MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
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CONDITION AND RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations ofIndependence 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 endedDecember 31, 2012 , as filed with theSecurities and Exchange Commission , and our unaudited Condensed Consolidated Financial Statements and related Notes thereto appearing elsewhere in this quarterly report. OverviewIndependence Holding Company , aDelaware 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 ofNew York ("Standard Security Life"),Madison National Life Insurance Company, Inc. ("Madison National Life"),Independence American Insurance Company ("Independence American"); and (ii) its marketing and administrative companies, includingIHC Risk Solutions, LLC ,IHC Health Solutions, Inc. andIHC Specialty Benefits, Inc. These companies are sometimes collectively referred to as the "Insurance Group ", and IHC and its subsidiaries (including theInsurance 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. AtJune 30, 2013 , the Company also owned an 80.6% 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 andNew 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
Three Months Ended Six Months Ended June 30, June 30, 2013 2012 2013 2012 Revenues$ 151,900 $ 101,443 $ 289,782 $ 203,599 Expenses 145,576 95,767 275,843 191,507 Income from operations before income 6,324 5,676 13,939 12,092 taxes Income taxes 2,166 1,846 4,741 3,932 Net income 4,158 3,830 9,198 8,160 Less: Income from noncontrolling (467) (299) (806) (707) interests in subsidiaries
Net income attributable to IHC
o
Net income of$.21 per share, diluted, for the three months endedJune 30, 2013 compared to$.20 per share, diluted, for the same period in 2012. Net income of$.47 per share, diluted, for the six months endedJune 30, 2013 , compared to$.41 per share, diluted, for the six months endedJune 30, 2012 . o Consolidated investment yields (on an annualized basis) of 3.5% and 3.7% for the three months and six months endedJune 30, 2013 compared to 3.8% and 3.9% for the comparable periods in 2012; o
Increase in IHC's ownership in AMIC to 80.6% as a result of AMIC's share repurchases in the first quarter of 2013;
o In the second quarter of 2013, Madison National Life entered into a coinsurance agreement with an unaffiliated reinsurer, effectiveMay 31, 2013 , to cede approximately$218.6 million of life and annuity reserves. Net realized investment gains were$16.4 million for the six months endedJune 30, 2013 , of which a significant portion resulted from sales of invested assets in connection with the transfer of assets in accordance with the terms of such coinsurance agreement. In addition, the Company wrote-off$9.3 million of deferred acquisition costs as a result of this coinsurance agreement, which was more than offset by the net realized investment gains in the period; and o
Book value of
The following is a summary of key performance information by segment:
o The Medical Stop-Loss segment reported income before taxes of$3.4 million for the second quarter of 2013 compared to$3.8 million in the same quarter in 2012, and reported income before taxes of$6.4 million for the first six months of 2013 compared to$9.9 million for the first six months of 2012. The decrease is primarily due to higher loss ratios in 2013; o Premiums earned increased$8.6 million and$16.2 million for the three months and six months endedJune 30, 2013 , respectively, when compared to the same periods in 2012. The increase in premiums earned is primarily due to increased volume. 29 o Underwriting experience for the Medical Stop-Loss segment, as indicated by its GAAP Combined Ratios, are as follows for the periods indicated (in thousands): Three Months Ended Six Months Ended June 30, June 30, 2013 2012 2013 2012 Premiums Earned$ 42,539 $ 33,984 $ 82,794 $ 66,635
Insurance Benefits, Claims & Reserves 28,580 22,588 57,494
40,995 Expenses 11,556 8,951 21,229 18,475 Loss Ratio(A) 67.2% 66.5% 69.5% 61.5% Expense Ratio (B) 27.2% 26.3% 25.6% 27.7% Combined Ratio (C) 94.4% 92.8% 95.1% 89.2% (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 and the expense ratio.
o The Company recorded an increase in the loss ratio in the medical stop-loss line of business for the six months endedJune 30, 2013 due to an unfavorable reserve development related to business written with a certain producer which resulted in a$2.1 million increase in claim reserves on this program. We have ceased writing new business with this producer.
·
The Fully Insured Health segment reported$0.2 million of income before taxes for the three months endedJune 30, 2013 as compared to$2.0 million for the comparable period in 2012, and reported$0.1 million of losses before taxes for the six months endedJune 30, 2013 compared to$3.2 million of income before taxes for the same period in 2012. The decrease is primarily due to higher
loss ratios in 2013; o Premiums earned increased$28.9 million and$53.7 million for the three months and six months endedJune 30, 2013 over the comparable 2012 periods primarily due to premiums generated by new lines of business (pet and international lines) combined with increased volume and retentions in certain other lines of the
business. o
Underwriting experience, as indicated by its GAAP Combined Ratios, for the Fully Insured segment are as follows for the periods indicated (in thousands):
30 Three Months Ended Six Months Ended June 30, June 30, 2013 2012 2013 2012 Premiums Earned$ 61,852 $ 32,982 $ 118,751 $ 65,067
Insurance Benefits, Claims & Reserves 43,780 21,370 83,458
42,382 Expenses 18,927 9,706 37,084 19,116 Loss Ratio 70.8% 64.8% 70.3% 65.1% Expense Ratio 30.6% 29.4% 31.2% 29.4% Combined Ratio 101.4% 94.2% 101.5% 94.5% o
The increase in the loss ratio was primarily attributable to an increase in the claims experience on major medical business for groups and individuals primarily due to unfavorable development on business that is produced by two non-owned third party administrators and a reserve adjustment for a potential lawsuit related to business written through an MGU that was previously terminated.
·
Income before taxes from the Group disability, life, annuities and DBL segment increased$1.7 million and$3.3 million for the three months and six months endedJune 30, 2013 compared to the three months and six months endedJune 30, 2012 primarily as a result of improved loss ratios in LTD and increased volume in DBL business; · Income before taxes from the Individual life, annuities and other segment decreased$9.4 million for both the three-month and six-month periods endedJune 30, 2013 as compared to the same periods in 2012 as a result of a$9.3 million write-off of deferred acquisition costs in connection with a coinsurance agreement in the second quarter of 2013;
·
Income before taxes from the Corporate segment remained comparable in the second quarter of 2013 as compared to the same period in 2012, and increased
·
Net realized investment gains were$11.7 million and$16.4 million for the three months and six months endedJune 30, 2013 compared to net realized investment gains of$1.9 million and$3.0 million for the three months and six months endedJune 30, 2012 . A significant portion of the net realized investment gains in 2013 resulted from sales of invested assets in connection with the transfer of assets in accordance with the terms of a coinsurance agreement. The Company did not record any other-than-temporary impairment losses in 2013. Other-than-temporary impairment losses recognized in earnings for the three months and six months endedJune 30, 2012 were$0.6 million and$0.7 million , respectively; and 31 ·
Premiums by principal product for the three months and six months ended
Three Months Ended Six Months Ended June 30, June 30, Gross Direct and Assumed Earned Premiums: 2013 2012 2013 2012 Medical Stop-Loss$ 50,416 $ 40,882 $ 98,511 $ 80,433 Fully Insured Health 72,365 53,002 137,846 105,449 Group disability, life, annuities and DBL 26,041 22,836 50,416 45,642 Individual, life, annuities and other 8,808 7,608 16,361 15,769$ 157,630 $ 124,328 $ 303,134 $ 247,293 Three Months Ended Six Months Ended June 30, June 30, Net Direct and Assumed Earned Premiums: 2013 2012 2013 2012 Medical Stop-Loss$ 42,539 $ 33,984 $ 82,794 $ 66,635 Fully Insured Health 61,852 32,982 118,751 65,067 Group disability, life, annuities and DBL 15,234 12,177 29,090 24,353 Individual, life, annuities and other 5,840 6,326 12,198 13,188$ 125,465 $ 85,469 $ 242,833 $ 169,243 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 endedDecember 31, 2012 . 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 endedDecember 31, 2012 . During the six months endedJune 30, 2013 , there were no additions to or changes in the critical accounting policies disclosed in the 2012 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
Information by business segment for the three months endedJune 30, 2013 and 2012 is as follows: Benefits, Amortization Selling, Net Fee and Claims of Deferred General Premiums Investment Other and Acquisition And June 30, 2013 Earned Income Income Reserves Costs Administrative Total (In thousands) Medical$ 42,539 1,130 (1) 28,580 - 11,672$ 3,416 Stop-Loss Fully Insured 61,852 497 6,086 43,780 5 24,459 191 Health Group disability, life, annuities and DBL 15,234 982 153 9,569 - 4,401 2,399 Individual life, annuities 5,840 4,373 1,460 7,347 10,943 2,932 (9,549) and other Corporate - 20 - - - 1,398 (1,378)
Sub total
Net realized investment gains 11,735 Other-than-temporary impairment losses - Interest expense on debt (490) Income from operations before income taxes 6,324 Income taxes 2,166 Net income$ 4,158 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 Premiums Earned
In the second quarter of 2013, premiums earned increased$40.0 million over the comparable period of 2012. The increase is primarily due to: (i) theFully Insured Health segment which had a$28.9 million increase in premiums primarily as a result of increased retentions on most lines of business and increased volume in the short term medical business and major medical business for groups and individuals in addition to premiums from the new pet and international lines of business; (ii) a$8.6 million increase in the Medical Stop-Loss segment due to increased volume of business in 2013; and (iii) a$3.0 million increase in the Group disability, life, annuities and DBL segment primarily due to increased premiums from the DBL line; partially offset by (iv) a decrease of$0.5 million of earned premiums in the Individual life, annuities and other segment primarily as a result of decreased premium volume from lines in run-off. 33 Net Investment Income
Total net investment income decreased$0.6 million . The overall annualized investment yields were 3.5% and 3.8% (approximately 3.6% and 3.9%, on a tax advantaged basis) in the second quarter of 2013 and 2012, respectively. The overall decrease was primarily a result of a decrease in investment income on bonds, equities and short-term investments due to the transfer of$215.1 million of invested assets in the second quarter of 2013 related to a coinsurance treaty. The annualized investment yields on bonds, equities and short-term investments were 3.5% and 3.7% in the second quarter of 2013 and 2012, respectively. IHC has approximately$121.8 million in highly rated shorter duration securities earning on average 1.5%. 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 The Company had net realized investment gains of$11.7 million in 2013 compared to$1.9 million in 2012. 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. In the second quarter of 2013, a significant portion of the net realized investment gains resulted from sales of invested assets in connection with the transfer of assets in accordance with the terms of a coinsurance agreement. The Company did not record any other-than-temporary impairment losses in the second quarter of 2013. In the second quarter of 2012, the Company recorded$0.6 million of other-than-temporary impairment losses, pre-tax. Other-than-temporary impairment losses in 2012 consist of credit losses resulting from expected cash flows of debt securities that are less than their amortized cost basis.
Fee Income and Other Income
Fee income increased
Other income increased
Insurance Benefits, Claims and Reserves
In the second quarter of 2013, insurance, benefits, claims and reserves increased$29.0 million over the comparable period in 2012. The increase is primarily attributable to: (i) an increase of$22.4 million in theFully Insured Health segment, principally due to the increase in premiums on the major medical business for groups and individuals and short term medical lines of business in addition to the new pet and international lines of business and higher loss ratios; (ii) an increase of$6.0 million in the Medical Stop-Loss segment as a result of an increase in premium volume and higher loss ratios; (iii) an increase of$1.3 million in the group disability, life, annuities and DBL segment primarily due to an increase in the DBL line of$1.9 million as a result of increased volume, partially offset by a$0.7 million decrease in the LTD line as a result of lower loss ratios in 2013; partially offset by (iv) a$0.7 million decrease in the Individual life, annuity and other segment primarily a result of decreased volume from lines in run-off.
Amortization of Deferred Acquisition Costs
In the second quarter of 2013, the Company wrote-off$9.3 million of deferred acquisition costs in connection with a coinsurance agreement. Excluding this write-off, amortization of deferred acquisition costs was comparable to the
same period in 2012. 34
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased$11.6 million . The increase is primarily due to: (i) a$7.9 million increase in theFully Insured Health segment largely due to an increase in commission and other general expenses in the major medical business for groups and individuals and short-term medical lines of business in addition to commission and other general expenses related to the new pet and international lines in 2013; (ii) a$3.8 million increase in commissions and other general expenses in the Medical Stop-Loss segment; (iii) an increase of$0.6 million in the group disability, life, annuities and DBL due to increased DBL volume; offset by (iv) a decrease of$0.7 million in Individual life, annuity and other segment.
Income Taxes
The effective tax rate for the three months endedJune 30, 2013 and 2012 was 34.3% and 32.5%, respectively. The lower effective tax rate in 2012 was due to a higher benefit from tax-advantaged securities as a percentage of income in 2012. 35
Results of Operations for the Six Months Ended
Information by business segment for the six months endedJune 30, 2013 and 2012 is as follows: Benefits, Amortization Selling, Net Fee and Claims of Deferred General Premiums Investment Other and Acquisition And June 30, 2013 Earned Income Income Reserves Costs Administrative Total (In thousands) Medical$ 82,794 2,700 296 57,494 - 21,864$ 6,432 Stop-Loss Fully Insured 118,751 1,017 12,350 83,458 10 48,791 (141) Health Group disability, life, annuities and DBL 29,090 1,578 175 18,534 - 8,334 3,975 Individual life, annuities 12,198 9,651 2,771 15,250 12,378 6,159 (9,167) and other Corporate - 57 - - - 2,594 (2,537)
Sub total
Net realized investment gains 16,354 Interest expense on debt (977) Income from operations before income taxes
13,939 Income taxes 4,741 Net income$ 9,198 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 Premiums Earned In the first six months of 2013, premiums earned increased$73.6 million over the comparable period of 2012. The increase is primarily due to: (i) theFully Insured Health segment which had a$53.7 million increase in premiums primarily as a result of increased retentions on most lines of business and increased volume in the short term medical business and major medical business for groups and individuals in addition to premiums from the new pet and international lines of business; (ii) a$16.2 million increase in the Medical Stop-Loss segment due to increased volume of business in 2013; and (iii) a$4.7 million increase in the Group disability, life, annuities and DBL segment primarily due to increased premiums from the DBL line; partially offset by (iv) a decrease of$1.0 million of earned premiums in the Individual life, annuities and other segment primarily as a result of decreased premium volume from lines in run-off. 36 Net Investment Income
Total net investment income decreased$1.4 million . The overall annualized investment yields were 3.7% and 3.9% (approximately 3.8% and 4.0%, on a tax advantaged basis) in the first six months of 2013 and 2012, respectively. The overall decrease was primarily a result of a decrease in investment income on bonds, equities and short-term investments due to the transfer of$215.1 million of invested assets in the second quarter of 2013 related to a coinsurance treaty. The annualized investment yields on bonds, equities and short-term investments were 3.5% and 3.7% in the first six months of 2013 and 2012, respectively. IHC has approximately$121.8 million in highly rated shorter duration securities earning on average 1.5%. 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 The Company had net realized investment gains of$16.4 million in 2013 compared to$3.0 million in 2012. These amounts include gains and losses from sales of fixed maturities and equity securities available-for-sale and other investments. Decisions to sell securities are based on management's ongoing evaluation of investment opportunities and economic and market conditions, thus creating fluctuations in gains and losses from period to period. A significant portion of the net realized investment gains in 2013 resulted from sales of invested assets in connection with the transfer of assets, during the second quarter, in accordance with the terms of a coinsurance agreement. The Company did not record any other-than-temporary impairment losses in the six months endedJune 30, 2013 . During the six months endedJune 30, 2012 , the Company recorded$.7 million of other-than-temporary impairment losses, pre-tax. Other-than-temporary impairment losses in 2012 consist of credit losses resulting from expected cash flows of debt securities that are less than their amortized cost basis. Fee Income and Other Income
Fee income decreased
Total other income increased
Insurance Benefits, Claims and Reserves
In the first six months of 2013, insurance, benefits, claims and reserves increased$57.3 million over the comparable period in 2012. The increase is primarily attributable to: (i) an increase of$41.1 million in theFully Insured Health segment, principally due to the increase in premiums on the major medical business for groups and individuals and short term medical lines of business in addition to the new pet and international lines of business and higher loss ratios; (ii) an increase of$16.5 million in the Medical Stop-Loss segment as a result of an increase in premium volume and higher loss ratios; (iii) an increase of$1.4 million in the group disability, life, annuities and DBL segment primarily due to an increase in the DBL line of$2.8 million as a result of increased volume, partially offset by a$1.6 million decrease in the LTD line as a result of lower loss ratios in 2013; offset by (iv) a$1.7 million decrease in the Individual life, annuity and other segment primarily a result of decreased volume from lines in run-off.
Amortization of Deferred Acquisition Costs
In the second quarter of 2013, the Company wrote-off$9.3 million of deferred acquisition costs in connection with a coinsurance agreement. Excluding this write-off, amortization of deferred acquisition costs decreased$0.1 million . 37
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased$17.9 million . The increase is primarily due to: (i) a$15.7 million increase in theFully Insured Health segment largely a result of an increase in commission and other general expenses in the major medical business due to the increase in volume for groups and individuals and short term medical lines of business in addition to commission and other general expenses related to the new pet and international lines in 2013; (ii) a$3.3 million increase in commissions and other general expenses in the Medical Stop-Loss segment due to the increase in volume; partially offset by (iii) a decrease of$1.0 million in corporate overhead expenses due to a reduction in employment and consulting related expenses.
Income Taxes
The effective tax rate for the six months ended
LIQUIDITYInsurance 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 theInsurance 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 theInsurance Group . No dividends were declared or paid by theInsurance Group in the first six months of 2013.The Insurance Group declared and paid$3.0 million of cash dividends to Corporate in the six months endedJune 30, 2012 . Cash Flows
The Company had
For the six months endedJune 30, 2013 , operating activities of the Company utilized$180.0 million of cash, whereas$182.0 million of cash was provided by investing activities. In the second quarter of 2013, the Company liquidated investments to fund a$215.1 million payment to an unaffiliated reinsurer in accordance with the terms of a coinsurance agreement causing the increase in investing activities and corresponding decrease in operating activities. Financing activities, which utilized$7.0 million for the period, includes$2.9 million utilized by IHC to acquire treasury shares and$1.2 million utilized by AMIC to purchase shares of its common stock from noncontrolling interests. The Company has$529.9 million of future policy benefits and claims and claim adjustment expenses 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 38 coincide with future cash flows. For the six months endedJune 30, 2013 , cash received from the maturities and other repayments of fixed maturities was$33.0 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 Cash and investments decreased$192.9 million fromDecember 31, 2012 largely due to the transfer of$215.1 million of cash and investments to an unaffiliated reinsurer in connection with a coinsurance agreement during the second quarter of 2013. The Company had net receivables from reinsurers of$338.4 million atJune 30, 2013 compared toat December 31, 2012 . The Company recorded$218.3 million of estimated reinsurance recoverables in connection with a coinsurance agreement during the second quarter of 2013. All of such reinsurance receivables are highly rated companies or are adequately secured. No allowance for doubtful accounts was necessary atJune 30, 2013 .
In connection with the coinsurance agreement mentioned above, the Company wrote-off
The Company's health reserves by segment are as follows (in thousands):
Total Health Reserves June 30, December 31, 2013 2012 Medical Stop-Loss$ 68,764 $ 59,029 Fully Insured Health 59,444 40,747 Group Disability 104,715 87,171
Individual A&H and Other 7,232 7,533
$ 240,155 $ 194,480 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 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 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. 39 The$13.0 million decrease in IHC's stockholders' equity in the first six months of 2013 is primarily due an$18.5 million decrease in other comprehensive income (loss) for the period, common stock dividends of$0.6 million and$2.9 million of treasury stock purchases, partially offset by net income of$8.4 million .
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$14.6 million atJune 30, 2013 , approximately 99.1% 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. AtJune 30, 2013 , approximately 0.9% (or$4.9 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 atJune 30, 2013 . The Company reviews its investments regularly and monitors its investments continually for impairments. The Company did not record any other-than-temporary impairment losses in the six months endedJune 30, 2013 . For the six months endedJune 30, 2012 , the Company recorded$0.7 million of losses for other-than-temporary impairments in earnings and$0.3 million of losses for other-than-temporary impairments in other comprehensive income (loss). The following table summarizes the carrying value of securities with fair values less than 80% of their amortized cost atJune 30, 2013 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 $ - $ - $ - $ 404$ 404 The unrealized losses on all available-for-sale securities have been evaluated in accordance with the Company's impairment policy and were determined to be temporary in nature atJune 30, 2013 . In 2013, the Company recorded$17.7 million of net unrealized losses on available-for sale securities, pre-tax, in other comprehensive income (loss) prior to DAC and reclassification adjustments. 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. 40 CAPITAL RESOURCES Due to its strong capital ratios, broad licensing and excellent asset quality and credit-worthiness, theInsurance 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 ofJune 30, 2013 , is not materially different from that reported in the schedule of such obligations atDecember 31, 2012 which was included in Item 7 of the Company's Annual Report on Form 10-K. OUTLOOK For 2013, we will emphasize: ·
Continued growth in our medical stop-loss segment as the demand for this product continues to grow and Risk Solutions continues to build its reputation as a direct writer and provider of captive solutions;
·
Our individual major medical premiums will decline somewhat in 2013, and more rapidly in 2014, as we discontinue writing new business in most states;
·
Further adapting to health care reform by continuing to proactively adjust our distribution strategies and mix of
·
Continued growth in pet insurance;
·
Increasing emphasis on direct-to-consumer distribution initiatives as we believe this will be a growing means for selling health insurance in the coming years;
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Growth in small group major medical premiums in 2013, but a decline in this line of business in 2014 as employers may choose to drop group health coverage or self-fund; ·
Increasing sales of short-term, limited medical and supplemental health products, such as dental, hospital indemnity and critical illness and international products to offset the reduction in major medical premiums in 2014;
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Selling non-subscriber occupational accident insurance in
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Increasing sales in our DBL line of business; and
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Continued focus on administrative efficiencies.
The Company remained highly liquid in 2013 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$121.8 million in highly rated shorter maturity securities earning on average 1.5%; 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 41
monitor the financial markets and invest accordingly.
At
We had a significant increase in the profitability and growth of our stop-loss business in 2012, our largest core business, which we attribute to the more efficient and controlled model of writing the majority of our medical stop-loss on a direct basis. At present, all indicators point to a continuation of this growth and higher level of profitability. There are a number of market forces that support this expectation. We have observed a trend on the part of our producers of stop-loss to consolidate their business with a smaller number of stop-loss carriers. The direct writing model employed by Risk Solutions is well suited to take advantage of this trend. There is an increased interest in self-funded options to address concerns about cost and regulatory burdens and we have developed targeted programs to address these needs. Finally there appears to be a market recognition that stop loss buying decisions need to be more about price. Service and fair claims payment practices are also important considerations and the partnership model under which Risk Solutions operates is increasingly recognized as addressing those issues. 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 Act of 2010, as amended, signed byPresident Obama inMarch 2010 and its subsequent interpretations by state and federal regulators. The appropriate regulatory agencies have now issued their 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 essential health benefit ("EHB") 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-EHB 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, the accuracy of our reserving methodology, returns on our invested assets, and our ability to manage expenses. We will also need to be diligent with the increased rate review scrutiny to effect timely rate changes and will need to stay focused on the management of medical cost drivers as medical trend levels have reversed direction in 2012 causing margin pressures. Therefore, factors affecting these items, as well as unemployment and global financial markets, may have a material adverse effect on our results of operations and financial condition.
ITEM 3.
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