(1) Further details of the calculation of basic and diluted earnings per share are set forth in Notes 2 and 22 of the audited Consolidated Financial Statements for the years ended December 31, 2020, 2019 and 2018.
This financial discussion contains an analysis of our consolidated financial position and financial performance as of December 31, 2020 and 2019, and consolidated results of operations for 2020, 2019 and 2018. References to the terms “we,” “our” or “us” used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), refer to TSM and unless the context otherwise requires, its direct and indirect subsidiaries. This analysis should be read in its entirety and in conjunction with the Consolidated Financial Statements, notes and tables included elsewhere in this Annual Report on Form 10-K.
• Consolidated premiums earned, net increased 10.8% year over year, to $3.6 billion, primarily reflecting an increase in membership and higher average premium rates within the Managed Care segment.
• Consolidated claims incurred for the year were $2.9 billion, up 10.5% over last year, mostly reflecting higher claims incurred in the Managed Care segment by $279.1 million mostly driven by higher enrollment. The consolidated loss ratio decreased 30 basis points, to 81.7%. The Managed Care segment’s MLR was to 84.5%, down 10 basis points year over year.
Triple-S is a health services company and one of the top players in the Puerto Rico health care industry. With more than 60 years of experience, we are the premier health care brand and serve more people through the most attractive provider networks on the island. We have the exclusive right to use the BCBS name and mark throughout Puerto Rico, the USVI, Costa Rica, the BVI, and Anguilla, and we offer a broad portfolio of managed care and related products in the Commercial, Medicare Advantage and Medicaid markets. In the Commercial market, we offer products to corporate accounts, U.S. federal government employees, local government employees, individual accounts and Medicare Supplement. We also participate in the Government of Puerto Rico Health Insurance Plan, a government of Puerto Rico and U.S. federal government funded managed care program for the medically indigent that is similar to the Medicaid program in the U.S. (Medicaid or the Government health plan).
Our commitment to our valued customers and provider partners ̶ backed by our heritage of excellent care, access and service ̶ has positioned Triple-S for continued growth in the health care arena. Our progressive use of technology and clinical data, partnerships with care providers and initial investments in ambulatory and primary care assets are a strong foundation for differentiation and growth through the development of an integrated delivery system over the next several years. We believe continued investment and focus on delivering an excellent health care experience and great service, coupled with health management programs that improve outcomes and quality of life while reducing the total cost of care, will separate Triple-S from our competition and strengthen the financial performance of our business well into the future.
General. Our revenue consists primarily of (i) premium revenue generated from our Managed Care segment, (ii) administrative service fees received for Managed Care services provided to self-insured employers, (iii) premiums we generate from our Life Insurance and Property and Casualty segments and (iv) investment income.
Administrative Service Fees. Administrative service fees include amounts paid to us for administrative services provided to self-insured contracts. We provide a range of customer services pursuant to our ASO contracts, including claims administration, billing, access to our provider networks and membership services. Administrative service fees are recognized in the month in which services are provided.
Investment Income. Investment income consists of interest and dividend income from investment securities. See Note 5, Net Investment Income of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
The MLR, which is calculated by dividing managed care Claims Incurred by managed care Premiums Earned, Net is one of our primary management tools for measuring these costs and their impact on our profitability. The MLR is affected by the cost and utilization of services. The cost of services is affected by many factors, in particular our ability to negotiate competitive rates with our providers. The cost of services is also influenced by inflation and new medical discoveries, including new prescription drugs, therapies and diagnostic procedures. Utilization rates, which reflect the extent to which beneficiaries utilize health care services, significantly influence our medical costs. The level of utilization of services depends in large part on the age, health and lifestyle of our members, among other factors. As the MLR is the ratio of Claims Incurred to Premiums Earned, Net, it is affected not only by our ability to contain cost trends but also by our ability to increase premium rates to levels consistent with or above medical cost trends. We use MLRs both to monitor our management of health care costs and to make various business decisions, including what plans or benefits to offer and our selection of health care providers.
Operating Expenses. Operating expenses include commissions to external brokers, general and administrative expenses, cost containment expenses such as case and disease management programs, and depreciation and amortization. The operating expense ratio is calculated by dividing Operating Expenses by Premiums Earned, Net, plus administrative service fees. A significant portion of our operating expenses are fixed costs. Accordingly, it is important that we maintain a certain level of business volume in order to compensate for the fixed costs. Significant changes in our volume of business will affect our operating expense ratio and results of operations. We also have variable costs, which vary in proportion to changes in business volume.
The following table sets forth our consolidated operating results for the years ended December 31, 2020, 2019, and 2018. Further details of the results of operations of each reportable segment are included in the analysis of operating results for the respective segments.
Year Ended December 31, 2020 Compared With the Year Ended December 31, 2019
Consolidated claims incurred increased by $280.5 million, or 10.5%, to $2.9 billion, during the year ended December 31, 2020 mostly due to the increase in membership. The consolidated loss ratio decreased 30 basis points, to 81.7%, from the prior year, mostly reflecting lower Managed Care utilization of services since mid-March as the result of the government-enforced lockdown during the COVID-19 pandemic and the effect in the MLR of the reinstatement of the HIP fee pass-through in 2020. These decreases were partially offset by the increased benefits in our 2020 Medicare product offering, unfavorable prior-period reserve development in the Managed Care segment and $5.0 million of earthquake losses recorded by the Property and Casualty segment.
Following the government-enforced lockdown related to the COVID-19 pandemic in mid-March, we saw a decrease in utilization of Managed Care services as members and providers deferred non-emergent or elective health services. While this trend has caused, and may continue to cause, a short-term decrease in our claim costs, we experienced an increase in these costs during the second half of the year, that affected our medical cost trends as the demand for deferred non-emergent or elective health services resumed. The access to and demand for care was most constrained from mid-March through April, and began to recover in late May, gradually increasing to expected levels in the fourth quarter.
Year Ended December 31, 2019 Compared With the Year Ended December 31, 2018
Premiums earned, net increased by $314.3 million, or 10.7%, to $3.3 billion. This increase primarily reflects higher premiums in the Managed Care segment by $298.4 million. The growth in managed care premiums reflects higher average premium rates across all lines of business and an increase in Medicare and Commercial fully insured membership. The increase was partially offset by lower Medicaid membership.
The $32.2 million in consolidated net unrealized investment gains on equity investments reflects the impact of changes in equity markets.
Consolidated operating expenses increased by $14.7 million, or 2.7%, to $569.4 million. The higher operating expenses are mostly the result of higher personnel costs, provision for bad debts, and commission expense; partially offset by the waiver of the 2019 HIP Fee. The consolidated expense ratio decreased 130 basis points to 17.5%.
We offer our products in the Managed Care segment to three distinct market sectors in Puerto Rico: Commercial, Medicare Advantage and Medicaid. For the year ended December 31, 2020, the Commercial, Medicare and Medicaid sectors represented 22.6%, 43.1%, and 26.4% of our consolidated premiums earned, net, respectively.
Medical premiums earned increased by $334.8 million, or 11.2%, to $3.3 billion. This increase is principally the result of the following:
• Premiums generated by the Medicare business increased by $145.5 million, or 10.3%, to $1.6 billion, mostly due to higher average premium rates, reflecting an increase in the CMS benchmark, and higher member months enrollment by approximately 91,000.
• Premiums generated by the Medicaid business increased by $174.9 million, or 22.5%, to $953.2 million, primarily reflecting higher average premium rates following the premium rates increases that became effective on November 1, 2019, May 1, 2020 and July 1, 2020, an increase in enrollment of approximately 258,000 member months, the reinstatement of the HIP fee pass-through in 2020, and a profit-sharing accrual recorded in 2019.
• Premiums generated by the Commercial business increased by $14.4 million, or 1.8%, to $815.6 million. This fluctuation primarily reflects higher fully insured enrollment during the year by approximately 38,000 member months and higher average premium rates, mostly due to the reinstatement of the HIP fee pass-through in 2020.
• Claims incurred in the Commercial business decreased by $15.1 million, or 2.3%, during 2020 and its MLR decreased 330 basis points, to 79.1%. These decreases mostly result from lower utilization related to the COVID-19 lockdown, partially offset by the higher fully insured enrollment and an unfavorable change in prior-period reserve developments when compared to the 2019 period. In addition, the lower MLR was impacted by the reinstatement of the HIP fee pass-through in 2020.
• Medical premiums generated by the Medicaid business increased by $2.3 million, or 0.3%, to $778.3 million. This increase primarily reflects higher premiums rates, offset by a decrease of $14.5 million related to the suspension of the HIP fee pass-through in 2019 and lower enrollment by approximately 299,000 member months. The decrease in membership follows the lower membership assigned to us by ASES when implementing the current Medicaid contract, which was effective November 1, 2018.
• The medical claims incurred of the Medicaid business increased by $55.5 million, or 8.1%, during the 2019 period. The MLR at 95.4% was 690 basis points higher than the same period last year. The increased MLR reflects the higher required target MLR of the current Medicaid contract, the impact of the elimination of the HIP fee pass-through in 2019, and a timing difference in the recognition of member acuity in premiums. The current Medicaid contract requires a minimum MLR of 92%, including allocation of health care quality improvements expenses.
• The medical claims incurred of the Commercial business increased by $15.6 million, or 2.4%, during the 2019 period and its MLR, remained steady at 82.4% despite impact of the elimination of the HIP fee pass-through in 2019. The HIP Fee pass-through lowered the 2018 MLR by approximately 130 basis points.
Medical operating expenses increased by $3.7 million, or 0.9%, to $436.7 million. The higher operating expenses are mainly due to an increase in personnel costs, provision for bad debts, and commission expense, partially offset by the waiver of the 2019 HIP fee. The operating expense ratio decreased 150 basis points, to 14.5%, in 2019.
Premiums earned, net increased by $13.8 million, or 7.6%, to $196.0 million, mainly as the result of higher sales across all lines of business, mainly in the Individual Life, Cancer and Group lines of business, and the acquisition of an insurance portfolio during the second quarter of 2020.
Underwriting and other expenses increased $6.6 million, or 8.1%, to $88.3 million, mostly reflecting higher amortization of deferred acquisition costs as a result of higher lapses during the COVID-19 lockdown. The segment’s operating expense ratio increased 30 basis points to 45.1%.
The increase of approximately $274.6 million in net cash provided by operating activities is mostly the result of higher premium collections due to the growth in volume of business, a reduction in account receivable and an increase in accounts payable, partially offset by higher claims paid, due to increased volume of business, cash paid to suppliers, employees and income taxes.
Net purchases from investment securities are part of our asset/liability management strategy.
In August 2017, the Company’s Board of Directors authorized a $30.0 million repurchase program of its Class B common stock and in February 2018 the Company’s Board of Directors authorized a $25.0 million expansion of this program. In October 2019, the Company’s Board of Directors authorized an additional expansion to this program increasing its remaining balance up to a total of $25.0 million, effective November 2019. Repurchases were conducted through open-market purchases of Class B shares only, in accordance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. During the year ended December 31, 2020, the Company repurchased and retired under this program 952,820 shares at an average per share price of $15.72, for an aggregate cost of $15.0 million, completing the amount available for repurchases under this program.
The net change in short-term borrowings represents the outstanding balance of short-term facilities available to address timing differences between cash receipts and disbursements.
Decrease in other uses of cash reflects the change in outstanding checks in excess of bank balances.
As detailed above the three term loans under our credit agreement with a commercial bank in Puerto Rico bear interest rates in relation to 1-month and 3-month LIBOR, a widely used interest rate benchmark.
If LIBOR rates are no longer available, we are subject to an alternative benchmark rate, as defined in the credit agreement of our long-term bank loan. At this time we cannot assess the impact, if any, on the interest paid on this loan. Alternatively, the loan could be refinanced by us without prepayment penalties.
We will closely follow any new developments regarding the LIBOR phase out.
The Company may, at its option and at any time, upon notice as specified in the Credit Agreement, prepay prior to maturity, all or any part of the Loan upon the payment of a penalty fee of the outstanding principal amount at the time of the prepayment of 3% during the first year, 2% during the second year, 1% during the third year and thereafter at par.
The Credit Agreement includes certain customary financial and non-financial covenants, including negative covenants imposing certain restrictions on the Corporation’s business. The Company was in compliance with these covenants as of December 31, 2020.
• TSA has a $10.0 million revolving loan agreement with a commercial bank in Puerto Rico. This line of credit has an interest rate of 30-day LIBOR plus 250 basis points and contains certain financial and non-financial covenants that are customary for this type of facility. This line of credit matures on June 30, 2021 and had no outstanding balance as of December 31, 2020.
Our contractual obligations impact our short-and long-term liquidity and capital resource needs. However, our future cash flow prospects cannot be reasonably assessed based solely on such obligations. Future cash outflows, whether contractual or not, will vary based on our future needs. While some cash outflows are completely fixed (such as commitments to repay principal and interest on borrowings), most are dependent on future events (such as the payout pattern of claim liabilities which have been incurred but not reported).
• Other long-term liabilities - Due to the indeterminate nature of their cash outflows, $199.8 million of other long-term liabilities are not reflected in the following table, consisting of $139.6 million of liability for pension benefits, $45.1 million in liabilities to the Federal Employees’ Health Benefits Plan Program and $15.1 million in deferred tax liabilities.
(1) As of December 31, 2020, our long-term borrowings consist of credit agreements with commercial banks in Puerto Rico. Short-term borrowings represent the outstanding balance of short-term facilities available to address timing differences between cash receipts and disbursements. See the “Financing and Financing Capacity” section for additional information regarding our borrowings
(4) Our Life Insurance segment establishes, and carries as liabilities, actuarially determined amounts that are calculated to meet its policy obligations when a policy matures or surrenders, an insured dies or becomes disabled or upon the occurrence of other covered events. A significant portion of the estimated obligation for future policy benefits to be paid included in this table considers contracts under which we are currently not making payments and will not make payments until the occurrence of an insurable event not under our control, such as death, illness, or the surrender of a policy. We have estimated the timing of the cash flows related to these contracts based on historical experience as well as expectations of future payment patterns. The amounts presented in the table above represent the estimated cash payments for benefits under such contracts based on assumptions related to the receipt of future premiums and assumptions related to mortality, morbidity, policy lapses, renewals, retirements, disability incidence and other contingent events as appropriate for the respective product type. All estimated cash payments included in this table are not discounted to present value nor do they take into account estimated future premiums on policies in-force as of December 31, 2020 and are gross of any reinsurance recoverable. The $759.3 million total estimated cash flows for all years in the table is different from the Liability of Future Policy Benefits of $415.0 million included in our Consolidated Financial Statements principally due to the time value of money. Actual cash payments to policyholders could differ significantly from the estimated cash payments as presented in this table due to differences between actual experience and the assumptions used in the estimation of these payments.
Our insurance subsidiaries are subject to the regulations of the Commissioner of Insurance. These regulations, among other things, require insurance companies to maintain certain levels of capital, thereby restricting the amount of earnings that can be distributed by the insurance subsidiaries to TSM. As of December 31, 2020, our insurance subsidiaries were in compliance with such minimum capital requirements. Please refer to Item 1. Business - Capital and Reserve Requirements.
These regulations are not directly applicable to TSM, as a holding company, since it is not an insurance company.
The $35.5 million credit agreement limits the amount of dividends or other distributions (including share repurchases) payable by the Corporation to $50.0 million per year.
To monitor the solvency of the operations, the BCBSA requires us, TSS, TSA, and TSB to comply with certain specified levels of RBC. RBC is designed to identify weakly capitalized companies by comparing each company’s adjusted surplus to its required surplus (RBC ratio). The RBC ratio reflects the risk profile of insurance companies. At December 31, 2020, TSM and TSS estimated RBC ratio was above the 375% minimum BCBSA RBC requirement to avoid monitoring. At December 31, 2020, TSA estimated RBC ratio was above the minimum BCBSA RBC requirement of 100% for smaller controlled affiliate.
Given the inherent unpredictability of these matters, it is possible that an adverse outcome in certain matters could, from time to time, have an adverse effect on our operating results and/or cash flows. For a description of our legal proceedings, see Note 25, Contingencies, of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
To operate in Puerto Rico, insurance companies, such as our insurance subsidiaries, are required to participate in guarantee associations, which are organized to pay policyholders contractual benefits on behalf of insurers declared insolvent. These associations levy assessments, up to prescribed limits, on a proportional basis, to all member insurers in the line of business in which the insolvent insurer was engaged. In 2019, two local property and casualty insurance companies entered a liquidation process; accordingly, the property and casualty guarantee fund initiated the process to settle unpaid claims and return unearned premiums of the insolvent insurers. In December 2019, the guarantee fund determined and imposed an assessment to cover claims and return premiums, payable in two installments during 2020 based on premiums written in 2018. TSP’s share in this assesment was $912 thousand. Annual assessments are limited to 2% of direct premiums written, as defined. TSP accrued $716 thousand to cover its estimate of assessments based in premiums written in 2019 and loss data made available by the guaranty fund. In accordance with insurance laws and regulations, assessments are recoverable through policy surcharges upon the approval by the Commissioner of Insurance. During 2018, no assessment or payment was made for this contingency. It is the opinion of management that any possible future guarantee association assessments will not have a material effect on our operating results and/or cash flows, although there is no ceiling on these payment obligations.
The Property and Casualty segment is also member of the Puerto Rico Fire and Allied Lines Underwriting Association and the Puerto Rico Auto Assign Plan. These entities periodically impose assessments to cover operations and other charges. The assessments recorded from these entities were $1 thousand, $10 thousand, and $9 thousand in 2020, 2019 and 2018, respectively.
Managed Care claim liabilities also include a provision for adverse deviation, which is an estimate for known environmental factors that are reasonably likely to affect the required level of reserves. This provision for adverse deviation is intended to capture the potential adverse development from known environmental factors such as our entry into new geographical markets, changes in our geographic or product mix, the introduction of new customer populations, variation in benefit utilization, disease outbreaks, changes in provider reimbursement, fluctuations in medical cost trend, variation in claim submission patterns and variation in claims processing speed and payment patterns, changes in technology that provide faster access to claims data or change the speed of adjudication and settlement of claims, variability in claim inventory levels, non-standard claim development and/or exceptional situations that require judgmental adjustments in setting the reserves for claims.
As described above, completion factors and claims trend factors can have a significant impact on the determination of our claim liabilities. The following example provides the estimated impact on our December 31, 2020 claim liabilities, assuming the indicated hypothetical changes in completion and trend factors:
(1)Assumes (decrease) increase in the completion factors for the most recent twelve months.
(2)Assumes (decrease) increase in the claims trend factors for the most recent twelve months.
Management expects that substantially all of the development of the 2020 estimate of medical claims payable will be known during 2021.
The claim liabilities related to the Life Insurance segment are based on methods and underlying assumptions in accordance with GAAP. The estimate of claim liabilities for this segment is based on the amount of benefits contractually determined for reported claims and, for unreported claims, on estimates based on past experience modified for current trends. This estimate relies on observations of ultimate loss experience for similar historical events.
At December 31, 2020, claim liabilities for the Property and Casualty segment amounted to $292.8 million and represented 37.2% of the total consolidated claim liabilities and 13.8% of our total consolidated liabilities. Claims liabilities related to losses caused by catastrophe events amounted to approximately $216.1 million.
Claim reserve reviews are generally conducted on a quarterly basis, in light of continually updated information. Our actuary certifies reserves for both current and prior accident years using current claims data. These reviews incorporate a variety of actuarial methods, judgments and analysis. For each line of business, a variety of actuarial methods are used, with the final selections of ultimate losses that are appropriate for each line of business selected based on the current circumstances affecting that line of business. These selections incorporate input from management, particularly from the claims, underwriting and operations divisions, about reported loss cost trends and other factors, including the severity and frequency of such claims, that could affect the reserve estimates.
Key assumptions are based on the consideration that past emergence of paid losses and case reserves is credible and likely indicative of future emergence and ultimate losses. A key assumption is the expected loss ratio for the current accident year. This expected loss ratio is generally determined through a review of the loss ratios of prior accident years and expected changes to earned pricing, loss costs, mix of business and other factors that are expected to impact the loss ratio for the current accident year. Another key assumption is the development patterns for paid and reported losses (also referred to as the loss emergence and settlement patterns). The reserves for unreported claims for each year are determined after reviewing the indications produced by each actuarial projection method, which, in turn, rely on the expected paid and reported development patterns and the expected loss ratio for that year.
Our Life Insurance segment establishes, and carries as liabilities, actuarially determined amounts that are calculated to meet its policy obligations when a policy matures or surrenders, an insured die, becomes disabled or upon the occurrence of other covered events. We compute the amounts for actuarial liabilities in conformity with GAAP.
Liabilities for future policy benefits for whole life and term insurance products and active life reserves for accident and health products are computed by the net level premium method, using interest assumptions of 3.90% in 2020, 4.40% in 2019 and ranging from 3.90% to 5.75% in 2018, and withdrawal, mortality, morbidity and maintenance expense assumptions appropriate at the time the policies were issued (or when a block of business was purchased, as applicable). Accident and health unpaid claim reserves are stated at amounts determined by estimates on individual claims and estimates of unreported claims based on past experience. Deferred annuity reserves are carried at the account value.
The costs of acquiring new life business, principally commissions, and certain variable underwriting and policy issue expenses of our Life Insurance segment, have been deferred. These costs, including value of business acquired (VOBA) recorded upon our acquisitions of TSV and TSB, are amortized to income over the premium-paying period of the related whole life and term insurance policies in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue, and over the anticipated lives of universal life policies in proportion to the ratio of the expected annual gross profits to the expected total gross profits. The expected premiums revenue and gross profits are based upon the same mortality and withdrawal assumptions used in determining the liability for future policy benefits. For universal life and deferred annuity policies, changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on the amortization of deferred policy acquisition costs (DPAC or DAC) of revisions to estimated gross profits (unlock adjustment) is reported in earnings in the period such estimated gross profits are revised.
The schedules of amortization of life insurance DPAC and VOBA are based upon actuarial assumptions regarding future events that are uncertain. For all products, other than universal life and deferred annuities, the most significant of these assumptions is the level of contract persistency and investment yield rates. For these products the basis for the amortization of DPAC and VOBA is established at the issue of each contract and would only change if our segment’s experience deteriorates to the point that the level of the net liability is not adequate. We do not currently expect that level of deterioration to occur. For the universal life and deferred annuity products, amortization schedules are based upon the level of historic and anticipated gross profit margins, from the date of each contract’s issued (or purchase, in the case of VOBA). These schedules are based upon several actuarial assumptions that are uncertain, are reviewed annually and are modified if necessary. The most significant of these assumptions are claims, investment yield rates and contract persistency. Based upon the most recent actuarial reviews of all the assumptions, we do not currently anticipate material changes to these amortization schedules.
Because of the subjective nature of the Company’s analysis and the judgment that must be applied in it, the Company could reach a different conclusion about whether to impair a security if it had access to additional information about the investee. Additionally, it is possible that the investee’s ability to meet future contractual obligations may be different than what the Company determined during its analysis, which may lead to a different impairment conclusion in future periods.
Management reviews the available-for-sale and other invested assets portfolios under the Company’s impairment review policy. Given market conditions and the significant judgments involved, there is a continuing risk that declines in fair value may occur and material allowances for credit losses may be recorded in future periods. The Company from time to time may sell investments as part of its asset/liability management process or to reposition its investment portfolio based on current and expected market conditions.
During the years ended December 31, 2020, 2019 and 2018, we were not required to recognize a credit-related impairment. The impairment analysis indicated that none of the securities whose carrying amount exceeded its estimated fair value was considered credit impaired as of that date; however, several factors are beyond management’s control, such as the following: financial condition of the issuers, movement of interest rates, specific situations within corporations, among others. Over time, the economic and market environment may provide additional insight regarding the estimated fair value of certain securities, which could change management’s judgment regarding impairment. This could result in the recognition of realized losses because of credit-related impairments that are charged against future income.
Our fixed-maturity securities are sensitive to interest rate and credit risk fluctuations, which impact the fair value of individual securities. Our equity securities are sensitive to equity price risks, for which potential losses could arise from adverse changes in the value of equity securities. For additional information on the sensitivity of our investments, see