Standard Security Life leases 13,000 square feet of office space in New York, New York as its corporate headquarters, and 3,000 square feet of office space in Farmington, New York for its DBL claims processing center.
The Selected Financial Data should be read in conjunction with the accompanying Consolidated Financial Statements and Notes thereto included in Item 8 of this report.
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." At December 31, 2009, the Company owned 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. In March 2010, IHC acquired a controlling interest in AMIC by purchasing additional shares of AMIC common stock in the open market and thereby increasing the total number of shares owned by the Company to more than 50% of AMIC's outstanding common stock.
While management considers a wide range of factors in its strategic planning and decision-making, underwriting profit is consistently emphasized as the primary goal in all decisions as to whether or not to increase our retention in a core line, expand into new products, acquire an entity or a block of business, or otherwise change our business model. Management's assessment of trends in healthcare and morbidity, with respect to medical stop-loss, fully insured medical, disability and DBL; mortality rates with respect to life insurance; and changes in market conditions in general play a significant role in determining the rates charged, deductibles and attachment points quoted, and the percentage of business retained. The Company believes that the acquisition of AMC has further enabled it to make these assessments. IHC also seeks transactions that permit it to leverage its vertically integrated organizational structure by generating fee income from production and administrative operating companies as well as risk income for its carriers and profit commissions. Management has always focused on managing costs of its operations and providing its insureds with the best cost containment tools available.
Revenues of $357.2 million for the year ended December 31, 2009 compared to $353.7 million for the year ended December 31 , 2008;
In the fourth quarter of 2009, this segment wrote-off $5.1 million of previously capitalized software. The Company had been working with a software developer on this project for a number of years in order to improve the Company’s administrative efficiency as it sought in prior years to quickly expand its premiums under management. The software was delivered to the Company in the fourth quarter of 2009. During testing of the software, it was determined that the system was not capable of administering the Company’s lines of business as is and it would take a substantial additional investment to implement. As a result of our decision to reduce the speed of our expansion in this segment, the Company determined not to continue to expend capital on this software. The termination of this project does not impact the Company’s ability to service its business.
Underwriting experience as indicated by its GAAP Combined Ratios, for the Fully Insured segment is as follows (in thousands):
Income before taxes from the group disability, life, annuities and DBL segment decreased $.3 million for the year ended December 31, 2009 compared to 2008, primarily from decreased profitability in DBL and group term life lines of business partially offset by an increase in the LTD business. The DBL business has experienced decreases in group sizes coupled with rate reductions as a result of the overall economic downturn while the group term life business has experienced higher loss ratios;
Loss before taxes from the corporate segment decreased $2.2 million for the year ended December 31, 2009 compared to the prior year primarily as a result of income from partnership investments recorded in 2009 versus losses from partnerships investments recorded in 2008;
Premiums by principal product for the years indicated are as follows (in thousands):
Information pertaining to the Company's business segments is provided in Note 22 of Notes to Consolidated Financial Statements included in Item 8.
Reserves for fully insured medical and dental business are established using historical claim development patterns. Claim development by number of months elapsed from the incurred month is studied each month and development factors are calculated. These claim development factors are then applied to the amount of claims paid to date for each incurred month to estimate fully complete claims. The difference between fully complete claims and the claims paid to date is the estimated reserve. Total reserves are the sum of the reserves for all incurred months.
The Company’s Group Disability segment is comprised of Long Term Disability (“LTD”) and Disability Benefits Law (“DBL”). The two “primary” assumptions on which Group Disability reserves are based are: (i) morbidity levels; and (ii) recovery rates. If morbidity levels increase, for example due to an epidemic or a recessionary environment, the Company would increase reserves because there would be more new claims than expected. In regard to the assumed recovery rate, if disabled lives recover more quickly than anticipated then the existing claims reserves would be reduced; if less quickly, the existing claims reserves would be increased. Advancements in medical treatments could affect future recovery,
termination, and mortality rates. With respect to LTD only, other assumptions are: (i) changes in market interest rates; (ii) changes in offsets; (iii) advancements in medical treatments; and (iv) cost of living. Changes in market interest rates could change reserve assumptions since the payout period could be as long as 40 years. Changes in offsets such as Social Security benefits, retirement plans and state disability 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.
For long duration type contracts, such as annuities and universal life business, amortization of DAC is charged to expense over the life of the underlying contracts based on the present value of the estimated gross profits ("EGPs") expected to be realized. EGPs consist of margins based on expected mortality rates, persistency rates, interest rate spreads, and other revenues and expenses. The Company regularly evaluates its EGPs to determine if actual experience or other evidence suggests that earlier estimates should be revised. If the Company determines that the current assumptions underlying the EGPs are no longer the best estimate for the future due to changes in actual versus expected mortality rates, persistency rates, interest rate spreads, or other revenues and expenses, the future EGPs are updated using the new assumptions and prospective unlocking occurs. These updated EGPs are utilized for future amortization calculations. The total amortization recorded to date is adjusted through a current charge or credit to the Consolidated Statement of Operations.
Internal replacements of insurance and investment contracts determined to result in a replacement contract that is substantially changed from the original contract, will be accounted for as an extinguishment of the original contract, resulting in a release of the unamortized deferred acquisition costs, unearned revenue, and deferred sales inducements associated with the replaced contract.
The Company has classified all of its investments as either available-for-sale or trading securities. These investments are carried at fair value with unrealized gains and losses reported in accumulated other comprehensive income (loss) in the Consolidated Balance Sheets for available-for-sale securities or as unrealized gains or losses in the Consolidated Statements of Operations for trading securities. Fixed maturities and equity securities available-for-sale totaled $750.7 million and $662.5 million at December 31, 2009 and 2008, respectively. Premiums and discounts on debt securities purchased at other than par value are amortized and accreted, respectively, to interest income in the Consolidated Statements of Operations, using the constant yield method over the period to maturity. Net realized gains and losses on investments are computed using the specific identification method and are reported in the Consolidated Statements of Operations.
Equity securities may experience other-than-temporary impairment in the future based on the prospects for full recovery in value in a reasonable period of time and the Company’s ability and intent to hold the security to recovery. If a decline in fair value is judged by management to be other-than-temporary, or management does not have the intent and ability to hold a security, a loss is recognized by a charge to total other-than-temporary impairment losses in the Consolidated Statements of Operations. For the purpose of other-than-temporary impairment evaluations, preferred stocks are treated in a manner similar to debt securities. Declines in the creditworthiness of the issuer of debt securities with both debt and equity-like features requires the use of the equity model in analyzing the security for other-than-temporary impairment.
AMIC. At December 31, 2009, the Company wrote-off $4.2 million of goodwill in connection with an other-than-temporary impairment loss related to it’s investment in AMIC. See Note 2 for further information. No impairment charge for AMIC goodwill was required in 2008 or 2007.
At December 31, 2009, 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 IHC stock in 2009. The Company does not believe that an impairment of goodwill exists at this time.
Loss from continuing operations was $7.4 million for the year ended December 31, 2009, an increase of $17.2 million compared to a loss from continuing operations of $24.6 million for the year ended December 31, 2008. The Company's loss from continuing operations before taxes decreased $22.9 million to $18.1 million for the year ended December 31, 2009 from a loss of $41.0 million for the year ended December 31, 2008. Information by business segment for the year ended December 31, 2009 and 2008 is as follows:
Total premiums earned decreased $22.5 million to $294.8 million in 2009 from $317.3 million in the comparable period of 2008. The decrease is largely due to: (i) the Medical Stop-Loss segment which decreased $31.7 million, primarily due to reduced production from stricter underwriting guidelines and the termination of certain managing general underwriters; and (ii) the individual life, annuities and other segment which decreased $2.4 million, primarily due to the ceding and commutation of certain ordinary life and annuity business during 2009, slightly offset by an increase in premiums due to the 2008 acquisition; offset by (iii) the Fully Insured Health segment which had a $3.7 million increase in premiums to $84.7 million in 2009 compared to $81.0 million in 2008, comprised primarily of a $4.2 million increase in dental premiums as a result of increased production, a $1.8 million increase in small group premiums earned as a result of new production sources and increased retention, offset by a $3.5 million decrease in student accident premiums as a result of the cancellation of a producer of this product and a $1.2 million net increase in all other lines of this segment due to increase retention; and (iv) a $7.9 million increase in the group disability, life, annuities and DBL segment primarily from the LTD line due to an increase in retention and new business written.
Fee income decreased $8.0 million to $31.7 million in the year ended December 31, 2009 from $39.7 million in the year ended December 31, 2008 primarily as a result of a decrease in gross premiums from the small group line of business in the Fully Insured Health segment due in part to stricter underwriting guidelines and downward pressure on enrollment due to the recession and due to a decrease in other business administered by IAC.
Interest expense decreased $1.0 million primarily as a result of principal repayments and lower interest rates.
In the fourth quarter of 2009, the Fully-Insured segment wrote-off $5.1 million of previously capitalized software. The Company had been working with a software developer on this project for a number of years in order to improve the Company’s administrative efficiency as it sought in prior years to quickly expand its premiums under management. The software was delivered to the Company in the fourth quarter of 2009. During testing of the software, it was determined that the system was not capable of administering the Company’s lines of business as is and it would take a substantial additional investment to implement. As the Company is not willing to incur the additional investment to make the software functional, the carrying value was fully written off.
Income tax expense increased $5.7 million to a tax benefit of $10.7 million for the year ended December 31, 2009 from a tax benefit of $16.4 million for the year ended 2008. The effective tax rate was (59.0)% for the year ended 2009 compared to (40.1%) for the year ended 2008. In 2009, the effective tax rate is the result of (i) tax expense on pre-tax income generated by the life companies; (ii) tax benefits derived from tax exempt interest and dividend received deductions as a result of the Company's investments in both state and political subdivisions and preferred securities; and (iii) tax benefits on pre-tax losses from the non-life businesses which have higher effective rates due to state tax benefits. In 2008, the effective tax rate is the result of tax benefits generated by a pre-tax net loss combined with tax benefits derived from tax exempt interest and dividend received deductions as a result of the Company's investments in both state and political subdivisions and preferred securities.
Total premiums earned grew $10.4 million to $317.3 million from $306.9 million in 2007. The increase is primarily due to: (i) the Fully Insured Health segment which had a $9.0 million increase in premiums in 2008 compared to 2007, comprised primarily of: (a) a $6.7 million increase in student accident premiums as a result of a new program initiated in 2008, (b) a $6.2 million increase in dental premiums and $1.0 million increase in limited medical premiums as a result of continuing growth, offset by (c) a decrease of $4.1 million in short-term medical premiums primarily due to lower production caused in part by an increase in rates, and (d) a $1.0 million decrease in the small group line due to lower production caused in part by an increase in rates; (ii) a $1.7 million increase in group disability, life, annuities and DBL segment primarily due to increased retention in the LTD line; (iii) a $2.7 million increase in the individual life, annuities and other segment primarily as a result of the acquisition of a block of life and annuity business; offset by (iv) a decrease of $3.0 million in the Medical Stop-Loss segment primarily due to stricter underwriting guidelines and the termination of certain production sources in 2008.
Total net investment income decreased $2.1 million, primarily due to losses from limited investment partnerships in 2008 compared to income from limited investment partnerships recorded in 2007. The losses from investment partnerships were primarily the result of the continued disruption in the equity markets in 2008 and the primary cause of the decrease in the overall investment yield to 4.9% in 2008 from 5.3% in 2007. The decrease in the investment yield on bonds, equities and short-term investments to 5.2% in 2008 from 5.4% in 2007 is primarily due to a higher percentage of investments in states and political subdivisions in our investment portfolio which provide lower yields but result in tax-advantaged earnings.
For the years ended December 31, 2008 and 2007, the Company recorded 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.
Total other income decreased $.5 million to $2.9 million from $3.4 million in 2007, primarily due to adjustments in 2007 in settlement of a reinsurance agreement.
Benefits, claims and reserves decreased $10.2 million. The decrease is mainly due to: (i) a decrease of $11.3 million in the Medical Stop-Loss segment, primarily resulting from a $11.9 million charge, before income taxes, in 2007 for reserve strengthening, as described in further detail below; (ii) a decrease of $1.1 million in the group disability, life, annuities and DBL segment primarily due to decreases in the DBL ($1.3 million) and group term life ($1.2 million) lines due to improved loss ratios and claims experience offset by an increase in the LTD line ($1.8 million) due to increased retention and higher loss ratios; offset by (iii) a $.6 million increase in the Fully Insured Health segment, primarily due to the increases in dental ($4.3 million) and student accident ($3.4 million) lines which correspond to premium growth, offset by decreases in the small group ($3.4 million) and short-term medical ($4.4 million) lines due to lower volumes of business and improved loss ratios; and (iv) a $1.6 million increase in the individual life, annuities and other segment primarily as a result of the acquisition of a block of life and annuity business.
As a result of these actions, the Company increased the Projected Net Loss Ratio on the business written in 2007 by 9.8% and increased the Net Loss Ratio (defined as insurance benefits, claims and reserves divided by (premiums earned less underwriting expenses)) on the business written in 2006 by 11.4%. This resulted in a charge of $11.9 million, before income taxes, in 2007 primarily relating to the re-estimation of unpaid losses from the prior year. In addition, the Company booked higher reserves of $5.6 million related to the 2007 business due to the increase of 9.8% in the Projected Net Loss Ratio from the rate at which new business was reserved for in 2006. The Company recorded Net Loss Ratios for the medical stop-loss line of 108.9%, 95.2% and 93.2% for the years ended December 31, 2007, 2006 and 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.
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.
As of December 31, 2009, the Company had $7.4 million of cash and cash equivalents compared with $7.8 million as of December 31, 2008.
Net cash used by operating activities of continuing operations for the year ended December 31, 2009 was $25.5 million largely as a result of a $38.4 million increase in net amounts due from reinsurers primarily due to the reinsurance treaty entered into by Madison National Life on April 1, 2009. Net cash
used by operating activities of discontinued operations for the year ended December 31, 2009 was $2.6 million.
The Company has $455.1 million of insurance reserves that it expects to ultimately pay out of current assets and cash flows from future business. If necessary, the Company could utilize the cash received from maturities and repayments of its fixed maturity investments if the timing of claim payments associated with the Company's insurance resources does not coincide with future cash flows. For the year ended December 31, 2009, cash received from the maturities and other repayments of fixed maturities was $170.6 million.
Due to the length of time, and the magnitude of the amount by which the quoted market price of AMIC has been below IHC’s carrying value, the Company recorded an other-than-temporary impairment loss of $29.2, pre-tax, on its investment in AMIC, including goodwill, at December 31, 2009.
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. Although the Company's gross unrealized losses on available-for-sale securities totaled $25.5 million at December 31, 2009, approximately 96.3% of the Company’s fixed maturities were investment grade and continue 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, 2009, approximately 3.7% (or $25.4 million) of the carrying value of fixed maturities was invested in non-investment grade fixed maturities (primarily mortgage securities) (investments in such securities have different risks than investment grade securities, including greater risk of loss upon default, and thinner trading markets). The increase in non-investment grade securities is primarily due to the
All goodwill carrying amounts, except the amount related to the Company equity method investment in AMIC, are evaluated for impairment at the reporting unit level which is equivalent to an operating segment
Goodwill was allocated to each reporting unit or operating segment at the time of acquisition. At December 31, 2009, total goodwill was $48.9 million, of which $44.7 million was attributable to the Fully Insured Health segment and $4.2 million to the Medical Stop Loss segment.
Goodwill related to the Company's equity method investment in AMIC is considered in the evaluation of whether there has been an other-than-temporary decline in value of the overall investment in AMIC. At December 31, 2009, the Company wrote-off $4.2 million of goodwill in connection with an other-than-temporary impairment loss related to it’s investment in AMIC.
The following table summarizes the prior year net unfavorable amount incurred in 2009 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 Company experienced $.2 million of favorable development in the Fully Insured Health segment primarily related to the 2007 business.
The Group Disability segment had a favorable development of $1.9 million. This amount consists of a favorable development of $3.2 million on the 2008 reserves due to DBL ($1.0 million) and LTD ($2.3 million) and a net unfavorable development of $1.3 million for all other years due to LTD.
The Individual Accident and Health and Other segment had favorable development of $.3 million. The Company experienced $.2 million favorable variance related to 2008 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 $.1 million favorable variance on all other Individual A&H lines related to 2008 and prior reserves. The reserving process used by management was consistent from 2008 to 2009.
Due to its strong capital ratios, broad licensing and excellent asset quality and credit-worthiness, the Insurance Group remains well positioned to increase or diversify its current activities. It is anticipated that future acquisitions or other expansion of operations will be funded internally from existing capital and surplus and parent company liquidity. In the event additional funds are required, it is expected that they would be borrowed or raised in the public or private capital markets to the extent determined to be necessary or desirable. In November 2004, December 2003 and March 2003, the Company borrowed
Improving the profitability of our Fully Insured Health business by proactively adjusting our mix of business and distribution strategies to take advantage of market conditions and increasing the efficiency of our administrative companies. We took great strides in this direction in 2009 which resulted in the consolidation of certain subsidiary companies in January 2010 we plan to continue to build on this effort.
In March 2010, IHC acquired control of AMIC through the purchase of additional shares of AMIC common stock in the open market; as of March 23, 2010, IHC owned approximately 50.13% of the outstanding common stock of AMIC. The principal reasons for acquiring control were: (i) the low price of the AMIC stock; (ii) the improved financial presentation for IHC resulting from the consolidation of financial reporting; and (iii) a closer relationship that will create greater long term value for both companies. The acquisition furthers our goal of creating efficiencies by integrating the back office operations of our MGUs and marketing companies. In the first quarter of 2010, it is anticipated that the acquisition will result in a gain on a bargain purchase that will significantly, if not fully, offset the other-than-temporary impairment loss recorded at December 31, 2009. The ultimate net gain or loss on the bargain purchase transaction cannot be quantified at this time because: (i) the carrying value of IHC's investment in AMIC as of the acquisition date is currently unknown, and (ii) the independent valuation of the identifiable assets acquired and liabilities assumed in this transaction is not complete. The Company will consider acquiring additional shares of AMIC stock in the market and/or in private transactions as opportunities arise.