Through our SEA Division, we offer a broad range of health insurance products for individuals, families, the self-employed and small businesses. Our plans are designed to accommodate individual needs and include basic hospital-medical expense plans, plans with preferred provider organization (“PPO”) features, catastrophic hospital expense plans, as well as other supplemental types of coverage.
The Master Agreement and Coinsurance Agreements provide for certain financial settlements following the Closing Date, including, without limitation, settlements with respect to the cash transferred to Wilton for statutory reserves and liabilities corresponding to the Coinsured Policies, and the cash flows arising out of the Coinsured Policies between the Coinsurance Effective Date and the Closing Date. We are currently in the process of resolving the financial settlements with Wilton; however, there can be no assurance that the financial settlements will be favorably resolved. The failure to favorably resolve the financial settlements could result in additional expense recorded; however, we do not currently believe that the outcome of the financial settlements will have a material adverse effect on the Company’s financial condition and results of operations.
In July 2006 and December 2006, in two separate transactions, we sold the assets comprising our former Star HRG Division and our former Student Insurance Division. In connection with these sales, we recorded an aggregate
As part of the sale transactions, insurance subsidiaries of the Company entered into 100% coinsurance arrangements with each of the purchasers, pursuant to which (a) the purchasers agreed to assume liability for all future claims associated with the policies in force as of the respective closing dates and (b) the Company’s insurance subsidiaries transferred to the purchasers cash in an amount equal to the actuarial estimate of those future claims. While under the terms of the coinsurance agreements the Company’s insurance subsidiaries have recorded a ceded liability for all future claims made on the insurance policies in force at the closing date, as the insurance subsidiaries remain primarily liable on those policies. Accordingly, at December 31, 2008 and 2007 the Company continues to report the policy liabilities ceded to and assumed by the purchasers under the coinsurance agreements as “Policy liabilities”, with a corresponding “Reinsurance recoverable - ceded policy liabilities” asset on its consolidated balance sheet. In addition, the Company will continue to report in future periods the residual results of operations of these businesses (anticipated to consist solely of residual wind-down expenses and any true-up provision associated with the sales, primarily of the Student Insurance Division) in continuing operations and classified as Disposed Operations. See Note 2 of Notes to Consolidated Financial Statements for additional information regarding the terms of the sales of the Star HRG Division and Student Insurance Division assets.
The table below sets forth premium by insurance division for each of the three most recent fiscal years (excluding for all periods presented premium associated with our former Life Insurance Division, Star HRG Division and Student Insurance Division):
The following is a comparative discussion of results of operations for the Company’s business segments and divisions - the Insurance segment, Corporate and Disposed Operations, which consists of the Life Insurance Division, the Student Insurance Division and the Star HRG Division.
Revenues and income (loss) from continuing operations before federal income taxes (“operating income (loss)”) for each of the Company’s business segments and divisions in 2008, 2007 and 2006 was as follows:
The Insurance segment includes the Company’s SEA Division, the Medicare Division and Other Insurance Division. Management reviews results of operations for the Insurance segment by reviewing each of the above mentioned divisions.
Set forth below is certain summary financial and operating data for the Company’s SEA Division for each of the three most recent fiscal years:
For 2008, the SEA Division reported operating income of $55.6 million compared to $150.4 million in 2007, a decrease of $94.8 million or 63.0%. The decrease in operating income is primarily attributable to a decrease in earned premium revenue of 11.1% and a decrease in investment and other income of 20.5%, which was slightly offset by a decrease in total expenses of 6.0%. Operating income in the SEA Division as a percentage of earned premium revenue (i.e., operating margin) in 2008 was 4.9% compared to 11.7% in 2007.
Earned premium revenue at the SEA Division was $1.1 billion in 2008 compared to $1.3 billion in 2007, a decrease of $141.8 million or 11.1%. This decrease is primarily attributable to a decrease in submitted annualized premium volume and a decrease in the average number of policies in force during the year. With respect to submitted annualized premium volume, the Company experienced a decrease of $218.8 million, or 32.2% in 2008 from $680.1 million in 2007 to $461.3 million in 2008. The decrease in earned premium revenue reflects an attrition rate that exceeds the pace of new sales. With respect to new sales, the Company is experiencing increased competition in the marketplace, as well as a decrease of approximately 32.6% in the average number of writing agents in our dedicated agency sales force. In addition, there was an increased focus, particularly in the first quarter of 2008, on our new Medicare products offered, which led to a decreased focus on our core health products in the SEA Division. The Company exited the Medicare Advantage marketplace on December 31, 2008 and its focus for 2009 will return to the Company’s core health products. With respect to the average number of polices in force during the year, the decrease is attributable to a decrease in new policies issued during 2008 compared to prior year and lower persistency on existing policies. Total policies in force decreased by 42,700 policies or 13.2% during the year to approximately 281,700 during 2008 as compared to approximately 324,400 during 2007.
Earned premium revenue at the SEA Division decreased by $48.0 million or 3.6% to $1.3 billion in 2007 compared to $1.3 billion in 2006. This decrease in earned premium revenue was primarily attributable to a slight decrease in policy persistency rates, a decline in submitted annualized premium volume, and a decrease in the conversion rate of submitted policies to issue policies. The period over period decrease in submitted annualized premium volume was due to a decrease in the average number of writing agents in the field from 2,143 during 2006 to 1,874 during 2007. In addition, the productivity of the writing agents decreased 6.6% based on the average number of weekly applications submitted per writing agent. The decrease in conversion experience on submitted policies was at least partly expected as it reflects the implementation of more rigorous underwriting procedures.
Benefits expense increased in 2007 compared to 2006 as reflected in the loss ratio of 57.4% versus 54.3%, respectively. The increase in the loss ratio reflects an ongoing gradual shift in product mix to the Company’s CareOne product suite and other PPO products which are designed to provide a higher proportion of premium
Underwriting, acquisition and insurance expenses increased to $478.1 million in 2007 from $444.0 million in 2006, an increase of $34.1 million or 7.7%. In 2007, the Company recognized a $20.0 million expense associated with the potential settlement of the multi-state market conduct examination (See Note 16 of Notes to Consolidated Financial Statements) and an $8.0 million asset impairment charge in 2007 associated with two technology assets that we determined were no longer of value to the Company. In addition, we incurred consulting and professional fees for various operational and technology focused initiatives that were new in 2007.
Set forth below is certain summary financial and operating data for the Company’s Medicare Division for each of the two most recent fiscal years:
Expense ratio. The expense ratio represents underwriting, acquisition and insurance expenses as a percentage of earned premium revenue.
In 2007, we initiated efforts to expand into the Medicare market. In the fourth quarter of 2007, we began offering a new portfolio of Medicare Advantage PFFS - called HMCA Plans - in selected markets in 29 states with calendar year coverage effective for January 1, 2008. Policies were issued by our Chesapeake subsidiary, under a contract with CMS.
In July 2008, the Company decided that it would not participate in the Medicare Advantage marketplace beyond the current year. The Company will continue to fulfill its remaining obligation under the 2008 calendar year Medicare contract.
The Medicare Division produced $96.4 million in earned premium in 2008 on 118,961 member months. The Company had approximately 9,975 enrolled members as of December 31, 2008. Benefit expenses for 2008 of $80.3 million resulted in a loss ratio of 83.3% consistent with the Company’s expectations after adjusting for the actual member risk scores as provided by CMS. Underwriting, acquisition and insurance expenses of $31.3 million for 2008 and $12.4 for 2007 include commissions, marketing costs, and all administrative and operating costs.
In connection with its exit from the Medicare market, the Company also incurred employee termination costs of $2.8 million and recorded asset impairment charges of $1.1 million for 2008, which were recorded in “Underwriting, acquisition and insurance expenses” on the consolidated statement of income (loss). The asset impairment charges were primarily related to certain Medicare specific technology projects in development. The Company believes that its exit from the Medicare market will not, in the aggregate, have a material adverse effect on the Company’s consolidated financial position, but may potentially have a material adverse effect on the results of operations or cash flows in any given accounting period.
Our Other Insurance Division consists of ZON Re, which underwrites, administers and issues accidental death, accidental death and dismemberment, accident medical, and accident disability insurance products, both on a primary and on a reinsurance basis. We expect to exit this line of business in 2009, with the existing reinsurance business managed to final termination of substantially all liabilities.
In 2008, ZON Re generated operating income of $4.4 million compared to $7.9 million in 2007, a decrease of $3.5 million or 44.3%. The results for 2008 reflect adverse claim experience, in particular the impact of a large catastrophic claim on reinsured excess loss business in the amount of $2.3 million. The decrease in underwriting, acquisition and insurance expenses for the current year includes a decrease in the incentive compensation plan tied to the current period profitability and a decrease in litigation expenses compared to the prior year periods.
Earned premium revenue decreased by $3.9 million or 11.5% to $30.0 million in 2007 compared to $33.9 million in 2006. During 2007, we experienced an increase in competitive pressure, which impacted new and renewal business.
Benefits expenses decreased in both dollars and in relation to earned premium revenue as expressed by the loss ratio of 42.2% in 2007, or 23.7% lower than the loss ratio in 2006 of 55.3%. The reduction in the loss ratio in 2007 reflected favorable claim experience in the current year including refinements to the reserve calculations.
Corporate includes investment income not otherwise allocated to the Insurance segment, realized gains and losses on sale of investments, interest expense on corporate debt, variable stock-based compensation and general expenses relating to corporate operations. In 2006, the incremental costs associated with the acquisition of the Company by the Private Equity Investors were reported in Corporate.
Corporate reported an operating loss in 2008 of $98.8 million, compared to operating loss of $31.3 million in 2007.
Interest expense on corporate debt decreased $1.9 million from $43.6 million in 2007 to $41.7 million in 2008. The decrease is due to a lower outstanding principal balance in 2008 on corporate debt reflecting a $75.0 million principal payment in the second quarter of 2007. However, the Company incurred additional interest expense of $3.1 million during 2008 associated with the use of the cash transferred to Wilton during the period from the Coinsurance Effective Date of the Life Insurance Division transaction (July 1, 2008) and the actual Closing Date (September 30, 2008).
The Company recognized realized losses of $20.5 million during 2008 as compared to realized gains of $5.2 million during 2007. Realized losses for 2008 were primarily due to impairment charges recognized on certain fixed maturities investments of $26.0 million. These impairment charges resulted from other than temporary reductions in the fair value of these investments compared to the Company’s cost basis. See Note 4 of Notes to Consolidated Financial Statements for additional information. Additionally, realized losses for 2008 includes $8.5 million of losses related to the Coinsurance Agreements entered into in connection with the Life Insurance Division, which was partially offset by the realization of $5.5 million of contingent consideration associated with the sale of the former Student Insurance Division. See Note 2 of Notes to Consolidated Financial Statements for additional information.
We maintain, for the benefit of our independent agents, various stock-based compensation plans. In connection with these plans, we record a non-cash variable stock-based compensation benefit or expense based on the
General corporate expenses increased $27.5 million from $31.1 million during 2007 to $58.7 million during 2008. The increase is primarily due to $19.2 million of employee termination costs incurred during 2008 associated with the departure of several corporate executives, as well as additional employee termination costs associated with the strategic reduction of our remaining workforce implemented on November 18, 2008. Additional expenses included in general corporate expenses for 2008 include $6.5 million of broker, legal and transaction fees related to the Life Insurance Division transaction.
Corporate reported an operating loss in 2007 of $31.3 million, compared to operating income of $89.1 million in 2006. On a comparative basis, the 2006 results were particularly impacted by the total $201.7 million of gains resulting from the sales of the Star HRG and Student Insurance Divisions partially offset by the $48.0 million of Merger costs.
In 2007, we recognized a benefit of $482,000 in connection with variable stock-based compensation as compared to an expense of $16.6 million in 2006. These results primarily reflect a decrease in the fair value of our common stock on December 31, 2007 as compared to December 31, 2006.
General corporate expenses of $31.1 million in 2007 represented a $15.0 million decrease from the $46.1 million spent in 2006. The 2006 results included substantially more costs for a corporate branding initiative and other professional fees incurred for various special projects that were undertaken following the Merger.
Our Disposed Operations segment includes the former Life Insurance Division, former Star HRG Division and former Student Insurance Division.
On September 30, 2008, the Company exited the Life Insurance Division business through a reinsurance transaction effective July 1, 2009. On July 11, 2006 and December 1, 2006, the Company completed the sales of the assets formerly comprising its Star HRG and Student Insurance Divisions, respectively. See Note 2 of Notes to Consolidated Financial Statements.
Set forth below is certain summary financial and operating data for the Company’s Life Insurance Division for the years ended December 31, 2008, 2007 and 2006:
Effective July 1, 2008, Wilton agreed to reinsure on a 100% coinsurance basis substantially all of the insurance policies associated with the Company’s former Life Insurance Division business. As such, the results of operations for 2008 are not comparable to results of operations for 2007 and 2006.
In 2007, the Company’s Life Insurance Division generated annualized paid premium volume (i.e., the aggregate annualized life premium amount associated with new life insurance policies issued by the company) of $18.4 million compared to $20.0 million in 2006.
The Company’s Student Insurance Division (which offered tailored health insurance programs that generally provided single school year coverage to individual students at colleges and universities) reported an operating loss of $359,000 in 2008 and operating income of $192,000 in 2007 and $12.2 million in 2006. Very little activity has occurred in the Student Insurance Division since the sale on December 1, 2006.
The Company’s Star HRG Division reported operating income of $118,000 in 2008, $199,000 in 2007 and $2.3 million in 2006. Very little activity has occurred in the Star HRG Division since it was sold on July 11, 2006.
We regularly monitor our liquidity position, including cash levels, credit line, principal investment commitments, interest and principal payments on debt, capital expenditures and matters relating to liquidity and to
compliance with regulatory requirements. We maintain a line of credit in excess of anticipated liquidity requirements. As of December 31, 2008, HealthMarkets had a $75 million unused line of credit available to it.
HealthMarkets, Inc. is a holding company, the principal asset of which is its investment in its wholly owned subsidiary, HealthMarkets, LLC (collectively referred to as the “holding company”). The holding company’s ability to fund its cash requirements is largely dependent upon its ability to access cash, by means of dividends or other means, from HealthMarkets, LLC. HealthMarkets, LLC’s principal assets are its investments in its separate operating subsidiaries, including its regulated insurance subsidiaries.
At December 31, 2008, 2007 and 2006, the aggregate cash and cash equivalents and short-term investments held at HealthMarkets, Inc. and HealthMarkets, LLC was $232.1 million, $42.5 million and $311.5 million, respectively. Set forth below is a summary statement of aggregate cash flows for HealthMarkets, Inc. and HealthMarkets, LLC for each of the three most recent years:
During 2008, 2007 and 2006, the holding company received an aggregate of $283.2 million, $176.2 million and $221.8 million, respectively, in cash dividends from our subsidiaries.
On April 5, 2006, the holding company received $985.0 million for the purchase of common stock by the Private Equity Investors in connection with the Merger.
In April 2006, the holding company utilized proceeds from additional indebtedness of $600.0 million, consisting of $500.0 million under a term loan credit facility and $100.0 million of Floating Rate Junior Subordinated Notes to finance the Merger.
During 2006, the holding company received a total of $144.3 million in distributions from the non-consolidated qualifying special purpose entity, Grapevine Finance LLC. Of this total, $72.4 million resulted from a principal repayment by CIGNA on the $150.8 million note issued as consideration in the sale of Star HRG. The other $71.9 million resulted from Grapevine’s issuance of senior secured notes.
During 2008, 2007 and 2006, the holding company paid $58.1 million, $41.5 million and $8.7 million, respectively, to repurchase shares of its common stock from former officers and former and current participants of the agent stock plans.
During 2007 and 2006, the holding company made principal prepayments of $75.0 million and $62.5 million, respectively, on the term loan.
In connection with the Merger, on April 15, 2006, the holding company utilized $1.6 billion to repurchase 43,567,252 shares of its common stock. Additionally, the holding company expended significant amounts of cash for expenses related to the Merger totaling $120.9 million.
Set forth below is a summary of the Company’s consolidated contractual obligations at December 31, 2008:
At each of December 31, 2008 and 2007, the Company had $33.9 million and $14.3 million, respectively, of letters of credit outstanding relating to its insurance operations.
The Company’s discussion and analysis of its consolidated financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to health and life insurance claims, bad debts, investments, intangible assets, income taxes, financing operations and contingencies and litigation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
the amount of claims liabilities expected to be paid in future periods;
reserves for contingencies, including reserves for losses in connection with unresolved legal matters; and
The Company has classified its investments in securities with fixed maturities as either “available for sale” or “trading.” Fixed maturities classified as available for sale and equity securities have been recorded at fair value, and unrealized investment gains and losses are reflected in stockholders’ equity. Trading investments have been recorded at fair value, and investment gains and losses are reflected in “Realized gains (losses)” on the statement of income (loss).
On August 3, 2006, Grapevine was incorporated in the State of Delaware as a wholly owned subsidiary of HealthMarkets, LLC. On August 16, 2006, the Company distributed and assigned to Grapevine the $150.8 million promissory note (“CIGNA Note”) and related Guaranty Agreement issued by Connecticut General Corporation in the Star HRG sale transaction. See Note 10 of Notes to Consolidated Financial Statements. On August 16, 2006, Grapevine issued $72.4 million of its senior secured notes to an institutional purchaser collateralized by Grapevine’s
Grapevine is a non-consolidated qualifying special purpose entity as defined in SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. As a qualifying special purpose entity, HealthMarkets does not consolidate the financial results of Grapevine. Instead, the Company accounts for its residual interest in Grapevine as an investment in fixed maturity securities pursuant to EITF 99-20, Recognition of Interest Income and Impairment on Purchase and Retained Beneficial Interests in Securitized Financial Assets.
As discussed in more detail below, the determination of fair value for certain assets and liabilities may require the application of a greater degree of judgment given current market conditions, as the ability to value assets can be significantly impacted by a decrease in market activity. The Company evaluates the various types of securities in its investment portfolio to determine the appropriate level in the fair value hierarchy based upon trading activity and the observability of market inputs. The Company employs control processes to validate the reasonableness of the fair value estimates of its assets and liabilities, including those estimates based on prices and quotes obtained from independent third party sources. The Company’s procedures generally include, but are not limited to, initial and on-going evaluation of methodologies used by independent third parties and monthly analytical reviews of the prices against current pricing trends and statistics.
Where possible, the Company utilizes quoted market prices to measure fair value. For investments that have quoted market prices in active markets, the Company uses the quoted market price as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices in active markets are unavailable, the Company determines fair values using various valuation techniques and models based on a range of observable market inputs including pricing models, quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, prepayment speeds, default rates and discounted cash flow. In most cases, these estimates are determined based on independent third party valuation information, and the amounts are disclosed in Level 2 of the fair value hierarchy. Generally, the Company obtains a single price or quote per instrument from independent third parties to assist in establishing the fair value of these investments.
For the majority of health insurance products in the SEA Division, the Company’s claim liabilities are estimated using the developmental method, which involves the use of completion factors for most incurral months, supplemented with additional estimation techniques, such as loss ratio estimates, in the most recent incurral months. This method applies completion factors to claim payments in order to estimate the ultimate amount of the claim. These completion factors are derived from historical experience and are dependent on the incurred dates of the claim, as well as the dates a payment is made against the claim. The completion factors are selected so that they are equally likely to be redundant as deficient.
The Company establishes the claims liability dependent upon the incurred dates, with certain adjustments, as described below. With respect to the SEA Division, for certain products introduced prior to 2008, claims liabilities for the cost of all medical services related to a distinct accident or sickness are recorded at the earliest date of diagnosis or treatment, even though the medical services associated with such accident or sickness might not be rendered to the insured until a later financial reporting period. A break in occurrence of a covered benefit service of
more than six months will result in the establishment of a new incurred date for subsequent services. A new incurred date is established if claims payments continue for more than thirty-six months without a six month break in service.
With respect to Other Insurance, the Company assigns incurred dates based on the date of loss, which estimates the liability for all payments related to a loss at the end of the applicable financial period in which the loss occurs.
Impact due to change in completion factors for incurred months prior to the most recent five months.
Set forth below is a summary of claim liabilities by business unit at each of December 31, 2008, 2007 and 2006:
Reflects claims liabilities associated with the Company’s former Life Insurance Division, former Student Insurance Division and former Star HRG Division. The claims liabilities remaining at December 31, 2008, 2007 and 2006 primarily represent the liability associated with a closed block of workers’ compensation business previously offered by the Company through its former Life Insurance Division.
The developmental method used by the Company to estimate most of its claim liabilities produces a single estimate of reserves for both in course of settlement (“ICOS”) and incurred but not reported (“IBNR”) claims on an integrated basis. Since the IBNR portion of the claim liability represents claims that have not been reported to the Company, this portion of the liability is inherently more imprecise and difficult to estimate than other liabilities. A separate IBNR or ICOS reserve is estimated from the combined reserve by allocating a portion of the combined reserve based on historical payment patterns. Approximately 81-83% of the Company’s claim liabilities represent IBNR claims.
Reflects incurred claims liabilities associated with the Company’s former Life Insurance Division, former Student Insurance Division and former Star HRG Division.
For the SEA Division, the favorable claims liability development experience in the prior year’s reserve for each of the years ended December 31, 2008, 2007, and 2006 is set forth in the table below by source:
Development in the most recent incurral months and development in completion factors
The Accumulated Covered Expense (“ACE”) rider is an optional benefit rider available with certain scheduled/basic health insurance products that provides for catastrophic coverage for covered expenses under the contract that generally exceed $100,000 or, in certain cases, $75,000. This rider pays benefits at 100% after the stop loss amount is reached up to the aggregate maximum amount of the contract for expenses covered by the rider. Development in the ACE rider is presented separately due to the greater level of volatility in the ACE product resulting from the nature of the benefit design where there are less frequent claims but larger dollar value claims. The development experience presented in the table above is largely attributable to development in the most recent incurral months and development in the completion factors. See discussion below regarding Changes in the SEA Claim Liability Estimates.
In 2008 and 2007, the SEA Division benefited from favorable development in its claim liability of $149,000 and $6.7 million, respectively, related to its reserve for benefits provided through group blanket contracts to the members of certain associations. These contracts were terminated at the end of 2006 and the Company’s subsequent actual experience was favorable in comparison to the reserve estimates established prior to the termination of the contracts.
During 2006, the Company determined that sufficient provision for large claims could be made within its normal reserve process, thus eliminating the need for the separate large claim reserve and producing favorable development in the amount of $10.6 million. Since this reserve was eliminated in 2006, there is no development, either favorable or unfavorable, related to this reserve in either 2008 or 2007.
The remaining favorable development in the prior year’s claim liability was $235,000, $4.7 million and $4.2 million in 2008, 2007, and 2006, respectively, which in each year represents less than 1.1% of the total claim liability established at the end of each preceding year.
During 2008 and 2007, the development of the claim liabilities for the Disposed Operations showed a small unfavorable development of $79,000 and a small favorable development of $206,000, respectively. The products of the Company’s former Student Insurance and Star HRG Divisions consist principally of health insurance. In general, health insurance business, for which incurred dates are assigned based on date of service, has a “short tail,” which means that a favorable development or unfavorable development shown for prior years relates primarily to actual experience in the most recent prior year. Also included in Disposed Operations is the development experience for each of the years presented of a closed block of workers’ compensation business at the former Life Insurance Division.
As discussed above, the SEA Division reported particularly favorable experience development on claims incurred in prior years in the reported values of subsequent years. As discussed below, a significant portion of the favorable experience development was attributable to the recognition of the patterns used in establishing the completion factors that were no longer reflective of the expected future patterns that underlie the claim liability.
In response to evaluating these results, the Company has recognized the nature of its business is constantly changing. As such, HealthMarkets has refined its estimates and assumptions used in calculating the claim liability estimate to regularly accommodate the changing patterns immediately as they emerge.
As a result of these efforts, no additional refinements to the claim liability estimation techniques were found to be necessary during 2008 over and above the regular update of the completion factors, the impact of which are included in the benefit expense of the period in which the update occurred.
The Company reduced the claim liability estimate by $11.2 million due to refinements of the estimate of the unpaid claim liability for the most recent incurral months. This update to the calculation distinguished between more mature products with reliable historical data and newer or lower volume products that had not established a reliable historical trend.
During 2006, the Company reduced the claim liability estimate by a total of $25.1 million for the ACE rider. These reductions were attributable to an update of the completion factors used in estimating the claim liability, reflecting both actual historical data for the ACE rider and historical data derived from other products. In 2005, the completion factors were calculated with more emphasis placed on historical data derived from other products since there was insufficient data related to the ACE product rider to provide accurate and reliable completion factors.
The cost of business acquired through acquisition of subsidiaries or blocks of business is determined based upon estimates of the future profits inherent in the business acquired. Such costs are capitalized and amortized over the estimated premium-paying period. Anticipated investment income is considered in determining whether a premium deficiency exists. The amortization period is adjusted when estimates of current or future gross profits to be realized from a group of products are revised. We monitor and assess the recoverability of these capitalized costs on a quarterly basis and, as of December 31, 2008, we believe these costs are recoverable. Traditionally, such costs have been primarily related to acquisitions by the Company’s former Life Insurance Division. At December 31, 2008, the Company did not have any remaining capitalized costs related to the cost of business acquired through acquisition of subsidiaries or blocks of business.
The Company accounts for goodwill and other intangibles according to Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). SFAS No. 142 requires that goodwill and other intangible assets with indefinite useful lives be tested for impairment at least annually or more frequently if certain indicators arise. An impairment loss would be recorded in the period such determination was made. SFAS No. 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment. The Company amortizes its intangible assets with estimable useful lives over a period ranging from five to twenty-five years. See Note 5 of Notes to Consolidated Financial Statements.
The Company sponsors a series of stock accumulation plans (the “Agent Plans”) established for the benefit of its independent insurance agents and independent sales representatives. Unvested benefits under the agent plans
vest in January of each year. The Company has established a liability for future unvested benefits under the Agent Plans and adjusts such liability based on the fair value of the Company’s common stock. As such, the Company has experienced, and will continue to experience, unpredictable stock-based compensation charges, depending upon fluctuations in the fair value of HealthMarkets Class A-2 common stock. These unpredictable fluctuations in stock based compensation charges may result in material non-cash fluctuations in the Company’s results of operations. See discussion above under the caption “Variable Stock-Based Compensation” and Note 13 of Notes to Consolidated Financial Statements.
The Company is subject to proceedings and lawsuits related to insurance claims and other matters. See Note 16 of Notes to Consolidated Financial Statements. The Company is required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of accruals required, if any, for these contingencies is made after careful analysis of each individual issue. The required accruals may change in the future due to new developments in each matter or changes in approach, such as a change in settlement strategy in dealing with these matters.
The Company encounters risk in the normal course of business and therefore we have designed risk management processes to help manage such risks. The Company is subject to varying degrees of market risks, inflation risk, operational risks and liquidity risks (see “ Liquidity and Capital Resources” discussion above) and monitors these risks on a consolidated basis.
In this sensitivity analysis model, the Company uses fair values to measure its potential loss. The primary market risk to the Company’s market sensitive instruments is interest rate risk. The sensitivity analysis model uses a 100 basis point change in interest rates to measure the hypothetical change in fair value of financial instruments included in the model. For invested assets, duration modeling is used to calculate changes in fair values. Duration on invested assets is adjusted to call, put and interest rate reset features.
The sensitivity analysis model increases the loss in fair value of market sensitive instruments by $41.7 million based on a 100 basis point increase in interest rates as of December 31, 2008. This loss value only reflects the impact of an interest rate increase on the fair value of the Company’s financial instruments.
The Company uses interest rate swaps as part of its risk management activities to protect against the risk of changes in prevailing interest rates adversely affecting future cash flows associated with $300.0 million of the $362.5 million term loan debt. Approximately $129.5 million of the Company’s remaining outstanding debt at December 31, 2008, was exposed to the fluctuation of the three-month London Inter-bank Offer Rate (LIBOR). The sensitivity analysis shows that if the three-month LIBOR rate changed by 100 basis points (1%), the Company’s interest expense would change by approximately $1.3 million.
Fixed maturity securities represented 78.3% and 88.0% of the Company’s total investments at December 31, 2008 and 2007, respectively. Fixed maturity securities at December 31, 2008 consisted of the following:
Represents security received from the purchaser as consideration upon sale of the Company’s former Student Insurance Division on December 1, 2006. To reduce the Company’s credit risk, the Company has taken out $75.0 million of credit default insurance on this security, reducing the Company’s default exposure to $19.8 million.
Operational risk is inherent in our business and may, for example, manifest itself in the form of errors, breaches in the system of internal controls, business interruptions, fraud or legal actions due to operating deficiencies or noncompliance with regulatory requirements. The Company maintains a framework including policies and a system of internal controls designed to monitor and manage operational risk and provide management with timely and accurate information.
See “Recently Issued Accounting Pronouncements” in Note 1 of Notes to Consolidated Financial Statements for information regarding new accounting pronouncements.