CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations of
Independence Holding Company ("IHC") and its subsidiaries (collectively, the
"Company") should be read in conjunction with, and is qualified in its entirety
by reference to, the Consolidated Financial Statements of the Company and the
related Notes thereto appearing in our annual report on Form 10-K for the fiscal
year ended December 31, 2011, as filed with the Securities and Exchange
Commission, and our unaudited Condensed Consolidated Financial Statements and
related Notes thereto appearing elsewhere in this quarterly report.
Overview
Independence Holding Company, a Delaware corporation ("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 Risk Solutions, LLC ("Risk Solutions"), IHC Health Solutions, Inc.
("Health Solutions"), and Actuarial Management Corporation ("AMC"). These
companies are sometimes collectively referred to as the "Insurance Group", and
IHC and its subsidiaries (including the Insurance Group) are sometimes
collectively referred to as the "Company." IHC also owns a significant equity
interest in a managing general underwriter ("MGU") that writes medical stop-loss
for Standard Security Life. At June 30, 2012, the Company also owned a 78.6%
interest in American Independence Corp. ("AMIC").
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 New York State short-term statutory disability benefit
product ("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. 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 the
costs of its operations and providing its insureds with the best cost
containment tools available.
28
The following is a summary of key performance information and events:
The results of operations for the three months and six months ended June 30,
2012 and 2011 are summarized as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Revenues $ 101,443 $ 105,525 $ 203,599 $ 209,844
Expenses 95,767 100,706 191,507 203,089
Income from operations before income 5,676 4,819 12,092 6,755
taxes
Income taxes (benefits) 1,846 1,355 3,932 (509)
Net income 3,830 3,464 8,160 7,264
Less: Income from noncontrolling (299) (424) (707) (1,040)
interests in subsidiaries
Net income attributable to IHC $ 3,531$ 3,040$ 7,453$ 6,224
o
Net income of $.20 per share, diluted, for the three months ended June 30, 2012
compared to $.17 per share, diluted, for the same period in 2011. Net income of
$.41 per share, diluted, for the six months ended June 30, 2012, compared to
$.36 per share, diluted, for the six months ended June 30, 2011.
o
Consolidated investment yields (on an annualized basis) of 3.8% and 3.9% for the
three months and six months ended June 30, 2012 compared to 4.2% and 4.3% for
the comparable periods in 2011;
o
Declared a special 10% stock dividend to IHC shareholders of record on February
17, 2012 with a distribution date of March 5, 2012. As a result, IHC issued 1.6
million shares of its common stock, net of treasury shares, with a fair value of
$15.8 million and paid cash in-lieu of fractional shares;
o
Announced an increase IHC's annual dividend from $.05 to $.07 per share; and
o
Book value of $15.13 per common share, an increase of $.67 per common share from
$14.46 at December 31, 2011.
The following is a summary of key performance information by segment:
o
The Medical Stop-Loss segment reported income before taxes of $3.8 million for
the second quarter of 2012 compared to $1.9 million in the same quarter in 2011,
and reported income before taxes of $9.9 million for the first six months of
2012 compared to $1.9 for the first six months of 2011. The increase is
primarily due to increased volume and improved loss ratios in 2012;
o
Premiums earned increased $6.6 million and $11.3 million for the three months
and six months ended June 30, 2012, respectively, when compared to the same
periods in 2011. The increase in premiums earned is primarily due to increased
volume and retention on business underwritten by Risk Solutions.
o
Underwriting experience for the Medical Stop-Loss segment, as indicated by its
GAAP Combined Ratios, are as follows for the periods indicated (in thousands):
29
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Premiums Earned $ 33,984 $ 27,421 $ 66,635 $ 55,316
Insurance Benefits, Claims & Reserves 22,588 18,233 40,995
39,127
Expenses 8,951 8,351 18,475 16,602
Loss Ratio(A) 66.5% 66.5% 61.5% 70.7%
Expense Ratio (B) 26.3% 30.4% 27.7% 30.0%
Combined Ratio (C) 92.8% 96.9% 89.2% 100.7%
o
Loss ratios for the six months ended June 30, 2012 decreased due to improved
underwriting results in business produced by both Risk Solutions and by
independent MGUs.
o
The expense ratio decreased for the three months and six months ended June 30,
2012 primarily due to a decrease in profit commission expense as a result of
poor performance on certain business written through one program at AMIC.
(A)
Loss ratio represents insurance benefits, claims and reserves divided by
premiums earned.
(B)
Expense ratio represents commissions, administrative fees, premium taxes and
other underwriting expenses divided by premiums earned.
(C)
The combined ratio is equal to the sum of the loss ratio, profit commission
expense ratio and the expense ratio.
·
The Fully Insured Health segment reported $2.0 million of income before taxes
for the three months ended June 30, 2012 as compared to $1.6 million for the
comparable period in 2011, and reported $3.2 million of income before taxes for
the six months ended June 30, 2012 compared to $4.9 million for the same period
in 2011.
o
Premiums earned decreased $3.5 million and $8.2 million for the three months and
six months ended June 30, 2012 over the comparable 2011 periods primarily due to
decreased volume and retentions in certain lines of the business.
o
Underwriting experience, as indicated by its GAAP Combined Ratios, for the Fully
Insured segment are as follows for the periods indicated (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
Premiums Earned $ 32,982 $ 36,452 $ 65,067 $ 73,247Insurance Benefits, Claims & Reserves 21,370 24,888 42,382
46,432
Expenses 9,706 10,662 19,116 22,219
Loss Ratio 64.8% 68.3% 65.1% 63.4%
Expense Ratio 29.4% 29.2% 29.4% 30.3%
Combined Ratio 94.2% 97.5% 94.5% 93.7%
30
o
The increase in the loss ratio for the six-month period was primarily
attributable to an increase in the claims experience on major medical business
for groups and individuals and dental businesses in the first quarter of 2012
partially offset by a decrease in claims experience on major medical business
for groups and individuals in the second quarter of 2012.
o
The underwriting expense ratio decreased for the six months ended June 30, 2012,
primarily as a result of a decrease in general expenses.
·
Income before taxes from the Group disability, life, annuities and DBL segment
decreased $1.1 million and $.9 million for the three months and six months ended
June 30, 2012 compared to the three months and six months ended June 30, 2011
primarily as a result of the transfer of certain group annuity contracts in
the
fourth quarter of 2011;
·
Income before taxes from the Individual life, annuities and other segment
decreased $.5 million and $.1 million for the three months and six months ended
June 30, 2012 compared to the same periods in 2011 primarily due to the decrease
in investment income;
·
Income before taxes from the Corporate segment increased $.7 million for the
three months ended June 30, 2012 and decreased $.8 million for the six months
ended June 30, 2012, primarily due to an increase in corporate overhead in the
first quarter of 2012;
·
Net realized investment gains were $1.9 million and $3.0 million for the three
months and six months ended June 30, 2012 compared to net realized investment
gains of $1.9 million and $1.7 million for the three months and six months ended
June 30, 2011. Other-than-temporary impairment losses recognized in earnings for
the three months and six months ended June 30, 2012 were $.6 million and $.7
million, respectively, and were $.2 million and $.5 million for the three months
and six months ended June 30, 2011, respectively; and
·
Premiums by principal product for the three months and six months ended June 30,
2012 and 2011 are as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
Gross Direct and Assumed
Earned Premiums: 2012 2011 2012 2011
Medical Stop-Loss $ 40,882 $ 35,655 $ 80,433 $ 70,830
Fully Insured Health 53,002 51,854 105,449 103,776 Group disability, life, annuities and DBL 22,836 23,713 45,642 48,071
Individual, life, annuities and other 7,608 8,504 15,769 17,219
$ 124,328 $ 119,726 $ 247,293 $ 239,896
Three Months Ended Six Months Ended
June 30, June 30,
Net Direct and Assumed
Earned Premiums: 2012 2011 2012 2011
Medical Stop-Loss $ 33,984 $ 27,421 $ 66,635 $ 55,316
Fully Insured Health 32,982 36,452 65,067 73,247
Group disability, life, 12,177 12,594 24,353 25,662
annuities and DBL
Individual, life, annuities 6,326 7,534 13,188 15,649
and other
$ 85,469 $ 84,001 $ 169,243 $ 169,874
31
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company conform to U.S. generally
accepted accounting principles ("GAAP"). The preparation of the Condensed
Consolidated Financial Statements in conformity with GAAP requires the Company's
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates. A summary of the Company's significant accounting policies
and practices is provided in Note 1 of the Notes to the Consolidated Financial
Statements included in Item 8 of the Annual Report on Form 10-K for the fiscal
year ended December 31, 2011. Management has identified the accounting policies
related to Insurance Premium Revenue Recognition and Policy Charges, Insurance
Reserves, Deferred Acquisition Costs, Investments, Goodwill and Other Intangible
Assets, and Deferred Income Taxes 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. A full discussion of these policies is included under the heading,
"Critical Accounting Policies" in Item 7 of the Annual Report on Form 10-K for
the fiscal year ended December 31, 2011. During the six months ended June 30,
2012, there were no additions to or changes in the critical accounting policies
disclosed in the 2011 Form 10-K except for the recently adopted accounting
standards discussed in Note 1(C) of the Notes to Condensed Consolidated
Financial Statements.
32
Results of Operations for the Three Months Ended June 30, 2012 Compared to the
Three Months Ended June 30, 2011
Information by business segment for the three months ended June 30, 2012 and
2011 is as follows:
Benefits, Amortization Selling,
Net Fee and Claims of Deferred General
Premiums Investment Other and Acquisition And
June 30, 2012 Earned Income Income Reserves Costs Administrative Total
(In thousands)
Medical $ 33,984 1,032 (718) 22,588 - 7,861 $ 3,849
Stop-Loss
Fully Insured 32,982 317 6,710 21,370 6 16,627 2,006
Health
Group
disability,
life,
annuities
and DBL 12,177 645 4 8,265 - 3,828 733
Individual
life,
annuities 6,326 5,595 1,140 8,042 1,625 3,566 (172)
and other
Corporate - 20 - - - 1,449 (1,429)
Sub total $ 85,469 $ 7,609 $ 7,136 $ 60,265 $ 1,631 $ 33,331 4,987
Net realized investment gains 1,850
Other-than-temporary impairment losses (621)
Interest expense on debt (540)
Income from operations before income taxes 5,676
Income taxes 1,846
Net income $ 3,830
Benefits, Amortization Selling,
Net Fee and Claims of Deferred General
Premiums Investment Other and Acquisition And
June 30, 2011 Earned Income Income Reserves Costs Administrative Total
(In thousands)
Medical $ 27,421 902 1,822 18,233 - 9,978 $ 1,934
Stop-Loss
Fully Insured 36,452 397 7,230 24,888 8 17,604 1,579
Health
Group
disability,
life,
annuities
and DBL 12,594 2,560 32 9,748 133 3,533 1,772
Individual
life,
annuities 7,534 6,194 1,089 9,288 1,617 3,582 330
and other
Corporate - (420) - - - 1,634 (2,054)
Sub total $ 84,001 $ 9,633 $ 10,173 $ 62,157 $ 1,758 $ 36,331 3,561
Net realized investment losses 1,883
Other-than-temporary impairment losses (165)
Interest expense on debt (460)
Income from operations before income taxes 4,819
Income tax benefits
1,355
Net income $ 3,464
33
Premiums Earned
In the second quarter of 2012, premiums earned increased $1.5 million over the
comparable period of 2011. The increase is primarily due to: (i) a $6.6 million
increase in the Medical Stop-Loss segment due to increased volume and retention
of business in 2012; partially offset by (ii) the Fully Insured Health segment
which had a $3.5 million decrease in premiums primarily as a result of decreased
retentions and volume in the short term medical business, major medical
business for groups and individuals, limited medical and dental lines of
business; (iii) a decrease of $1.2 million of earned premiums in the Individual
life, annuities and other segment primarily as a result of the transfer of
certain annuity contracts in the fourth quarter of 2011 and decreased premium
volume from other lines in run-off; and (iv) a $.4 million decrease in the Group
disability, life, annuities and DBL segment primarily due to decreased premiums
from the group term life and LTD lines due in part to reduced production sources
partially offset by premiums generated by a new line of international LTD and
life business.
Net Investment Income
Total net investment income decreased $2.0 million. The overall annualized
investment yields were 3.8% and 4.2% (approximately 3.9% and 4.3%, on a tax
advantaged basis) in the second quarter of 2012 and 2011, respectively. The
overall decrease was primarily a result of a decrease in investment income on
bonds, equities and short-term investments due to lower yields and the shorter
duration of our portfolio. The annualized investment yields on bonds, equities
and short-term investments were 3.7% and 4.3% in the second quarter of 2012 and
2011, respectively. IHC has approximately $160.9 million in highly rated shorter
duration securities earning on average 1.8%. A portfolio that is shorter in
duration enables us, if we deem prudent, the flexibility to reinvest in much
higher yielding longer-term securities, which would significantly increase
investment income.
Net Realized Investment Gains and Other-Than-Temporary Impairment Losses, Net
The Company had net realized investment gains of $1.9 million in both 2012 and
2011. These amounts include gains and losses from sales of fixed maturities and
equity securities available-for-sale 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.
For the three months ended June 30, 2012 and 2011, the Company recorded $.6
million and $.2 million, respectively, of other-than-temporary impairment
losses, pre-tax. Other-than-temporary impairment losses in both 2012 and 2011
consist of credit losses resulting from expected cash flows of debt securities
that are less than the their amortized cost basis.
Fee Income and Other Income
Fee income decreased $2.4 million for the three months ended June 30, 2012
compared to the three months ended June 30, 2011 primarily as a result of higher
retentions and therefore an increase in the elimination of intercompany fee
income.
Total other income decreased $.6 million in the three months ended June 30, 2012
to $1.2 million from $1.8 million in the three months ended June 30, 2011.
Insurance Benefits, Claims and Reserves
In the second quarter of 2012, insurance, benefits, claims and reserves
decreased $1.9 million over the comparable period in 2011. The decrease is
primarily attributable to: (i) a decrease of $3.5 million in the Fully Insured
Health segment, principally due to the decrease in premiums on the major medical
business for groups and individuals, short term medical and dental lines of
business in addition to improved loss
34
ratios on the short term medical business; (ii) a $1.5 million decrease in the
Group disability, life, annuities and DBL segment primarily as a result of the
transfer of certain annuity contracts in the fourth quarter of 2011 and reduced
production of LTD business; and (iii) a $1.3 million decrease in the Individual
life, annuity and other segment primarily resulting from the transfer of certain
group annuity contracts in the fourth quarter of 2011 and decreased premium
volume from other lines in run-off; offset by (iv) an increase of $4.4 million
in the Medical Stop-Loss segment as a result of an increase in premium volume by
Risk Solutions.
Amortization of Deferred Acquisition Costs
Amortization of deferred acquisition costs decreased $.2 million primarily as a
result of the write-off, in the fourth quarter of 2011, of certain deferred
acquisition costs in connection with a coinsurance agreement.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased $3.0 million. The
decrease is primarily due to: (i) a $2.1 million decrease in commissions and
other general expenses in the Medical Stop-Loss segment due to increased
retentions partially offset by increases in expenses due to volume as a result
of increased production; and (ii) a $1.0 million decrease in the Fully Insured
Health segment largely due to decreased volume of business in the short term
medical and limited medical lines of business in 2012.
Income Taxes
The effective tax rate for the three months ended June 30, 2012 was 32.5%
compared to 28.1% in 2011. The lower effective tax rate in 2011 was due to a
higher benefit from tax advantaged securities as a percentage of income due
to
lower income in 2011.
35
Results of Operations for the Six Months Ended June 30, 2012 Compared to the Six
Months Ended June 30, 2011
Information by business segment for the six months ended June 30, 2012 and 2011
is as follows:
Benefits, Amortization Selling,
Net Fee and Claims of Deferred General
Premiums Investment Other and Acquisition And
June 30, 2012 Earned Income Income Reserves Costs Administrative Total
(In thousands)
Medical $ 66,635 2,386 537 40,995 - 18,629 $ 9,934
Stop-Loss
Fully Insured 65,067 646 12,963 42,382 12 33,124 3,158
Health
Group
disability,
life,
annuities
and DBL 24,353 1,322 66 17,104 - 7,935 702
Individual
life,
annuities 13,188 11,516 2,147 16,919 3,213 6,521 198
and other
Corporate - 490 - - - 3,594 (3,104)
Sub total $ 169,243 $ 16,360 $ 15,713 $ 117,400 $ 3,225 $ 69,803 10,888
Net realized investment gains 2,987
Other-than-temporary impairment losses (704)
Interest expense on debt (1,079)
Income from operations before income taxes 12,092
Income taxes 3,932
Net income $ 8,160
Benefits, Amortization Selling,
Net Fee and Claims of Deferred General
Premiums Investment Other and Acquisition And
June 30, 2011 Earned Income Income Reserves Costs Administrative Total
(In thousands)
Medical $ 55,316 2,192 3,272 39,127 - 19,746 $ 1,907
Stop-Loss
Fully Insured 73,247 750 13,321 46,432 15 35,929 4,942
Health
Group
disability,
life,
annuities
and DBL 25,662 4,703 78 21,134 264 7,457 1,588
Individual
life,
annuities 15,649 11,974 2,337 19,713 3,170 6,733 344
and other
Corporate - 130 - - - 2,452 (2,322)
Sub total $ 169,874 $ 19,749 $ 19,008 $ 126,406 $ 3,449 $ 72,317 6,459
Net realized investment losses 1,681
Other-than-temporary impairment losses (468)
Interest expense on debt (917)
Income from operations before income taxes
6,755
Income tax benefits (509)
Net income $ 7,264
36
Premiums Earned
In the first six months of 2012, premiums earned decreased $.6 million over the
comparable period of 2011. The decrease is primarily due to: (i) the Fully
Insured Health segment which had a $8.2 million decrease in premiums primarily
as a result of decreased retentions and volume in the short term medical
business, major medical business for groups and individuals, limited medical
and dental lines of business; (ii) a decrease of $2.4 million of earned premiums
in the Individual life, annuities and other segment primarily as a result of the
transfer of certain annuity contracts in the fourth quarter of 2011and decreased
premium volume from other lines in run-off; and (iii) a $1.3 million decrease in
the Group disability, life, annuities and DBL segment primarily due to decreased
premiums from the group term life and LTD lines due in part to reduced
production sources, partially offset by premiums generated by a new line of
international LTD and life business; partially offset by (iv) an $11.3 million
increase in the Medical Stop-Loss segment due to increased volume and retention
of business in 2012.
Net Investment Income
Total net investment income decreased $3.3 million. The overall annualized
investment yields were 3.9% and 4.3% (approximately 4.0% and 4.5%, on a tax
advantaged basis) in the first six months of 2012 and 2011, respectively. The
overall decrease was primarily a result of a decrease in investment income on
bonds, equities and short-term investments due to lower yields and the shorter
duration of our portfolio. The annualized investment yields on bonds, equities
and short-term investments were 3.7% and 4.2% in the first six months of 2012
and 2011, respectively. IHC has approximately $160.9 million in highly rated
shorter duration securities earning on average 1.8%. A portfolio that is shorter
in duration enables us, if we deem prudent, the flexibility to reinvest in much
higher yielding longer-term securities, which would significantly increase
investment income.
Net Realized Investment Gains and Other-Than-Temporary Impairment Losses, Net
The Company had net realized investment gains of $3.0 million in 2012 compared
to $1.7 million in 2011. These amounts include gains and losses from sales of
fixed maturities and equity securities available-for-sale 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.
For the six months ended June 30, 2012 and 2011, the Company recorded $.7
million and $.5 million, respectively, of other-than-temporary impairment
losses, pre-tax. Other-than-temporary impairment losses in both 2012 and 2011
consist of credit losses resulting from expected cash flows of debt securities
that are less than their amortized cost.
Fee Income and Other Income
Fee income decreased $2.4 million for the six months ended June 30, 2012
compared to the six months ended June 30, 2011 primarily as a result of
increased retentions and therefore an increase in the elimination of
intercompany fee income.
Total other income decreased $.9 million in the six months ended June 30, 2012
to $2.4 million from $3.3 million in the six months ended June 30, 2011.
Insurance Benefits, Claims and Reserves
In the first six months of 2012, insurance, benefits, claims and reserves
decreased $9.0 million over the comparable period in 2011. The decrease is
primarily attributable to: (i) a decrease of $4.1 million in the Fully Insured
Health segment, principally due to the decrease in premiums on the short term
medical, major medical business for groups and individuals, limited medical and
dental lines of business in addition to
37
improved loss ratios on the short term medical business; (ii) a $4.0 million
decrease in the Group disability, life, annuities and DBL segment as a result of
lower production coupled with lower loss ratios in the LTD line and the transfer
of certain annuity contracts in the fourth quarter of 2011; and (iii) a $2.8
million decrease in the Individual life, annuity and other segment primarily
resulting from the transfer of certain group annuity contracts in the fourth
quarter of 2011 and decreased premium volume from other lines in run-off;
partially offset by (iv) an increase of $1.9 million in the Medical Stop-Loss
segment as a result of improved loss ratios offset by an increase in premium
volume by Risk Solutions.
Amortization of Deferred Acquisition Costs
Amortization of deferred acquisition costs decreased $.2 million primarily as a
result of the write-off, in the fourth quarter of 2011, of certain deferred
acquisition costs in connection with a coinsurance agreement.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased $2.5 million. The
decrease is primarily due to: (i) a $1.1 million decrease in commissions and
other general expenses in the Medical Stop-Loss segment due to increased
retentions partially offset by increases in expenses due to volume as a result
of increased production; and (ii) a $2.8 million decrease in the Fully Insured
Health segment largely due to decreased volume of business in the short term
medical, major medical business for groups and individuals, limited medical and
dental lines of business in 2012; partially offset by (iii) an increase of $1.1
million in corporate overhead expenses.
Income Taxes
The effective tax rate for the six months ended June 30, 2012 was 32.5%. In
2011, IHC eliminated $2.3 million of previously recorded deferred income taxes
due to management's intention to adopt tax planning strategies to recover its
investment in AMIC in a tax-free manner. Excluding this transaction, the
effective tax rate for the six months ended June 30, 2011 was 26.8%. The lower
effective tax rate in 2011 was due to a higher benefit from tax advantaged
securities as a percentage of income due to lower income in 2011.
LIQUIDITY
Insurance Group
The Insurance Group normally provides cash flow from: (i) operations; (ii) the
receipt of scheduled principal payments on its portfolio of fixed maturities;
and (iii) earnings on investments. Such cash flow is partially used to fund
liabilities for insurance policy benefits. These liabilities represent long-term
and short-term obligations.
Corporate
Corporate derives its funds principally from: (i) dividends from the Insurance
Group; (ii) management fees from its subsidiaries; and (iii) investment income
from Corporate liquidity. Regulatory constraints historically have not affected
the Company's consolidated liquidity, although state insurance laws have
provisions relating to the ability of the parent company to use cash generated
by the Insurance Group. The insurance group declared and paid $3.0 million of
cash dividends to Corporate in the first six months of 2012. No dividends were
declared or paid by the Insurance Group in the six months ended June 30, 2011.
38
Cash Flows
The Company had $13.4 million and $18.2 million of cash and cash equivalents as
of June 30, 2012 and December 31, 2011, respectively.
In February 2012, Standard Security Life transferred $143.5 million cash to an
unaffiliated reinsurer in connection with a coinsurance agreement, representing
a significant portion of the $139.7 million decrease in cash from operating
activities. Cash provided by investing activities of $135.7 million consists
primarily of proceeds from the net sales of investments in preparation for such
transfer of funds.
The Company has $456.5 million of insurance reserves that it expects to
ultimately pay out of current assets and cash flows from future business. If
necessary, the Company could utilize the cash received from maturities and
repayments of its fixed maturity investments if the timing of claim payments
associated with the Company's insurance resources does not coincide with future
cash flows. For the six months ended June 30, 2012, cash received from the
maturities and other repayments of fixed maturities was $35.9 million.
The Company believes it has sufficient cash to meet its currently anticipated
business requirements over the next twelve months including working capital
requirements and capital investments.
BALANCE SHEET
The Company had net receivables from reinsurers of $268.8 million at June 30,
2012 compared to $119.7 million at December 31, 2011. The increase is primarily
due to a coinsurance agreement with an unaffiliated reinsurer to transfer
approximately $143.5 million of group annuity reserves. All of such reinsurance
receivables are highly rated companies or are adequately secured. No allowance
for doubtful accounts was necessary at June 30, 2012.
The Company's health reserves by segment are as follows (in thousands):
Total Health Reserves
June 30, December 31,
2012 2011
Medical Stop-Loss $ 53,323 $ 58,741
Fully Insured Health 32,994 32,508
Group Disability 97,265 93,278Individual A&H and Other 7,935 8,460
$ 191,517 $ 192,987
Major factors that affect the Projected Net Loss Ratio assumption in reserving
for medical stop-loss relate to: (i) frequency and severity of claims; (ii)
changes in medical trend resulting from the influences of underlying cost
inflation, changes in utilization and demand for medical services, the impact of
new medical technology and changes in medical treatment protocols; and (ii) the
adherence by the MGUs that produce and administer a portion of this business to
the Company's underwriting guidelines. Changes in these underlying factors are
what determine the reasonably likely changes in the Projected Net Loss Ratio.
The primary assumption in the determination of fully insured reserves is that
historical claim development patterns tend to be representative of future claim
development patterns. Factors which may affect this assumption include changes
in claim payment processing times and procedures, changes in product design,
changes in time delay in submission of claims, and the incidence of unusually
large claims. 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 minimal. The time delay in
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submission of claims tends to be stable over time and not subject to significant
volatility. Since our analysis considered a variety of outcomes related to these
factors, the Company does not believe that any reasonably likely change in these
factors will have a material effect on the Company's financial condition,
results of operations, or liquidity.
The $10.6 million increase in IHC's stockholders' equity in the first six months
of 2012 is primarily due to $7.5 million of net income and $4.6 million of other
comprehensive income, partially offset by $1.0 million of treasury share
purchases.
Asset Quality and Investment Impairments
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 $3.7 million at June 30, 2012,
approximately 98.3% 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. At June 30, 2012, approximately 1.7% (or $12.5 million) of the
carrying value of fixed maturities was invested in non-investment grade fixed
maturities (primarily mortgage securities) (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
non-performing fixed maturities at June 30, 2012.
The Company reviews its investments regularly and monitors its investments
continually for impairments. For the six months ended June 30, 2012 and 2011,
the Company recorded $.7 million and $.5 million of losses for
other-than-temporary impairments in earnings. The Company also recognized $.3
million of other-than-temporary impairments in other comprehensive income for
the six months ended June 30, 2012. No losses for other-than-temporary
impairments were recognized in other comprehensive income for the six months
ended June 30, 2011. The following table summarizes the carrying value of
securities with fair values less than 80% of their amortized cost at June 30,
2012 by the length of time the fair values of those securities were below 80% of
their amortized cost (in thousands):
Greater than Greater than
3 months, 6 months,
Less than less than less than Greater than
3 months 6 months 12 months 12 months Total
Fixed maturities $ 2 $ 119 $ - $ 620 $ 741
The unrealized losses on all remaining available-for-sale securities have been
evaluated in accordance with the Company's impairment policy and were determined
to be temporary in nature at June 30, 2012. In 2012, the Company experienced an
increase in net unrealized gains of $8.6 million which was offset by $2.3
million of deferred taxes and $1.6 million of deferred policy acquisition costs.
From time to time, as warranted, the Company may employ investment strategies to
mitigate interest rate and other market exposures. Further deterioration in
credit quality of the companies backing the securities, further deterioration in
the condition of the financial services industry, a continuation of the current
imbalances in liquidity that exist in the marketplace, a continuation or
worsening of the current economic recession, or additional declines in real
estate values may further affect the fair value of these securities and increase
the potential that certain unrealized losses be designated as
other-than-temporary in future periods and the Company may incur additional
write-downs.
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CAPITAL RESOURCES
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.
IHC enters into a variety of contractual obligations with third parties in the
ordinary course of its operations, including liabilities for insurance reserves,
funds on deposit, debt and operating lease obligations. However, IHC does not
believe that its cash flow requirements can be fully assessed based solely upon
an analysis of these obligations. Future cash outflows, whether they are
contractual obligations or not, also will vary based upon IHC's future needs.
Although some outflows are fixed, others depend on future events. The maturity
distribution of the Company's obligations, as of June 30, 2012, is not
materially different from that reported in the schedule of such obligations at
December 31, 2011 which was included in Item 7 of the Company's Annual Report on
Form 10-K.
OUTLOOK
For 2012, we will continue to emphasize:
·
Adapting to health care reform by continuing to proactively adjust our
distribution strategies and mix of Fully Insured Health products to take
advantage of changing market demands.
·
Leveraging our strategy of directly distributing our Medical Stop-Loss products
through Risk Solutions to organically generate additional Medical Stop-Loss
business while maintaining the profitability of the block.
·
Seeking to acquire additional stop-loss blocks through transactions such as the
acquisition by Risk Solutions in July 2012 of the assets of an MGU with a block
of approximately $10 million of Medical Stop-Loss premiums.
·
Closely monitoring the experience in our Group disability, life annuities and
DBL business.
·
Continuing to increase the efficiency of our administrative companies.
The Company remained highly liquid in 2012 with a shorter duration portfolio. As
a result, the yields on our investment portfolio were, and continue to remain,
lower than in prior years and investment income may continue to be depressed for
the balance of the year. IHC has approximately $160.9 million in highly rated
shorter maturity securities earning on average 1.8%; our portfolio as a whole is
rated, on average, AA. The low duration of our portfolio enables us, if we deem
prudent, the flexibility to reinvest in much higher yielding longer-term
securities, which would significantly increase investment income. A low
duration portfolio such as ours also mitigates the adverse impact of potential
inflation. IHC will continue to monitor the financial markets and invest
accordingly.
In the fourth quarter of 2011, Standard Security Life entered into a coinsurance
agreement with an unaffiliated reinsurer effective January 26, 2012 and
transferred approximately $143.5 million of group annuity reserves in the first
quarter of 2012.
At June 30, 2012, IHC owned approximately 78.6% of the outstanding common stock
of AMIC.
We will continue to focus on our strategic objectives, including expanding our
distribution network. However, the success of a portion of our Fully Insured
Health business may be affected by the passage of the Patient Protection and
Affordable Care and Education Reconciliation Act of 2010 signed by
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President Obama in March 2010, and its subsequent interpretations by state and
federal regulators. The National Association of Insurance Commissioners has now
issued its proposed regulations. The regulations proposed to-date (including
those mandating minimum loss ratios) seem to have validated our strategy of
pursuing niche lines of business across many states utilizing multiple carriers.
We have begun a comprehensive review of all the options for IHC and we are
continuing a thorough evaluation of our options for those health insurance
products that may be affected. Although the law will generally require insurers
to operate with a lower expense structure for major medical plans in the small
employer and individual markets, the law appears to make exceptions for
carriers, such as ours, that have a minimal presence in any one state.
"Non-essential" lines of business and Medical Stop-Loss have been impacted by
health care reform minimally or not at all.
Our results depend on the adequacy of our product pricing, our underwriting and
the accuracy of our reserving methodology, returns on our invested assets and
our ability to manage expenses. Therefore, factors affecting these items,
including unemployment and global financial markets, may have a material adverse
effect on our results of operations and financial condition.
ITEM 3.
