We own a seven story building located at 1441 F.D. Roosevelt Avenue, in San Juan, Puerto Rico, and two adjacent buildings, as well as the adjoining parking lot. In addition, we own five floors of a fifteen-story building located at 1510 F.D. Roosevelt Avenue, in Guaynabo, Puerto Rico. We also own land and a multi-segment customer service center in the municipalities of Mayagüez and Ponce, Puerto Rico. In addition to the properties described above, we or our subsidiaries are parties to operating leases that are entered into in the ordinary course of business. In addition, through a health clinic in which we have a controlling interest, we own land and a two-story medical facility in the municipality of Bayamón. These properties are subject to liens under our credit facilities. In connection with our entrance to the Costa Rican market, we acquired a two-story building located in the city of San José, Costa Rica. See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources”.
(1) Further details of the calculation of basic earnings per share are set forth in notes 2 and 22 of the audited consolidated financial statements for the years ended December 31, 2015, 2014 and 2013.
We are one of the most significant players in the managed care industry in Puerto Rico and have over 50 years of experience in this industry. We offer a broad portfolio of managed care and related products in the Commercial, Medicaid and Medicare Advantage 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 Reform (a government of Puerto Rico-funded managed care program for the medically indigent that is similar to the Medicaid program in the U.S.) (Medicaid), by administering the provision of the physical health component in designated service regions in Puerto Rico. We served all eight regions on an administrative service only basis (ASO) until March 31, 2015. Effective April 1, 2015, the government changed the Medicaid delivery model from an ASO to a risk-based model and we elected to participate in this sector as a fully-insured provider in only two regions of Puerto Rico.
We have the exclusive right to use the BCBS name and mark throughout Puerto Rico, the U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla. As of December 31, 2015 we serve approximately 1,094,000 members across all regions of Puerto Rico. For the years ended December 31, 2015 and 2014 respectively, our managed care segment represented approximately 91% and 89% of our total consolidated premiums earned, net, and approximately 51% and 57% of our operating income. We also have significant positions in the life insurance and property and casualty insurance markets.
The Commissioner of Insurance of the Government of Puerto Rico (“Commissioner of Insurance of Puerto Rico”) recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the Puerto Rico insurance laws and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the Commissioner of Insurance of Puerto Rico to financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) in making such determinations. See note 25 to our audited consolidated financial statements.
General. Our revenue consists primarily of (i) premium revenue generated from our managed care business, (ii) administrative service fees received for services provided to self-insured employers, (iii) premiums we generate from our life insurance and property and casualty insurance businesses and (iv) investment income.
(3) Membership for 2015 is on at-risk basis and for 2014 and 2013 on a self-insured basis. Effective April 1, 2015, membership decreased since we elected to provide services to only two regions when the delivery model changed to an at-risk basis.
Operating expenses during the year ended December 31, 2015 increased by $21.5 million, or 4.3%, to $518.7 million as compared to the year ended December 31, 2014. The higher operating expenses are mainly related to increases in the Health Insurance Providers Fee, the provision for doubtful receivables, and payroll and related expenses resulting from recent management changes and retirements, a $4.4 million expense related to settlement agreements entered with governmental agencies, as well as to higher professional services incurred during the year ended December 31, 2015. These increases were partially offset by the impact of the cost containment initiatives, including lower expenses related to the change in the Medicaid membership after we elected to decrease the number of regions we serve from eight regions under an ASO agreement to only two regions when the contract was changed to a fully-insured model. Despite the increase in operating expenses, the consolidated operating expense ratio decreased 380 basis points to 18.3% for the 2015 period, reflecting the higher premium revenue during this year.
Income tax expense during the year ended December 31, 2015 increased by $4.4 million to $5.1 million when compared to the income tax expense during the year ended December 31, 2014. The higher income tax expense primarily results from the following:
• The 2014 period includes a one-time $6.3 million adjustment increasing the consolidated deferred tax liability related to investments classified as available for sale after the July 1, 2014 enactment of Puerto Rico tax legislation that increased the corporate tax rate over long-term capital gains, from 15% to 20%, for all transactions occurring after June 30, 2014.
Premiums earned, net decreased by $74.4 million, or 3.4%, to $2.1 billion during the year ended December 31, 2014 compared to the year ended December 31, 2013. The decrease was mostly the result of lower member month enrollment in the Commercial and Medicare businesses and the receipt of lower risk score adjustments from CMS in 2014 as compared to 2013.
Administrative service fees increased by $10.6 million, or 9.8%, to $119.3 million for the year ended December 31, 2014 when compared with the year ended December 31, 2013, mostly as the result of the increased enrollment after the addition of the three new Medicaid regions under the ASO agreement with ASES effective October 1, 2013.
Net realized investment gains of $18.2 million during the year ended December 31, 2014 are the result of net realized gains from the sale of debt and equity securities classified as available for sale, following our asset/liability management and tax planning strategies. The net realized gains were partially offset by a $1.2 million other-than-temporary impairments related to certain investments in Puerto Rico government obligations.
Other income decreased by $13.0 million during the year ended December 31, 2014 when compared to the year ended December 31, 2013, mostly due to a $12.8 million (net of special tax) special distribution received during 2013 from the Puerto Rico Joint Underwriting Association (“JUA”) in the Property and Casualty segment.
Operating expenses during the year ended December 31, 2014 increased by $19.0 million, or 4.0%, to $497.2 million as compared to the year ended December 31, 2013. For the year ended December 31, 2014, the consolidated operating expense ratio increased by 140 basis points to 22.1%. The higher operating expenses and operating expenses ratio are mainly related to $27.7 million of Health Insurance Providers Fee that became effective January 1, 2014, an increase of $4.4 million in premium taxes and incremental expenses related to the administration of the three new service regions of the Medicaid ASO agreement effective October 1, 2013. The increase was partly offset by the impact of cost containment initiatives in place during 2014.
Income tax expense during the year ended December 31, 2014 decreased by $1.6 million, or 69.6%, to $0.7 million when compared to the year ended December 31, 2013. This decrease is primarily due to an income tax benefit of $17.0 resulting from the execution of a closing agreement between TSM and its subsidiaries with the Puerto Rico Treasury Department that took advantage of a temporary preferential tax rate window on capital gains, allowing the Company to benefit from the enacted lower taxable rate and the reassessment of the realizability of some of its deferred tax assets. This benefit was offset by an additional tax expense of $6.3 million resulting from the increase in the corporate tax rate over long-term capital gains from 15% to 20% for all transactions occurring after June 30, 2014.
• Medical premiums generated by the Medicaid business amounted to $607.2 million during the year ended December 31, 2015 after the change in the Medicaid service model, from an ASO agreement to a fully insured model effective April 1, 2015.
• Medical premiums generated by the Commercial business decreased by $37.8 million, or 4.3%, to $844.6 million during the year ended December 31, 2015 as compared to the year ended December 31, 2014. This fluctuation is primarily the result of a decrease in fully-insured member month enrollment by 532,889, or 10.6%, mainly in our rated groups and individual accounts products and reflecting cancellation of several commercial accounts and attrition in existing accounts as a result of Puerto Rico’s challenging economic situation. The effect of the decreased membership is partially offset by a 7.1% year over year increase in average premium rates.
Administrative service fees increased by $10.8 million, or 9.6%, to $123.6 million during the year ended December 31, 2014. This is primarily a result of higher Medicaid enrollment after the addition of three regions under the ASO agreement with ASES effective October 1, 2013.
• The medical claims incurred of the Medicare business increased by $1.7 million, or 0.2%, during the 2014 period and its MLR was 86.3%, which is 230 basis points higher than the MLR for the prior year. Excluding the effect of risk-score premium adjustments and prior period reserve developments in the 2014 and 2013 periods, the MLR increased by 440 basis points, primarily reflecting higher pharmacy costs, lower risk score revenue and a non-recurring adjustment in the 2014 period.
Premiums earned, net for the year ended December 31, 2015 increased by $5.6 million, or 3.9%, to $148.1 million as compared to the year ended December 31, 2014, mostly reflecting combined premium growth in the segment’s Individual Life, Cancer, and Major Medical Health lines of business of $4.5 million, as well as to an increase of $2.3 million of new premiums assumed on retrocession reinsurance agreements entered during the second quarter of 2014.
Premiums earned, net for the year ended December 31, 2014 increased by $11.9 million, or 9.1%, to $142.5 million as compared to the year ended December 31, 2013, mostly as result of $7.0 million of additional Life premiums provided by the ASICO acquisition which was effective as of November 2013. Premiums from the Cancer and Individual Life lines of business increased by $2.4 million as the result of new sales of home service products, while the premiums from the Group Life line of business increased $2.5 million year over year.
Underwriting and other expenses for the segment increased by $3.0 million, or 4.6%, to $68.8 million during the year ended December 31, 2014, mostly related to the additional $2.4 million in operating expenses related to the newly acquired ASICO business and a lower amount of net expenses capitalized as Deferred Policy Acquisition Costs. As a result of the segment’s proportionally higher increase in premiums during this period, the operating expense ratio decreased by 210 basis points from 50.4% in 2013 to 48.3% in 2014.
Total premiums written during the year ended December 31, 2015 decreased by $6.7 million, or 4.7%, to $134.4 million, mostly resulting from lower sales of commercial products, primarily package and auto insurance products.
Claims incurred during the year ended December 31, 2014 decreased by $8.8 million, or 16.0%, to $46.3 million. The loss ratio decreased by 460 basis points, to 50.3% in 2014, primarily as a result of a favorable loss experience, mostly in the Commercial Multi-peril and Commercial and Personal Auto lines of business, which was offset with an unfavorable loss experience in the Medical Malpractice line of business.
Year ended December 31, 2015 compared to year ended December 31, 2014
Cash flow from operating activities increased by $191.1 million for the year ended December 31, 2015 as compared to the year ended December 31, 2014, principally due to an increase in premium collections by $634.4 million, offset in part by higher claims paid by $432.2 million. The increase in premiums collected and claims paid is principally the result of the change in the Medicaid delivery model from ASO agreement to a fully insured model.
The decrease in other uses of cash is attributed to the changes in the amount of outstanding checks over bank balances in the 2015 period.
Cash flows from operating activities decreased by $74.9 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013, principally due to the effect of a decrease in premiums collected of $79.9 million and higher cash paid to suppliers and employees of $57.3 million, offset in part by lower claims paid of $46.0 million. The increase in payments to suppliers and employees is primarily related to the higher Medicaid ASO enrollment, the Health Insurance Providers Fee Assessment of approximately $27.7 million that was paid for the first time during the 2014 period and the collection in 2013 of the $12.8 million JUA special distribution. The decrease in premiums collected and claims paid is principally the result of lower Managed Care membership enrollment.
Net proceeds of investment securities were $34.0 million during the year ended December 31, 2014, primarily resulting from the net cash flows received from the sales, net of purchases, of investment securities during 2014. During the year ended December 31, 2013 we had net purchases of investments of $66.2 million, primarily resulting from higher excess cash flows from operations
· On March 6, 2013, the Company’s Board authorized the repurchase of up to $30.0 million of Class B shares (2013 $30.0 million stock repurchase program) concurrent with the conversion of 7 million Class A shares into Class B shares and the public offering of a substantial majority of such converted shares. As part of the Offering, on May 17, 2013, the Company repurchased and retired 1,000,000 shares at a price of $18.25 per share.
· In November 2015 the Company’s Board of Directors authorized a $25.0 million repurchase program (2015 $25.0 million share repurchase program) of its Class B common stock. As of December 31, 2015 The Company has $21.4 million remaining under this repurchase program.
The stock repurchase activity under stock repurchase programs for the years ended December 31, 2015, 2014, and 2013 is summarized as follows:
On November 1, 2010, we entered into a $25.0 million arrangement to sell securities under repurchase agreements that matured on November 2015. The proceeds obtained from this agreement were used to repay $25.0 million of the 6.6% notes. The repurchase agreement paid interest quarterly at 1.96%. During November 2015, at maturity date, we paid the repurchase agreement outstanding balance of $25.0 million. This repurchase agreement had pledged as collateral investment securities available for sale with fair value of $27.1 million (face value of $27.1 million) of December 31, 2014. The investment securities underlying such agreements were delivered to the financial institution with whom the agreement was transacted. The dealers may have loaned, or used as collateral securities in the normal course of business operations. We maintained effective control over the investment securities pledged as collateral until the repurchase agreement was paid.
We anticipate that we will have sufficient liquidity to support our currently expected needs.
The table below describes the payments due under our contractual obligations, aggregated by type of contractual obligation, including the maturity profile of our debt, operating leases and other long-term liabilities, but excludes an estimate of the future cash outflows related to the following liabilities:
• Unearned premiums - This amount accounts for the premiums collected prior to the end of coverage period and does not represent a future cash outflow. As of December 31, 2015, we had $80.3 million in unearned premiums.
• Other long-term liabilities - Due to the indeterminate nature of their cash outflows, $104.7 million of other long-term liabilities are not reflected in the following table, including $62.9 million of liability for pension benefits, $15.1 million in deferred tax liabilities, and $26.7 million in liabilities to the Federal Employees’ Health Benefits Plan Program.
(1) As of December 31, 2015, our long-term borrowings consist of our 6.6% senior unsecured notes payable. Total contractual obligations for long-term borrowings include the current maturities of long term debt. For the 6.6% senior unsecured notes, scheduled interest payments were included in the total contractual obligations for long-term borrowings until the maturity date of the note in 2020. We may redeem the senior unsecured note starting five years after issuance; however no redemption is considered in this schedule. See the “Financing and Financing Capacity” section for additional information regarding our long-term 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, 2015 and are gross of any reinsurance recoverable. The $357.8 million total estimated cash flows for all years in the table is different from the liability of future policy benefits of $289.5 million included in our audited 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.
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 2013, the property and casualty segment paid $0.6 million for an assessment imposed by the Puerto Rico Guaranty Association for Property and Casualty Insurers. In accordance with insurance laws and regulations assessments are recoverable through policy surcharges. In 2014 and 2013, the property and casualty segment has recorded recoveries of assessments for $0.5 million and $15 thousand. 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.
In addition, our property and casualty insurance subsidiary is a member of the Compulsory Vehicle Liability Insurance Joint Underwriting Association (the “Association”). The Association was organized in 1997 to underwrite insurance coverage of motor vehicle property damage liability risks effective January 1, 1998. As a participant, the segment shares the risk proportionally with other members based on a formula established by the Insurance Code. During the years 2015, 2014 and 2013, the Association distributed the Company a distribution based on the good experience of the business amounting to $0.7 million, $0.9 million and $1.2 million, respectively. In September 2013, the Association declared a special distribution to its members for $200 million, subject to a special and unique tax rate of 50%. The property and casualty segment then received $12.8 million, net of tax, from this distribution. In December 2015 the Association declared a special dividend of $21 million subject to a special tax of 15% that will be retained upon distribution. This special dividend will be paid in three installments during 2016. The share of the property and casualty segment in this special dividend is approximately $1.7 million, net of tax.
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 in 2015 and 2014 and $3 thousand in 2013, respectively.
Because the reserve methodology is based upon historical information, it must be adjusted for known or suspected operational and environmental changes. These adjustments are made by our actuaries based on their knowledge and their estimate of emerging impacts to benefit costs and payment speed.
As described above, completion factors and claims trend factors can have a significant impact on determination of our claim liabilities. The following example provides the estimated impact on our December 31, 2015 claim liabilities, assuming the indicated hypothetical changes in completion and trend factors:
At December 31, 2015, claim liabilities for the life insurance segment amounted to $44.6 million and represented 9.1% of total consolidated claim liabilities and 3.3% of our total consolidated liabilities.
At December 31, 2015, claim liabilities for the property and casualty insurance segment amounted to $99.8 million and represented 20.3% of the total consolidated claim liabilities and 7.3% of our total consolidated liabilities.
At December 31, 2015, the actuarial reserve range determined by the actuaries was from $88 million to $103 million. Management reviews the results of the reserve estimates in order to determine any appropriate adjustments in the recording of reserves. Adjustments to reserve estimates are made after management’s consideration of numerous factors, including but not limited to the magnitude of the difference between the actuarial indication and the recorded reserves, improvement or deterioration of actuarial indications in the period, the maturity of the accident year, trends observed over the recent past and the level of volatility within a particular line of business. In general, changes are made more quickly to more mature accident years and less volatile lines of business. Varying the net expected loss ratio by +/-1% in all lines of business for the six most recent accident years would increase/decrease the claims incurred by approximately $5.7 million.
Impairment of an investment exists if a decline in the estimated fair value is below the amortized cost of the security. Management regularly monitors and evaluates the difference between the cost and estimated fair value of investments. For investments with a fair value below cost, the process includes evaluating: (1) the length of time and the extent to which the estimated fair value has been less than amortized cost for fixed maturity securities, or cost for equity securities, (2) the financial condition, near-term and long-term prospects for the issuer, including relevant industry conditions and trends, and implications of rating agency actions, (3) the Company’s intent to sell or the likelihood of a required sale prior to recovery, (4) the recoverability of principal and interest for fixed maturity securities, or cost for equity securities, and (5) other factors, as applicable. This process is not exact and further requires consideration of risks such as credit and interest rate risks. Consequently, if an investment’s cost exceeds its estimated fair value solely due to changes in interest rates, other-than temporary impairment may not be appropriate. Due to the subjective nature of our analysis, along with the judgment that must be applied in the analysis, it is possible that we could reach a different conclusion whether or not 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 we determined during its analysis, which may lead to a different impairment conclusion in future periods. If after monitoring and analyzing impaired securities, management determines that a decline in the estimated fair value of any available-for-sale or held-to-maturity security below cost is other than temporary, the carrying amount of the security is reduced to its fair value according to current accounting guidance. The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment. For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted into net investment income in future periods based on prospective changes in cash flow estimates, to reflect adjustments to the effective yield.
During the year ended December 31, 2015, we recognized other-than-temporary impairments amounting to $5.2 million, $4.3 million on fixed income securities issued by the Government of Puerto Rico and $0.9 million on equity securities classified as available for sale. The impairment analysis as of December 31, 2015 indicated that, other than those securities for which an other-than-temporary impairment was recognized, none of the securities whose carrying amount exceeded its estimated fair value was considered other-than-temporarily 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 realized losses related to other-than-temporary declines being charged against future income.
For our audited consolidated financial statements as of December 31, 2015 and 2014 and for each of the three years ended December 31, 2015 see Index to financial statements in “Item 15. Exhibits and Financial Statements Schedules” to this Annual Report on Form 10-K.