TSM owns a seven story (including the basement floor) building located at 1441 F.D. Roosevelt Avenue, in San Juan, Puerto Rico where the main offices of TSM, TSI and ISI are located, and two adjacent buildings that house TCI and certain offices of TSI, as well as the adjoining parking lot. In addition, TSM is the owner of five floors of a fifteen-story building located at 1510 F.D. Roosevelt Avenue, in Guaynabo, Puerto Rico. These floors house the Internal Auditing Office of TSM, the main offices of SVTS and STS and some divisions of TSI. The Corporation is currently renovating the facilities in one of the two buildings adjacent to its main offices to house the operations of ISI, including its mainframe facilities, and some divisions of TSI. ISI’s mainframe facilities are currently located in a leased property that will be vacated once the renovation project is completed.
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, 2005, 2004 and 2003.
The Corporation (on a consolidated basis and for each reportable segment), similar to most insurance entities, uses the loss ratio, the expense ratio and the combined ratio as measures of performance. The loss ratio is the claims incurred divided by the premiums earned, net and fee revenue multiplied by 100. The expense ratio is the operating expenses divided by the premiums earned, net and fee revenue multiplied by 100. The combined ratio is the sum of the loss ratio and the expense ratio. These ratios are relative measurements that describe for every $100 of premiums earned, net and fee revenue, the costs of claims and operating expenses, respectively. The combined ratio represents the total cost per $100 of premium production. A combined ratio below 100 demonstrates underwriting profit; a combined ratio above 100 demonstrates underwriting loss.
The analysis in this section is included to provide an overall view of certain information, the consolidated statements of operations, and key financial information. Further details of the results of operations of each reportable segment are included in the respective segment’s section.
Consolidated premiums earned, net and fee revenue during the year 2005 increased by $86.4 million, or 6.6 %, when compared to the premiums earned, net and fee revenue during 2004. This increase is mostly due to the fluctuation in premiums earned, net of both Health Insurance segments.
The premiums earned, net and fee revenue corresponding to the Health Insurance - Commercial Program presented an increase of $59.1 million, or 8.2%, during this period. The increase in premiums earned, net of this segment is due to a 1.2% increase in average enrollment together with a 6.0% increase in average premium rates in 2005.
The premiums earned, net of the Health Insurance - Reform segment presented an increase of $26.1 million, or 5.4%, in 2005, as compared to the premiums earned, net in 2004. This increase is the result of a 4.5% increase in average premium rates together with a 0.9% increase in the average membership of the segment.
Consolidated claims incurred during the year 2005 reflected an increase of $92.6 million, or 8.3%, when compared to the consolidated claims incurred for the year 2004. The loss ratio reflects an increase of 1.3 percentage points during the same period. This increase is mostly driven by the fluctuations in the claims incurred and the loss ratio of the Health Insurance - Commercial Program and Reform segments, which are attributable primarily to the following:
During 2005, the claims incurred of the Health Insurance - Commercial segment increase of $57.1 million, or 9.2%, is primarily attributed to an increase in utilization and costs of services as well as to an increase in average enrollment.
The claims incurred of the Health Insurance -Reform segment increased $40.2 million, or 9.2%, when comparing the amounts incurred in the years 2005 and 2004. The increase in the claims incurred of this segment results mostly from higher utilization trends and costs, particularly in the risks assumed by the segment, such as cardiovascular services, dialysis and obstetrics and HIV, among others. In addition, this segment also experienced an increase in claims incurred that is attributed to the increase in its average enrollment.
The amount of claims incurred in the Property and Casualty Insurance segment decreased $2.4 million, or 5.2%, during the year 2005. This decrease is primarily due to incurred losses from Tropical Storm Jeanne in September 2004, which resulted in net losses of $2.1 million.
The unrealized (loss) gain on trading securities is related to investments held by segments in corporate bonds and equity securities. The unrealized loss experienced during the year 2005 is mostly attributed to losses in the portfolios held by segments in equity securities that seek to replicate the Standard & Poor’s 500 Index, the Russell 1000 Growth Index and the Russell 1000 Value Index. These Indexes experienced positive returns in 2005, however; the Corporation has recognized unrealized losses since during the second quarter of the year 2005 certain investments with unrealized gains within the equity securities portfolio were sold. This caused the realization of such gains, thus reducing the unrealized gains of the portfolios.
Consolidated premiums earned, net and fee revenue increased by $35.5 million, or 2.8 %, during the year 2004 when compared to the premiums earned, net and fee revenue during 2003. This increase is mostly due to the fluctuation in premiums earned, net of both Health Insurance segments and the property and casualty insurance segment.
experienced higher costs per service and utilization trends when compared to the prior period. The increase was mainly noted in the cost and utilization of prescription drugs, X-rays, and emergency room services as well as to an increase in the cost of surgical procedures and laboratory services.
The unrealized gain on trading securities is related to investments held by segments in corporate bonds and equity securities. The unrealized gain experienced during the year 2004 is mostly attributed to gains in the portfolios held by segments in equity securities that replicate the Standard & Poor’s 500 Index, the Russell 1000 Growth Index and the Russell 1000 Value Index. All Indexes experienced positive returns in 2004.
The Health Insurance - Commercial Program segment’s total revenues are primarily generated from premiums earned for risk-based healthcare services provided to its members, revenues generated from self-funded arrangements and investment income. Claims incurred include healthcare services and other benefit expenses consisting primarily of
payments to physicians, hospitals and other service providers. A portion of the claims incurred for each period consists of an actuarial estimate of claims incurred but not reported to the segment during the period. Operating expenses are comprised of general, selling, commissions, depreciation, payroll and other related expenses. The segment’s results of operations depend largely on its ability to accurately predict and effectively manage healthcare costs.
The claims incurred for the year 2004 were $36.3 million, or 6.2%, higher than 2003, mostly as a consequence of an increase in claims experience trends. The claims experience trends increased 5.7% and 3.9% during 2004 and 2003, respectively, mostly due to higher costs per service and higher utilization levels. The segment’s loss ratio reflects an increase of 2.5 percentage points during the same period. The increase in the loss ratio is the result of increases in the cost and utilization of prescription drugs, emergency room services, X-ray services and major medical services experienced by the segment in the 2004 period. Total claims paid during 2004 for both medical services and prescription drug coverage increased by 8.6% and 8.2%, respectively, when compared to 2003. Claims paid during 2004 on major medical services present an increase $11.3 million, or 55.0%, when compared to 2003.
The business growth experienced in 2004 resulted in an increase of $2.3 million in payroll expenses and commissions due to agents and brokers.
The Health Insurance - Reform segment’s total revenues are primarily generated from premiums earned according to the provisions of the Government’s Reform contracts and investment income. Claims incurred include health services and other benefit expenses consisting primarily of payments to physicians, hospitals and other service providers. A portion of the claims incurred for each period consists of an actuarial estimate of claims incurred but not reported during the period. Operating expenses consist of a disease management program and general, depreciation, payroll and other related expenses. The segment’s results of operations depend largely on its ability to accurately predict and effectively manage healthcare costs.
Premiums earned, net of the Reform segment increased $26.1 million, or 5.4%, during the year 2005. This increase is the result of the net effect of the following:
Approximately 84% of the increase in total premiums is due to increases in premium rates. The remaining 16% is attributable to an increase in the segment’s volume of business.
Claims incurred during the 2005 period increased by $40.2 million, or 9.2%, when compared to the 2004 period. The segment’s loss ratio also experienced an increase (3.3 percentage points) when comparing the year 2005 with 2004. This increase results mostly from higher utilization trends and costs as well as to the segment’s increased average enrollment during 2005. In the 2005 period the segment experienced higher utilization trends and costs, particularly in the risks assumed by the segment, such as cardiovascular services, dialysis and obstetrics and HIV, among others. In addition, the ultimate liability for the year 2004 exceeded the amount originally provided by the segment by approximately $7.0 million.
Operating expenses for the year 2005 were $655 thousand, or 1.8%, higher than the operating expenses for the year 2004. This increase is due to the normal inflationary effect of higher operational costs. The expense ratio decreased by 0.3 percentage points during the year 2005.
The premiums earned, net of the Reform segment increased $7.1 million, or 1.5%, during the year 2004. This increase is the result of the following:
The average enrollment for this segment decreased by 15,024 members, or 2.4%, during the year 2004. This decrease is attributed to the continuous review and screening performed by the Government of Puerto Rico over the lists of persons eligible to participate in the Reform.
The increase of $9.8 million, or 2.3%, in claims incurred during the year 2004 is attributed to the higher utilization and costs experienced by the segment. The segment experienced an increase in utilization in some of the risks it assumes, particularly catastrophe risks such as cardiovascular services, dialysis and obstetrics, among others. Also, during 2004, the capitation payments to IPAs increased when compared to the prior year. The segment’s loss ratio also experienced an increase (0.7 percentage points) when comparing the year 2004 with 2003.
Premiums ceded to reinsurers during the year 2005 increased by $7.0 million, or 13.5%, when compared to 2004. The increase noted in the premiums ceded is mostly due to the segment’s increased volume of business. The ratio of premiums ceded to total premiums written reflects an increase of 2.4 percentage points, from 36.8% in 2004 to 39.2% in 2005. The ceding risk transfer percentages in the commercial and personal lines quota share arrangements increased from 37.5% to 42.5% and from 7.5% to 10.0%, respectively. In addition, the catastrophe coverage was increased during the 2005 period.
Total premiums written during 2004 increased by $13.7 million, or 10.7%, when compared to the total premiums written for the year 2003. This increase is mostly reflected in the premiums written for the dwelling, auto physical damage and other liability lines of business, which experienced an increase in premiums of $5.7 million, or 25.2%, $3.1 million, or 19.6%, and $2.0 million, or 30.1%, during this period, respectively. The strengthening of business relationships with financial institutions has resulted in additional growth in the dwelling line of business. The commercial auto, including auto physical damage coverage, and other liability lines of business have been targeted for growth through new business.
The increase experienced in net premiums earned is mainly attributable to an increase in the segment’s volume of business.
Premiums ceded to reinsurers during the year 2004 increased by $8.4 million, or 19.3%, when compared to 2003. The ratio of premiums ceded to total premiums written reflects an increase of 2.6 percentage points, from 34.2% in 2003 to 36.8% in 2004. The increase in the ratio of premiums ceded to total premiums written is the net result of several factors:
In 2004, the segment experienced increased costs for catastrophe coverage as well as the need to compensate for the coverage increase in the property business.
During 2003 the segment increased its retention in the personal lines quota share treaty from 70% to 95%. In addition, as a result of the increased retention, the segment received an incoming reinsurance portfolio transfer causing a reduction in the premiums ceded in the 2003 period.
The decrease in the change in unearned premiums of $2.6 million is also primarily due to the effect of the reinsurance portfolio transfers done during the year 2003 as well as to the changes in the mix of the business subscribed.
The effect of an increase in commission expense due to the segment’s increased volume of business
The earned premiums of the cancer and other dreaded diseases line of business increased by $1.6 million during the year 2005. This fluctuation is attributed to an increase in the average certificates in force of this business by 8,221 during this year. This line of business was introduced during the latter part of the year 2004.
Claims incurred during the year 2005 decreased by $2.3 million, or 20.7%, when compared to the claims incurred during 2004. The loss ratio decreased by 16.3 percentage points during 2005. The fluctuation in the amount of claims incurred and in the loss ratio is the direct result of the segment’s strategy to concentrate on the profitability of the business rather than on its volume. As previously mentioned, the segment close monitoring of claims experience upon each group’s renewal process has resulted in the loss in the renewal process of several groups with higher than expected claims experience, thus improving the profitability of the segment.
Total earned premiums in the 2004 period presented a decrease of $994 thousand, or 4.0%, when compared to the 2003 period. This decrease is the result of the following:
Excluding the effect of the above mentioned adjustment to the 2003 earned premiums, premiums increased by $139 thousand in 2004 as compared to 2003, approximately 98% of which is attributed to increased volume of business. The remaining 2% of the increase experienced is attributed to increased premium rates.
The claims incurred during the year 2004 presented an increase of $1.8 million, or 18.6%, when compared to the claims incurred during the year 2003. The loss ratio presented an increase of 13.9 percentage points during this period. This increase is attributed to the segment’s continued growth in the disability line of business since this particular line of business has a higher loss ratio than the life business. In addition, the segment has experienced an increased claims trend in the disability and group life lines of business when compared to the 2003 period. These factors contributed to the increased claims incurred and loss ratio in the 2004 period. During the year 2004, the segment implemented several corrective measures in order to improve its loss ratio, such as adjusting premiums to reflect each group’s actual claims experience during the group’s renewal process.
As of December 31, 2005 and 2004, the Corporation’s cash and cash equivalents amounted to $49.0 million and $35.1 million, respectively. Sources of funds considered in meeting the objectives of the Corporation’s operations include cash provided from operations, maturities and sales of securities classified within the trading and available-for-sale portfolios, securities sold under repurchase agreements, and issuance of long and short-term debt.
Net cash flows from operations are expected to sustain operations for the next year and thereafter, as long as the operations continue showing positive results. In addition, the Corporation monitors its premium rates and its claims
incurred to ascertain proper cash flows and has the ability to increase premium rates throughout the year in the monthly renewal process.
Most of the cash flows from operating activities are generated from the insurance subsidiaries. The basic components of the cash flows from operations are premium collections, claims payments less reinsurance premiums, maturities or sales and purchases of trading securities, and payment of operating expenses.
Net cash flows provided by operating activities amounted to $49.1 million, $8.8 million and $10.1 million for the years ended December 31, 2005, 2004 and 2003, respectively, an increase (decrease) of $40.3 million and $(1.3) million in 2005 and 2004, respectively. The fluctuation in cash flows provided by operating activities is mainly attributed to the net effect of the following:
Increase in collections of premiums of $86.2 million in 2005 and $35.3 million in 2004. The increase in premium collections is the result of the increased premium rates and increased volume of business of the operating segments.
Increase of $100.7 million and $26.3 million in 2005 and 2004, respectively, in the amount of claims losses and benefits paid. In both years the increase in the amount of claims losses and benefits paid is mostly the result of the segment’s increased volume of business as well as to increased utilization trends in both Health Insurance segments.
The amount of interest paid increased by $1.8 million in 2005 and $712 thousand in 2004. This increase is principally attributed to the interest paid related to the 6.3% senior unsecured notes issued and sold by TSI in September 2004.
Net cash flows used in investing activities amounted to $100.5 million, $45.0 million and $90.6 million for the years ended December 31, 2005, 2004 and 2003, respectively. The cash flows used in investing activities during these years were mainly due to the investment of the excess cash generated from the operations and reinvestment of securities sold, called or matured during the same period. Also, in 2005 the proceeds from sale of the corporate bonds trading portfolio
The Corporation is currently rehabilitating facilities in one of the two buildings adjacent to the Corporation’s main offices, on which the Corporation incurred costs of approximately $1.6 million during the year 2005 (see “Item 2. Properties” and section “Planned Capital Expenditures” for additional details).
In 2005, TSI acquired approximately $1.0 million of telephone equipment and services for the operation of the Medicare business call center.
During the year 2005, STS has incurred expenses of approximately $1.0 million related to the acquisition of a new computer system to manage its insurance operations (see section “Planned Capital Expenditures” for additional details.
In the 2005 period the proceeds from short-term borrowings exceeded payments of short-term borrowings by $40 thousand. On the other hand, in the year 2004 the payment of short-term borrowings exceeded the proceeds of short-term borrowings by $37.0 million. Short-term borrowings are used to address timing differences between cash receipts and disbursements.
The amount of net proceeds from annuity contracts during the years 2005, 2004 and 2003 amounted to $6.4 million, $6.4 million and $11.2 million, respectively. This fluctuation noted between the years 2004 and 2003 is primarily due to the Corporation’s new deferred annuity product introduced in late 2002.
For the selected quarterly financial data corresponding to the years 2005 and 2004, see note 26 of the audited consolidated financial statements as of December 31, 2005, 2004 and 2003.