Through May 31, 2006, Madison National Life is leasing 17,500 square feet of office space in Middleton, Wisconsin as its corporate headquarters. Commencing June 1, 2006, Madison National Life will move its corporate headquarters to Madison, Wisconsin, where it will begin leasing 27,450 square feet of space. Madison National Life also leases 3,900 square feet in Birmingham, Alabama for its military and government individual life and annuity division, 1,300 square feet in Austin, Texas for executive office space, and 2,400 square feet in Wilkesboro, North Carolina for its credit agency.
HPA leases 4,083 square feet of office space in Tampa, Florida as its corporate headquarters and 210 square feet in Pewaukee, Wisconsin.
IAC leases 49,000 square feet of office space in Phoenix, Arizona as its corporate headquarters, and 5,000 square feet in Rockford, Illinois.
Independence Holding Company, a Delaware corporation (NYSE: IHC), is a holding company principally engaged in the life and health insurance business through: (i) its wholly-owned insurance companies, Standard Security Life Insurance Company of New York ("Standard Security Life") and Madison National Life Insurance Company, Inc. ("Madison National Life"); and (ii) its marketing and administrative companies, including Insurers Administrative Corporation (“IAC”), managing general underwriter (“MGU”) affiliates, Health Plan Administrators (“HPA”), GroupLink Inc. (“GroupLink”) and Community America Insurance Services Inc. (“CAIS”, formerly CA Insurance Services LLC). These companies are sometimes collectively referred to as the "Insurance Group," and IHC and its subsidiaries (including the Insurance Group) are sometimes collectively referred to as the "Company." The Company also owns a 48% equity interest in American Independence Corp. (NASDAQ:AMIC) which owns Independence American Insurance Company (“Independence American”) and several MGU’s.
Net income of $17.3 million in 2005 ($1.21 per share, diluted), a 24.6% decrease from 2004;
Generated consolidated investment yield of 5.1% in 2005 as compared to 6.2% in 2004 which had a particularly adverse effect on the Individual Life, Annuities and Other segment;
As of January 1, 2005, reinsured, on a 100% quota share basis, a block of group major medical policies. All regulatory approvals to assume this block have been received, and policies were assumed effective December 1, 2005. Through December 31, 2005, the Company has recorded $39.9 million of gross earned premiums and $13 million of net earned premiums on this block; and
Approved to write a variety of fully-insured medical products in a majority of states for the insurance companies.
The Company’s health reserves by segment at December 31, 2005 are as follows (in thousands):
increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the 2005 Consolidated Statement of Operations.
Predicting ultimate claims and estimating reserves in Medical Stop-Loss is more complex than first dollar medical and disability business due to the “excess of loss” nature of these products with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. The level of these deductibles makes it more difficult to predict the amount and payment pattern of such claims. Fluctuations in results for specific coverage are primarily due to the severity and frequency of individual claims, whereas fluctuations in aggregate coverage are largely attributable to frequency of underlying claims rather than severity. Liabilities for first dollar medical reserves and disability coverages are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data.
Reserves for fully-insured medical and dental business are established using historical claim development patterns. Claim development by number of months elapsed from the incurred month is studied each month and development factors are calculated. These claim development factors are then applied to the amount of claims paid to date for each incurred month to estimate fully complete claims. The difference between fully complete claims and the claims paid to date is the estimated reserve. Total reserves are the sum of the reserves for all incurred months.
The primary assumption in the determination of fully insured reserves is that historical claim development patterns are representative of future claim development patterns. Factors which may affect this assumption include changes in claim payment processing times and procedures, changes in time delay in submission of claims, and the incidence of unusually large claims. The reserving analysis includes a review of claim processing statistical measures and large claim early notifications; the potential impacts of any changes in these factors are minimal. The delay in submission of claims tends to be stable over time and not subject to significant volatility. The Company does not believe that any reasonably likely change in these factors will have a Material Effect.
The primary assumptions used in estimating the Credit A&H reserves relate to: (i) the mix of ages of the insured; (ii) the rate of disability; and (iii) the rate of mortality of disabled lives. If the mix is skewed towards older age groups the probability of disability increases. If the rate of disability increases, the Company would increase reserves. If mortality of disabled lives improves, the Company would have to pay benefits for a longer period of time. Ranges are not used to determine the ultimate amount of reported reserves for Credit A&H. Management records its best estimate based on the Company’s experience. Credit A&H policies are accounted for
The Company accounts for its investments in debt and equity securities under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Company has classified all of its investments as available-for-sale or trading securities. These investments are carried at fair value based on quoted market prices with unrealized gains and losses reported in either accumulated other comprehensive income (loss) in the Consolidated Balance Sheets for available-for-sale securities or as unrealized gains or losses in the Consolidated Statements of Operations for trading securities. The Company has approximately $8.3 million and $7.5 million in trading accounts at December 31, 2005 and 2004, respectively. Net realized gains and losses on investments are computed using the specific identification method and are reported in the Consolidated Statements of Operations.
Information by business segment for the years ended December 31, 2005 and 2004 is as follows:
Total premiums earned grew $62.9 million to $237.0 million in 2005 from $174.1 million in 2004. The increase is due to: (i) the Medical Stop-Loss segment which increased $31.4 million primarily due to $29.8 million in increased retention and a $1.6 million increase due to a Net Loss Ratio cover for the 2004 underwriting year that did not exist in 2004; (ii) the new Fully-Insured Health segment (formerly Strategic Health) which had $17.4 million of premiums in 2005; (iii) the Individual and Other segment which increased $7.8 million comprised of an increase in retention in blanket accident and sickness policies, an increase in the ordinary life line primarily due to acquisitions and growth in the military and civilian government employee division; (iv) the Credit segment which increased $1.2 million; and (v) a $5.1 million increase in the Group segment due to a $2.7 million increase in group LTD and group life, a $4.3 million increase in other group A&H due to new Point of Service business, partially offset by a $1.9 million decrease in DBL due to the 20% reinsurance agreement with Independence American effected as of July 1, 2004.
Fee income increased $7.2 million due to: (i)$6.7 million in fee income from the Fully-Insured Health segment (formerly Strategic Health), which did not exist in 2004, primarily due to $5.6 million in fee income at HPA, and $1.1 million in fee income at GroupLink, and; (ii) a $0.5 million increase in the Medical Stop-Loss segment primarily caused by a $1.0 million increase in fee income at Majestic, partially offset by a $0.5 million decrease in fee income at another MGU.
Total other income increased $4.0 million due primarily to (i) a $1.4 million increase from a commutation agreement, pursuant to which, effective as of January 1, 2005, the reinsurer returned 94% of the net premium collected to date with respect to the 2003 Medical Stop-Loss business ceded to such reinsurer, and the Company has released most future liabilities of such reinsurer with respect to such business; (ii) a $1.4 million increase from the Excess of Loss
Income tax expense decreased $2.1 million to $8.6 million for the year ended December 31, 2005 from $10.7 million for 2004. This results in effective rates of 33.1% for the year ended December 31, 2005 and 31.8% for the year ended December 31, 2004. The higher effective tax rate in 2005 primarily reflects the impact in 2004 of the reversal of $1.1 million in prior tax expenses based upon the provisions of the 2004 American Jobs Creation Act, which was not repeated in 2005, partially offset by an increase in income earned on tax-advantaged securities in 2005.
Net income amounted to $895,000, or $.06 per share, diluted, for the three months ended December 31, 2005 compared to $6,343,000, or $.44 per share, diluted, for the three months ended December 31, 2004. The decrease in net income in the fourth quarter of 2005 is primarily attributable to higher than expected Net Loss Ratios on the employer Medical Stop-Loss segment due to claim development in 2005; and a significant reduction in investment income due to lower yields in 2005 as compared to 2004.
Results of Operations for the Year Ended December 31, 2004 Compared to the Year Ended December 31, 2003
Information by business segment for the years ended December 31, 2004 and 2003 is as follows:
The Company had net realized and unrealized gains of $2.4 million in 2004 compared to $.3 million in 2003, for an increase in realized and unrealized gains of $2.1 million. Decisions to sell securities are based on cash flow needs, investment opportunities and economic and market conditions, thus creating fluctuations in gains and losses from period to period.
Total net investment income increased $7.1 million primarily due to an increase in invested assets due to the acquisition of policy blocks in 2004. The annualized return on investments was 6.2% for the year ended December 31, 2004 versus 6.5% in 2003.
Benefits, claims and reserves increased $23.8 million. The increase is due to: (i) a $14.8 million increase in the Medical Stop-Loss segment primarily due to a $16.0 million increase in Medical Stop-Loss direct and assumed lines commensurate with increased premiums, partially offset by decreases of $.7 million and $.5 million in the Provider Excess line and HMO Reinsurance line, respectively, caused by improvements in loss experience in those lines in 2004 versus 2003; (ii) a $6.4 million increase in the Individual and Other segment primarily due to a $2.9 million increase in annuities due to acquisitions in the fourth quarter of 2003 and June 2004,
a $1.3 million increase in the VFD annuity line due to increased business, a $1.8 million increase in ordinary life claims and reserves due to higher premiums, and $.4 million of other increases; and (iii) a $2.6 million increase in the Group and DBL segment primarily due a $1.2 million increase in the LTD line due to higher loss development on the new business, a $.7 million increase in group annuities due to new business, and a $1.2 million increase in the GTL line due to new business, partially offset by a $.5 million decrease in the DBL line due to the 20% reinsurance agreement previously mentioned.
Amortization of deferred acquisition costs increased $1.5 million primarily due to a $1.1 million increase in the Individual and Other segment, and a $.4 million increase in the Credit segment caused by increased amortization of expenses related to acquisitions of new policy blocks.
Selling, general and administrative expenses increased $6.2 million primarily due to (i) an increase in the Medical Stop-Loss segment of $8.4 million, principally due to higher commissions and other general expenses which corresponds with the increase in premiums; (ii) a $2.0 million decrease in the Individual and Other segment due to $1.7 million in reduced commissions and a $.3 million decrease in other expenses; (iii) a $.3 million decrease in the Group and DBL segment due to a $.1 million decrease in commissions and a $.2 million decrease in other expenses; (iv) a $.3 million decrease in the Credit segment due to a $.5 million decrease in commissions caused by increased deferrals on new business, partially offset by a $.2 million increase in other expenses; and (v) a $.4 million increase in Corporate segment expenses primarily due to higher compensation costs and listing IHC’s stock on the NYSE.
Total investments and cash and cash equivalents increased $134.6 million at December 31, 2005 largely due to net cash of $21.7 million provided by operating activities and $130.5 million received in the purchase of policy blocks, partially offset by $12.0 million in cash used for acquisitions and $5.6 million in net cash used for other purposes. The decrease in insurance reserves-health of $6.5 million is primarily due to the timing of claims payments. The $102.1 million increase in insurance reserves-life and annuity is primarily due to the acquisition of policy blocks. The $62.2 million increase in funds on deposit is primarily a result of the purchase of individual annuity policies in the second quarter of 2005. The $9.9 million increase in total stockholders' equity is primarily due to net income generated in the year ended December 31, 2005 and issuances of common shares, partially offset by an increase in net unrealized losses on investments, dividend payments and purchases of the Company's common stock.
The Company's gross unrealized losses on fixed maturities totaled $18.2 million at December 31, 2005. Substantially all of these securities were investment grade. The Company holds all fixed maturities as available-for-sale securities and, accordingly, marks all of its fixed maturities to market through accumulated other comprehensive income or loss. The unrealized losses on all available-for-sale securities have been evaluated in accordance with the Company's policy and were determined to be temporary in nature at December 31, 2005.
The following table summarizes the prior year amount incurred in 2005 according to the year to which it relates, together with the reserve at the beginning of the year to which it relates (in thousands):
The following sections describe, for each segment, the deficiency (unfavorable development) or redundancy (favorable development) experienced in 2005, together with the key assumptions and changes therein affecting the reserve estimates.
The Group Disability segment had a favorable development of $1.1 million. This amount consists of a favorable development of $1.7 million on the 2004 reserves primarily due to DBL and an unfavorable development of $.6 million for all other years due to LTD.
Due to the long-term nature of LTD, in establishing loss reserves the Company must make estimates for case reserves, incurred but not reported reserves (“IBNR”), and reserves for Loss Adjustment Expenses (“LAE”). Case reserves generally equal the Company’s best estimate of the present value of the liability for future benefits to be paid on claims incurred as of the balance sheet date. The LAE reserve is calculated based on an actuarial expense study. Since the LTD block of policies is relatively small, results can vary from year to year solely on the basis of one or two policies. It is not uncommon for a reserve of several hundred thousand dollars to be associated with one policy. If a small number of claimants with large policy reserves were to recover or a few large claims were incurred, the results could distort the Company’s reserve estimates from year to year. However, there were no individual factors in 2003 that caused the unfavorable development in LTD. With respect to DBL, reserves for the most recent quarter of earned premium are established using a Net Loss Ratio methodology. The Net Loss Ratio is determined by applying the completed prior four quarters of historical Net Loss Ratios to the last quarter of earned premium. Reserves associated with the premium earned prior to the last quarter are established using a completion factor methodology. The completion factors are developed using the historical payment patterns for DBL. The favorable development in the DBL line is due to lower than expected claims.
The Credit A&H unfavorable development for 2005 was $.2 million which relates to 2004 reserves. There were no changes in the Company’s experience factor or the IBNR factor for Credit A&H used in the reserving process from 2004 to 2005.
In accordance with SFAS No. 115, the Company may carry its portfolio of fixed maturities either as held to maturity (carried at amortized cost), as trading securities (carried at fair market value) or as available-for-sale (carried at fair market value). The Company has chosen to carry all of its debt securities as available-for-sale. In 2005, the Company experienced an increase in unrealized losses of $12.4 million which, net of deferred tax benefits of $3.6 million and net of deferred policy acquisition costs of $2.4 million, decreased stockholders' equity by $6.4 million (reflecting net unrealized losses of $8.4 million at December 31, 2005 compared to net unrealized losses of $2.0 million at December 31, 2004). From time to time, as warranted, the Company employs investment strategies to mitigate interest rate and other market exposures.
The Company's operating results have been heavily dependent on the results of its Medical Stop-Loss line of business, particularly as IHC h as increased its risk retention in recent years. The Company emphasizes underwriting profits and not top line growth. However, Medical Stop-Loss is excess business, which is more volatile and tends to be more cyclical in nature than Fully-Insured Health business. When an excess product experiences several consecutive years of underwriting profitability, it is not unusual for there to be more competitors entering that line , which can increase pressure on pricing and create a "softer" market. The Medical Stop-Loss market began to "soften" in 2003, and less favorable conditions continued through 2005. Despite these market conditions, the Company produced Net Loss Ratio s of 84.1%, 86.6% and 93.2% for the years ended December 31, 2003 , 2004 and 2005, respectively , from its Medical Stop-Loss line. While still profitable in 2005 , the Company does not consider this to be an acceptable Net Loss Ratio . In 2005, the Company increased rates and made changes in its underwriting guidelines in response to the results of its underwriting audits . Based on currently available information, business incepting in 2005, of which a material portion will be earned and recorded in 2006, is projected to achieve a Net Loss Ratio that is lower than the previous year.
IHC will continue to look for financially viable life and annuity acquisitions during 2006. Although the source and timing of new acquisitions is unpredictable, the Company believes that there exists an ample supply of acquisition prospects for the remainder of 2006. It is doubtful that IHC would make a major life and annuity acquisition during the first half of 2006¸ but the probability increases during the second half of 2006. The addition of GroupLink has now made it possible to acquire blocks of dental business, and the Company made its first such acquisition in the first quarter of 2006. The Company is also exploring the possibility of leveraging the administrative capabilities of IAC and GroupLink to administer large blocks of life and annuities for other carriers for whom this is not a core business.
FASB Staff Position No. FAS 115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" (the "FSP"), was issued in November 2005 and addresses the determination of when an investment is considered impaired; whether the impairment is other than temporary; and how to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment loss on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance in EITF Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations (principally SFAS No. 115 and SEC Staff Accounting Bulletin 59). Under the FSP, an impairment loss must be recognized in earnings in an amount equal to the entire difference between the security's cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also requires that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale. The FSP is effective for reporting periods beginning after December 15, 2005. The Company does not expect that the application of the FSP will have a material impact on its financial condition, results of operations or financial statement disclosures.
See Index to Consolidated Financial Statements and Schedules on page 53.