On February 11, 2014, the Company filed a Current Report on Form 8-K including the earnings press release announcing the Company's consolidated financial results for its fiscal fourth quarter and year ended December 31, 2013. The consolidated financial statements included in this Annual Report on Form 10-K differ from those included in our earnings press release, primarily reflecting the effect of the refinement of the Managed Care segment’s risk scores estimate based upon evidence obtained subsequent to the filing of our earnings press release, as well as other adjustments increasing the segment’s incurred claims and operating expenses. As a result, the Company’s consolidated net income for the year ended December 31, 2013 included in this Annual Report on Form 10-K increased $1.6 million to $55.9 million, or $2.01 per diluted share, as compared to net income of $54.3 million or $1.95 per diluted share, as reported on February 11, 2014. The consolidated and Managed Care premiums, claims incurred and operating expenses are $5.4 million, $1.9 million and $0.8 million, respectively, higher than as reported in our earnings press release.
We have the exclusive right to use the BCBS name and mark throughout Puerto Rico, the U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla. As of December 31, 2013 we serve approximately 2,188,000 members across all regions of Puerto Rico. For the years ended December 31, 2013 and 2012 respectively, our managed care segment represented approximately 89.5% and 90.2% of our total consolidated premiums earned, net, and approximately 73.4% and 67.6% of our operating income. We also have significant positions in the life insurance and property and casualty insurance markets. Our life insurance segment had a market share of approximately 13.9% (in terms of premiums written) for 2012. Our property and casualty segment had a market share of approximately 8.5% (in terms of direct premiums) during the nine-month period ended September 30, 2013.
We participate in the life insurance market through our subsidiary, TSV, and in the property and casualty insurance market through our subsidiary, TSP. TSV and TSP represented approximately 5.9% and 4.6%, respectively, of our consolidated premiums earned, net for the year ended December 31, 2013 and 32.9% and 4.5%, respectively, of our operating income for that period.
Other Premium Revenue. Other premium revenue includes premiums generated from the sale of life insurance and property and casualty insurance products. Premiums on traditional life insurance policies are reported as earned when due. Premiums on accident and health and other short-term contracts are recognized as earned, primarily on a pro rata basis over the contract period. Premiums on credit life policies are recognized as earned in proportion to the amounts of insurance in force. Group insurance premiums are billed one month in advance and a grace period of one month is provided for premium payment. If the insured fails to pay within the one-month grace period, we may cancel the policy. We recognize premiums on property and casualty contracts as earned on a pro rata basis over the policy term. Property and casualty policies are subscribed through general agencies, which bill policy premiums to their clients in advance or, in the case of new business, at the inception date and remit collections to us, net of commissions. The portion of premiums related to the period prior to the end of coverage is recorded in the consolidated balance sheet as unearned premiums and is transferred to premium revenue as earned.
(2) Includes Medicare Advantage as well as stand-alone PDP plan membership.
Consolidated income tax expense during the year ended December 31, 2013 decreased by $10.2 million, or 81.6%, to $2.3 million as compared to the income tax expense during the year ended December 31, 2012. This decrease is primarily due to the effect of a $7.7 million adjustment to the consolidated net deferred tax assets after an increase in the enacted tax rate from 30% to 39% and the lower income before taxes during the year 2013, net of additional tax expense due to the aforementioned tax rate increase that was effective January 1, 2013. The effective tax rate decreased from 14.8% in 2012 to 4.0% in 2013 primarily reflecting the net effect of the change in the enacted tax rate.
The increase in the administrative service fees of the Managed Care segment of $71.6 million, or 186.0%, to $110.1 million in 2012 is attributed to a higher amount of self-insured contracts after resuming our participation in the Medicaid sector.
Consolidated net realized investment gains of $5.2 million during the year ended December 31, 2012 are the result of net realized gains from the sale of debt and equity securities available for sale, as part of asset/liability management and tax planning strategies.
Medical premiums earned for the year ended December 31, 2013 decreased by $58.8 million, or 2.9%, to $2.0 billion when compared to the medical premiums earned during the year ended December 31, 2012. This decrease is principally the result of the following:
Administrative service fees decreased by $2.0 million, or 1.7%, to $112.8 million during the year ended December 31, 2013 when compared with the year ended December 31, 2012. This fluctuation primarily reflects the effect of the amended Medicaid contract, which includes lower per-member per-month fees, offset in part by the increased enrollment after the addition of the three new regions effective October 1, 2013. The new rate per-member per-month fees were effective July 1, 2013.
• The medical claims incurred of the Medicare business decreased by $79.9 million, or 8.4%, during the 2013 period and its MLR was 84.0%, which is 480 basis points lower than the MLR for the prior year. The lower member month enrollment in this sector contributed to the decrease in claims incurred. Excluding the effect of risk-score premium adjustments and prior period reserve developments in the 2013 and 2012 periods, the MLR decreased by 460 basis points, mostly as the result of lower utilization and cost trends. The decrease also reflects improved drug costs after the new PBM contract in AH and the impact of changes in 2013 product design.
• Medical premiums generated by the Commercial business increased by $12.9 million, or 1.4%, to $960.0 million during the year ended December 31, 2012 as compared to the year ended December 31, 2011. This is the result of higher average premium rates per member of approximately 1.2% and an increase in member month enrollment by 10,956, or 0.2%.
Medical operating expenses for the year ended December 31, 2012 increased by $67.9 million, or 27.9%, to $311.3 million when compared to the year ended December 31, 2011, primarily resulting from the higher member month enrollment in 2012. The operating expense ratio increased by 160 basis points, from 12.9% in 2011 to 14.5% in 2012, reflecting a higher amount of self-insured contracts after resuming our participation in the Medicaid sector in November 2011.
Policy benefits and claims incurred increased by $4.4 million, or 6.6%, to $70.8 million during the year ended December 31, 2013. This increase is the result of claims received in the 2013 period, reflecting the growth of the segment’s inforce portfolio and the addition $0.8 million of claims related to the ASICO acquisition. The loss ratio for the period increased from 53.2% in 2012 to 54.2% in 2013, or 100 basis points.
Underwriting and other expenses for the segment increased by $6.1 million, or 10.8%, to $62.4 million during the year ended December 31, 2012 primarily the related to higher commissions as a result of the higher volume of business of this segment. Expense control and the growth in premiums during this period resulted in a slightly higher operating expense ratio, which increased by 20 basis points, from 49.8% in 2011 to 50.0% in 2012.
Premiums ceded to reinsurers during the year ended December 31, 2013 decreased by approximately $5.9 million, or 9.3%, to $57.6 million. The ratio of premiums ceded to premiums written decreased by 120 basis points, to 37.8% in 2013, mostly resulting from a change in the mix of business subscribed and lower volume of premiums during 2013.
Total premiums written during the year ended December 31, 2012 increased by $9.8 million, or 6.4%, to $162.7 million, mostly related to higher volume in the Commercial Auto, Commercial Liability, Commercial Package, and Commercial Property insurance products after the acquisition of several government and municipality accounts. In addition, this segment reported increased sales in the Personal Package insurance products. Nonetheless, the commercial business remains under soft market conditions with strong competition.
Cash flows from operating activities increased by $3.2 million for the year ended December 31, 2013 as compared to the year ended December 31, 2012, principally due to the effect of lower claims paid by $70.6 million, offset in part by lower premiums collections by $53.6 million and higher cash paid to suppliers and employees by $9.0 million. The decrease in premiums collected is principally the result of the lower Managed Care membership enrollment. The decrease in claim payments mostly results from the lower enrollment in the Managed Care membership. This decrease also reflects improved drug costs after the new PBM contract in AH and the impact of changes in 2013 product design.
The increase in other sources of cash for the year ended December 31, 2013 is attributed to changes in the amount of outstanding checks in excess of bank balances.
Net purchases of investment securities were $66.2 million during the year ended December 31, 2013, $24.9 million lower than last year, primarily resulting from the investment of lower excess cash flows from operations.
The decrease in other uses of cash is attributed to changes in the amount of outstanding checks over bank balances in the 2013 period.
During the year ended December 31, 2012 we repurchased and retired 136,222 shares at an average per share price of $16.86, for an aggregate cost of $2.3 million.
We have several short-term facilities available to address timing differences between cash receipts and disbursements. These short-term facilities are mostly in the form of arrangements to sell securities under repurchase agreements. As of December 31, 2013, 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, 2013.
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 $41,000, 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, 2013, this secured loan had an outstanding balance of $16.1 million and average annual interest rate of 1.29%. 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, 2013, 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.
As part of the acquisition of the controlling stake in a health clinic during 2012, we assumed a secured term loan with balance of $13.2 million as of December 31, 2013. The loan requires monthly payments of $0.1 million, including principal and interest, is due on December 23, 2014, with a final payment of $12.9 million and bears interest at an annual rate of 4.75%. This loan is guaranteed by a first position held by the bank on the health clinic’s premises (land and building) and all of the health clinic's assets as collateral for the term of the loan under a continuing general security agreement. This secured loan contains certain financial and 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. During the year 2013, the health clinic was in default with the loan’s debt service ratio financial covenant, which required the health clinic to open and maintain a deposit account, which was funded by the Company, with the bank until the health clinic meets the financial covenant.
As of December 31, 2013, our insurance subsidiaries were in compliance with such minimum capital requirements.
To monitor the solvency of the operations, the BCBSA requires us, TSS and AH 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, 2013, 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, 2013, AH estimated RBC ratio was above the minimum BCBSA RBC requirement of 100% for smaller controlled affiliate.
To operate in Puerto Rico, insurance companies, such as our insurance subsidiaries, are required to participate in guarantee associations, which are organized to pay policyholders contractual benefits on behalf of insurers declared insolvent. These associations levy assessments, up to prescribed limits, on a proportional basis, to all member insurers in the line of business in which the insolvent insurer was engaged. In 2013, the property and casualty segment paid $0.6 million for an assessment imposed by the Puerto Rico Guaranty Association for Property and Casualty Insurers. In accordance with insurance laws and regulations assessments are recoverable through policy surcharges. In 2013, the property and casualty segment has recorded recoveries of assessments for $15 thousand. During the years ended December 31, 2012 and 2011, no assessment or payment was made in connection with insurance companies declared insolvent. It is the opinion of management that any possible future guarantee association assessments will not have a material effect on our operating results and/or cash flows, although there is no ceiling on these payment obligations.
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 2013, 2012 and 2011, 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.
At December 31, 2013, claim liabilities for the managed care segment amounted to $283.6 million and represented 67.5% of our total consolidated claim liabilities and 22.3% of our total consolidated liabilities.
Amounts incurred related to prior years vary from previously estimated liabilities as the claims are ultimately settled. Liabilities at any year-end are continually reviewed and re-estimated as information regarding actual claims payments, or run-out becomes known. This information is compared to the originally established year-end liability. Negative amounts reported for incurred claims related to prior years result from claims being settled for amounts less than originally estimated. The reverse is true of reserve shortfalls. Medical claim liabilities are usually described as having a “short tail”: which means that they are generally paid within several months of the member receiving service from the provider. Accordingly, the majority, or approximately 93%, of any redundancy or shortfall relates to claims incurred in the previous calendar year-end, with the remaining 7% related to claims incurred prior to the previous calendar year-end. Management has not noted any significant emerging trends in claim frequency and severity and the normal fluctuations in enrollment and utilization trends from year to year.
The claim liabilities related to the life insurance segment are based on methods and underlying assumptions in accordance with GAAP. The estimate of claim liabilities for this segment is based on the amount of benefits contractually determined for reported claims, and on estimates based on past experience modified for current trends, for unreported claims. This estimate relies on observations of ultimate loss experience for similar historical events.
Claim reserve reviews are generally conducted on a quarterly basis, in light of continually updated information. Our actuary certifies reserves for both current and prior accident years using current claims data. These reviews incorporate a variety of actuarial methods, judgments, and analysis. For each line of business, a variety of actuarial methods are used, with the final selections of ultimate losses that are appropriate for each line of business selected based on the current circumstances affecting that line of business. These selections incorporate input from management, particularly from the claims, underwriting and operations divisions, about reported loss cost trends and other factors that could affect the reserve estimates.
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 acquisitions of GA Life (now TSV) and ASICO, 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.
The property and casualty business acquisition costs consist of commissions incurred during the production of business and are deferred and amortized ratably over the terms of the policies. The method used in calculating deferred acquisition costs limits the amount of such deferred costs to actual costs or their estimated realizable value, whichever is lower.
Our process for identifying and reviewing invested assets for other-than temporary impairments during any quarter includes the following: