IAC leases 49,117 square feet of office space in Phoenix, Arizona as its corporate headquarters, 6,000 square feet in Rockford, Illinois and 1,765 square feet in Golden Valley, Minnesota.
AMC leases 6,408 square feet of office space in Lafayette, California and an additional 2,983 square feet of office space in Phoenix, Arizona.
While management considers a wide range of factors in its strategic planning and decision-making, underwriting profit is consistently emphasized as the primary goal in all decisions as to whether or not to increase our retention in a core line, expand into new products, acquire an entity or a block of business, or otherwise change our business model. Management's assessment of trends in healthcare and morbidity, with respect to medical stop-loss, fully insured medical, disability and DBL; mortality rates with respect to life insurance; and changes in market conditions in general play a significant role in determining the rates charged, deductibles and attachment points quoted, and the percentage of business retained. The Company believes that the acquisition of Actuarial Management Corp. (“AMC”) has further enabled it to make these assessments. IHC also seeks transactions that permit it to leverage its vertically integrated organizational structure by generating fee income from production and administrative operating companies as well as risk income for its carriers and profit commissions. Management has always focused on managing costs of its operations and providing its insureds with the best cost containment tools available.
The results of operations for the years ended December 31, 2007, 2006 and 2005, are summarized as follows (in thousands):
Acquired CA Marketing and Management Services, LLC and merged this company with IHC Health Solutions, Inc. ("IHC Health Solutions") as of January 2, 2007;
Effective June 20, 2007, increased the Company's controlling interest in Majestic Underwriters LLC ("Majestic"), a medical stop-loss MGU, to 62.3% with the purchase of an additional 10.3% interest from a retired senior officer; and
The combined ratio is equal to the sum of the loss ratio and the expenses ratio.
Underwriting experience as indicated by its GAAP Combined Ratios for the Fully Insured segment are as follows (in thousands):
Loss before taxes from the Corporate segment increased $1.5 million for the year ended December 31, 2007 primarily due to lower income from partnership investments in 2007;
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 of this report. 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.
Management believes that the Company's methods of estimating the liabilities for insurance reserves provided appropriate levels of reserves at December 31, 2007. Changes in the Company's reserve estimates are recorded through a charge or credit to its earnings.
The Company believes that its recorded insurance reserves are reasonable and adequate to satisfy its ultimate liability. The Company primarily uses its own loss development experience, but will also supplement that with data from its outside actuaries, reinsurers and industry loss experience as warranted. To illustrate the impact that Loss Ratios have on the Company’s loss reserves and related expenses, each hypothetical 1% change in the Loss Ratio for the health business (i.e., the ratio of insurance benefits, claims and settlement expenses to earned health premiums) for the year ended December 31, 2007, would increase reserves (in the case of a higher ratio) or decrease reserves (in the case of a lower ratio) by approximately $2.7 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the Consolidated Statement of Operations. Depending on the circumstances surrounding a change in the Loss Ratio, other pre-tax amounts reported in the Consolidated Statement of Operations could also be affected, such as amortization of deferred acquisition costs and commission expense.
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 2004, 2005 and 2006 underwriting years which deviated by 11.7, 7.4 and 11.4 Net Loss Ratio points, respectively. After the recorded reserve increase, 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 2007 at December 31, 2007. The impact of these reasonably likely changes at December 31, 2007, 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 $3.4 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the 2007 Consolidated Statement of Operations.
development represent true indications of emerging experience or are simply due to random claim fluctuations.
claims reserves would be increased. Advancements in medical treatments could affect future recovery, termination, and mortality rates. With respect to LTD only, other assumptions are: (i) changes in market interest rates; (ii) changes in offsets; (iii) advancements in medical treatments; and (iv) cost of living. Changes in market interest rates could change reserve assumptions since the payout period could be as long as 40 years. Changes in offsets such as Social Security benefits, retirement plans and state disability plans also impact reserving. As a result of the forgoing assumptions, it is possible that the historical trend may not be an accurate predictor of the future development of the block. As with most long term insurance reserves that require judgment, the reserving process is subject to uncertainty and volatility and fluctuations may not be indicative of the claim development overall.
For long duration type contracts accounted for under SFAS No. 97, such as annuities and universal life business, amortization of DAC is charged to expense over the life of the book of such contracts based on the present value of the estimated gross profits ("EGPs") expected to be realized over the life of the book of contracts. EGPs consist of margins based on expected mortality rates, persistency rates, interest rate spreads, and other revenues and expenses. The Company regularly evaluates its EGPs to determine if actual experience or other evidence suggests that earlier estimates should be revised. If the Company determines that the current assumptions underlying the EGPs are no longer the best estimate for the future due to changes in actual versus expected mortality rates, persistency rates, interest rate spreads, or other revenues and expenses, the future EGPs are updated using the new assumptions and prospective unlocking occurs. These updated EGPs are utilized for future amortization calculations. The total amortization recorded to date is adjusted through a current charge or credit to the Consolidated Statement of Operations.
Declines in value of securities available-for-sale that are judged to be other-than-temporary are determined based on the specific identification method and are reported in the Consolidated Statements of Operations as realized losses. The factors considered by management in determining when a decline is other than temporary include but are not limited to: the length of time and extent to which the fair value has been less than cost; the financial condition and near-term prospects of the issuer; adverse changes in ratings announced by one or more rating agencies; whether the issuer of a debt security has remained current on principal and interest payments; 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.
Total net investment income decreased $1.6 million, primarily due to: (i) lower investable assets as a result of the acquisitions of CAM and AMC in 2007; (ii) lower investment income from limited partnerships due to the liquidation of certain partnership investments in 2007 and losses reported by certain partnerships in 2007 versus income reported in 2006; and (iii) a slightly lower investment yield. The overall investment yield was 5.3% for 2007 versus 5.5% for 2006.
Fee income increased $11.6 million to $44.1 million from $32.5 million in 2006, primarily due to an increase in administrative fees in the Fully Insured Health segment including an increase of $6.7 million earned by IAC (acquired January 31, 2006) in addition to $4.9 million of fees earned by IHC Health Solutions, Inc (acquired January 1, 2007) and AMC (acquired April 1, 2007).
Total other income increased $1.3 million to $3.4 million from $2.1 million in 2006, primarily due to adjustments in 2007 in settlement of a reinsurance agreement.
In accordance with our reserving methodology, the Company initially establishes its medical stop-loss reserves based on its best estimate of the Projected Net Loss Ratio, which is set based on underlying assumptions developed using completed prior experience trended forward ("Projected Net Loss Ratio"). This use of projections reflects the fact that actual claims on medical stop-loss cases typically are not fully reported until after the end of the policy period. We use the Projected Net Loss Ratio to set reserves until developing losses provide a better indication of ultimate results and it is feasible to set reserves based on claim development patterns. IHC's typical practice is to then increase or decrease claims reserves once we know the actual claims experience. We then review quarterly the Projected Net Loss Ratios and claim development patterns as we develop reserve estimates based on recent claim development history ("Claim Development Patterns").
Results of Operations for the Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005
Income from continuing operations was $14.5 million, or $.95 per share, diluted, for the year ended December 31, 2006, a decrease of $3.0 million compared to income from continuing operations of $17.5 million, or $1.22 per share, diluted, for the year ended December 31, 2005. The Company's income from continuing operations before taxes decreased $5.1 million to $21.1 million for the year ended December 31, 2006 from $26.2 million for 2005. The loss from discontinued operations was $.4 million, or $.02 per share, diluted, for the year ended December 31, 2006 compared to $.2 million, or $.01 per share, diluted, for the year ended December 31, 2005.
Information by business segment for the years ended December 31, 2006 and 2005 is as follows:
Fee income increased $22.8 million to $32.5 million from $9.7 million in 2005, primarily due to fees of $23.1 million earned by IAC and $.6 million earned by CAIS, which are subsidiaries that were not part of the Company during 2005, partially offset by $.9 million earned by GroupLink that is eliminated in consolidation in 2006 as a result of transferring business from outside insurance carriers to subsidiaries of IHC.
Amortization of deferred acquisition costs increased $.1 million, primarily due to costs associated with the purchase of blocks of business in 2005 offset by amounts eliminated in 2006 as a result of certain acquisitions of subsidiaries in 2006.
Total selling, general and administrative expenses increased $38.0 million in 2006 as compared to 2005. The increase is primarily due to (i) a $29.1 million increase in expenses associated with the operation of the Fully Insured segment, primarily due to the acquisitions of IAC and GroupLink, and higher commission expense due to the increase in premiums; (ii) a $5.4 million increase in commissions and other general expenses in the Medical Stop-Loss segment due to a higher level of premiums earned; (iii) a $1.5 million increase in the Individual and Other segment due to the block acquisitions in 2005; (iv) a $.6 million decrease in the Group segment primarily due to loss experience refunds which reduced commissions in the group A&H business as a result of higher loss ratios in 2006 compared to the prior year; and (v) a $2.6 million increase in other corporate expenses, including $1.1 million of expenses related to share-based compensation due to the adoption of SFAS 123R in 2006.
The Insurance Group normally provides cash flow from: (i) operations; (ii) the receipt of scheduled principal payments on its portfolio of fixed maturities; and (iii) earnings on investments and other investing activities. Such cash flow is partially used to fund liabilities for insurance policy benefits. These liabilities represent long-term and short-term obligations. The Company reported a net use of cash from the operating activities of continuing operations of $3.6 million primarily due to the settlement of two reinsurance contracts. The Company’s net use from operations is not reasonably likely to have a material adverse impact on its liquidity.
Total investments and cash and cash equivalents decreased $27.8 million during 2007 largely due to $9.0 million in cash used for acquisitions, a $10.9 million increase in unrealized losses on available for sale securities and $9.4 million of increases in net amounts due from reinsurers.
In addition, the Company recorded additional reserves of $5.6 million on its 2007 Business, primarily as a result of the Company’s review of the Claim Development Patterns of the 2006 Business. This business was reserved using the Projected Net Loss Ratio. This change represents a deviation of approximately 9.8% from the Projected Net Loss Ratio as originally estimated.
The $8.3 million decrease in total stockholders' equity in 2007 is primarily due to a $2.3 million net loss and a $6.8 million increase in after-tax net unrealized losses on investments.
was invested in investment grade fixed maturities, resale agreements, policy loans and cash and cash equivalents at December 31, 2007. Also at such date, approximately 98.9% of the Insurance Group's fixed maturities were investment grade. These investments carry less risk and, therefore, lower interest rates than other types of fixed maturity investments. At December 31, 2007, approximately 1.1% of the carrying value of fixed maturities was invested in diversified non-investment grade fixed maturities (investments in such securities have different risks than investment grade securities, including greater risk of loss upon default, and thinner trading markets). The Company does not have any mortgage loans or non-performing fixed maturities at December 31, 2007. At December 31, 2007, the Company had $44.5 million invested in whole loan CMOs backed by Alt-A mortgages, all of which were rated AAA. Of this amount, 37.5% were in CMOs that originated in 2005 or earlier and 62.5% were in CMOs that originated in 2006. The Company’s mortgage security portfolio has no exposure to sub-prime mortgages. The decline in market 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.
The Company reviews its investments regularly and monitors its investments continually for impairments. For the years ended December 31, 2007 and 2006, the Company recorded $.4 million and $.2 million, respectively, of realized losses for other-than-temporary impairments.
The following table summarizes the prior year net unfavorable amount incurred in 2007 according to the year to which it relates, together with the opening reserve balance (net of reinsurance recoverable) to which it relates (in thousands):
The following sections describe, for each segment, the deficiency - unfavorable development or redundancy - favorable development experienced in 2007, together with the key assumptions and changes therein affecting the reserve estimates.
The Group Disability segment had an unfavorable development of $.2 million. This amount consists of a favorable development of $1.1 million on the 2006 reserves primarily due to DBL and a net unfavorable development of $1.3 million for all other years due to LTD.
The Individual A&H and Other segment had favorable development of $1.0 million. The Company experienced $.7 million favorable variance related to 2006 reserves on our Blanket Accident and sickness product that is sold to volunteer fire districts, due to lower claims experience than historically experienced. The Company had $.3 favorable variance on all other Individual A&H lines related to 2005 and prior reserves. The reserving process used by management was consistent from 2006 to 2007.
In accordance with SFAS No. 115, the Company may carry its portfolio of fixed maturities either as held to maturity (carried at amortized cost), as trading securities (carried at fair market value) or as available-for-sale (carried at fair market value). The Company has chosen to carry its fixed maturities as available-for-sale. In 2007, the Company experienced an increase in unrealized losses of $10.9 million which, net of deferred tax benefits and an allocation to deferred policy acquisition costs, decreased stockholders' equity by $6.8 million (reflecting net unrealized losses of $16.1 million at December 31, 2007 compared to net unrealized losses of $9.3 million at December 31, 2006). From time to time, as warranted, the Company employs investment strategies to mitigate interest rate and other market exposures.
IHC has historically been a life and health insurance holding company for two insurance companies, Standard Security Life Insurance Company of New York ("Standard Security Life") and Madison National Life Insurance Company, Inc. ("Madison National Life"), which relied on independent general agents, managing general underwriters ("MGUs") and administrators to perform the majority of all marketing, underwriting, claims and administrative functions for our two primary product segments (Medical Stop-Loss and Group disability, life, annuities and DBL). While it is always our intent to
, the medical stop-loss industry as a whole succumbed to pricing pressures caused by an unexpectedly long down cycle (or "soft" market) from 2003 through 2007. As a consequence of these market conditions, we curtailed our growth, and believed that we had taken sufficient action to insure that business written in 2006 would produce better margins than that written in 2005. Unfortunately, certain of our MGUs exercised discretion within our underwriting guidelines to make pricing concessions on particular cases, which ultimately resulted in business incepting in 2006 having higher loss ratios than that incepting in 2005. We recorded GAAP Combined Ratios of 91.9%, 94.0% and 104.9% for the calendar years ended December 31, 2005, 2006 and 2007, respectively. As the 2007 Combined Ratio includes reserve strengthening of $11.9 million, we expect the 2008 GAAP Combined Ratio to improve.
Medical Stop-Loss premiums in 2008 due to tighter underwriting guidelines and fewer MGUs, partially offset by rate increases. The Company anticipates its
Collectively, IHC will administer, manage and distribute its Fully Insured Health Products through its access to approximately 50,000 general agents, agents and brokers (“Producers”) in the majority of states. IHC believes this is one
of the largest networks of Producers focusing on the sale of Fully Insured Health Products in the country.
through alternative distribution methods in addition to general agents. These companies now produce about 30% of the Company's fully insured business. Through the acquisition of Actuarial Management Corp., the Company brought in-house the actuarial expertise necessary to maintain the profitability of the block, and added another source of fee income and potentially profit commission.
, estimated at $500 billion compared to a Medical Stop-Loss market of approximately $4 billion.
As a result of its multiple product filings, distribution sources, and the sheer size of the market, the Company is optimistic that its
The Company announced that it has entered into an agreement to acquire a block of life and annuity reserves of approximately $65 million, which is scheduled to close and be effective as of April 1, 2008. We
capabilities to administer large blocks of life and annuities for other carriers for whom this is not a core business.
See Index to Consolidated Financial Statements and Schedules on page 56.