Newswires
HEALTHMARKETS, INC. – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations
| Edgar Online, Inc. |
The following discussion should be read in conjunction with HealthMarkets' consolidated financial statements and the related notes included elsewhere in this Form 10-K. This discussion contains certain statements which may be considered forward-looking. Actual results and the timing of events may differ significantly from those expressed or implied in such forward-looking statements due to a number of factors, including those set forth in the section entitled "Risk Factors" and elsewhere in this Form 10-K. Additionally, the Company may also disclose financial information on a non-GAAP basis when management uses this information and believes this information will be valuable to investors in measuring the quality of our financial performance, identifying trends in our results and providing more meaningful period-to-period comparisons. Business SummaryHealthMarkets, Inc. , aDelaware corporation incorporated in 1984, is a holding company, the principal asset of which is its investment in its wholly owned subsidiary,HealthMarkets, LLC .HealthMarkets, LLC's principal assets are its investments in its separate operating subsidiaries, including its regulated insurance subsidiaries. HealthMarkets conducts its insurance underwriting businesses through its indirect wholly owned insurance company subsidiaries,The MEGA Life and Health Insurance Company ("MEGA"),Mid-West National Life Insurance Company of Tennessee ("Mid-West") andThe Chesapeake Life Insurance Company ("Chesapeake"), and conducts its insurance distribution business through its indirect insurance agency subsidiary,Insphere Insurance Solutions, Inc. ("Insphere") Through our insurance subsidiaries, we issue primarily health insurance policies, covering individuals, families, the self-employed and small businesses, and supplemental products. MEGA is an insurance company domiciled inOklahoma and is licensed to issue health, life and annuity insurance policies in theDistrict of Columbia and all states exceptNew York . Mid-West is an insurance company domiciled inTexas and is licensed to issue health, life and annuity insurance policies inPuerto Rico , theDistrict of Columbia , and all states exceptMaine ,New Hampshire ,New York andVermont . Chesapeake is an insurance company domiciled inOklahoma and is licensed to issue health and life insurance policies in theDistrict of Columbia and all states exceptNew Jersey ,New York andVermont . The Company has recently experienced significant strategic changes, primarily in connection with the launch of its Insphere insurance agency in 2009 and the development of Insphere since that time. Insphere serves as an authorized insurance agency in 50 states and theDistrict of Columbia , specializing in the distribution to the small business and middle-income market. Insphere distributes life, health, long-term care and retirement insurance through a portfolio of products from nationally recognized insurance carriers. As ofDecember 31, 2011 , Insphere had offices in 36 states with approximately 2,900 independent agents, of which approximately 1,800 agents on average write health insurance applications each month. Insphere distributes products underwritten by the Company's insurance subsidiaries, as well as non-affiliated insurance companies. The Company is generally focused on business opportunities that allow us to maximize the value of the Insphere independent agent sales force, with particular focus on the sale of supplemental insurance products underwritten by the Company's insurance subsidiaries and third-party health insurance products underwritten by non-affiliated insurance companies. In 2010, we discontinued the sale of the Company's traditional "scheduled benefit" health insurance products and discontinued marketing all health benefit plans underwritten by our insurance subsidiaries in all but a limited number of states in which Insphere does not have access to third-party health insurance products. We believe that this shift better positions the Company for the future, particularly in light of changes resulting from the enactment, inMarch 2010 , of the Patient Protection and Affordable Care Act and a reconciliation measure, the Health Care and Education Reconciliation Act of 2010 (collectively, the "Health Care Reform Legislation"). The Company continues to maintain a significant in-force block of health benefits plans and evaluates on an ongoing basis the impact of Health Care Reform Legislation on this block. 36
--------------------------------------------------------------------------------
Table of Contents
The Company operates four business segments: the Commercial Health Division, Insphere, Corporate and Disposed Operations. Through ourCommercial Health Division, we underwrite and administer a broad range of health and supplemental insurance products. Insphere includes net commission revenue, agent incentives, marketing costs and costs associated with the creation and development of Insphere. Corporate includes investment income not allocated to the other segments, realized gains or losses, interest expense on corporate debt, the Company's student loan business, general expenses relating to corporate operations and operations that do not constitute reportable operating segments. Disposed Operations includes the remaining run out of the Medicare Division and the Other Insurance Division, as well as the residual operations from the disposition of other businesses prior to 2009. (See Note 19 of Notes to Consolidated Financial Statements for financial information regarding our segments).
Results of Operations
The table below sets forth certain summary information about our consolidated operating results for each of the three most recent fiscal years:
For the Year Ended December 31, 2011 2010 2009 (In thousands) Revenue: Health premiums $ 543,092 $ 735,538 $ 977,568 Life premiums and other considerations 1,565 1,913 2,381 544,657 737,451 979,949 Investment income 28,028 42,246 43,166 Commissions and other income 83,570 76,906 62,401 Net impairment losses recognized in earnings - (765 ) (4,504 ) Realized gains, net 8,942 5,815 2,385 Total revenues 665,197 861,653 1,083,397 Benefits and Expenses: Benefits, claims, and settlement expenses 359,424 366,644 584,878 Underwriting, acquisition and insurance expenses 101,441 173,830 338,028 Other expenses 163,540 209,070 98,821 Interest expense 22,082 30,082 32,432 Total benefits and expenses 646,487 779,626 1,054,159 Income from continuing operations before income taxes 18,710 82,027 29,238 Federal income tax expense 8,042 31,896 11,676 Income from continuing operations 10,668 50,131 17,562 Income from discontinued operations (net of income tax) 79 66 162 Net income $ 10,747 $ 50,197 $ 17,724 Revenue The majority of our 2011 revenue was earned on health premiums derived from our inforce block of our indemnity and preferred provider organization ("PPO") policies in our Commercial Health Division. Premiums on health insurance contracts are recognized as earned over the period of coverage on a pro rata basis. We also earned revenue on premiums from traditional life insurance polices, which are recognized as revenue when due. The decrease in premium reflects the change in the Company's strategic focus, in connection with the launch of Insphere, on selling products underwritten by third-party carriers. The Company currently markets its health benefit plans in only a limited number of states in which Insphere does not have access to third-party health insurance products. The Company continues to offer supplemental insurance products underwritten by the Company's insurance subsidiaries. 37
--------------------------------------------------------------------------------
Table of Contents
Effective in 2011, if the medical loss ratios of our fully insured health products(calculated in accordance with the Health Care Reform Legislation and implementing regulations) fall below certain targets, our insurance subsidiaries will be required to rebate ratable portions of their premiums annually. Rebate payments for 2011 are to be paid byAugust 1, 2012 . As a result, the decrease in earned premium also reflects the recording of an accrual for the estimated medical loss ratio rebate. AtDecember 31, 2011 , the Company has accrued$26.9 million for this medical loss ratio rebate.
Investment income includes investment income derived from our investment portfolio and interest received on student loans.
Commission and other income consists primarily of commission and bonus revenue generated from the sale of third-party insurance products, association memberships and ancillary services.
Benefits and Underwriting, Acquisition and Insurance Expenses
These expenses consist primarily of insurance claim expense and expenses associated with the underwriting and acquisition of insurance policies underwritten by the Company's insurance subsidiaries. Claims expense consists primarily of payments to physicians, hospitals and other healthcare providers under health policies, and includes an estimated amount for incurred but not reported and unpaid claims. Underwriting, acquisition and insurance expenses consist of marketing and direct expenses incurred across all insurance lines in connection with issuance, maintenance and administration of in-force insurance policies, including amortization of deferred policy acquisition costs, commissions paid to agents, administrative expenses and premium taxes. Benefits and underwriting, acquisition and insurance expenses have continued to decrease in tandem with the decrease in premiums. Additionally, beginning in 2008, the Company initiated certain general and administrative cost reduction programs. These cost reduction efforts are still ongoing. Beginning in 2010, the Company's focus has been on selling third-party products rather the health benefit plans underwritten by its own insurance companies. As a result, the majority of our marketing costs have been incurred by Insphere. These marketing costs incurred by Insphere are recorded on the Company's consolidated statements of operations in "Other Expenses." Other Expenses Other Expenses consists of costs incurred with our Insphere operations, general expenses relating to corporate operations and direct expenses incurred in connection with generating income from ancillary services and marketing services provided to the membership associations with which we maintain contracts. The Insphere expenses include agent compensation for the sale of third-party products, other agent incentives, employee compensation, lead costs, costs associated with our field offices and other expenses related to the continuing development of Insphere. Other expenses also include expenses incurred with the Company-matching feature of the Invest Stock Ownership Plan.
Business Segments
The following is a comparative discussion of results of operations for our business segments and divisions. Allocations of investment income and certain general expenses are based on a number of assumptions and estimates, and the reported operating results for our business segments would change if different allocation methods were applied. Certain assets are not individually identifiable by segment and, accordingly, have been allocated by formulas. Segment revenues include premiums and other policy charges and considerations, net investment income, commission revenue, fees and other income. Management does not allocate income taxes to segments. Transactions between reportable segments are accounted for under respective agreements, which provide for such transactions generally at cost. 38
--------------------------------------------------------------------------------
Table of Contents
Revenue from continuing operations and income (loss) from continuing operations before federal income taxes ("Operating income") for each of our business segments and divisions were as follows:
For the Year Ended December 31, 2011 2010 2009 (In thousands) Revenue from continuing operations: Commercial Health Division $ 585,269 $ 798,666 $ 1,061,450 Insphere 73,723 46,170 1,192 Corporate 24,009 24,737 13,616 Intersegment Eliminations (19,397 ) (10,327 ) (2,088 )
Total revenues excluding disposed operations 663,604 859,246
1,074,170
Disposed Operations 1,593 2,407
9,227
Total revenue from continuing operations
$ 1,083,397 For the Year Ended December 31, 2011 2010 2009 (In thousands) Income (loss) from continuing operations before federal income taxes: Commercial Health Division $ 101,928 $ 236,771 $ 117,498 Insphere (53,694 ) (81,335 ) (11,902 ) Corporate (31,251 ) (76,432 ) (73,336 ) Total operating income excluding disposed operations 16,983 79,004 32,260 Disposed Operations 1,727 3,023 (3,022 ) Total income from continuing operations before federal income taxes $ 18,710 $ 82,027 $ 29,238 Assets by operating segment atDecember 31, 2011 , 2010, and 2009 are set forth in the table below: December 31, 2011 2010 2009 (In thousands) Assets: Commercial Health Division $ 404,033 $ 490,088 $ 731,594 Insphere 62,194 77,139 14,507 Corporate 830,253 769,105 734,040 Total assets excluding assets of Disposed Operations 1,296,480 1,336,332 1,480,141 Disposed Operations 380,238 383,319 391,357 Total assets $ 1,676,718 $ 1,719,651 $ 1,871,498
Disposed Operations assets at
Commercial Health Division
Through our Commercial Health Division, we issued a broad range of health insurance products for individuals, families, the self-employed and small businesses. Our plans are designed to accommodate individual needs and include basic hospital-medical expense plans, plans with preferred provider organization features, catastrophic hospital expense plans, as well as other supplemental types of coverage. Prior to 2010 we marketed 39
--------------------------------------------------------------------------------
Table of Contents
these products to the self-employed and individual markets through independent agents contracted with our insurance subsidiaries. Beginning in 2010, these products were primarily marketed through independent agents contracted with Insphere.
Set forth below is certain summary financial and operating data for the Commercial Health Division for each of the three most recent fiscal years:
For the Year Ended December 31, 2011 2010 2009 (Dollars in thousands) Revenues: Earned premium revenue $ 544,661 $ 736,809 $ 973,331 Investment income 13,999 21,579 26,427 Commission and other income 26,609 40,278 61,692 Total revenues 585,269 798,666 1,061,450 Expenses: Benefits, claims and settlement expenses 360,087 369,764 578,361 Underwriting, acquisition and insurance expenses 115,747 177,924 331,437 Other expenses 7,507 14,207 34,154 Total expenses 483,341 561,895 943,952 Operating income $ 101,928 $ 236,771 $ 117,498 Other operating data: Loss ratio 66.1% 50.2% 59.4% Expense ratio 21.3% 24.1% 34.1% Combined health ratio 87.4% 74.3% 93.5% Operating margin 18.7% 32.1% 12.1% Submitted annualized volume $ 58,910 $ 59,008 $ 321,918
Loss Ratio. The loss ratio is defined as benefits expense as a percentage of earned premium revenue.
Expense Ratio. The expense ratio is defined as underwriting, acquisition and insurance expenses as a percentage of earned premium revenue.
Operating Margin. Operating margin is defined as operating income as a percentage of earned premium revenue.
Submitted Annualized Volume. Submitted annualized premium volume in any period is the aggregate annualized premium amount associated with health insurance applications submitted by the Company's agents in such period for underwriting by the Company.
Year Ended
The Commercial Health Division reported earned premium revenue of$544.7 million in 2011 compared to$736.8 million in 2010, a decrease of$192.1 million or 26.1%, which is primarily due to a decrease in policies in force. Total policies in force decreased by 21.5% to approximately 117,000 during 2011 as compared to approximately 149,000 during 2010. The decrease in policies in force is primarily due to the Company's decision to discontinue the marketing of its health benefit plans in all but a limited number of states in which Insphere does not currently have access to third-party health insurance products. The Company continues to offer its supplemental products underwritten by Chesapeake and is focused on growing this line of business. However, the premium generated by the supplemental business has not been enough to offset the decline in premium associated with the Company's health benefit plans. The decrease in premium in 2011 also reflects the accrual of$26.9 million for the medical loss ratio rebate. 40
--------------------------------------------------------------------------------
Table of Contents
The Commercial Health Division reported operating income of$101.9 million in 2011 compared to operating income of$236.8 million in 2010, a decrease of$134.9 million or 57.0%. The decrease in operating income during the current year period is generally attributable to an increase in the loss ratio as discussed more fully below, partially offset by a reduction in underwriting acquisition and insurance expenses. During 2011 and 2010, the Company updated its loss reserve analysis to reflect more recent patterns of paid claims. The impact on the operating margin as a result of the update of its loss reserve analysis was larger in 2010 than in 2011. The 2010 favorable impact was$40.8 million compared to the favorable impact of$7.8 million for 2011. Additionally, the 2010 claim development also reflects the Company's refinement of a previously estimated claim liability, established in the fourth quarter of 2009, arising from a review of claim processing for state mandated benefits. As a result of this refinement, during 2010, the Company recognized a decrease in claim liabilities of$19.6 million . Underwriting, acquisition and insurance expense decreased by$62.2 million , or 35.0% to$115.7 million in 2011 from$177.9 million in 2010. This decrease reflects the variable nature of commission expenses and premium taxes included in these amounts which generally vary in proportion to earned premium revenue. Additionally, the Company continues to decrease its administrative costs, which are being reflected as a decrease in the expense ratio. Other factors contributing to the decrease in underwriting, acquisition and insurance expenses include a decrease in the overall effective commission rate as a result of the decrease in new business. Generally, first year commission rates paid to agents are higher than renewal year commission rates. Additionally, with the formation of Insphere and the sale of third-party health insurance products underwritten by non-affiliated insurance carriers, the Commercial Health Division has significantly decreased the amount of marketing and acquisition costs. Commission and other income and Other expenses both decreased in the current period compared to the prior year period. Commission and other income largely consists of fee and other income received for sales of association memberships prior to the formation of Insphere, for which Other expenses are incurred for bonuses and other compensation provided to the agents. Association memberships are generally sold with a health insurance policy and as the number of health insurance policies decrease, the income and expense will generally decrease.
Year Ended
The Commercial Health Division reported earned premium revenue of$736.8 million in 2010 compared to$973.3 million in 2009, a decrease of$236.5 million or 24%, which is due to a decrease in policies in force. Total policies in force decreased by 32% to approximately 149,000 during 2010 as compared to approximately 218,000 during 2009. The decrease in policies in force reflects an attrition rate that exceeds the pace of new sales, and is evident in the reduction in submitted annualized premium volume from$321.9 million in 2009 to$59.0 million in 2010. The decrease in policies in force is due in large part to the Company's decision to discontinue the marketing of its health benefit plans in all but a limited number of states in which Insphere does not currently have access to third-party health insurance products. The Commercial Health Division reported operating income of$236.8 million in 2010 compared to operating income of$117.5 million in 2009, an increase of$119.3 million or 102%. The increase in operating income during the current year period is generally attributable to a loss ratio reflecting better claims experience and a reduction in underwriting acquisition and insurance expenses. The favorable claims development reflects an update to the completion factors used at the end of the third quarter of 2010 to reflect more recent patterns of claim payments. The favorable impact of the updated completion factors was$30.6 million . The favorable claim development also reflects the Company's refinement of a previously estimated claim liability, established in the fourth quarter of 2009, arising from a review of claim processing for state mandated benefits. As a result of this refinement, during 2010, the Company recognized a decrease in claim liabilities of$19.6 million . In the fourth quarter of 2010, the Company made additional refinements to its claim reserving process which reduced the claim reserve by approximately$10.2 million . 41
--------------------------------------------------------------------------------
Table of Contents
Underwriting, acquisition and insurance expense decreased by$153.5 million , or 46% to$177.9 million in 2010 from$331.4 million in 2009. This decrease reflects the variable nature of commission expenses and premium taxes included in these amounts which generally vary in proportion to earned premium revenue and, in addition certain cost reduction programs initiated in the fourth quarter of 2008, which are being reflected as a decrease in the expense ratio. Other factors contributing to the decrease in underwriting, acquisition and insurance expenses include a decrease in the overall effective commission rate as a result of the decrease in new business. Generally, first year commission rates paid to agents are higher than renewal year commission rates. Additionally, with the formation of Insphere and the sale of third-party health insurance products underwritten by non-affiliated insurance carriers, theCommercial Health Division has significantly decreased the amount of marketing and acquisition costs. Other income and other expenses both decreased in the current period compared to the prior year period. Other income largely consists of fee and other income received for sales of association memberships prior to the formation of Insphere, for which other expenses are incurred for bonuses and other compensation provided to the agents. Association memberships are generally sold with a health insurance policy and as the number of health insurance policies decrease, other income and other expense will generally decrease.
Insphere
During the second quarter of 2009, we formed Insphere, an authorized insurance agency in 50 states and theDistrict of Columbia specializing in small business and middle-income market life, health, long-term care and retirement insurance. Insphere distributes products underwritten by our insurance subsidiaries, as well as non-affiliated insurance companies. Set forth below is certain summary financial and operating data for Insphere for the twelve months endedDecember 31 , for each of the three most recent years: For the Year Ended December 31, 2011 2010 2009 (Dollars in thousands) Revenue: Commission revenue from non-affiliates $ 44,293 $ 35,136 $ 1,137 Commission revenue from affiliates 15,154 4,917 - Commission revenue from association memberships 12,112 4,498 - Investment income 1,024 442 - Other income 1,140 1,177 55 Total revenue 73,723 46,170 1,192 Expenses: Commission expenses 39,127 22,410 459 Agent incentives and leads 27,513 37,322 3,568 Other expenses 60,777 67,773 9,067 Total expenses 127,417 127,505 13,094 Operating loss $ (53,694 ) $ (81,335 ) $ (11,902 ) Insphere generates revenue primarily from base commissions and override commissions received from insurance carriers whose policies are purchased through Insphere's independent agents. The commissions are typically based on a percentage of the premiums paid by the insured to the carrier. In some instances, Insphere also receives bonus payments for achieving certain sales volume thresholds. Insphere typically receives commission payments on a monthly basis for as long as a policy remains active. As a result, much of our revenue for a given financial reporting period relates to policies sold prior to the beginning of the period and is recurring in nature. Commission rates are dependent on a number of factors, including the type of insurance product and the particular insurance company underwriting the policy. 42
--------------------------------------------------------------------------------
Table of Contents
The Company continues to evaluate new distribution opportunities and continues efforts to expand its portfolio and the size of its field force by developing additional marketing arrangements. We believe the implementation of these new opportunities, along with the current cost reduction program, will help mitigate future operating losses.
Year Ended
For the years endedDecember 31, 2011 and 2010, the Company earned commission revenue of approximately$71.6 and$44.6 million , respectively. For 2011 and 2010, respectively, approximately 91% and 93% of commission revenue from non-affiliates was generated from four carriers. Insphere did not begin writing business until the fourth quarter of 2009 and as a result the revenue for the 2011 is significantly greater than the comparable period in 2010. Partially offsetting Insphere's revenue growth in sales in 2011 is the impact of certain elements of Health Care Reform. Beginning in 2011, in response to Health Care Reform, both the Company's insurance subsidiaries and certain third-party carriers decreased the level of commissions paid to Insphere. Commission revenue for 2010 also reflects certain one-time payments from third-party carriers for achieving certain production thresholds and consideration for contract renegotiation fees. The results for 2011 do not reflect similar amounts of these one-time payments. Commission expense includes commissions and overrides paid to our independent agents. Commissions are generally based on a percentage of the premiums paid by the insured to the carrier. The increase in commission expense from$22.4 million incurred during the twelve months endedDecember 31, 2010 to$39.1 million incurred during the twelve months endedDecember 31, 2011 , primarily trends with commission revenue. However, beginning in the third quarter of 2010, Insphere increased its commission rates paid to its agents to incorporate some of the costs previously included in Agent incentives. Agent incentives primarily include production and agent recruiting bonuses paid to our independent agents as well as lead generation costs incurred to facilitate the production of commission revenue. The decrease in Agent incentives as a percentage of Commission revenue from the prior year reflects the adjustment to commission rates to incorporate some of these costs as discussed above. In addition, beginning in the last half of 2010, the agents started sharing some of the costs of purchasing customer leads which reduced some of the lead generation costs for the Company. Other expenses associated with Insphere are related to employee compensation, costs associated with our field offices, depreciation and amortization, and other administrative expenses. Other expenses also reflect the significant amount of development to build-out technology to support multiple carriers and enhance the Insphere distribution channel by equipping our agents with efficient technology to cross-sell products. Other expenses have decreased from prior year as a result of both cost cutting initiatives and a reduction in costs associated with the development of Insphere. During the second and third quarters of 2010 the Company made the decision to wind down its broker-dealer operations,Insphere Securities, Inc. and to consolidate some of its agent sales offices, as a result of which it closed various leased facilities. During 2010, Insphere recorded lease impairment charges in the amount of$1.3 million and other wind down costs of$1.7 million . The wind-down charges incurred byInsphere Securities, Inc. related to employee termination costs, write-down of fixed assets and intangible assets and operations termination costs. These charges are reflected in "Other expenses" in the table above.
Year Ended
Insphere was formed during the second quarter of 2009, and as a result Insphere reported an operating loss of
43
--------------------------------------------------------------------------------
Table of Contents
Corporate
Corporate includes investment income not otherwise allocated to the other segments, realized gains and losses on sales, interest expense on corporate debt, the Company's Student Loan business, general expense relating to corporate operations and operations that do not constitute reportable operating segments.
Set forth below is a summary of the components of operating income (loss) at Corporate for each of the three most recent fiscal years:
For the Year Ended December 31, 2011 2010 2009 (In thousands) Operating income (loss): Investment income $9,317 $15,358 $10,519 Net investment impairment losses recognized in earnings - (765) (4,504) Realized gains, net 8,942 5,815 2,385 Interest expense on corporate debt (22,080) (30,081) (31,566) Student loan operations (174) (324) (14) Variable stock-based compensation (expense) benefit (619) 1,682 (858) General corporate expenses and other (26,637) (68,117) (49,298) Operating loss $(31,251) $(76,432) $(73,336)
Year Ended
Corporate continues to report operating losses primarily as a result of the decreased earnings on its investment portfolio not exceeding the debt service costs and other general corporate expenses. The changes for the period are primarily due to the following items:
• Investment income decreased by$6.0 million due to a decrease in the
amount of assets invested in higher yielding fixed maturities. As fixed
maturities in the bond portfolio are sold or mature, the Company has been
reinvesting these in short-term investments in preparation to repay its
$362.5 million term loan. • Realized gains, net increased by$3.1 million over prior year. The increase in realized gains during 2011 is the result of the sale of
various fixed maturities to increase liquidity to repay the Company's term
loan which matures in 2012. The Company repaid this debt in full onFebruary 29, 2012 .
• Net investment impairment losses recognized in earnings decreased by
impairments in 2011 as compared to one impairment loss recorded in 2010 on
one security. The impairment charges in 2010 resulted from other than
temporary reductions in the fair value of these investments compared to
our cost basis (see Note 4 of Notes to Consolidated Financial Statements
for additional information). • Interest expense on corporate debt decreased by$8.0 million in 2011
compared to 2010, primarily due to the lower interest rate environment
experienced in 2011 and the maturity of the remaining interest rate swap
inApril 2011 . • We maintain, for the benefit of our independent agents and certain
designated employees, a stock-based compensation plan - the HealthMarkets,
Inc. InVest Stock Ownership Plan (the "ISOP"). In connection with this
plan, we record a non-cash variable stock-based compensation benefit or
expense based on the performance of the fair value of our common stock.
Variable stock-based compensation expense increased by
primarily as a result of the increase in share price during 2011. • General corporate expenses and other decreased by$41.5 million from the
prior year. The 2010 results include approximately$37.4 million of additional salary expense and stock compensation compared to the 2011. These charges are primarily related to reductions in the Company's work
force and the previously announced changes to the Company's executive
management team during 2010. 44
--------------------------------------------------------------------------------
Table of Contents
Year Ended
Corporate reported an operating loss in 2010 of
• Investment income increased by
amount of investment income allocated to the Commercial Health Division in
2010 compared to 2009. Overall, investment income was comparable to prior
year; however, the amount of investment income allocated to the Commercial
Health Division was significantly lower than the prior year. The basis for
the allocation was consistently applied for both years.
• Realized gains, net increased by
unrealized gains related to our portfolio increased and the Company sold a
substantial portion of its municipal investments to reduce its exposure,
which generated realized gains.
• Net investment impairment losses recognized in earnings decreased by
impairments of$765,000 in 2010 on one security, compared to$4.5 million on four securities during 2009. These impairment charges resulted from
other than temporary reductions in the fair value of these investments
compared to our cost basis. • Interest expense on corporate debt decreased by$1.5 million in 2010
compared to 2009, primarily due to the lower interest rate environment
experienced in 2010 and the maturity of one of our interest rate swaps in
("Grapevine") subsidiary. Pursuant to the Company's adoption of ASU
2009-16 Accounting for Transfers of Financial Assets and Servicing Assets
and Liabilities, the Company began to include the activities of Grapevine
into its consolidated financial statements effectiveJanuary 1, 2010 . • In connection with the ISOP plan, we record a non-cash variable
stock-based compensation benefit or expense based on the performance of
the fair value of our common stock. Variable stock-based compensation
decreased by$2.5 million as a result of the decrease in share price during 2010.
• General corporate expenses and other increased by
prior year. The 2010 results include approximately
additional severance expense and
compensation compared to the prior year. These charges are primarily
related to reductions in the Company's work force and the previously
announced changes to the Company's executive management team.
Disposed Operations
Disposed Operations includes the remaining run out of the former Medicare Division and the former Other Insurance Division as well as the residual operations from the disposition of other businesses prior to 2009.
The table below sets forth income (loss) from continuing operations for our Disposed Operations for the years ended
For the Year Ended December 31, 2011 2010 2009 (In thousands) Income (loss) from Disposed Operations before federal income taxes: Medicare Insurance Division $424 $1,183 $(4,564) Other Insurance Division 1,381 1,825 3,863 Operations disposed of prior to 2009 (78) 15 (2,321) Total Disposed Operations $1,727 $3,023 $(3,022) 45
--------------------------------------------------------------------------------
Table of Contents
Medicare Division
In 2007, we expanded into the Medicare market by offering a new portfolio of Medicare Advantage Private-Fee-for-Service Plans in selected markets in 29 states with calendar year coverage effective forJanuary 1, 2008 . InJuly 2008 , we determined we would not continue to participate in this Medicare Advantage Private-Fee-for-Service Plans business as an underwriter after the 2008 plan year. As such, the results of operations for 2009 are not comparable to the results of operations for 2008.
Set forth below is certain summary financial and operating data for the Medicare Division for each of the three most recent fiscal years:
For the Year Ended December 31, 2011 2010 2009 (Dollars in thousands) Revenues: Earned premium revenue $ - $ (14 ) $ 1,103 Investment income - 2 136 Total revenues - (12 ) 1,239 Benefits and expenses: Benefits, claims and settlement expenses (457 ) (1,448 ) 5,707 Underwriting, acquisition and insurance expenses 33 253 96 Total expenses (424 ) (1,195 ) 5,803 Operating income (loss) $ 424 $ 1,183 $ (4,564 ) During 2009 we experienced a higher than expected claim volume and, as a result, we increased our claim liability to reflect this adverse experience. During 2010, as the claim activity began to subside, the Company refined its claim liability and decreased the lifetime loss ratio from 88.2% as ofDecember 31, 2009 to 85.6% as ofDecember 31, 2010 . During 2011, generally all liabilities have been settled. We do not expect any material activity with this business in 2012. Other Insurance Our Other Insurance Division consisted of ZON-Re, an 82.5%-owned subsidiary, which underwrote, administered and issued accidental death, accidental death and dismemberment, accident medical, and accident disability insurance products, both on a primary and on a reinsurance basis. We distributed these products through professional reinsurance intermediaries and a network of independent commercial insurance agents, brokers and third party administrators. OnJune 5, 2009 ,HealthMarkets, LLC , entered into an Acquisition Agreement for the sale of its 82.5% membership interest in ZON-Re to Venue Re. The transaction contemplated by the Acquisition Agreement closed effectiveJune 30, 2009 . We will continue to reflect the existing insurance business on our financial statements to final termination of all liabilities. 46
--------------------------------------------------------------------------------
Table of Contents
Set forth below is certain summary financial and operating data for the Other Insurance Division for each of the three most recent fiscal years:
For the Year Ended December 31, 2011 2010 2009 (In thousands) Revenues: Earned premium revenue $ 34 $ 677 $ 5,515 Investment income 1,587 1,744 1,827 Other income - (4 ) 552 Total revenues 1,621 2,417 7,894 Expenses: Benefits, claims and settlement expenses (145 ) (1,398 ) (808 ) Underwriting, acquisition and insurance expenses 385 1,990 4,839 Total expenses 240 592 4,031 Operating income $ 1,381 $ 1,825 $ 3,863 As disclosed in the table above, we recognized positive experience related to benefits expense as a result of favorable claims experience on the expired policies maturing during the periods, which policies were not renewed. We also recognized positive results as favorable claims experience was realized on contracts expiring prior to or during the period. Underwriting, acquisition and insurance expenses continue to decline reflecting our exit from this line of business.
Operations disposed of prior to 2009
This group incurred a loss of
Liquidity and Capital Resources
We regularly monitor our liquidity position, including cash levels, principal investment commitments, interest and principal payments on debt, capital expenditures and compliance with regulatory requirements. We maintain liquidity at two levels: our insurance subsidiaries and our holding company. Our regulated domestic insurance subsidiaries generate significant cash flows from operations. Liquidity requirements at the insurance subsidiaries generally consist of claim and benefit payments to policyholders and operating expenses, primarily for employee compensation and benefits. The Company meets such requirements by maintaining appropriate levels of cash, cash equivalents and short-term investments, using cash flows from operating activities and selling investments. After considering expected cash flows from operating activities, we generally invest cash at our regulated subsidiaries that exceeds our expected short-term obligations in longer term, investment-grade, marketable debt securities to improve our overall investment return. These investments are made after consideration of return objectives, regulatory limitations, tax implications and risk tolerances. Cash in excess of the capital needs of our domestic regulated insurance entities is paid to their non-regulated parent company, typically in the form of dividends, when and as permitted by applicable regulations. The holding company generates cash flows primarily through dividends from its subsidiaries. Cash flows generated from dividends and through the issuance of long-term debt, further strengthen our operating and financial flexibility. Liquidity requirements at the holding company level generally consist of servicing debt, funding the start up costs of Insphere, reinvestments in our businesses through the expansion of our products and services and the repurchase of shares of our common stock. 47
--------------------------------------------------------------------------------
Table of Contents
Consolidated Cash Flows
Historically, our primary source of cash on a consolidated basis has been premium revenue from policies issued. The primary uses of cash on a consolidated basis have been for the payment for benefits, claims and commissions under those policies, as well as operating expenses, primarily employee compensation and benefits. For the Year Ended December 31, 2011 2010 2009 (In thousands) Cash Provided By (Used In): Operating activities: Net income $ 10,747 $ 50,197 $ 17,724 Non-cash charges 32,274 63,106 72,146 Other operating activities (20,711 ) (146,786 ) (104,422 ) Net cash provided by (used in) operating activities 22,310 (33,483 ) (14,552 ) Investing activities (539 ) 171,220 (49,638 ) Financing activities (17,346 ) (142,269 ) (18,743 ) Net change in cash and cash equivalents 4,425 (4,532 ) (82,933 ) Cash and cash equivalents at beginning of period 12,874 17,406 100,339
Cash and cash equivalents at end of period
Operating Activities Cash flows generated from operating activities are principally from net income, net of depreciation and amortization and other non-cash expenses. During 2010 and 2009 the Company's operating activities used cash flows primarily as a result of the declining block of health insurance business and the costs incurred with the development of Insphere. In 2011, we generated cash flows primarily as a result of the reduction in development costs in Insphere and a reduction in salary and other employee costs as a result of work force reductions and compensation costs incurred as a result of changes in executive management in 2010. Investing Activities
Cash flows from investing activities primarily consist of net investment purchases or sales and net purchases of property and equipment, including capitalized software. Investing activities for 2010 includes the redemption of invested assets used to pay a dividend in the amount of
Financing Activities
Cash flows used in financing activities primarily consist of repurchases of treasury stock, repayment of the student loan credit facility and dividends to shareholders. Cash flows provided by financing activities primarily consist of proceeds from shares issued to the ISOP. In 2010, cash flows used in financing activities were primarily related to dividend payments to shareholders of$118.5 million . Holding CompanyHealthMarkets, Inc. is a holding company, the principal asset of which is its investment in its wholly owned subsidiary,HealthMarkets, LLC (collectively referred to as the "holding company"). The holding company's ability to fund its cash requirements is largely dependent upon its ability to access cash, by means of dividends or other means, fromHealthMarkets, LLC .HealthMarkets, LLC's principal assets are its investments in its separate operating subsidiaries, including its regulated domestic insurance subsidiaries. 48
--------------------------------------------------------------------------------
Table of Contents
Set forth in the table below is the aggregate cash and cash equivalents and short-term investments held at
For the Year Ended December 31, 2011 2010 2009 (In thousands) Cash, cash equivalents and short-term investments at: HealthMarkets, Inc. $ 74,244 $ 67,171 $ 24,394 HealthMarkets, LLC. 376,061 101,235 217,771 Total $ 450,305 $ 168,406 $ 242,165 Set forth below is a summary statement of aggregate cash flows forHealthMarkets, Inc. andHealthMarkets, LLC for each of the three most recent years: For the Year Ended December 31, 2011 2010 2009 (In thousands) Cash and cash equivalents and short-term investments on hand at beginning of year $ 168,406 $ 242,165 $ 232,123 Sources of cash: Dividends from domestic insurance subsidiaries 308,500 96,900 68,800 Dividends from offshore insurance subsidiaries - 5,000 3,000 Dividends from non-insurance subsidiaries 13,750 26,600 2,480 Proceeds from other financing activities 4,227 6,998 11,468 Net tax treaty payments from subsidiaries 29,009 50,292 26,669 Net investment activities - 18,966 4,579 Total sources of cash 355,486 204,756 116,996 Uses of cash: Cash to operations (20,147 ) (39,890 ) (37,387 ) Contributions/investment in subsidiaries - - (120 ) Interest on debt (12,472 ) (18,756 ) (25,143 ) Financing activities (30,363 ) (91,697 ) (23,152 ) Dividends paid to shareholders - (118,454 ) - Purchases of HealthMarkets common stock (10,605 ) (9,718 ) (21,152 ) Total uses of cash (73,587 ) (278,515 ) (106,954 ) Cash and cash equivalents on hand at end of year $ 450,305 $ 168,406 $ 242,165 Sources of Cash and Liquidity
• During 2011, 2010 and 2009, the holding company received an aggregate of
$322.3 million ,$128.5 million and$74.3 million , respectively, in cash dividends from its subsidiaries. The amount in 2011 includes an extraordinary dividend in the amount of$159.4 million paid form the Company's MEGA insurance subsidiary.
• In 2011, 2010 and 2009, the holding company received
financing activities largely consisting of
its predecessor plans. 49
--------------------------------------------------------------------------------
Table of Contents Uses of Cash and Liquidity
• During 2011, 2010 and 2009, the holding company paid
common stock from former officers and former and current participants of
the ISOP or its predecessor plans. • In 2011, 2010 and 2009, the holding company paid$12.5 million ,
debt.
• During 2011, 2010 and 2009, the holding company used
million and
approximately$30.4 million ,$90.7 million and$19.5 million , respectively, was used to fund Insphere operations.
• During 2010, the holding company paid a special cash dividend of $118.5
million. 2010 Dividend to Shareholders EffectiveFebruary 25, 2010 , the Board of Directors ofHealthMarkets, Inc. declared a special dividend in the amount of$3.94 per share for Class A-1 and Class A-2 common stock to holders of record as of the close of business onMarch 1, 2010 , payable onMarch 9, 2010 . In connection with the special cash dividend, the Company paid dividends to stockholders in the aggregate of$118.5 million with an additional$661,000 of dividends associated with restricted stock options to be paid upon vesting of those restricted stock options and$399,000 dividend equivalents credited to the employee participant accounts in the ISOP. Regulatory Requirements The state of domicile of each of the Company's domestic insurance subsidiaries imposes minimum risk-based capital requirements that were developed by the NAIC. The formulas for determining the amount of risk-based capital specify various weighting factors that are applied to financial balances and premium levels based on the perceived degree of risk. Regulatory compliance is determined by a ratio of a company's regulatory total adjusted capital, as defined, to its authorized control level risk-based capital, as defined. Companies' specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. Generally, the total stockholders' equity of domestic insurance subsidiaries (as determined in accordance with statutory accounting practices) in excess of minimum statutory capital requirements is available for transfer to the parent company. However, the amount of equity available for dividends in any given year without prior approval from state regulatory authorities is subject to certain limitations as discussed below under Dividend Restrictions.
The required minimum aggregate statutory capital and surplus of our principal domestic insurance subsidiaries were as follows at
Minimum Actual (In millions) Mega $ 51.1 $ 110.5 Mid-West $ 22.0 $ 73.7 Chesapeake $ 8.0 $ 35.7
At
Dividend Restrictions We conduct a significant portion of our business through our insurance subsidiaries, which are subject to regulations and standards established by their respective states of domicile. Most of these regulations and standards conform to those established by the NAIC. These standards require our insurance subsidiaries to 50
--------------------------------------------------------------------------------
Table of Contents
maintain specified levels of statutory capital, as defined by each state, and restrict the timing and amount of dividends and other distributions that may be paid to their parent company. Generally, the amount of dividend distributions that may be paid by a regulated subsidiary, without prior approval by state regulatory authorities, is limited based on the entity's level of statutory net income and statutory capital and surplus. These limitations are based upon the greater of 10% of statutory surplus at the end of the preceding year or the preceding year's statutory gain from operations. Our domestic insurance companies paid dividends of$308.5 million ,$96.9 million and$68.8 million , respectively, toHealthMarkets, LLC in 2011, 2010 and 2009, respectively. The dividend amount for 2011 includes$159.4 million of extraordinary dividends paid from the Company's MEGA insurance subsidiary. InJanuary 2012 , the Company's Mid-West insurance subsidiary paid an extraordinary dividend in the amount of$30.0 million to its parent,HealthMarkets, LLC . During 2012, the Company's domestic insurance companies are eligible to pay additional aggregate dividends in the ordinary course of business toHealthMarkets, LLC of approximately$48.1 million without prior approval by statutory authorities. However, as it has done in the past, the Company will continue to assess the results of operations of the regulated domestic insurance companies to determine the prudent dividend capability of the subsidiaries. This is consistent with our practice of maintaining risk-based capital ratios at each of our domestic insurance subsidiaries in excess of minimum requirements.
Contractual Obligations and Off Balance Sheet Arrangements
The following table sets forth additional information with respect to our outstanding debt: December 31, Maturity Date 2011 2010 (In thousands) 2006 credit agreement: Term loan 2012 $ 362,500 $ 362,500 Grapevine Note 2021 72,350 72,350
Trust preferred securities:
UICI Capital Trust I 2034 15,470
15,470
HealthMarkets Capital Trust I 2036 51,550
51,550
HealthMarkets Capital Trust II 2036 51,550
51,550
Total $ 553,420 $
553,420
Student Loan Credit Facility 60,050 68,650 Total $ 613,470 $ 622,070 InApril 2006 , we borrowed$500.0 million under a term loan credit facility and issued$100.0 million of Floating Rate Junior Subordinated Notes. The Company made principal payments on the term loan and, atDecember 31, 2011 ,$362.5 million remained outstanding. The maturity date of the term loan isApril 5, 2012 . OnFebruary 29, 2012 , the Company paid in full the remaining principal and interest on the term loan in an amount of$363.3 million .Grapevine Finance LLC issued$72.4 million of senior secured notes to an institutional purchaser which matures inJuly 2021 . The net proceeds were distributed toHealthMarkets, LLC . The note bears interest at an annual rate of 6.712%. The interest is to be paid semi-annually onJanuary 15th andJuly 15th of each year. 51
--------------------------------------------------------------------------------
Table of Contents
InApril 2006 ,HealthMarkets Capital Trust I and HealthMarkets Capital Trust II ("Trusts") issued$100.0 million of floating rate trust preferred securities and$3.1 million of floating rate common securities and invested the proceeds in$100.0 million principal amount ofHealthMarkets, LLC's floating rate junior subordinated notes dueJune 15, 2036 . The notes accrue interest at a floating rate equal to three-monthLIBOR plus 3.05%. InApril 2004 , UICI Capital Trust I completed the private placement of$15.0 million amount of floating rate trust preferred securities and$470,000 of floating rate common securities and invested the proceeds in an equivalent face amount of the Company's floating rate junior subordinated notes due 2034. The notes will mature onApril 29, 2034 and accrue interest at a floating rate equal to three-monthLIBOR plus 3.50%, payable quarterly. AtDecember 31, 2011 , the Company had indebtedness outstanding under a secured student loan credit facility which indebtedness is represented by Student Loan Asset-Backed Notes issued by a bankruptcy-remote special purpose entity. Indebtedness outstanding under the Student Loan Credit Facility is secured by student loans and accrued interest and by a pledge of cash, cash equivalents and other qualified investments. Set forth below is a summary of our consolidated contractual obligations atDecember 31, 2011 : Payment Due by Period Less than More than Total 1 Year 1-3 Years 3-5 Years 5 Years (In thousands) Corporate debt $ 553,420 $ 362,500 $ - $ - $ 190,920 Student Loan Credit Facility 60,050 7,300 12,050 10,150 30,550 Future policy benefits(1) 473,163 26,799 53,961 45,580 346,823 Claim liabilities(1) 94,743 84,616 9,011 772 344 Student loan commitments(2) 56,320 3,765 11,284 12,937 28,334Goldman Sachs Real Estate Partners, L.P. 1,617 - 1,617 - -Blackstone Strategic Alliance Fund L.P. 317 317 - - - Operating lease obligations 11,431 3,963 5,162 2,166 140 Total $ 1,251,061 $ 489,260 $ 93,085 $ 71,605 $ 597,111
(1) In connection with various reinsurance agreements the Company entered into
coinsurance arrangements pursuant to which the reinsurers agreed to assume
liability for
claim liabilities associated with such businesses.
(2) The Company has outstanding commitments to fund student loans through 2026
for an aggregate amount of
rates and policy lapse rates, the Company only expects to fund
Critical Accounting Policies and Estimates
Our discussion and analysis of the consolidated financial condition and results of operations are based upon the consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles inthe United States of America ("GAAP"). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to health and life insurance claims, bad debts, investments, intangible assets, income taxes, financing operations and contingencies and litigation. We base our estimates on historical experience, as well as various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. 52
--------------------------------------------------------------------------------
Table of Contents
We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements, which are discussed in more detail below:
• the valuations of certain assets and liabilities require fair value estimates; • recognition of premium revenue; • recognition of commission revenue; • the estimate of claim liabilities; • the realization of deferred acquisition costs; • the carrying amount of goodwill and other intangible assets; • the amortization period of intangible assets; • stock-based compensation plan forfeitures; • the realization of deferred taxes;
• reserves for contingencies, including reserves for losses in connection
with unresolved legal and regulatory matters; and • other matters that affect the reported amounts and disclosure of contingencies in the financial statements. Estimates, by their nature, are based on judgment and available information. Therefore, actual results could differ from those estimates and could have a material impact on the consolidated financial statements.
Fair Value Measurements
We account for our investments and certain other assets and liabilities recorded at fair value in accordance withFinancial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 820, Fair Value Measurements and Disclosures ("ASC 820"), which requires us to categorize such assets and liabilities into a three-level hierarchy. As discussed in more detail below, the determination of fair value for certain assets and liabilities may require the application of a greater degree of judgment given recent volatile market conditions, as the ability to value assets can be significantly impacted by a decrease in market activity. We evaluate the various types of securities in our investment portfolio to determine the appropriate level in the fair value hierarchy based upon trading activity and the observability of market inputs. We employ control processes to validate the reasonableness of the fair value estimates of our assets and liabilities, including those estimates based on prices and quotes obtained from independent third party sources. Our procedures generally include, but are not limited to, initial and ongoing evaluation of methodologies used by independent third parties and monthly analytical reviews of the prices against current pricing trends and statistics. Where possible, we utilize quoted market prices to measure fair value. For investments that have quoted market prices in active markets, we use the quoted market price as fair value and include these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices in active markets are unavailable, we determine fair values using various valuation techniques and models based on a range of observable market inputs including pricing models, quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, prepayment speeds, default rates and discounted cash flow. In most cases, these estimates are determined based on independent third party valuation information, and the amounts are disclosed in Level 2 of the fair value hierarchy. Generally, we obtain a single price or quote per instrument from independent third parties to assist in establishing the fair value of these investments. If quoted market prices and independent third party valuation information are unavailable, we produce an estimate of fair value based on internally developed valuation techniques, which, depending on the level of observable market inputs, will render the fair value estimate as Level 2 or Level 3. On occasions when pricing 53
--------------------------------------------------------------------------------
Table of Contents
service data is unavailable, we may rely on bid/ask spreads from dealers in determining the fair value. When dealer quotations are used to assist in establishing the fair value, we generally obtain one quote per instrument. The quotes obtained from dealers or brokers are generally non-binding. When dealer quotations are used, we use the mid-mark as fair value. When broker or dealer quotations are used for valuation or price verification, greater priority is given to executable quotes. As part of the price verification process, valuations based on quotes are corroborated by comparison both to other quotes and to recent trading activity in the same or similar instruments. To the extent we determine that a price or quote is inconsistent with actual trading activity observed in that investment or similar investments, or if we do not think the quote is reflective of the market value for the investment, we will internally develop a fair value using this observable market information and disclose the occurrence of this circumstance.
Investments
We have classified our investments in securities with fixed maturities as "available for sale" Fixed maturities and equity securities have been recorded at fair value, and unrealized investment gains and losses are reflected in stockholders' equity.
Investments are reviewed at least quarterly, using both quantitative and qualitative factors, to determine if they have experienced an impairment of value that is considered other-than-temporary. In its review, management considers the following indicators of impairment: fair value significantly below cost; decline in fair value attributable to specific adverse conditions affecting a particular investment; decline in fair value attributable to specific conditions, such as conditions in an industry or in a geographic area; decline in fair value for an extended period of time; downgrades by rating agencies from investment grade to non-investment grade; financial condition deterioration of the issuer and situations where dividends have been reduced or eliminated or scheduled interest payments have not been made. Additionally, we assess whether the amortized cost basis will be recovered by comparing the present value of cash flows expected to be collected with the amortized cost basis of the investment. When the determination is made that an other-than-temporary impairment ("OTTI") exists but we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before the recovery of its remaining amortized cost basis, we determine the amount of the impairment related to a credit loss and the amount related to other factors. OTTI losses attributed to a credit loss are recorded in "Net impairment losses recognized in earnings" on the statement of operations. OTTI losses attributed to other factors are reported in "Accumulated other comprehensive income (loss)" as a separate component of stockholders' equity and accordingly have no effect on our net income (loss). Testing for impairment of investments requires significant management judgment. The identification of potentially impaired investments, the determination of their fair value and the assessment of whether any decline in value is other than temporary are the key judgment elements. The discovery of new information and the passage of time can significantly change these judgments. Revisions of impairment judgments are made when new information becomes known, and any resulting impairments are made at that time. The economic environment and volatility of securities markets increase the difficulty of determining fair value and assessing investment impairment. The same influences tend to increase the risk of potentially impaired assets. Upon our adoption of FSP SFAS No. 115-2 in the second quarter of 2009, which was codified into FASB ASC Topic 320, Investments - Debt and Equity Securities ("ASC 320"), we recorded a cumulative-effect adjustment for debt securities held at adoption for which an OTTI had been previously recognized. We recognized such tax-effected cumulative effect of initially applying this guidance as an adjustment to "Retained earnings" for $1.0 million , net of tax, with a corresponding adjustment to "Accumulated other comprehensive income." 54
--------------------------------------------------------------------------------
Table of Contents Premium Revenue Health Premiums Health insurance policies issued by the Company are considered long-duration contracts. The contract provisions generally cannot be changed or canceled during the contract period; however, the Company may adjust premiums for health policies issued within prescribed guidelines and with the approval of state insurance regulatory authorities. Insurance premiums for health policies are recognized as earned over the premium payment periods of the policies. Benefits and expenses are matched with premiums so as to result in recognition of income over the term of the contract. This matching is accomplished by means of the provision for future policyholder benefits and expenses and the deferral and amortization of acquisition costs.
Life Premiums
Premiums on traditional life insurance are recognized as revenue when due. Benefits and expenses are matched with premiums so as to result in recognition of income over the term of the contract. This matching is accomplished by means of the provision for future policyholder benefits and expenses and the deferral and amortization of acquisition costs. Premiums and annuity considerations collected on universal life-type and annuity contracts are recorded using deposit accounting, and are credited directly to an appropriate policy reserve account, without recognizing premium income. Revenues from universal life-type and annuity contracts are amounts assessed to the policyholder for the cost of insurance (mortality charges), policy administration charges and surrender charges and are recognized as revenue when assessed based on one-year service periods. Amounts assessed for services to be provided in future periods are reported as unearned revenue and are recognized as revenue over the benefit period. Contract benefits that are charged to expense include benefit claims incurred in the period in excess of related contract balances and interest credited to contract balances.
Commission Revenues
Insphere and its agents distribute insurance products underwritten by the Company's insurance subsidiaries, as well as third-party insurance products underwritten by non-affiliated insurance companies. The Company earns commissions for third-party insurance products sold by Insphere agents. The majority of our commission revenue is derived from insurance policies and association memberships that are billed monthly. The Company also receives a small percentage of commission revenue based on quarterly, semi-annual, and annual billing modes. For all billing modes, the commission revenue is recognized as earned on a monthly basis beginning with the effective date of the insurance policy and continues as long as the policy continues to pay premium. For single premium annuity commission revenue, and other commissions that are received on a one-time basis, commission revenues are recognized as of the effective date of the insurance policy or the date on which the policy premium is billed to the customer, whichever is later. Subsequent commission adjustments are recognized upon our receipt of notification concerning matters necessitating such adjustments from the insurance companies. Production bonuses, volume overrides and contingent commissions are recognized when determinable, either (i) when such commissions are received from insurance companies, (ii) when we receive formal notification of the amount of such payments or (iii) when the amounts of such payments can be reasonably estimated.
Acquisition Costs
Deferred Acquisition Costs ("DAC")
We incur various costs in connection with the origination and initial issuance of its health insurance policies, including underwriting and policy issuance costs, costs associated with lead generation activities and distribution costs (i.e., sales commissions paid to agents). We defer these costs and amortize the deferred expense over the expected premium paying period of the policy, which approximates five years. Additionally, certain 55
--------------------------------------------------------------------------------
Table of Contents
underwriting and policy issuance costs, which we determined to be more variable than fixed in nature are capitalized and amortized over the expected premium paying period of the policy. We also defer commissions paid to agents and premium taxes with respect to the portion of health premium collected but not yet earned. The calculation of DAC requires us to use estimates based on actuarial valuation techniques. We review our actuarial assumptions and deferrable acquisition costs each year and, when necessary, we revise such assumptions to more closely reflect recent experience. For policies in force, we evaluate DAC to determine whether such costs are recoverable from future revenues. Any resulting adjustment is charged against net earnings.
Goodwill and Other Identifiable Intangible Asset
We account for goodwill and other intangibles in accordance with FASB ASC Topic 350, Intangibles - Goodwill and Other ("ASC 350"), which requires that goodwill and other intangible assets be tested for impairment at least annually or more frequently if certain indicators arise. An impairment loss would be recorded in the period such determination was made. Consistent with prior years, we use assumptions and estimates in our valuation, and actual results could differ from those estimates. ASC 350 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives to their estimated residual values. Management makes assumptions regarding the useful lives assigned to intangible assets. We currently amortize intangible assets with estimable useful lives over a period ranging from five to twenty-five years, however, management may revise amortization periods if they believe there has been a change in the length of time that an intangible asset will continue to have value. If these estimates or their related assumptions change in the future, we may be required to record impairment losses or change the useful life, including accelerating amortization for these assets.
Claims Liabilities
We establish liabilities for benefit claims that have been reported but not paid and claims that have been incurred but not reported under health and life insurance contracts. Consistent with overall company philosophy, the claims liabilities estimate is developed and is expected to be adequate under reasonably likely circumstances. This estimate is developed using actuarial principles and assumptions that consider a number of items as appropriate, including but not limited to historical and current claim payment patterns, product variations, the timely implementation of appropriate rate increases and seasonality. We do not develop ranges in the setting of the claims liabilities reported in the financial statements. The majority of our claims liabilities are estimated using the developmental method, which involves the use of completion factors for most incurral months, supplemented with additional estimation techniques, such as loss ratio estimates, in the most recent incurral months. This method applies completion factors to claim payments in order to estimate the ultimate amount of the claim. These completion factors are derived from historical experience and are dependent on the service dates of the claim payments. The completion factors are selected so that they are equally likely to be redundant as deficient. Prior to 2011, the majority of health insurance products offered through the Commercial Health Division establish the claims liabilities using the modified incurred date. Under the modified incurred date methodology, claims liabilities for the cost of all medical services related to the accident or sickness are recorded at the earliest date of diagnosis or treatment, even though the medical services associated with such accident or sickness might not be rendered to the insured until a later financial reporting period. A break in service of more than six months will result in the establishment of a new incurred date for subsequent services. A new incurred date will be established if claims payments continue for more than thirty-six months without a six month break in service. See Change in Accounting Principle on Claim Liabilities below for discussion on the change in methodology from the modified incurred date to service date. Beginning in 2008, the Commercial Health Division began using date of service as opposed to the modified incurred date to establish the claims liabilities for new contracts introduced or updated in or after 2008. 56
--------------------------------------------------------------------------------
Table of Contents
In estimating the ultimate level of claims for the most recent incurral months, we use what we believe are prudent estimates that reflect the uncertainty involved in these incurral months. An extensive degree of judgment is used in this estimation process. For healthcare costs payable, the claim liability balances and the related benefit expenses are highly sensitive to changes in the assumptions used in the claims liability calculations. With respect to health claims, the items that have the greatest impact on our financial results are the medical cost trend, which is the rate of increase in healthcare costs, and the unpredictable variability in actual experience. Any adjustments to prior period claim liabilities are included in the benefit expense of the period in which adjustments are identified. Due to the considerable variability of healthcare costs and actual experience, adjustments to health claim liabilities usually occur each quarter and are sometimes significant. We believe that the recorded claim liabilities are reasonable and adequate to satisfy its ultimate claims liability. We use our own experience as appropriate and rely on industry loss experience as necessary in areas where our data is limited. Our estimate of claim liabilities represents management's best estimate of the liability for each period presented.
The completion factors and loss ratio estimates in the most recent incurred months are the most significant factors affecting the estimate of the claim liability. The Company believes that the greatest potential for variability from estimated results is likely to occur at the Commercial Health Division.
The following table illustrates the sensitivity of these factors and the estimated impact to the
Completion Factor(a) Loss Ratio Estimate(b) Increase (Decrease) in Estimated Increase Increase (Decrease) Increase (Decrease) Claim (Decrease) in Estimated Claim in Factor Liability in Ratio Liability (In thousands) (In thousands) 6% $ (4,318 ) 6% $ 4,113 4% (2,879 ) 4% 2,742 2% (1,440 ) 2% 1,371 -2% 1,441 -2% (1,371 ) -4% 2,882 -4% (2,742 ) -6% 4,325 -6% (4,113 )
(a) Impact due to change in completion factors for incurred months prior to the
most recent three months.
(b) Impact due to change in estimated loss ratio for the most recent three month.
Changes in Commercial Health Claim Liability Estimates
The Commercial Health Division reported particularly favorable experience development during the reporting periods on claims incurred in prior years in the reported values of subsequent years (see Note 8 of Notes to Consolidated Financial Statements for discussion of claims liability development experience). A significant portion of the favorable experience development was attributable to the recognition that the claims payment patterns used in establishing the completion factors were no longer reflective of the expected future claims payment patterns underlying the claim liability. As a result, we refined the estimates and assumptions used in calculating the claims liabilities estimate to accommodate the changing patterns as they emerge. The Company continues to update its completion factors to reflect more recent patterns of claim payments. Throughout 2010, we saw an ongoing decrease in the time period from incurral to payment of a claim, resulting in higher completion factors and lower reserves. In response to these trends, we used more recent experience to develop the completion factors, resulting in a decrease in claim liabilities of$30.6 million recognized during the three months endedSeptember 30, 2010 . During 2011, the Company again updated its completion factors to 57
--------------------------------------------------------------------------------
Table of Contents
reflect the more recent patterns of claim payments resulting in a decrease in the claim liabilities of$7.8 million in the three months endedSeptember 30, 2011 . We will continue to evaluate and update completion factors on an ongoing basis, as appropriate, and will evaluate the impact, if any, that Health Care Reform Legislation may have on the completion factors. During the fourth quarter of 2010, we revised the loss development technique for the most recent incurral months. We revised our technique to use a Bornhuetter-Ferguson calculation which weights a completion factor estimate with an exposure-based estimate. The weights used are the completion factors, which results in a reserve estimate that is the reciprocal of the completion factor times the exposure-based estimate. The exposure-based estimate is the earned premium multiplied by the anticipated loss ratio, which in most cases is the 12-month average loss ratio for the months prior to the most recent incurral months. As a result of this revision, during the fourth quarter of 2010, we recognized a decrease in claim liabilities of$10.2 million . The estimate with respect to claims liability and related benefit expenses are subject to an extensive degree of judgment. During the fourth quarter of 2009, based on a review of the claims processing for state mandated benefits, we refined the claim liability estimate related to state mandated benefits. Based on this review of submitted charges for state mandated benefits, we recorded a claim liability estimate of$23.9 million ($25.7 million including loss adjustment expense). During 2010, we adjusted the estimated claim liability established in the fourth quarter of 2009 related to the review of claims processing for state mandated benefits based upon actual results from reprocessing approximately 81% of these claims. As a result of this refinement, during 2010, we recognized a decrease in the claims liabilities of$19.6 million .
Change in Accounting Principle on Claim Liabilities
EffectiveJanuary 1, 2011 , the Company changed the method used to calculate its policy liabilities for the majority of its health insurance products because it believes that the new method will be preferable in light of, among other factors, certain changes required by Health Care Reform Legislation. For the majority of health insurance products in the Commercial Health Division, the Company's claims liabilities are estimated using the developmental method. The Company establishes the claims liabilities based upon claim incurral dates, supplemented with certain refinements as appropriate. Prior toJanuary 1, 2011 , for products introduced prior to 2008, the Company used a technique for calculating claims liabilities referred to as the Modified Incurred Date ("MID") technique. Under the MID technique, claims liabilities for the cost of all medical services related to a distinct accident or sickness are based on the earliest date of diagnosis or treatment, even though the medical services associated with such accident or sickness might not be rendered to the insured until a later financial reporting period. Claims liabilities based on the earliest date of diagnosis generally result in larger initial claims liabilities which complete over a longer period of time than claims estimation techniques using dates of service. Under the MID technique, the Company modifies the original incurred date coding by establishing a new incurral date if: (i) there is a break of more than six months in the occurrence of a covered benefit service or (ii) if claims payments continue for more than thirty-six months without a six month break in service. For products introduced in 2008 and later, claims payments were considered incurred on the date the service is rendered, regardless of whether the sickness or accident is distinct or the same. This is referred to as the Service Date ("SD") technique. This is consistent with the assumptions used in the pricing of these products and the policy language. AtDecember 31, 2010 , the Company had claims liabilities for products using the SD technique in the amount of$10.6 million , representing approximately 8% of the total claims liabilities of the Commercial Health Division. The use of the SD technique in establishing claims liabilities requires the establishment of a future policy benefit reserve while the MID technique does not. For the reasons discussed below, we believe that it is preferable to estimate the Company's claims liabilities using the SD technique, and to apply such technique for claims liabilities previously calculated based on the MID technique. 58
--------------------------------------------------------------------------------
Table of Contents
As previously disclosed, inMarch 2010 , Health Care Reform Legislation was signed into law. The Health Care Reform Legislation requires, beginning in 2011, a mandated minimum loss ratio ("MLR") of 80% for the individual and small group markets. If MLR is below the mandated minimum, the Health Care Reform Legislation generally requires that the insurer return the amount of premium that is in excess of the required MLR to the policyholder in the form of rebates. The MLR is calculated for each of our insurance subsidiaries on a state-by-state basis in each state where the Company has issued major medical business.Department of Health and Human Services ("HHS") rules indicate that the MLR calculation shall utilize data on incurred claims for the calendar year, paid through March of the following year. Any refund of premiums in excess of the required MLR will be based on the completion of claims three months after the calendar year end. Based on the MLR calculation requiring only three additional months of claims and the SD technique being the most prevalent method of estimating claims liabilities in the health insurance industry, the Company believes that the SD technique is the preferable method for calculating the MLR. The Company also believes that using the SD method for the settlement of the MLR calculation will reduce uncertainty regarding the ultimate amount of incurred claims, as the MID technique estimates claims over a longer settlement period. The calculation of the MLR using the Company's current data results in claims for a given incurred year that are approximately 95% complete three months after the valuation date using the SD technique, whereas claims are approximately 82% complete 3 months after the valuation date using the MID technique. Additionally, the use of the MID technique for financial reporting purposes, with the settlement of the MLR calculated on a SD basis, may result in an over accrual of the claims liabilities on the financial statements as a result of the Company's accrual for rebates in the MLR calculation. In light of the changes resulting from the Health Care Reform Legislation, and given that the Company's insurance contracts would support the use of either reserving technique, the Company, after discussions with its domiciliary insurance regulators on the preferred methodology for calculating rebates under the MLR requirements of the Health Care Reform Legislation, determined that the SD method is preferable in determining the estimation of its claims liabilities. For the in-force policies utilizing the MID technique for estimation of claims liabilities, effectiveJanuary 1, 2011 , the Company changed the method used to calculate its claims liabilities from the MID technique to the SD technique. Consistent with the Company's products introduced in 2008 and later, the Company established a reserve for future policy benefits for products introduced prior to 2008. The Company has determined it is impracticable to determine the period-specific effects of the change in reserving methodology from MID to SD on all prior periods since retrospective application requires significant estimates of amounts and it is impossible to distinguish objectively information about those estimates at previous reporting dates. Based on the guidance of ASC 250-10-45 Accounting Changes - Change in Accounting Principle if the cumulative effect of applying a change in accounting principle to all prior periods is determinable, but it is impracticable to determine the period-specific effects of that change to all prior periods presented, the cumulative effect of the change to the new accounting principle shall be applied to the carrying amounts of assets and liabilities as of beginning of the earliest period to which the new accounting principle can be applied. As such the Company accounted for the change effectiveJanuary 1, 2011 by recording the cumulative effect of the change in accounting at that date. EffectiveJanuary 1, 2011 , as a result of this change, the Company recorded the following: (i) a decrease in the amount of$77.9 million to claims and claims administration liabilities, (ii) an increase in the amount of$35.1 million to future policy and contract benefits, (iii) an increase in the amount of$15.0 million to deferred federal income tax liability and (iv) an increase in the amount of$27.8 million to retained earnings.
Accounting for ISOP
Historically, we have sponsored a series of stock accumulation plans established for the benefit of our independent insurance agents and independent sales representatives. In connection with the reorganization of the Company's agent sales force into an independent career-agent distribution company, and the launch of Insphere, 59
--------------------------------------------------------------------------------
Table of Contents
effectiveJanuary 1, 2010 , these plans were superseded and replaced by theHealthMarkets, Inc. InVest Stock Ownership Plan (the "ISOP"). Generally, unvested benefits under the ISOP vest in January of each year. We have established a liability for future unvested benefits under the ISOP, and we adjust such liability based on the fair value of our common stock. As such, we have experienced, and will continue to experience, unpredictable stock-based compensation charges, depending upon fluctuations in the fair value of HealthMarkets common stock. These unpredictable fluctuations in stock-based compensation charges may result in material non-cash fluctuations in our earnings (see Note 13 of Notes to Consolidated Financial Statements).
Deferred Taxes
We record deferred tax assets to reflect the impact of temporary differences between the financial statement carrying amounts and tax basis of assets. Realization of the net deferred tax asset is dependent on generating sufficient future taxable income. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. We establish a valuation allowance when management believes, based on the weight of the available evidence, that it is more likely than not that all or some portion of the deferred tax asset will not be realized. We consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the continued need for a recorded valuation allowance. Establishing or increasing the valuation allowance would result in a charge to income in the period such determination was made. In the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.
Loss Contingencies
We are subject to proceedings and lawsuits related to insurance claims, regulatory issues, and other matters (see Note 16 of Notes to Consolidated Financial Statements). We are required to assess the likelihood of any adverse judgments or outcomes to these matters, as well as potential ranges of probable losses. A determination of the amount of accruals required, if any, for these contingencies is made after careful analysis of each individual issue. The required accruals may change in the future due to new developments in each matter or changes in approach, such as a change in settlement strategy in dealing with these matters.
Risk Management
HealthMarkets encounters risk in the normal course of business, and therefore, we have designed risk management processes to help manage such risks. The Company is subject to varying degrees of market risks, inflation risk, operational risks and liquidity risks (see "Liquidity and Capital Resources" discussion above) and monitors these risks on a consolidated basis.
Market Risks
Our assets and liabilities, including financial instruments, are subject to the risk of potential loss arising from adverse changes in market rates and prices. Market risk is directly influenced by the volatility and liquidity in the markets in which the related underlying assets are traded. Sensitivity analysis is defined as the measurement of potential loss in future earnings, fair values or cash flows of market sensitive instruments resulting from one or more selected hypothetical changes in interest rates and other market rates or prices over a selected time. In our sensitivity analysis model, a hypothetical change in market rates is selected that is expected to reflect reasonably possible near-term changes in those rates. "Near term" is defined as a period of time going forward up to one year from the date of the consolidated financial statements. 60
--------------------------------------------------------------------------------
Table of Contents
In this sensitivity analysis model, we use fair values to measure its potential loss. The primary market risk to our market sensitive instruments is interest rate risk. The sensitivity analysis model uses a 100 basis point change in interest rates to measure the hypothetical change in fair value of financial instruments included in the model. For invested assets, duration modeling is used to calculate changes in fair values. Duration on invested assets is adjusted to call, put and interest rate reset features. The sensitivity analysis model decreases the gain in fair value of market sensitive instruments by$10.4 million based on a 100 basis point increase in interest rates as ofDecember 31, 2011 . This decreased value only reflects the impact of an interest rate increase on the fair value of our financial instruments.
At
Our Investment Committee monitors the investment portfolio of the Company and its subsidiaries. The Investment Committee receives investment management services from our in-house investment management team. The internal investment management team directly manages the investment assets. Investments are selected based upon the parameters established in the Company's investment policies. Emphasis is given to the selection of high quality, liquid securities that provide current investment returns. Maturities or liquidity characteristics of the securities are managed by continually structuring the duration of the investment portfolio to be consistent with the duration of the policy liabilities. Consistent with regulatory requirements and internal guidelines, we invest in a range of assets, but limit our investments in certain classes of assets, and limit our exposure to certain industries and to single issuers.
Fixed maturity securities represented 40.6% and 64.6% of our total investments at
December 31, 2011 % of Total Carrying Carrying Value Value (Dollars in thousands) U.S. and U.S. Government agencies $ 24,602 5.7 % Corporate bonds and municipals 252,279 58.9 % Mortgage-backed securities issued by U.S. Government agencies and authorities 46,940 11.0 % Other mortgage and asset backed securities 15,007 3.5 % Other 89,371
20.9 %
Total fixed maturity securities$ 428,199
100.0 %
Corporate bonds, included in the fixed maturity portfolio, consist primarily of short term and medium term investment grade bonds. The Company's investment policy with respect to concentration risk limits individual investment grade bonds held by its insurance company subsidiaries to 3% of assets and non-investment grade bonds to 2% of assets. The policy also limits the investments in any one industry to 20% of assets. As ofDecember 31, 2011 , the largest concentration in any one investment grade corporate bond held by an insurance company subsidiary was$105.6 million ($94.8 million face value), which represented 10.0% of total invested assets. This security was received as payment on the sale of our Student Insurance Division. To limit its credit risk, we have taken out$75.0 million of credit default insurance on this bond, reducing our default exposure to$19.8 million , or 1.9% of total invested assets. The largest concentration in any one non-investment grade corporate bond was$4.9 million , which represented less than 1% of total invested assets. The largest concentration to any one industry was less than 10%. Additionally, due primarily to long standing conservative investment guidelines, our direct exposure to sub prime investments is 0.1% of investments. 61
--------------------------------------------------------------------------------
Table of Contents
Included in the fixed maturity portfolio are mortgage-backed securities, including collateralized mortgage obligations, mortgage-backed pass-through certificates and commercial mortgage-backed securities. To limit our credit risk, we invest in mortgage-backed securities that are rated investment grade by the public rating agencies. Our mortgage-backed securities portfolio is a conservatively structured portfolio that is concentrated in the less volatile tranches, such as planned amortization classes and sequential classes. We seek to minimize prepayment risk during periods of declining interest rates and minimize duration extension risk during periods of rising interest rates. We have less than 1% of our investment portfolio invested in the more volatile tranches. A quality distribution for fixed maturity securities atDecember 31, 2011 is set forth below: December 31, 2011 % of Total Carrying Carrying Rating Value Value (Dollars in thousands) U.S. Government and AAA $ 100,529 23.5 % AA 30,216 7.1 % A 170,339 39.8 % BBB 118,434 27.6 % Less than BBB 8,681 2.0 % $ 428,199 100.0 % We regularly monitor our investment portfolio to attempt to minimize our concentration of credit risk in any single issuer. Set forth in the table below is a schedule of all investments representing greater than 1% of our aggregate investment portfolio atDecember 31, 2011 and 2010, excluding investments inU.S. Government securities: December 31, 2011 2010 % of Total % of Total Carrying Carrying Carrying Carrying Amount Value Amount Value (Dollars in thousands) Issuer - Fixed Maturities: UnitedHealth Group(1) $ 105,565 10.0 % $ 101,301 9.6 % Cigna Corporation(2) 89,371 8.5 % 86,392 8.2 % Exelon 5,149 0.5 % 14,944 1.4 % Issuer - Short-term investments (3): Fidelity Institutional Money Market $ - - $ 208,208 19.8 % Fidelity Institutional Government Fund 478,841 45.4 % 94,277 9.0 % Invesco STIT Government Fund 89,215 8.5 % - - First American Treasury Obligations Fund 37,797 3.6 % 37,767 3.6 %
(1) Represents
consideration upon sale of our former Student Insurance Division on
of credit default insurance on this security, reducing our default exposure
to$19.8 million .
(2) Represents
consideration upon sale of our former Star HRG Division in
security is held in a bankruptcy remote entity with the Company's exposure
limited to its residual investment of approximately
31, 2011.
(3) Funds are diversified institutional money market funds that invest solely in
United States dollar denominated money market securities. 62
--------------------------------------------------------------------------------
Table of Contents
Inflation Risk
Inflation historically has had a significant impact on the health insurance business. In recent years, inflation in the costs of medical care covered by such insurance has exceeded the general rate of inflation. Under basic hospital medical insurance coverage, established ceilings for covered expenses limit the impact of inflation on the amount of claims paid. Under catastrophic hospital expense plans and preferred provider contracts, covered expenses are generally limited only by a maximum lifetime benefit and a maximum lifetime benefit per accident or sickness. Therefore, inflation may have a significantly greater impact on the amount of claims paid under catastrophic hospital expense and preferred provider plans as compared to claims under basic hospital medical coverage. As a result, trends in healthcare costs must be monitored and rates adjusted accordingly. Under the health insurance policies issued in the self-employed market, the primary insurer generally has the right to increase rates upon 30-60 days written notice and subject to regulatory approval in some cases. The annuity and universal life-type policies issued directly and assumed by HealthMarkets are significantly impacted by inflation. Interest rates affect the amount of interest that existing policyholders expect to have credited to their policies. However, we believe that our annuity and universal life-type policies are generally competitive with those offered by other insurance companies of similar size, and the investment portfolio is managed to minimize the effects of inflation. Operational Risks Operational risk is inherent in our business and may, for example, manifest itself in the form of errors, breaches in the system of internal controls, business interruptions, fraud or legal actions due to operating deficiencies or noncompliance with regulatory requirements. We maintain a framework, including policies and a system of internal controls designed to monitor and manage operational risk, and provide management with timely and accurate information.
Privacy Initiatives
The business of insurance is primarily regulated by the states and is affected by a range of legislative developments at both the state and federal levels. Legislation and regulations governing the use and security of individuals' nonpublic personal data by financial institutions, including insurance companies, may have a significant impact on the financial condition and results of operations. See Item 1. Business - Regulatory and Legislative Matters.
Recently Issued Accounting Pronouncements
See Recent Accounting Pronouncements in Note 2 of Notes to Consolidated Financial Statements for information regarding new accounting pronouncements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Quantitative and qualitative disclosures about market risk are included under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations - Risk Management."
| Wordcount: | 15129 |
Advisor News
- Alternative investments in 401(k)s: What advisors must know
- The modern advisor: Merging income, insurance, and investments
- Financial shocks, caregiving gaps and inflation pressures persist
- Americans unprepared for increased longevity
- More investors will seek comprehensive financial planning
More Advisor NewsAnnuity News
- Aspida Life and WealthVest Offer a Powerful New Guaranteed Income Product with the WealthLock® Income Builder
- Lack of digital tools drives wedge between insurers, advisors
- LIMRA: Annuity sales notch 10th consecutive $100B+ quarter
- AIG to sell remaining shares in Corebridge Financial
- Corebridge Financial, Equitable Holdings post Q1 earnings as merger looms
More Annuity NewsHealth/Employee Benefits News
- Private Medicare plans get a break
- Best’s Special Report: US Property/Casualty and Health Insurers Exceed Cost of Capital; Life Insurers Narrowly Miss
- Arizona's Medicaid, AHCCCS, undergoes huge changes
- Rob Schofield: NC’s new Medicaid ‘compromise’ comes at a cost
- We have to stop this with our votes | RODNEY WALKER
More Health/Employee Benefits NewsLife Insurance News
- Best’s Special Report: US Property/Casualty and Health Insurers Exceed Cost of Capital; Life Insurers Narrowly Miss
- Aspida Life and WealthVest Offer a Powerful New Guaranteed Income Product with the WealthLock® Income Builder
- Lack of digital tools drives wedge between insurers, advisors
- Living benefits: A better way to position life insurance
- Best’s Market Segment Report: AM Best Maintains Stable Outlook on Italy’s Non-Life Insurance Segment
More Life Insurance News