While management considers a wide range of factors in its strategic planning, the overriding consideration is underwriting profitability. Management's assessment of trends in healthcare and in the medical stop-loss market play a significant role in determining whether to expand Independence American's health insurance premiums. Since Independence American reinsures a portion of all of the business produced by our MGUs, and since these companies are also eligible to earn profit sharing commissions based on the profitability of the business they place, our MGUs also emphasize underwriting profitability. In addition, management focuses on controlling operating costs. By sharing employees with IHC and sharing resources among our subsidiaries, we strive to maximize our earnings.
Net income per share decreased to $.11 per share, diluted, or $1.0 million, for the year ended December 31, 2008, compared to $.13 per share, diluted, or $1.1 million for the year ended December 31, 2007.
Premiums earned decreased 9% to $97.0 million for the year ended December 31, 2008 from $106.1 million for the year ended December 31, 2007, primarily due to a decrease in stop-loss and fully insured health premiums assumed from IHC, offset by an increase in direct fully insured health premiums and the additional premiums written by IPA (see Note 3 of Notes to Consolidated Financial Statements).
For the year ended December 31, 2008, Independence American wrote $4.3 million of individual health business produced by our marketing organization IPA, and ceded 50% to a third-party reinsurer.
Expense ratio represents net commissions (including profit commissions), administrative fees, premium taxes and other underwriting expenses divided by premiums earned.
On April 1, 2008, the Company purchased the remaining 20% interest in Marlton, thereby increasing our interest in this medical stop-loss MGU to 100% (see Note 3 of Notes to Consolidated Financial Statements).
The Company maintains loss reserves to cover its estimated liability for unpaid losses and loss adjustment expenses, where material, including legal and other fees, for reported and unreported claims incurred as of the end of each accounting period. These loss reserves are based on actuarial assumptions and are
The Company reviews its investment securities regularly and determines whether other than temporary impairments have occurred. If a decline in fair value is judged by management to be other than temporary, a loss is recognized by a charge to net realized investment gains in the Consolidated Statements of Operations, establishing a new cost basis for the security. The factors considered by management in its regular review include, but are not limited to: the length of time and extent to which the fair value has been less than cost; the financial condition and near-term prospects of the issuer; adverse changes in ratings announced by one or more rating agencies; whether the issuer of a debt security has remained current on principal and interest payments;
Goodwill and intangible assets with indefinite lives, which consist of licenses, are not amortized but are evaluated for impairment in the aggregate at the end of the fourth quarter of each year, or more frequently if indicators arise. If the fair value of a reporting unit is less than its carrying amount (including goodwill), further evaluation is required to determine if a write-down of goodwill is required. Any impairment write-down of goodwill would be charged to expense. No impairment charge was required in 2008 or 2007. If the Company experiences a sustained decline in its results of operations and cash flows, or other indicators of impairment exist, the Company 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.
Results of Operations for the Year Ended December 31, 2008, Compared to the Year Ended December 31, 2007
Information by line of business for the years ended December 31, 2008 and 2007 is as follows:
respectively. The increase is primarily due to an increase in premiums written by Independence American, offset by a net decrease in group major medical and STM premiums assumed from IHC. Premiums relating to DBL were $3,435,000 and $3,481,000 for 2008 and 2007, respectively, a decrease due to a reduction in rates. For 2008, Independence American assumed 10% of IHC’s STM business, 8.8% of certain of IHC’s group major medical business, 20% of IHC’s DBL business and approximately 23% of IHC’s medical stop-loss business. There were no significant changes to these percentages from the prior year.
Net Investment Income. Net investment income decreased $84,000 to $3,527,000 for 2008, compared to $3,611,000 for 2007 due to lower average investible assets as a result of the Marlton and IPA acquisitions in the second quarter of 2008, and a lower return on investments. The return on investments of the Company was 5.3% and 5.4% for 2008 and 2007, respectively.
Net Realized Investment Gains (Losses). The Company recorded a net realized investment loss of $2,902,000 for 2008, compared to a gain of $321,000 for 2007. For 2008 and 2007, the Company recorded a loss of $1,006,000 and $0, respectively, for other-than-temporary impairments. The loss of $1,006,000 for 2008 represents a loss on bonds and preferred stock that the Company determined to be other-than-temporary due to the severity of the decrease in fair values and the length of time that these securities were in a loss position. In the fourth quarter of 2008, the Company became aware of certain activities engaged in by the non-affiliate broker-dealer that managed a trading account of the Company. Accordingly, the Company recorded a $2,006,000 loss, net of expected recoveries, in the fourth quarter of 2008 relating to assets invested with this broker-dealer. See Note 5 of Notes to Consolidated Financial Statements for additional information. The Company's decision as to whether to sell securities is based on management’s ongoing evaluation of investment opportunities and economic market conditions, thus creating fluctuations in realized gains or losses from period to period.
Income Taxes. The provision for income taxes decreased $60,000 to $631,000, an effective rate of 37.8%, for 2008, compared to $691,000, an effective rate of 37.8%, for 2007. Net income for 2008 and 2007 includes a non-cash provision for federal income taxes of $497,000 and $518,000, respectively. The state tax effective rate decreased to 8.1% for 2008 from 8.4% for 2007. As compared to our MGUs, Independence American pays a nominal amount of state income tax; therefore, the Company’s state tax effective rate will increase relative to a decrease in Independence American’s pre-tax income. For as long as AMIC utilizes its NOL carryforwards, it will not pay any income taxes, except for federal alternative minimum taxes and state income taxes.
Net Income. The Company’s net income decreased 15% to $965,000, or $.11 per share, diluted, for 2008, compared to $1,138,000, or $.13 per share, diluted, for 2007.
As of December 31, 2008, the Company had $57,248,000 of cash, cash equivalents, and investments net of amounts due to/from brokers compared with $66,432,000 as of December 31, 2007.
At December 31, 2008, the Company had $6,980,000 of restricted cash at our MGUs. The amount at our MGUs is directly offset by corresponding liabilities for Premium and Claim Funds Payable of $6,980,000. This asset, in part, represents the premium that is remitted by the insureds and is collected by our MGUs on behalf of the insurance carriers they represent. Each month the premium is remitted to the insurance carriers by our MGUs. Until such remittance is made the collected premium is carried as an asset on the balance sheet of each of our MGUs with a corresponding payable to each insurance carrier. In addition to the premium being held at our MGUs, our MGUs are in possession of cash to pay claims. The cash is deposited by each insurance carrier into a bank account that our MGUs can access. The cash is used by our MGUs to pay claims on behalf of the insurance carriers they represent. The availability of cash enables our MGUs to reimburse claims in a timely manner.
The composition of the Company's fixed maturities at December 31, 2008, utilizing Standard and Poor's rating categories, was as follows:
In 2009 and beyond, the percentage of medical stop-loss ceded to Independence American will depend on how much IHC determines it has available to reinsure and Independence American’s desire to reinsure IHC’s business. Since the percentage being ceded is now well in excess of the contractual minimum, there is no guaranty that IHC will continue to increase the percentage of business ceded to Independence American or, in fact, cede in excess of 15%. However, our MGUs are the largest producers of medical stop-loss business for IHC, controlling a majority of this premium in 2008.
The gross medical stop-loss premiums written by IHC decreased in 2008 by 9.3% and such premiums produced by our MGUs decreased by 10.4% in 2008 as a result of writing and/or renewing fewer policies due to competitors' willingness to write business at profit margins lower than those acceptable to the Company, partially offset by increased rates on the policies retained. This resulted in a decrease in the gross amount of premium available to be ceded to Independence American in 2008, which decrease could extend into 2009. Our MGUs do not anticipate materially increasing their production of medical stop-loss business in 2009. IHC has reported that it expects its DBL and fully insured premiums to remain steady in 2009
In February 2006, Independence American entered into an agreement with a marketing organization with a block of fully insured health business, including CDHPs, primarily sold to small employer groups, and medical stop-loss, to begin writing for Independence American. The organization that produces this business began writing employer medical stop-loss through Independence American in 2006, and moved the majority of its existing block of fully insured and stop-loss health insurance to Independence American during 2007. Independence American will be the exclusive issuing carrier for business underwritten by this organization through December 31, 2011. Subject to certain conditions, the agreement will automatically extend until December 31, 2016, and this organization could be entitled to additional cash consideration (see Note 19 of Notes to Consolidated Financial Statements).
In addition, in 2007 the Company entered into an agreement with IPA, a national career agent marketing organization, to begin marketing health plans to individuals and families utilizing Independence American as the carrier. Independence American retains 50% of the risk on this business. Gross premiums of $4,295,000 and $231,000 were written under this program in 2008 and 2007, respectively. The program is administered by Insurers Administrative Corporation, a wholly owned subsidiary of IHC. AMIC purchased a 51% interest in IPA in April 2008 (see Note 3 of Notes to Consolidated Financial Statements).
Consolidated Statements of Operations for the years ended December 31, 2008 and 2007
Summary of investments - Other than investments in related parties at
Management assessed the effectiveness of AMIC's internal control over financial reporting as of December 31, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control -Integrated Framework. Based on our assessment we concluded that, as of December 31, 2008, AMIC's internal control over financial reporting is effective.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2008 and 2007, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
Due to reinsurers ($25 and $1,789, respectively, due to related parties)
MGU and agency income ($6,128 and $6,896, respectively, from related parties)
American Independence Corp. is a Delaware corporation (NASDAQ: AMIC). We are a holding company principally engaged in the insurance and reinsurance business through: a) our wholly owned insurance company, Independence American Insurance Company ("Independence American"); b) our managing general underwriter subsidiaries: IndependenceCare Holdings L.L.C. and its subsidiaries (collectively referred to as "IndependenceCare"); Risk Assessment Strategies, Inc. ("RAS"), and Marlton Risk Group LLC ("Marlton"); c) our 23% investment in Majestic Underwriters LLC ("Majestic"); d) our 51% ownership in HealthInsurance.org, LLC (“HIO”), an insurance and marketing agency; e) our 51% ownership in Independent Producers of America, LLC (“IPA”), a national career agent marketing organization; and f) our wholly owned claims administration company, Excess Claims Administrators, Inc. (“ECA”). IndependenceCare, RAS and Marlton are collectively referred to as "our MGUs". HIO and IPA are collectively referred to as “our Agencies”.
Minority interest is to be reported at the percentage of the historical financial statement carrying amounts of the net assets of the acquired enterprise based on the ownership interest of the remaining minority interest owners in the acquired enterprise. The Company incorrectly recorded minority interest from the January 1, 2003 acquisition of Marlton based on the fair value of the net assets of the acquired enterprise. Accordingly, the December 31, 2007 minority interest amount reflected on the consolidated balance sheet has been reduced by $3,987,000 with an
offsetting reduction to goodwill. This correction had no effect on consolidated stockholders' equity or on the results of operations.
The Company's investment in Majestic Underwriters LLC (see Note 7 of Notes to Consolidated Financial Statements) is carried on the equity method with the Company's share of income or loss credited or charged, as appropriate, to net investment income in the Consolidated Statements of Operations with a corresponding charge to the Company's investment account. The Company also reduces its investment for its proportionate share of the amortization expense for the intangible assets recorded in the acquisition.
At December 31, 2008, 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 AMIC stock in 2008. As a result of this assessment, the Company does not believe that an impairment of goodwill exists at this time (see Note 3 of Notes to Consolidated Financial Statements).
(ii) Financial instruments sold, but not yet purchased, represent obligations to replace borrowed securities that have been sold. Such transactions occur in anticipation of declines in the fair value of the securities. The Company's risk is an increase in the fair value of the securities sold in excess of the consideration received, but that risk is mitigated as a result of relationships to certain securities owned. Unrealized gains or losses on open transactions are credited or charged, as appropriate, to net realized investment gains in the Consolidated Statements of Operations. While the transaction is open, the Company will also incur an expense for any accrued dividends or interest payable to the lender of the securities. When the transaction is closed, the Company realizes a gain or loss in an amount equal to the difference between the price at which the securities were sold and the cost of replacing the borrowed securities. There were no such transactions outstanding at December 31, 2008 and 2007.
(vi) The Company reviews its investment securities regularly and determines whether other than temporary impairments have occurred. If a decline in fair value is judged by management to
be other than temporary, a loss is recognized by a charge to the Consolidated Statements of Operations, establishing a new cost basis for the security. Beginning with fourth quarter of 2008, for purposes of other-than-temporary impairment evaluation, preferred stocks are treated in a manner similar to debt securities. The factors considered by management in its regular review include, but are not limited to: the length of time and extent to which the fair value has been less than cost; the financial condition and near-term prospects of the issuer; adverse changes in ratings announced by one or more rating agencies; subordinated credit support; whether the issuer of a debt security has remained current on principal and interest payments; current expected cash flows; whether the decline in fair value appears to be issuer specific or, alternatively, a reflection of general market or industry conditions (including, in the case of fixed maturities, the effect of changes in market interest rates); and the Company's intent and ability to hold the security for a period of time sufficient to allow for a recovery in fair value. For structured securities such as mortgage backed securities, an impairment loss is recognized when there has been a decrease in expected cash flows combined with a decline in the security's fair value below cost.
development patterns are representative of future claim development patterns. Factors which may affect this assumption include changes in claim payment processing times and procedures, changes in time delay in submission of claims and the incidence of unusually large claims. Liabilities for fully insured medical reserves and disability coverages are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data. The reserving analysis includes a review of claim processing statistical measures and large claim early notifications; the potential impacts of any changes in these factors are not material. The delay in submission of claims tends to be stable over time and not subject to significant volatility.
Amounts recoverable or paid for under reinsurance contracts are included in total assets or total liabilities as due from reinsurers or due to reinsurers. In 2008, Independence American derived most of its business from pro rata quota share reinsurance treaties with Standard Security Life and Madison National Life, which are wholly owned subsidiaries of IHC.
adoption of Interpretation 48 on January 31, 2007 did not have a material effect on the Company’s financial statements and the Company believes there are no significant tax positions that would require disclosure under Interpretation 48. Interest income or expense and penalties when applicable will be credited or charged, as appropriate, to selling, general and administrative expenses in the Consolidated Statements of Operations. The IRS has completed their audit of the Company’s 2003 and 2004 consolidated income tax returns in the third quarter of 2008 and made no changes to the reported tax for those periods.
In November 2008, the Financial Accounting Standards Board ("FASB") issued Emerging Issues Task Force (“EITF”) Issue No. 08-7, "Accounting for Defensive Intangible Assets," ("EITF No. 08-7"). EITF No. 08-7 applies to defensive intangible assets, which are acquired intangible assets that the acquirer does not intend to actively use but intends to hold to prevent its competitors from obtaining access to them. As these assets are separately identifiable, EITF No. 08-7 requires an acquiring entity to account for defensive intangible assets as a separate unit of accounting. Defensive intangible assets should not be included as part of the cost of the acquirer's existing intangible assets because the defensive intangible assets are separately identifiable. Defensive intangible assets must be recognized at fair value in accordance with Statement of Financial Accounting Standards ("SFAS") 141(R) and SFAS 157. EITF No. 08-7 is effective for fiscal years beginning after December 15, 2008. The adoption of EITF No. 08-7 is not expected to have a material effect on the Company’s consolidated financial statements.
In November 2008, the FASB issued EITF Issue No. 08-6, "Equity Method Investment Accounting” (“EITF No. 08-6”). EITF No. 08-6 requires that the cost basis of an equity method investment be determined by using a cost-accumulation model, which would continue the practice of including transaction costs in the cost of the investment and would exclude the value of contingent consideration. Equity method investments will be subject to other-than-temporary impairment analysis, however, an equity investor shall not separately test and investee’s underlying indefinite-lived intangible assets for impairment. EITF No. 08-6 also requires an equity investor to account for a share issuance by an investee as if the investor had sold a proportionate share if its investment. Any gain or loss to the investor resulting from an investee’s share issuance shall be recognized in earnings. EITF No. 08-6 is effective for fiscal years beginning after December 15, 2008. The adoption of EITF No. 08-6 is not expected to have a material effect on the Company’s consolidated financial statements.
In May 2008, the FASB issued SFAS No. 163, "Accounting for Financial Guarantee Insurance Contracts - An interpretation of FASB Statement No. 60" (“SFAS 163”). SFAS 163 requires that an insurance enterprise recognize a claim liability prior to an event of default when there is evidence that credit deterioration has occurred in an insured financial obligation. It also clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities, and requires expanded disclosures about financial guarantee insurance contracts. It is effective for financial statements issued for fiscal years beginning after December 15, 2008, except for some disclosures about the insurance enterprise's risk-management activities. SFAS 163 requires that disclosures about the risk-management activities of the insurance enterprise be effective for the first period beginning after issuance. Except for those disclosures, earlier application is not permitted. The adoption of SFAS 163 is not expected to have a material effect on the Company’s consolidated financial statements.
In April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of the Useful Life of Intangible Assets.” (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets.” FSP FAS 142-3 applies prospectively to intangible assets that are acquired, individually or with a group of other assets, after the effective date in either a business combination or asset acquisition. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. The adoption of FSP FAS 142-3 is not expected to have a material effect on the Company’s consolidated financial statements.
In February 2008, the FASB issued FSP FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP FAS 140-3”). The objective of FSP FAS 140-3 is to provide guidance on accounting for a transfer of a financial asset and a repurchase financing. FSP FAS 140-3 presumes that an initial transfer of a financial asset and a repurchase
In November 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”) and SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements”, an amendment of ARB No. 51 (“SFAS 160”). These standards aim to improve, simplify, and converge internationally the accounting for business combinations and the reporting of non-controlling interests in consolidated financial statements. SFAS 141(R) will change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. SFAS 160 will change the accounting and reporting for minority interests, which will be re-characterized as non-controlling interests and classified as a component of equity. SFAS 141(R) and SFAS 160 are effective for both public and private companies for fiscal years beginning on or after December 15, 2008. SFAS 141(R) will be applied prospectively. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 will be applied prospectively. Early adoption is prohibited for both standards. The adoption of SFAS 141(R) and SFAS 160 is not expected to have a material effect on the Company’s consolidated financial statements.
In January 2009, the FASB issued FSP No. EITF 99-20-1, "Amendments to the Impairment Guidance of EITF Issue No. 99-20" ("FSP EITF 99-20-1"). FSP EITF 99-20-1 aligns the impairment guidance in EITF Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to be Held by a Transferor in Securitized Financial Assets", with that in SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities", and other related guidance. The adoption of FSP EITF 99-20-1 did not have a material effect on the Company's consolidated financial statements.
the seller to perform under the credit derivative and the current status of the payment/performance risk of the credit derivative, (b) the maximum potential amount of future payments (undiscounted) the seller could be required to make under the credit derivative, (c) the fair value of the credit derivative, and (d) the nature of (1) any recourse provisions that would enable the seller to recover from third parties any of the amounts paid under the credit derivative, and (2) any assets held either as collateral or by third parties that, upon the occurrence of any specified triggering event or condition, the seller can obtain and liquidate to recover all or a portion of the amounts paid under the credit derivative. With respect to hybrid instruments that have an embedded credit derivative, the seller shall disclose the required information for the entire hybrid instrument, not just the embedded derivative. Disclosure requirements of Interpretation 45 were expanded to include the current status of the payment/performance risk of the guarantee. FSP FAS 133-1 and FIN 45-4 shall be effective for annual or interim periods ending after November 15, 2008. FSP FAS 133-1 and FIN 45-4 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The adoption of FSP FAS 133-1 and FIN 45-4 did not have a material effect on the Company’s consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" (“SFAS 162”). SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. It is effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles", which occurred on September 16, 2008. The adoption of SFAS 162 did not have a material effect on the Company’s consolidated financial statements.
On April 1, 2008, the Company purchased the remaining 20% interest in Marlton for $3,700,000, which was funded from corporate liquidity, thereby increasing its interest in this medical stop-loss MGU to 100%. The Company reduced minority interest by $39,000 for the 20% interest in net assets acquired. The Company recorded goodwill based on the fair value of the remaining 20% interest at the acquisition date. As a result of the acquisition, the Company also reduced the valuation allowance on deferred tax assets by $436,000 with a corresponding decrease in goodwill for the amount of net operating losses it estimates it will utilize.
On April 15, 2008, the Company acquired certain of the assets and assumed certain of the liabilities of Insurance Producers Group of America, Inc. and its subsidiaries for $1,750,000, which was funded from corporate liquidity. These assets were acquired by IPA, an indirect, 51% owned subsidiary of the Company.
The amortized cost and fair value of fixed maturities at December 31, 2008 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The average life of mortgage backed securities is affected by prepayments on the underlying loans and, therefore, is materially shorter than the original stated maturity.
Substantially all of the unrealized losses at December 31, 2008 and 2007 relate to investment grade securities and are attributable to changes in market interest rates and general disruptions in the credit market subsequent to purchase. The unrealized losses on corporate securities are due to wider spreads. Spreads have widened as investors shifted funds to US Treasuries in response to the current market turmoil. The Company reviews its investments regularly and monitors its investments for impairments. At December 31, 2008, the Company had $1.9 million invested in whole loan CMOs backed by Alt-A mortgages. Of this amount, 46.3% were in CMOs that originated in 2005 or earlier and 53.7% were in CMOs that originated in 2006. The Company’s mortgage security portfolio has no direct exposure to sub-prime mortgages. The unrealized loss for the equity securities was primarily due to wider spreads for preferred stocks issued by financial institutions following the disruption in credit markets in late 2007 and continuing in 2008. Some of these financial institutions have exposure to sub-prime mortgages.
Based on management’s review of the portfolio, which considered the various factors described in Note 2 of Notes to Consolidated Financial Statements, the Company recorded a loss of $1,006,000 for other-than-temporary impairments for the twelve months ended December 31, 2008. This was due to the severity of the decrease in fair values and the length of time that these securities were in a loss position. The Company did not record any losses for other-than-temporary impairments for the twelve months ended December 31, 2007. The loss for the twelve months ended December 31, 2008 of $1,006,000 represents a loss on investment grade bonds and preferred stocks of financial institutions that the Company determined to be other-than-temporary. Further deterioration in credit quality of the companies backing the securities, further deterioration in the condition of the financial services industry, a continuation of the current imbalances in liquidity that exist in the marketplace, a continuation or worsening of the current economic recession, or additional declines in real estate values may further affect the fair value of these securities and increase the potential that certain unrealized losses be designated as other-than-temporary in future periods and the Company may incur additional write-downs.
Gross gains of $112,000 and gross losses of $115,000 were realized on sales of available-for-sale securities for the year ended December 31, 2007.
In the fourth quarter of 2008, the Company became aware of certain activities engaged in by the non-affiliate broker-dealer that managed a trading account of the Company. Net realized investment gains reported in the accompanying Consolidated Statements of Operations for 2008 and 2007 includes income related to the trading account of $142,000 and $324,000, respectively. Short-term investments in the December 31, 2007 consolidated balance sheet include the Company’s investment in the account with a carrying amount of $4,802,000. The carrying amount of the Company’s investment at the time of loss was $2,566,000. The broker-dealer is now in bankruptcy. The Company intends to file a claim and believes it will likely recover the $500,000
Major categories of net investment income for years 2008 and 2007 are summarized as follows:
Net realized investment gains (losses) for years 2008 and 2007 are as follows:
would use when pricing the asset or liability. In support of this principle, SFAS 157 establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.
The valuation techniques required by SFAS 157 are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market expectations. These two types of inputs create the following fair value hierarchy:
Investments included in Level 1 are primarily equities with quoted market prices. Level 2 is primarily comprised of our portfolio of corporate fixed income securities, government agency mortgage-backed securities, government sponsored enterprises ("GSEs"), certain CMO securities, municipals and certain preferred stocks that were priced with observable market inputs. Level 3 securities consist of certain CMO securities, primarily Alt-A mortgages.
Financial liabilities consist of a derivative liability relating to the EDH Agreement (see Note 19 of Notes to Consolidated Financial Statements), and is included in Level 2. The liability is valued using market-observable inputs including market price, interest rate, and volatility within a Black-Scholes model.
Inputs for certain fixed maturity securities that were observable during the second and third quarters of 2008 were not unobservable at December 31, 2008 as a result of limited or inactive markets. These securities were transferred out of Level 2 and into the Level 3 category during 2008. No securities were sold or transferred out of the Level 3 category in 2008. Changes in the carrying value of Level 3 financial assets and liabilities for the year ended December 31, 2008 are summarized as follows (in thousands):
At December 31, 2008 and December 31, 2007, the Company had an equity investment in Majestic with a carrying value of $862,000 and $918,000, respectively. For years 2008 and 2007, the Company recorded $(56,000) and $(28,000), respectively, for its share of income (loss) from its investment in Majestic in Net Investment Income in the Consolidated Statements of Operations.
Fixed maturities with a carrying value of $5,112,000 are on deposit with various state insurance departments at December 31, 2008.
Future minimum lease payments under non-cancelable operating leases as of December 31, 2008, are as follows (in thousands):
The Company's net rent expense for years 2008 and 2007 were $412,000 and $357,000, respectively.
The following table summarizes the outstanding options to purchase common stock shares for years 2008 and 2007:
The following table summarizes information regarding outstanding and exercisable options as of December 31, 2008:
The fair value of each stock option on the date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions for years 2008 and 2007:
The Company and its subsidiaries file a consolidated federal income tax return on a September 30 fiscal tax year. The provision for income taxes for the periods ended December 31, 2008 and 2007 are as follows:
Taxes computed at the federal statutory rate of 35% for the years ended December 31, 2008 and 2007 are reconciled to the Company's actual income tax expense as follows:
The federal income tax provision for the periods ending December 31, 2008 and 2007 include income tax provisions of $497,000 and $518,000, respectively, for the utilization of the Company's federal NOL carryforwards. The Company recorded deferred tax benefits on discontinued operations of $40,000 and $0 for the periods ending December 31, 2008 and 2007, which were included in Loss on Disposition of Discontinued Operations, net of tax, in the Consolidated Statements of Operations.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Management believes that it is more likely than not that the Company will realize the benefits of these net deferred tax assets recorded at December 31, 2008.
At December 31, 2008, the Company had federal NOL carryforwards of approximately $276,340,000 which expire as follows (in thousands).
At December 31, 2008, the Company also had NOL carryforwards of approximately $25,814,000 for state income tax purposes, primarily in the State of California. Management believes that it is more likely than not that the state tax benefit of these net operating loss carryforwards will not be realized.
The IRS has completed their audit of the Company’s 2003 and 2004 consolidated income tax returns in the third quarter of 2008 and made no changes to the reported tax for those periods. As the NOL carryforwards are utilized by AMIC, the amount of our NOL carryforwards could be reduced upon audit by the IRS for those tax years open for assessment under the statute of limitations.
The preceding schedule reflects (i) due and unpaid claims, (ii) claims in the course of settlement, (iii) estimated incurred but not reported reserves and (iv) the present value of amounts not yet due on claims. The incurred and paid data above reflects all activity for the year. The amount incurred in 2008 for prior years of $(124,000) is a result of a redundancy of $301,000 of DBL reserves, offset by the re-estimation of unpaid losses on fully insured health reserves of $177,000. The amount incurred in 2007 for prior years of $2,964,000 is a result of the re-estimation of unpaid losses on medical stop-loss reserves of $2,778,000 and of fully insured health reserves of $438,000, slightly offset by a redundancy of $252,000 of DBL reserves. Fluctuations are generally the result of on-going analysis of recent loss development trends.
Independence American’s statutory surplus was $40,365,000 (unaudited) as of December 31, 2008 and $41,353,000 as of December 31, 2007. Independence American’s statutory net income was $2,323,000 (unaudited) for 2008 and $1,325,000 for 2007.
Our MGUs are no longer managed separately as the majority of their business is written by affiliates and is integrated in the management of our stop-loss line of business. Therefore, the Company has reported the current period’s financial information as one segment with three lines of business.
In February 2006, Independence American entered into an agreement (the “EDH Agreement”) with Employers Direct Health, Inc. (“EDH”). Under the EDH Agreement, EDH began writing employer medical stop-loss for Independence American in 2006, and moved the majority of its existing block of employer-sponsored group major medical and medical stop-loss to Independence American during 2007. The employer-sponsored group major medical product is part of the Company’s fully insured health line of business. Independence American paid EDH $2,500,000, which EDH simultaneously paid to IHC in consideration of IHC issuing 125,000 shares of IHC common stock (“IHC Stock”) to EDH. As part of the EDH Agreement, an affiliate of EDH and Independence American agreed to a profit/loss sharing arrangement whereby Independence American will pay to, or receive from, such affiliate 35% of the underwriting profit or loss of the business written by Independence American. Accordingly, the Company has recorded a profit sharing commission expense on the business underwritten in the twelve months period ended December 31, 2008. The IHC stock is held by Independence American as collateral to satisfy EDH’s obligation under the profit/loss sharing agreement.
The EDH Agreement terminates on December 31, 2011; provided, it will automatically be extended to December 31, 2016, subject to satisfaction of certain conditions as to premium volume and profitability. Assuming these conditions are satisfied, EDH would be entitled to up to an additional $2,500,000 depending on the value of the IHC Stock as of December 31, 2011. The Company recorded a derivative liability (“EDH Derivative”) and an intangible asset on its balance sheet in the amount of $743,000 to account for the fair value of such contingent payment at closing. The fair value of the EDH Derivative is evaluated each quarter and the corresponding changes in unrealized gains or losses are reported in other income (loss) in the Consolidated Statements of Operations. As of December 31, 2008, the value of the EDH Derivative was $205,000. The value of the EDH Derivative decreased $1,043,000 for the twelve months ended December 31, 2008. If the EDH Agreement is extended to December 31, 2016, subject to satisfaction of certain further conditions as to premium volume and profitability, EDH would be entitled to up to an additional $5,000,000 depending on the value of the IHC Stock as of December 31, 2016. In addition, EDH could be entitled to a $1,000,000 bonus on December 31, 2013, subject to satisfaction of certain conditions as to premium volume and profitability.