Independence Holding Company, a Delaware corporation (NYSE: IHC), is a holding company principally engaged in the life and health insurance business through: (i) its insurance companies, Standard Security Life Insurance Company of New York ("Standard Security Life"), Madison National Life Insurance Company, Inc. ("Madison National Life"), and Independence American Insurance Company (“Independence American”); and (ii) its marketing and administrative companies, including IHC Specialty Benefits Inc. IHC Carrier Solutions, Inc. and a majority interest in PetPartners, Inc. (“PetPartners”). IHC also owns a significant equity interest in Ebix Health Exchange Holdings, LLC (“Ebix Health Exchange”), an administration exchange for health insurance. Standard Security Life, Madison National Life and Independence American are sometimes collectively referred to as the “Insurance Group”. IHC and its subsidiaries (including the Insurance Group) are sometimes collectively referred to as the "Company", or “IHC”, or are implicit in the terms “we”, “us” and “our”.
IHC’s health insurance products serve niche sectors of the commercial market through multiple classes of business and varied distribution channels. With regard to those persons in the growing individual market, IHC’s products offer coverage for individuals and families with short-term needs, and fixed indemnity limited benefit and scheduled benefit plans through multiple distribution partners. We offer pet insurance for dogs and cats in all 50 states through select distributors. Our fixed indemnity limited benefit product is primarily purchased by hourly workers and others who are generally not eligible for coverage
Medical stop-loss was marketed to employer groups that self-insure their medical risks. On March 31, 2016, the Company sold IHC Risk Solutions, LLC (“Risk Solutions”), a managing general underwriter that was its principal source of medical stop-loss business. In addition, all of the in-force medical stop-loss business of Standard Security Life and Independence American produced by Risk Solutions was 100% co-insured as of January 1, 2016 and IHC’s block of medical stop-loss business is in run-off.
On December 22, 2017, President Trump signed tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including, but not limited to reducing the federal corporate income tax rate from 35% to 21%.The Company has completed its accounting for the income tax effects under the Tax Act that are relevant to the Company using best estimates based on reasonable and supportable assumptions and available inputs and underlying information. We believe that our accounting is final relative to the Tax Act. The Consolidated Financial Statements reflect all such adjustments and disclosures related to the Tax Act. Refer to Note 12 of the Consolidated Financial Statements for more information regarding the impacts of the Tax Act.
oIncome taxes for the years ended December 31, 2017 and 2016, include income tax benefits of $11.6 million and $3.9 million, respectively, on worthless stock deductions representing the Company’s tax basis on its unrecovered investments in those subsidiaries.
Book value of $28.98 per common share at December 31, 2017 compared to $25.53 at December 31, 2016.
The Specialty Health segment reported $13.2 million of income before taxes for the year ended December 31, 2017 compared to $7.2 million for the comparable period in 2016.
oPremiums earned increased 17.8% or $27.5 million for the year ended December 31, 2017 over the comparable period in 2016. Short term medical premiums increased $9.7 million, and fixed indemnity limited benefit premiums increased $36.7 million as a result of the growing demand for these products and new significant distribution relationships. Premium increases in these lines were partially offset by reduced premium volume in occupational accident business following the sale of Accident Insurance Services, Inc., our primary producer of occupational accident business, in 2016, other lines in run-off, and dental business.
Income before taxes from the Group disability, life and DBL segment increased $0.4 million in 2017 compared to prior year results primarily due to lower claims in the short and long term disability and group term life lines, partially offset by lower income from the international line due to run-off of that line of business;
The Individual life, annuities and other segment reported losses before income taxes of $0.5 million in 2017 compared with losses of $2.5 million in 2016. The losses in 2016 were related to the accelerated amortization of deferred costs in connection with the assumption of certain ceded life and annuity policies for which there are no minimal amounts in 2017;
The Company believes that its liability for policy benefits and claims is reasonable and adequate to satisfy its ultimate liability. The Company primarily uses its own loss development experience, but will also supplement that with data from its outside actuaries, reinsurers and industry loss experience as warranted. To illustrate the impact that Loss Ratios have on the Company’s loss reserves and related expenses, each hypothetical 1% change in the Loss Ratio for the health business (i.e., the ratio of insurance benefits, claims and settlement expenses to earned health premiums) for the year ended December 31, 2017, would increase reserves (in the case of a higher ratio) or decrease reserves (in the case of a lower ratio) by approximately $2.6 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the Consolidated Statement of Income. Depending on the circumstances surrounding a change in the Loss Ratio, other pre-tax amounts reported in the Consolidated Statement of Income could also be affected, such as amortization of deferred acquisition costs and commission expense.
For the Specialty Health business, incurred but not reported (“IBNR”) claims liabilities plus expected development on reported claims are calculated using standard actuarial methods and practices. The “primary” assumption in the determination of Specialty Health reserves is that historical Claim Development Patterns are representative of future Claim Development Patterns. Factors that may affect this assumption include changes in claim payment processing times and procedures, changes in time delay in submission of claims, and the incidence of unusually large claims. Liabilities for policy benefits and claims for specialty health medical and disability coverage are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data. 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 not material. The Company has business that is serviced by third-party administrators. From time to time, there are changes in the timing of claims processing due to any number of factors including, but not limited to, system conversions and staffing changes during the year. These changes are monitored by the Company and the effects of these changes are taken into consideration during the claim reserving process. Other than these considerations, there have been no significant changes to methodologies and assumptions from the prior year.
Due to the sale of Risk Solutions, the Medical Stop-Loss segment is in run-off. The Company has $2.3 million in reserves at December 31, 2017. Liabilities for policy benefits and claims on medical stop-loss coverage are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data. Policy benefits and claims for medical stop-loss insurance are more volatile in nature than those for specialty health 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.
Management believes that the Company's methods of estimating the liabilities for policy benefits and claims provided appropriate levels of reserves at December 31, 2017. Changes in the Company's policy benefits and claims estimates are recorded through a charge or credit to its earnings.
products, the Company computes the liability for future policy benefits primarily using the net premium method based on anticipated investment yield, mortality, and withdrawals. These methods are widely used in the life insurance industry to estimate the liabilities for insurance reserves. Inherent in these calculations are management and actuarial judgments and estimates that could significantly impact the ending reserve liabilities and, consequently, operating results. Actual results may differ, and these estimates are subject to interpretation and change.
Management believes that the Company's methods of estimating the liabilities for future policy benefits provided appropriate levels of reserves at December 31, 2017 and 2016. Changes in the Company's future policy benefits estimates are recorded through a charge or credit to its earnings.
The Company has classified all of its investments as either available-for-sale or trading securities. These investments are carried at fair value with unrealized gains and losses reported through other comprehensive income (loss) for available-for-sale securities or as unrealized gains or losses in the Consolidated Statements of Income for trading securities. Available-for-sale securities totaled $447.5 million and $454.8 million at December 31, 2017 and 2016, 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 Income, using the constant yield method over the period to maturity. Net realized gains and losses on investments are computed using the specific identification method and are reported in the Consolidated Statements of Income on the trade date.
pricing information is used to determine fair value. In these instances, management will assess the quality of the data sources, the underlying assumptions and the reasonableness of the broker quotes based on the current market information available. To determine if an exception represents an error, management will often have to exercise judgment. Procedures to resolve an exception vary depending on the significance of the security and its related class, the frequency of the exception, the risk of material misstatement, and the availability of information for the security. These procedures include, but are not limited to: (i) a price challenge process with the vendor; (ii) pricing from a different vendor; (iii) a reasonableness review; and (iv) a change in price based on better information, such as an actual market trade, among other things. Management considers all facts and relevant information obtained during the above procedures to determine the proper classification of each security in the Fair Value Hierarchy.
Other intangible assets are amortized to expense over their estimated useful lives and are subject to impairment testing. Any impairment of other intangible assets would be charged to expense. No impairment charges for intangible assets were required in 2017, 2016 or 2015.
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 in the years in which those temporary differences are expected to be recovered or settled. 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.
Results of Operations for the Year Ended December 31, 2017 Compared to the Year Ended December 31, 2016
Total net investment income decreased $0.3 million over the comparable period in 2016. The overall annualized investment yields for the years ended December 31, 2017 and 2016 were 3.2% and 2.7%, respectively. The overall decrease was primarily the result of lower average invested assets in 2017 largely due to the retirement of debt in the fourth quarter of 2016 partially offset by higher returns on partnership investment.
In 2016, the Company recognized $1.5 million of other-than-temporary impairment losses on certain fixed maturities available-for-sale due to credit losses. The Company determined that it was more likely than not that the securities would be sold before the recovery of their amortized cost basis.
Fee income increased $.3 million for the year ended December 31, 2017 compared to the comparable period in 2016 primarily due to fee income earned by PetPartners, our recently acquired subsidiary, with no comparable amounts in 2016, partially offset by a decrease in fee income related to occupational accident business as a result of the sale of our primary producer of that business in 2016.
Total selling, general and administrative expenses increased $24.9 million over the comparable period in 2016. The increase is primarily attributable to: (i) a $21.5 million increase in the Specialty Health segment primarily due to administrative and commission expenses associated with the increased premium volume in the short term medical and fixed indemnity limited benefit lines, and agency expenses from PetPartners with no comparable expenses in the prior year, partially offset by a decrease in administrative expenses in 2017 from Accident Insurance Services, Inc., our primary producer of Occupational Accident line of business, which was sold in the third quarter of 2016; (ii) an increase of $3.6 million in the Medical Stop-Loss segment primarily due to a credit in premium taxes in 2016 with no comparable amount for 2017; (iii) an increase of $2.5 million in the Group disability, life, annuities and DBL segment due principally to higher general expenses on increased volume; partially offset by (iv) a decrease of $1.5 million in the Individual life, annuity and other segment largely due to lower amortization of deferred costs and general expenses from business in run-off; (v) a decrease of $1.2 million in Corporate due to a decrease in audit and consulting fees.
Excluding the impact of the Tax Act in 2017, the worthless stock deductions in both 2017 and 2016, and the reduction in the valuation allowance in 2017, the effective rate was significantly lower in 2017 due to: (i) a decrease in non-deductible expenses in 2017; (ii) tax benefits realized in 2017 upon the exercise and vesting of sharebased compensation awards with no comparable amounts in 2016; and (iii) a decrease in state taxes as a percentage of income.
In 2016, premiums earned decreased $216.8 million over the comparable period of 2015. The decrease is primarily due to: (i) a decrease of $197.7 million in the Stop Loss segment as a result of the sale of Risk Solutions and exit from the medical stop-loss business, further described in Note 3; (ii) a decrease of $17.5 million in the Specialty Health segment principally as a result of a $26.8 million decrease in premiums from exiting the Major Medical line, a $11.9 million decrease in the fixed indemnity limited benefit line due to the cancellation of a distribution source, and a $1.4 million decrease in international medical business premiums due to lower retention, partially offset by premium increases in the short-term medical, pet and occupational accident lines of business of $17.7 million, $4.7 million and $1.6 million, respectively, as a result of higher volume; and (iii) a decrease of $11.8 million in the Individual life, annuities and other segment as a result of this business being in run-off; partially offset by (iv) a $10.2 million increase in earned premiums from the Group disability, life, annuities and DBL segment primarily due to increased volume and retention in the LTD and group term life lines and increased volume in DBL business.
Fee income increased $5.8 million in 2016 compared to 2015 primarily due to increased fee income from the Specialty Health segment partially offset by decreased fees due to the partial sale and deconsolidation of a previously wholly owned third party administrator.
Total selling, general and administrative expenses decreased $45.5 million over the comparable period in 2015. The decrease is primarily attributable to: (i) a decrease of $42.9 million in the Medical Stop Loss segment primarily as a result of the sale of Risk Solutions and exit from the medical stop-loss business, further described in Note 3, (ii) a decrease of $0.8 million in the Specialty Health segment primarily due to decreased expenses from the run-off of Major Medical and lower volume of fixed indemnity business, partially offset by an increase in expenses due to increased volume in the short term medical line; and (iii) a decrease of $11.6 million in the Individual life, annuity and other segment largely due to a decrease in amortization of deferred acquisition costs as a result of ceding life and annuity policies in 2015 and lower general expenses from business in run-off; partially offset by (iv) an increase of $6.5 million in the group disability, life, annuities and DBL segment primarily due to increased commission and other expenses in the LTD line as a result of volume; and (v) an increase of $3.3 million in Corporate principally from increased compensation costs in addition to higher audit and consulting fees in 2016.
The Company had $26.5 million and $22.0 million of cash and cash equivalents as of December 31, 2017 and 2016, respectively.
The Company repurchased 2,289,502 shares of its common stock. Of that amount, 703,000 shares were repurchased in private transactions for an aggregate cost of $14.0 million; 1,385,118 shares were repurchased for an aggregate cost of $27.7 million pursuant to the terms of a tender offer; and the remaining shares were repurchased in the open market.. The tender offer was fully funded through corporate liquidity.
The $5.0 million decrease in IHC’s stockholders' equity in 2017 is primarily due to $46.5 million of treasury stock purchases, $2.4 million in common stock dividends declared and $1.3 million related to share-based compensation, partially offset by $42.0 million of net income attributable to IHC and $3.2 million of other comprehensive income attributable to IHC.
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 $7.4 million at December 31, 2017, 100% 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. The Company does not have any non-performing fixed maturity investments at December 31, 2017.
Certain fixed maturities, primarily municipal obligations, in our investment portfolio are insured by financial guaranty insurance companies. The insurance, however, does not enhance the credit ratings on these securities. The following table summarizes the credit quality of our fixed maturity portfolio, as rated, at December 31, 2017:
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, 2017, total goodwill was $50.7 million, all of which was attributable to the Specialty Health segment.
Management uses a significant amount of judgment in estimating the fair value of the Company’s reporting units. The key assumptions underlying the fair value process are subject to uncertainty and change. The following represent some of the potential risks that could impact these assumptions and the related expected future cash flows: (i) increased competition; (ii) an adverse change in the insurance industry and overall business climate; (iii) changes in state and federal regulations; (iv) rating agency downgrades of our insurance companies; and (v) a sustained and significant decrease in our share price and market capitalization. Our market capitalization as of December 31, 2017 was below the sum of our reporting units’ fair values. As a result, the Company assessed the factors contributing to the performance of IHC stock in 2017, and concluded that the market capitalization does not represent the fair value of the Company. The Company noted several factors that have led to a difference between the market capitalization and the fair value of the Company, including (i) the Company’s stock is thinly traded and a sale of even a small number of shares can have a large percentage impact on the price of the stock, (ii) Geneve Corporation and insiders own approximately 67% of the outstanding shares, which has had a significant adverse impact on the number of shares available for sale and therefore the trading potential of IHC stock, and (iii) lack of analyst coverage of the Company. If we experience a sustained decline in our results of operations and cash flows, or other indicators of impairment exist, we may incur a material non-cash charge to earnings relating to impairment of our goodwill, which could have a material adverse effect on our results.
The following table summarizes the prior year net favorable amount of policy benefits and claims incurred in 2017 according to the year in which it relates, together with the opening balances of the corresponding liability for policy benefits and claims (net of reinsurance recoverable) (in thousands):
The following sections describe, for each segment, the unfavorable (favorable) development in the liability for policy benefits and claims experienced in 2017, together with the key assumptions and changes therein affecting the reserve estimates.
The Specialty Health segment had a net unfavorable development of $1.4 million related to prior years. The Company experienced net unfavorable developments of $2.2 million in the STM line and $1.5 million in our occupational accident business. Due to a system conversion there was a claim processing and inventory backlog at the end of 2016 and as that backlog and those processing issues were resolved it revealed a much more favorable dental and vision block of experience than what was expected. The short-term medical line of business also had a processing and backlog issue, however, as the inventory was paid down the block experienced a worse development than what was expected revealing higher trend levels than expected. Some pricing changes and reserve strengthening has occurred on the STM block prior to this year-end. The occupational accident line of business has some low frequency and high severity components to it and we had a few rather large claims develop during the year. Since this is a small product for us that was not performing well, the Company has since sold the principal agency that produced this occupational accident business and discontinued risk exposure to the rather high severity features of the product. These developments were partially offset by a favorable development of $1.1 million in dental business.
The Group Disability segment had a net favorable development of $3.7 million primarily related to $2.1 million of DBL benefits and claims and $1.1 million of LTD benefits and claims experience primarily related to the 2015 business.
The Company experienced a net favorable development of $2.6 million related to the Medical Stop-Loss segment. Our Medical Stop-Loss business is currently in run-off.
Due to its strong capital ratios, broad licensing and excellent asset quality and credit-worthiness, the Insurance Group remains well positioned to increase or diversify its current activities. It is anticipated that future acquisitions or other expansion of operations will be funded internally from existing capital and surplus and parent company liquidity. In the event additional funds are required, it is expected that they would be borrowed or raised in the public or private capital markets to the extent determined to be necessary or desirable. The Company has no long-term debt outstanding at December 31, 2017 or 2016. See Note 11 of the Notes to Consolidated Financial Statements in Item 8 of this report.
The chart below reflects the maturity distribution of IHC’s contractual obligations at December 31, 2017 (in thousands):
Continue to show significant increases in specialty health premiums (including STM, hospital indemnity, group limited medical and group gap and other supplemental health products, such as accident medical, gap and critical illness (“CI”) products). Given the extremely high cost and high deductible nature of ACA-compliant plans, IHC has found an increasing demand for its STM and hospital indemnity, accident and critical illness plans as either an alternative to ACA-compliant plans or in order to provide affordable ways for insureds to finance high deductibles and co-pays. We have found that consumers who do not receive significant subsidies for ACA-compliant plans are worried about how they will pay for deductible and co-pays in the event they are hospitalized are attracted to hospital indemnity, accident and CI products. Consumers who are looking for coverage that also covers out-patient services are typically more interested in purchasing STM plans and often combine it with one or more of our HIP and/or gap plans. IHC continued to sell record numbers of STM policies in 2017 despite the federal government imposing a restriction on duration of these policies to 90 days. In February 2018, three federal agencies issued a proposed rule that would reverse such executive order and return to the states the ability to determine the duration of STM in each state. Assuming the proposed rule is enacted, the Company believes the demand for STM will increase. The Company further believes that these packages (which combine STM with other benefits such as hospital indemnity, accident and critical illness, telemedicine and dental plans) will also become much more attractive once the duration of our STM products is increased to 364 days, subject to state law. In anticipation of this growth we have begun to make material enhancements to our systems and infrastructure. For all the preceding reasons, we believe that we will continue in 2018 the solid sales growth we experienced in 2017.
Continue to increase IHC’s emphasis on lead generation for its direct-to-consumer and career advisor distribution initiatives, as well as expanding our controlled sales through our call center, career model and transactional websites: HealtheDeals.com, PetPlace.com, akcpetinsurance, AspiraAmas and HealthInsurance.org.
Expand sales of our specialty health products as a result of private-label and white-label distribution arrangements with large national partners and our equity investments in two call center agencies and a worksite marketing company. We expect to continue our relationship with eHealth to sell packages of specialty health products.
On March 31, 2016, IHC and a subsidiary of AMIC sold the stock of Risk Solutions. In addition, under the purchase and sale agreement, all of the in-force stop-loss business of Standard Security Life and Independence American produced by Risk Solutions was co-insured by Westport as of January 1, 2016. The aggregate purchase price was $152.5 million in cash, subject to adjustments and settlements. This transaction resulted in a gain of $100.8 million for the year ended December 31, 2016, net of taxes and amounts attributable to noncontrolling interests.
As a result of the sale of Risk Solutions, IHC remains highly liquid with excess capital; however, we have used some of this capital to make equity investments, retire debt and purchase IHC stock. If the Specialty Health business were to grow exponentially as a result of the turmoil in the major medical markets, IHC may need to contribute additional capital to one or more of its carriers. While the run-off of the Medical Stop-Loss line of business had a negative impact on future earnings in 2017, the growth in our other lines of business has offset this reduction in earnings.