We also own land in the municipality of Mayagüez, Puerto Rico, in which we plan to build a multi-segment customer service center. In addition to the properties described above, we or our subsidiaries are parties to operating leases that are entered into in the ordinary course of business.
On January 31, 2006 we completed the acquisition of GA Life (now TSV). The results of operations and financial condition of GA Life are included in this table for the period following the effective date of the acquisition.
Shareowners holding qualifying shares were excluded from dividend payment. See note 19 of the audited financial consolidated financial statements for the years ended December 31, 2009, 2008 and 2007.
We participate in the managed care market through our subsidiary, TSS. Our managed care subsidiary is a BCBSA licensee, which provides us with exclusive use of the Blue Cross and Blue Shield brand in Puerto Rico and U.S. Virgin Islands. We offer products to the Commercial, including corporate accounts, federal government employees, local government employees, individual accounts, Medicare Supplement, Reform and Medicare (including Medicare Advantage and PDP) markets.
The Commissioner of Insurance of the Commonwealth of Puerto Rico recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the Puerto Rico insurance laws and for determining whether its financial
condition warrants the payment of a dividend to its stockholders. No consideration is given by the Commissioner of Insurance of the Commonwealth of Puerto Rico to financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) in making such determinations. See note 25 to our audited consolidated financial statements.
Premiums are generally fixed by contract in advance of the period during which healthcare is covered. Our Commercial premiums are generally fixed for the plan year in the annual renewal process throughout the year. Fully-insured Reform contracts typically have one-year terms, at which time, after a bidding process, premiums are fixed for the plan year. Our Medicare Advantage contracts entitle us to premium payments from CMS on behalf of each Medicare beneficiary enrolled in our plans, generally on a per member per month (“PMPM”) basis. We submit
Investment Income and Other Income. Investment income consists of interest income and other income consists of net realized gains (losses) on investment securities. See note 2 to our audited consolidated financial statements.
Operating Expenses. Operating expenses include commissions to external brokers, general and administrative expenses, cost containment expenses such as case and disease management programs, and depreciation and amortization. The operating expense ratio is calculated by dividing operating expenses by premiums earned, net and administrative service fees. A significant portion of our operating expenses are fixed
Our results of operation depend in large part on our ability to maintain or grow our membership. In addition to driving revenues, membership growth is necessary to successfully introduce new products, maintain an extensive network of providers and achieve economies of scale. Our ability to maintain or grow our membership is affected principally by the competitive environment and general market conditions.
The following table sets forth our consolidated operating results for the years ended December 31, 2009, 2008 and 2007.
Consolidated net investment income decreased by $4.1 million, or 7.3%, to $52.1 million during the year ended December 31, 2009. This decrease is attributed to a lower yield in investments acquired during the period.
Consolidated premiums earned, net increased by $211.9 million, or 14.3%, to $1.69 billion during the year ended December 31, 2008 compared to the year ended December 31, 2007. This increase was primarily due to an increase in the premiums earned, net in our managed care segment, principally due to a higher volume in the Medicare Advantage business and general increases in premium rates.
The administrative service fees of the managed care segment increased by $5.2 million, or 37.1%, to $19.2 million for the year ended December 31, 2008, mostly as the result of a higher member months enrollment that is mainly attributed to the contract for the Reform’s Metro-North region, which we began servicing on November 1, 2008 on an ASO basis.
Consolidated net investment income presented an increase of $9.0 million, or 19.1%, to $56.2 million during the year ended December 31, 2008. This increase is attributed to a higher yield in 2008 as well as to a higher balance of invested assets.
The combined balance of our consolidated net unrealized loss on trading securities and other income (expense), net was a loss of $23.6 million during the year ended December 31, 2008, an increase of $22.7 million, as compared to the combined loss of $0.9 million in 2007. This increase is attributable to the net result of the unrealized loss on the trading portfolio, together with a decrease the fair value of the derivative component of our investment in structured notes linked to the Euro Stoxx 50 and Nikkei 225 stock indexes amounting to $4.7 million due to general market conditions. The unrealized loss experienced on trading securities represents a decrease of 36.7% and 35.8% in TSS and 36.8% in TSP in the fair value of the portfolio, which is lower than the decrease experienced by the comparable indexes of 37.0% in the S&P 500 and 38.44% in the Russell 1000 Growth. The change in the fair value of the derivative component of these structured notes is included within other income (expense), net.
Consolidated claims incurred during the year ended December 31, 2008 increased by $211.1 million, or 17.2%, to $1.43 billion when compared to the claims incurred during the year ended December 31, 2007. This increase is principally due to increased claims in the managed care segment as a result of higher enrollment and utilization trends. The consolidated loss ratio increased by 2.1 percentage points, to 84.6% in the 2008 period, primarily due to higher utilization trends in the managed care segment for the period, particularly in the Medicare Advantage business.
The decrease in consolidated income tax expense during the year ended December 31, 2008 is primarily the result of the lower income before tax during the period. The consolidated effective tax rate for the 2008 period reflects an increase of 2.9 percentage points to 22.3% in 2008, mostly due to a lower 2007 deferred tax expense in the property and casualty insurance segment resulting from changes in its effective tax rate.
We offer our products in the managed care segment to three distinct market sectors in Puerto Rico: Commercial, Reform and Medicare (including Medicare Advantage and PDP). For the year ended December 31, 2009, the Commercial sector represented 43.8% and 11.2% of our consolidated premiums earned, net and operating income, respectively. During the same period the Reform sector represented 18.6% and 22.5%, of our consolidated premiums earned, net and our operating income, respectively. Premiums earned, net and operating income generated from our Medicare contracts (including PDP) during the year ended December 31, 2009 represented 27.4% and 33.9%, respectively, of our consolidated earned premiums, net and operating income, respectively.
Medical premiums earned for the year ended December 31, 2009 increased by $171.1 million, or 11.3%, to $1.68 billion when compared to the medical premiums earned during the year ended December 31, 2008. This increase is principally the result of the following:
Medical premiums generated by the Commercial business increased by $87.9 million, or 12.0%, to $822.1 million during the year ended December 31, 2009. This fluctuation is primarily the result of an increase in member months enrollment of 473,732, or 9.6%, and higher average premium rates per member of
approximately 2.9%. Increase in member months was mainly attributed to new members acquired from LCA effective July 1, 2009, which represented 49.1% of the increase in member months enrollment during this period, and to new groups acquired during the period.
Medical premiums generated by the Medicare business increased during the year ended December 31, 2009 by $75.2 million, or 17.1%, to $513.9 million, primarily due to higher average premium rates by approximately 11% and an increase in member months enrollment of 5,434 or 0.6%. The fluctuation in member months is the net result of an increase of 15,392, or 2.1%, in the membership of our Medicare Advantage products and a decrease of 9,958, or 7.8%, in the membership of our PDP product. In addition, the premiums for the year ended December 31, 2009 include the net effect of approximately $8.7 million in adjustments related to CMS final risk score adjustment for 2008. The premiums for the year ended December 31, 2008 include the net effect of approximately $1.4 million related to CMS final risk score adjustments for 2007.
Administrative service fees increased by $28.8 million, to $51.3 million during the 2009 period, mainly due to an increase in self-funded member months enrollment of 2,621,065. Such increase is mainly the result of the contract obtained to administer the Reform’s Metro-North region, which began on an ASO basis on November 1, 2008, new ASO Commercial contracts effective January 1, 2009, as well as the ASO members from the contracts acquired from LCA. In addition, as the result of the savings achieved in the Metro-North region, during 2009 we recognized a performance incentive of approximately $6.0 million. Total ASO member months enrollment for the Metro-North region and LCA for the year ended December 31, 2009 totaled 2,321,144 and 469,530, respectively.
Medical claims incurred during the year ended December 31, 2009 increased by $169.8 million, or 12.6%, to $1.52 billion, when compared to the year ended December 31, 2008. The MLR of the segment increased by 1.1 percentage points during the 2009 period, to 90.0%. These fluctuations are primarily attributed to the effect of the following:
The medical claims incurred of the Commercial business increased by $99.3 million during the 2009 period and its MLR increased by 2.8 percentage points during the year ended December 31, 2009. The increase in claims was partially attributed to the increase in members. The increase in the MLR is primarily due to the effect of prior period reserve developments in the 2009 and 2008 periods and higher utilization trends. Excluding the effect of prior period reserve developments, the MLR increased by 1.6 percentage points. This variance in the MLR is due to a higher than expected claims experience in the local government employees’ policy, mainly in the utilization of pharmacy and in-patient benefits, and the effect of the AH1N1 flu of approximately $4.4 million, or 0.5 percentage points.
The medical claims incurred of the Medicare business increased by $59.2 million during the 2009 period primarily due to the higher member months enrollment of this business. The MLR for the year ended December 31, 2009 was 88.1%, 1.6 percentage points lower than 2008. The reduction in MLR is attributed to the effect of risk score premium adjustments recorded during this period, as well as premium rate increases and lower utilization trends. Excluding the effect of prior period reserve developments in the 2009 and 2008 periods, as well as premium adjustments, the MLR decreased by 4.7 percentage points, mostly due to the effect of lower medical costs resulting from an improvement in utilization trends and premium rate increases effective January 1, 2009.
Medical operating expenses for the year ended December 31, 2009 increased by $24.0 million, or 14.9%, to $184.6 million when compared to the year ended December 31, 2008. This increase is mainly due to the higher volume of business of the segment, associated to the higher member months enrollment, as well as to the operating costs related to the administration of the Metro-North region and the acquisition and administration of the LCA customers. In addition, an accrual for litigation expense of approximately $7.5 million was recorded during the 2009 period, partially offset by the effect in this period of $3.6 million related to the settlement of an insurance recovery of legal expenses. The segment’s operating expenses ratio increased by 0.1 percentage points, from 10.5% in 2008 to 10.6% in 2009.
Medical premiums earned during 2008 increased by $211.2 million, or 16.2%, to $1.51 billion when compared to earned premiums during 2007. This increase is principally the result of the following:
Medical premiums earned of the Reform business increased by $12.6 million, or 3.8%, to $340.1 million during 2008. This fluctuation is primarily due to the increases in premium rates of approximately 10% effective on July 1, 2008 and of 8.6% during 2007, partially offset by a decrease in member months enrollment of 160,343, or 3.8%.
received by this business during June 2007 amounting to $2.8 million corresponding to 2006. Excluding the effect of prior period reserve developments in the 2007 and 2008 periods and considering the effect of this retroactive premium rate increase, the MLR actually decreased by 1.5 percentage points during the 2008 period.
Medical operating expenses for the year ended December 31, 2008 increased by $12.5 million, or 8.4%, to $160.6 million when compared to 2007. This increase is primarily attributed to the higher volume of the segment, particularly in the Medicare business. The segment’s operating expense ratio decreased by 0.7 percentage points during the 2008 period, to 10.5%.
Policy benefits and claims incurred during the year ended December 31, 2009 increased by $2.9 million, or 6.1%, to $50.3 million during the year ended December 31, 2009. This fluctuation is primarily the result of the segments increased volume in the Cancer and Home Service lines of business and a higher amount of claims incurred in the Ordinary Life business, partially offset by a lower volume and claims experience in the Group Life line of business. The segment also experienced an increase in the change of the liability for future policy benefits. The segment’s loss ratio decreased by 0.9 percentage points, to 50.2% during the year ended December 31, 2009.
Premiums earned, net for the segment increased by $3.9 million, or 4.4%, to $92.8 million during the year ended December 31, 2008 as compared to the year ended December 31, 2007, primarily as the result of higher sales in the Cancer and Home Service lines of business during 2008.
Policy benefits and claims incurred during the year ended December 31, 2008 increased by $1.7 million, or 3.7%, to $47.4 million in 2008. This increase is primarily the result of an increase in claims incurred in the Disability and Cancer lines of business. Despite the higher claim experience, as a result of the increased volume of premiums, the segment experienced a lower loss ratio by 0.3 percentage points, to 51.1%.
The change in unearned premiums presented an increase of $2.5 million, to $0.4 million during the year ended December 31, 2009, primarily as the result of the lower volume of premiums written.
Total premiums written during the year ended December 31, 2008 decreased by $2.9 million, or 1.7%, to $168.0 million. This fluctuation is mostly due to the decrease in the premiums written for the Commercial Auto and Inland Marine insurance policies amounting to $7.3 million. These decreases were partially offset by increases in the Commercial Multi-peril and Dwelling and Property Mono-line insurance policies of $4.4 million. The commercial products are under soft market conditions reducing premiums and increasing competition for renewals and new business. The auto insurance products have been affected by lower economic activity in sales and auto loan originations.
On December 8, 2008 we announced the immediate commencement of a $40.0 million share repurchase program. We paid approximately $26.1 million under the stock repurchase program during the year ended December 31, 2009.
As of December 31, 2009, we had the following senior unsecured notes payable:
In addition, as of December 31, 2009 we are a party to a secured term loan with a commercial bank, FirstBank Puerto Rico. This secured loan bears interest at a rate equal to the London Interbank Offered Rate (LIBOR) plus 100 basis points and requires monthly principal repayment of $0.1 million. As of December 31, 2009, this secured loan had an outstanding balance of $22.7 million and an average annual interest rate of 1.66%.
This secured loan is guaranteed by a first lien on our land, buildings and substantially all leasehold improvements, as collateral for the term of the agreements under a continuing general security agreement. This secured loan contains certain non-financial covenants which are customary for this type of facility, including, but not limited to, restrictions on the granting of certain liens, limitations on acquisitions and limitations on changes in control. As of December 31, 2009, we are in compliance with these covenants. Failure to meet these non-financial covenants may trigger the accelerated payment of the secured loan’s outstanding balances. Principal repayments on this loan are expected to be paid out from our operating and investing cash flows.
During 2005, our managed care business began a project to change a significant part of its operations computer system. This project is expected to be carried out in phases until 2012 at a cost of approximately $64.0 million. Our managed care business expects to incur costs of approximately $26.6 million during 2010. We estimate that $14.3 million of the costs expected to be incurred in 2009 will be capitalized over the system’s useful life and the remaining amount will be expensed. This amount is expected to be paid out of the operating cash flows of our managed care business.
Policyholder deposits - The cash outflows related to these instruments are not included because they do not have defined maturities, such that the timing of payments and withdrawals is uncertain. There are currently
Our life insurance segment establishes, and carries as liabilities, actuarially determined amounts that are calculated to meet its policy obligations when a policy matures or surrenders, an insured dies or becomes disabled or upon the occurrence of other covered events. A significant portion of the estimated obligation for future policy benefits to be paid included in this table considers contracts under which we are currently not making payments and will not make payments until the occurrence of an insurable event not under our control, such as death, illness, or the surrender of a policy. We have estimated the timing of the cash flows related to these contracts based on historical experience as well as expectations of future payment patterns. The amounts presented in the table above represent the estimated cash payments for benefits under such contracts based on assumptions related to the receipt of future premiums and assumptions related to mortality, morbidity, policy lapses, renewals, retirements, disability incidence and other contingent events as appropriate for the respective product type. All estimated cash payments included in this table are not discounted to present value nor do they
take into account estimated future premiums on policies in-force as of December 31, 2009 and are gross of any reinsurance recoverable. The $1,038.3 million total estimated cash flows for all years in the table is different from the liability of future policy benefits of $222.6 million included in our audited consolidated financial statements principally due to the time value of money. Actual cash payments to policyholders could differ significantly from the estimated cash payments as presented in this table due to differences between actual experience and the assumptions used in the estimation of these payments.
To monitor the solvency of the operations, the BCBSA requires us and our managed care subsidiary to comply with certain specified levels of RBC. RBC is designed to identify weakly capitalized companies by comparing each company’s adjusted surplus to its required surplus (RBC ratio). The RBC ratio reflects the risk profile of insurance companies. At December 31, 2009, both we and our managed care subsidiary’s estimated RBC ratio were above the 200% of our RBC required by the BCBSA and the 375% of our RBC level required by the BCBSA to avoid monitoring.
Based on the information currently known by our management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have a material adverse effect on our financial position, results of operations and cash flows. However, given the inherent unpredictability of these matters, it is possible that an
adverse outcome in certain matters could, from time to time, have an adverse effect on our operating results and/or cash flows. See “Item 3. Legal Proceedings”.
Claim liabilities by segment as of December 31, 2009 were as follows:
At December 31, 2009, claim liabilities for the managed care segment amounted to $236.4 million and represented 65.6% of our total consolidated claim liabilities and 21.5% of our total consolidated liabilities.
Liabilities for reported but incomplete claims are recorded at the contractual rate. Liabilities for unreported losses are determined employing actuarial methods that are commonly used by managed care actuaries and meet Actuarial Standards of Practice, which require that the claim liabilities be adequate under moderately adverse circumstances. The segment determines the amount of the liability for unreported losses by following a detailed actuarial process that entails using both historical claim payment patterns as well as emerging medical cost trends to project a best estimate of claim liabilities. Under this process, historical claims incurred dates are compared to actual dates of claims payment. This information is analyzed to create “completion” or “development” factors that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the total expected claims incurred. The majority of unpaid claims, both reported and unreported, for any period, are those claims which are incurred in the final months of the period. Since the percentage of claims paid during the period with respect to claims incurred in those months is generally very low, the above-described completion factor methodology is less reliable for such months. In order to complement the analysis to determine the unpaid claims, historical completion factors and payment patterns are applied to incurred and paid claims for the most recent twelve months and compared to the prior twelve month
Circumstances to be considered in developing our best estimate of reserves include changes in enrollment, utilization levels, unit costs, mix of business, benefit plan designs, provider reimbursement levels, processing system conversions and changes, claim inventory levels, regulatory and legislative requirements, claim processing patterns, and claim submission patterns. A comparison or prior period liabilities to re-estimated claim liabilities based on subsequent claims development is also considered in making the liability determination. In the actuarial process, the methods and assumptions are not changed as reserves are recalculated, but rather the availability of additional paid claims information drives our changes in the re-estimate of the unpaid claim liability. Changes in such development are recorded as a change to current period benefit expense. The re-estimates or recasts are done monthly for the previous four calendar quarters. On average, about 77% of the claims are paid within three months after the last day of the month in which they were incurred and about 13% are within the next three months, for a total of 90% paid within six months after the last day of the month in which they were incurred.
Management expects that substantially all of the development of the 2009 estimate of medical claims payable will be known during 2010 and that the variance of the total incurred claims on a retrospective basis when compared to reported incurred claims will be similar to the prior years.
The claim liabilities related to the life insurance segment are based on methods and underlying assumptions in accordance with GAAP and applicable actuarial standards. The estimate of claim liabilities for this segment is based on the amount of benefits contractually determined and on actuarial estimates of the amount of loss inherent
in that period’s claims, including losses for which claims have not been reported. This estimate relies on actuarial observations of ultimate loss experience for similar historical events. Principal assumptions used in the establishment of claim liabilities for this segment are mortality, morbidity and claim submission patterns, among others.
Claim reserve reviews are generally conducted on a monthly basis, in light of continually updated information. These reviews incorporate a variety of actuarial methods, judgments and analysis. We review reserves using current inventory of policies and claims data. These reviews incorporate a variety of actuarial methods, judgments and analysis.
business. Varying the net expected loss ratio by +/-1% in all lines of business for the six most recent accident years would increase/decrease the claims incurred by approximately $5.5 million.
The costs of acquiring new life business, principally commissions, and certain variable underwriting, agency and policy issue expenses of our life insurance segment, have been deferred. These costs, including value of business acquired (VOBA) recorded upon our acquisition of GA Life (now TSV), are amortized to income over the premium-paying period of the related whole life and term insurance policies in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue, and over the anticipated lives of universal life policies in proportion to the ratio of the expected annual gross profits to the expected total gross profits. The expected premiums revenue and gross profits are based upon the same mortality and withdrawal assumptions used in determining the liability for future policy benefits. For universal life and deferred annuity policies, changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on the amortization of deferred policy acquisition costs of revisions to estimated gross profits is reported in earnings in the period such estimated gross profits are revised.
Impairment of an investment exists if a decline in the estimated fair value is below the amortized cost of the security. Management regularly monitors and evaluates the difference between the cost and estimated fair value of investments. For investments with a fair value below cost, the process includes evaluating: (1) the length of time and the extent to which the estimated fair value has been less than amortized cost for fixed maturity security securities, or cost for equity securities, (2) the financial condition, near-term and long-term prospects for the issuer, including relevant industry conditions and trends, and implications of rating agency actions, (3) the Company’s intent sell or the likelihood of a required sale prior to recovery, (4) the recoverability of principal and interest for fixed maturity securities, or cost for equity securities, and (5) other factors, as applicable. This process is not exact and further requires consideration of risks such as credit and interest rate risks. Consequently, if an investment’s cost exceeds its estimated fair value solely due to changes in interest rates, other-than temporary impairment may not be appropriate. Due to the subjective nature of our analysis, along with the judgment that must be applied in the analysis, it is possible that we could reach a different conclusion whether or not to impair a security if it had access to additional information about the investee. Additionally, it is possible that the investee’s ability to meet future contractual obligations may be different than what we determined during its analysis, which may lead to a different impairment conclusion in future periods. If after monitoring and analyzing impaired securities, management determines that a decline in the estimated fair value of any available-for-sale or held-to-maturity security below cost is other than temporary, the carrying amount of the security is reduced to its fair value by the credit component of the other-than-temporary impairment. The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment. For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted into net investment income in future periods based on prospective changes in cash flow estimates, to reflect adjustments to the effective yield.
Review and evaluation of any other security based on the investee’s current financial condition, liquidity, near-term recovery prospects, implications of rating agency actions, the outlook for the business sectors in which the investee operates and other factors. This evaluation is in addition to the evaluation of those securities with a gross unrealized investment loss representing 20% or more of cost.
Consideration of evidential matter, including an evaluation of factors or triggers that may or may not cause individual investments to qualify as having other-than-temporary impairments; and
During the years ended December 31, 2009, 2008 and 2007 we recognized other-than-temporary impairments amounting to $7.1 million, $16.5 million and $1.1 million, respectively, on fixed income, equity securities and perpetual preferred stocks classified as available for sale. As of December 31, 2009, of the total amount of investments in securities of $1,043.4 million, $43.9 million, or 4.2%, are classified as trading securities, and thus are recorded at fair value with changes in estimated fair value recognized in the statement of operations. The remaining $999.5 million is classified as either available-for-sale or held-to-maturity and consists of high-quality investments. Of this amount, $819.6 million, or 78.6%, are securities in obligations of U.S. government-sponsored enterprises, U.S. Treasury securities, obligations of the Commonwealth of Puerto Rico, municipal securities, obligations of U.S. states and its political subdivisions, mortgage backed and collateralized mortgage obligations that are U.S. agency-backed. The remaining $115.2 million, or 11.0%, are from corporate fixed, equity securities and mutual funds. The
net unrealized gain as of December 31, 2009 of the available-for-sale and held-to-maturity portfolios amounted to $11.5 million.