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, which is mainly used by the Managed Care segment. In addition, we own five floors of a fifteen-story building located at 1510 F.D. Roosevelt Avenue, in Guaynabo, Puerto Rico, which is mainly used by the Property and Casualty segment. 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. 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, Puerto Rico. 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, which is used by the Life Insurance segment. See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources”.
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, 2017 we serve approximately 978,000 members across all regions of Puerto Rico. For the years ended December 31, 2017 and 2016 respectively, our managed care segment represented approximately 92% of our total consolidated premiums earned, net. We also participate in the life insurance and property and casualty insurance markets in Puerto Rico.
We participate in the managed care market through our subsidiaries, TSS, TSB and TSA. TSS, TSA and TSB are BCBSA licensees.
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 24, Statutory Accounting, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Consolidated premiums earned, net decreased 2.2% year over year, to $2.8 billion, primarily reflecting lower Managed Care and Property and Casualty premiums.
The lower Managed Care premiums reflect lower membership in the segment’s Medicaid and Commercial businesses, the impact of the suspension of the HIP fee pass through in 2017, and lower Medicare additional risk score revenue. These decreases were partially offset by higher average premium rates in the Commercial and Medicaid businesses, as well as by higher Medicare membership.
Consolidated operating expenses for the year were $477.2 million and the operating expense ratio was 16.8%.
Net income for the year was $54.5 million, an increase from a net income of $17.4 million in the prior year, primarily reflecting improvements in the Managed Care segment’s MLR.
Administrative Service Fees. Administrative service fees include amounts paid to us for administrative services provided to self-insured contracts. We provide a range of customer services pursuant to our administrative services only (“ASO”) contracts, including claims administration, billing, access to our provider networks and membership services. Administrative service fees are recognized in the month in which services are provided.
Investment Income. Investment income consists of interest and dividend income from investment securities. See Note 4, Net Investment Income, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
The MLR, which is calculated by dividing managed care claims incurred by managed care premiums earned, net is one of our primary management tools for measuring these costs and their impact on our profitability. The MLR is affected by the cost and utilization of services. The cost of services is affected by many factors, in particular our ability to negotiate competitive rates with our providers. The cost of services is also influenced by inflation and new medical discoveries, including new prescription drugs, therapies and diagnostic procedures. Utilization rates, which reflect the extent to which beneficiaries utilize healthcare services, significantly influence our medical costs. The level of utilization of services depends in large part on the age, health and lifestyle of our members, among other factors. As the MLR is the ratio of claims incurred to premiums earned, net, it is affected not only by our ability to contain cost trends but also by our ability to increase premium rates to levels consistent with or above medical cost trends. We use MLRs both to monitor our management of healthcare costs and to make various business decisions, including what plans or benefits to offer and our selection of healthcare providers.
Consolidated claims incurred decreased by $119.1 million, or 4.8%, to $2.4 billion, mostly due to lower claims in the Managed Care segment offset by an increase in claims in the Property and Casualty segment. The decrease in Managed Care claims primarily reflects lower claims incurred across all businesses in the segment driven by the estimated decrease in utilization as a consequence of the aforementioned Hurricanes, lower enrollment in the Commercial and Medicaid enrollment, and favorable fluctuations in the prior period reserve developments in the Commercial and Medicare businesses. The Property and Casualty segment’s estimated net retained losses related to Hurricanes Irma and Maria were approximately $14.8 million after the application of reinsurance. The consolidated loss ratio decreased by 230 basis points to 83.2%. Excluding the impact of prior-period reserve developments, and moving the Medicare risk score revenue and other revenue adjustments to the corresponding period, the Managed Care MLR for the year was 83.7%, 100 basis points lower than the same metric from the prior year.
Consolidated operating expenses decreased by $16.7 million, or 3.4%, to $477.2 million. The lower operating expenses are mostly the result of the decrease in the HIP Fee of $44.2 million due to the 2017 moratorium offset by increase in personnel costs, professional services, and business promotion expenses totaling approximately $30.4 million.
Premiums earned, net increased by $107.4 million, or 3.9%, to $2.9 billion. This increase primarily reflects higher premiums in the Managed Care segment by $99.0 million as a result of the change in the Medicaid service model effective April 1, 2015, from an ASO agreement to a fully insured model, and higher premium rates in the Commercial business. This increase was offset by lower member month enrollment in the Medicare and Commercial businesses and a decrease in the Medicare average premiums rates.
Consolidated claims incurred increased by $153.5 million, or 6.6%, to $2.5 billion, mostly due to higher claims in the Managed Care segment. This increase primarily reflects higher claims incurred in the segment’s Medicaid business by $150.7 million after the contract changed to a fully insured model and the impact of Managed Care prior period reserve developments. The consolidated loss ratio increased by 220 basis points to 85.5%. Excluding the impact of prior period development, as well as moving the 2015 risk score revenue adjustments to its corresponding period, consolidated loss ratio was 84.1%, 70 basis points higher than last year.
We offer our products in the managed care segment to three distinct market sectors in Puerto Rico: Commercial, Medicare Advantage and Medicaid. For the year ended December 31, 2017, the Commercial, Medicare and Medicaid sectors represented 28.4%, 36.6% and 26.6% of our consolidated premiums earned, net, respectively.
The medical claims incurred of the Commercial business decreased by $94.5 million, or 13.2%, during the 2017 period and its MLR, at 77.5%, was 770 basis points lower than the same period last year. Adjusting for the effect of prior period reserve developments, the Commercial MLR would have been 77.9%, 590 basis points lower than the adjusted MLR for last year, primarily reflecting the estimated decrease in utilization caused by Hurricanes Irma and Maria in September 2017 as well as the ongoing claim trends that are lower than our premium trends following the continuity of our underwriting discipline. The estimated decrease in utilization related to the aforementioned hurricanes account for approximately 310 of the 590 basis-points decrease in the adjusted MLR.
The medical claims incurred of the Medicare business decreased by $16.6 million, or 1.8%, during the 2017 period and its MLR decreased by 260 basis points, to 87.7 %. Adjusting for the effect of prior period reserve developments in 2017 and 2016 and moving the additional risk score revenue adjustments to their corresponding period, the Medicare MLR would have been approximately 88.4%, about 80 basis points lower than last year. The estimated decrease in utilization caused by Hurricanes Irma and Maria mitigated the impact of the higher trends in Part B drugs and pharmacy benefits experienced by this business as well as the improvement of benefits in 2017 products taking advantage of the HIP fee moratorium. The estimated decrease in utilization related to the aforementioned hurricanes lowered by approximately 270 basis points the adjusted MLR.
Medical premiums generated by the Commercial business decreased by $3.2 million, or 0.4%, to $841.4 million primarily resulting from a decrease in fully-insured member months enrollment, partially offset by an approximately 5% year over year increase in average premium rates.
Administrative service fees decreased by $26.9 million, or 54.6%, to $22.4 million mainly due to the previously mentioned change in the Medicaid contract effective April 1, 2015.
Policy benefits and claims incurred increased by $0.4 million, or 0.5%, to $87.3 million, mostly reflecting a higher volume of business during the year, particularly in the Cancer and Individual Life lines of business, which claims increased by $2.7 million, offset by a decrease of $2.3 million in actuarial reserves.
Increase in underwriting and other expenses of $6.5 million, or 8.9%, to $79.9 million mostly reflects higher commissions following the segment’s premium growth mentioned above. In addition, the segment has incurred in higher development and marketing expenses related to the expansion of the Costa Rica operations. As a result, the segment’s operating expense ratio increased to 49.4%, or 260 basis points.
Policy benefits and claims incurred increased by $4.3 million, or 5.2%, to $86.9 million, mostly reflecting a higher volume of business during the year, particularly in the Cancer line of business, which claims increased by $2.7 million, as well as to an increase of $2.6 million in actuarial reserves.
The premiums ceded to reinsurers increased by $16.3 million, or 35.4%, mostly reflecting higher premiums written in Commercial insurance products during 2017 as well as adjustments related to the catastrophe reinsurance, including $9.2 million for catastrophe reinsurance reinstatement costs.
Claims incurred decreased by $1.8 million, or 4.2%, to $40.8 million. The loss ratio decreased 220 basis points, to 46.4%, during this period, primarily as a result of favorable loss experience in the Commercial Package insurance products.
Underwriting and other operating expenses decreased by $1.5 million, or 3.3%, to $43.9 million mostly due to lower net commission expenses driven by a decrease in net premiums earned. The operating expense ratio decreased by 190 basis points, to 50.0% in 2016.
Cash flow from operating activities increased by $279.7 million for the year ended December 31, 2017 as compared to the year ended December 31, 2016, principally due to, lower claims paid by $134.8 million, a decrease in cash paid to suppliers and employees of $191.6 million; offset by a decrease in premium collections of $55.1 million.
Repurchase and retirement of common stock amounted to $21.4 million reflecting the repurchase and retirement of 951,831 shares of common stock during the year ended December 31, 2016 under the Corporation’s Class B common stock repurchase programs.
The Company repurchases shares through open market transactions, in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended, under repurchase programs authorized by the Board of Directors. Shares purchased under share repurchase programs are retired and returned to authorized and unissued status. See Note 18, Stock Repurchase Program, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
Policyholder deposits - The cash outflows related to these instruments are not included because they do not have defined maturities, such that the timing of payments and withdrawals is uncertain. There are currently no significant policyholder deposits in paying status. As of December 31, 2017, our policyholder deposits had a carrying amount of $176.5 million.
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, 2017 and are gross of any reinsurance recoverable. The $657.9 million total estimated cash flows for all years in the table is different from the liability of future policy benefits of $339.5 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 monitor the solvency of the operations, the BCBSA requires us, TSS, TSA, and TSB to comply with certain specified levels of Risk Based Capital (”RBC”). RBC is designed to identify weakly capitalized companies by comparing each company’s adjusted surplus to its required surplus (RBC ratio). The RBC ratio reflects the risk profile of insurance companies. At December 31, 2017, TSM and TSS estimated RBC ratio was above the 375% minimum BCBSA RBC requirement to avoid monitoring. At December 31, 2017, TSA estimated RBC ratio was above the minimum BCBSA RBC requirement of 100% for smaller controlled affiliate.
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 accordance with insurance laws and regulations assessments are recoverable through policy surcharges. 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 2016 and 2015, the Association distributed to the Company an amount based on the good experience of the business amounting to $0.5 million and $0.7 million, respectively. In December 2015 the Association declared a special dividend of $21 million subject to a special tax of 15% that was retained upon distribution. This special dividend was paid in three installments during 2016. The share of the Property and Casualty segment in this special dividend was approximately $1.7 million, net of tax. In June 2017, the Association declared a special dividend of $70 million as authorized by a recent amendment to the Act creating the Association. The distribution was subject to a unique and special tax rate of 50% that was already paid to the Puerto Rico Treasury. The dividend net of tax is payable in December 2018. The share of the Property and Casualty segment in this distribution is $2.4 million
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 2017, 2016 and 2015.
At December 31, 2017, claim liabilities for the managed care segment amounted to $367.0 million and represented 33.1% of our total consolidated claim liabilities and 16.6% of our total consolidated liabilities.
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, 2017 claim liabilities, assuming the indicated hypothetical changes in completion and trend factors:
The costs of acquiring new life business, principally commissions, and certain variable underwriting and policy issue expenses of our life insurance segment, have been deferred. These costs, including value of business acquired (“VOBA”) recorded upon our acquisitions of TSV and TSB, are amortized to income over the premium-paying period of the related whole life and term insurance policies in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue, and over the anticipated lives of universal life policies in proportion to the ratio of the expected annual gross profits to the expected total gross profits. The expected premiums revenue and gross profits are based upon the same mortality and withdrawal assumptions used in determining the liability for future policy benefits. For universal life and deferred annuity policies, changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on the amortization of deferred policy acquisition costs of revisions to estimated gross profits is reported in earnings in the period such estimated gross profits are revised.
Management reviews investment portfolios under our impairment review policy. Given current market conditions and the significant judgments involved, there is a continuing risk that further declines in fair value may occur and material other-than-temporary impairments may be recorded in future periods. Management from time to time may sell investments as part of its asset/liability management process or to reposition its investment portfolio based on current and expected market conditions.