IndependenceCare leases 6,900 square feet of office space in Minneapolis, Minnesota, which expires on May 31, 2008. Beginning June 1, 2008, the office space leased will decrease to 4,200 square feet and will
expire on May 31, 2011. RAS leases 4,200 square feet of office space in South Windsor, Connecticut, which expires on January 31, 2010. Marlton leases 6,000 square feet of office space in Voorhees, New Jersey, which expires on January 31, 2009.
The Book Value of the Company increased to $9.96 at December 31, 2007, from $9.82 at December 31, 2006.
The return on investments of the Company was 5.4% for both 2007 and 2006.
Our 2007 results were negatively impacted by higher than expected claims from certain of Independence American's medical stop-loss programs.
Income (loss) before income taxes from the Medical Stop-Loss portion of the Independence American segment decreased $1.9 million for the year ended December 31, 2007 compared to the same period in 2006 primarily as a result of a $2.8 million charge in 2007 relating to the re-estimation of insurance reserves from the prior year in addition to an increase in the rate that the Company is reserving for current year business as more fully described in the Reserve Strengthening discussion under Results of Operations for the Year Ended December 31, 2007.
The average percentage of gross medical stop-loss premiums written ceded from IHC to Independence American slightly increased to 22.7% during 2007 from 22.2% during 2006.
For the year ended December 31, 2007, Independence American wrote $5.0 million of medical stop-loss business and $21.5 million of small-group major medical business pursuant to the agreement with the aforementioned production source. For the year ended December 31, 2006, Independence American
wrote $0.3 million of medical stop-loss business and $0 of small-group major medical business under the same agreement.
Underwriting experience, as indicated by its GAAP Combined Ratios on the three lines of business within the Independence American segment, are as follows:
The Company’s medical stop-loss business is comprised of employer stop-loss, HMO Reinsurance and Provider Excess. The two “primary” or “key” assumptions underlying the calculation of loss reserves 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.
policy individually for potential liability by reviewing open claims with each HMO or provider group and applying completion factors using historical data.
In 2007, Independence American derived most of its business from pro rata quota share reinsurance treaties with Standard Security Life and Madison National Life, which are wholly owned subsidiaries of IHC. These treaties were entered into in 2002 and terminate on December 31, 2014, unless terminated sooner by Independence American. Standard Security Life and Madison National Life must cede at least 15% of their medical stop-loss business to Independence American under these treaties. Additionally, Standard Security Life, Madison National Life and Independence American have received regulatory approval to cede up to 30% to Independence American under most of IHC’s medical stop-loss programs. For the twelve months ended December 31, 2007 and 2006, Standard Security Life and Madison National Life ceded an average of 22.7% and 22.2%, respectively, of their medical stop-loss business to Independence American. Commencing in July 2004, Independence American began reinsuring 20% of Standard Security Life’s short-term statutory disability benefit product (“DBL”) business. In 2005, Standard Security Life and Madison National Life began ceding 10% of the majority of its fully insured health business to Independence American.
IHC provides the Company with pro rata quota share reinsurance on business written by Independence American. Commencing in January 2004, Independence American began ceding 30% of its Provider Excess insurance to Madison National Life. In January 2005, Independence American increased the amount ceded to Madison National Life to 55%. This treaty was entered into on January 1, 2004 and will remain in force for an indefinite period, unless terminated by either party as of any December 31. The Company is not aware of any regulatory or other restrictions on the ability of IHC to fund its obligations under agreements in which IHC reinsures such Provider Excess business. Any such restrictions would at this point have a minimal impact on the
The Company accounts for its investments in debt and equity securities under SFAS No. 115 ("SFAS 115"), Accounting for Certain Investments in Debt and Equity Securities. The Company has classified all of its investments as available-for-sale or trading securities. These investments are carried at fair value based on quoted market prices with unrealized gains and losses reported in either accumulated other comprehensive income (loss) in the Consolidated Balance Sheets for available-for-sale securities or as unrealized gains or losses in the Consolidated Statements of Operations for trading securities. Fixed maturities and equity securities available-for-sale totaled $49.4 million and $44.9 million at December 31, 2007 and 2006, respectively. Premiums and discounts on debt securities purchased at other than par value are amortized and accreted, respectively, to interest income in the Consolidated Statements of Operations, using the constant yield method over the period to maturity. The Company also had $4.5 million and $4.0 million, on average, in trading accounts during December 31, 2007 and 2006, respectively. All such trading securities were liquidated at December 31, 2007 and 2006. Net realized gains and losses on investments are computed using the specific identification method and are reported in the Consolidated Statements of Operations.
The Company’s other intangible assets consisting of broker/third party relationships are amortized over five years.
The Company accrued estimates of expected liabilities related to discontinued operations through its eventual discharge. The estimated remaining liabilities related to discontinued operations include contract terminations, litigation and loss from operations subsequent to September 30, 2002. The Company reviews the estimated closure costs liability on a quarterly basis to determine changes in the costs of the discontinued operations activities. The cash flows used in discontinued operations are presented separately in the operating activities section of the statement of cash flows; there were no cash flows associated with investing and financing activities for the years presented for discontinued operations.
Net Investment Income. Net investment income increased $344,000 to $3,611,000 for 2007, compared to $3,267,000 for 2006 due to an increase in invested assets. The return on investments of the Company was 5.4% for both 2007 and 2006.
In accordance with our reserving methodology, the Company initially establishes its medical stop-loss reserves based on its best estimate of the Projected Net Loss Ratio, which is set based on underlying assumptions developed using completed prior experience trended forward ("Projected Net Loss Ratio"). This use of projections reflects the fact that actual claims on medical stop-loss cases typically are not fully reported until after the end of the policy period. We use the Projected Net Loss Ratio to set reserves until developing losses provide a better indication of ultimate results and it is feasible to set reserves based on claim development patterns. AMIC’s typical practice is to then increase or decrease claims reserves once we know the actual claims experience. We then review quarterly the Projected Net Loss Ratios and claim development patterns as we develop reserve estimates based on recent claim development history ("Claim Development Patterns").
Medical stop-loss business is excess coverage with a short duration. Predicting ultimate claims and estimating reserves in medical stop-loss is especially complicated due to the “excess of loss” nature of these products with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. Fluctuations in results for specific coverage are primarily due to the severity and frequency of
As a result of these actions, we increased the Projected Net Loss Ratio on the business written in 2007 by 8% and increased the Net Loss Ratio (defined as insurance benefits, claims and reserves divided by (premiums earned less underwriting expenses)) on the business written in 2006 by 7.8%. This resulted in a charge of $2,778,000, before income taxes, in 2007 relating to the re-estimation of unpaid losses from the prior year and additional expense of $1,758,000 in 2007 related to the 2007 business. The Company recorded a Net Loss Ratio for the medical stop-loss line of 103.9% and 100.5% for the years ended December 31, 2007 and 2006 respectively. The Net Loss Ratio equation primarily differs from the Combined Ratio in that it subtracts out expenses from the premiums prior to dividing by the insurance benefits, claims and reserves. We primarily use Net Loss Ratio from a reserving standpoint and as a management tool to measure the profitability of each medical stop-loss program. The Company primarily uses Combined Ratio as an accounting measurement for reporting purposes.
Income Taxes. The provision for income taxes decreased $269,000 to $691,000, an effective rate of 37.8%, for 2007, compared to $960,000, an effective rate of 38.9%, for 2006. Net income for 2007 and 2006 includes a non-cash provision for federal income taxes of $518,000 and $778,000 respectively. The effective rate of 37.8% for 2007 is lower than the same period in 2006 due to a tax benefit recognized in the current year from the true-up of the September 30, 2006 tax provision to the fiscal September 30, 2006 tax return. For as
Independence American maintains a $5,000,000 credit facility with a financial institution to support the issuance of standby letters of credit in connection with Independence American’s ordinary course of business. This credit facility has never been drawn upon and there are no outstanding standby letters of credit under the facility. The facility terminates on December 28, 2009, although, to the extent no standby letters of credit are outstanding, it may be reduced or cancelled by Independence American at any time.
Net cash provided by operating activities of continuing operations for the year ended December 31, 2007 was $8,574,000. Net cash flows were the result of insurance revenues and fees from our MGUs, partially offset by higher than expected claims and losses.
Net cash used by investing activities of continuing operations for year ended December 31, 2007 was $4,311,000. This results from purchases of fixed maturities and equity securities net of sales of all such securities.
The Company reviews its investments regularly and monitors its investments continually for impairments. For the years ended December 31, 2007 and 2006, the Company had no realized losses for other than temporary impairments. The Company's gross unrealized losses on fixed maturities totaled $1,002,000 and $1,172,000 at December 31, 2007 and 2006 respectively. Substantially all of these securities were investment grade. The unrealized losses have been evaluated in accordance with the Company's policy and were determined to be temporary in nature at December 31, 2007. The Company holds all fixed maturities as available-for-sale and accordingly marks all of its securities to market through accumulated other comprehensive income (loss).
Independence American, which is domiciled in Delaware, is licensed to write property and/or casualty insurance in 46 states and the District of Columbia, and has an A- (Excellent) rating from A.M. Best Company, Inc. ("A.M. Best"). An A.M. Best rating is assigned after an extensive quantitative and qualitative evaluation of a company's financial condition and operating performance, and is also based upon factors relevant to policyholders, agents, and intermediaries, and is not directed towards protection of investors. A.M. Best ratings are not recommendations to buy, sell or hold securities of the Company.
Since its acquisition by AMIC in 2002, Independence American’s primary source of revenue has been reinsurance premiums. The majority of these premiums are ceded to Independence American from pro rata quota share loss reinsurance treaties (the “IHC Treaties”) with Standard Security Life and Madison National Life, which are wholly owned subsidiaries of Independence Holding Company (“IHC”). IHC currently owns 49.7% of the Company’s common stock. The IHC Treaties were entered into in 2002 and terminate on December 31, 2014, unless terminated sooner by Independence American. There are three factors that determine the amount of premiums assumed by Independence American: (i) the percentage of business ceded to Independence American pursuant to the IHC Treaties or otherwise; (ii) the amount of gross premium produced by the MGUs and other distribution sources written by Standard Security Life or Madison National Life that is ceded to Independence American under the IHC Treaties; and (iii) the amount of gross premium produced by the MGUs and other distribution sources written by carriers other than Standard Security Life or Madison National Life that is ceded to Independence American. With respect to the IHC Treaties, Independence American assumes medical stop-loss, fully insured health and short-term statutory disability benefit (DBL) premiums from IHC.
The gross medical stop-loss premiums written by IHC decreased in 2007 by 5.1% and such premiums produced by our MGUs decreased by 5.3% in 2007 as a result of writing and/or renewing fewer policies due to competitors' willingness to write business at profit margins lower than those acceptable to the Company, partially offset by increased rates on the policies retained. This resulted in a decrease in the gross amount of premium available to be ceded to Independence American. Our MGUs do not anticipate materially increasing their production of medical stop-loss business in 2008. IHC has reported that it expects its gross DBL premiums to decrease slightly in 2008.
The medical stop-loss market is generally cyclical in nature. When a product experiences several consecutive years of underwriting profitability, it is not unusual for there to be more competitors entering that line which can increase pressure on pricing and create a “softer” market. The medical stop-loss market began to “soften” in 2003 and less favorable conditions continued through 2007. As a result of these market conditions, the rate that the carriers that cede business to the Company were able to charge for medical stop-loss increased at a lesser rate in recent years, however, increases in medical trend have also been held in check to a greater extent and deductibles and attachment points have increased. This reduces the risk taker’s overall risk exposure. Fully insured health business tends to be less volatile and less cyclical than excess insurance.
In February 2006, Independence American entered into an agreement with a marketing organization with a block of fully insured health business, including CDHPs, primarily sold to small employer groups, and medical stop-loss, to begin writing for Independence American. The organization that produces this business began writing employer medical stop-loss through Independence American in 2006, and moved the majority of its existing block of fully insured and stop-loss health insurance to Independence American during 2007. Independence American will be the exclusive issuing carrier for business underwritten by this organization through December 31, 2011. Subject to certain conditions, the agreement will automatically extend until December 31, 2016, and this organization could be entitled to additional cash consideration (see Note 18 of Notes to Consolidated Financial Statements).
In addition, the Company has entered into an agreement with a national, career agent marketing organization to begin marketing health plans to individuals and families utilizing Independence American as the carrier. Independence American retains 50% of the risk on this business. Gross premiums of $231,000 were written under this program in 2007. The program will be administered by Insurers Administrative Corporation, a wholly owned subsidiary of IHC.
Consolidated Balance Sheets as of December 31, 2007 and December 31, 2006
We have audited the accompanying consolidated balance sheets of American Independence Corp. and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for the years then ended. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedules listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion of the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion in 2007. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Due from reinsurers ($9,242 and $11,003, respectively, due from related parties)
Due to reinsurers ($1,789 and $1,914 respectively, due to related parties)
American Independence Corp. ("AMIC" or "the Company") is a holding company engaged in the insurance and reinsurance business through: a) its wholly owned insurance company, Independence American Insurance Company ("Independence American"); b) its managing general underwriter subsidiaries: IndependenceCare Holdings L.L.C. and its subsidiaries (collectively referred to as "IndependenceCare"); Risk Assessment Strategies, Inc. ("RAS"), and Marlton Risk Group LLC ("Marlton"); c) its 23% investment in Majestic Underwriters LLC ("Majestic"); and d) its 51% ownership in HealthInsurance.org, LLC (“HIO”), an insurance agency. IndependenceCare, RAS and Marlton are collectively referred to as "our MGUs".
Prior to November 14, 2002, the Company (then known as SoftNet Systems, Inc.) was a holding company principally engaged in providing Internet services. All previously reported business segments have ceased operations or have been sold, and accordingly are reported as discontinued operations (see Note 8 of Notes to Consolidated Financial Statements).
Certain reclassifications have been made to prior years' consolidated financial statements and related notes to the consolidated financial statements in order to conform to the current year presentation.
The Company's investment in Majestic Underwriters LLC (see Note 6 of Notes to Consolidated Financial Statements) is carried on the equity method with the Company's share of income or loss credited or charged, as appropriate, to net investment income in the Consolidated Statement of Operations with a corresponding charge to the Company's investment account. The
(ii) Financial instruments sold, but not yet purchased, represent obligations to replace borrowed securities that have been sold. Such transactions occur in anticipation of declines in the fair value of the securities. The Company's risk is an increase in the fair value of the securities sold in excess of the consideration received, but that risk is mitigated as a result of relationships to certain securities owned. Unrealized gains or losses on open transactions are credited or charged, as appropriate, to net realized investment gains in the Consolidated Statements of Operations. While the transaction is open, the Company will also incur an expense for any accrued dividends or interest payable to the lender of the securities. When the transaction is closed, the Company realizes a gain or loss in an amount equal to the difference between the price at which the securities were sold and the cost of replacing the borrowed securities. There were no such transactions outstanding at December 31, 2007 and 2006.
furniture and fixtures). Amortization of leasehold improvements has been provided on the straight-line method over the shorter of the lease term or the estimated useful life of the asset.
Liabilities for insurance reserves on certain short-term medical coverages, such as medical stop-loss, are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data. Reserves for medical stop-loss insurance are more volatile in nature than those for fully insured medical insurance. This is primarily due to the excess nature of medical stop-loss, with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. The level of these deductibles makes it more difficult to predict the amount and payment pattern of such claims. Furthermore, these excess claims are highly sensitive to changes in factors such as medical trend, provider contracts and medical treatment protocols, adding to the difficulty in predicting claim values and estimating reserves. Also, because medical stop-loss is in excess of an underlying benefit plan, there is an additional layer of claim reporting and processing that can affect claim payment patterns. Finally, changes in the distribution of business by effective month can affect reserve estimates due to the timing of claim occurrences and the time required to accumulate claims against the stop-loss deductible.
Due to the short-term nature of Medical Stop-Loss, redundancies or deficiencies will typically emerge during the course of the following year rather than over a number of years. For Employer Stop-Loss, as noted above, the Company typically maintains its reserves based on underlying assumptions until it determines that an adjustment is appropriate based on emerging experience from all of its MGUs for prior underwriting years. Reserves for HMO Reinsurance and Provider Excess are adjusted on a policy by policy basis. Because of the small number of HMO Reinsurance and Provider Excess policies it writes or reinsures, the Company is able to evaluate each policy individually for potential liability by reviewing open claims with each HMO or provider group and applying completion factors using historical data.
The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial carrying amounts of existing assets and liabilities and their respective tax basis, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets where it is more likely than not that the deferred tax asset will not be realized (see Note 12 of Notes to Consolidated Financial Statements).
Basic income per common share is computed using the weighted average number of common stock shares outstanding during the period. Diluted income per common share is computed using the weighted average number of common stock shares and common stock equivalent shares outstanding during the period. Common stock equivalents consist of stock options (using the "treasury stock" method). Common stock equivalent shares are excluded from the computation if the effect is anti-dilutive. As a result of the anti-dilutive effect, common stock equivalent shares have been excluded from the computation of diluted earnings per share for periods presented with a net loss. Included in the diluted earnings per share calculation for years 2007 and 2006, are 51,000 and 54,000 shares, respectively, from the assumed exercise of options using the treasury stock method. Net income does not change as a result of the assumed dilution of options.
On October 5, 2007, the Company acquired certain assets, including the domain name www.healthinsurance.org, for $430,000 including closing costs of $55,000. The Company recorded $318,000 of goodwill and $112,000 of intangible assets representing the value of the www.healthinsurance.org internet domain name and related internet relationships which will be amortized over 15 years. These assets were acquired by HealthInsurance.org, LLC, an indirect, 51%-owned subsidiary of the Company (“HIO”). This acquisition gives the Company access to a well-established internet domain that generates hundreds of daily leads of business from individuals and small employers seeking affordable health insurance solutions. Under certain circumstances set forth in the operating agreement of HIO, the Company has the right and/or obligation to purchase some or all of the minority interest in HIO.
The amortized cost and fair value of fixed maturities at December 31, 2007 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. The average life of mortgage backed securities is affected by prepayments on the underlying loans and, therefore, is materially shorter than the original stated maturity.
The following tables summarizes, for all securities in an unrealized loss position at December 31, 2007 and December 31, 2006, the aggregate fair value and gross unrealized loss by length of time, those securities that have continuously been in an unrealized loss position (in thousands):
The Company had derivative instruments representing the value of the contingent payment due to EDH as of December 31, 2007 and 2006 (see Note 18 of Notes to Consolidated Financial Statements).
The Company maintains a securities trading account in addition to its securities classified as available-for-sale. The Company realized net gains from trading securities of $319,000 in 2007 and $392,000 in 2006. The Company had $4,500,000 and $4,000,000 million, on average, in trading securities during 2007 and 2006, respectively. All such trading securities were liquidated at December 31, 2007 and 2006.
Net realized investment gains (losses) for years 2007 and 2006 are as follows:
Until April 2002, the Company (then known as SoftNet Systems, Inc.) was an Internet service provider. Due to difficult and deteriorating conditions in that market, the Company discontinued this business. In December 2000, the Company's board of directors approved a plan to discontinue the operations of its subsidiary, ISP Channel, Inc., which had provided cable-based Internet access and related services, and the operations of another subsidiary, Aerzone Corporation, which provided Internet and related services at airports. In April 2002, the Company, ceased operations of its remaining operating subsidiary, Intelligent Communications, Inc., following the disposition of its key assets. The operating results of discontinued operations have been segregated from continuing operations and are reported as a gain or loss from discontinued operations on the consolidated statements of operations. Although it is difficult to predict the final results, the gain or loss on disposition from discontinued operations includes management's estimates of costs to wind down the business and costs to settle its outstanding liabilities. The actual results could differ from these estimates. The net liabilities associated with discontinued operations are reflected in net liabilities associated with discontinued operations in the accompanying consolidated balance sheets.
Following the sale of its operating business and certain assets on March 29, 2002, the Company's board of directors unanimously agreed to cease the operations of Intellicom on April 3, 2002. Principally due to the Company's guaranty of Intellicom's lease for its facility in Livermore, California, the Company has reserves for discontinued operations of Intellicom of $399,000 for this liability at December 31, 2007, and $555,000 at December 31, 2006. In October of 2006, the Company entered into an agreement with a third party to sublease the property in Livermore, California for the remaining life of the lease. The income associated with the sublease was previously estimated in the reserve balance. Loss from disposition of discontinued operations results from re-estimation of certain expected expenses.
The minimum lease payments shown above do not include $225,000 of sublease income to be received in the future under non-cancelable subleases.
The Company's net rent expense for years 2007 and 2006 were $357,000 and $649,000, respectively.
The Company has additional obligations in regard to its agreement with EDH as further described in Note 18 of Notes to Consolidated Financial Statements.
Independence American maintains a $5,000,000 credit facility with a financial institution to support the issuance of standby letters of credit in connection with Independence American’s ordinary course of business. This credit facility has never been drawn upon and there are no
outstanding standby letters of credit under the facility. The facility terminates on December 28, 2009, although, to the extent no standby letters of credit are outstanding, it may be reduced or cancelled by Independence American at any time.
Effective October 1, 1998, the Company implemented the 1998 Plan, which the Company's stockholders approved on April 13, 1999. The 1998 Plan provides for the grants of non-statutory and incentive stock options, stock appreciation rights, restricted stock awards, performance shares, and other awards to officers, employee and other individuals. Under the terms of the 1998 Plan, stock options have a maximum term of ten years from the date of grant, and have various vesting criteria depending on the grant with most grants vesting 25% on the first year anniversary date of the grant and ratably over the next 36 months. In addition, the number of common stock shares reserved for issuance under the 1998 Plan will automatically increase on the first trading day of each calendar year, beginning in calendar year 2000, by an amount equal to seven percent of the total number of common stock shares outstanding on the last trading day of the preceding calendar year, but in no event will any such annual increase exceed 1,333,333 shares, subject to adjustment for subsequent stock splits, stock dividends and similar transactions. At December 31, 2007, a total of 6,558,919 stock shares are reserved for issuance under the 1998 Plan. At December 31, 2007, stock options for 443,499 common stock shares were outstanding, stock options for 381,971 common stock shares were vested, and 5,968,611 common stock shares remained available for future stock options grants and other awards.
The following table summarizes the outstanding options to purchase common stock shares for years 2007 and 2006:
On January 1, 2006, the Company adopted the provisions of SFAS No. 123 (R), "Share Based Payment", which requires compensation cost relating to share-based payment transactions to be recognized in the financial statements, based upon the fair value of the instruments issued. SFAS No. 123 (R) covers a wide range of share-based compensation arrangements including share options, restricted stock plans, performance-based awards, share appreciation rights and employee purchase plans. SFAS No. 123 (R) replaces SFAS No. 123, which established as preferable a fair value based method of accounting for share-based compensation with employees, but permitted the option of continuing to apply the guidance of APB Opinion No. 25, as long as the notes to the financial statements disclosed the effects of the preferable fair value method. In March 2005, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107 (SAB 107) regarding the SEC's interpretation of SFAS No. 123 (R) and the valuation of share-based payments for public companies. The Company has applied the provisions of SAB 107 in its adoption of SFAS No. 123 (R) and accordingly recorded share-based payment expense in Selling, General and Administrative expenses in the Consolidated Statements of Operations. Since the Company previously adopted the provisions of SFAS No. 123, effective November 14, 2002, the adoption of SFAS No. 123 (R) did not have a material impact on the Company's Consolidated Financial Statements.
The fair value of each stock option on the date of grant was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions for years 2007 and 2006:
Independence American is primarily a reinsurer, and currently derives most of its business from pro rata quota share reinsurance treaties with Standard Security Life and Madison National Life, which are wholly owned subsidiaries of IHC. These treaties were entered into in 2002 and terminate on December 31, 2014, unless terminated sooner by Independence American. Standard Security Life and Madison National Life must cede at least 15% of their medical stop-loss business to Independence American under these treaties. Additionally, Standard Security Life, Madison National Life and Independence American have received regulatory approval to cede up to 30% to Independence American under most of IHC’s medical stop-loss programs. For the twelve months ended December 31, 2007 and 2006, Standard Security Life and Madison National Life ceded an average of 22.7% and 22.2%, respectively, of their medical stop-loss business to Independence American. Commencing in July 2004, Independence American began reinsuring 20% of Standard Security Life’s short-term statutory disability benefit product (“DBL”) business. In 2005, Standard Security Life and Madison National Life began ceding 10% of the majority of its fully insured health business to Independence American.
Independence American assumes these premiums from Standard Security Life and Madison National Life, and records related insurance income, expenses, assets and liabilities. Independence American pays administrative fees and commissions to subsidiaries of IHC in connection with fully insured health business written by Independence American. Additionally, our MGUs market, underwrite and provide administrative services (including premium collection, medical management and claims adjudication) for a substantial portion of the medical stop-loss business written by the insurance subsidiaries of IHC and records related income, assets and liabilities in connection with that business. Such related party information is disclosed on the Consolidated Balance Sheets and Consolidated Statements of Operations. The Company also contracts for several types of insurance coverage (e.g. directors and officers and professional liability coverage) jointly with IHC. The cost of
IHC provides the Company with pro rata quota share reinsurance on business written by Independence American. Commencing in January 2004, Independence American began ceding 30% of its provider excess insurance to Madison National Life. In January 2005, Independence American increased the amount ceded to Madison National Life to 55%. This treaty was entered into on January 1, 2004 and will remain in force for an indefinite period, unless terminated by either party as of any December 31. The Company is not aware of any regulatory or other restrictions on the ability of IHC to fund its obligations under agreements in which IHC reinsures such provider excess business. Any such restrictions would at this point have a minimal impact on the Company. In addition, in 2007, Independence American ceded 50% of its STM and major medical for individuals and families business to unrelated reinsurers.
AMIC and its subsidiaries incurred expense of $776,000 and $622,000 for the twelve months ended December 31, 2007 and 2006, respectively, from its service agreements with IHC and its subsidiaries. These payments reimburse IHC and its subsidiaries, at agreed upon rates including an overhead factor, for management services provided to AMIC and its subsidiaries, including accounting, legal, compliance, underwriting, and claims.
The Company and its subsidiaries file a consolidated Federal income tax return on a September 30 fiscal tax year. The provision (benefit) for income taxes for the periods ended December 31, 2007 and 2006 are as follows:
The Federal income tax provision (benefit) for the periods ending December 31, 2007 and 2006 include income tax provisions of $537,000 and $792,000, respectively, for the utilization of the Company's Federal net operating loss carryforwards (NOLs). The Company recorded deferred tax benefits on discontinued operations of $0 and $29,000 for the periods ending December 31, 2007 and 2006, which were included in Gain (loss) on Disposition of Discontinued Operations, net of tax, in the Statement of Operations.
During the year ended December 31, 2007, the Company decreased its valuation allowance by $3,000 representing a decrease of deferred tax on unrealized losses allocated to
equity. During the year ended December 31, 2006, the Company increased its valuation allowance by $44,000, representing an increase of deferred tax on unrealized losses allocated to equity.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Management believes that it is more likely than not that the Company will realize the benefits of these net deferred tax assets recorded at December 31, 2007.
At December 31, 2007, the Company also had net operating loss carryforwards of approximately $25,814,000 for state income tax purposes, primarily in the State of California. Management believes that it is more likely than not that the state tax benefit of these net operating loss carryforwards will not be realized.
amount incurred in 2007 of $2,964,000 is a result of the re-estimation of unpaid losses on medical stop-loss reserves of $2,778,000 and of fully insured health reserves of $438,000, slightly offset by a redundancy of $252,000 of DBL reserves. The amount incurred in 2006 for prior years of $1,969,000 is primarily a result of re-estimation of unpaid losses on medical stop-loss reserves. These increases are generally the result of on-going analysis of recent loss development trends.
Medical stop-loss business is excess coverage with a short duration. Predicting ultimate claims and estimating reserves in medical stop-loss is especially complicated due to the “excess of loss” nature of these products with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. Fluctuations in results for specific coverage are primarily due to the severity and frequency of individual claims. Due to the short-term nature of medical stop-loss, redundancies and deficiencies will typically emerge during the following year rather than over a number of years. In the third quarter of 2007, the Company identified a material increase in claims and reserves with respect to business written in 2006. Such adverse development was primarily driven by the frequency of claims relative to the business written in that year proving significantly higher than what would have been predicted by prior loss development patterns. This increased frequency of medical stop-loss claims was due, in part, to increased severity of primary claims.
Independence American reinsures a portion of its small-group major medical, major medical for individuals and families, and provider excess loss business in order to limit the assumption of disproportionate risks. Amounts not retained are ceded to other companies on an automatic basis. Independence American is contingently liable with respect to reinsurance in the unlikely event that the assuming reinsurers are unable to meet their obligations. The ceding of reinsurance does not discharge the primary liability of the original insurer to the insured. At December 31, 2007, Independence American ceded to highly rated reinsurers.
(a) Primarily represents a release of reserves relating to provider excess business ceded that experienced a lower loss ratio than reserved in the prior year.
disapproved by the Delaware Insurance Commissioner within 30 days of its receipt of notice thereof. Independence American did not pay any dividends in 2007 and 2006.
Independence American’s statutory surplus was $41,353,000 as of December 31, 2007 and $40,778,000 as of December 31, 2006. Independence American’s statutory net income was $1,325,000 for 2007 and $1,897,000 for 2006.
The components of total comprehensive income, net of tax, include net income and certain amounts reported directly in equity, such as the after-tax unrealized gains and losses on investment securities available-for-sale. The components of other comprehensive income for years 2007 and 2006 are as follows:
As part of the agreement, an affiliate of EDH and Independence American entered into a profit/loss sharing arrangement, whereby Independence American will pay to, or receive from, such affiliate 35% of the underwriting profit or loss of the business written for Independence American.