Declared a special 10% stock dividend to IHC shareholders of record on February 17, 2012 with a distribution date of March 5, 2012. As a result, IHC issued 1.6 million shares of its common stock, net of treasury shares, with a fair value of $15.8 million and paid cash in-lieu of fractional shares. All references to number of common shares and earnings per share amounts have been adjusted retroactively for all periods presented to reflect the change in capital structure;
Income from continuing operations of $1.09 per share, diluted, for the year ended December 31, 2012, compared to $.74 per share, diluted, for the year ended December 31, 2011. Net income for 2010 includes a $16.7 million after-tax gain on the bargain purchase of AMIC;
Consolidated investment yield (on an annualized basis) of 4.1% in 2012 compared to 4.3% in 2011;
Book value of $15.93 per common share, an increase of 10% from December 31, 2011.
Premiums earned increased $25.2 million for the year ended December 31, 2012 when compared to 2011. The increase in premiums earned is primarily due to increased volume and retention on business underwritten by Risk Solutions;
The expense ratio decreased for the year ended December 31, 2012 primarily due to a decrease in profit commission expense as a result of poor performance on certain business written through one program at AMIC.
The Fully Insured Health segment reported $4.4 million of income from continuing operations before taxes for the year ended December 31, 2012 as compared to $7.7 million for the year ended December 31, 2011;
The increase in the loss ratio was primarily attributable to an increase in the claims experience on major medical business for groups and individuals not administered by Health Solutions and dental.
The underwriting expense ratio decreased primarily as a result of a decrease in general expenses.
Other-than-temporary impairment losses recognized in earnings for the years ended December 31, 2012 and 2011 were $0.7 million and $1.5 million, respectively; and
The Company believes that its recorded insurance reserves are reasonable and adequate to satisfy its ultimate liability. The Company primarily uses its own loss development experience, but will also supplement that with data from its outside actuaries, reinsurers and industry loss experience as warranted.
The two “primary” assumptions underlying the calculation of loss reserves for Medical Stop-Loss business are (i) projected Net Loss Ratio, and (ii) claim development patterns. The projected Net Loss Ratio is set at expected levels consistent with the underlying assumptions (“Projected Net Loss Ratio”). Claim development patterns are set quarterly as reserve estimates are developed and are based on recent claim development history (“Claim Development Patterns”). The Company uses the Projected Net Loss Ratio to establish reserves until developing losses provide a better indication of ultimate results and it is feasible to set reserves based on Claim Development Patterns. The Company has concluded that a reasonably likely change in the Projected Net Loss Ratio assumption could have a material effect on the
The Company’s Group Disability segment is comprised of Long Term Disability (“LTD”) and Disability Benefits Law (“DBL”). The two “primary” assumptions on which Group Disability reserves are based are: (i) morbidity levels; and (ii) recovery rates. If morbidity levels increase, for example due to an epidemic or a recessionary environment, the Company would increase reserves because there would be more new claims than expected. In regard to the assumed recovery rate, if disabled lives recover more quickly than anticipated then the existing claims reserves would be reduced; if less quickly, the existing claims reserves would be increased. Advancements in medical treatments could affect future recovery, termination, and mortality rates. With respect to LTD only, other assumptions are: (i) changes in market interest rates; (ii) changes in offsets; (iii) advancements in medical treatments; and (iv) cost of living. Changes in market interest rates could change reserve assumptions since the payout period could be as long as 40 years. Changes in offsets such as Social Security benefits, retirement plans and state disability plans also impact reserving. As a result of the forgoing assumptions, it is possible that the historical trend may not be an accurate predictor of the future development of the block. As with most long term insurance reserves that require judgment, the reserving process is subject to uncertainty and volatility and fluctuations may not be indicative of the claim development overall.
Costs that vary with and are primarily related to acquiring insurance policies and investment type contracts are deferred and recorded as deferred policy acquisition costs ("DAC"). These costs are principally broker fees, agent commissions, and the purchase prices of the acquired blocks of insurance policies and investment type policies. DAC is amortized to expense and reported separately in the Consolidated Statements of Operations. All DAC within a particular product type is amortized on the same basis using the following methods:
For long duration type contracts, such as annuities and universal life business, amortization of DAC is charged to expense over the life of the underlying contracts based on the present value of the estimated gross profits ("EGPs") expected to be realized over the life of the book of contracts. EGPs consist of margins based on expected mortality rates, persistency rates, interest rate spreads, and other revenues and expenses. The Company regularly evaluates its EGPs to determine if actual experience or other evidence suggests that earlier estimates should be revised. If the Company determines that the current assumptions underlying the EGPs are no longer the best estimate for the future due to changes in actual versus expected mortality rates, persistency rates, interest rate spreads, or other revenues and expenses, the future EGPs are updated using the new assumptions and prospective unlocking occurs. These updated EGPs are utilized for future amortization calculations. The total amortization recorded to date is adjusted through a current charge or credit to the Consolidated Statements of Operations.
The Company has classified all of its investments as either available-for-sale or trading securities. These investments are carried at fair value with unrealized gains and losses reported through other comprehensive income for available-for-sale securities or as unrealized gains or losses in the Consolidated Statements of Operations for trading securities. Fixed maturities and equity securities available-for-sale totaled $735.2 million and $880.4 million at December 31, 2012 and 2011, respectively. Premiums and discounts on debt securities purchased at other than par value are amortized and accreted, respectively, to interest income in the Consolidated Statements of Operations, using the constant yield method over the period to maturity. Net realized gains and losses on investments are computed using the specific identification method and are reported in the Consolidated Statements of Operations.
Equity securities may experience other-than-temporary impairment in the future based on the prospects for full recovery in value in a reasonable period of time and the Company’s ability and intent to hold the security to recovery. If a decline in fair value is judged by management to be other-than-temporary or management does not have the intent or ability to hold a security, a loss is recognized by a charge to total other-than-temporary impairment losses in the Consolidated Statement of Operations. For the purpose of other-than-temporary impairment evaluations, preferred stocks with maturities are treated in a manner similar to debt securities. Declines in the creditworthiness of the issuer of debt securities with both debt and equity-like features requires the use of the equity model in analyzing the security for other-than-temporary impairment.
Goodwill carrying amounts are evaluated for impairment, at least annually, at the reporting unit level which is equivalent to an operating segment. If the fair value of a reporting unit is less than its carrying amount, further evaluation is required to determine if a write-down of goodwill is required. In determining the fair value of each reporting unit, we used an income approach, applying a discounted cash flow method which included a residual value. Based on historical experience, we make assumptions as to: (i) expected future performance and future economic conditions, (ii) projected operating earnings, (iii) projected new and renewal business as well as profit margins on such business, and (iv) a discount
rate that incorporated an appropriate risk level for the reporting unit. Any impairment of goodwill would be charged to expense. No impairment charge for goodwill was required in 2012, 2011 or 2010.
Other intangible assets are amortized to expense over their estimated useful lives and are subject to impairment testing. Any impairment write-down of other intangible assets would be charged to expense. No impairment charges for intangible assets were required in 2012, 2011 or 2010.
At December 31, 2012, the Company’s market capitalization was less than its book value indicating a potential impairment of goodwill. As a result, the Company assessed the factors contributing to the performance of IHC stock in 2012. The Company does not believe that an impairment of goodwill exists at this time.
In 2012, premiums earned increased $19.7 million over the comparable period of 2011. The increase is primarily due to: (i) an $25.2 million increase in the Medical Stop-Loss segment due to increased volume and retention of business in 2012; and (ii) a $0.2 million increase in the Fully Insured Health segment primarily as a result of premiums from the new pet and international lines of business, partially offset by decreased retentions and premium volume in the short term medical business, major medical business for groups and individuals, limited medical and dental lines of business; partially offset by (iii) a decrease of $4.4 million of earned premiums in the Individual life, annuities and other segment primarily as a result of the transfer of certain annuity contracts in the fourth quarter of 2011and decreased premium volume from other lines in run-off; and (iv) a $1.4 million decrease in the Group disability, life, annuities and DBL segment primarily due to decreased premiums from the group term life and LTD lines
Total net investment income decreased $6.4 million. The overall annualized investment yields were 4.1% and 4.3% (approximately 4.2% and 4.4%, on a tax advantaged basis) for 2012 and 2011, respectively. The overall decrease was primarily a result of a decrease in investment income on bonds, equities and short-term investments due to the transfer of $143.5 million of assets in the first quarter of 2012 related to a coinsurance treaty. The annualized investment yields on bonds, equities and short-term investments were 3.8% and 4.1% in 2012 and 2011, respectively. IHC has approximately $197.5 million in highly rated shorter duration securities earning on average 1.6%. A portfolio that is shorter in duration enables us, if we deem prudent, the flexibility to reinvest in much higher yielding longer-term securities, which would significantly increase investment income.
The Company had net realized investment gains of $5.1 million in 2012 compared to $8.7 million in 2011. These amounts include gains and losses from sales of fixed maturities and equity securities available-for-sale and other investments. Decisions to sell securities are based on management's ongoing evaluation of investment opportunities and economic and market conditions, thus creating fluctuations in gains and losses from period to period. A significant portion of the net realized investment gains in 2011 resulted from sales of invested assets in anticipation of a transfer of assets in the first quarter of 2012 in accordance with the terms of a coinsurance agreement.
For the year ended December 31, 2012 and 2011, the Company recorded $0.7 million and $1.5 million, respectively, of other-than-temporary impairment losses in earnings. The other-than-temporary impairment losses in 2012 consist of credit losses resulting from expected cash flows of debt securities that are less than their amortized cost. In 2011, other-than-temporary impairment losses recognized in earnings consist of $1.3 million of credit losses resulting from expected cash flows of debt securities that are less than the debt securities’ amortized cost and $0.2 million of losses resulting from the Company’s intent to sell certain corporate debt securities prior to the recovery of their amortized cost bases.
transfer of certain group annuity contracts in the fourth quarter of 2011 and decreased premium volume from other lines in run-off.
In 2012, the Company recorded a $5.9 million credit to federal income taxes as a result of the reduction in AMIC’s valuation allowance related to its deferred tax asset at December 31, 2012. Excluding this transaction, the effective tax rate for the year ended December 31, 2012 was 32.1%. In 2011, IHC eliminated $2.3 million of previously recorded deferred income taxes due to management’s intention to adopt tax planning strategies to recover its investment in AMIC in a tax-free manner. Excluding this transaction, the effective tax rate for the year ended December 31, 2011 was 32.4%. The lower effective tax rate in 2012 was due to a higher benefit from tax advantaged securities as a percentage of income in 2012.
minority shareholders. The fair value of the noncontrolling interests in AMIC was based on the closing market price of AMIC’s common stock.
Premiums in 2011 include twelve months of earned premiums from AMIC of $72.4 million compared to ten months of earned premiums from AMIC of $61.6 million in 2010. Excluding these amounts, earned premiums decreased $.5 million. The decrease is primarily due to: (i) a $15.6 million net increase of premiums earned in the Fully Insured Health segment in 2011 primarily as a result of increased retentions in the major medical business for groups and individuals, short term medical and
limited medical lines of business and increased volume in the major medical business for groups and individuals and limited medical lines, partially offset by a decrease in the student accident line as a result of the cancellation of a producer of this product; (ii) an increase of $1.6 million of earned premiums in the Individual life, annuities and other segment primarily as a result of the ceding of certain ordinary life and annuity business during 2010, in part offset by reduced production of annuity contracts; more than offset by (iii) a $12.3 million decrease in the Medical Stop-Loss segment primarily due to the cancellation of non-owned managing general underwriters in 2010; and (iv) a $5.4 million decrease in the Group disability, life, annuities and DBL segment primarily due to lower production and reduced rates in the DBL line and the discontinuance of the point of service line.
On December 31, 2011, the Company wrote-off $4.6 million of deferred acquisition costs in connection with a coinsurance agreement that is effective in the first quarter of 2012. Excluding this write-off, amortization of deferred acquisition costs increased $0.8 million.
In July 2012, the Company made a $2.0 million principal debt repayment in accordance with the terms of its amortizing term loan.
As of December 31, 2012, the Company had $23.9 million of cash and cash equivalents compared with $18.2 million as of December 31, 2011.
The decrease in cash from operating activities of $115.4 million is primarily the result of $143.5 million cash that Standard Security Life transferred to an unaffiliated reinsurer in connection with a coinsurance agreement in February 2012, partially offset by net income of $22.6 million. Cash provided by investing activities of $122.9 million consists primarily of proceeds from the net sales of investments in preparation for such transfer of funds by Standard Security Life.
Financing activities for the year ended December 31, 2012 used $1.8 million, primarily consisting of dividends paid, the repayment of debt and repurchases of common stock, net of proceeds from investment-type insurance contracts.
The Company had net receivables from reinsurers of $118.7 million at December 31, 2012. All of such reinsurance receivables are either due from highly rated companies or are adequately secured. No allowance for doubtful accounts was necessary at December 31, 2012.
Based upon the goodwill impairment testing performed at December 31, 2012, the fair value of each reporting unit exceeded its carrying value and no impairment charge was required. Fair value exceeded carrying value by 10% or more in both the Fully Insured Health and the Medical Stop Loss segments.
Management uses a significant amount of judgment in estimating the fair value of the Company’s reporting units. The key assumptions underlying the fair value process are subject to uncertainty and change. The following represent some of the potential risks that could impact these assumptions and the related expected future cash flows: (i) increased competition; (ii) an adverse change in the insurance industry and overall business climate; (iii) changes in state and federal regulations; (iv) rating agency downgrades of our insurance companies; and (v) a sustained and significant decrease in our share price and market capitalization. As a result of the global economic crisis that began in 2008, we experienced a significant decline in our stock price. Due to this significant decline, our market capitalization as of December 31, 2012 was significantly below the sum of our reporting units’ fair values. As a result, the Company assessed the factors contributing to the performance of IHC stock in 2012, and concluded that the market capitalization does not represent the fair value of the Company. The Company noted several factors that have led to a difference between the market capitalization and the fair value of the Company, including (i) the Company’s stock is thinly traded and a sale of even a small number of shares can have a large percentage impact on the price of the stock, (ii) Geneve Corporation and insiders own approximately 56% of the outstanding shares, which has had a significant adverse impact on the number of shares available for sale and therefore the trading potential of IHC stock, and (iii) lack of analyst coverage of the Company. If we experience a sustained decline in our results of operations and cash flows, or other indicators of impairment exist, we may incur a material non-cash charge to earnings relating to impairment of our goodwill, which could have a material adverse effect on our results.
The Fully Insured Health segment had a favorable development of $0.4 million. The Company experienced a $0.8 million favorable variance related to 2010 reserves primarily on the vision line of business offset by additional expense incurred related to 2011 reserves primarily due to group major medical business.
Due to the long-term nature of LTD, in establishing loss reserves the Company must make estimates for case reserves, IBNR, and reserves for Loss Adjustment Expenses (“LAE”). Case reserves generally equal the actuarial present value of the liability for future benefits to be paid on claims incurred as of the balance sheet date. The IBNR reserve is established based upon historical trends of existing incurred claims that were reported after the balance sheet date. The LAE reserve is calculated based on an actuarial expense study. Since the LTD block of policies is relatively small, with the potential for very large claims on individual policies, results can vary from year to year. If a small number of claimants with large claim reserves were to recover or several very large claims were incurred, the results could distort the Company’s reserve estimates from year to year. High termination rates and offsets caused favorable development in LTD prior year reserves. 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.
All other lines, primarily due to the blanket and other individual health products, experienced a favorable development of $1.0 million.
Due to its strong capital ratios, broad licensing and excellent asset quality and credit-worthiness, the Insurance Group remains well positioned to increase or diversify its current activities. It is anticipated that future acquisitions or other expansion of operations will be funded internally from existing capital and surplus and parent company liquidity. In the event additional funds are required, it is expected that they would be borrowed or raised in the public or private capital markets to the extent determined to be necessary or desirable. In November 2004, December 2003 and March 2003, the Company borrowed $15.0 million, $12.0 million and $10.0 million, respectively, through pooled trust preferred issuances by unconsolidated subsidiary trusts. In August 2009, the outstanding line of credit was cancelled and converted into an amortizing term loan. In 2011 the term loan was amended and increased from $7.5 million to $10.0 million. See Note 13 of the Notes to Consolidated Financial Statements in Item 8 of this report.
Adapting to health care reform by continuing to proactively adjust our distribution strategies and mix of Fully Insured Health products to take advantage of changing market demands;
Increasing sales of short-term, limited medical and supplemental health products, such as dental, hospital indemnity and critical illness and international products to offset the reduction in major medical premiums in 2014;
The Company remained highly liquid in 2012 with a shorter duration portfolio. As a result, the yields on our investment portfolio were, and continue to remain, lower than in prior years and investment income may continue to be depressed for the balance of the year. IHC has approximately $197.5 million in highly rated shorter maturity securities earning on average 1.6%; our portfolio as a whole is rated, on average, AA. The low duration of our portfolio enables us, if we deem prudent, the flexibility to reinvest in much higher yielding longer-term securities, which would significantly increase investment income. A low duration portfolio such as ours also mitigates the adverse impact of potential inflation. IHC will continue to monitor the financial markets and invest accordingly.
At December 31, 2012, IHC owned 78.6% of AMIC’s outstanding common stock. In January 2013, as a result of AMIC’s share repurchases, IHC’s ownership interest increased to 80.6%.
We had a significant increase in the profitability and growth of our stop-loss business in 2012, our largest core business, which we attribute to the more efficient and controlled model of writing the majority of our medical stop-loss on a direct basis. At present, all indicators point to a continuation of this growth and higher level of profitability. There are a number of market forces that support this expectation. We have observed a trend on the part of our producers of stop-loss to consolidate their business with a smaller number of stop-loss carriers. The direct writing model employed by Risk Solutions is well suited to take advantage of this trend. There is an increased interest in self-funded options to address concerns about cost and regulatory burdens and we have developed targeted programs to address these needs. Finally there appears to be a market recognition that stop loss buying decisions need to be more about price. Service and fair claims payment practices are also important considerations and the partnership model under which Risk Solutions operates is increasingly recognized as addressing those issues.
all the options for IHC and we are continuing a thorough evaluation of our options for those health insurance products that may be affected. Although the law will generally require insurers to operate with a lower expense structure for major medical essential health benefit (“EHB”) plans in the small employer and individual markets, the law appears to make exceptions for carriers, such as ours, that have a minimal presence in any one state. Non-EHB lines of business and Medical Stop-Loss have been impacted by health care reform minimally or not at all.
See Index to Consolidated Financial Statements and Schedules on page 58.