Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This financial discussion contains an analysis of our consolidated financial position and financial performance as of December 31, 2020 and 2019, and consolidated results of operations for 2020, 2019 and 2018. References to the terms “we,” “our” or “us” used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A), refer to TSM and unless the context otherwise requires, its direct and indirect subsidiaries. This analysis should be read in its entirety and in conjunction with the Consolidated Financial Statements, notes and tables included elsewhere in this Annual Report on Form 10-K.
The structure of our MD&A is as follows:
Executive Summary
Overview details
Membership
Results of Operations
Consolidated Operating Results
Managed Care Segment Operating Results
Life Insurance Segment Operating Results
Property and Casualty Segment Operating Results
Liquidity and Capital Resources
Critical Accounting Estimates
Recently Issued Accounting Standards
Executive Summary
Key developments in our business during 2020 are described below:
Net income for the year was $67.2 million, a decrease from a net income of $92.9 million for the prior year. The decrease in net income primarily reflects the recognition of a $32 million contingency reserve related to a legal proceeding in our Managed Care segment (see Note 25, Contingencies, of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data , of this Annual Report on Form 10-K ) and the impact of lower net unrealized gains on equity investments.
Consolidated premiums earned, net increased 10.8% year over year, to $3.6 billion, primarily reflecting an increase in membership and higher average premium rates within the Managed Care segment.
Consolidated claims incurred for the year were $2.9 billion, up 10.5% over last year, mostly reflecting higher claims incurred in the Managed Care segment by $279.1 million mostly driven by higher enrollment. The consolidated loss ratio decreased 30 basis points, to 81.7%. The Managed Care segment’s MLR was to 84.5%, down 10 basis points year over year.
Consolidated operating expenses for the year were $655.9 million and the operating expense ratio was 18.1%, 60 basis points higher than last year mostly driven by the return of the HIP fee.
Overview details
Triple-S is a health services company and one of the top players in the Puerto Rico health care industry. With more than 60 years of experience, we are the premier health care brand and serve more people through the most attractive provider networks on the island. We have the exclusive right to use the BCBS name and mark throughout Puerto Rico, the USVI, Costa Rica, the BVI, and Anguilla, and we offer a broad portfolio of managed care and related products in the Commercial, Medicare Advantage and Medicaid markets. In the Commercial market, we offer products to corporate accounts, U.S. federal government employees, local government employees, individual accounts and Medicare Supplement. We also participate in the Government of Puerto Rico Health Insurance Plan, a government of Puerto Rico and U.S. federal government funded managed care program for the medically indigent that is similar to the Medicaid program in the U.S. (Medicaid or the Government health plan).
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Our commitment to our valued customers and provider partners ̶ backed by our heritage of excellent care, access and service ̶ has positioned Triple-S for continued growth in the health care arena. Our progressive use of technology and clinical data, partnerships with care providers and initial investments in ambulatory and primary care assets are a strong foundation for differentiation and growth through the development of an integrated delivery system over the next several years. We believe continued investment and focus on delivering an excellent health care experience and great service, coupled with health management programs that improve outcomes and quality of life while reducing the total cost of care, will separate Triple-S from our competition and strengthen the financial performance of our business well into the future.
We participate in the managed care market through our subsidiaries, TSS, TSA, and TSB. TSS, TSA and TSB are BCBS licensees. As of December 31, 2020, we served approximately 979,000 managed care members across all regions of Puerto Rico.
Triple-S is also a well-known brand in the life insurance and property and casualty insurance markets, with a significant share in each. We participate in the life insurance market through our subsidiary TSV, and in the property and casualty insurance market through our subsidiary, TSP.
The Commissioner of Insurance of the Government of Puerto recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the Puerto Rico insurance laws, and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the Commissioner of Insurance of Puerto Rico to financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) in making such determinations. See Note 26, Statutory Accounting of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Intersegment revenues and expenses are reported on a gross basis in each of the operating segments but eliminated in the consolidated results. Except as otherwise indicated, the numbers presented in this Annual Report on Form 10-K do not reflect intersegment eliminations. These intersegment revenues and expenses affect the amounts reported on the financial statement line items for each segment, but are eliminated in consolidation and do not change net income. The following table shows Premiums Earned, Net and Administrative Service Fees and Operating Income for each segment, as well as the intersegment premiums earned, service revenues and other intersegment transactions, which are eliminated in the consolidated results:
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Years ended December 31,
(Dollar amounts in millions)
Premiums earned, net:
Managed care
Life insurance
Property and casualty insurance
Intersegment premiums earned
Consolidated premiums earned, net
Administrative service fees:
Managed care
Intersegment administrative service fees
Consolidated administrative service fees
Operating income (loss):
Managed care
Life insurance
Property and casualty insurance
Intersegment and other
Consolidated operating income (loss)
Revenue
General. Our revenue consists primarily of (i) premium revenue generated from our Managed Care segment, (ii) administrative service fees received for Managed Care services provided to self-insured employers, (iii) premiums we generate from our Life Insurance and Property and Casualty segments and (iv) investment income.
Premium Revenue . Our revenue primarily consists of premiums earned from the sale of managed care products to the Commercial, Medicare Advantage and Medicaid sectors. We receive a monthly payment from or on behalf of each member enrolled in our managed care plans (excluding ASO). We recognize all premium revenue in our Managed Care segment during the month in which we are obligated to provide services to an enrolled member. Premiums we receive in advance of that date are recorded as unearned premiums. See Note 2, Significant Accounting Policies – Revenue Recognition – of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data , of this Annual Report on Form 10-K.
Administrative Service Fees. Administrative service fees include amounts paid to us for administrative services provided to self-insured contracts. We provide a range of customer services pursuant to our ASO contracts, including claims administration, billing, access to our provider networks and membership services. Administrative service fees are recognized in the month in which services are provided.
Investment Income. Investment income consists of interest and dividend income from investment securities. See Note 5, Net Investment Income of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data , of this Annual Report on Form 10-K.
Other Operating Revenues. Other operating revenues primarily consist of revenues generated by the health clinics reporting unit.
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Expenses
Claims Incurred. Our largest expense is the Managed Care segment’s medical claims incurred, or the cost of medical services we arrange for our members. Medical claims incurred include the payment of benefits and losses, mostly to physicians, hospitals, pharmacies and other service providers, and to policyholders. We generally pay our providers on one of three forms: (1) fee-for-service contracts based on negotiated fee schedules; (2) capitation arrangements, generally on a fixed PMPM payment basis, whereby the provider generally assumes some of the medical expense risk; and (3) risk-sharing arrangements, whereby we advance a PMPM payment and share the risk of certain medical costs of our members with the provider based on actual experience as measured against pre-determined sharing ratios. Claims incurred also include claims incurred in our Life Insurance and Property and Casualty segments. Each segment’s results of operations depend to a significant extent on our ability to accurately predict and effectively manage claims and losses. A portion of the incurred for each period consists of reported but not paid during the period, as well as a management and actuarial estimate of incurred but not reported during the period.
The MLR, which is calculated by dividing managed care Claims Incurred by managed care Premiums Earned, Net is one of our primary management tools for measuring these costs and their impact on our profitability. The MLR is affected by the cost and utilization of services. The cost of services is affected by many factors, in particular our ability to negotiate competitive rates with our providers. The cost of services is also influenced by inflation and new medical discoveries, including new prescription drugs, therapies and diagnostic procedures. Utilization rates, which reflect the extent to which beneficiaries utilize health care services, significantly influence our medical costs. The level of utilization of services depends in large part on the age, health and lifestyle of our members, among other factors. As the MLR is the ratio of Claims Incurred to Premiums Earned, Net, it is affected not only by our ability to contain cost trends but also by our ability to increase premium rates to levels consistent with or above medical cost trends. We use MLRs both to monitor our management of health care costs and to make various business decisions, including what plans or benefits to offer and our selection of health care providers.
Operating Expenses. Operating expenses include commissions to external brokers, general and administrative expenses, cost containment expenses such as case and disease management programs, and depreciation and amortization. The operating expense ratio is calculated by dividing Operating Expenses by Premiums Earned, Net, plus administrative service fees. A significant portion of our operating expenses are fixed costs. Accordingly, it is important that we maintain a certain level of business volume in order to compensate for the fixed costs. Significant changes in our volume of business will affect our operating expense ratio and results of operations. We also have variable costs, which vary in proportion to changes in business volume.
Membership
Our results of operations depend in large part on our ability to maintain or grow our membership. In addition to driving revenues, membership growth is necessary to successfully introduce new products, maintain an extensive network of providers and achieve economies of scale. Our ability to maintain or grow our membership is affected principally by the competitive environment, the economy and general market conditions.
The following table sets forth selected membership data as of the dates set forth below:
As of December 31,
Commercial (1)
Medicare
Medicaid
Total
(1) Commercial membership includes corporate accounts, self-funded employers, individual accounts, Medicare Supplement, federal government employees and local government employees.
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Results of Operations
Consolidated Operating Results
The following table sets forth our consolidated operating results for the years ended December 31, 2020, 2019, and 2018. Further details of the results of operations of each reportable segment are included in the analysis of operating results for the respective segments.
(Dollar amounts in millions)
Years ended December 31,
Revenues:
Premiums earned, net
Administrative service fees
Net investment income
Other operating revenues
Total operating revenues
Net realized investment gains
Net unrealized investment gains (losses) on equity investments
Other income, net
Total revenues
Benefits and expenses:
Claims incurred
Operating expenses
Total operating costs
Interest expense
Total benefits and expenses
Income (loss) before taxes
Income tax expense (benefit)
Net income (loss) attributable to TSM
Year Ended December 31, 2020 Compared With the Year Ended December 31, 2019
Premiums Earned, Net
Consolidated premiums earned, net increased by $352.6 million, or 10.8%, to $3.6 billion during the year ended December 31, 2020. This increase primarily reflects higher premiums earned, net in the Managed Care segment by $334.8 million due to higher average premium rates and fully insured member months across all Managed Care businesses.
Net Unrealized Investment Gains on Equity Investments
The $7.6 million in consolidated net unrealized investment gains on equity investments reflect the impact of changes in equity markets.
Claims Incurred
Consolidated claims incurred increased by $280.5 million, or 10.5%, to $2.9 billion, during the year ended December 31, 2020 mostly due to the increase in membership. The consolidated loss ratio decreased 30 basis points, to 81.7%, from the prior year, mostly reflecting lower Managed Care utilization of services since mid-March as the result of the government-enforced lockdown during the COVID-19 pandemic and the effect in the MLR of the reinstatement of the HIP fee pass-through in 2020. These decreases were partially offset by the increased benefits in our 2020 Medicare product offering, unfavorable prior-period reserve development in the Managed Care segment and $5.0 million of earthquake losses recorded by the Property and Casualty segment.
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Following the government-enforced lockdown related to the COVID-19 pandemic in mid-March, we saw a decrease in utilization of Managed Care services as members and providers deferred non-emergent or elective health services. While this trend has caused, and may continue to cause, a short-term decrease in our claim costs, we experienced an increase in these costs during the second half of the year, that affected our medical cost trends as the demand for deferred non-emergent or elective health services resumed. The access to and demand for care was most constrained from mid-March through April, and began to recover in late May, gradually increasing to expected levels in the fourth quarter.
Operating Expenses
Consolidated operating expenses increased by $86.5 million, or 15.2%, to $655.9 billion. The increase in operating expenses mostly resulted from the reinstatement of the HIP fee in 2020 of $55.5 million, the recognition of a $32.0 million contingency reserve related to a legal proceeding in our Managed Care segment (see Note 25, Contingencies of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data , of this Annual Report on Form 10-K ), higher amortization of deferred acquisition costs and higher business promotion expenses, mainly related to COVID-19 relief efforts. These increases were partially offset by lower professional fees and provision for doubtful accounts. The consolidated operating expense ratio increased 60 basis points, to 18.1%.
Income Taxes
Consolidated income tax expense for the year ended December 31, 2020 decreased by $14.9 million, to $24.5 million, primarily reflecting a lower taxable income in all segments in 2020.
Year Ended December 31, 2019 Compared With the Year Ended December 31, 2018
Premiums Earned, Net
Premiums earned, net increased by $314.3 million, or 10.7%, to $3.3 billion. This increase primarily reflects higher premiums in the Managed Care segment by $298.4 million. The growth in managed care premiums reflects higher average premium rates across all lines of business and an increase in Medicare and Commercial fully insured membership. The increase was partially offset by lower Medicaid membership.
Net Unrealized Investment Gains on Equity Investments
The $32.2 million in consolidated net unrealized investment gains on equity investments reflects the impact of changes in equity markets.
Claims Incurred
Consolidated claims incurred increased by $138.7 million, or 5.5%, to $2.7 billion, mostly driven by an increase in the claims incurred in the Managed Care segment of $254.2 million, partially offset by lower claims incurred in the Property and Casualty segment of $128.7 million. The increase in Managed Care claims primarily reflects higher Medicare and Commercial fully insured enrollment, offset in part by the decrease in Medicaid membership. The decrease in claims incurred in the Property and Casualty segment was due to prior year losses related to hurricane Maria. The consolidated loss ratio decreased by 400 basis points to 82.0%.
Operating Expenses
Consolidated operating expenses increased by $14.7 million, or 2.7%, to $569.4 million. The higher operating expenses are mostly the result of higher personnel costs, provision for bad debts, and commission expense; partially offset by the waiver of the 2019 HIP Fee. The consolidated expense ratio decreased 130 basis points to 17.5%.
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Income taxes
Consolidated income tax expense for the year ended December 31, 2019 was $39.4 million, compared to a benefit of $29.8 million in 2018. The year over year change in income taxes primarily reflects higher taxable income in all segments and the 2018 loss before taxes in the Property and Casualty segment.
Managed Care Segment Operating Results
We offer our products in the Managed Care segment to three distinct market sectors in Puerto Rico: Commercial, Medicare Advantage and Medicaid. For the year ended December 31, 2020, the Commercial, Medicare and Medicaid sectors represented 22.6%, 43.1%, and 26.4% of our consolidated premiums earned, net, respectively.
(Dollar amounts in millions)
Operating revenues:
Medical premiums earned, net:
Commercial
Medicare
Medicaid
Medical premiums earned, net
Administrative service fees
Net investment income
Total operating revenues
Medical operating costs:
Medical claims incurred
Medical operating expenses
Total medical operating costs
Medical operating income
Additional data:
Member months enrollment:
Commercial:
Fully insured
Self-funded
Total Commercial member months
Medicare member months
Medicaid member months
Total member months
Medical loss ratio
Operating expense ratio
Year Ended December 31, 2020 Compared With the Year Ended December 31, 2019
Medical Premiums Earned, Net
Medical premiums earned increased by $334.8 million, or 11.2%, to $3.3 billion. This increase is principally the result of the following:
Premiums generated by the Medicare business increased by $145.5 million, or 10.3%, to $1.6 billion , mostly due to higher average premium rates, reflecting an increase in the CMS benchmark, and higher member months enrollment by approximately 91,000.
Premiums generated by the Medicaid business increased by $174.9 million, or 22.5%, to $953.2 million, primarily reflecting higher average premium rates following the premium rates increases that became effective on November 1, 2019, May 1, 2020 and July 1, 2020, an increase in enrollment of approximately 258,000 member months, the reinstatement of the HIP fee pass-through in 2020, and a profit-sharing accrual recorded in 2019.
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Premiums generated by the Commercial business increased by $14.4 million, or 1.8%, to $815.6 million. This fluctuation primarily reflects higher fully insured enrollment during the year by approximately 38,000 member months and higher average premium rates, mostly due to the reinstatement of the HIP fee pass-through in 2020.
Medical Claims Incurred
Managed Care claims incurred increased by $279.0 million, or 11.0%, to $2.8 billion when compared to the year ended December 31, 2019. The MLR of the segment decreased 10 basis points during 2020, to 84.5%. This fluctuation is primarily attributed to the net effect of the following:
Claims incurred in the Medicare business increased by $132.2 million, or 11.8%, during the 2020 period and its MLR increased 110 basis points, to 80.9%. The increase in claims incurred is due to higher member months, improved benefits in product offerings, and unfavorable prior-period reserve development, partially offset by lower utilization of services as the result of the government-enforced lockdown during the COVID-19 pandemic.
Claims incurred in the Medicaid business increased by $162.0 million, or 21.8%, during 2020 and its MLR decreased 50 basis points, to 94.9%. The increase in claim cost is due to higher member months, and unfavorable prior-period reserve development in the 2020 period. Lower MLR, reflected higher premium rates and the reinstatement of the HIP fee pass-through in 2020. In addition, the 2020 MLR reflects lower utilization of services as the result of the government-enforced lockdown during the COVID-19 pandemic.
Claims incurred in the Commercial business decreased by $15.1 million, or 2.3%, during 2020 and its MLR decreased 330 basis points, to 79.1%. These decreases mostly result from lower utilization related to the COVID-19 lockdown, partially offset by the higher fully insured enrollment and an unfavorable change in prior-period reserve developments when compared to the 2019 period. In addition, the lower MLR was impacted by the reinstatement of the HIP fee pass-through in 2020.
Medical Operating Expenses
Managed Care operating expenses increased by $75.4 million, or 17.3%, to $512.1 million. The operating expense ratio increased 90 basis points, to 15.4% in 2020. The higher operating expenses mostly resulted from the reinstatement in 2020 of the HIP fee of $55.5 million, the recognition of $32.0 million as a contingency reserve related to a legal proceeding (see Note 25, Contingencies of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data , of this Annual Report on Form 10-K ) , and expenses related to providing much-needed assistance to seniors to help them manage through the COVID-19 pandemic, offset in part by a decrease in the provision for doubtful accounts and professional fees.
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Year Ended December 31, 2019 Compared With the Year Ended December 31, 2018
Medical Premiums Earned, Net
Medical premiums earned increased by $298.4 million, or 11.1%, to $3.0 billion. This increase is principally the result of the following:
Medical premiums generated by the Medicare business increased by $277.7 million, or 24.6%, to $1,408.0 million, primarily reflecting an increase in enrollment of approximately 203,000 member months and higher average premium rates, mainly reflecting higher membership risk score in 2019 and an increase in reimbursement rates.
Medical premiums generated by the Commercial business increased by $18.4 million, or 2.4%, to $801.2 million. This fluctuation primarily reflects higher fully insured member months during the year by approximately 69,000 member months and higher average premium rates, offset in part by $12.1 million related to the suspension of the HIP fee pass-through in 2019.
Medical premiums generated by the Medicaid business increased by $2.3 million, or 0.3%, to $778.3 million. This increase primarily reflects higher premiums rates, offset by a decrease of $14.5 million related to the suspension of the HIP fee pass-through in 2019 and lower enrollment by approximately 299,000 member months. The decrease in membership follows the lower membership assigned to us by ASES when implementing the current Medicaid contract, which was effective November 1, 2018.
Medical Claims Incurred
Medical claims incurred increased by $254.2 million, or 11.2%, to $2.5 billion. The MLR of the segment increased 10 basis points during the 2019 period, to 84.6%. This fluctuation is primarily attributed to the net effect of the following:
The medical claims incurred of the Medicare business increased by $183.1 million, or 19.5%, during the 2019 period mostly driven by higher enrollment. The MLR at 79.8% was 340 basis points lower than the same period last year, driven by favorable prior period reserve developments in 2019 and the impact of cost containment initiatives. These decreases were partially offset by improved benefits in the 2019 product offerings.
The medical claims incurred of the Medicaid business increased by $55.5 million, or 8.1%, during the 2019 period. The MLR at 95.4% was 690 basis points higher than the same period last year. The increased MLR reflects the higher required target MLR of the current Medicaid contract, the impact of the elimination of the HIP fee pass-through in 2019, and a timing difference in the recognition of member acuity in premiums. The current Medicaid contract requires a minimum MLR of 92%, including allocation of health care quality improvements expenses.
The medical claims incurred of the Commercial business increased by $15.6 million, or 2.4%, during the 2019 period and its MLR, remained steady at 82.4% despite impact of the elimination of the HIP fee pass-through in 2019. The HIP Fee pass-through lowered the 2018 MLR by approximately 130 basis points.
Medical Operating Expenses
Medical operating expenses increased by $3.7 million, or 0.9%, to $436.7 million. The higher operating expenses are mainly due to an increase in personnel costs, provision for bad debts, and commission expense, partially offset by the waiver of the 2019 HIP fee. The operating expense ratio decreased 150 basis points, to 14.5%, in 2019.
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Life Insurance Segment Operating Results
(Dollar amounts in millions)
Years ended December 31,
Operating revenues:
Premiums earned, net:
Premiums earned
Assumed earned premiums
Ceded premiums earned
Premiums earned, net
Net investment income
Total operating revenues
Operating costs:
Policy benefits and claims incurred
Underwriting and other expenses
Total operating costs
Operating income
Additional data:
Loss ratio
Expense ratio
Year Ended December 31, 2020 Compared With the Year Ended December 31, 2019
Operating Revenues
Premiums earned, net increased by $13.8 million, or 7.6%, to $196.0 million, mainly as the result of higher sales across all lines of business, mainly in the Individual Life, Cancer and Group lines of business, and the acquisition of an insurance portfolio during the second quarter of 2020.
Policy Benefits and Claims Incurred
Policy benefits and claims incurred increased by $1.3 million, or 1.2%, to $107.2 million, mostly as the result of higher actuarial reserves following portfolio growth offset in part by a slowdown in claim trends in the Cancer and Accidental Death lines of business due to the COVID-19 lockdown. The segment’s loss ratio decreased 340 basis points, to 54.7%.
Underwriting and Other Expenses
Underwriting and other expenses increased $6.6 million, or 8.1%, to $88.3 million, mostly reflecting higher amortization of deferred acquisition costs as a result of higher lapses during the COVID-19 lockdown. The segment’s operating expense ratio increased 30 basis points to 45.1%.
Year Ended December 31, 2019 Compared With the Year Ended December 31, 2018
Operating Revenues
Premiums earned, net increased by $13.6 million, or 8.1% to $182.2 million, mainly as the result of higher sales and improved policy retention in the Individual Life and Cancer lines of business.
Policy Benefits and Claims Incurred
Policy benefits and claims incurred increased by $6.9 million, or 7.0%, to $105.9 million, mostly resulting from higher volume of sales and actuarial reserves following improved portfolio persistency during 2019. The segment’s loss ratio decreased 60 basis points, to 58.1%.
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Underwriting and Other Expenses
Underwriting and other expenses increased by $6.4 million, or 8.5%, to $81.7 million mostly resulting from higher commission expense reflecting the segment’s higher volume of business and improved portfolio persistency. As a result, the segment’s operating expense ratio increased 10 basis points, to 44.8%.
Property and Casualty Segment Operating Results
(Dollar amounts in millions)
Years ended December 31,
Operating revenues:
Premiums earned, net:
Premiums written
Premiums ceded
Change in unearned premiums
Premiums earned, net
Net investment income
Total operating revenues
Operating costs:
Claims incurred
Underwriting and other operating expenses
Total operating costs
Operating income (loss)
Additional data:
Loss ratio
Expense ratio
Year Ended December 31, 2020 Compared With the Year Ended December 31, 2019
Operating Revenues
Total premiums written increased by $7.4 million, or 4.9%, to $157.9 million, mostly driven by higher premiums, particularly in Commercial Auto, Commercial Package and Personal Package products.
The premiums ceded to reinsurers increased by $8.8 million, or 16.8%, mostly due to approximately $3.0 million of reinsurance reinstatement premiums following losses recorded after the earthquakes in the southwest region of Puerto Rico in January 2020, as well as higher premiums written.
The lower change in unearned premiums had a favorable impact on premiums earned of $5.7 million when compared to prior year, mostly reflecting higher premiums written and the effect of changes in the current year’s reinsurance program.
Claims Incurred
Claims incurred decreased by $4.5 million, or 11.4%, to $35.1 million because of better loss experience in the segment’s on-going business from the effects of the COVID-19 measures and lockdown, partially offset by the recognition of $5.0 million of earthquake losses after the January 2020 events. As a result, the loss ratio decreased by 700 basis points, to 38.2% during this period.
Underwriting and Other Expenses
Underwriting and other operating expenses increased by $2.6 million, or 6.0%, to $46.0 million, mostly because of higher net commission expense following the increase in net premiums earned. Current year net commission expense is affected by a lower capitalization of deferred acquisition costs. The operating expense ratio was 50.0%, 50 basis points higher than prior year.
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Year Ended December 31, 2019 Compared With the Year Ended December 31, 2018
Operating Revenues
Total premiums written increased by $10.7 million, or 7.7%, to $150.5 million, driven by higher volume of Commercial and Personal Package, Commercial Auto and Commercial Liability products. This increase in volume was offset by lower sales of Commercial Property products, mostly resulting from the selective and disciplined underwriting of Commercial risks.
The premiums ceded to reinsurers decreased by $8.1 million, or 13.4%, mostly reflecting a decrease in cessions in the Commercial quota share agreement from 35% in 2017 to 25% since April 2019, as well as the impact of the related incoming portfolio transfer. These decreases were offset in part by higher non-proportional reinsurance costs, mostly in property catastrophe reinsurance.
The $14.6 million decrease in the change in unearned premiums reflects the segments higher premiums written in 2019.
Claims Incurred
Claims incurred decreased by $120.3 million, or 75.2%, to $39.6 million driven by a $128.7 million unfavorable prior period reserve development in claims in prior year related to Hurricane Maria. As a result, the segment’s loss ratio decreased to 45.2%.
Underwriting and Other Expenses
Underwriting and other operating expenses decreased by $1.1 million, or 2.5%, to $43.4 million mostly due to lower net commission expense. The segment’s operating expense ratio decreased by 380 basis points, to 49.5%.
Liquidity and Capital Resources
Cash Flows
A summary of our major sources and uses of cash for the periods indicated is presented in the following table:
(Dollar amounts in millions)
Sources (uses) of cash:
Cash provided by (used in) operating activities
Net purchases of investment securities
Net capital expenditures
Capital contribution to equity method investees
Proceeds from long-term borrowings
Payments of long-term borrowings
Proceeds from policyholder deposits
Surrenders of policyholder deposits
Repurchase and retirement of common stock
Net change in short-term borrowings
Other
Net increase (decrease) in cash and cash equivalents
Year Ended December 31, 2020 Compared With the Year Ended December 31, 2019
The increase of approximately $274.6 million in net cash provided by operating activities is mostly the result of higher premium collections due to the growth in volume of business, a reduction in account receivable and an increase in accounts payable, partially offset by higher claims paid, due to increased volume of business, cash paid to suppliers, employees and income taxes.
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Net purchases from investment securities are part of our asset/liability management strategy.
On June 19, 2020, TSM entered into a $31.4 million Credit Agreement (the Loan) with a commercial bank in Puerto Rico. The proceeds of the Loan were used by the Company to partially finance the acquisition of a building (the Building), which is included in Capital Expenditures in the Statement of Cash Flows. For further details, see Note 13, Borrowing of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data , of this Annual Report on Form 10-K.
The increase in capital contribution reflects capital contributions in exchange for a participation in equity method investees.
The net change in short-term borrowings represents the repayment of short-term facilities available to address timing differences between cash receipts and disbursements.
In August 2017, the Company’s Board of Directors authorized a $30.0 million repurchase program of its Class B common stock and in February 2018 the Company’s Board of Directors authorized a $25.0 million expansion of this program. In October 2019, the Company’s Board of Directors authorized an additional expansion to this program increasing its remaining balance up to a total of $25.0 million, effective November 2019. Repurchases were conducted through open-market purchases of Class B shares only, in accordance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. During the year ended December 31, 2020, the Company repurchased and retired under this program 952,820 shares at an average per share price of $15.72, for an aggregate cost of $15.0 million, completing the amount available for repurchases under this program.
Year Ended December 31, 2019 Compared With the Year Ended December 31, 2018
Cash flows from operating activities decreased by $24.3 million during the year ended December 31, 2019, mostly due to higher claims paid by $296.6 million partially offset by an increase in premium collections of $223.6 million; both fluctuations reflected the increased volume in 2019. In addition, cash paid to suppliers and employees decreased by $45.5 million when compared to the prior year.
Decrease in net purchases of investments in securities are part of our asset/liability management strategy.
Increase in capital contribution reflects capital contributions in exchange for fifty percent participation in equity method investees.
In August 2017, the Company’s Board of Directors authorized a $30.0 million repurchase program of its Class B common stock (2017 Repurchase Program). In February 2018 the Company’s Board of Directors authorized a $25.0 million expansion of this program. In October 2019 the Company’s Board of Directors authorized an additional expansion to this program increasing its remaining balance up to a total of $25.0 million, effective November 2019. Repurchases were conducted through open-market purchases of Class B shares only, in accordance with Rule 10b-18 under the Securities Exchange Act of 1934, as amended. During the year 2019, the Company repurchased and retired 527,881 shares of our Class B Common Stock shares at an average per share price of $18.92, for an aggregate cost of $10.0 million.
The net change in short-term borrowings represents the outstanding balance of short-term facilities available to address timing differences between cash receipts and disbursements.
Decrease in other uses of cash reflects the change in outstanding checks in excess of bank balances.
Stock Repurchase Program
The Company repurchases shares through open market transactions, in accordance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended, under repurchase programs authorized by the Board of Directors. Shares purchased under share repurchase programs are retired and returned to authorized and unissued status. See Note 19, Stock Repurchase Program of the Notes to Consolidated Financial Statements in Item 8 . Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
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Financing and Financing Capacity
Long-Term Borrowings
TSM has a $35.5 million credit agreement with a commercial bank in Puerto Rico. The agreement consists of three term loans: (i) Term Loan A in the principal amount of $11.2 million, (ii) Term Loan B in the principal amount of $20.2 million, and (iii) Term Loan C in the principal amount of $4.1 million. Term Loan A matures in October 2023, while Term Loans B and C mature in January 2024. Term Loan A was used to refinance a previous $41.0 million secured loan payable with the same commercial bank. Pursuant to the credit agreement, interest is payable on the outstanding balance of the Loan at the following annual rate: (i) 100 basis points over LIBOR for Term Loan A, (ii) 275 basis points over LIBOR for Term Loan B, and, (iii) 325 basis points over LIBOR for Term Loan C. The loan includes certain financial and non-financial covenants, which are customary for this type of facility, including negative covenants imposing certain restrictions on the Company’s business. Failure to meet these covenants may trigger the accelerated payment of the outstanding balance. The Company was in compliance with these covenants as of December 31, 2020.
As detailed above the three term loans under our credit agreement with a commercial bank in Puerto Rico bear interest rates in relation to 1-month and 3-month LIBOR, a widely used interest rate benchmark.
In July 2017, the Financial Conduct Authority (FCA) in the United Kingdom, which regulates LIBOR, announced that it would phase out this benchmark by the end of 2021. In response, the U.S. Federal Reserve convened the Alternative Reference Rates Committee (ARRC), a working group comprised of private market participants, to ensure a transition to a new reference rate.
The ARRC has recommended the use of the Secured Overnight Financing Rate (SOFR), which is an index based on the cost of borrowing overnight cash collateralized by U.S. Treasury securities. Currently, there is no definitive information regarding the future use of SOFR as a widely accepted benchmark or any other replacement rate.
If LIBOR rates are no longer available, we are subject to an alternative benchmark rate, as defined in the credit agreement of our long-term bank loan. At this time we cannot assess the impact, if any, on the interest paid on this loan. Alternatively, the loan could be refinanced by us without prepayment penalties.
We will closely follow any new developments regarding the LIBOR phase out.
On June 19, 2020, TSM entered into a $31.4 million Credit Agreement with a commercial bank in Puerto Rico. The proceeds were used by the Company to partially finance the acquisition of the Building. The Credit Agreement is guaranteed by a mortgage over the Building, a pledge of all collateral related to the Building and an assignment of the rents collected for the lease of office space in the Building. Approximately 64.25% of the acquired Building is currently leased to third parties. The Company expects to move within the next year some of its offices currently leased to third parties to the new Building and together with the leased space to fully occupy the new facilities. Pursuant to the Credit Agreement, interest is payable on the outstanding principal balance of the Loan at an annual rate equal to the Prime Rate. Monthly interest payments commenced on July 1, 2020, and will continue to be paid each month until the principal of the Loan has been paid in full.
The Company may, at its option and at any time, upon notice as specified in the Credit Agreement, prepay prior to maturity, all or any part of the Loan upon the payment of a penalty fee of the outstanding principal amount at the time of the prepayment of 3% during the first year, 2% during the second year, 1% during the third year and thereafter at par.
The Credit Agreement includes certain customary financial and non-financial covenants, including negative covenants imposing certain restrictions on the Corporation’s business. The Company was in compliance with these covenants as of December 31, 2020.
For further details, see Note 13, Borrowings of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.
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Short-Term Facilities
We have several short-term facilities available to address timing differences between cash receipts and disbursements, consisting of collateralized advances from the Federal Home Loan Bank of New York (FHLBNY), repurchase agreements, and a revolving credit facility.
In August 2019, TSS and TSV became members of the FHLBNY, which provides access to collateralized advances. The borrowing capacity of TSS and TSV is up to 30% of their admitted assets as disclosed in the most recent filing with the Commissioner of Insurance but is constrained by the amount of collateral held at the FHLBNY. See Note 3, Investment in Securities of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. As of December 31, 2020 and 2019, the borrowing capacity was approximately $200.3 million and $131.1 million, respectively. The outstanding balance as of December 31, 2020 and 2019 was $30.0 million and $54.0 million, respectively. The average interest rate of the outstanding balances was 0.33% and 1.79% as of December 31, 2020 and 2019, respectively.
As of December 31, 2020, TSS has $35.0 million of available credit under repurchase agreements with broker-dealers, which are short-term borrowing facilities using securities as collateral. There were no outstanding short-term borrowings under these facilities as of December 31, 2020.
TSA has a $10.0 million revolving loan agreement with a commercial bank in Puerto Rico. This line of credit has an interest rate of 30-day LIBOR plus 250 basis points and contains certain financial and non-financial covenants that are customary for this type of facility. This line of credit matures on June 30, 2021 and had no outstanding balance as of December 31, 2020.
We anticipate that we will have sufficient liquidity to support our currently expected needs.
Contractual Obligations
Our contractual obligations impact our short-and long-term liquidity and capital resource needs. However, our future cash flow prospects cannot be reasonably assessed based solely on such obligations. Future cash outflows, whether contractual or not, will vary based on our future needs. While some cash outflows are completely fixed (such as commitments to repay principal and interest on borrowings), most are dependent on future events (such as the payout pattern of claim liabilities which have been incurred but not reported).
The table below describes the payments due under our contractual obligations, aggregated by type of contractual obligation, including the maturity profile of our debt, operating leases and other long-term liabilities, but excludes an estimate of the future cash outflows related to the following:
Alternative investments – The Company has $52.6 million of unfunded capital commitments related to alternative investments. These commitments were excluded from this disclosure due to the undetermined timing of their cash flows.
Unearned premiums – This amount accounts for the premiums collected prior to the end of coverage period and does not represent a future cash outflow. As of December 31, 2020, we had $97.5 million in unearned premiums.
Policyholder deposits – The cash outflows related to these instruments are not included because they do not have defined maturities, such that the timing of payments and withdrawals is uncertain. There are currently no significant policyholder deposits in paying status. As of December 31, 2020, our policyholder deposits had a carrying amount of $206.1 million.
Other long-term liabilities – Due to the indeterminate nature of their cash outflows, $199.8 million of other long-term liabilities are not reflected in the following table, consisting of $139.6 million of liability for pension benefits, $45.1 million in liabilities to the Federal Employees’ Health Benefits Plan Program and $15.1 million in deferred tax liabilities.
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Contractual obligations by year
(Dollar amounts in millions)
Total
Thereafter
Borrowings (1)
Operating leases
Purchase obligations (2)
Claim liabilities (3)
Estimated obligation for future policy benefits (4)
As of December 31, 2020, our long-term borrowings consist of credit agreements with commercial banks in Puerto Rico. Short-term borrowings represent the outstanding balance of short-term facilities available to address timing differences between cash receipts and disbursements. See the “Financing and Financing Capacity” section for additional information regarding our borrowings
Purchase obligations represent payments required by us under material agreements to purchase goods or services that are enforceable and legally binding and where all significant terms are specified, including: quantities to be purchased, price provisions and the timing of the transaction. Other purchase orders made in the ordinary course of business for which we are not liable are excluded from the table above. Estimated pension plan contributions amounting to $10.0 million were included within the total purchase obligations. However, this amount is an estimate which may be subject to change in view of the fact that contribution decisions are affected by various factors such as market performance, regulatory and legal requirements and plan funding policy.
Claim liabilities represent the amount of our claims processed and incomplete as well as an estimate of the amount of incurred but not reported claims and loss-adjustment expenses. This amount does not include an estimate of claims to be incurred subsequent to December 31, 2020. The expected claims payments are an estimate and may differ materially from the actual claims payments made by us in the future. Also, claim liabilities are presented gross, and thus do not reflect the effects of reinsurance under which $344.0 million of reserves had been ceded at December 31, 2020.
Our Life Insurance segment establishes, and carries as liabilities, actuarially determined amounts that are calculated to meet its policy obligations when a policy matures or surrenders, an insured dies or becomes disabled or upon the occurrence of other covered events. A significant portion of the estimated obligation for future policy benefits to be paid included in this table considers contracts under which we are currently not making payments and will not make payments until the occurrence of an insurable event not under our control, such as death, illness, or the surrender of a policy. We have estimated the timing of the cash flows related to these contracts based on historical experience as well as expectations of future payment patterns. The amounts presented in the table above represent the estimated cash payments for benefits under such contracts based on assumptions related to the receipt of future premiums and assumptions related to mortality, morbidity, policy lapses, renewals, retirements, disability incidence and other contingent events as appropriate for the respective product type. All estimated cash payments included in this table are not discounted to present value nor do they take into account estimated future premiums on policies in-force as of December 31, 2020 and are gross of any reinsurance recoverable. The $759.3 million total estimated cash flows for all years in the table is different from the Liability of Future Policy Benefits of $415.0 million included in our Consolidated Financial Statements principally due to the time value of money. Actual cash payments to policyholders could differ significantly from the estimated cash payments as presented in this table due to differences between actual experience and the assumptions used in the estimation of these payments.
Off-Balance-Sheet Arrangements
We have no off-balance-sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, revenues and expenses, results of operations, liquidity, capital expenditures or capital resources.
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Restriction on Certain Payments by the Corporation’s Subsidiaries
Our insurance subsidiaries are subject to the regulations of the Commissioner of Insurance. These regulations, among other things, require insurance companies to maintain certain levels of capital, thereby restricting the amount of earnings that can be distributed by the insurance subsidiaries to TSM. As of December 31, 2020, our insurance subsidiaries were in compliance with such minimum capital requirements. Please refer to Item 1. Business – Capital and Reserve Requirements.
These regulations are not directly applicable to TSM, as a holding company, since it is not an insurance company.
The $35.5 million credit agreement limits the amount of dividends or other distributions (including share repurchases) payable by the Corporation to $50.0 million per year.
We do not expect that any of the previously described dividend restrictions will have a significant effect on our ability to meet our cash obligations.
Solvency Regulation
To monitor the solvency of the operations, the BCBSA requires us, TSS, TSA, and TSB to comply with certain specified levels of RBC. RBC is designed to identify weakly capitalized companies by comparing each company’s adjusted surplus to its required surplus (RBC ratio). The RBC ratio reflects the risk profile of insurance companies. At December 31, 2020, TSM and TSS estimated RBC ratio was above the 375% minimum BCBSA RBC requirement to avoid monitoring. At December 31, 2020, TSA estimated RBC ratio was above the minimum BCBSA RBC requirement of 100% for smaller controlled affiliate.
BCBSA’s primary licensees could be subject to monitoring if, over a 6 or 12 month period, its RBC ratio declines by 80 or more points and which results in a level that is below 500%.
Other Contingencies
Legal Proceedings
Various litigation claims and assessments against us have arisen in the course of our business, including but not limited to, our activities as an insurer and employer. Furthermore, the Commissioner of Insurance, as well as other Federal, Puerto Rico, and Costa Rica government authorities, regularly make inquiries and conduct audits concerning our compliance with applicable insurance and other laws and regulations.
Given the inherent unpredictability of these matters, it is possible that an adverse outcome in certain matters could, from time to time, have an adverse effect on our operating results and/or cash flows. For a description of our legal proceedings, see Note 25, Contingencies , of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Guarantee Associations and Other Regulatory Commitments
To operate in Puerto Rico, insurance companies, such as our insurance subsidiaries, are required to participate in guarantee associations, which are organized to pay policyholders contractual benefits on behalf of insurers declared insolvent. These associations levy assessments, up to prescribed limits, on a proportional basis, to all member insurers in the line of business in which the insolvent insurer was engaged. In 2019, two local property and casualty insurance companies entered a liquidation process; accordingly, the property and casualty guarantee fund initiated the process to settle unpaid claims and return unearned premiums of the insolvent insurers. In December 2019, the guarantee fund determined and imposed an assessment to cover claims and return premiums, payable in two installments during 2020 based on premiums written in 2018. TSP’s share in this assesment was $912 thousand. Annual assessments are limited to 2% of direct premiums written, as defined. TSP accrued $716 thousand to cover its estimate of assessments based in premiums written in 2019 and loss data made available by the guaranty fund. In accordance with insurance laws and regulations, assessments are recoverable through policy surcharges upon the approval by the Commissioner of Insurance. During 2018, no assessment or payment was made for this contingency. It is the opinion of management that any possible future guarantee association assessments will not have a material effect on our operating results and/or cash flows, although there is no ceiling on these payment obligations.
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Pursuant to the Puerto Rico Insurance Code, our Property and Casualty subsidiary is a member of Sindicato de Aseguradores para la Suscripción Conjunta de Seguros de Responsabilidad Profesional Médico-Hospitalaria (SIMED). The syndicate was organized for the purpose of underwriting medical-hospital professional liability insurance. As a member, the Property and Casualty segment shares risks with other member companies and, accordingly, is contingently liable in the event the syndicate cannot meet their obligations. During 2020, 2019, and 2018, no assessment or payment was made for this contingency. It is the opinion of management that any possible future syndicate assessments will not have a material effect on our operating results and/or cash flows, although there is no ceiling on these payment obligations. In December 2018, SIMED declared a distribution to its members; the TSP’s share of this distribution was $2.9 million, which is presented with Other Income in the accompanying Consolidated Statement of Earnings.
In addition, our Property and Casualty insurance subsidiary is a member of the Compulsory Vehicle Liability Insurance Joint Underwriting Association (the Association). The Association was organized in 1997 to underwrite insurance coverage of motor vehicle property damage liability risks effective January 1, 1998. As a participant, the segment shares the risk proportionally with other members based on a formula established by the Insurance Code. During the years 2020, 2019 and 2018, the Association distributed to the Company $0.2 million each year, respectively, based on the good experience of the business. In June 2017, the Association declared a special dividend of $70.0 million as authorized by a recent amendment to the Act creating the Association. The distribution was subject to a unique and special tax rate of 50%. The dividend was paid net of its related tax in December 2018. The share of the Property and Casualty segment in this distribution was $2.4 million.
The Property and Casualty segment is also member of the Puerto Rico Fire and Allied Lines Underwriting Association and the Puerto Rico Auto Assign Plan. These entities periodically impose assessments to cover operations and other charges. The assessments recorded from these entities were $1 thousand, $10 thousand, and $9 thousand in 2020, 2019 and 2018, respectively.
Critical Accounting Estimates
Our Consolidated Financial Statements and accompanying Notes included in this Annual Report on Form 10-K have been prepared in accordance with GAAP applied on a consistent basis. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We continually evaluate the accounting policies and estimates we use to prepare our consolidated financial statements. In general, management’s estimates are based on historical experience and various other assumptions it believes to be reasonable under the circumstances. The following is an explanation of our accounting policies considered most significant by management. These accounting policies require us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information is known. Actual results could differ materially from those estimates.
The policies discussed below are considered by management to be critical to an understanding of our consolidated financial statements because their application places the most significant demands on management’s judgment, with financial reporting results relying on estimation about the effect of matters that are inherently uncertain. For all these policies, management cautions that future events may not necessarily develop as forecasted, and that the best estimates routinely require adjustment. Management believes that the amounts provided for these critical accounting estimates are adequate.
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Claim Liabilities
Claim liabilities by segment as of December 31, 2020 were as follows:
(Dollar amounts in millions)
Managed care
Property and casualty insurance
Life insurance
Consolidated
Management continually evaluates the potential impact of changes in the factors considered for its claim liabilities estimates, both positive and negative, and uses the results of these evaluations to adjust recorded claim liabilities and underwriting criteria. Our profitability depends in large part on our ability to accurately predict and effectively manage the amount of claims incurred, particularly those of the Managed Care segment and the losses arising from the Life Insurance and Property and Casualty segments. Management regularly reviews its premiums and benefits structure to reflect our underlying claims experience and revised actuarial data; however, several factors could adversely affect our underwriting results. Some of these factors are beyond management’s control and could adversely affect its ability to accurately predict and effectively control claims incurred. Examples of such factors include changes in health practices, economic conditions, change in utilization trends including those caused by epidemic conditions, health care costs, the advent of natural disasters and . Costs in excess of those anticipated could have a material effect on our results of operations.
We recognize claim liabilities as follows:
Managed Care Segment
At December 31, 2020, claim liabilities for the Managed Care segment amounted to $444.4 million and represented 56.5% of our total consolidated claim liabilities and 21.0% of our total consolidated liabilities.
Claim liabilities are determined employing actuarial methods that are commonly used by managed care actuaries and meet Actuarial Standards of Practice, which require that the claim liabilities be adequate under moderately adverse circumstances. The segment determines the amount of the liability by following a detailed actuarial process that entails using both historical claim payment patterns as well as emerging medical cost trends to project a best estimate of claim liabilities. Under this process, historical claims incurred dates are compared to actual dates of claims payment. This information is analyzed to create “completion” or “development” factors that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Completion factors are applied to claims paid through the consolidated financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the total expected claims incurred. The majority of unpaid , both reported and , for any period, are those which are incurred in the final months of the period. Since the percentage of paid during the period with respect to incurred in those months is generally very low, the above-described completion factor methodology is less reliable for such months. In order to complement the analysis to determine the , historical completion factors and payment patterns are applied to incurred and paid for the most recent twelve months and compared to the prior twelve month period. Incurred for the most recent twelve months also take into account recent expense levels and health care trend levels (trend factors). Using all of the above methodologies, our actuaries determine based on the different circumstances the as of the end of period.
Because the reserve methodology is based upon historical information, it must be adjusted for known or suspected operational and environmental changes. These adjustments are made by our actuaries based on their knowledge and their estimate of emerging impacts to benefit costs and payment speed.
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Managed Care claim liabilities also include a provision for adverse deviation, which is an estimate for known environmental factors that are reasonably likely to affect the required level of reserves. This provision for adverse deviation is intended to capture the potential adverse development from known environmental factors such as our entry into new geographical markets, changes in our geographic or product mix, the introduction of new customer populations, variation in benefit utilization, disease outbreaks, changes in provider reimbursement, fluctuations in medical cost trend, variation in claim submission patterns and variation in claims processing speed and payment patterns, changes in technology that provide faster access to claims data or change the speed of adjudication and settlement of claims, variability in claim inventory levels, non-standard claim development and/or exceptional situations that require judgmental adjustments in setting the reserves for claims.
Circumstances to be considered in developing our best estimate of reserves include changes in enrollment, utilization levels, unit costs, mix of business, benefit plan designs, provider reimbursement levels, processing system conversions and changes, claim inventory levels, regulatory and legislative requirements, claim processing patterns and claim submission patterns. A comparison or prior period liabilities to re-estimated claim liabilities based on subsequent claims development is also considered in making the liability determination. In the actuarial process, the methods and assumptions are not changed as reserves are recalculated, but rather the availability of additional paid claims information drives our changes in the re-estimate of the unpaid claim liability. Changes in such development are recorded as a change to current period benefit expense. The re-estimates or recasts are done monthly for the previous four calendar quarters. On average, about 93% of the claims are paid within three months after the last day of the month in which they were incurred and about 4% are within the next three months, for a total of 97% paid within six months after the last day of the month in which they were incurred.
Management regularly reviews its assumptions regarding claim liabilities and makes adjustments to claims incurred when necessary. If management’s assumptions regarding cost trends and utilization are significantly different than actual results, our Consolidated Statement of Earnings and Balance Sheets could be affected in future periods. Changes to prior year estimates may result in an increase in claims incurred or a reduction of claims incurred in the period the change is made. Further, due to the considerable variability of health care costs, adjustments to claims liabilities are made in each period and are sometimes significant as compared to the net income recorded in that period. Prior year development of claim liabilities is recognized immediately upon the actuary’s judgment that a portion of the prior year liability is no longer needed or that an additional liability should have been accrued. Health care trends are monitored in conjunction with the claim reserve analysis. Based on these analyses, rating trends are adjusted to anticipate future changes in health care cost or utilization. Thus, the Managed Care segment incorporates those trends as part of the development of premium rates in an effort to keep premium rating trends in line with claims trends.
As described above, completion factors and claims trend factors can have a significant impact on the determination of our claim liabilities. The following example provides the estimated impact on our December 31, 2020 claim liabilities, assuming the indicated hypothetical changes in completion and trend factors:
(Dollar amounts in millions)
Completion Factor 1
Claims Trend Factor 2
(Decrease) Increase
(Decrease) Increase
In unpaid claim
liabilities
In claims trend
factor
In unpaid claim
liabilities
In completion factor
(1) Assumes (decrease) increase in the completion factors for the most recent twelve months.
(2) Assumes (decrease) increase in the claims trend factors for the most recent twelve months.
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The segments’ reserving practice is to consistently recognize the actuarial best estimate as the ultimate liability for claims within a level of confidence required by actuarial standards. Management believes that the methodology for determining the best estimate for claim liabilities at each reporting date has been consistently applied.
Amounts incurred related to prior years vary from previously estimated liabilities as the claims are ultimately settled. Liabilities at any year-end are continually reviewed and re-estimated as information regarding actual claims payments or run-out becomes known. This information is compared to the originally established year-end liability. Negative amounts reported for incurred claims related to prior years result from claims being settled for amounts less than originally estimated. The reverse is true of reserve shortfalls. Medical claim liabilities are usually described as having a “short tail”, which means that they are generally paid within several months of the member receiving service from the provider. Accordingly, the majority, or approximately 93%, of any redundancy or shortfall relates to claims incurred in the previous calendar year-end, with the remaining 7% related to claims incurred prior to the previous calendar year-end. Management has not noted any significant emerging trends in claim frequency and severity and the normal fluctuations in enrollment and utilization trends from year to year.
The following table shows the variance between the segment’s incurred claims for current period insured events and the incurred claims for such years had they been determined retrospectively (the “Incurred claims related to current period insured events” for the year shown plus or minus the “Incurred claims related to prior period insured events” for the following year as included in Note 11, Claim Liabilities and Claim Adjustment Expenses of the Notes to Consolidated Financial Statements, in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. This table shows that the segments’ estimates of this liability have approximated the actual development.
(Dollar amounts in millions)
Years ended December 31,
Total incurred claims:
As reported (1)
On a retrospective basis
Variance
Variance to total incurred claims as reported
Includes total claims incurred less adjustments for prior year reserve development.
Management expects that substantially all of the development of the 2020 estimate of medical claims payable will be known during 2021.
In the event this segment experiences an unexpected increase in health care cost or utilization trends, we have the following options to cover claim payments:
Through the management of our cash flows and investment portfolio.
In the Commercial business we have the ability to increase the premium rates throughout the year in the monthly renewal process when renegotiating the premiums for the following contract year of each group as they become due. We consider the actual claims trend of each group when determining the premium rates for the following contract year.
We have available short-term borrowing facilities to address differences between cash receipts and disbursements.
For additional information on our credit facilities, see section Financing and Financing Capacity of this Item.
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Life Insurance Segment
At December 31, 2020, claim liabilities for the Life Insurance segment amounted to $49.9 million and represented 6.3% of total consolidated claim liabilities and 2.4% of our total consolidated liabilities.
The claim liabilities related to the Life Insurance segment are based on methods and underlying assumptions in accordance with GAAP. The estimate of claim liabilities for this segment is based on the amount of benefits contractually determined for reported claims and, for unreported claims, on estimates based on past experience modified for current trends. This estimate relies on observations of ultimate loss experience for similar historical events.
Claim reserve reviews are generally conducted on a monthly basis, in light of continually updated information. We review reserves using current inventory of policies and claims data. These reviews incorporate a variety of actuarial methods, judgments and analysis.
The key assumption about claim liabilities for our Life Insurance segment is related to claims incurred prior to the end of the year but not yet reported to our subsidiary. A liability for these claims is estimated based upon experience with regards to amounts reported subsequent to the close of business in prior years. There are uncertainties in the development of these estimates; however, in recent years our estimates have resulted in immaterial redundancies or deficiencies.
Property and Casualty Segment
At December 31, 2020, claim liabilities for the Property and Casualty segment amounted to $292.8 million and represented 37.2% of the total consolidated claim liabilities and 13.8% of our total consolidated liabilities. Claims liabilities related to losses caused by catastrophe events amounted to approximately $216.1 million.
Estimates of the ultimate cost of claims and loss-adjustment expenses of this segment are based largely on the assumption that past developments, with appropriate adjustments due to known or unexpected changes, are a reasonable basis on which to predict future events and trends, and involve a variety of actuarial techniques that analyze current experience, trends and other relevant factors. Property and Casualty insurance claim liabilities are categorized and tracked by line of business. Medical malpractice policies are written on a claims-made basis. Policies written on a claims-made basis require that claims be reported during the policy period. Other lines of business are written on an occurrence basis. Hurricane losses initially include the use of models from industry recognized firms having data, historical and current information about the events to estimate ultimate losses. These estimates are supplemented by internal estimates of other costs deemed necessary to develop the ultimate losses. As information emerges, are separated between those with solid estimates and those for which we cannot make a reasonable estimate of ultimate cost of claim. Additional reserves are provided based on paid experience for , potential development, and expenses.
Individual case estimates for reported claims are established by a claims adjuster and are changed as new information becomes available during the course of handling the claim. Our Property and Casualty business, other than medical malpractice, is primarily a short-tailed business, where losses (e.g. paid losses and case reserves) are generally reported quickly.
Claim reserve reviews are generally conducted on a quarterly basis, in light of continually updated information. Our actuary certifies reserves for both current and prior accident years using current claims data. These reviews incorporate a variety of actuarial methods, judgments and analysis. For each line of business, a variety of actuarial methods are used, with the final selections of ultimate losses that are appropriate for each line of business selected based on the current circumstances affecting that line of business. These selections incorporate input from management, particularly from the claims, underwriting and operations divisions, about reported loss cost trends and other factors, including the severity and frequency of such claims, that could affect the reserve estimates.
Key assumptions are based on the consideration that past emergence of paid losses and case reserves is credible and likely indicative of future emergence and ultimate losses. A key assumption is the expected loss ratio for the current accident year. This expected loss ratio is generally determined through a review of the loss ratios of prior accident years and expected changes to earned pricing, loss costs, mix of business and other factors that are expected to impact the loss ratio for the current accident year. Another key assumption is the development patterns for paid and reported losses (also referred to as the loss emergence and settlement patterns). The reserves for unreported claims for each year are determined after reviewing the indications produced by each actuarial projection method, which, in turn, rely on the expected paid and reported development patterns and the expected ratio for that year.
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At December 31, 2020, the claim liabilities of the Property and Casualty segment fall within the actuarial reserve range determined by the actuaries. Management reviews the results of the reserve estimates in order to determine any appropriate adjustments in the recording of reserves. Adjustments to reserve estimates are made after management’s consideration of numerous factors, including but not limited to the magnitude of the difference between the actuarial indication and the recorded reserves, improvement or deterioration of actuarial indications in the period, the maturity of the accident year, trends observed over the recent past and the level of volatility within a particular line of business. In general, changes are made more quickly to more mature accident years and less volatile lines of business. Varying the net expected loss ratio by +/-1% in all lines of business for the six most recent accident years would increase/decrease the claims incurred by approximately $5.2 million.
Liability for Future Policy Benefits
Our Life Insurance segment establishes, and carries as liabilities, actuarially determined amounts that are calculated to meet its policy obligations when a policy matures or surrenders, an insured die, becomes disabled or upon the occurrence of other covered events. We compute the amounts for actuarial liabilities in conformity with GAAP.
Liabilities for future policy benefits for whole life and term insurance products and active life reserves for accident and health products are computed by the net level premium method, using interest assumptions of 3.90% in 2020, 4.40% in 2019 and ranging from 3.90% to 5.75% in 2018, and withdrawal, mortality, morbidity and maintenance expense assumptions appropriate at the time the policies were issued (or when a block of business was purchased, as applicable). Accident and health unpaid claim reserves are stated at amounts determined by estimates on individual claims and estimates of unreported claims based on past experience. Deferred annuity reserves are carried at the account value.
For deferred annuities and universal life products, the liability for future policy benefits is equal to total policy account values. The liabilities for all other products are based upon a variety of actuarial assumptions that are uncertain. The most significant of these assumptions is the level of anticipated death and health claims. Other assumptions that are less significant to the appropriate level of the liability for future policy benefits are anticipated policy persistency rates, investment yields and operating expense levels. Policy portfolio valuations are performed frequently by our subsidiary’s external actuaries, to assure that the current level of liabilities for future policy benefits is sufficient, in combination with anticipated future cash flows, to provide for all contractual obligations. For all products, except for deferred annuities and universal life products, the basis for the liability for future policy benefits is established at the time of issuance of each contract and would only change if our experience deteriorates to the point that the level of the liability is not adequate to provide for future policy benefits. We do not currently expect that level of deterioration to occur.
Deferred Policy Acquisition Costs and Value of Business Acquired
Certain costs incurred for acquiring life and property and casualty insurance business are deferred. Acquisition costs related to the Managed Care segment are expensed as incurred.
The costs of acquiring new life business, principally commissions, and certain variable underwriting and policy issue expenses of our Life Insurance segment, have been deferred. These costs, including value of business acquired (VOBA) recorded upon our acquisitions of TSV and TSB, are amortized to income over the premium-paying period of the related whole life and term insurance policies in proportion to the ratio of the expected annual premium revenue to the expected total premium revenue, and over the anticipated lives of universal life policies in proportion to the ratio of the expected annual gross profits to the expected total gross profits. The expected premiums revenue and gross profits are based upon the same mortality and withdrawal assumptions used in determining the liability for future policy benefits. For universal life and deferred annuity policies, changes in the amount or timing of expected gross profits result in adjustments to the cumulative amortization of these costs. The effect on the amortization of deferred policy acquisition costs (DPAC or DAC) of revisions to estimated gross profits (unlock adjustment) is reported in earnings in the period such estimated gross profits are revised.
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The schedules of amortization of life insurance DPAC and VOBA are based upon actuarial assumptions regarding future events that are uncertain. For all products, other than universal life and deferred annuities, the most significant of these assumptions is the level of contract persistency and investment yield rates. For these products the basis for the amortization of DPAC and VOBA is established at the issue of each contract and would only change if our segment’s experience deteriorates to the point that the level of the net liability is not adequate. We do not currently expect that level of deterioration to occur. For the universal life and deferred annuity products, amortization schedules are based upon the level of historic and anticipated gross profit margins, from the date of each contract’s issued (or purchase, in the case of VOBA). These schedules are based upon several actuarial assumptions that are uncertain, are reviewed annually and are modified if necessary. The most significant of these assumptions are claims, investment yield rates and contract persistency. Based upon the most recent actuarial reviews of all the assumptions, we do not currently anticipate material changes to these amortization schedules.
The property and casualty business acquisition costs consist of commissions net of reinsurance commissions, during the production of business and are deferred and amortized ratably over the terms of the policies. The method used in calculating deferred acquisition costs limits the amount of such deferred costs to actual costs or their estimated realizable value, whichever is lower.
Impairment of Investments
An investment is considered to be impaired when the estimated fair value is below the amortized cost of the security and it is more likely than not the Company will have to sell the fixed-maturity security before the recovery of its amortized cost basis. Management regularly monitors and evaluates the difference between the amortized cost and estimated fair value of fixed-maturity investments and other invested assets. For fixed-maturity securities with a fair value below amortized cost, the process includes evaluating: (1) the extent to which the estimated fair value has been less than amortized cost, (2) the financial condition, near-term and long-term prospects for the issuer, including relevant industry conditions and trends, and implications of rating agency actions, (3) the Company’s intent to sell or the likelihood of a required sale prior to recovery, (4) the recoverability of principal and interest, and (5) other factors, as applicable. This process is not exact and requires further consideration of risks such as credit and interest rate risks. Consequently, if an investment’s cost exceeds its estimated fair value solely due to changes in interest rates, an allowance for credit losses is not recorded.
Because of the subjective nature of the Company’s analysis and the judgment that must be applied in it, the Company could reach a different conclusion about whether to impair a security if it had access to additional information about the investee. Additionally, it is possible that the investee’s ability to meet future contractual obligations may be different than what the Company determined during its analysis, which may lead to a different impairment conclusion in future periods.
If a fixed-maturity security is in an unrealized loss position and the Company has the intent to sell the security, or it is more likely than not that the Company will have to sell the fixed-maturity security before recovery of its amortized cost basis, the Company will write off any previously recognized allowance for credit losses and will decrease the amortized cost basis of the security. If the allowance has been fully written off and the fair value is less than its amortized cost basis, the amortized cost basis is written down and an impairment loss is recognized in the Company’s Consolidated Statements of Earnings.
The credit component of the impairment is determined by comparing the net present value of projected future cash flows with the amortized cost basis of the fixed-maturity security. The net present value is calculated by discounting the Company’s best estimate of projected future cash flows at the effective interest rate implicit in the fixed-maturity security at the date of acquisition. If there is an increase in the projected future cash flows of the fixed-maturity security in subsequent periods, all or part of the allowance for credit losses may be reversed.
In addition, the Company considers the following factors when evaluating whether or not a credit loss exists: the reasons for the impairment, the severity of the impairment, market conditions, changes in the security’s rating, changes in value subsequent to year-end, forecasted performance of the investee, and the general market condition in the geographic area or industry in which the investee operates.
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Management reviews the available-for-sale and other invested assets portfolios under the Company’s impairment review policy. Given market conditions and the significant judgments involved, there is a continuing risk that declines in fair value may occur and material allowances for credit losses may be recorded in future periods. The Company from time to time may sell investments as part of its asset/liability management process or to reposition its investment portfolio based on current and expected market conditions.
During the years ended December 31, 2020, 2019 and 2018, we were not required to recognize a credit-related impairment. The impairment analysis indicated that none of the securities whose carrying amount exceeded its estimated fair value was considered credit impaired as of that date; however, several factors are beyond management’s control, such as the following: financial condition of the issuers, movement of interest rates, specific situations within corporations, among others. Over time, the economic and market environment may provide additional insight regarding the estimated fair value of certain securities, which could change management’s judgment regarding impairment. This could result in the recognition of realized losses because of credit-related impairments that are charged against future income.
Our fixed-maturity securities are sensitive to interest rate and credit risk fluctuations, which impact the fair value of individual securities. Our equity securities are sensitive to equity price risks, for which potential losses could arise from adverse changes in the value of equity securities. For additional information on the sensitivity of our investments, see Item 7A. Quantitative and Qualitative Disclosures About Market Risk in this Annual Report on Form 10-K.
A detail of the gross unrealized losses on investment securities and the estimated fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2020 and 2019 is included in Note 3, Investment in Securities of the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Allowance for Doubtful Receivables
We estimate the amount of uncollectible receivables in each period and establish an allowance for doubtful receivables considering, among other things, the continued deterioration of the local economy, the exposure to government accounts and the challenging business environment in the Island. The allowance for doubtful receivables amounted to $50.7 million and $56.5 million as of December 31, 2020 and 2019, respectively. As of December 31, 2020 and 2019, the Company had premiums and other receivables of 52.5 million and $49.2 million, respectively, from the Government of Puerto Rico, including its agencies, municipalities, and public corporations. The related allowance for doubtful receivables as of December 31, 2020 and 2019 was $21.5 million and $22.1 million, respectively. The amount of the allowance is based on the aging of unpaid accounts, information about the customer’s creditworthiness and other relevant information. The estimates of uncollectible accounts are revised each period, and changes are recorded in the period they become known. In determining the allowance, we use predetermined percentages applied to aged account balances, as well as individual analysis of large accounts. These percentages are based on our collection experience and are periodically evaluated. A significant change in the level of accounts would have a material effect on our results of operations.
In addition to premium-related receivables, we evaluate the risk in the realization of other accounts receivable, including balances due from third parties related to overpayment of medical claims and rebates, among others. These amounts are individually analyzed, and the allowance determined based on the specific collectivity assessment and circumstances of each individual case.
We consider this allowance adequate to cover probable losses that may result from our inability to subsequently collect the amounts reported as accounts receivable. However, such estimates may change significantly in the event that unforeseen economic conditions adversely impact the ability of third parties to repay the amounts due to us.
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Goodwill and Other Intangible Assets
Our consolidated goodwill and other intangible assets at December 31, 2020 were $28.6 million and $1.4 million, respectively. At December 31, 2019 the consolidated goodwill and other intangible assets were $28.6 million and $1.9 million, respectively. The goodwill and other intangible assets balance for both years were primarily related to the acquisition of TSA in 2011. As of December 31, 2020 and 2019, the goodwill related to TSA was $25.0 million. As of December 31, 2020 and 2019 other intangible assets related to the TSA acquisition were $1.4 million and $1.9 million, respectively.
We account for goodwill and intangible assets with indefinite lives in accordance with Accounting Standard Codification (ASC) No. 350, Goodwill and Other Intangible Assets , which specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill. Under this guidance, goodwill is not amortized but is tested for impairment at least annually and more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. For goodwill, the impairment determination is made at the reporting unit level.
Our impairment tests involve the use of estimates related to the fair value of the reporting unit and require a significant degree of management judgment and the use of subjective assumptions. The Company may perform a qualitative analysis or perform a quantitative analysis. In the qualitative analysis, the Company determines if it is more likely than not that the fair value of a reporting unit is less than its carrying amount by assessing current events and circumstances. If there are factors present indicating potential impairment, the Company would proceed to the quantitative analysis. The quantitative analysis is used to identify potential goodwill impairment and measure the amount (if any) of a goodwill impairment loss to be recognized. The goodwill impairment is determined by comparing the fair value of a reporting unit to its carrying amount and recognizing an impairment charge for the difference by which the carrying amount exceeds the reporting unit’s fair value, up to the carrying amount of the goodwill.
Our goodwill impairment test uses the income and market approach to estimate a reporting unit’s fair value. Use of the income and market approach for our goodwill impairment test reflects our view that valuation methodology provides a reasonable estimate of fair value. The income approach is developed using assumptions about future premiums, expected claims, MLR, operating expenses and net income derived from our internal planning process and historical trends. These estimated future cash flows are then discounted. Our assumed discount rate is based on our industry’s weighted average cost of capital. It assumes the effective implementation of measures to contain the utilization and cost trends. Events or changes in circumstances, including a decrease in membership, an increase in MLR and/or operating expenses, could result in goodwill impairment. The market approach is developed based upon the valuation multiples of various financial or operational measures calculated using the market value of minority interest in publicly traded guideline companies. These multiples are then applied to the relevant financial or operational metrics of the interest and used to develop an estimate of value.
We completed our annual impairment tests of existing goodwill during the fourth quarter of 2020 and 2019. Limited interim impairment tests are also performed when potential impairment indicators exist or other changes in our business occur. If we do not achieve our earnings objectives or the cost of capital rises significantly, the assumptions and estimates underlying these impairment evaluations could be adversely affected and result in future impairment charges that would negatively impact our operating results. The result of the impairment test performed in 2020 and 2019 indicated that the fair value of the TSA unit exceeded its carrying value by approximate ly 25% an d 35%, respectively.
While we believe we have appropriately allocated the purchase price of our acquisitions, this allocation requires many assumptions to be made regarding the fair value of assets and liabilities acquired. In addition, estimated fair values developed based on our assumptions and judgments might be significantly different if other reasonable assumptions and estimates were to be used. If estimated fair values are less than the carrying values of the reporting unit or if significant impairment indicators are noted relative to other intangible assets subject to amortization, we may be required to record impairment losses against future income.
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Other Significant Accounting Policies
We have other accounting policies that are important to an understanding of the Consolidated Financial Statements. See Note 2, Significant Accounting Policies of the Notes to Consolidated Financial Statements in Item 8 . Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Recently Issued Accounting Standards
For a description of our recently issued accounting standards, see Note 2, Significant Accounting Policies of the Notes to Consolidated Financial Statements in Item 8 . Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
