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. In addition, we own five floors of a fifteen-story building located at 1510 F.D. Roosevelt Avenue, in Guaynabo, Puerto Rico. The properties are subject to liens under our credit facilities. See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources”.
We are the one of the most significant players in the managed care industry in Puerto Rico and have over 50 years of experience in this industry. We offer a broad portfolio of managed care and related products in the Commercial and the Medicare (including Medicare Advantage and the Part D stand-alone prescription drug plans (“PDP”)) markets. We also participated in the government of Puerto Rico Health Care Plan (similar to Medicaid) (“Medicaid”) up to September 30, 2010, and beginning on November 1st, 2011 we resumed our participation in this sector by administering the provision of the physical health component in designated service regions in the Commonwealth of Puerto Rico (“the government of Puerto Rico”).
We have the exclusive right to use the Blue Cross and Blue Shield name and mark throughout Puerto Rico and U.S. Virgin Islands. As of December 31, 2011 we serve approximately 1,684,000 members across all regions of Puerto Rico. For the years ended December 31, 2011 and 2010 respectively, our managed care segment represented approximately 89.9% and 89.4% of our total consolidated premiums earned, net, and approximately 68.6% and 72.4% of our operating income. We also have significant positions in the life insurance and property and casualty insurance markets. Our life insurance segment had a market share of approximately 13.6% (in terms of premiums written) for 2010. Our property and casualty segment had a market share of approximately 8% (in terms of direct premiums) during the nine-month period ended September 30, 2011.
We participate in the managed care market through our subsidiaries, Triple-S Salud, Inc. (“TSS”) and AH. TSS is a BCBSA licensee, which provides us with exclusive use of the Blue Cross and Blue Shield Association (“BCBSA”) licensee, which provides us with exclusive use of the Blue Cross and Blue Shield name and mark throughout Puerto Rico and U.S. Virgin Islands.
The Commissioner of Insurance of the Commonwealth 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 26 to our audited consolidated financial statements.
The medical loss ratio (“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.
In February 7, 2011, our subsidiary TSS completed the AH acquisition, as of December 31, 2011, the Medicare membership attributable to AH was 47,552.
The following table sets forth our consolidated operating results for the years ended December 31, 2011, 2010 and 2009.
Consolidated premiums earned, net increased by $153.4 million, or 8.1%, to $2.1 billion during the year ended December 31, 2011 compared to the year ended December 31, 2010. The increase was mostly the result of a higher member months enrollment in the Medicare business attributed to new members acquired from AH, offset in part by the termination of the Medicaid contracts effective September 30, 2010.
The decrease in the administrative service fees of the Managed Care segment of $1.1 million, or 2.8%, to $38.5 million in the 2011 period is attributed to a lower self-funded member months enrollment.
Consolidated operating expenses during the year ended December 31, 2011 increased by $42.6 million, or 14.0%, to $347.6 million as compared to the operating expenses during the year ended December 31, 2010, primarily due to the acquisition of AH. For the year ended December 31, 2011, the consolidated operating expense ratio increased by 90 basis points to 16.6%. The higher operating expense ratio is mainly due to additional operating costs incurred by the Managed Care segment in order to maintain the level of services offered to members and providers while transitioning to its new IT system and a higher amount of self-insured contracts after resuming our participation in the Medicaid sector. Also contributing to the higher operating expense ratio are the expenses related to the AH operations, which run at a higher operating expense ratio than the Medicaid business lost in 2010. Approximately $7.6 million of the expense associated to the AH operations are related to the amortization of intangible assets.
Consolidated premiums earned, net increased by $32.0 million, or 1.7%, to $1.9 billion during the year ended December 31, 2010 compared to the year ended December 31, 2009. The increase was primarily due to the net effect of an increase in the premiums earned in our Managed Care segment, primarily from growth in Commercial member months enrollment, as well as higher premium rates across all businesses, offset in part by the termination of the Medicaid contracts effective September 30, 2010.
The decrease in the administrative service fees of the Managed Care segment of $9.0 million in the 2010 period is attributed to a lower self-funded member months enrollment after the termination of the Medicaid contract for the Metro-North region, which we served on an ASO basis until September 30, 2010.
Consolidated claims incurred during the year ended December 31, 2010 decreased by $9.0 million, or 0.6%, to $1.6 billion when compared to the claims incurred during the year ended December 31, 2009. This decrease is principally due to the termination of the Medicaid contracts effective September 30, 2010 offset in part by increased claims in the Managed Care segment’s Commercial business as a result of higher volume. The consolidated loss ratio decreased by 190 basis points to 84.0%, mostly as the result of lower MLRs in the Managed Care segment’s Commercial and Medicare businesses.
We offer our products in the managed care segment to three distinct market sectors in Puerto Rico: Commercial, Medicare (including Medicare Advantage and PDP) and Medicaid. For the year ended December 31, 2011, the Commercial sector represented 46.1% and 41.0% of our consolidated premiums earned, net and operating income, respectively. Premiums earned, net and operating income generated from our Medicare contracts (including PDP) during the year ended December 31, 2011 represented 43.6% and 12.5%, respectively, of our consolidated earned premiums, net and operating income, respectively.
The medical claims incurred of the Medicare business increased by $408.3 million during the 2011 period primarily due to the acquisition of AH effective February 1, 2011. Total claims incurred during the 2011 period related to the AH business amounted to $385.4 million. The Medicare MLR was 89.4%, which is 550 basis points higher than the MLR for the prior year. The MLR excluding prior period reserve developments in the 2011 and 2010 periods and risk-score adjustments presents an increase of 500 basis points. The higher adjusted MLR is due to higher utilization trends in our non-dual product as compared to last year as well as to the addition of AH which has a higher MLR than our Medicare legacy products.
Medical premiums generated by the Commercial business increased by $125.0 million, or 15.2%, to $947.1 million. This fluctuation is primarily the result of an increase in member months enrollment of 560,508, or 10.3%, and higher average premium rates per member of approximately 4.4%. Increase in member months was mainly attributed to the La Cruz Azul acquisition in July 2009 and organic growth, mostly in large accounts. Premium rate increases were consistent with claims trends.
Medicare premiums decreased by $38.5 million, or 7.6%, to $468.4 million, primarily due to a lower member months enrollment of approximately 77,819 or 9.0%, mostly in our dual eligible product, particularly during the first half of the year and resulting from changes in our product offering. In addition, the premiums for the year ended December 31, 2010 reflect a lower final risk score adjustment as compared to 2009. The 2010 and 2009 periods include the net effect of approximately $3.0 million and $8.7 million in adjustments related to CMS final risk score adjustment corresponding to prior periods. These fluctuations were partially offset by higher average premium rates, mostly due to higher risk scores in our dual-eligible product.
Medical claims incurred during the year ended December 31, 2010 decreased by $10.4 million, or 0.7%, to $1.5 billion, when compared to the year ended December 31, 2009. The MLR of the segment presented a decrease of 180 basis points during the 2010 period, to 88.1%. These fluctuations are primarily attributed to the effect of the following:
Total premiums written during the year ended December 31, 2011 decreased by $6.3 million, or 4.0%, to $152.9 million, mostly resulting from lower premiums in the Dwelling and Commercial Property Mono-line and Commercial Auto insurance products; offset in part by higher sales in the Commercial Multi-Peril products. The commercial business remains under soft market conditions, thus reducing premium rates and increasing competition for renewals and new business.
Underwriting and other operating expenses for the year ended December 31, 2011 decreased by $2.1 million, or 3.7%, to $54.4 million. This decrease is primarily due to a lower commission expense as a result of lower premiums; offset in part by an increase in the provision for uncollectible amounts. The operating expense ratio decreased by 130 percentage points during the same period, to 57.7% in 2011.
Total premiums written during the year ended December 31, 2010 decreased by $4.1 million, or 2.5%, to $159.2 million, mostly in its Commercial Multi-peril product. The commercial business continues under soft market conditions, thus reducing premiums and increasing competition for renewals and new business. Also, economic conditions affected the construction activity affecting the volume of related insurance premiums.
Premiums ceded to reinsurers during the year ended December 31, 2010 decreased by approximately $3.8 million, or 5.6%, to $63.7 million. The ratio of premiums ceded to premiums written decreased by 130 basis points, to 40.0% in 2010. This fluctuation was the result of the a reduction of reinsurance cessions in quota share contracts for commercial and personal property insurance risks of 3.0% and 2.2%, respectively.
Cash flows from operating activities increased by $124.8 million for the year ended December 31, 2011 as compared to the year ended December 31, 2010, principally due to the effect of higher premiums collections by $289.9 million and increase in net proceeds from our trading portfolio by $51.9 million, offset in part by an increase in claims paid, cash paid to suppliers and employees and income tax paid by $125.6 million, $76.7 million and $15.2 million, respectively. The increase in premiums and service fee collected is principally the effect of the AH acquisition as well as to the collection of past due Medicaid balances. The higher net proceeds from our trading portfolio results from the sale of our trading portfolio. The fluctuations in claims paid and cash paid to suppliers and employees is primarily as the result of the effect of the AH acquisition. The increase in income tax payments results from the use of tax credits during the year ended December 31, 2010.
During the year ended December 31, 2011 we received higher net proceeds from policyholder deposits, increasing by $23.6 million when compared to the prior year primarily as the result of new annuity products that are more attractive to prospective policyholders.
Net payments of short-term borrowings increased by $15.6 million during the year ended December 31, 2011 to address timing differences between cash receipts and disbursements.
In the 2011 period we cash-settled 432,567 stock options for $2.4 million, its fair value on settlement date.
On September 29, 2010 we announced the commencement of a $30.0 million share repurchase program. We paid approximately $11.3 million under the stock repurchase program during the year ended December 31, 2011.
On February 7, 2011, we acquired AH at a cost of $54.7 million, net of $30.1 million of cash acquired.
Cash flows from operating activities decreased by $34.9 million during the year ended December 31, 2010 as compared to the year ended December 31, 2009, principally due to the increases claims paid and cash paid to suppliers and employees amounting to $23.7 million and $4.2 million, respectively, offset in part by the effect of increase in premiums collections by $12.3 million and lower income tax payments by $11.1 million. The increase in premiums collected is the result of a higher member months enrollment, mainly in the Managed Care segment’s Commercial business offset in part by a higher amount in accounts receivable. The fluctuation in claims paid is primarily the result of the effect of the run-off of the Medicaid business and a higher volume in the Commercial business. The decrease in income tax payments results from the use of tax credits acquired during the year ended December 31, 2009.
Net acquisition of investment securities increased by $6.4 million during the year ended December 31, 2010 when compared to the prior year.
Net proceeds from borrowings increased by $40.6 million during the year ended December 31, 2010. The increase in borrowings is the net result of proceeds from securities sold under agreements of repurchases amounting to $15.6 million and $25.0 million from a long-term repurchase agreement to partially repay a long-term borrowing.
As of December 31, 2011, we had the following senior unsecured notes payable:
The 6.6% notes and the 6.7% notes contain certain non-financial covenants. At December 31, 2011, we are in compliance with these covenants.
Other long-term liabilities - Due to the indeterminate nature of their cash outflows, $121.2 million of other long-term liabilities are not reflected in the following table, including $77.5 million of liability for pension benefits, $24.6 million in deferred tax liabilities, and $19.1 million in liabilities to the Federal Employees’ Health Benefits Plan Program.
As of December 31, 2011, our long-term borrowings consist of our 6.6% senior unsecured notes payable, our 6.7% senior unsecured notes payable, a $25.0 million arrangement to sell securities under repurchase agreements which requires quarterly interest payments at 1.96%, and a loan payable to a commercial bank. Total contractual obligations for long-term borrowings include the current maturities of long term debt. For the 6.6% and 6.7% senior unsecured notes and the arrangement to sell securities under repurchase agreements, scheduled interest payments were included in the total contractual obligations for long-term borrowings until the maturity dates of the notes in 2020, 2021, and 2015 respectively. We may redeem the senior unsecured notes starting five years after issuance; however no redemption is considered in this schedule. The interest payments related to our loan payable were estimated using the interest rate applicable as of December 31, 2011. The actual amount of interest payments of the loan payable will differ from the amount included in this schedule due to the loan’s variable interest rate structure. See the “Financing and Financing Capacity” section for additional information regarding our long-term borrowings.
Purchase obligations represent payments required by us under material agreements to purchase goods or services that are enforceable and legally binding and where all significant terms are specified, including: quantities to be purchased, price provisions and the timing of the transaction. Other purchase orders made in the ordinary course of business for which we are not liable are excluded from the table above. Estimated pension plan contributions amounting to $13.0 million were included within the total purchase obligations. However, this amount is an estimate which may be subject to change in view of the fact that contribution decisions are affected by various factors such as market performance, regulatory and legal requirements and plan funding policy.
Claim liabilities represent the amount of our claims processed and incomplete as well as an estimate of the amount of incurred but not reported claims and loss-adjustment expenses. This amount does not include an estimate of claims to be incurred subsequent to December 31, 2011. The expected claims payments are an estimate and may differ materially from the actual claims payments made by us in the future. Also, claim liabilities are presented gross, and thus do not reflect the effects of reinsurance under which $37.2 million of reserves had been ceded at December 31, 2011.
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, 2011 and are gross of any reinsurance recoverable. The $993.3 million total estimated cash flows for all years in the table is different from the liability of future policy benefits of $254.2 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 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 to be 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. During the years ended December 31, 2011, 2010 and 2009, no assessment or payment was made in connection with insurance companies declared insolvent. 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.
Pursuant to the Puerto Rico Insurance Code, our property and casualty insurance subsidiary is a member of Sindicato de Aseguradores para la Suscripción Conjunta de Seguros de Responsabilidad Profesional Médico-Hospitalaria (SIMED). The syndicate was organized for the purpose of underwriting medical-hospital professional liability insurance. As a member, the property and casualty insurance segment shares risks with other member companies and, accordingly, is contingently liable in the event the syndicate cannot meet their obligations. During 2011, 2010 and 2009, no assessment or payment was made for this contingency. It is the opinion of management that any possible future syndicate 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, pursuant to Article 12 of Rule LXIX of the Insurance Code, 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 2011, 2010 and 2009, the Association distributed the Company a dividend based on the good experience of the business amounting to $1.3 million in 2011 and 2010 and $1.1 million in 2009.
Claim liabilities by segment as of December 31, 2011 were as follows:
At December 31, 2011, claim liabilities for the managed care segment amounted to $262.2 million and represented 67.0% of our total consolidated claim liabilities and 21.8% 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, 2011 claim liabilities, assuming the indicated hypothetical changes in completion and trend factors:
Management expects that substantially all of the development of the 2011 estimate of medical claims payable will be known during 2012 and that the variance of the total incurred claims on a retrospective basis when compared to reported incurred claims will be similar to the prior years.
At December 31, 2011, claim liabilities for the life insurance segment amounted to $43.4 million and represented 11.1% of total consolidated claim liabilities and 3.6% of our total consolidated liabilities.
Impairment of an investment exists if a decline in the estimated fair value is below the amortized cost of the security. Management regularly monitors and evaluates the difference between the cost and estimated fair value of investments. For investments with a fair value below cost, the process includes evaluating: (1) the length of time and the extent to which the estimated fair value has been less than amortized cost for fixed maturity securities, or cost for equity securities, (2) the financial condition, near-term and long-term prospects for the issuer, including relevant industry conditions and trends, and implications of rating agency actions, (3) the Company’s intent sell or the likelihood of a required sale prior to recovery, (4) the recoverability of principal and interest for fixed maturity securities, or cost for equity securities, and (5) other factors, as applicable. This process is not exact and further requires consideration of risks such as credit and interest rate risks. Consequently, if an investment’s cost exceeds its estimated fair value solely due to changes in interest rates, other-than temporary impairment may not be appropriate. Due to the subjective nature of our analysis, along with the judgment that must be applied in the analysis, it is possible that we could reach a different conclusion whether or not to impair a security if it had access to additional information about the investee. Additionally, it is possible that the investee’s ability to meet future contractual obligations may be different than what we determined during its analysis, which may lead to a different impairment conclusion in future periods. If after monitoring and analyzing impaired securities, management determines that a decline in the estimated fair value of any available-for-sale or held-to-maturity security below cost is other than temporary, the carrying amount of the security is reduced to its fair value according to current accounting guidance. The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment. For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted into net investment income in future periods based on prospective changes in cash flow estimates, to reflect adjustments to the effective yield.
During the years ended December 31, 2011, 2010 and 2009 we recognized other-than-temporary impairments amounting to $0.3 million, $3.0 million and $7.1 million, respectively, on fixed income, equity securities and perpetual preferred stocks classified as available for sale. As of December 31, 2011, the investments in securities of $1.1 billion is classified as either available-for-sale or held-to-maturity and consists of high-quality investments. Of this amount, $863.6 million, or 75.3%, are securities in obligations of U.S. government-sponsored enterprises, U.S. Treasury securities, obligations of the Commonwealth of Puerto Rico, municipal securities, obligations of U.S. states and its political subdivisions, mortgage backed and collateralized mortgage obligations that are U.S. agency-backed. The remaining $283.4 million, or 27.4%, are from corporate fixed, equity securities and mutual funds. The net unrealized gain as of December 31, 2011 of the available-for-sale and held-to-maturity portfolios amounted to $82.1 million.
The impairment analysis as of December 31, 2011 indicated that, other than those securities for which an other-than-temporary impairment was recognized, none of the securities whose carrying amount exceeded its estimated fair value was considered other-than-temporarily impaired as of that date; however, several factors are beyond management’s control, such as the following: financial condition of the issuer, movement of interest rates, specific situations within corporations, among others. Over time, the economic and market environment may provide additional insight regarding the estimated fair value of certain securities, which could change management’s judgment regarding impairment. This could result in realized losses related to other-than-temporary declines being charged against future income.
Our fixed maturity securities are sensitive to interest rate and credit risk fluctuations, which impact the fair value of individual securities. Our equity securities are sensitive to equity price risks, for which potential losses could arise from adverse changes in the value of equity securities. For additional information on the sensitivity of our investments, see ”
For our audited consolidated financial statements as of December 31, 2011 and 2010 and for each of the three years ended December 31, 2011 see Index to financial statements in “Item 15. Exhibits and Financial Statements Schedules” to this Annual Report on Form 10-K.
The consolidated and Managed Care premiums would have increased by $0.4 million and $1.6 million during the three months ended March 31, 2011 and June 30, 2011, respectively.