Commencing August 1, 2006, Madison National Life moved its corporate headquarters and began leasing 27,850 square feet of space in Madison, Wisconsin. Madison National Life also leases 3,900 square feet in Birmingham, Alabama for its military and government individual life and annuity division, 1,300 square feet in Austin, Texas for executive office space, and 2,400 square feet in Wilkesboro, North Carolina for its credit agency.
HPA leases 7,947 square feet of office space in Tampa, Florida as its corporate headquarters and 210 square feet in Pewaukee, Wisconsin.
GroupLink leases 9,024 square feet of office space in Indianapolis, Indiana as its corporate headquarters and 1,495 square feet in Tempe, Arizona.
Certain statements and materials contained in this report may be considered “forward-looking statements,” such as statements relating to management's views with respect to future events and financial performance. Such forward-looking statements are subject to risks, uncertainties and other factors which could cause actual results to differ materially from historical experience or from future results expressed or implied by such forward-looking statements. For a discussion of risk factors affecting the Company’s business and prospects, see Item 1A Risk Factors.
interest in American Independence Corp. (NASDAQ:AMIC) which owns Independence American Insurance Company (“Independence American”) and several MGU’s.
IHC’s health insurance products serve all sectors of the commercial market through multiple classes of business and varied distribution channels. Medical Stop-Loss is marketed to large employer groups that self-insure their medical risks; in 2006 the Company’s average case size was 600 covered lives. The small-group major medical product is purchased by employers with between two and 50 covered lives. With regard to those persons in the growing individual market, IHC’s products offer major medical coverage for individuals and families and persons with short-term medical needs Standard Security Life’s limited medical product is primarily purchased by hourly workers and others who are generally not eligible for coverage under their employer’s group medical plan. The dental and vision products are marketed to large and small groups as well as individuals. With respect to IHC’s life and disability business, Madison National Life has historically sold almost all of this business through one distribution source specializing in serving school districts and municipalities. Beginning in 2007, IHC’s goal is to diversify marketing of these products through other channels, including its health insurance distribution.
While management considers a wide range of factors in its strategic planning and decision-making, underwriting profit is consistently emphasized as the primary goal in all decisions as to whether or not to increase our retention in a core line, expand into new products, acquire an entity or a block of business, or otherwise change our business model. Management's assessment of trends in healthcare and morbidity, with respect to medical stop-loss, fully insured medical, disability and DBL; mortality rates with respect to life insurance; and changes in market conditions in general play a significant role in determining the rates charged, deductibles and attachment points quoted, and the percentage of business retained. The Company believes that the anticipated acquisition of Actuarial Management Corp. (“AMC”) will further enable it to make these assessments. IHC also seeks transactions that permit it to leverage its vertically integrated organizational structure by generating fee income from production and administrative operating companies as well as risk income for its carriers and profit commissions. Management has always focused on managing costs of its operations and providing its insureds with the best cost containment tools available.
Net income of $14.1 million ($.93 per share, diluted) in 2006, as compared to $17.3 million ($1.21 per share, diluted) in 2005;
Consolidated investment yield of 5.5% in 2006 as compared to 5.1% in 2005;
Book value of $15.23 per common share; an 8.3% increase from December 31, 2005, primarily reflecting net income and stock issuances partially offset by dividends, option exercises and net unrealized losses on securities;
As of January 31, 2006, acquired IAC, a leading producer and administrator of group and individual major medical insurance (including Consumer Driven Health Plans ("CDHPs")) and other life and health policies, which contributed significantly to the growth of fee income in the fully insured health line of business;
As of March 1, 2006, acquired the remaining 55% of CAIS to further the marketing reach for CDHPs and other products; as of March 31, 2006, CAIS acquired a block of $50 million of fully insured group major medical business, the majority of which transitioned to Madison National Life effective August 1, 2006; and
The Net Loss Ratio (defined as insurance benefits, claims and reserves divided by (premiums earned less underwriting expenses)) for the Medical Stop-Loss line of business was 95.2% in 2006 compared to 93.2% in 2005. Based on currently available information, business incepting in 2006, of which a material portion will be earned and recorded in 2007, is projected to achieve a net loss ratio that is meaningfully lower than that of business incepting in 2005, just as the net loss ratio on business incepting in 2005 was meaningfully lower than that of business incepting in 2004;
The Group disability, life, annuities and DBL segment reported an increase in income before taxes of $1.6 million for 2006, compared to a year earlier, primarily due to a decrease in LTD paid claims and net claims reserves;
The Individual life, annuities and other segment reported an increase in income before taxes of $1.0 million compared to a year earlier, primarily due to an increase in investment income as a result of increased invested assets following the acquisitions of policy blocks of life and annuity business in mid to late 2005;
The Credit life and disability segment reported an increase in its loss before taxes of $.3 million for 2006, compared to a year earlier, primarily due to higher death and disability claims;
identified the accounting policies described below as those that, due to the judgments, estimates and assumptions inherent in those policies, are critical to an understanding of the Company's Consolidated Financial Statements and this Management's Discussion and Analysis.
Premiums for short-duration medical insurance contracts are intended to cover expected claim costs resulting from insured events that occur during a fixed period of short duration. The Company has the ability to cancel the annual contract or to revise the premium rates at the beginning of each annual contract period to cover future insured events. Insurance premiums from annual health contracts are collected monthly and are recognized as revenue evenly as insurance protection is provided.
All of the Company’s short-duration contracts are generated from its accident and health business, and are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
The Company’s Medical Stop-Loss segment is comprised of Employer Stop-Loss, HMO Reinsurance and Provider Excess. All of the Company’s Medical Stop-Loss policies are short-duration and are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims or open claims from prior periods, including losses incurred for claims that have not been reported (“IBNR”). Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
The two “primary” 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 pricing 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.
While the Company establishes a best estimate of the Projected Net Loss Ratio, actual experience may deviate from this estimate. While the Company believes that larger variations are possible (as was the case with the 2004 and 2005 underwriting years which deviated by 12.5 and 7.1 Net Loss Ratio points, respectively), based on a review of historical Net Loss Ratios experienced by the Company, the reasonably likely deviation from the expected Net Loss Ratio is between three and five Net Loss Ratio points. Therefore, based on its experience to date, it is reasonably likely that the actual experience will fall within a range up to five Net Loss Ratio points above or below the expected pricing Net Loss Ratio. The impact of these reasonably likely changes at December 31, 2006, would be an increase in net reserves (in the case of a higher ratio) or a decrease in net reserves (in the case of a lower ratio) of up to approximately $2.9 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the 2006 Consolidated Statement of Operations.
The Company also establishes its best estimates of claim development factors to be applied to more developed treaty year experience. While these factors are based on historical Claim Development Patterns, actual claim development may vary from these estimates. The Company does not believe that reasonably likely changes in its actual claim development patterns would have a Material Effect.
disability coverages are computed using completion factors and expected Net Loss Ratios derived from actual historical premium and claim data.
For traditional life insurance and other premium paying policies accounted for under SFAS No. 60, amortization of DAC is charged to expense over the related premium revenue recognition period. Assumptions used in the amortization of DAC are determined based upon the conditions as of the date of policy issue or assumption and are not generally revised during the life of the policy.
The Company accounts for its investments in debt and equity securities under SFAS No. 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 $725.4 million and $745.3 million at December 31, 2006 and 2005, respectively. The Company also had $8.9 million and $7.9 million, on average, in trading accounts during 2006 and 2005, respectively. All such trading securities were liquidated at December 31, 2006 and 2005. Net realized gains and losses on investments are computed using the specific identification method and are reported in the Consolidated Statements of Operations.
Declines in value of securities available-for-sale that are judged to be other-than-temporary are determined based on the specific identification method and are reported in the Consolidated Statements of Operations as realized losses. The factors considered by management in determining when a decline is other than temporary include but are not limited to: the length of time and extent to which the fair value has been less than cost; the financial condition and near-term prospects of the issuer; adverse changes in ratings announced by one or more rating agencies; whether the issuer of a debt security has remained current on principal and interest payments; whether the decline in fair value appears to be issuer specific or, alternatively, a reflection of general market or industry conditions (including, in the case of fixed maturities, the effect of changes in market interest rates); and the Company's intent and ability to hold the security for a period of time sufficient to allow for a recovery in fair value. For securities within the scope of Emerging Issues Task Force Issue 99-20, such as purchased interest-only securities, an impairment loss is recognized when there has been a decrease in expected cash flows combined with a decline in the security's fair value below cost.
Total premiums earned grew $43.2 million to $280.2 million from $237.0 million in 2005. The increase is due to: (i) the Medical Stop-Loss segment which increased $24.6 million primarily due to increased retentions and increased production from business written by other carriers; (ii) the Fully Insured segment which had a $15.1 million increase in premiums, comprised of a $3.4 million increase in dental premiums, a $5.3 million increase in short-term medical and a $6.4 million increase in group major medical primarily due to business that was transferred to the Company's carriers during 2006; (iii) an increase of $2.3 million in the Group segment primarily due to a $2.1 million increase in point of service and a $.9 million increase in group term life, partially offset by a $1.1 million decrease in DBL caused by a reduction in statutory rates; (iv) a $.9 million increase in the Credit Life and Disability segment due to new business; and (v) the Individual and Other segment which increased $.3 million.
Total net investment income increased $7.8 million primarily due to the maintenance of a higher level of invested assets due to the acquisitions of policy blocks in 2005, and an increase in the investment rate of return during the current year. In addition, the Company’s investments in limited partnerships in the Corporate segment contributed more investment income in 2006 than in 2005. The annualized return on total investments was 5.5% for 2006 versus 5.1% for 2005.
Net realized investment gains decreased $1.5 million to $.6 million in 2006 from $2.1 million in 2005. These amounts include gains and losses from sales of fixed maturities and equity securities available-for-sale, as well as trading securities and other investments. Decisions to sell securities are based on management's ongoing evaluation of investment opportunities and economic and market conditions, thus creating fluctuations in gains and losses from period to period.
Total other income decreased $3.4 million to $2.1 million from $5.5 million in 2005. This was primarily due to the inclusion of $3.5 million of other income in 2005 from a commutation agreement and a loss ratio cover with a reinsurer that have no equivalent in 2006.
Interest expense increased $.4 million, primarily due to an increase in the interest rate on $12.4 million of floating rate junior subordinated debt, which averaged 9.1% in 2006 as compared to 7.3% in 2005. In addition, outstanding debt under a line of credit increased $2.5 million during the third quarter of 2006 and the average rate paid on that line was higher in 2006.
Total selling, general and administrative expenses increased $38.6 million in 2006 as compared to 2005. The increase is primarily due to (i) a $29.1 million increase in expenses associated with the operation of the Fully Insured segment, primarily due to the acquisitions of IAC and GroupLink, and higher commission expense due to the increase in premiums; (ii) a $5.4 million increase in commissions and other general expenses in the Medical Stop-Loss segment due to a higher level of premiums earned; (iii) a $1.5 million increase in the Individual and Other segment due to the block acquisitions in 2005; (iv) a $.6 million decrease in the Group segment primarily due to loss experience refunds which reduced commissions in the group A&H business as a result of higher loss ratios in 2006 compared to the prior year; (v) a $.6 million increase in the Credit Life and Disability segment due to new business; and (vi) a $2.6 million increase in other corporate expenses, including $1.1 million of expenses related to share-based compensation due to the adoption of SFAS 123R in 2006.
Equity income from AMIC decreased $.9 million due to a decrease in earnings of AMIC, partially offset by an increase in IHC's ownership to approximately 48% at December 31, 2005 from 40% at December 31, 2004.
Fee income increased $7.2 million due to: (i) $6.7 million in fee income from the Fully Insured Health segment (formerly Strategic Health), which did not exist in 2004, primarily due to $5.6 million in fee income at HPA and $1.1 million in fee income at GroupLink; and (ii) a $.5 million increase in the Medical Stop-Loss segment primarily caused by a $1.0 million increase in fee income at Majestic, partially offset by a $.5 million decrease in fee income at another MGU.
Amortization of deferred acquisition costs increased $1.5 million due to amortization of expenses related to the new Fully Insured Health segment and acquisitions of policy blocks.
Selling, general and administrative expenses increased $28.1 million primarily due to (i) an $8.5 million increase in the Medical Stop-Loss segment caused by a $2.9 million increase in commissions due to greater retention rates, higher profit commissions and higher levels of assumed premiums, which charge higher commission rates, and a $5.6 million increase in other general expenses corresponding with the increase in premiums; (ii) a $13.3 million increase in the Fully Insured Health segment due to the inception of this line of business in 2005 and the lack of any business from HPA and GroupLink, in 2004; (iii) a $3.7 million increase in the Group segment primarily due to a $1.8 million increase in commissions, $.5 million in expenses on new business in the group A&H line, a $1.1 million increase in commissions on annuities, and $.5 million of increased expenses in the GTL line, partially offset by a $.2 million decrease in other expenses; (iv) a $1.8 million increase in the Individual and Other segment due to $1.0 million in increased commissions on annuities, a $.5 million increase in expenses on the blanket line, and a $.3 million increase in other expenses; (v) a $.4 million increase in the Credit segment due to increased commissions and expenses commensurate with higher premiums; and (vi) a $.4 million increase in Corporate segment expenses primarily due to higher audit fees and Sarbanes-Oxley compliance costs.
Total Corporate liquidity (cash, cash equivalents, resale agreements, short-term investments, fixed maturities, equity securities, partnership interests and certain other current assets, net of current liabilities) amounted to $23.9 million at December 31, 2006.
Total investments and cash and cash equivalents increased $8.3 million during 2006 largely due to a $26.1 million decrease in net amounts due from and to reinsurers and $2.5 million of debt proceeds, partially offset by $21.0 million in cash used for acquisitions and a $1.3 million increase in unrealized losses on available for sale securities.
The $32.4 million increase in total stockholders' equity in 2006 is primarily due to $14.1 million in net income and a $20.4 million net increase in common stock and paid-in capital, mostly from issuances of common shares in acquisitions, partially offset by dividends of $.8 million and a $.9 million increase in after-tax net unrealized losses on investments.
The Company previously reported actual premiums and related amounts from its Medical Stop-Loss and Fully Insured Health lines of business using a consistent one and two month lag, respectively, rather than through the end of the reporting period. The resulting misstatement primarily arose over the period from 2002 to 2005 when the Company experienced considerable growth in these lines of business. This misstatement was not material to the consolidated financial statements in any of the respective years affected.
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. Of the aggregate carrying value of the Insurance Group's investment assets, approximately 90.6% was invested in investment grade fixed maturities, resale agreements, policy loans and cash and cash equivalents at December 31, 2006. Also at such date, approximately 99.0% of the Insurance Group's fixed maturities were investment grade. These investments carry less risk and, therefore, lower interest rates than other types of fixed maturity investments. At December 31, 2006, approximately 1.0% of the carrying value of fixed maturities was invested in diversified non-investment grade fixed maturities (investments in such securities have different risks than investment grade securities, including greater risk of loss upon default, and thinner trading markets). The Company does not have any mortgage loans or non-performing fixed maturities at December 31, 2006.
The Company reviews its investments regularly and monitors its investments continually for impairments. For the year ended December 31, 2006, the Company recorded $.2 million of realized losses for other-than-temporary impairments.
The following table summarizes the prior year net unfavorable amount incurred in 2006 according to the year to which it relates, together with the opening reserve balance (net of reinsurance recoverable) to which it relates (in thousands):
The following sections describe, for each segment, the deficiency - unfavorable development or redundancy - favorable development experienced in 2006, together with the key assumptions and changes therein affecting the reserve estimates.
The Company experienced net unfavorable development of $6.2 million in the Medical Stop-Loss segment. The net unfavorable development is based on $7.0 million negative development in the 2005 reserves, partially offset by positive development of $.8 million related to prior years. While the Company establishes a best estimate of the Projected Net Loss Ratio, it is reasonably likely that the actual experience will fall within a range up to five Net Loss Ratio points above or below this ratio. Larger variations are also possible, as was the case with the 2004 and 2005 underwriting years which deviated by 12.5 and 7.1 Net Loss Ratio points, respectively. The Company sets its pricing and underwriting guidelines at the beginning of each treaty year based on its evaluation of its own experience and current market conditions. Changes in market conditions through the treaty year have unexpected effects on the underwriting and rating decisions of its MGUs and produce results which vary from the expectations implicit in its pricing. With respect to the 2005 reserves, the deficiency was primarily due to the continuing deterioration of the business underwritten in 2004 and 2005. The higher deviation was largely a result of: (i) the “soft” Medical Stop-Loss market continuing longer than anticipated; (ii) deviations from underwriting guidelines and disclosure protocols by certain of its MGUs and producers as a result of the soft market, which were detected by the Company in its 2005 underwriting audits; and (iii) an unanticipated continuation of historically high inpatient hospital cost trends. This, larger than expected, deviation was magnified for 2005 reserves because of an overall increase in the Company’s risk retention. With respect to the 2004 and prior reserves, the positive deviation resulted from loss development being much lower than anticipated based on the Company's historical loss development patterns.
Due to the long-term nature of LTD, in establishing loss reserves the Company must make estimates for case reserves, incurred but not reported reserves (“IBNR”), and reserves for Loss Adjustment Expenses (“LAE”). Case reserves generally equal the Company’s best estimate of the present value of the liability for future benefits to be paid on claims incurred as of the balance sheet date. The LAE reserve is calculated based on an actuarial expense study. Since the LTD block of policies is relatively small, results can vary from year to year solely on the basis of one or two policies. It is not uncommon for a reserve of several hundred thousand dollars to be associated with one policy. If a small number of claimants with large policy reserves were to recover or a few large claims were incurred, the results could distort the Company’s reserve estimates from year to year. However, there were no individual factors in 2006 that caused the favorable development in LTD. With respect to DBL, reserves for the most recent quarter of earned premium are established using a Net Loss Ratio methodology. The Net Loss Ratio is determined by applying the completed prior four quarters of historical Net Loss Ratios to the last quarter of earned premium. Reserves associated with the premium earned prior to the last quarter are established using a completion factor methodology. The completion factors are developed using the historical payment patterns for DBL. The favorable development in the DBL line is due to lower than expected claims.
There were no changes in the Company’s experience factor or the IBNR factor for Group Disability. The reserving process used by management was consistent from 2005 to 2006.
IHC enters into a variety of contractual obligations with third-parties in the ordinary course of its operations. These obligations, as of December 31, 2006, are set forth in the table below. However, we do not believe that our cash flow requirements can be fully assessed based upon an analysis of these obligations. Future cash outflows, whether they are contractual obligations or not, also will vary based upon our future needs. Although some outflows are fixed, others depend on future events. The Company had the following expected contractual obligations relating to debt, trust preferred securities (junior subordinated debt), non-cancelable leases, insurance reserves and funds on deposit at December 31, 2006:
In accordance with SFAS No. 115, the Company may carry its portfolio of fixed maturities either as held to maturity (carried at amortized cost), as trading securities (carried at fair market value) or as available-for-sale (carried at fair market value). The Company has chosen to carry its fixed maturities as available-for-sale. In 2006, the Company experienced an increase in unrealized losses of $1.4 million which, net of deferred tax benefits and an allocation to deferred policy acquisition costs, decreased stockholders' equity by $.9 million (reflecting net unrealized losses of $9.3 million at December 31, 2006
compared to net unrealized losses of $8.4 million at December 31, 2005). From time to time, as warranted, the Company employs investment strategies to mitigate interest rate and other market exposures.
continue its rapid expansion into the Fully Insured Health sector with particular emphasis on transactions that leverage its vertically integrated strategy of generating fee income at multiple levels of marketing and administration, as well as risk profit and profit commission income, (ii) continue to improve the profitability of its core lines of business, in particular Medical Stop-Loss, while expanding distribution, (iii) expand distribution of its life and disability products, and
, and blocks of fully insured health and dental to the extent opportunities arise
The Company emphasizes underwriting profits and not top line growth. However, Medical Stop-Loss is excess business, which is more volatile and tends
business, including group life and disability, DBL, and credit life and disability.
acquisitions of HPA and GroupLink in 2005 and IAC in 2006, IHC has expanded into multiple new
to include limited medical. Collectively, IHC will administer, manage and distribute its Fully Insured Health Products to 50,000 general agents, agents and brokers (“Producers”) in the majority of states. IHC believes this is one of the largest networks of Producers focusing on the sale of Fully Insured Health Products in the country.
ealth market is a much larger market than the excess market
yield profitable results, which will help balance the more volatile and cyclical
. Although the source and timing of new acquisitions is unpredictable, the Company believes that
improved profitability of its Medical Stop-Loss business; (iii) reduced susceptibility to market cycles due to