This financial discussion contains an analysis of our consolidated financial position and financial performance as of December 31, 2015 and 2014, and consolidated results of operations for 2015, 2014 and 2013. References to the terms “we”, “our” or “us” used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”), refer to TSM and unless the context otherwise requires, its direct and indirect subsidiaries. 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.
On November 12, 2015, the Company converted 1,426,721 shares issued and outstanding of Class A common stock into Class B common stock, pursuant to the provisions of the Articles of Incorporation of the Corporation.
(2) Includes Medicare Advantage as well as stand-alone PDP plan membership in 2014 and 2013.
The following table sets forth our consolidated operating results for the years ended December 31, 2015, 2014 and 2013. Further details of the results of operations of each reportable segment are included in the analysis of operating results for the respective segments.
Premiums earned, net increased by $654.6 million, or 30.8%, to $2.8 billion during the year ended December 31, 2015 when compared to the year ended December 31, 2014. This increase primarily reflects higher premiums in the Managed Care segment by $653.4 million after the change in the Medicaid service model effective April 1, 2015, from an ASO agreement to a fully insured model as well as to higher premiums in the Medicare business. Higher Medicare premiums are the result of increased member month enrollment offset by lower average premiums rates. Offsetting the premium revenue increase is a lower premiums earned in our Commercial business due to lower fully insured membership offset by higher average per member per month premiums.
Administrative service fees decreased by $74.6 million, or 62.5%, to $44.7 million for the year ended December 31, 2015 when compared with the year ended December 31, 2014, mostly as a result of the previously mentioned change in the Medicaid contract model effective April 1, 2015.
Net realized investment gains of $18.9 million during the year ended December 31, 2015 are the result of net realized gains from the sale of debt and equity securities classified as available for sale, following our asset/liability management and tax planning strategies. The net realized gains were partially offset by $5.2 million other-than-temporary impairments, mostly related to certain investments in Puerto Rico government obligations.
• During the years ended December 31, 2014 and 2015, the Company executed in the fourth quarter of 2014 and the second quarter of 2015 Closing Agreements between TSM and its subsidiaries and the Puerto Rico Treasury Department that allowed the Company to take advantage of a temporary preferential tax rate window on capital gains. These events allowed the Company to record a tax benefit of $3.1 million and $17.0 million, in 2015 and 2014, respectively, resulting from the enacted lower taxable rate and the reassessment of the realizability of some of its deferred taxes.
Claims incurred during the year ended December 31, 2014 decreased by $88.6 million, or 4.8%, to $1.7 billion when compared to the claims incurred during the year ended December 31, 2013. This decrease is mostly in the Commercial business of the Managed Care segment primarily as a result of lower member month enrollment in the 2014 period. The consolidated loss ratio decreased by 120 basis points to 82.1%.
We offer our products in the managed care segment to three distinct market sectors in Puerto Rico: Commercial, Medicare Advantage and Medicaid. For the year ended December 31, 2015, the Commercial, Medicare and Medicaid sectors represented 30.2%, 39.4% and 21.8% of our consolidated premiums earned, net, respectively.
Medical premiums earned for the year ended December 31, 2015 increased by $653.4 million, or 34.5%, to $2.5 billion when compared to the year ended December 31, 2014. This increase is principally the result of the following:
• Medical premiums generated by the Medicare business increased by $84.0 million, or 8.3%, to $1.1 billion during the year ended December 31, 2015 as compared to the year ended December 31, 2014. This fluctuation primarily results from higher member month enrollment in Medicare Advantage products, which carry a higher average premium rate, offset by our exit of stand-alone PDP product. In 2015 we also had a higher risk score revenue as compared with 2014. The increase in premiums resulting from the change in mix of our products was offset in part by a decrease in PMPM of our Medicare Advantage products by 3.0% during 2015.
Administrative service fees decreased by $74.3 million, or 60.1%, to $49.3 million during the year ended December 31, 2015. This fluctuation is mainly due to the previously mentioned change in the Medicaid contract effective April 1, 2015.
• The medical claims incurred of the Medicare business increased by $53.8 million, or 6.2%, during the 2015 period due to higher enrollment and lower MLR in 2015 was 84.6%, which is 170 basis points lower than the MLR for the prior year. Excluding the effect of prior period reserve developments and risk-score adjustments in the 2015 and 2014 periods, the MLR presents a decrease of 260 basis points, largely reflecting the impact of initiatives implemented last year and a non-recurring adjustment in 2014.
• The medical claims incurred of the Commercial business decreased by $41.5 million, or 5.5%, during the 2015 period mostly reflecting a lower fully-insured member month enrollment. The 2015 Commercial MLR was 84.2%, which is 110 basis points lower than the prior year. Excluding the effect of prior period reserve developments in 2015 and 2014, the MLR would have decreased by 120 basis points, mostly reflecting premium trends that were higher than claims trends.
Medical operating expenses for the year ended December 31, 2015 increased by $19.2 million, or 5.1%, to $393.4 million when compared to the year ended December 31, 2014. The increase is mainly related to increases in the Health Insurance Providers Fee, the provision for doubtful receivables, and payroll and related expenses resulting from recent management changes and retirements, a $4.4 million expense recorded in 2015 related to settlement agreements entered with governmental agencies, as well as to higher professional services. These increases were partially offset by the impact of the cost containment initiatives, including lower expenses related to the change in the Medicaid membership after we elected to decrease the number of regions we serve from eight to only two regions when the contract was changed to a fully-insured model. Despite the increase in operating expenses, the medical operating expense ratio decreased 340 basis points, from 18.5% to 15.1% in the 2015 period, reflecting the higher premium revenue during this year.
Medical premiums earned for the year ended December 31, 2014 decreased by $78.6 million, or 4.0%, to $1.9 billion when compared to the year ended December 31, 2013. This decrease is principally the result of the following:
• Medical premiums generated by the Medicare business decreased by $25.2 million, or 2.4%, to $1.0 billion during the year ended December 31, 2014 as compared to the year ended December 31, 2013. This fluctuation primarily results from lower risk score adjustments when compared to the 2013 period, a decrease in risk score revenue when compared to last year, the decline in 2014 premiums mandated by CMS, and a change in membership mix in 2014.
• The medical claims incurred of the Commercial business decreased by $85.6 million, or 10.2%, during the 2014 period mostly reflecting a lower fully-insured member month enrollment. The 2014 Commercial MLR was 85.3%, which is 430 basis points lower than the prior year. Excluding the effect of prior period reserve developments in 2014 and 2013, the MLR would have increased by 100 basis points, mostly reflecting higher cost trends, particularly for pharmacy benefits.
Policy benefits and claims incurred for the year ended December 31, 2015 increased by $7.8 million, or 10.4%, to $82.6 million when compared to the year ended December 31, 2014 mostly reflecting $4.9 million of benefits increase in the Cancer and Major Medical Health line of business claims, and an increase of $1.8 million of claims assumed under retrocession reinsurance agreements, which carry a higher loss ratio.
Policy benefits and claims incurred for the year ended December 31, 2014 increased by $4.0 million, or 5.6%, to $74.8 million when compared to the year ended December 31, 2013 mostly reflecting the segment’s increased volume of business, including the additional $2.5 million in claims related to the ASICO business. The loss ratio for the period decreased from 54.2% in 2013 to 52.5% in 2014, or 170 basis points.
Claims incurred during the year ended December 31, 2015 decreased by $3.7 million, or 8.0%, to $42.6 million. The loss ratio decreased by 170 basis points, to 48.6% in 2015, primarily as a result of a favorable loss experience, mostly in the Commercial Multi-peril, Commercial Auto and Medical Malpractice lines of business, which was offset with an unfavorable loss experience in the Personal Auto line of business. Loss ratio improved with better experience in comercial multiperil, medical malpractice and general liability.
Underwriting and other operating expenses for the year ended December 31, 2014 decreased by $6.9 million, or 13.5%, to $44.4 million primarily due to a lower net commission expense resulting from the decrease in net premiums earned, favorable variance in salaries and benefits after the implementation of changes in employee benefits and headcount reduction, and recoveries resulting from premium surcharges to recover assessments paid to the Puerto Rico Guarantee Fund. The operating expense ratio decreased by 290 basis points, to 48.2% in 2014.
Repayments of long-term borrowings of $37.6 million during the year ended December 31, 2015, primarily due to the payment of a repurchase agreement of $25.0 million that matured during the period and an $11.0 million repayment of the senior unsecured notes principal.
Repurchase and retirement of common stock amounted to $48.3 million reflecting the repurchase and retirement of 2,241,086 shares of common stock during the year ended December 31, 2015 under the Corporation’s Class B common stock repurchase programs.
Payments of long-term borrowings of $14.8 million during the year ended December 31, 2014 are primarily the result of a $12.9 million payment of one secured loan that was due in 2014.
A summary of share repurchase programs in place during the three-year-period ended December 31, 2015 is as follows:
· In September 2010, the Company’s Board approved a repurchase program (2010 $30.0 million stock repurchase program). This program was discontinued on March 23, 2013.
· In July 2013 the Company’s Board of Directors authorized a $11.5 million repurchase program (2013 $11.5 million stock repurchase program) of its Class B common stock. This program was discontinued on October 28, 2014.
· In October 2014 the Company’s Board of Directors authorized a $50.0 million repurchase program (2014 $50.0 million share repurchase program) of its Class B common stock. This program was completed on October 7, 2015.
We have several short-term facilities available to address timing differences between cash collections and disbursements. These short-term facilities are mostly in the form of arrangements to sell securities under repurchase agreements. As of December 31, 2015, we had $110.0 million of available credit under these facilities. There are no outstanding short-term borrowings under these facilities as of December 31, 2015.
On December 21, 2005, we issued and sold $60.0 million of our 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 until the principal becomes due and payable. These notes can be redeemed after five years at par, in whole or in part, as determined by us. On October 1, 2010 and May 14, 2015 we repaid $25.0 million and $11.0 million, respectively, of the principal of these senior unsecured notes. Amount currently outstanding is $24.0 million. The 6.6% notes contain certain non-financial covenants. At December 31, 2015, we are in compliance with these covenants.
In addition, we are a party to a secured term loan with a commercial bank in Puerto Rico. This secured loan, with original principal balance of $41.0 million, bears interest at a rate equal to the London Interbank Offered Rate (LIBOR) plus 100 basis points and requires monthly principal repayments of $0.1 million. As of December 31, 2015, this secured loan had an outstanding balance of $12.8 million and average annual interest rate of 1.23%. 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, 2015, 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.
On November 4, 2015, TSS entered into a $50.0 million revolving loan agreement with a commercial bank in Puerto Rico. This unused line of credit has an interest rate of LIBOR plus 250 basis points, matures on November 4, 2016, and contains certain financial and non-financial covenants that are customary for this type of facility. The agreement stipulates that any unused balance would become unavailable should TSS stop collecting payments under the Medicaid contract for four consecutive weeks.
On March 11, 2016, TSS entered into a $30.0 million revolving loan agreement with a commercial bank in Puerto Rico. This unused line of credit has an interest rate of LIBOR plus 220 basis points, matures on March 11, 2017, and contains certain financial and non-financial covenants that are customary for this type of facility.
• Policyholder deposits - The cash outflows related to these instruments are not included because they do not have defined maturities, such that the timing of payments and withdrawals is uncertain. There are currently no significant policyholder deposits in paying status. As of December 31, 2015, our policyholder deposits had a carrying amount of $179.3 million.
(3) Claim liabilities represent the amount of our claims processed and incomplete as well as an estimate of the amount of incurred but not reported claims and loss-adjustment expenses. This amount does not include an estimate of claims to be incurred subsequent to December 31, 2015. The expected claims payments are an estimate and may differ materially from the actual claims payments made by us in the future. Also, claim liabilities are presented gross, and thus do not reflect the effects of reinsurance under which $43.5 million of reserves had been ceded at December 31, 2015.
Our insurance subsidiaries are subject to the regulations of the Commissioner of Insurance of Puerto Rico. These regulations, among other things, require insurance companies to maintain certain levels of capital, thereby restricting the amount of earnings that can be distributed by the insurance subsidiaries to TSM. As of December 31, 2015, our insurance subsidiaries were in compliance with such minimum capital requirements.
Our secured term loan, with original principal balance of $41.0 million, restricts the amount of dividends that we and our subsidiaries can declare or pay to shareholders. Under this secured term loan, dividend payments cannot be made in excess of the accumulated retained earnings of the paying entity.
To monitor the solvency of the operations, the BCBSA requires us, TSS, TSA, and TSB 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, 2015, TSM and TSS estimated RBC ratio was above the minimum BCBSA RBC requirement of 200% and the 375% of RBC level required by the BCBSA to avoid monitoring. At December 31, 2015, TSA estimated RBC ratio was above the minimum BCBSA RBC requirement of 100% for smaller controlled affiliate.
Pursuant to the Puerto Rico Insurance Code, our property and casualty insurance subsidiary is a member of Sindicato de Aseguradores para la Suscripción Conjunta de Seguros de Responsabilidad Profesional Médico-Hospitalaria (SIMED). The syndicate was organized for the purpose of underwriting medical-hospital professional liability insurance. As a member, the property and casualty insurance segment shares risks with other member companies and, accordingly, is contingently liable in the event the syndicate cannot meet their obligations. During 2015, 2014 and 2013, no assessment or payment was made for this contingency. It is the opinion of management that any possible future syndicate assessments will not have a material effect on our operating results and/or cash flows, although there is no ceiling on these payment obligations.
Claim liabilities by segment as of December 31, 2015 were as follows:
Claim liabilities 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 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 period. Incurred claims for the most recent twelve months also take into account recent claims expense levels and health care trend levels (trend factors). Using all of the above methodologies, our actuaries determine based on the different circumstances the unpaid claims as of the end of period.
(1) Assumes (decrease) increase in the completion factors for the most recent twelve months.
The following table shows the variance between the segment’s incurred claims for current period insured events and the incurred claims for such years had they been determined retrospectively (the “Incurred claims related to current period insured events” for the year shown plus or minus the “Incurred claims related to prior period insured events” for the following year as included in note 11 to the audited consolidated financial statements). This table shows that the segments’ estimates of this liability have approximated the actual development.
Management expects that substantially all of the development of the 2015 estimate of medical claims payable will be known during 2016.