IHC’s health insurance products serve niche sectors of the commercial market through multiple classes of business and varied distribution channels. Medical Stop-Loss is marketed to large employer groups that self-insure their medical risks; in 2013 the Company’s average case size was 230 covered employee lives. This niche is expected to grow as result of federal health care reform. The small-group major medical product is purchased by employers with between two and 50 covered lives. With regard to those persons in the growing individual market, IHC’s products offer coverage for individuals and
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. 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 the costs of its operations and providing its insureds with the best cost-containment tools available.
The results of operations for the years ended December 31, 2013, 2012 and 2011, are summarized as follows (in thousands):
The Medical Stop-Loss segment reported income before taxes of $12.7 million and $15.8 million for the years ended December 31, 2013 and 2012, respectively. The decrease is primarily due to higher loss ratios in 2013;
Premiums earned increased $26.6 million for the year ended December 31, 2013 when compared to 2012. The increase in premiums earned is primarily due to increased volume.
The Fully Insured Health segment reported $0.8 million of income before taxes for the year ended December 31, 2013 as compared to $4.4 million for the year ended December 31, 2012. The decrease is primarily due to higher loss ratios in 2013;
Income before taxes from the Group disability, life, annuities and DBL segment in 2013 was comparable to prior year results;
Income before taxes from the Corporate segment increased $1.5 million for the year ended December 31, 2013 compared to the prior year primarily due to a decrease in corporate expenses;
Annuities and interest-sensitive life contracts, such as universal life and interest-sensitive whole life, are contracts whose terms are not fixed and guaranteed. Premiums from these policies are reported as funds on deposit. Policy charges consist of fees assessed against the policyholder for cost of insurance (mortality risk), policy administration and early surrender. These revenues are recognized when assessed against the policyholder account balance.
The two “primary” assumptions underlying the calculation of policy benefits and claims for Medical Stop-Loss business are (i) projected Net Loss Ratio, and (ii) claim development patterns. The projected Net Loss Ratio is set at expected levels consistent with the underlying assumptions (“Projected Net Loss Ratio”). Claim development patterns are set quarterly as reserve estimates are developed and are based on recent claim development history (“Claim Development Patterns”). The Company uses the Projected Net Loss Ratio to establish reserves until developing losses provide a better indication of ultimate results and it is feasible to set reserves based on Claim Development Patterns. The Company has concluded that a reasonably likely change in the Projected Net Loss Ratio assumption could have a material effect on the Company’s financial condition, results of operations, or liquidity (“Material Effect”) but a reasonably likely change in the Claim Development Pattern would not have a Material Effect.
While the Company establishes a best estimate of the Projected Net Loss Ratio, actual experience may deviate from this estimate. This was the case with the 2010, 2011 and 2012 underwriting years which deviated by (1.2), 4.8 and (0.2) Net Loss Ratio points, respectively. After the recorded reserve estimate, it is reasonably likely that the actual experience will fall within a range up to five Net Loss Ratio points above or below the expected Projected Net Loss Ratio for the 2013 underwriting year at December 31, 2013. The impact of these reasonably likely changes at December 31, 2013, would be an increase in net reserves (in the case of a higher ratio) or a decrease in net reserves (in the case of a lower ratio) of up to approximately $4.1 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the Consolidated Statement of Income.
Subsequent to the first twelve months of an underwriting year, the Company’s developing losses provide a better indication of ultimate losses. At this point, claims have developed to a level where Claim Development Patterns can be applied to generate reasonably reliable estimates of ultimate claim levels. Development factors based on historical patterns are applied to paid and reported claims to estimate fully developed claims. Claim Development Patterns are reviewed quarterly as reserve estimates are developed and are based on recent claim development history. The Company must determine whether changes in development represent true indications of emerging experience or are simply due to random claim fluctuations.
The primary assumption in the determination of fully insured policy benefits and claims is that historical claim development patterns tend to be representative of future claim development patterns. Factors which may affect this assumption include changes in claim payment processing times and procedures, changes in product design, changes in time delay in submission of claims, and the incidence of unusually large claims. The reserving analysis includes a review of claim processing statistical measures and large claim early notifications; the potential impacts of any changes in these factors are minimal. The time delay in submission of claims tends to be stable over time and not subject to significant volatility. Since our analysis considered a variety of outcomes related to these factors, the Company does not believe that any reasonably likely change in these factors will have a Material Effect.
Management believes that the Company's methods of estimating the liabilities for future policy benefits provided appropriate levels of reserves at December 31, 2013. Changes in the Company's future policy benefits estimates are recorded through a charge or credit to its earnings.
Declines in value of securities available-for-sale that are judged to be other-than-temporary are determined based on the specific identification method. The Company reviews its investment securities regularly and determines whether other-than-temporary impairments have occurred. The factors considered by management in its regular review to identify and recognize other-than-temporary impairment losses on fixed maturities include, but are not limited to: the length of time and extent to which the fair value has been less than cost; the Company's intent to sell, or be required to sell, the debt security before the anticipated recovery of its remaining amortized cost basis; the financial condition and near-term prospects of the issuer; adverse changes in ratings announced by one or more rating agencies; subordinated credit support; whether the issuer of a debt security has remained current on principal and interest payments; current expected cash flows; whether the decline in fair value appears to be issuer specific or, alternatively, a reflection of general market or industry conditions including the effect of changes in market interest rates. If the Company intends to sell a debt security, or it is more likely than not that it would be required to sell a debt security before the recovery of its amortized cost basis, the entire difference between the security's amortized cost basis and its fair value at the balance sheet date would be recognized by a charge to total other-than-temporary impairment losses in the Consolidated Statement of Income. If a decline in fair value of a debt security is judged by management to be other-than-temporary and; (i) the Company does not intend to sell the security; and (ii) it is not more likely than not that it will be required to sell the security prior to recovery of the security’s amortized cost, the Company assesses whether the present value of the cash flows to be collected from the security is less than its amortized cost basis. To the extent that the present value of the cash flows generated by a debt security is less than the amortized cost basis, a credit loss exists. For any such security, the impairment is bifurcated into (a) the amount of the total impairment related to the credit loss, and (b) the amount of the total impairment related to all other factors. The amount of the other-than-temporary impairment related to the credit loss is recognized by a charge to total other-than-temporary impairment losses in the Consolidated Statement of Income, establishing a new cost basis for the security. The amount of the other-than-temporary impairment related to all other factors is recognized in other comprehensive income (loss) in the Consolidated Balance Sheet. It is reasonably possible that further declines in estimated fair values of such investments, or changes in assumptions or estimates of anticipated recoveries and/or cash flows, may cause further other-than-temporary impairments in the near term, which could be significant.
Goodwill carrying amounts are evaluated for impairment, at least annually, at the reporting unit level which is equivalent to an operating segment. If the fair value of a reporting unit is less than its carrying amount, further evaluation is required to determine if a write-down of goodwill is required. In determining the fair value of each reporting unit, we used an income approach, applying a discounted cash flow method which included a residual value. Based on historical experience, we make assumptions as to: (i) expected future performance and future economic conditions, (ii) projected operating earnings, (iii) projected new and renewal business as well as profit margins on such business, and (iv) a discount rate that incorporated an appropriate risk level for the reporting unit. Any impairment of goodwill would be charged to expense. No impairment charge for goodwill was required in 2013, 2012 or 2011.
The provision for deferred income taxes is based on the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized by applying enacted statutory tax rates to temporary differences between amounts reported in the Consolidated Financial Statements and the tax bases of existing assets and liabilities. A valuation allowance is recognized for the portion of deferred tax assets that, in management's judgment, is not likely to be realized. A liability for uncertain tax positions is recorded when it is more likely than not that a tax position will not be sustained upon examination by taxing authorities. The effect on deferred income taxes of a change in tax rates or laws is recognized in income tax expense in the period that includes the enactment date. The Company has certain tax-planning strategies that were used in determining that a valuation allowance was not necessary on its deferred taxes.
In 2013, premiums earned increased $139.9 million over the comparable period of 2012. The increase is primarily due to: (i) the Fully Insured Health segment which had a $107.3 million increase in premiums primarily as a result of increased retentions on most lines of business and increased volume in the short term medical business and major medical business for groups and individuals in addition to premiums from the new pet and international lines of business; (ii) a $26.6 million increase in the Medical Stop-Loss segment due to increased volume of business in 2013; and (iii) a $10.7 million increase in the Group disability, life, annuities and DBL segment primarily due to increased premiums from the DBL line; partially offset by (iv) a decrease of $4.7 million of earned premiums in the Individual life, annuities and other segment primarily as a result of decreased premium volume from the coinsurance agreement and from lines in run-off.
The effective tax rate for 2013 was 35.5%. In 2012, the Company recorded a $5.9 million credit to federal income taxes as a result of the reduction in AMIC’s valuation allowance related to its deferred tax asset at December 31, 2012. Excluding this transaction, the effective tax rate for 2012 was 32.1%. The lower effective tax rate in 2012 was due to a higher benefit from tax-advantaged securities as a percentage of income in 2012.
In 2012, premiums earned increased $19.7 million over the comparable period of 2011. The increase is primarily due to: (i) an $25.2 million increase in the Medical Stop-Loss segment due to increased volume and retention of business in 2012; and (ii) a $0.2 million increase in the Fully Insured Health segment primarily as a result of premiums from the new pet and international lines of business, partially offset by decreased retentions and premium volume in the short term medical business, major medical business for groups and individuals, fixed indemnity limited benefit and dental lines of business; partially offset by (iii) a decrease of $4.4 million of earned premiums in the Individual life, annuities and other segment primarily as a result of the transfer of certain annuity contracts in the fourth quarter of 2011and decreased premium volume from other lines in run-off; and (iv) a $1.4 million decrease in the Group disability, life, annuities and DBL segment primarily due to decreased premiums from the group term life and LTD lines due in part to reduced production sources, partially offset by premiums generated by a new line of international LTD and life business.
Total net investment income decreased $6.4 million. The overall annualized investment yields were 4.1% and 4.3% (approximately 4.2% and 4.4%, on a tax advantaged basis) for 2012 and 2011, respectively. The overall decrease was primarily a result of a decrease in investment income on bonds, equities and short-term investments due to the transfer of $143.5 million of assets in the first quarter of 2012 related to a coinsurance treaty. The annualized investment yields on bonds, equities and short-term investments were 3.8% and 4.1% in 2012 and 2011, respectively. IHC had approximately $197.5 million in highly rated shorter duration securities earning on average 1.6% at December 31, 2012. A portfolio that is shorter in duration enables us, if we deem prudent, the flexibility to reinvest in much higher yielding longer-term securities, which would significantly increase investment income.
In 2012, insurance, benefits, claims and reserves increased $5.9 million over the comparable period in 2011. The decrease is primarily attributable to: (i) an increase of $14.9 million in the Medical Stop-Loss segment as a result of an increase in premium volume by Risk Solutions, offset by improved loss ratios; and (ii) an increase of $5.7 million in the Fully Insured Health segment, principally due to increases arising from the new pet and international lines of business offset by volume decreases in the short term medical and dental lines of business; partially offset by (iii) a $10.3 million decrease in the Group disability, life, annuities and DBL segment as a result of lower production coupled with lower loss ratios in the LTD line and the transfer of certain annuity contracts in the fourth quarter of 2011; (iv) a $4.4 million decrease in the Individual life, annuity and other segment primarily resulting from the transfer of certain group annuity contracts in the fourth quarter of 2011 and decreased premium volume from other lines in run-off.
Amortization of deferred acquisition costs in 2011 includes the write-off of $4.6 million of deferred acquisition costs that were recorded in connection with a coinsurance agreement. Excluding this write-off in 2011, amortization of deferred acquisition costs decreased $0.3 million.
In accordance with the terms of its amortizing term loan, the Company made a $2.0 million principal debt repayment in both 2013 and 2012.
For the year ended December 31, 2013, operating activities of the Company utilized $162.3 million of cash, whereas $181.7 million of cash was provided by investing activities. In the second quarter of 2013, the Company liquidated investments to fund a $215.1 million payment to an unaffiliated reinsurer in accordance with the terms of a coinsurance agreement causing the increase in investing activities and corresponding decrease in operating activities. Financing activities, which utilized $19.1 million for the period, includes a $2.0 million debt repayment, $3.6 million utilized by IHC to acquire treasury shares, and $8.8 million utilized to purchase shares of AMIC common stock from noncontrolling interests.
The Company has $525.2 million of liabilities for future policy benefits and liabilities for policy benefits and claims 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 year ended December 31, 2013, cash received from the maturities and other repayments of fixed maturities was $57.1 million.
Cash and investments decreased $202.1 million from December 31, 2012 largely due to the transfer of $215.1 million of cash and investments to an unaffiliated reinsurer in connection with a coinsurance agreement during the second quarter of 2013.
The Company had net receivables from reinsurers of $343.1 million at December 31, 2013 compared to $118.7 million at December 31, 2012. The Company recorded $218.3 million of estimated reinsurance recoverables in connection with a coinsurance agreement during the second quarter of 2013. All of such reinsurance receivables are highly rated companies or are adequately secured. No allowance for doubtful accounts was necessary at December 31, 2013.
Debt decreased as a result of a $2.0 million principal repayment in the third quarter of 2013.
The $16.9 million decrease in IHC’s stockholders' equity in 2013 is primarily due to a $25.4 million decrease in other comprehensive income (loss) for the period, common stock dividends of $1.2 million and $3.6 million of treasury stock purchases, partially offset by net income of $13.8 million.
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 $20.1 million at December 31, 2013, approximately 99.9% 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, 2013, approximately 0.1% (or $0.6 million) of the carrying value of fixed maturities was invested in non-investment grade fixed maturities (a commercial mortgage obligation). Investments in such securities have different risks than investment grade securities, including greater risk of loss upon default, and thinner trading markets. The Company does not have any non-performing fixed maturity investments at December 31, 2013.
Approximately 2.2% of fixed maturities, primarily municipal obligations, in our investment portfolio are insured by financial guaranty insurance companies. The purpose of this insurance is to increase the credit quality of the fixed maturities and their credit ratings. If the obligations of these financial guarantors ceased to be valuable, either through a credit rating downgrade or default, these debt securities would likely receive lower credit ratings by the rating agencies that would reflect the creditworthiness of the various obligors as if the fixed maturities were uninsured. The following table summarizes the credit quality of our fixed maturity portfolio as rated, and as rated if the fixed maturities were uninsured, at December 31, 2013:
The Company reviews its investments regularly and monitors its investments continually for impairments, as discussed in Note 1(G) (vi) of the Notes to Consolidated Financial Statements in Item 8 of this report. For the years ended December 31, 2013 and 2012 the Company recorded losses of $0 and $1.0 million, respectively, for other-than-temporary impairments on available-for-sale securities. Of those impairment losses, credit losses of $0.7 million were recognized in earnings for the year ended 2012, and the remaining non-credit losses were recognized in other comprehensive income (loss). The following table summarizes the carrying value of securities with fair values less than 80% of their amortized cost at December 31, 2013 by the length of time the fair values of those securities were below 80% of their amortized cost (in thousands):
All goodwill carrying amounts 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, 2013, total goodwill was $50.3 million, of which $44.6 million was attributable to the Fully Insured Health segment and $5.7 million to the Medical Stop Loss segment.
The Company experienced net unfavorable development of $2.0 million in the Medical Stop-Loss segment primarily related to 2011 and 2012 business written with a certain producer and two non-owned MGU programs. We have since ceased writing business with this producer and terminated the aforementioned MGU programs.
There were normal fluctuations to the Company's experience factor. The IBNR factors were updated to reflect the current experience. The reserving process used by management was consistent from 2012 to 2013.
All other lines, primarily blanket and other individual health products, experienced favorable development of $1.1 million.
Further adaption to health care reform by continuing to proactively adjust our distribution strategies and mix of Fully Insured Health products to take advantage of changing market demands;
Increasing sales of short-term, fixed indemnity limited benefit and supplemental health products, such as dental, hospital indemnity and critical illness and international products;
In 2013, we continued to achieve significant growth in our controlled direct written stop-loss business through Risk Solutions. This growth was achieved while maintaining underwriting profitability consistent with the prior year. Our overall results in 2013 were adversely impacted by business written through two non-owned MGU’s, both of which have been terminated. This result reemphasizes the importance of our decision to focus our stop-loss business through our direct writing model. The favorable results of Risk Solutions are a direct result of their positioning to take advantage of market trends, including consolidation of relationships by producers and increased interest in stop loss as a result of health care reform. We see these trends continuing and strengthening as we move into 2014 and beyond. Risk Solutions has established a reputation in the market for delivering innovative solutions for small to medium sized employer groups looking for self-funded alternatives. Risk Solutions has also established a reputation in the market for fair and responsible pricing and superior service levels. We foresee continued growth and favorable underwriting results as more of our stop-loss business comes through the Risk Solutions platform.
We will continue to focus on our strategic objectives, including expanding our distribution network. However, the success of a portion of our Fully Insured Health business has been affected by the passage of the Patient Protection and Affordable Care Act of 2010, as amended, and its subsequent interpretations by state and federal regulators. We are continuing our comprehensive review of all the options for IHC and we our evaluation of our portfolio of health insurance products. While the law has
influenced our decision, and that of many other insurers, to exit or reduce their presence in major medical essential health benefit (“EHB”) plans in the small employer and individual markets, non-EHB lines of business and Medical Stop-Loss have been impacted by health care reform minimally or not at all.
See Index to Consolidated Financial Statements and Schedules on page 57.