodwill would be charged to expense. No impairment charge was required in 2008 or 2007.
The Company's intangible assets with definite lives, consisting of broker/third party relationships and marketing agreements, are amortized over the expected life of the assets (see Note 4 of Notes to Consolidated Financial Statements).
Securities purchased under agreements to resell ("resale agreements") and securities sold under agreements to repurchase ("repurchase agreements") are carried at the amounts at which the securities will be subsequently resold or repurchased as specified in the agreements. 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.
(b) Securities not held for trading purposes which may or may not be held to maturity ("available-for-sale securities") are carried at fair value. Unrealized gains and losses deemed temporary are credited or charged, as appropriate, directly to accumulated other comprehensive income (a component of stockholders' equity). 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. Realized gains and losses on sales of available-for-sale securities, and unrealized losses considered to be other than temporary, are credited or charged, as appropriate, to net realized investment gains in the Consolidated Statements of Operations.
(iv) The Company enters into derivative transactions, 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. Gains (losses) on these instruments were $1,196,000 and $(480,000) during 2008 and 2007, respectively. There were no such derivative transactions outstanding at December 31, 2008 and 2007.
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
Management believes that the Company's methods of estimating the liabilities for insurance reserves provided appropriate levels of reserves at December 31, 2008 and December 31, 2007. Changes in the Company's reserve estimates are recorded through a charge or credit to its earnings in the period in which they arise.
In June 2006, the Financial Accounting Standards Board (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. 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
1”). FSP EITF No. 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore need to be included in the earnings allocation in calculating earnings per share under the two-class method described in SFAS No. 128, “Earnings per Share”. FSP EITF No. 03-6-1 requires companies to treat unvested share-based payment awards that have non-forfeitable rights to dividend or dividend equivalents as a separate class of securities in calculating earnings per share. FSP EITF No. 03-6-1 is effective for fiscal years beginning after December 15, 2008; earlier application is not permitted. The adoption of FSP EITF No. 03-6-1 is not expected to have a material effect on the Company’s consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133” (“SFAS 161”). SFAS 161 expands the current disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. In addition, SFAS 161 requires disclosure of fair values of derivative instruments and their gains and losses in a tabular format as well as cross-referencing within the footnotes to allow users of financial statements to locate important information about derivative instruments. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The adoption of SFAS 161 is not expected to have a material effect on the Company’s consolidated financial statements
financing are considered part of the same arrangement (linked transaction) under Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” ("SFAS 140"). However, if certain criteria are met, the initial transfer and repurchase financing shall not be evaluated as a linked transaction and shall be evaluated separately under SFAS No. 140. FSP FAS 140-3 is effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within these fiscal years. Earlier application is not permitted. The adoption of FSP FAS 140-3 is not expected to have a material effect on the Company’s consolidated financial statements.
In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities” (“FSP FAS 140-4 and FIN 46(R)-8”). This FSP amends SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, requiring public entities to provide additional disclosures about transfers of financial assets. It also amends FASB Interpretation No. 46 (revised December 2003), “Consolidation of Variable Interest Entities”, requiring public enterprises, including sponsors that have a variable interest in a variable interest entity, to provide additional disclosures about their involvement with variable interest entities. FSP FAS 140-4 and FIN 46(R)-8 shall be effective for annual or interim periods ending after December 15, 2008. The adoption of FSP FAS 140-4 and FIN 46(R)-8 did not have a material effect on the Company’s consolidated financial statements.
In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, "Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161" ("FSP FAS 133-1 and FIN 45-4"). FSP FAS 133-1 and FIN 45-4 expands the disclosure requirements of SFAS 133 for sellers of credit derivatives and hybrid instruments that have embedded credit derivatives to include (a) the nature of the credit derivative, including the approximate term, the reasons for entering into the credit derivative and the events or circumstances that would require
In September 2006, the FASB issued SFAS No. 157, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements. FASB Staff Position FIN 157-2, "Effective Date of FASB Statement No. 157", amends SFAS 157 to defer its effective date to fiscal years beginning after November 15, 2008, and for interim periods within those fiscal years. The delayed effective date applies to all non-financial assets and non-financial liabilities except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). FSP FAS 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active" clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. Revisions resulting from a change in the valuation technique or its application shall be accounted for as a change in accounting estimate. The partial adoption of SFAS 157 for financial assets and liabilities did not have a material impact on the Company’s consolidated financial statements.
As required by SFAS 142, the goodwill impairment test must be performed annually. Additionally, SFAS 142 states that goodwill shall be tested for impairment between annual tests if an event or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. The Company utilized a discounted cash flow model, which includes residual value, to determine the fair value of the reporting unit. The Company performed its annual test at September 30, 2008 and determined that goodwill was not impaired.
At December 31, 2008, the Company’s market capitalization was less than its book value indicating a potential impairment of goodwill. As a result, the Company assessed the factors contributing to the performance of AMIC stock in 2008, and concluded that the market capitalization does not represent the fair value of the Company. The Company noted several factors that have led to a difference between the market capitalization and the fair value of the Company, including (i) the Company’s stock is thinly traded and a sale of even a small number of shares can have a large percentage impact on the price of the stock, (ii) IHC and insiders own over 50% of the outstanding shares, which has had a significant adverse impact on the number of shares available for sale and therefore the trading potential of AMIC stock, (iii) the general lack of confidence in equity securities, which has resulted in a flight to US Treasury securities and other investments perceived to be of a higher quality, (iv) both financial institutions and the insurance industry as a whole have seen similar drops in share prices, particularly in the fourth quarter of 2008 as concerns over the effects of the volatile equity and bond markets on insurance company’s investment portfolios are translating into lower share prices. In light of such developments, the Company updated its evaluation at December 31, 2008 and reaffirmed that goodwill was not impaired. Going forward, the Company changed its annual impairment testing date from September 30 to December 31. If the Company experiences a sustained decline in its results of operations and cash flows, or other indicators of impairment exist, the Company may incur a material non-cash charge to earnings relating to impairment of our goodwill, which could have a material adverse effect on our results.
Intangible assets at December 31, 2008 and 2007 consist of the following (in thousands):
Intangible asset additions of $1,204,000 in 2008 are a result of the Company’s purchase of the remaining 20% interest in Marlton on April 1, 2008 ($480,000), and the acquisition of certain of the assets and assumption of certain of the liabilities of Insurance Producers Group of America, Inc. and its subsidiaries on April 15, 2008 ($724,000). These assets were acquired by IPA, an indirect, 51% owned subsidiary of the Company. Intangible assets related to the purchase of the remaining 20% interest in Marlton represent broker relationships with an estimated useful life of 10 years. Intangible assets related to Insurance Producers Group of America, Inc. and its subsidiaries represent various relationships and proprietary technology with estimated useful life spans of 4 to 12 years.
A total of 30 securities were in a continuous unrealized loss position for less than 12 months and 43 securities for 12 months or longer as of December 2008. A total of 24 securities were in a continuous unrealized loss position for less than 12 months and 51 securities for 12 months or longer as of December 31, 2007. For fixed maturities, there are no securities past due or securities for which the Company currently believes it is not probable that it will collect all amounts due according to the contractual terms of the investment.
The Company had derivative instruments representing the value of the contingent payment due to EDH as of December 31, 2008 and 2007 (see Note 19 of Notes to Consolidated Financial Statements).
Gross gains of $50,000 and gross losses of $83,000 were realized on sales of available-for-sale securities for the year ended December 31, 2008.
maximum amount available from the Securities Investor Protection Corporation (“SIPC”). Accordingly, the Company recorded a pre-tax loss of $2,006,000, net of expected recoveries, in net realized investment losses in the fourth quarter of 2008 in the Consolidated Statements of Operations. While the Company may be subject to legal claims in this matter, the ultimate resolution of any such claims would not be material to its financial condition.
The adoption of SFAS 157 did not have a material impact on our financial statements. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 applies whenever other standards require or permit assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. In this standard, the FASB clarifies the principle that fair value should be based on the assumptions market participants
When available, we use quoted market prices to determine fair value and classify such items in Level 1. In some cases, we use quoted market prices for similar instruments in active markets and/or model-derived valuations where inputs are observable in active markets and classify such items in Level 2. When there are limited or inactive trading markets, we use industry-standard pricing methodologies, including discounted cash flow models, whose inputs are based on management assumptions and available current market information. These items are classified in Level 3. Further, we retain independent pricing vendors to assist in valuing certain instruments.
Net liabilities of $366,000 and $399,000 associated with discontinued operations at December 31, 2008 and December 31, 2007, respectively, represent estimated closure costs of Intellicom. A loss on disposition of discontinued operations was recorded in the fourth quarter of 2008 due to the loss of rental income associated with the sublease of a property located in Livermore, California, and a re-estimation of expected expenses related to the lease. The company entered into an agreement with a third party to sublease the property in October of 2006 and estimated the income associated with the sublease in the reserve balance. Due to the insolvency of the lessee, the Company recorded a loss of $75,000, net of tax, in the fourth quarter of 2008.
The Company has additional obligations in regard to its agreement with EDH as further described in Note 19 of Notes to Consolidated Financial Statements.
Effective October 1, 1998, the Company implemented the 1998 Plan, which the Company's stockholders approved on April 13, 1999. The 1998 Plan provided for the grants of non-statutory 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 1998 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, 2008, stock options for 419,817 common stock shares were outstanding, stock options for 380,864 common stock shares were vested, and 6,550,556 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 $143,000 and $231,000 for the twelve months ended December 31, 2008 and 2007, respectively. Related tax benefits of $50,000 and $81,000 for the twelve months ended December 31, 2008 and 2007, respectively. As of December 31, 2008, there was approximately $132,000 of total unrecognized compensation expense related to non-vested options which will be recognized over the remaining requisite service periods.
The following table summarizes restricted stock activity for the twelve months ended December 31, 2008:
As of December 31, 2008, there was approximately $68,000 of total unrecognized compensation expense related to non-vested restricted stock which will be recognized over the remaining requisite service periods.
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 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, 2008 and 2007, Standard Security Life and Madison National Life ceded an average of approximately 23% 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 8.9% of the majority of its fully insured health business to Independence American.
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, our MGUs market, underwrite and provide administrative services, and ECA provides medical management and claims adjudication, for a substantial portion of the medical stop-loss business written by the insurance subsidiaries of IHC. Our MGUs and ECA record 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 the Company’s portion is recorded in Selling, General and Administrative Expenses.
IHC provides the Company with pro rata quota share reinsurance on business written by Independence American. In June 2008, Independence American began ceding 30% of its direct stop-loss busines sold through Marlton to Madison National Life. In addition, in 2008, Independence American ceded 50% of its STM and major medical for individuals and families business to unrelated reinsurers. Independence American incurs an administration expense on its retained share of major medical for individual and families busness that is paid to Insurers Administrative Corporation, a subsidiary of IHC.
The Company and its subsidiaries incurred expense of $805,000 and $776,000 for the twelve months ended December 31, 2008 and 2007, respectively, from 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 the Company and its subsidiaries, including accounting, legal, compliance, underwriting, and claims.
The tax effect of temporary differences that give rise to significant portions of the net deferred tax assets at December 31, 2008 and 2007 are as follows:
During the year ended December 31, 2008 the Company increased its valuation allowance by $414,000. This increase included $999,000 representing an increase of deferred tax on unrealized losses allocated to equity, offset by reductions of $436,000 for the acquisition of 20% of Marlton and $149,000 for the 51% acquisition of IPA, both of which were allocated to goodwill. During the year ended December 31, 2007 the Company reduced its valuation allowance by $3,000 representing a decrease of deferred tax on unrealized losses allocated to equity.
AMIC's ability to utilize its federal NOL carrryforwards would be substantially reduced if AMIC were to undergo an "ownership change" within the meaning of Section 382(g)(1) of the Internal Revenue Code. AMIC will be treated as having had an "ownership change" if there is more than a 50% increase in stock ownership during a three year '"testing period" by "5% stockholders." In order to reduce the risk of an ownership change, in November 2002, AMIC's stockholders approved an amendment to its certificate of incorporation restricting transfers of shares of its common stock that could result in the imposition of limitations on the use, for federal, state and city income tax purposes, of AMIC's NOL carryforwards and certain federal income tax credits. The certificate of incorporation generally restricts any person from attempting to sell, transfer or dispose, or purchase or acquire any AMIC stock, if such transfer would affect the percentage of AMIC stock owned by a 5% stockholder. Any person attempting such a transfer will be required, prior to the date of any proposed transfer, to request in writing that the board of directors review the proposed transfer and authorize or not authorize such proposed transfer. Any transfer attempted to be made in violation of the stock transfer restrictions will be null and void. In the event of an attempted or purported transfer involving a sale or disposition of capital stock in violation of stock transfer restrictions, the transferor will remain the owner of such shares. Notwithstanding such transfer restrictions, there could be circumstances under which an issuance by AMIC of a significant number of new shares of Common Stock or other new class of equity security having certain characteristics (for example, the right to vote or convert into Common Stock) might result in an ownership change under the Code.
The Company maintains loss reserves to cover its estimated liability for unpaid losses and loss adjustment expenses, including legal and other fees and a portion of the Company's general expenses, for reported and unreported claims incurred as of the end of each accounting period. These loss reserves are based on actuarial assumptions and are maintained at levels that are in accordance with U.S. GAAP. Many factors could affect these reserves, including economic and social conditions, inflation, healthcare costs, changes in doctrines of legal liability and damage
awards in litigation. Therefore, the Company's reserves are necessarily based on estimates, assumptions and analysis of historical experience. The Company's results depend upon the variation between actual claims experience and the assumptions used in determining reserves and pricing products. Reserve assumptions and estimates require significant judgment and, therefore are inherently uncertain. The Company cannot determine with precision the ultimate amounts that will be paid for actual claims or the timing of those payments.
All of the Company's short-duration contracts are generated from its accident and health business, and are accounted for based on actuarial estimates of the amount of loss inherent in that period's claims, including losses incurred for which claims have not been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
Medical stop-loss business is excess coverage with a short duration. Predicting ultimate claims and estimating reserves in medical stop-loss is especially complicated due to the “excess of loss” nature of these products with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. Fluctuations in results for specific coverage are primarily due to the severity and frequency of individual claims. Due to the short-term nature of medical stop-loss, redundancies and deficiencies will typically emerge during the following year rather than over a number of years. In the third quarter of 2007, the Company
identified a material increase in claims and reserves with respect to business written in 2006. Such adverse development was primarily driven by the frequency of claims relative to the business written in that year proving significantly higher than what would have been predicted by prior loss development patterns. This increased frequency of medical stop-loss claims was due, in part, to increased severity of primary claims.
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, 2008, Independence American ceded to highly rated reinsurers.
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 years 2008 and 2007 are as follows:
The Company has classified the $2,500,000 payment and $743,000 original value of the EDH Derivative as an intangible asset that will be amortized over the five year contract period.
Such amortization started January 1, 2007 to coincide with the transfer of business on January 1, 2007.