Independence Holding Company, a Delaware corporation (NYSE: IHC), is a holding company principally engaged in the life and health insurance business through: (i) its wholly owned insurance companies, Standard Security Life Insurance Company of New York ("Standard Security Life") and Madison National Life Insurance Company, Inc. ("Madison National Life") (these companies are sometimes collectively referred to as the "Insurance Group"); and (ii) its marketing, administrative and actuarial companies, including Insurers Administrative Corporation (“IAC”), Majestic Underwriters LLC (“Majestic”), in which it owns a majority interest, Health Plan Administrators (“HPA”), GroupLink Inc. (“GroupLink”), in which it owns a majority interest, IHC Health Solutions, Inc. (“IHC Health Solutions”), and Actuarial Management Corporation ("AMC"). IHC and its subsidiaries (including the Insurance Group) are sometimes collectively referred to as the "Company." The Company currently owns a 49.7% equity interest in American Independence Corp. (NASDAQ:AMIC) which owns Independence American Insurance Company (“Independence American”), three managing general underwriters ("MGU’s"), and controlling interests in two agencies.
Loss from continuing operations of $24.5 million, or $1.59 per share, diluted, for the year ended December 31, 2008 compared to income of $1.5 million, or $.10 per share, diluted, for the year ended December 31, 2007. The loss in 2008 is primarily attributed to $38.2 million of pre-tax losses from other-than-temporary impairments due to the write down in value of investments in preferred stocks of certain financial institutions and fixed maturities (primarily Alt-A mortgage securities). The income in 2007 includes charges for reserve strengthening of $11.9 million,
before income taxes, in the Medical Stop-Loss segment as more fully described in the Reserve Strengthening discussion under Results of Operations for the Year Ended December 31, 2007;
Revenues of $353.7 million, a decrease of 12.1% from 2007; the result of realized losses from other-than-temporary impairments;
Book value of $10.56 per common share; a 27.8% decrease from December 31, 2007, primarily reflecting net realized and unrealized losses on securities;
Effective April 1, 2008, acquired a block of life insurance policies with approximately $64.4 million of life reserves. The block consists of approximately $32.2 million of older, traditional life reserves and $32.2 million of annuity reserves. Under the terms of the acquisition, Madison National Life assumed administration of the policies on November 1, 2008.
Income from the disposition of discontinued operations of $.1 million, net of taxes, a result of the final settlement on the sale of the credit segment.
Premiums earned from this segment have increased $9.0 million for the year ended December 31, 2008 compared to 2007, primarily due to increases in certain new lines of business.
Underwriting experience as indicated by the GAAP Combined Ratios for the Fully Insured segment are as follows (in thousands):
Income before taxes from the group disability, life, annuities and DBL segment increased $.5 million for the year ended December 31, 2008 compared to 2007, primarily due to improved loss ratios in the group term life business in 2008 offset by an increase in commissions and other expenses in the long-term disability ("LTD") business in 2008;
Income before taxes from the individual life, annuities and other segment decreased $1.1 million for the year ended December 31, 2008 compared to the prior year. Prior year results include $.9 million of other income due to adjustments in settlement of a reinsurance agreement;
Net realized investment losses were $50.6 million for the year ended December 31, 2008 compared to gains of $1.3 million in 2007. Included in realized losses for the year ended December 31, 2008 are $38.2 million of pre-tax losses from other-than-temporary impairments due to the write down in value of investments in preferred stocks of certain financial institutions and fixed maturities (primarily Alt-A mortgage securities) primarily due to the severity of the decrease in fair value and length of time that these securities were in a loss position; and
Information pertaining to the Company's business segments is provided in Note 21 of Notes to Consolidated Financial Statements included in Item 8.
Policies that do not subject the Company to significant risk arising from mortality or morbidity are considered investment contracts. Deposits received from such contracts are reported as other
policyholder funds. Policy charges for investment contracts consist of fees assessed against the policyholder account for maintenance, administration and surrender of the policy prior to contractually specified dates, and are recognized when assessed against the policyholder account balance.
Premiums related to long-term and short-term disability contracts are recognized on a pro rata basis over the applicable contract term.
The Company maintains loss reserves to cover its estimated liability for unpaid losses and loss adjustment expenses, where material, (including legal, other fees, and costs not associated with specific claims but related to the claims payment function) for reported and unreported claims incurred as of the end of each accounting period. These loss reserves are based on actuarial assumptions and are maintained at levels that are in accordance with GAAP. The Company’s estimate of loss reserves represents management’s best estimate of the Company’s liability at the balance sheet date.
Management believes that the Company's methods of estimating the liabilities for insurance reserves provided appropriate levels of reserves at December 31, 2008. Changes in the Company's reserve estimates are recorded through a charge or credit to its earnings.
The Company believes that its recorded insurance reserves are reasonable and adequate to satisfy its ultimate liability. The Company primarily uses its own loss development experience, but will also supplement that with data from its outside actuaries, reinsurers and industry loss experience as warranted. To illustrate the impact that Loss Ratios have on the Company’s loss reserves and related expenses, each hypothetical 1% change in the Loss Ratio for the health business (i.e., the ratio of insurance benefits, claims and settlement expenses to earned health premiums) for the year ended December 31, 2008, would increase reserves (in the case of a higher ratio) or decrease reserves (in the case of a lower ratio) by approximately $2.8 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the Consolidated Statement of Operations. Depending on the circumstances surrounding a change in the Loss Ratio, other pre-tax amounts reported in the Consolidated Statement of Operations could also be affected, such as amortization of deferred acquisition costs and commission expense.
open claims from prior periods, including losses incurred for claims that have not been reported (“IBNR”). Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
Due to the short-term nature of Medical Stop-Loss, redundancies or deficiencies will typically emerge during the course of the following year rather than over a number of years. For Employer Stop-Loss, as noted above, the Company maintains its reserves based on underlying assumptions until it determines that an adjustment is appropriate based on emerging experience from all of its MGUs for prior underwriting years. Reserves for HMO Reinsurance and Provider Excess are adjusted on a policy by policy basis. Because of the small number of HMO Reinsurance and Provider Excess policies it writes, the Company is able to evaluate each policy individually for potential liability by reviewing open claims with each HMO or provider group and applying completion factors using historical data.
plans also impact reserving. As a result of the forgoing assumptions, it is possible that the historical trend may not be an accurate predictor of the future development of the block. As with most long term insurance reserves that require judgment, the reserving process is subject to uncertainty and volatility and fluctuations may not be indicative of the claim development overall.
Results of Operations for the Year Ended December 31, 2008 Compared to the Year Ended December 31, 2007
Information by business segment for the years ended December 31, 2008 and 2007 is as follows:
Net realized investment gains (losses) decreased $51.9 million to a net loss of $50.6 million in 2008 from a net gain of $1.3 million in 2007. These amounts include gains and losses from sales of fixed maturities and equity securities available-for-sale, as well as trading securities and other investments. Decisions to sell securities are based on management's ongoing evaluation of investment opportunities and economic and market conditions, thus creating fluctuations in gains and losses from period to period. Included in net realized investment gains (losses) for years ended December 31, 2008 and 2007 are pre-tax losses of $38.2 million and $.4 million, respectively, from other-than-temporary impairments primarily due to the write-down in value of investments in preferred stocks of certain financial institutions and fixed maturities (primarily Alt-A mortgage securities) primarily due to the severity of the decrease in fair value and length of time that these securities were in a loss position. In addition, the Company has recently become aware of certain activities engaged in by the non-affiliate broker-dealer that managed the trading accounts of the Company. The Company reduced the value of the assets held in such accounts to their estimated recoverable amounts. As a result, the Company recorded a $6.8 million pre-tax loss, net of expected recoveries, in the fourth quarter of 2008 related to such accounts. See Note 7 in the Notes to Consolidated Financial Statements included in item 8 of this report for more information about net realized investment gains and losses.
Fee income decreased $4.4 million to $39.7 million from $44.1 million in 2007, primarily due to a decrease in administrative fees in the Fully Insured Health segment primarily as a result of decreases in gross premiums from the short-term medical and small group lines of business.
Total selling, general and administrative expenses increased $4.5 million in 2008 as compared to 2007. The increase is primarily due to (i) a $3.9 million increase in commission and administrative expenses associated with the operation of the Fully Insured Health segment, primarily due to (a) increases in commission and administrative expenses for the dental ($2.2 million) and student accident ($2.0 million) lines due to increased volume; (b) increase of $3.2 million primarily in commission expenses in the small group line due to higher profit commissions on 2007 business; offset by (c) a decrease of $.9 million in short-term medical expenses due to lower production; and (d) a decrease of $3.0 million primarily from administrative expenses at the third party administrators due in part to cost reductions; (ii) a $2.0 million increase in commission and administration expenses in the individual life, annuities and other segment as a result of increased volume from the recent acquisition of a block of life and annuity policies; (iii) a $1.8 million increase in the group disability, life, annuities and DBL segment primarily due to the increase in retention of the LTD business; and (iv) a $3.2 million decrease in corporate overhead expenses (primarily employee benefits, audit expenses, interest income on accrued income tax refunds and a higher allocation of expenses to the subsidiaries).
Income tax expense decreased $16.8 million resulting in a tax benefit of $16.4 million for 2008 from an expense of $.4 million in 2007. The effective tax rates were 40.1% and 22.2% for 2008 and 2007, respectively. The difference in the effective tax rates is primarily attributable to tax benefits generated by a pre-tax loss in 2008 coupled with other tax benefits derived from dividend received deductions ("DRDs") and tax exempt interest compared to tax expense generated by pre-tax income in 2007. During 2007, and continuing in 2008, the Company increased its positions in both state and political subdivision investments and preferred securities that generate tax exempt interest and DRDs, creating a greater benefit in 2008 than in 2007.
Results of Operations for the Year Ended December 31, 2007 Compared to the Year Ended December 31, 2006
Consistent with our experience, the industry as a whole has succumbed to the pricing pressures caused by an unexpectedly long down cycle (or "soft" market) for medical stop-loss business. The medical stop-loss market has been “soft” for the past four years, including cases written in 2006 and 2007, which means that many of the Company’s competitors have been willing to write business at little or no margin. We had been aware of these market conditions and had curtailed our growth in order to attempt to achieve higher profit margins. The Company believed that it had taken sufficient action to insure that business written in 2006 would produce better margins than that written in 2005 and formulated a Projected Net Loss Ratio reflecting such expectations. As is typical with medical stop-loss business, MGUs do have some discretion with in our underwriting guidelines to make pricing concessions on certain cases, particularly as it relates to maintaining their core renewal business and production sources.
2005 respectively. The Net Loss Ratio equation primarily differs from the Combined Ratio in that it subtracts out expenses from the premiums prior to dividing by the insurance benefits, claims and reserves. We primarily use Net Loss Ratios from a reserving standpoint and as a management tool to measure the profitability of medical stop-loss with respect to each program. The Company primarily uses Combined Ratios as an accounting measurement for reporting purposes.
As of December 31, 2008, the Company had $7.8 million of cash and cash equivalents compared with $72.8 as of December 31, 2007. The decrease in cash and cash equivalents was primarily offset by an increase in securities purchased under agreements to resell of $47.1 million. Total investments, net of amounts due to and from brokers, were $763.7 million and $779.4 million at December 31, 2008 and 2007, respectively.
Net cash provided by operating activities of continuing operations for the year ended December 31, 2008 was $3.3 million. Net cash used by operating activities of discontinued operations for the year ended December 31, 2008 was $18.0 million primarily due to cash used for the settlement of the Credit Life and Disability segment.
Total investments, net of amounts due to and from brokers, decreased $15.7 million during 2008 largely due to: (i) a $69.2 million increase in unrealized losses on available for sale securities; (ii) $38.2 million of losses realized for other-than-temporary impairments; (iii) $6.8 million of other net trading account losses; (iv) a $4.9 million decrease in partnership investments; (v) offset by $107.2 million of net purchases of short-term investments, resale agreements, and fixed maturities and equity securities available-for-sale.
The Company had net receivables from reinsurers of $100.7 million at December 31, 2008. Substantially all of the business ceded to such reinsurers is of short duration. All of such receivables are either due from highly rated companies or are adequately secured. No allowance for doubtful accounts was necessary at December 31, 2008.
Other assets increased $39.8 million primarily due to a $39.0 million increase in net deferred tax assets recorded as a result of a $23.8 million net loss and $70.7 million of net unrealized losses on investment securities allocated to stockholders' equity.
The nature and quality of insurance company investments must comply with all applicable statutes and regulations, which have been promulgated primarily for the protection of policyholders. Of the aggregate carrying value of the Insurance Group's cash and investment assets, approximately 91.2% was invested in investment grade fixed maturities, resale agreements, policy loans and cash and cash equivalents at December 31, 2008. The Company's gross unrealized losses on available-for-sale securities totaled $99.2 million at December 31, 2008. Also at such date, approximately 99.1% of the Insurance Group's fixed maturities were investment grade and continues to be rated on average AA. The Company marks all of its available-for-sale securities to fair value through accumulated other comprehensive income or loss. These investments tend to carry less default risk and, therefore, lower interest rates than other types of fixed maturity investments. At December 31, 2008, approximately .9% (or $5.7 million) of the carrying value of fixed maturities was invested in diversified non-investment grade fixed maturities (investments in such securities have different risks than investment grade securities, including greater risk of loss upon default, and thinner trading markets). The Company has only one non-performing fixed maturity at December 31, 2008 with a carrying value of $.7 million, or .1% of the total carrying value of fixed maturities.
The Company reviews its investments regularly and monitors its investments continually for impairments, as discussed in Note 1(F)(vi) of the Notes to Consolidated Financial Statements in Item 8 of this report. For the years ended December 31, 2008 and 2007 the Company recorded losses of $38.2 million and $.4 million, respectively, for other-than-temporary impairments. The following table summarizes the carrying value of securities with fair values less than 80% of their amortized cost at December 31, 2008 by the length of time the fair values of those securities were below 80% of their amortized cost (in thousands):
The following table summarizes the prior year net unfavorable amount incurred in 2008 according to the year to which it relates, together with the opening reserve balance (net of reinsurance recoverable) to which it relates (in thousands):
The following sections describe, for each segment, the deficiency - unfavorable development or redundancy - favorable development experienced in 2008, together with the key assumptions and changes therein affecting the reserve estimates.
The Company experienced net unfavorable development of $3.3 million in the Medical Stop-Loss segment primarily related to $3.2 million of negative development on the 2007 reserves. With respect to the 2007 reserves, the deficiency was the result of on-going analysis of recent loss development trends with respect to 2007 primarily attributable to the increased frequency of claims and the severity of primary claims. In the third quarter of 2007, the Company identified a material increase in claims and reserves with respect to business written in 2006. Such adverse development was primarily driven by the frequency of claims relative to the business written in that year proving significantly higher than what would have been predicted by prior loss development patterns. This increased frequency of medical stop-loss claims was due, in part, to increased severity of primary claims.
The Group Disability segment had an unfavorable development of $.2 million. This amount consists of a favorable development of $1.4 million on the 2007 reserves primarily due to DBL and a net unfavorable development of $1.6 million for all other years due to LTD.
Due to the long-term nature of LTD, in establishing loss reserves the Company must make estimates for case reserves, incurred but not reported reserves (“IBNR”), and reserves for Loss Adjustment Expenses (“LAE”). Case reserves generally equal the Company’s best estimate of the present value of the liability for future benefits to be paid on claims incurred as of the balance sheet date. The LAE reserve is calculated based on an actuarial expense study. Since the LTD block of policies is relatively small, results can vary from year to year solely on the basis of one or two policies. It is not uncommon for a reserve of several hundred thousand dollars to be associated with one policy. If a small number of claimants with large policy reserves were to recover or a few large claims were incurred, the results could distort the Company’s reserve estimates from year to year. However, there were no individual factors in 2008 that caused the unfavorable development in LTD. With respect to DBL, reserves for the most recent quarter of earned premium are established using a Net Loss Ratio methodology. The Net Loss Ratio is determined by applying the completed prior four quarters of historical Net Loss Ratios to the last quarter of earned premium. Reserves associated with the premium earned prior to the last quarter are established using a completion factor methodology. The completion factors are developed using the historical payment patterns for DBL. The favorable development in the DBL line is due to lower than expected claims.
The Individual Accident and Health and Other segment had favorable development of $.7 million. The Company experienced $.5 million favorable variance related to 2007 reserves on our Blanket Accident and sickness product that is sold to volunteer fire districts, due to lower claims experience than historically experienced. The Company had $.2 million favorable variance on all other Individual A&H lines related to 2007 and prior reserves. The reserving process used by management was consistent from 2007 to 2008.
, the medical stop-loss industry as a whole succumbed to pricing pressures caused by an unexpectedly long down cycle (or "soft" market) from 2004 through 2008. As a consequence of these market conditions, we made a decision to curtail our growth and our 2008 loss ratios are improved. Due to stricter underwriting guidelines and the termination of several MGUs in 2008, we expect a decline in stop-loss premiums in 2009. The Company expects its gross group life and disability premiums to increase in 2009 as a result of taking over an estimated $18 million block from an insurer that exited the market, of which we will retain approximately 20%.
The Fully Insured Health market (estimated at $500 billion) in the U.S. is a much larger market than the Medical Stop-Loss market (estimated at $4 billion). The Company limited the amount of its growth in this segment in 2008 and expects to continue to do so in 2009. In the event we determine to accelerate our growth, we are optimistic that (as a result of its multiple product filings, distribution sources, and the sheer size of the market) our Fully Insured Health business could grow while maintaining profitable underwriting results.