See Note C of Notes to Consolidated Financial Statements for additional information regarding the terms of the sales of the Star HRG Division and Student Insurance Division assets.
The Company’s 2006 results from continuing operations benefited from improved results at its former Student Insurance Division, which the Company sold in December 2006. The Company’s Student Insurance Division reported operating earnings of $12.2 million in 2006 (through its date of sale on December 1, 2006), compared to operating losses of $(8.9) million in 2005. This improved performance reflected more favorable loss experience on the Student Insurance book of business, lower administrative expenses as a percentage of earned premium and better utilization of network service agreements with healthcare providers.
Despite a 5% decrease in health premium revenue, benefits, claims and settlement expenses increased nominally to $784.9 million in 2006 from $777.7 million in 2005, primarily as a result of an increase in the claim benefits as a percentage of earned premium associated with business written at the SEA Division. See Self-Employed Agency discussion below.
Operating income at the SEA Division in 2006 was negatively impacted by a decrease in earned premium revenue, an increase in the loss ratio (benefits as a percentage of earned premium), and an increase in underwriting, policy acquisition costs and insurance expenses as a percentage of earned premium. Earned premium revenue at the SEA Division decreased to $1.330 billion in 2006 compared to earned premium revenue of $1.395 billion in 2005. The decrease in earned premium revenue at the Self-Employed Agency division during 2006 was due to the decline in submitted annualized premium volume in 2004 and 2005. However, during 2006, annualized premium volume increased by 10% over annualized premium volume in 2005. The increase in the loss ratio was due to a product mix shift to new health insurance products in the Company’s recently-introduced CareOne product suite and cost
At December 31, 2006, the Company changed its accounting policy, effective January 1, 2006, with respect to the amortization of a portion of deferred acquisition costs associated with commissions paid to agents. Generally, first year and second year commission rates are higher than the renewal year commission rates, and the Company amortized (i.e., charged to income) the excess commissions associated with those earlier years ratably over the estimated life of the policy rather than in the year the commission is paid. Accordingly, the Company has elected to amortize the first and second year excess commissions over a two year period, based on recent persistency studies indicating that SEA policies have an average life of 2.09 years. Applying recently adopted SEC Staff Accounting Bulletin No. 108 as of January 1, 2006, the Company has determined that adoption of this new accounting policy with respect to the amortization of the excess first and second year commissions had the effect of increasing reported underwriting, policy acquisition costs and insurance expenses in 2006 by the amount of $15.5 million. See Note A of Notes to Consolidated Financial Statements.
Other income (consisting primarily of income derived by the SEA Division from ancillary services and membership marketing and administrative services provided to the membership associations that make available to their members the Company’s health insurance products) decreased by 6% to $103.6 million in 2005 from $110.7 million in 2004. The decrease was primarily related to a year over year decrease in new business for which the Company receives membership marketing and administrative fees.
student loan commitments only until February 1, 2007, after which any monies then remaining on deposit in the acquisition fund created by the indenture not used to purchase additional student loans are required to be used to redeem the SPE Notes. After February 1, 2007, the Company will fund loans with cash on hand from HealthMarkets LLC. During 2006, principal payments on the Notes were made in the amount of $12.0 million from the proceeds from the repayment on the student loan receivables. See discussion above under the caption “Liquidity and Capital Resources - Consolidated” and Note J of Notes to Consolidated Financial Statements.
The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
the redundancy ($35.5 million, excluding a refinement to the claim liability for the ACE rider described below) is attributable to experience in the most recent incurral months developing more favorably than anticipated. The Company also experienced a redundancy attributable to the completion factors utilized of $6.6 million (excluding the refinements in the ACE completion factors in the third and fourth quarters of 2006 described below) as the result of claims developing in amounts less than anticipated by the completion factors used at December 31, 2005. Furthermore, the SEA Division also benefited from a reduction in the claim liability of $10.8 million in its reserve for large claims as a result of a change in estimate recorded in the second quarter of 2006, of which $10.6 million was attributable to prior years. In addition, the Company experienced favorable development of approximately $4.8 million associated with its reserves for regulatory and legal matters due to settlements of certain litigation and matters on terms more favorable than originally anticipated. In 2006, the Company made certain refinements to its estimate of the claim liability for the ACE rider which contributed to the favorable claims liability development experience for the year, including revisions to the completion factors utilized in computing this reserve as well as revisions to the estimate of the unpaid claim liability for the most recent incurral months. The impact of these refinements on the development of the claim liabilities established at December 31, 2005 is $24.2 million, including $19.1 million attributable to the revised completion factors and $5.1 million attributable to the estimate in the most recent incurral months. The remaining favorable experience in 2006 in the claims liability attributable to other issues was $4.2 million, or 1.0% of total claim liabilities established for the SEA Division at December 31, 2005.
the actual claims experience developed in 2004, these augmented claim liabilities in the amount of $47.8 million proved to be redundant. These claim liabilities were released during 2004 and, as a result, did not influence the level of claim liabilities redundancies in 2005 and will not influence the level of claim liabilities redundancies in future periods. Excluding the impact of the augmented claim liabilities established at December 31, 2003 in response to the rapid pay down during 2003 of an excess pending claims inventory, the favorable experience in 2004 in the claims liability was $43.9 million, or 9.6% of total claim liabilities established for the SEA Division at December 31, 2003. Of the remaining redundancy, $42.9 million was attributable to experience in the five most recent incurral months developing more favorably than anticipated as a result of unanticipated improvements in the experience on products that had been showing indications of deterioration in response to a reduction in the level of rate increases. The Company experienced an additional favorable development in the completion factors of $7.7 million as a result of lower than expected claim payments. The Company also experienced favorable development of $5.4 million in its reserve for large claims as a result of lower frequency and severity of large claims than anticipated. In addition, the Company experienced unfavorable development of nearly $18.9 million associated with its reserves for regulatory and legal matters as the result of certain claim litigation and the establishment of additional reserves in response to claim payment issues raised in a market conduct examination.
Dividends paid by domestic insurance companies out of earned surplus in any year are limited by the law of the state of domicile. See Item 5 - Market for Registrant’s Common Stock and Related Stockholder Matters and Note N of Notes to Consolidated Financial Statements.