(1) Further details of the calculation of basic and diluted earnings per share are set forth in Notes 2 and 22 of the audited consolidated financial statements for the years ended December 31, 2019, 2018, and 2017.
This financial discussion contains an analysis of our consolidated financial position and financial performance as of December 31, 2019 and 2018, and consolidated results of operations for 2019, 2018, and 2017. 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.
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, 2019 we serve approximately 924,000 members across all regions of Puerto Rico. For the years ended December 31, 2019 and 2018 respectively, our Managed Care segment represented approximately 92% of our total consolidated premiums earned, net. We also participate in the life and property and casualty insurance markets in Puerto Rico.
The Commissioner of Insurance of the Government of Puerto 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 Puerto Rico to financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) in making such determinations. See Note 25, Statutory Accounting, of the Notes to Consolidated Financial Statements, included in “Item 8, Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.
● Consolidated premiums earned, net increased 10.7% year over year, to $3.3 billion, primarily reflecting an increase in membership and higher average premium rates within the Managed Care segment.
General. Our revenue consists primarily of (i) premium revenue generated from our Managed Care segment, (ii) administrative service fees received for Managed Care services provided to self-insured employers, (iii) premiums we generate from our Life and Property and Casualty segments, and (iv) investment income.
The following table sets forth selected membership data as of the dates set forth below:
Consolidated income tax expense for the year ended December 31, 2019 was $39.4 million, compared to a benefit of $29.8 million during the last year. The year over year change in income taxes primarily reflects higher taxable income in all segments and the loss before taxes in 2018 in the Property and Casualty segment.
Consolidated claims incurred increased by $174.5 million, or 7.4%, to $2.5 billion, mostly driven by an increase in the Property and Casualty segment gross losses related to Hurricane Maria, a category 4 hurricane that impacted Puerto Rico in September 2017, causing the segment to exceed its applicable catastrophe reinsurance coverage limits and resulting in $128.7 million unfavorable reserve development recorded in 2018. In addition, in 2017 the Managed Care segment experienced significantly lower utilization following the hurricanes that occurred during that year, this hurricane-related drop in utilization is estimated to have lowered the Managed Care segment’s claims by approximately $55 million. The 2017 period also includes $14.8 million of losses related to Hurricanes Irma and Maria recognized by the Property and Casualty segment. The consolidated loss ratio increased by 280 basis points to 86.0%.
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, 2019, the Commercial, Medicare and Medicaid sectors represented 24.6%, 43.3% and 23.9% of our consolidated premiums earned, net, respectively.
● Medical premiums generated by the Medicare business increased by $277.7 million, or 24.6%, to $1,408.0 million, primarily reflecting an increase in enrollment of approximately 203,000 member months and higher average premium rates, mainly reflecting higher membership risk score in 2019 and an increase in reimbursement rates.
● Medical premiums generated by the Medicaid business increased by $2.3 million, or 0.3%, to $778.3 million. This increase primarily reflects higher premiums rates, offset by a decrease of $14.5 million related to the suspension of the HIP fee pass-through in 2019 and lower enrollment by approximately 299,000 member months. The decrease in membership follows the lower membership assigned to us by ASES when implementing the current Medicaid contract, which was effective November 1, 2018.
● The medical claims incurred of the Medicare business increased by $183.1 million, or 19.5%, during the 2019 period mostly driven by higher enrollment. The MLR at 79.8% was 340 basis points lower than the same period last year, driven by favorable prior period reserve developments in 2019 and the impact of cost containment initiatives. These decreases were partially offset by improved benefits in the 2019 product offerings.
● Medical premiums generated by the Medicaid business increased by $24.6 million, or 3.3%, to $776.0 million. This increase primarily reflects higher premiums rates effective July 1, 2017 and $14.5 million related to the reinstatement of the HIP fee pass-through. These increases were offset in part by a lower enrollment by approximately 76,000 in member months and the impact of the profit sharing accrual, which lowered 2018 premiums by $4.3 million. The decrease in membership reflects the lower membership assigned by ASES when implementing the current Medicaid contract, which was effective November 1, 2018. At the effective date of the current agreement TSS was assigned by ASES approximately 280,000 subscribers. After this date, subscribers had approximately three months to select their insurance carrier, during which time TSS was able to compete for membership across Puerto Rico. As of December 31, 2018, our Medicaid membership was approximately 319,000 members.
Premiums earned, net increased by $6.8 million, or 4.2% to $168.6 million, mainly as the result of higher sales and improved policy retention in the Individual Life and Cancer lines of business.
Decrease in underwriting and other expenses of $4.6 million, or 5.8%, to $75.3 million mostly results from a lower amortization of deferred acquisition costs and value of business acquired assets reflecting the segment’s improved portfolio persistency. As a result, the segment’s operating expense ratio improved to 44.7%, or 470 basis points.
Total premiums written increased by $10.7 million, or 7.7%, to $150.5 million, driven by higher volume of Commercial and Personal Package, Commercial Auto, and Commercial Liability products. This increase in volume was offset by lower sales of Commercial Property products, mostly resulting from the selective and disciplined underwriting of Commercial risks.
Underwriting and other operating expenses decreased by $1.1 million, or 2.5%, to $43.4 million mostly due to lower net commission expense. The segment’s operating expense ratio decreased by 380 basis points, to 49.5%.
The premiums ceded to reinsurers decreased by $1.9 million, or 3.0%. Prior year premiums ceded include approximately $9.2 million of catastrophe reinsurance reinstatement costs. The 2018 includes an increase in cessions in the Commercial quota share agreement from 30% in 2017 to 35% effective April 2018, as well as higher reinsurance costs for facultative and non-proportional property reinsurance.
Decrease in net purchases of investments in securities are part of our asset/liability management strategy.
The ARRC has recommended the use of the Secured Overnight Financing Rate (“SOFR”), which is an index based on the cost of borrowing overnight cash collateralized by U.S. Treasury securities. Currently, there is no definitive information regarding the future use of SOFR as a widely accepted benchmark or any other replacement rate.
We have several short-term facilities available to address timing differences between cash receipts and disbursements, consisting of collateralized advances from the Federal Home Loan Bank of New York (“FHLBNY”), repurchase agreements, and a revolving credit facility.
● In August 2019, TSS and TSV became members of the FHLBNY, which provides access to collateralized advances. The borrowing capacity of TSS and TSV is up to 30% of their admitted assets as disclosed in the most recent filing to the Commissioner of Insurance but is constrained by the amount of collateral held at the FHLBNY. See Note 3, Investment in Securities, of the Notes to Consolidated Financial Statements, included in “Item 8, Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K. As of December 31, 2019, the borrowing capacity is approximately $82.2 million for TSS and $48.9 million for TSV. The outstanding balance as of December 31, 2019 for TSS and TSV is $25.0 million and $29.0 million, respectively. The average interest rate of the outstanding balance as of December 31, 2019 is 1.79%.
Our contractual obligations impact our short and long-term liquidity and capital resource needs. However, our future cash flow prospects cannot be reasonably assessed based solely on such obligations. Future cash outflows, whether contractual or not, will vary based on our future needs. While some cash outflows are completely fixed (such as commitments to repay principal and interest on borrowings), most are dependent on future events (such as the payout pattern of claim liabilities which have been incurred but not reported).
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, 2019, our insurance subsidiaries were in compliance with such minimum capital requirements. Please refer to “Item 1. Business - Capital and Reserve Requirements”.
To monitor the solvency of the operations, the BCBSA requires us, TSS, TSA, and TSB to comply with certain specified levels of Risk Based Capital (”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, 2019, TSM and TSS estimated RBC ratio was above the 375% minimum BCBSA RBC requirement to avoid monitoring. At December 31, 2019, TSA estimated RBC ratio was above the minimum BCBSA RBC requirement of 100% for smaller controlled affiliate.
BCBSA’s primary licensees could be subject to monitoring if, over a 6 or 12 month period, its RBC ratio declines by 80 or more points and which results in a level that is below 500%.
Pursuant to the Puerto Rico Insurance Code, our Property and Casualty 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 segment shares risks with other member companies and, accordingly, is contingently liable in the event the syndicate cannot meet their obligations. During 2019, 2018, and 2017, 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. In December 2018, SIMED declared a distribution to its members; the Company’s share of this distribution was $2.9 million, which is presented with other income in the accompanying consolidated statement of earnings.
In addition, our Property and Casualty insurance subsidiary is a member of the Compulsory Vehicle Liability Insurance Joint Underwriting Association (the “Association”). The Association was organized in 1997 to underwrite insurance coverage of motor vehicle property damage liability risks effective January 1, 1998. As a participant, the segment shares the risk proportionally with other members based on a formula established by the Insurance Code. During the years 2019 and 2018, the Association distributed to the Company an amount based on the good experience of the business amounting to $0.2 million and $0.2 million, respectively. In June 2017, the Association declared a special dividend of $70.0 million as authorized by a recent amendment to the Act creating the Association. The distribution was subject to a unique and special tax rate of 50%. The dividend was paid net of its related tax in December 2018. The share of the Property and Casualty segment in this distribution was $2.4 million.
The Property and Casualty segment is also member of the Puerto Rico Fire and Allied Lines Underwriting Association and the Puerto Rico Auto Assign Plan. These entities periodically impose assessments to cover operations and other charges. The assessments recorded from these entities were $10 thousand, $9 thousand and $1 thousand in 2019, 2018 and 2017, respectively.
Management regularly reviews its assumptions regarding claim liabilities and makes adjustments to claims incurred when necessary. If management’s assumptions regarding cost trends and utilization are significantly different than actual results, our consolidated statement of earnings and financial position could be impacted in future periods. Changes to prior year estimates may result in an increase in claims incurred or a reduction of claims incurred in the period the change is made. Further, due to the considerable variability of health care costs, adjustments to claims liabilities are made in each period and are sometimes significant as compared to the net income recorded in that period. Prior year development of claim liabilities is recognized immediately upon the actuary’s judgment that a portion of the prior year liability is no longer needed or that an additional liability should have been accrued. Health care trends are monitored in conjunction with the claim reserve analysis. Based on these analyses, rating trends are adjusted to anticipate future changes in health care cost or utilization. Thus, the Managed Care segment incorporates those trends as part of the development of premium rates in an effort to keep premium rating trends in line with claims trends.
Management expects that substantially all of the development of the 2019 estimate of medical claims payable will be known during 2020.
● Through the management of our cash flows and investment portfolio.
● We have available short-term borrowing facilities to address differences between cash receipts and disbursements.
At December 31, 2019, claim liabilities for the life segment amounted to $47.1 million and represented 6.6% of total consolidated claim liabilities and 2.5% of our total consolidated liabilities.
The claim liabilities related to the life 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.
At December 31, 2019, claim liabilities for the Property and Casualty segment amounted to $322.0 million and represented 45.4% of the total consolidated claim liabilities and 17.2% of our total consolidated liabilities. Claims liabilities related to losses caused by Hurricanes Irma and Maria amount to approximately $241.7 million.
The costs of acquiring new life business, principally commissions, and certain variable underwriting and policy issue expenses of our Life segment, have been deferred. These costs, including value of business acquired (“VOBA”) recorded upon our acquisitions of TSV and TSB, 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 (“DPAC” or “DAC”) of revisions to estimated gross profits is reported in earnings in the period such estimated gross profits are revised.
The schedules of amortization of life insurance DPAC and VOBA are based upon actuarial assumptions regarding future events that are uncertain. For all products, other than universal life and deferred annuities, the most significant of these assumptions is the level of contract persistency and investment yield rates. For these products the basis for the amortization of DPAC and VOBA is established at the issue of each contract and would only change if our segment’s experience deteriorates to the point that the level of the net liability is not adequate. We do not currently expect that level of deterioration to occur. For the universal life and deferred annuity products, amortization schedules are based upon the level of historic and anticipated gross profit margins, from the date of each contract’s issued (or purchase, in the case of VOBA). These schedules are based upon several actuarial assumptions that are uncertain, are reviewed annually and are modified if necessary. The most significant of these assumptions are claims, investment yield rates and contract persistency. Based upon the most recent actuarial reviews of all of the assumptions, we do not currently anticipate material changes to the level of these amortization schedules.
If after monitoring and analyzing impaired securities, management determines that a decline in the estimated fair value of any fixed maturity security or other invested asset below cost is other than temporary, the carrying amount of the security is reduced to its fair value according to current accounting guidance. 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.
During the years ended December 31, 2019 and 2018, we were not required to recognize an other-than-temporary impairment. During the year ended December 31, 2017 we recognized an other-than-temporary impairment on equity securities amounting to $49 thousand. The impairment analysis indicated that, none of the securities whose carrying amount exceeded its estimated fair value was considered other-than-temporarily impaired as of that date; however, several factors are beyond management’s control, such as the following: financial condition of the issuers, movement of interest rates, specific situations within corporations, among others. Over time, the economic and market environment may provide additional insight regarding the estimated fair value of certain securities, which could change management’s judgment regarding impairment. This could result in realized losses related to other-than-temporary declines being charged against future income.