Our corporate headquarters are located in White Plains, New York. We also have offices in Lake Mary, Florida; Houston, Texas; Syracuse, New York; Brookfield, Wisconsin; Columbia, Maryland and Mechanicsburg, Pennsylvania. In addition, we maintain other smaller, local offices to support Medicaid contracts. Management considers its office facilities suitable and adequate for the current level of operations. Additional information regarding our lease obligations is included in Note 23-Commitments and Contingencies in the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.
The table below provides selected financial data and other operating information as of and for the five years ended December 31, 2014. We derived the selected financial data presented below from our audited financial statements. Our Medicare Part D business was sold in 2011 and reported as discontinued operations in the 2011 and 2010 selected financial data presented below. We have prepared the following data, other than statutory data, in conformity with U.S. generally accepted accounting principles. You should read this selected financial data together with our Consolidated Financial Statements and the Notes to Consolidated Financial Statements as well as the discussion
the federal government to provide enrollees with health insurance. Our current focus is to grow our Medicare Advantage business in Texas (especially Houston/Beaumont), upstate New York (especially the Syracuse area) and Maine, regions in which we have meaningful market positions.
• Medicare Accountable Care Organizations: We believe there is an opportunity to address the high cost of health care for the majority of the Medicare population enrolled in traditional fee-for-service Medicare and have joined primarily with primary-care and multi-specialty provider groups to operate twenty-four Accountable Care Organizations, or ACOs, pursuant to the Medicare Shared Saving Program, known as the MSSP.
• Medicaid. We also provide services to Medicaid agencies and health plans through APS Healthcare and through our Total Care Medicaid health plan serving approximately 40,000 members in upstate New York.
• We align incentives through gain sharing arrangements so that providers are each incented to assist members to achieve healthy outcomes.
• We provide actionable data and analytics to providers and employ enabling technology to ensure that the right care is delivered at the right time in the right setting.
We believe that attractive growth opportunities exist in providing health insurance to the growing senior market. At present, approximately 53 million Americans are eligible for Medicare, the Federal program that offers basic hospital and medical insurance to people over 65 years old and some disabled people under the age of 65. According to the U.S. Census Bureau, more than two million Americans turn 65 in the United States each year, and this number is expected to grow as the so-called baby boomers continue to turn 65. In addition, many large employers that traditionally provided medical and prescription drug coverage to their retirees have begun to curtail these benefits. Medicare Advantage continues to grow its share of the overall Medicare market and we believe is likely to continue to gain positive acceptance with consumers.
Medicare Advantage-Texas: Universal American's largest Medicare Advantage market is Texas, primarily the Houston/Beaumont region and North Texas. We market our products using the Texan Plus® brand.
• Our Network PFFS plans, which are provided under the name "Today's Options®" are offered under contracts with CMS and provide enhanced health care benefits compared to traditional Medicare, subject to cost sharing and other limitations. Even though these plans allow the members more flexibility in the delivery of their health care services than other Medicare Advantage plans, we actively coordinate care for these members in a similar manner to our PPO and HMO plans. Some of these products include a defined prescription drug benefit. In addition to a fixed monthly payment per member from CMS, individuals in these plans may be required to pay a monthly premium in selected counties or for selected enhanced products.
The MSSP is designed to improve beneficiary outcomes and increase value of care by:
• requiring coordinated care for all services provided under Medicare FFS; and
At January 1, 2015, Universal American sponsors 24 ACOs in ten States, which include 3,800 participating providers and approximately 285,000 Medicare FFS beneficiaries covering more than $3 billion of medical spend. Certain of our ACOs overlap a portion of our Medicare Advantage footprint (Houston, Dallas and Syracuse) which capitalizes on our existing relationship with providers. The other ACOs have no overlap with existing operations, offering an opportunity for expansion into other products and services. We provide these ACOs with care coordination, analytics and reporting, technology and other administrative capabilities to enable participating providers to deliver better care and lower healthcare costs for their Medicare fee-for-service beneficiaries. We employ local market staff (operations and clinical) to drive physician and their staff engagement and care coordination improvements. During 2014, we reduced the number of our active ACOs based on a variety of factors, including the level of engagement by the physicians in the ACO and the likelihood of the ACO achieving shared savings. We may make further reductions in 2015.
The three ACOs qualifying for savings received payments of $20.4 million, part to be shared between the physicians of those ACOs and us and part to be used by us to reimburse a portion of the costs that we had incurred. Our share of these savings, including expense recovery, amounted to $13.4 million, which is reflected in equity in losses of unconsolidated subsidiaries in our consolidated statements of operations. We received these payments in October 2014. We did not recognize any shared savings revenue in 2013 or 2012.
Due to the Medicaid expansion provisions under the ACA, CMS projects that Medicaid expenditures will increase from approximately $505 billion in 2014 to approximately $860 billion by 2022. In addition, as part of the Affordable Care Act, approximately 70 million people are expected to qualify for Medicaid in 2015.
APS Healthcare-In March 2012, we acquired APS Healthcare. APS Healthcare provides a variety of healthcare services primarily to State Medicaid agencies and private health plans. In February 2015, we sold the APS Healthcare Puerto Rico business for $26.5 million. APS Puerto Rico provides
managed behavioral health services for the Government Health Plan Medicaid program under a contract that terminates on March 31, 2015.
The ACA was signed into law in March 2010 and legislates broad-based changes to the U.S. health care system. Due to the complexity of the health reform legislation, including yet to be promulgated implementing regulations, lack of interpretive guidance, and gradual implementation, the impact of the health reform legislation remains difficult to predict and quantify. In addition, we believe that any impact from the health reform legislation could potentially be mitigated by certain actions we may take in the future including modifying future Medicare Advantage bids to compensate for such changes. For example, the anticipation of additional revenues from Star bonuses or reduced CMS reimbursement rates are factored into the anticipated level of benefits included in our Medicare Advantage bids for the upcoming year.
The provisions of these new laws include the following key points, which are discussed further below:
Implementation of quality bonus for Star ratings-Beginning in 2012, Medicare Advantage plans with an overall "Star rating" of three or more stars (out of five) based on 2011 performance were eligible for a "quality bonus" in their basic premium rates. For 2015 and beyond, plans must achieve an overall star rating of at least 4 stars to receive the quality bonus. Plans receiving Star bonus payments are required to use the additional dollars to provide "extra benefits" for the plans' enrollees, to comply with required minimum loss ratios, resulting in a competitive advantage for those plans rather than a direct financial impact. In addition, beginning in 2012, Medicare Advantage Star ratings affect the rebate percentage available for plans to provide additional member benefits (plans with quality ratings of 3.5 stars or above will have their rebate percentage increased from a base rate of 50% to 65% or 70%). In all cases, this rebate percentage is lower than the pre-ACA rebate percentage of 75%. Our Medicare Advantage plans for 2015 are rated from 3.0 to 4.0 stars out of 5.0, with approximately 86% of our membership now in plans rated 4 stars, which ratings were considered when preparing our bids to be submitted for 2015. A summary of our membership and related ratings as of January 1, 2015 is presented below:
Notwithstanding continued efforts to improve or maintain our Star ratings and other quality measures, there can be no assurances that we will be successful in doing so. Accordingly, our plans may not be eligible for full level quality bonuses or increased rebates, which could adversely affect the benefits such plans can offer, reduce membership, and reduce profit margins.
premiums, that is not deductible for income tax purposes. As a result, our effective income tax rate increased in 2014, and will likely remain at a higher level in future years. Our share of the new fee is based on our pro rata percentage of premiums written during the preceding calendar year compared to the industry as a whole, calculated annually. This fee, first expensed and paid in 2014, adversely affects the profitability of our Medicare Advantage business and could have a material adverse effect on our results of operations. We paid a fee of $23.1 million in 2014, based on 2013 net written premiums and estimate that the fee to be paid in 2015, based on 2014 net written premiums, will be approximately $29 million. Pursuant to the guidance issued by the FASB in July 2011, for reporting in accordance with U.S generally accepted accounting principles (GAAP), the liability for the fee will be estimated and recorded in full once the entity provides qualifying health insurance in the corresponding period with a corresponding deferred cost that is to be amortized to expense on a straight-line basis over the applicable calendar year. For statutory reporting purposes, the fee will be expensed on January 1 in the year of payment, rather than amortized to expense over the year. The ACA fee is included in other operating costs; however, will be factored in when calculating the stipulated minimum MLR.
Limitation on the federal tax deductibility of compensation earned by individuals-Beginning in 2013, with respect to services performed during 2010 and afterward, for health insurance companies, the federal tax deductibility of compensation is limited under Section 162(m)(6) of the Code to $500,000 per individual and will not contain an exception for "performance-based compensation." In September 2014, the Internal Revenue Service issued final regulations on this compensation deduction limitation which provided additional information regarding the definition of a health insurance issuer. Based on our analysis of the final regulations, we no longer believe we are subject to the limitation. As a result, during the fourth quarter of 2014, we recorded a tax benefit of $3.2 million related to prior years and $1.7 million related to the first nine months of 2014. Prior to receiving the final regulations, our application of this limitation had increased our effective tax rate by approximately 60 basis points for the year ended December 31, 2013 and 200 basis points for the year ended December 31, 2012. However, there is a risk that the Internal Revenue Service or other regulators may disagree with our interpretation, which could result in higher taxes.
As of December 31, 2014, we have incurred inception-to-date expenses of approximately $107 million, pre-tax, related to our ACO business, including our equity in the losses of our unconsolidated ACOs and have recognized our portion of shared savings revenues and expense
On August 1, 2013, our Board of Directors authorized the repurchase of up to $40 million of our outstanding common stock. Purchases may occur from time to time in the open market, in privately negotiated transactions, or otherwise as market conditions permit.
(1)Excludes 13,200 members in areas subject to 2014 Service Area Reductions. This includes 10,700 rural members whose plans were not renewed for 2014.
As a result of the growth of our ACOs and Total Care, we have modified the way we manage and report our business. Our Medicare Advantage and Traditional Insurance segments remain unchanged; however, we have split our ACO and Total Care businesses from the Corporate & Other segment to form two new segments-Management Services Organization ("MSO") and Medicaid, respectively. We will continue to report the activities of our holding company, the operations of APS Healthcare since its acquisition on March 2, 2012, and other ancillary operations in our Corporate & Other segment. See Note 24-Business Segment Information in the Notes to Consolidated Financial Statements for a description of our segments.
Our Medicaid segment generated income before income taxes of $2.6 million for the year ended December 31, 2014 compared to a loss of $0.5 million for the year ended December 31, 2013. This was due to 2013 consisting of only one month of activity that included approximately $0.6 million of acquisition related costs, as we acquired Total Care on December 1, 2013.
The loss before income taxes from our Corporate & Other segment decreased by $184.7 million for the year ended December 31, 2014 compared to 2013. This was primarily due to asset impairment charges related to APS Healthcare in 2013 totaling $189.4 million, improved profitability of our APS Healthcare business, corporate expense reduction initiatives and higher net investment income, partially offset by higher legal and settlement costs related to our non-core business, primarily APS Healthcare, Traditional Insurance and the New York Health Benefits Exchange, known as the Exchange.
Our effective tax rate was a benefit of 13.1% for 2014 compared with a benefit of 5.4% for 2013. The effective rate in 2014 differs from the expected benefit of the 35% federal rate due to non-recurring tax benefits (discussed below), net of permanent items, primarily the new ACA fee and preferred dividends, and foreign and state income taxes. The variance in the 2013 effective tax rate compared with the expected benefit of the 35% federal rate was driven by permanent items relating primarily to non-deductible goodwill impairment, the limitation on the deductibility of executive compensation for health insurers enacted in the ACA, interest on the mandatorily redeemable preferred stock, foreign and state income taxes and non-recurring tax expenses.
Income taxes include non-recurring tax benefits (expenses) of $5.8 million and ($1.2) million for the years ended December 31, 2014 and 2013, respectively. The 2014 benefit primarily relates to the reversal of executive compensation previously considered non-deductible under Code section 162(m)(6) that resulted in the recording of a $3.2 million benefit for amounts considered non-deductible in our prior year tax return, recording of $1.3 million of foreign tax credits related to APS Healthcare and a $0.7 million reserve release related to items on which the statute of limitations has expired. The 2013 expense primarily relates to the establishment of a valuation allowance against deferred tax assets principally related to foreign tax credits from our APS Puerto Rico subsidiary.
Our Medicaid segment generated a loss before income taxes of $0.5 million for the year ended December 31, 2013 reflecting only one month of activity that included approximately $0.6 million of acquisition related costs. We acquired the Total Care Medicaid health plan on December 1, 2013.
Our effective tax rate on continuing operations was a benefit of 5.4% for 2013 compared with an expense of 31.7% for 2012. The variance in the 2013 effective tax rate compared with the expected benefit of the 35% federal rate was driven by permanent items relating primarily to non-deductible goodwill impairment, the limitation on the deductibility of executive compensation for health insurers enacted in the ACA, interest on the mandatorily redeemable preferred stock, foreign and state income taxes and non-recurring tax expenses. The effective tax rate in 2012 was favorably impacted by the recognition of certain state tax benefits, partially offset by permanent items, including non-deductible executive compensation and interest. During 2014, we determined that we are no longer subject to the limitation on the deductibility of executive compensation, and in 2014 we recorded a tax benefit related to these amounts that were not deducted in prior years. See Note 12-Income Taxes in the Notes to Consolidated Financial Statements for additional information.
Income taxes include non-recurring tax (expenses) benefits of ($1.2) million and $7.3 million for the years ended December 31, 2013 and 2012, respectively. The 2013 expense primarily related to the establishment of a valuation allowance against deferred tax assets primarily related to foreign tax credits of our APS Puerto Rico subsidiary. The 2012 benefit primarily relates to acceptance of amended returns for prior years that removed certain revenues from revenue-based state taxes that resulted in a reserve release of $2.6 million and the recording of a receivable of $3.6 million. In addition, the 2012 benefit includes a $1.2 million reserve release related to items on which the statute of limitations has expired.
Net premiums. Net premiums for the Medicare Advantage segment decreased by $2.2 million compared to the year ended December 31, 2012. In 2013, net premiums included $33.2 million of favorable prior period items compared to $34.4 million of favorable prior period items in 2012.
Medical expenses. Medical expenses increased by $44.9 million compared to the year ended December 31, 2012, increasing the medical benefit ratio to 85.1% for 2013 from 82.3% for 2012. During 2013, medical expenses included $9.9 million of net unfavorable items related to prior periods, compared to $7.0 million of net unfavorable items related to prior periods in 2012. 2013 medical expenses were also unfavorably impacted by an increase in inpatient and emergent care utilization in our non-HMO lines of business and an increase in the volume of large dollar claims in our HMO lines of business. In addition, $7.4 million, or 0.4% of the medical expense ratio, is related to the results of sequestration from the April-December period of 2013.
(1)Represents shared savings revenues received in 2014 related to program year 2012/2013.
Formerly included in our Corporate & Other segment, our MSO segment includes our CHS subsidiary, which collaborates with physicians and other healthcare professionals to operate ACOs under the MSSP. As of January 1, 2015 we sponsored twenty-four active ACOs in ten states previously approved for participation in the program by CMS. Based on data provided by CMS, these twenty-four ACOs currently include approximately 3,800 participating providers with approximately 285,000 assigned Medicare fee-for-service beneficiaries, both within and outside our current Medicare Advantage footprint, including southeast Texas and upstate New York. CHS provides these ACOs with care coordination, analytics and reporting, technology and other administrative capabilities to enable participating providers to deliver better care and lower healthcare costs for their Medicare fee-for-service beneficiaries. We have determined that we cannot consolidate the ACOs and therefore, include our share of their operating results in Equity in losses of unconsolidated subsidiaries on our Consolidated Statement of Operations. In the table above, we have presented our share of the results of the ACOs' revenues and expenses and combined that with the results of CHS so provide a better understanding of the results of operations.
Our MSO segment generated a loss before income taxes of $30.8 million for the year ended December 31, 2014; a decrease of $10.8 million compared to the year ended December 31, 2013. This improvement was driven by the receipt of $13.4 million of revenue in 2014 related to the initial ACO program period ended December 31, 2013, partially offset by an increase in ACO operating expenses as we had four new ACOs start up on January 1, 2014.
During September 2014, we received notice that the ACOs we formed in partnership with primary care physicians and other healthcare professionals generated $66 million in total program savings for CMS, as part of the MSSP for program years 2012 and 2013. Of our 30 ACOs with start dates in 2012 and 2013, the results showed that:
• 3 ACOs, serving more than 56,000 Medicare beneficiaries and including our largest ACO in Houston, generated savings in excess of their Minimum Savings Rate and therefore, qualified to share those savings with CMS;
On December 1, 2013, we acquired the Total Care Medicaid health plan. Total Care provides Medicaid managed care services to approximately 40,000 members in three counties in upstate New York that overlap with our existing Medicare Advantage footprint. Roughly 80% of its members are located in Onondaga County. In addition to the Medicaid program, Total Care also participates in the Child Health Plus program for low-income, uninsured children.
Our Medicaid segment generated income before income taxes of $2.6 million for the year ended December 31, 2014 compared to a loss of $0.5 million for the year ended December 31, 2013. This was due to 2013 consisting of only one month of activity that included approximately $0.6 million of acquisition related costs.
Our Traditional Insurance segment generated income before taxes of $2.5 million for 2014, a decrease of $8.4 million compared to 2013. The decrease in earnings is primarily driven by the reduction of business in-force combined with higher benefits ratios on our Specialty health lines which resulted in lower underwriting income. Additionally, operating expenses included higher consulting costs related to the transition and outsourcing of certain functions.
Commissions and general expenses, net of allowances. Commissions and general expenses, net of allowances, decreased by $4.1 million from 2013. This decrease is primarily attributed to lower commissions on less insurance in-force as well as lower costs required to run a smaller book of business in-force, partially offset by higher consulting costs related to the transition and outsourcing of certain functions.
Commissions and general expenses, net of allowances. Commissions and general expenses, net of allowances, decreased by $4.2 million from 2012. This decrease is primarily attributed to the decision to stop marketing and selling Traditional insurance products and lower costs required to run a smaller book of business in-force partially offset by higher consulting and outside services costs.
Corporate & Other includes the activities of our holding company, the operations of APS Healthcare since its acquisition on March 2, 2012, our participation in the Exchange and other ancillary operations. We are not participating in the Exchange for 2015.
The loss before income taxes from our Corporate & Other segment decreased by $184.7 million for the year ended December 31, 2014 compared to 2013. This was primarily due to asset impairment charges related to APS Healthcare in 2013 totaling $189.4 million, improved profitability of our APS Healthcare business, corporate expense reduction initiatives and higher net investment income, partially offset by higher legal and settlement costs related to our non-core business, primarily APS Healthcare, Traditional Insurance and our participation in the Exchange.
The following table details the loss before income taxes for our Corporate & Other segment:
Net premiums. Net premiums decreased by $0.7 million for the year ended December 31, 2014 compared to 2013. This was due to a decrease of $2.0 million in APS Healthcare premiums due to a smaller block of risk business partially offset by $1.3 million related to the Exchange product we
launched in upstate New York on January 1, 2014. The following table details net premiums for our Corporate & Other segment:
Fee and other income. Fee and other income decreased by $19.3 million for the year ended December 31, 2014 compared to 2013 primarily due to planned reductions in fee for service business at APS Healthcare and lower revenue in our corporate agencies. The following table details fee and other income for our Corporate & Other segment:
Amortization of intangible assets. This represents the amortization of APS Healthcare intangible assets. The decrease is primarily due to prior year impairment of APS Healthcare intangible assets, resulting in a lower asset balance being amortized.
Net premiums. Net premiums increased by $28.9 million for the year ended December 31, 2013 compared to 2012 due to 2013 including a full year of APS Healthcare results compared with ten months in 2012 as APS Healthcare was acquired on March 2, 2012.
Claims and other benefits. Claims and other benefits increased by $28.9 million for the year ended December 31, 2013 compared to 2012, due to 2013 including a full year of APS Healthcare results compared to ten months in 2012 as well as higher utilization levels in our APS Puerto Rico business.
Amortization of intangible assets. This represents the amortization of APS Healthcare intangible assets. The increase is primarily due to 2013 including a full year of APS Healthcare results compared to ten months in 2012.
Asset impairment charges. During calendar year 2013, we recorded asset impairment charges related to APS Healthcare of $189.4 million, which included impairments to goodwill of $164.8 million, amortizing intangibles of $16.1 million and tangible assets of $8.5 million. For additional information, see Note 8-Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements.
Commissions and general expenses. Total commissions and general expenses decreased by $4.9 million for the year ended December 31, 2013 compared to 2012. This was driven by a $15.2 million decrease at APS Healthcare primarily related to expense reduction initiatives and lower levels of business. General corporate expenses increased $10.4 million compared with 2012, primarily related to business development activities, legal costs related to APS Healthcare and restructuring charges. The following table details commissions and general expenses for our Corporate & Other segment:
Sources and Uses of Liquidity to the Parent Company, Universal American Corp. We require cash at our parent company to support the operations and growth of our HMO, insurance and other subsidiaries, fund new business opportunities through acquisitions or otherwise and pay the operating expenses necessary to function as a holding company, as applicable insurance department regulations require us to bear our own expenses.
• the cash flows of our ACO business and other growth initiatives-For 2014, we incurred losses of approximately $30.8 million, pre-tax, related to our ACO business. This includes 100% of program year 2014 operating expenses, net of our share of revenue related to program years 2012 and 2013, which amounted to $13.4 million. We received these revenue payments in October 2014.
• payment of dividends to holders of our mandatorily redeemable preferred shares-In 2014, we paid $3.4 million of dividends to holders of our mandatorily redeemable preferred shares. The $40 million face value of those shares cannot be redeemed prior to 2017, unless there is a change of control of the Company.
• payment of debt principal, interest and fees required under our 2012 Credit Facility-During 2014, we made interest payments totaling $2.8 million and other fee payments totaling $0.5 million. We were not required to make any principal payments as all scheduled 2014 principal payments, totaling $14.3 million, were prepaid in 2013, in connection with the amendment of our credit facility on November 4, 2013. Currently, there is a bullet payment of $74.9 million due in 2017. However, as a result of the recent subsidiary sale activity, under the 2012 Credit Facility, we have twelve months from receipt of the proceeds to either reinvest those proceeds or make a principal prepayment. If the proceeds are not reinvested, we would need to make prepayments totaling approximately $38 million by February 2016. We have elected to prepay $55 million on March 31, 2015, which will fulfill this obligation and provide additional restricted payment flexibility under the 2012 Credit Facility. We are required to ratably apply this prepayment and any other future prepayments through the remaining scheduled repayments, which would change the amount of the quarterly and bullet payments due through 2017.
• payment of certain corporate overhead costs and public company expenses, net of revenues which amounted to $30.7 million for the year ended December 31, 2014.
• repurchase of our common stock under our stock repurchase plan-On August 1, 2013, our Board of Directors authorized the repurchase of up to $40 million of our outstanding common stock. Purchases may occur from time to time in the open market, in privately negotiated transactions, or otherwise as market conditions permit. On May 13, 2014 we repurchased and retired six million shares of our common stock directly from funds associated with Capital Z Partners Management, LLC at a price of $6.03 per share. We used cash on hand to fund the repurchase of these shares.
• proceeds from the sale of subsidiaries-During 2014, we completed the sale of TOOK, generating cash proceeds of $15.2 million plus a receivable of $0.3 million, which was settled in cash in 2015. Additionally, in December 2014, we completed the sale of SCOK for $1.9 million in cash. In February 2015 we completed the sale of our APS Healthcare Puerto Rico subsidiaries for $26.5 million in cash.
The National Association of Insurance Commissioners, known as the NAIC, imposes regulatory risk-based capital, known as RBC, requirements on insurance companies. The level of RBC is calculated and reported annually. A number of remedial actions could be enforced if a company's total adjusted capital is less than 200% of authorized control level RBC. However, we generally consider
target surplus to be 350% of authorized control level RBC. At December 31, 2014, all but one of our insurance subsidiaries had total adjusted capital in excess of our target of 350% of authorized control level RBC. One insurance company fell below our target surplus with a 240% ratio, but still has total adjusted capital in excess of the NAIC's 200%. Excess capital can be used by the insurance and HMO subsidiaries to make dividend payments to their respective holding companies, subject to certain restrictions, and from there to our parent company.
Total Care. We require cash at Total Care to pay claims and other benefits for our members, to pay operating expenses, to maintain adequate capital levels. The primary sources of liquidity are premiums received from the New York Department of Health and members. Total Care is required to maintain a contingent reserve equal to a percentage of premium that grades from 7.25% for 2013, ultimately to 12.5%. At December 31, 2014, Total Care had net worth in excess of the contingent reserve requirements.
Investments. We invest primarily in fixed maturity securities of the U.S. Government and its agencies, U.S. state and local governments,
The average book yield of our total investment portfolio was 3.0% at December 31, 2014 and 3.3% at December 31, 2013. The decrease in our average book yield is principally driven by the greater percentage of our assets being held in lower yielding cash and cash equivalents as of December 31, 2014 versus the prior year end.
In connection with the amendment, we had prepaid all scheduled 2013 and 2014 principal payments, including the final 2013 payment due December 31, 2013 of $3.6 million and all 2014 scheduled payments totaling $14.3 million. We also paid fees and expenses of approximately $0.5 million in 2013.
Our consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles, known as GAAP. The preparation of our financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts of
claims on our life policies. We reinsure substantially all of our in force life insurance and annuity business under a 100% coinsurance treaty. A portion of our traditional business was not included in that reinsurance transaction, however much of that business is partially reinsured under separate treaties.
Our net retained reserves for life insurance products were $26.5 million, or 5% of our direct and assumed reserves for life insurance products, as of December 31, 2014. Our net retained reserves for life insurance products were $23.3 million, or 4% of our direct and assumed reserves for life insurance products, as of December 31, 2013.
For our fixed benefit accident and sickness and our long-term care products, we establish a reserve for future policy benefits at the time we issue each policy based on the present value of future benefit payments less the present value of future premiums. We have ceased issuing new long-term care policies, although our current policies are renewable annually at the discretion of the policyholder, as evidenced by the policyholder continuing to make premium payments. At policy issuance, these reserves are recognized on a net level premium method based on interest rates, mortality, morbidity, and maintenance expense assumptions. Interest rates are based on our expected net investment returns on the investment portfolio supporting the reserves for these blocks of business. Mortality, a measure of expected death, and morbidity, a measure of health status, assumptions are based on published actuarial tables, modified based upon actual experience. The assumptions used to determine the liability for future policy benefits are established and locked in at the time each contract is issued and only change if our expected future experience deteriorates to the point that the level of the liability, together with the present value of future gross premiums, are not adequate to provide for future expected policy benefits and maintenance costs (i.e. the loss recognition date). Because these policies have long-term claim payout periods, there is a greater risk of significant variability in claims costs, either positive or negative. We perform loss recognition tests at least annually in the fourth quarter, and more frequently if adverse events or changes in circumstances indicate that the level of the liability, together with the present value of future gross premiums, may not be adequate to provide for future expected policy benefits and maintenance costs.
primarily from a trend analysis based upon per member per month, known as PMPM, claims trends developed from our historical experience in the preceding months, adjusted for known changes in estimates of recent hospital and drug utilization data, provider contracting changes, changes in benefit levels, product mix, and seasonality.
• the inflationary effect on the cost per unit of each of these expense components.
Activity in the liability for policy and contract claims health is as follows:
The liability for policy and contract claims-health decreased from $166.5 million to $146.9 million during the year ended December 31, 2014. The decrease in the liability was primarily attributable to the decrease in IBNR for our Medicare Advantage business due to lower membership levels, including the effect of the sale of TOOK and SCOK.
The claim reserve balances at December 31, 2012 settled during 2013 for $5.9 million more than originally estimated. This prior year development represents less than 0.4% of the incurred claims recorded in 2012.
cost trend rates will develop differently from our historical patterns and therefore could be outside of the ranges illustrated below.
• other costs directly related to the specified acquisition activities that would not have been incurred had that contract acquisition transaction not occurred; and
• advertising costs meeting the capitalization criteria for direct- response advertising.
is subject to an annual impairment test. ASC 350, Goodwill and Other Intangible Assets, requires that goodwill balances be reviewed for impairment at the reporting unit level at least annually or more frequently if events occur or circumstances change that would indicate that a triggering event, as defined in ASC 350, has occurred. A reporting unit is defined as an operating segment or one level below an operating segment. Our reporting units are equivalent to our operating segments. We have goodwill assigned to our Medicare Advantage reporting unit. The goodwill related to the acquisition of APS Healthcare was included in our Corporate & Other segment prior to being written off in 2013.
We use a range of discount rates that correspond to a market based weighted average cost of capital. Discount rates are determined for each reporting unit based on the implied risk inherent in their forecasts. This risk is evaluated using comparisons to market information such as peer company weighted average costs of capital and peer company stock prices in the form of revenue and earnings multiples. The most significant estimates in the discount rate determinations include the risk free rates and equity risk premium. Company specific adjustments to discount rates are subjective and thus are difficult to measure with certainty.
(2)The goodwill in our Corporate & Other segment is associated with our APS Healthcare reporting units.
(4)Represents goodwill impairment charge related to APS Healthcare. See further discussion below.
During the quarter ended December 31, 2014, we performed our annual assessment of goodwill based on information as of October 1, 2014. We determined based on our "Step 1" impairment test that our estimated fair value of our Medicare Advantage reporting unit was in excess of its carrying value by 70%. We do not have goodwill assigned to any other reporting units.
• APS Healthcare failed to win certain new contracts that had previously been anticipated;
• APS Healthcare's Puerto Rico contract to provide managed behavioral health services under the Mi Salud program (the "APS Puerto Rico Contract"), which represented a significant portion of APS Healthcare's historical revenue was renewed, but at a lower rate than had previously been anticipated;
Based on the foregoing, we performed an interim impairment review as of June 30, 2013, that included lowered expectations for future revenue growth and new business development and a higher discount rate. Based on the results of the step one impairment test, we determined that as of June 30, 2013 the carrying value of APS Healthcare exceeded its fair value. We then proceeded to the second step of the impairment test to estimate the implied fair value of the APS Healthcare goodwill. This implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, that is, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the estimated fair value was the purchase price paid. Based on the June 30, 2013 step two analysis, the carrying amount of the APS Healthcare goodwill exceeded its implied fair value, resulting in a pre-tax impairment charge of $91.7 million, which we allocated on a pro rata basis between taxable and non-taxable goodwill.
The investment advisor uses their own rules-based pricing system to evaluate the prices it receives from various pricing vendors to ensure the data adheres to certain vendor-to-vendor and day-to-day variance tolerances. Exceptions to the rules are monitored, investigated and challenged, as needed. We review and test the security pricing procedures used to value our fixed maturity portfolio on an ongoing basis. Our procedures include review of the investment valuation policy and understanding of the procedures used to obtain investment valuations and review of pricing controls at our investment advisor, including their Statements on Standards for Attestation Engagements 16 controls review report. We also test the prices provided by the advisor monthly by comparing the data to another independent pricing source and monitoring the change in prices from month to month and upon sale of the security. Significant changes or variances are investigated and explained. During the year ended December 31, 2014, we did not modify any price provided by the advisor.
We regularly evaluate the amortized cost of our investments compared to the fair value of those investments. We generally recognize impairments of securities when we consider a decline in fair value
Our accounting policy, which follows ASC 320-65-1, requires that we assess a decline in the value of a security below its cost or amortized cost basis to determine if the decline is other-than-temporary.
• If we intend to sell a debt security, or it is more likely than not that we will be required to sell the debt security before recovery of its amortized cost basis, we recognize an other-than-temporary-impairment, or OTTI, in earnings equal to the entire difference between the debt security's amortized cost basis and its fair value.
Part C-Under the Medicare Advantage program, private plans provide Medicare-covered healthcare benefits to enrollees and can include prescription drug coverage. Part C benefits are provided through private HMO, PPO and PFFS plans. An individual must have Medicare Part A and Part B in order to join a Medicare Advantage Plan.
These programs are administered by CMS. These benefits are provided through HMO, PPO, PFFS and stand-alone Part D Plans in exchange for contractual risk-adjusted payments received from CMS. We contract with CMS under the Medicare program to provide a comprehensive array of health insurance and prescription drug benefits to Medicare eligible persons through our Medicare Advantage plans.
Policy and contract claims include actual claims reported but not paid and estimates of healthcare services and prescription drug claims incurred but not reported. The estimated claims incurred but not reported are based upon current enrollment, historical claim receipt and payment patterns, historical medical cost trends and health service utilization statistics. These estimates and assumptions are derived from and are continually evaluated using per member per month trend analysis, claims trends developed from our historical experience in the preceding month (adjusted for known changes in estimates of recent hospital and drug utilization data), provider contracting changes, benefit level changes, product mix and seasonality. These estimates are based on information available at the time the estimates are made, as well as anticipated future events. Actual results could differ materially from these estimates. We periodically evaluate our estimates, and as additional information becomes
available or actual amounts become determinable, we may revise the recorded estimates and reflect them in operating results.
Membership. We analyze the membership for our Medicare HMO, PPO and Network PFFS plans (collectively, the "Plans") in our administrative system and reconcile to the enrollment provided by CMS. There are timing differences between the addition of a member to our administrative system and the approval, or accretion, of the member by CMS. Additionally, the monthly payments from CMS include adjustments to reflect changes in the status of membership as a result of retroactive terminations, additions, whether CMS is secondary to other insurance coverage or other changes. Current period membership, net premium, CMS subsidies and claims expense are adjusted to reflect retroactive changes in membership.
CMS Direct Premium Subsidy. We receive a monthly premium from CMS based on the Plan year bid we submitted to CMS. The monthly payment is a risk-adjusted amount per member and is based upon the member's risk score status, as determined by CMS. The CMS premium is recognized over the contract period and reported as premium revenue. In addition, under Medicare Secondary Payer, or MSP provisions, the premium will be reduced by CMS if CMS has determined that it is secondary to other insurance coverage. Star rating quality bonus revenues are included in the CMS Direct Premium subsidy which is reported as premium revenue and recognized over the contract period.
Low-Income Cost Sharing Subsidy. For qualifying LIS members of our Plans with Part D benefits, CMS will reimburse the Plans for all or a portion of the LIS member's deductible, coinsurance and co-payment amounts above the out of pocket threshold for low income beneficiaries. Low-income cost sharing subsidies are paid by CMS prospectively as a fixed amount per member per month, and are determined based upon the Plan year bid we submitted to CMS. After the close of the annual Plan year, CMS reconciles actual experience to low-income cost sharing subsidies paid to the Plan and any differences are settled between CMS and the Plan. The low-income subsidy is accounted for as deposit accounting and therefore not recognized in operations.
CMS Risk Corridor Provisions for the Part D benefits of our HMO and PPO Plans. Premiums from CMS for members of our HMO and PPO Plans with Part D benefits are subject to risk corridor provisions. The CMS risk corridor calculation compares the target amount of prescription drug costs
(limited to costs under the standard coverage as defined by CMS) less rebates in our annual Plan bid (target amount) to actual experience. Variances of more than 5% above the target amount will result in CMS making additional payments to us, and variances of more than 5% below the target amount will require us to refund to CMS a portion of the premiums we received. Risk corridor payments due to or from CMS are estimated throughout the year and are recognized as adjustments to premium revenues and due and unpaid premiums. This estimate requires us to consider factors that may not be certain, including: membership, risk scores, prescription drug events, or PDEs, and rebates. After the close of the annual Plan year, CMS reconciles actual experience to the target amount and any differences are settled between CMS and the Plan.
Stipulated minimum MLRs-Beginning in 2014, the ACA stipulates a minimum medical loss ratio, or MLR, of 85% for Medicare Advantage plans. This MLR takes into account benefit costs, quality initiative expenses, the ACA fee and taxes. Financial and other penalties may result from failing to achieve the minimum MLR ratio. For the year ended December 31, 2014 our Medicare Advantage plans exceeded the minimum MLR, as defined by CMS.
We believe that the negative evidence of our cumulative loss is not indicative of future projected income or our ability to realize the deferred tax assets existing as of December 31, 2014. The remaining deferred tax assets, for which a valuation allowance was not established, relate to amounts that can be realized through future reversals of existing taxable temporary differences, prudent and feasible tax planning strategies and the Company's estimates of future taxable income. Any 2014 U.S. tax losses can be carried back to 2012 subject to certain limitations.
The significant acquired tax attributes that create deferred tax assets include net operating loss and foreign tax credit carryforwards. To use the foreign tax credit carryforwards, two conditions must be met. There must be foreign source income and there must be taxable income after application of any loss carryforwards. Based upon reversing timing items and projected income we expect taxable income to be sufficient to utilize the entire operating loss carryforward. However, we do not expect to have sufficient foreign source income to fully utilize the acquired foreign tax credit carryforwards. Consequently, we established a valuation allowance of $0.8 million against the foreign tax credit carryforwards as of December 31, 2014.
For the year ended December 31, 2014, we will file a consolidated federal income tax return that includes most corporate subsidiaries but excludes any subsidiary that qualifies as a life insurance company or is taxed as a partnership under the Internal Revenue Code, as well as our subsidiaries domiciled in Puerto Rico. Subsidiaries that qualify as life insurance companies and partnerships will file separate federal income tax returns and the Puerto Rico subsidiaries will file tax returns in Puerto Rico. We will include the taxable income or loss from a subsidiary taxed as a partnership in the tax return of its corporate owner.
At December 31, 2014, we had unrecognized tax benefits of $0.8 million, net of federal income tax, primarily related to refund claims filed in various state jurisdictions during 2010 and various pre-acquisition benefits related to APS Healthcare. During the years ended December 31, 2014, 2013 and 2012, we recognized $0.7 million, $1.3 million and $8.9 million, respectively, of refund claims filed in 2010.
We recognize interest and penalties related to unrecognized tax benefits in federal and state tax expense. During the year ended December 31, 2014, we recognized no such interest expense and penalties. During the years ended December 31, 2013 and 2012, we recognized $0.5 million and $0.6 million, respectively, of interest expense and penalties.