This financial discussion contains an analysis of the consolidated financial position and financial performance as of December 31, 2005 and 2004, and consolidated results of operations for 2005, 2004 and 2003. This analysis should be read in its entirety and in conjunction with the consolidated financial statements, notes and tables included elsewhere in this Annual Report on Form 10-K.
Consolidated operating expenses increased $9.8 million, or 5.7%, during the year 2005. The increase in the operating expenses is basically attributed to the increased volume of business of its reportable segments. The consolidated expense ratio decreased 0.1 percentage points during the year 2005, from 13.1% in 2004 to 13.0% in 2005.
The consolidated realized gain on sale of securities is the result of the management of the investment portfolio in accordance with corporate investment policies and from normal portfolio turnover of the trading and available-for-sale securities. The decrease of $3.8 million in the realized gain during 2005 when compared to the year 2004 is mostly due to the sale of common stock of Popular, Inc. during 2004, which generated a realized gain of approximately $6.2 million. In addition, in the year 2005 the Corporation realized gains of $1.7 million in the sale of its corporate bonds trading portfolio.
The consolidated income tax expense during the year 2005 decreased by $10.2 million when compared to the year 2004. This decrease is mostly due to a decrease in the taxable income when comparing the years 2005 and 2004. This was offset in part by an increase in the Property and Casualty Insurance segment’s deferred tax expense of approximately $1.6 million in 2005. This increase was the result of an update by the segment of the tax rate at which certain deferred taxes were accounted for in order to reflect the tax rate at which deferred taxes are expected to reverse.
The premiums earned of the property and casualty insurance segment increased by $7.9 million, or 10.1%, during the year 2004. This increase is mostly the result of the segment’s increased volume of business, particularly in the Dwelling and Auto Physical Damage lines of business.
The premiums earned, net of the Health Insurance - Reform segment increased $7.1 million, or 1.5%, in 2004, as compared to the premiums earned, net in 2003. The increase in the premiums earned, net of this segment is due to increases in premium rates during the contract renegotiation process, net of a decrease in membership.
The consolidated claims incurred during the year 2004 were $50.4 million, or 4.7%, higher than the consolidated claims incurred for the year 2003. The loss ratio reflects an increase of 1.6 percentage points during the same period. This increase is mostly driven by the fluctuations in the claims incurred and the loss ratio of the Health Insurance - Commercial Program and Reform segments. During 2004, the Health Insurance - Commercial and Reform segments
In addition, claims incurred in the Property and Casualty Insurance segment also increased during 2004. The increase in the claims incurred of this segment is mostly due to an increase in its volume of business and to approximately $2.0 million of net losses from claims incurred related to the passage of Tropical Storm Jeanne through Puerto Rico.
The consolidated realized gain on sale of securities is the result of the management of the investment portfolio in accordance with corporate investment policies and from normal portfolio turnover of the trading and available-for-sale securities. The consolidated realized gain during 2004 is mostly due to the sale of common stock of Popular, Inc., which generated a realized gain of approximately $6.2 million and also to normal portfolio turnover of the trading and available for sale securities.
The consolidated income tax expense during the year 2004 decreased $51.4 million when compared to 2003 primarily as a result of the termination of TSI’s tax ruling in July 2003. As a result, TSM recognized an income tax expense in 2003 amounting to $51.8 million.
During 2005, the Health Insurance - Commercial Program segment reported an increase of $59.5 million, or 8.2%, in the amount of premiums earned, net and fee revenue. This increase in the amount of premiums earned, net and fee revenue is the result of the following:
Premiums for the segment’s Medicare Advantage program, which was launched in the year 2005, amounted to $34.2 million. No Medicare Advantage premiums were reflected in the 2004 period.
In 2005, the segment’s average enrollment increased 7,714 members, or 1.2%, when compared to the year 2004. The increase in the average enrollment is mostly reflected in the self-funded employers and corporate accounts businesses, which membership increased by 11,185, or 7.9%, and 2,728, or 0.9%, during this period, respectively. This increase in average enrollment is mostly attributed to new groups acquired throughout 2005. The average enrollment of the local government employees and Federal employees businesses, on the other hand, decreased by 5,347, or 13.3%, and 2,673, or 5.1%, during this year, respectively.
On average, this segment increased premium rates by approximately 6% during the year 2005.
The claims incurred for the year 2005 were $57.1 million, or 9.2%, higher than 2004. The segment’s loss ratio reflects an increase of 0.7 percentage points during the same period. The increase in the loss ratio is attributed to an increase in claims experience trends from 5.7% in 2004 to 6.7% in 2005, mostly due to higher utilization levels and higher costs per service. The segment experienced an increase in utilization and costs of service for office visits, prescription drugs, laboratory services and specialized procedures, such as MRIs and CT scans, which contributed to the increased loss ratio for the period.
The segment continues to enhance cost containment initiatives that control claims trends and maintains them at levels consistent with pricing and margin objectives.
Operating expenses increased by $8.6 million, or 9.1%, during 2005 when compared to the 2004 period. This increase is principally attributed to expenses amounting to $9.4 million related to the launching of the new Medicare Advantage program and approximately $1.0 million of commission expense related to the new business generated during the year. On the other hand, the segment experienced a reduction of approximately $3.0 million in the amount expensed related to several operating projects. The expense ratio experienced an increase of 0.1 percentage points during the year 2005.
The segment constantly monitors claims trends, particularly in the rated corporate accounts and Individual lines of business. This practice assures adequate premium rates that reflect the actual claims trend of each particular business. On average, this segment increased premium rates by 4.5% during the year 2004.
The increase in total average enrollment of 5,144 members, or 0.8%, during the year 2004 when compared to 2003 is mainly the result of flat employment levels in Puerto Rico during the last three years. The most significant increase in enrollment is in the Self-funded Employers, which presents an increase of 12,206 members, or 9.5%, since during this period certain large corporate accounts groups shifted from the rated business to self-funded arrangements, assuming the risk associated with insuring their employees. The increase experienced in this business is mitigated by the decrease experienced in 2004 in the Local government employees and Federal employees businesses, which present a decrease of 2,920 members, or 6.8%, and 2,076, or 3.8%, respectively.
Approximately 73% of the increase in total premiums is due to increases in premium rates. The remaining 27% is attributable to an increase in the segment’s volume of business.
During 2004, the segment experienced an increase in legal expenses of $1.3 million and an increase in professional services and consulting fees of $1.5 million mostly as a result of assistance related to legal, governmental and regulatory matters related to its business.
Premium rates for this segment were increased, effective August 1st, 2005, by approximately 5.8% during the Healthcare Reform contract renegotiation process for the eleven-month period ending June 30, 2006. In addition, premium rates were increased by approximately 4.4% for the thirteen-month period ended July 31, 2005. On average the increase in premium rates during 2005 was 4.5%.
The average enrollment for this segment increased by 5,308 members, or 0.9%, when comparing the 2005 and 2004 periods.
During the Reform contract renegotiation process, premium rates were increased by approximately 4.4% and 4.2% for the twelve-month periods ended June 30, 2005 and June 30, 2004, respectively. On average the increase in premium rates during 2004 was 4.4%.
Operating expenses for the year 2004 were $1.1 million, or 3.3%, higher than the operating expenses for the year 2003. The expense ratio also increased, from 7.3% during 2003 to 7.4% during 2004. This fluctuation is due to the normal inflationary effect of operational costs.
The property and casualty insurance segment’s total revenues are primarily generated from net premiums earned and investment income. Claims incurred are composed of losses and loss-adjustment expenses. A portion of the claims incurred for each period consists of an estimate of unreported losses to the segment during the period. Operating expenses consist of general, commissions, depreciation, payroll and other related expenses.
Claims incurred decreased by $2.4 million, or 5.2%, when comparing the claims incurred during 2005 with the claims incurred in the year 2004. The loss ratio experienced a decrease of 3.1 percentage points during the year 2005 as compared to the prior year. This decrease is primarily due to incurred losses from the passing of Tropical Storm Jeanne in September 2004. Net incurred losses reported for Tropical Storm Jeanne amounted to $2.1 million. In addition, the segment’s focus on quality underwriting has also resulted in an improvement in loss experience, particularly in the auto and medical malpractice lines of business.
The operating expenses for the year 2005 decreased by $540 thousand, or 1.3%, when compared to the operating expenses for the year 2004. The expense ratio decreased by 0.9 percentage points during the year 2005.
Claims incurred increased by $2.6 million, or 6.0%, when comparing the claims incurred during 2004 with the claims incurred in the year 2003. This increase is primarily due to incurred losses from the passing of Tropical Storm Jeanne in September 2004, which amounted to $2.1 million. The loss ratio, on the other hand, experienced a decrease of 2.1 percentage points during the year 2004 as compared to the prior year since the segment’s loss experience was lower in the commercial multi-peril and auto insurance lines of business. The auto insurance lines of business experienced an improvement in its loss ratio in both the physical damage and liability business.
The operating expenses for the year 2004 increased by $2.8 million, or 7.6%, when compared to the operating expenses for the year 2003. The expense ratio, however, experienced a decrease of 1.1 percentage points during the year 2004. The increase in the operating expenses and the decrease in the expense ratio is due to, among other things:
During 2004, the segment recorded a guaranty fund assessment to cover liabilities of insolvent companies. This assessment, which amounted to $871 thousand, was charged to operations during 2004.
The experience refund received from the Compulsory Vehicle Liability Insurance Joint Underwriting Association increased by $202 thousand, from $633 thousand during 2003 to $840 thousand during 2004. This refund is recorded as a decrease to the operating expenses for the period.
The life and disability insurance segment’s total revenues are primarily generated from net premiums earned and investment income. Claims incurred are composed of losses and loss-adjustment expenses. A portion of the claims incurred for each period consists of an estimate of unreported losses to the segment during the period. Operating expenses consist of general, commissions, depreciation, payroll and other related expenses.
Earned premiums during the year 2005 presented an increase of $486 thousand, or 2.0%, when compared to the earned premiums for 2004. The increase in earned premiums during this year is the result of the following factors:
Operating expenses increased by $854 thousand, or 11.6% during the year 2005. The expense ratio increased by 3.2 percentage points during this period, from 44.7% in 2004 to 47.9% in 2005. This increase is mostly expenses related to the cancer and other dreaded diseases line of business, which was launched during the year 2004.
The earned premiums of the group disability line of business decreased by $723 thousand, or 5.1%, during the year 2004. This decrease is mostly attributed to the fact that during the first quarter of 2003, the segment revised its methodology for estimating the premiums of its short-term disability business. This revision resulted in a non-recurring adjustment increasing earned premiums of this line of business by approximately $1.1 million during the year 2003. The average certificates in force of the group disability line of business increased by 3,996 certificates, or 2.3%, during the year 2004.
The earned premiums of the group life line of business decreased by $450 thousand, or 4.3%, during the 2004 period is attributed to a decrease in the average certificates in force of 9,802, or 6.6%. This decrease is attributed to the loss of several groups with higher than expected claims experience since the segment is closely monitoring claims experience and considering this experience upon each group’s renewal process.
Operating expenses increased by $1.3 million, or 21.7%, during the 2004 period. The expense ratio increased by 10.0 percentage points during the same period. This increase is mostly the result of an increase in legal and professional services, commissions and advertising expenses. Most of these expenses are related to corporate projects in the area of technology and compliance.
Decrease in income taxes paid of $35.6 million in 2005 and an increase in income taxes paid of $5.4 million in 2004. The decrease in the amount of income taxes paid in 2005 is mostly due to the fact that the 2004 period includes the payment of $14.8 million of the last installment of the $51.8 million income tax liability related to the closing agreement with the PRTD upon the termination of TSI’s tax exemption. In addition, on April 15, 2004 TSI paid $22.1 million corresponding to its income tax liability for the year 2003 and the first installment of the estimated tax corresponding to the year 2004. In the 2005 period, the Corporation paid its regular estimated income tax installments.
The contingency reserve funds payment from the Federal Employee Health Benefit Plan decreased by $4.1 million in 2005 and $7.8 million in 2004. The amount collected from the contingency reserve funds of the FEHBP was $1.1 million, $5.2 million and $13.0 million during 2005, 2004 and 2003, respectively. This fluctuation is related to the results of operations of the program during each particular year.
The basic components of the cash flows from investing activities is derived from acquisitions and proceeds from investments in the available-for-sale and held-to-maturity portfolios, and capital expenditures. The Corporation monitors the duration of its investment portfolio and executes purchases and sales of these investments with the objective of having adequate asset allocation within different sectors and to have funds available, when necessary, to satisfy any maturing liability.
were invested in fixed income securities, which are accounted for as available-for-sale securities. Total acquisition of investments exceeded the proceeds from investments sold or matured by $92.9 million and $41.5 million during the years 2005 and 2004, respectively. In addition, capital expenditures increased by $4.1 million during the year 2005. The increase in capital expenditures is basically attributed to the following:
Net cash flows provided by financing activities amounted to $65.3 million, $23.5 million and $45.5 million for the years ended December 31, 2005, 2004 and 2003, respectively. The increase of $42.0 million during the year 2005 and the decrease of $22.0 million during the year 2004 in the cash flows from financing activities are due to the effect of the following fluctuations:
The change in outstanding checks in excess of bank balances decreased by $2.8 million during the year 2005 and increased by $9.5 during the year 2004. This represents a timing difference between the issuance of checks and the cash balance in the bank account at one point in time.
The repayments of long-term borrowings increased by $2.5 million during the year 2005 and by $1.0 million in the year 2004. The fluctuations in the repayments of long-term borrowings are due to additional repayments to one of the Corporation’s credit agreements amounting to $3.5 in 2005 and $1.0 million in 2004.
Total long-term borrowings proceeds amounted to $60.0 million and $50.0 million during the years 2005 and 2004. There were no long-term borrowings proceeds during the year 2003. In 2005, the Corporation received proceeds from the 6.6% senior unsecured notes amounting to $60.0 million. In 2004, the Corporation received proceeds from the 6.3% senior unsecured notes amounting to $50.0 million. This represents an increase of $10.0 million in the amount of proceeds received from the issuance of long-term borrowings during the year 2005.
The Corporation has significant short-term liquidity supporting its businesses. It also has available short-term borrowings that from time to time address timing differences between cash receipts and disbursements. These short-term borrowings are mostly in the form of securities sold under repurchase agreements. As of December 31, 2005, the Corporation had $227.5 million in available credit on these agreements. Outstanding short-term borrowings as of December 31, 2005 amount to $1.7 million. The amount due under outstanding short-term borrowings is expected to be paid out of the operating and investing cash flows of the Corporation.
On September 30, 2004 TSI issued and sold $50.0 million of its 6.3% senior unsecured notes due September 2019 (the 6.3% notes). The 6.3% notes are unconditionally guaranteed as to payment of principal, premium, if any, and interest by the Corporation. The notes were privately placed to various institutional accredited investors. The notes pay interest semiannually beginning on March 2005, until such principal becomes due and payable. These notes can be prepaid after five years at par, in total or partially, as determined by the Corporation. Most of the proceeds obtained from this issuance were used to repay $37.0 million of short-term borrowings made by TSI. The remaining proceeds were used for general business purposes.
On December 21, 2005 TSM issued and sold $60.0 of its 6.6% senior unsecured notes due December 2020 (the 6.6% notes). The 6.6% notes were privately placed to various institutional accredited investors. The notes pay interest each month beginning on January 2006, until such principal becomes due and payable. These notes can be prepaid after five years at par, in full or in part, as determined by the Corporation. The proceeds obtained from this issuance were used to pay the initial ceding commission to GA Life on the effective date of the coinsurance funds withheld reinsurance agreement (described in “Item 1. Business” of this Annual Report on Form 10-K in the section corresponding to the Life and Disability Insurance segment).
Both the 6.3% and the 6.6% notes contain certain covenants with which TSI and the Corporation have complied with at December 31, 2005.
In addition to the two senior unsecured notes described above, on January 31, 2006 the Corporation issued and sold $35.0 million of its 6.7% senior unsecured notes payable due January 2021 (the 6.7% notes). The 6.7% notes were privately placed to various accredited institutional investors. The notes pay interest each month beginning on March 1, 2006, until such principal becomes due and payable. These notes can be prepaid after five years at par, in full or in part, as determined by the Corporation. The proceeds obtained from this issuance were used to finance the acquisition of 100% of the common stock of GA Life effective January 31, 2006.
In addition, the Corporation has two credit agreements with a commercial bank, FirstBank Puerto Rico. These credit agreements bear interest rates determined by the London Interbank Offered Rate (LIBOR) plus a margin specified at the time of the agreement. As of December 31, 2005, the two credit agreements have outstanding balances of $29.1 million and $11.5 million and average annual interest rates of 4.36% and 4.65%, respectively. The first agreement stipulates monthly principal repayment of $137 thousand. The second agreement stipulates repayments of principal amounts of not less than $250 thousand and in integral multiples of $50 thousand. The aggregate principal amounts of this credit agreement shall be reduced annually to the amounts specified on or before the dates described below:
These credit agreements are guaranteed by a first position on the Corporation’ land, building, and substantially all leasehold improvements, as collateral for the term of the agreements under a continuing general security agreement. These credit facilities contain certain covenants which are normal in this type of facility. As of December 31, 2005, management believes the Corporation is in compliance with these covenants. Failure to meet these covenants may trigger the accelerated payment of the credit agreements’ outstanding balances. Principal repayments on these loans are expected to be paid out from the operating and investing cash flows of the Corporation.
The Corporation has an interest-rate swap agreement which changes the variable rate of one of its credit agreements and fixes the rate at 4.72%. For additional details regarding the interest rate swap agreement refer to note 12 of the audited consolidated financial statements and to “
For the audited consolidated financial statements as of December 31, 2005 and 2004 for the three years ended December 31, 2005 see Index to financial statements in “Item 15. Exhibits and Financial Statement Schedules” to this Annual Report on Form 10-K.