Real-time Form 4 intelligence. Smarter insider tracking.
YoY shift: Neutral
Year-over-year tone shift - average net-tone change across Risk Factors and MD&A vs the prior 10-K. This filing is -0.03pp more bearish than last year's.
Why YoY instead of absolute: the LM lexicon has ~6.6× more negative words than positive (legal/risk-disclosure language is heavy on hedging), so every 10-K reads bearish on raw tone. Year-over-year change strips that bias and surfaces the actual shift in management's framing.
Tone shift by section
The two components the gauge averages: how Risk Factors and MD&A each shifted in net tone versus last year's 10-K. The headline above is their average, so a green needle over a soft section just means the other section carried it.
Risk Factors
-0.15pp
Flat
Net-tone change vs last year's 10-K.
MD&A
+0.10pp
Flat
Net-tone change vs last year's 10-K.
Per-snippet highlights
Sentence-level sentiment highlighting with category and subcategory filters is coming once the snippet-scoring pipeline lands. For now, dig into the actual section text on the Sections tab.
Language change vs prior 10-K
Risk Factors (Item 1A) - words with the biggest YoY frequency increase
Negative rising
noncompliance+7
adversely+5
fail+3
threats+3
disasters+2
Positive rising
profitability+3
benefit+1
successfully+1
prospered+1
Risk Factors (Item 1A)
14,431 words
Item 1A.
Risk Factors
We must deal with several risk factors during the normal course of business. You should carefully consider the following risks and all other information set forth in this Annual Report on Form 10-K. The risk and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that are currently deemed insignificant may also impair our business operations. The occurrence of any of the following risks could materially affect our business, financial condition, operating results, and cash flows. See section Special Note Regarding Forward-Looking Statements in this Annual Report on Form 10-K for a summary of our Risk Factors.
Risks Related to Our Business
Our inability to contain managed care costs may adversely affect our business and profitability.
A substantial portion of our managed care revenue is generated by premiums consisting of monthly payments per member that are established by contracts with our commercial customers, ASES or CMS (for our Medicare Advantage plans), all of which are typically renewable on an annual basis. If our medical expenses exceed our estimates, except in very limited circumstances or resulting from risk score adjustments for member acuity in case of the Medicare products, we will be to increase the premiums we receive for these contracts during the then-current terms. As a result, our in any year depends, to a significant degree, on our ability to predict and effectively manage our medical expenses related to the provision of managed care services through underwriting criteria, medical management, product design and negotiation of provider contracts with hospitals, physicians and other health care providers. The aging of the population and other demographic characteristics and in medical technology continue to contribute to rising health care costs. Also, we may continue to enter into new lines of business in the future, and it may be to estimate the anticipated costs. Numerous factors affecting the cost of managed care, including changes in health care practices, inflation, new technologies such as genetic laboratory screening for diseases including breast cancer, electronic recordkeeping, cost of prescription drugs, clusters of high cost cases, changes in the regulatory environment including the implementation of ACA, may affect our ability to predict and manage managed care costs, as well as our business, financial condition and results of operations.
Language change vs prior 10-K
MD&A (Item 7) - words with the biggest YoY frequency increase
Negative rising
doubtful+2
negative+1
severity+1
lapses+1
late+1
Positive rising
gains+2
excellent+2
best+1
favorable+1
premier+1
MD&A (Item 7)
15,018 words
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:
Introduction of new high-cost specialty drugs and sudden costs spikes for existing drugs increase the risk that the pharmacy cost assumptions used to develop our rates are not adequate enough to cover the actual pharmacy costs, which jeopardizes the overall actuarial soundness of our rates. Bearing the high costs of new specialty drugs or the high cost inflation of generic drugs without an appropriate rate adjustment or other reimbursement mechanism adversely affects our financial condition and operational results. In addition, evolving state and federal regulation may affect the ability of our health plans to continue to receive existing price discounts on pharmaceutical products for our members. Other factors affecting our pharmaceutical costs include, but are not limited to, geographic variation in utilization of new and existing pharmaceuticals, and changes in discounts. Although we will continue to work with state agencies in an effort to ensure that we receive appropriate and actuarially sound reimbursement for all new drug therapies and pharmaceutical cost and utilization trends, there can be no assurance that we will always be successful.
Our profitability may be adversely affected if we are unable to maintain our current provider agreements and unable to enter into other appropriate agreements.
Our profitability is partially dependent upon our ability to contract on favorable terms with hospitals, physicians and other managed care providers. Puerto Rico legislation authorizes providers to collectively negotiate the services fees through cooperatives, on a voluntary basis, with health insurance companies and other health care related organizations. If collective negotiations with providers become mandatory or we are otherwise required to enter into collective negotiations with providers, it could become more difficult to maintain cost-effective managed care provider contracts, which could adversely affect our business.
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We are dependent on a small number of government contracts to generate a significant amount of the revenues for our Managed Care segment.
Our managed care business participates in government contracts that generate a significant amount of our consolidated operating revenues, including:
Commercial: One of our Managed Care subsidiaries is a qualified contractor that provides managed care coverage to federal government employees within Puerto Rico. Such coverage is provided pursuant to a contract with the OPM that is subject to termination in the event of noncompliance not corrected to the satisfaction of the OPM. During each of the years ended December 31, 2020, 2019, and 2018 premiums generated under this contract represented 4.6%, 5.3%, and 5.5% of our consolidated premiums earned, net, respectively.
Under the commercial business, we also provide health coverage to certain employees of the Government of Puerto Rico and its instrumentalities. During each of the years ended December 31, 2020, 2019, and 2018, earned premium revenue related to such health plans represented 1.8%, 2.2%, and 3.0% of our consolidated premiums earned, net, respectively.
Medicare: We provide services through our Medicare Advantage products pursuant to a limited number of contracts with CMS. These contracts generally have terms of one year and must be renewed annually. Each of our CMS contracts are cancellable for cause if we breach a material provision of the contract or violate relevant laws or regulations. If we are unable to renew, or to successfully re-bid or compete for any of these contracts, or if the process for bidding materially changes or if any of these contracts are terminated, our business could be materially impaired. During each of the years ended December 31, 2020, 2019, and 2018, contracts with CMS represented 42.9%, 43.3%, and 38.5% of our consolidated Premiums Earned, Net, respectively.
Medicaid: We participate in the government of Puerto Rico Health Reform Program (similar to Medicaid), known as Vital (Vital), to provide health coverage (including medical, mental, pharmacy and dental services) to medically indigent citizens in Puerto Rico. The term of our current agreement with ASES is from November 1, 2018 to September 30, 2021, and may be extended for an additional year at ASES’s option. Premium rates are negotiated for each contract year. Participants may change insurance carriers once every year. Under the previous agreement with ASES, we provided services to eligible members in the Metro North and West regions of Puerto Rico. During the years ended December 31, 2020, 2019, and 2018 Medicaid premiums generated through our agreements with ASES represented 26.3 %, 26.5% and 26.4%, respectively.
If any of these contracts is terminated for any reason, including noncompliance by us, or not renewed or replaced by a comparable contract, our consolidated premiums and profitability earned could be materially adversely affected. See also Risks Relating to the Regulation of our Industry — As a Medicare Advantage program participant, we are subject to complex regulations. If we fail to comply with these regulations, we may be exposed to criminal sanctions and significant civil penalties. Our Medicare Advantage contracts may also be terminated or our operations may be required to change in a manner that has a material effect on our business. in this Annual Report on Form 10-K.
A change in our managed care commercial product mix may affect our profitability.
Our managed care products that involve greater potential risk, such as fully insured arrangements, generally tend to be more profitable than ASO products and those managed care products where employer groups retain the risk, such as self-funded financial arrangements. As of December 31, 2020, 2019 and 2018, 76%, 73% and 69% of our managed care commercial customers, respectively, had fully insured arrangements and 24%, 27% and 31%, respectively, had ASO arrangements. Unfavorable changes in the relative profitability or customer participation among our various products could have a material adverse effect on our business, financial condition, and results of operations.
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Our failure to accurately estimate incurred but not reported claims would affect our reported financial results.
A portion of the claim liabilities recorded by our insurance segments represents an estimate of amounts needed to pay for insured events that have occurred, including events that have not yet been reported to us. These amounts are based on estimates of the ultimate expected cost of claims and on actuarial estimation techniques. Judgment is required in actuarial estimation to ascertain the relevance of historical payment and claim settlement patterns under each segment’s current facts and circumstances. Accordingly, the ultimate liability may be in excess of or less than the amount provided. We regularly compare prior period liabilities to re-estimate claim liabilities based on subsequent claims development; any difference between these amounts is adjusted in the operations of the period determined. Additional information on how each reportable segment determines its claim liabilities, and the variables considered in the development of this amount, is included elsewhere in this Annual Report on Form 10-K under Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations―Critical Accounting Estimates . Actual experience will likely differ from assumed experience. And to the extent the actual claims experience is less favorable than estimated based on our underlying assumptions, our incurred losses would increase and future earnings could be adversely affected.
The termination or modification of our license agreements to use the BCBS name and mark could have a material adverse effect on our business, financial condition and results of operations.
We are a party to license agreements with the BCBSA that entitle us to the exclusive use of the BCBS name and mark in Puerto Rico, the USVI, Costa Rica, the BVI and Anguilla. These license agreements contain certain standards, requirements and restrictions regarding our operations and our use of the BCBS name and mark, which may be modified in certain instances by the BCBSA. Changes to the terms of our license agreements may restrict various potential business activities. Failure to comply with the standards, requirements and restrictions established could result in the termination of a license agreement. Events that could cause the termination of a license agreement with the BCBSA: include failure to comply with minimum capital requirements imposed by the BCBSA, a change of control or violation of the BCBSA ownership limitations on our capital stock, impending financial insolvency and the appointment of a trustee or receiver or the commencement of any action against a licensee seeking its dissolution. Upon termination of a license agreement, the BCBSA would impose a re-establishment fee upon us, which would allow the BCBSA to entitle another managed care company to use the BCBS name and marks in the service areas we currently serve. This re-establishment fee is currently $98.33 per licensed enrollee. If the re-establishment fee were applied to our total BCBS enrollees as of December 31, 2020, we would be assessed approximately $96.0 million by the BCBSA.
We believe that the BCBS name and mark are valuable identifiers of our products and services in the marketplace. Termination of these license agreements, including modifications to the current term and conditions, could have a material adverse effect on our business, financial condition and results of operations. See Item 1. Business ― Blue Cross and Blue Shield License for more information.
Our ability to manage our exposure to underwriting risks in our Life Insurance and Property and Casualty segments depends on the availability and cost of reinsurance coverage.
Reinsurance is the practice of transferring part of an insurance company’s liability and premium under an insurance policy to another insurance company. We use reinsurance arrangements to limit and manage the amount of risk we retain, to stabilize our underwriting results and to increase our underwriting capacity. During 2020, 40.4%, or $62.5 million, of the premiums written in the Property and Casualty segment and 4.9%, or $10.0 million, of the premiums written in the Life Insurance segment were ceded to reinsurers. Total premiums ceded, on a consolidated basis, represent 2.1%, or $76.8 million of our premiums. The premiums ceded and the availability and cost of reinsurance is subject to changing market conditions and may vary significantly over time. Any decrease in the amount of our reinsurance coverage will increase our risk of loss. We may be unable to maintain our desired reinsurance coverage or obtain other reinsurance coverage in adequate amounts and at favorable rates. If we are unable to renew our expiring coverage or obtain new coverage, it will be difficult for us to manage our underwriting risks and operate our business profitably.
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It is also possible that the losses we experience on insured risks for which we have obtained reinsurance will exceed the coverage limits of the reinsurance. See Risks Related to Our Business ― Large-scale natural disasters may have a material adverse effect on our business, financial condition and results of operations. If the amount of our reinsurance coverage is insufficient, our insurance losses could increase substantially.
If our reinsurers do not pay our claims or do not pay them in a timely manner, we may incur losses.
We are subject to loss and credit risk with respect to the reinsurers with whom we deal. In accordance with general industry practices, our Property and Casualty and Life Insurance subsidiaries annually purchase reinsurance to lessen the impact of large unforeseenlosses and mitigate sudden and unpredictable changes in our net income and shareholders’ equity. Reinsurance contracts do not relieve us from our obligations to policyholders. In the event that all or any of the reinsurance companies are unable to meet their obligations under existing reinsurance agreements or pay on a timely basis, we will continue to be liable to our policyholders notwithstanding such defaults or delays. If our reinsurers are not capable of fulfilling their financial obligations to us, our insurance losses would increase, which would negatively affect our financial condition and results of operations.
A downgrade in our A.M. Best rating could affect our ability to write new business or renew our existing business in our Property and Casualty segment.
Ratings assigned by AM Best are an important factor influencing the competitive position of the property and casualty insurance companies in Puerto Rico. On June 18, 2020, AM Best rated our Property and Casualty subsidiary B+ (Good).
AM Best ratings represent independent opinions of financial strength and ability to meet obligations to policyholders and are not directed toward the protection of investors. Financial strength ratings are used by brokers and customers as a means of assessing the financial strength and quality of insurers. AM Best reviews its ratings periodically and we may be further downgraded following their annual evaluation. Since the lines of business that this segment writes and the market in which it operates are particularly sensitive to changes in AM Best financial strength ratings, any downgrade of our Property and Casualty segment’s rating could limit or prevent us from writing and renewing certain types of business or accounts that requires insurers with stronger ratings.
We are dependent on the success of our relationships with third parties for various services and functions, including outsourced IT, claims processing and PBM services.
We contract with various third parties to perform certain functions and services and provide us with certain information technology systems. Certain of these third parties provide us with significant portions of our business infrastructure and operating requirements, and we could become overly dependent on key vendors, which could cause us to lose core competencies. We are also dependent on some third parties for compliance with certain regulatory requirements. A termination of our agreements with, or disruption in the performance of, one or more of these service providers could result in service disruptions or unavailability; reduced service quality and effectiveness; increased or duplicative costs; fines or corrective action plans imposed by our regulators; or an inability to meet our obligations to our customers. In addition, we may also have to seek alternative service providers, which may be unavailable or only available on less favorable contract terms. Any of these outcomes could adversely affect our business, reputation, cash flows, financial condition and operating results.
TSS has a Master Services Agreement (MSA) with OptumInsight, Inc. (Optum), pursuant to which Optum provides health care technology and operations services, including information technology, claims processing and application development, to Triple-S and its affiliates. As a result, we are dependent on Optum for the provision of essential services to our business, and there can be no assurances that the quality of the services will be appropriate or that Optum will be able to continue to provide us with the necessary claims processing and technology services. Potential breakdowns or failures of Optum could harm our business by disrupting our delivery of services, which could have a material adverse impact on our financial condition and results of operations.
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Abarca Health provides pharmacy benefit management services for all of our Commercial and Medicare Advantage managed care members. Therefore, any issues or failures affecting this vendor or the services it provides us could have a material adverse effect on our managed care business, which could adversely affect our reputation, financial condition and operating results.
Significant competition and market conditions in Puerto Rico could negatively affect our ability to maintain or increase our profitability.
We are subject to strong competition in each line of business in which we operate. Competition in the insurance industry is based on many factors, including premiums charged, services provided, speed of claim payments and reputation. This competitive environment has produced and will likely continue to produce significant pressures on our profitability. The industry in which we operate has unique characteristics that, if we are unable to manage adequately, may adversely affect our business, financial conditions and results of operations. Some of the trends and characteristics related to the competition we contend with in our different lines of business include the following:
The managed care market in Puerto Rico is mature. According to the U.S. Census Bureau, Puerto Rico’s population decreased by 14.3% between 2010 and 2019. However, for the same period, the population 65 years and older increased. As a result, the competition for this segment of the market is significant.
Local economy is in a downturn. A challenging economy and a shrinking population in Puerto Rico continue to produce conditions that are adverse to the generation of new sources of business in this segment. As a result, insurance companies compete for the same customers through pricing, policy terms and quality of services. Also, our industry is subject to aggressive marketing and sales practices that target our current and prospective customers. We may not be successful in attracting and retaining our customers. See Risks Related to Our Business ― Our business is geographically concentrated in Puerto Rico and weakness in the economy and the fiscal health of the government has adversely affected and may continue to adversely affect us.
Our industry is highly regulated. Future legislation at the federal and local levels may also result in increased competition, especially in the Managed Care segment. While we do not anticipate that any of the current legislative proposals of which we are aware would increase the competition we face, future legislative proposals, if enacted, might do so.
Market concentration. Concentration in our industry has created an increasingly competitive environment, both for customers and for potential acquisition targets, which may make it difficult for us to grow our business. The parent companies of some of our competitors are larger and have greater financial and other resources than we do. We may have difficulty competing with larger companies, which can create downward price pressures on premium rates.
We believe these trends will continue. There can be no assurance that these competitive pressures will not adversely affect our business, financial condition and results of operations.
As a holding company, we are largely dependent on rental payments, dividends and other payments from our subsidiaries. The ability of our regulated subsidiaries to pay dividends or make other payments to us is subject to the regulations of the Commissioner of Insurance including maintenance of minimum levels of capital, as well as covenant restrictions in their indebtedness.
We are a holding company whose assets include, among other things, all of the outstanding shares of common stock of our subsidiaries, including our regulated insurance subsidiaries. We principally rely on rental income and dividends from our subsidiaries to fund our debt service, dividend payments and operating expenses, although our subsidiaries may not declare dividends every year. We also benefit to a lesser extent from income on our investment portfolio.
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Our insurance subsidiaries are subject to the regulations of the Commissioner of Insurance, which include, among other things, the requirement that insurance entities to maintain certain levels of capital, thereby restricting the amount of earnings that can be distributed. See Risks Related to Our Business ― Our insurance subsidiaries are subject to minimum capital requirements. Our failure to meet these standards could subject us to regulatory actions . Our subsidiaries’ ability to make any payments to us will also depend on their earnings, the terms of their indebtedness, if any, and other business and legal restrictions. Furthermore, our subsidiaries are not obligated to make funds available to us, and creditors of our subsidiaries have a superior claim to such subsidiaries’ assets. Our subsidiaries may not be able to pay dividends or otherwise contribute or distribute funds to us in an amount sufficient for us to meet our financial obligations. In addition, from time to time, we may find it necessary to provide financial assistance, either through subordinated loans or capital infusions to our subsidiaries that may adversely affect our financial condition.
Our results may fluctuate as a result of many factors, including cyclical changes in the insurance industry.
Results of companies in the insurance industry, historically have been subject to significant fluctuations and uncertainties. The industry’s profitability can be affected significantly by:
Rising levels of actual costs that are not known by companies at the time they price their products;
Volatile and unpredictable developments, including man-made and natural catastrophes;
Changes in reserves resulting from the general claims and legal environments as different types of claims arise and judicial interpretations relating to the scope of insurers’ liability develop; and
Fluctuations in interest rates, inflationary pressures and other changes in the investment environment, which affect returns on invested capital.
Historically, the financial performance of the insurance industry has fluctuated in cyclical periods of low premium rates and excess underwriting capacity resulting from increased competition, followed by periods of high premium rates and a shortage of underwriting capacity resulting from decreased competition. Fluctuations in underwriting capacity, demand and competition, and the impact on us from the other factors identified above, could have a negative impact on our results of operations and financial condition. We believe that underwriting capacity and price competition in the current market is increasing. This additional underwriting capacity may result in increased competition from other insurers seeking to expand the kinds or amounts of business they write or cause some insurers to seek to maintain market share at the expense of underwriting discipline. We may not be able to retain or attract customers in the future at prices we consider adequate.
Our investment portfolios are subject to varying economic and market conditions.
We have exposure to market risk and credit risk in our investment activities. The fair values of our investments vary from time to time depending on economic and market conditions. Fixed-maturity securities expose us to interest rate risk as well as credit risk. Equity securities expose us to equity price risk. Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. These and other factors also affect the equity securities we own. The outlook of our investment portfolio depends on the future direction of interest rates, fluctuations in the equity markets and the amount of cash flows available for investment.
Therefore, adverse conditions in the U.S. and global capital markets could significantly and adversely affect the value of our investments in debt and equity securities, other investments, our profitability and our financial position.
As an insurer, we have a substantial investment portfolio comprised mainly of debt and equity securities of issuers located in the U.S. As a result, the income we earn from our investment portfolio is largely driven by interest rate levels in the U.S. financial markets, volatility, uncertainty and/or disruptions in the global capital markets, particularly the U.S. credit markets, and governments’ monetary policy. These factors can significantly and adversely affect the value of our investment portfolio, our profitability and/or our financial position by:
Significantly reducing the value of debt and equity securities we hold in our investment portfolio, and creating net unrealized capital losses that reduce our operating results and/or net realized capital losses in the event we are required to sell some of those investments.
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Lowering interest rates on high-quality short-term debt securities and thereby materially reducing our net investment income and operating results.
Making it more difficult to value certain of our investment securities. For example, if trading becomes less frequent, it could lead to significant period-to-period changes in our estimates of the fair values of these securities and cause period-to-period volatility in our operating results and shareholders’ equity.
Reducing our ability to issue other securities.
We believe our cash balances, investment securities, operating cash flows, and funds available under credit agreement, taken together, provide adequate resources to fund ongoing operating and regulatory requirements. However, continuing adverse securities and credit market conditions could significantly affect the availability of credit.
For additional information, see Item 7A. Quantitative and Qualitative Disclosures About Market Risk for an analysis of our exposure to interest and equity price risks and the procedures in place to manage these risks. Our investment portfolios may lose money in future periods, which could have a material adverse effect on our financial condition.
In addition, our insurance subsidiaries are subject to local laws and regulations that require diversification of our investment portfolios and limit the amount of investments in certain riskier investment categories, such as below-investment-grade fixed income securities, equities, and private market investments, among others, which could generate higher returns on our investments. Notwithstanding, the Insurance Code of Puerto Rico requires insurers to invest an amount equal to no less than half of the insurer’s required capital in Puerto Rico Securities. Since February 2014, the credit ratings of bonds issued by the Government of Puerto Rico and most of Puerto Rico public corporations have been downgraded to below-investment grade, which makes it difficult to comply with this requirement. We therefore requested and obtained a waiver authorization from the Commissioner of Insurance to fulfill the requirement by investing in mortgage securities issued by Ginnie Mae, backed by mortgages issued in Puerto Rico for 2020, and will request an extension of this waiver for 2021. These securities are of high credit quality due to the Ginnie Mae guarantee.
If we experience a significant realized or unrealized loss on investments or fail to comply with the Insurance Code requirements, any investments exceeding regulatory limitations would be treated as non-admitted assets for purposes of measuring statutory surplus and risk-based capital and may adversely affect our financial condition and results of operations.
Our business is geographically concentrated in Puerto Rico and weakness in the economy and the fiscal health of the government has adversely affected and may continue to adversely affect us.
Our principal lines of business are concentrated in Puerto Rico, which is currently in the midst of a severe fiscal and economic crisis. The Puerto Rico economy entered a recession in the fourth quarter of fiscal year 2006 and its GNP contracted (in real terms) every fiscal year between 2007 and 2018, with the exception of fiscal year 2012. The 2020 Fiscal Plan estimated that the economy of Puerto Rico would contract by 4% in real terms in fiscal year 2020, largely because of the COVID-19 pandemic, with a limited recovery of 0.5% in fiscal year 2021.
Puerto Rico’s population has also been in decline over the past decade. Estimates by the U.S. Census Bureau indicate the population has declined in the past decade by approximately 14.3%, from 2010 to 2019, and the 2020 Fiscal Plan projects that the population will continue to decline through fiscal year 2025.
The weakness of Puerto Rico’s economy has also adversely affected employment. Total average annual employment, as measured by the Puerto Rico Department of Labor and Human Resources (the DLHR) has decreased approximately 20% since 2007, and the unemployment rate stands at 8.5% as of November 2020.
The Government of Puerto Rico has also faced significant fiscal and financial challenges over the past years.
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In response to such challenges, the U.S. Congress enacted PROMESA in June 2016. The Commonwealth of Puerto Rico and several of its instrumentalities are currently in the process of restructuring their debts through the mechanisms provided by PROMESA. In February 2020, the Oversight Board announced it had reached an agreement with certain creditors on a new framework for a plan of adjustment for the Commonwealth of Puerto Rico and certain of its instrumentalities. However, the confirmation of such proposed plan was put on hold as a result of the COVID-19 pandemic, and stakeholders are currently in court-ordered mediation negotiating the economic terms of a revised plan of adjustment.
We have significant direct exposure to the government through our contract with ASES, which administers the Medicaid program in Puerto Rico, and certain other business relationships with the government of Puerto Rico and its instrumentalities. As a result, we may be adversely affected by the liquidity problems of such entities, reductions in such entities’ contributions to their employees’ health plans as a result of fiscal control measures, by a reduction in the size of government or privatization of public corporations.
On the other hand, as part of the Further Consolidated Appropriations Act of 2020, Puerto Rico’s Medicaid program will receive up to approximately $5.342 billion in funding through September 30, 2021. This action has brought temporary financial stability to Puerto Rico’s Medicaid program, and funding conditions related to compliance with program management standards have further promoted stability and predictability. The government of Puerto Rico and the health care industry are lobbying Congress to address Puerto Rico’s Medicaid spending cliff permanently. However, there are no guarantees that these efforts will succeed. If our efforts are not successful, ASES may not be able to fulfill its payment obligations to us under our agreement for the provision of health coverage to Vital participants, which would adversely affect our financial results
Furthermore, our insureds’ financial capacity is affected by, among other things, the general economic conditions in Puerto Rico and other adverse conditions affecting Puerto Rico consumers and businesses. The effects of the prolongedrecession are reflected as a decrease in insured customers in our commercial line of business and premiums earned, net. Moreover, the measures taken to address the fiscal crisis and those that may have to be taken in the near future, will likely affect many of our insureds, which could result in a lower amount of insureds, insureds moving to lower premium plans, among others. The foregoing could also result in decreased demand for our insurance products or migration to less profitable products.
If global or local economic conditions worsen or the government of Puerto Rico is unable to manage its fiscal and economic challenges, including consummating an orderly restructuring of its debt obligations while continuing to provide essential services, the conditions described above could continue or worsen in ways that are unpredictable and outside of our control. While PROMESA provides the government with tools to restructure Puerto Rico’s debt obligations and that of its instrumentalities, these restructuring tools are relatively new and untested. Furthermore, the Fiscal Plan’s projections indicate the possibility of significant creditor losses. Both of these factors have made the debt restructuring processes lengthy and highly adversarial.
The success of our business depends on developing and maintaining effective information systems.
Our business and operations may be affected if we do not maintain and upgrade our information systems and the integrity of our proprietary information. We are materially dependent on our information systems, including Internet-enabled products and information, for all aspects of our business operations. Monitoring utilization and other factors, supporting our managed care management techniques, processing provider claims, providing data to our regulators, and our ability to compete depends on adopting technology on a timely and cost-effective basis. Malfunctions in our information systems, fraud, error, communication and energy disruptions, security breaches or the failure to maintain effective and up-to-date information systems could disrupt our business operations, alienate customers, and contribute to customer and provider disputes. This could result in regulatory violations, possible liability, increase administrative expenses or lead to other adverse consequences any of which could have a material adverse effect on our results of operations or financial condition.
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The use of member data by all of our businesses is regulated at federal and local levels. These laws and rules change frequently, and developments require adjustments or modifications to our technology infrastructure. Our information systems and applications therefore require an ongoing commitment of significant resources to maintain, upgrade and enhance existing systems and develop new systems in order to keep pace these changes and evolving operational needs, technology and industry standards. In addition, we may from time to time obtain significant portions of our systems-related or other services or facilities from independent third parties, which may make our operations vulnerable to such third parties’ failure to perform adequately or failure to secure against cyber threats.
The accuracy and reliability of the information we rely upon to run our business is crucial. Therefore, failure to maintain our information systems and data integrity effectively could result in operational disruptions, such as the inability to pay claims or to make claims payments on a timely basis, problems in determining medical cost estimates and establishing appropriate pricing and reserves, loss of members, and difficulty in attracting new members, regulatory violations, possible liability and limitations on our operations, increases in operating expenses or suffer other adverse consequences. See Item 1A Risk Factors – Risks Relating to the Regulation of Our Industry – As a Medicare Advantage program participant, we are subject to complex regulations. If we fail to comply with these regulations, we may be exposed to criminal sanctions and significant civil penalties.Our Medicare Advantage contracts may also be terminated or our operations may be required to change in a manner that has a material effect on our business . See also Item 1A. Risk Factors – Risks Relating to the Regulation of Our Industry – We may be subject to government audits, regulatory proceedings or investigative actions, that, may find our policies, procedures, practices or contracts are not compliant with, or are in violation of, applicable health care regulations .
Security breaches could result in misappropriation of our confidential information or interruptions in services or operations. Because of the confidential health information we store and transmit, such security breaches could expose us to a risk of regulatory action, litigation, possible liability and loss. See “Item 1A. Risk Factors–Risks Relating to the Regulation of Our Industry – If we fail to comply with applicable privacy and security laws, regulations and standards, including with respect to third-party service providers that utilize sensitive personal information on our behalf; or if we fail to address emerging security threats, including cybersecurity threats, or fail to detect and prevent privacy and security incidents, including those related to cybersecurity, our business, reputation, results of operations, financial position and cash flows could be materially and adversely affected. In the past, computer viruses or software programs that disable or impair computers have been distributed and have rapidly spread over the internet. Computer viruses could be introduced into our systems, or those of our providers or regulators, which could disrupt our operations, or make our systems inaccessible to our providers or regulators.
We may be required to expend significant capital and other resources to protect against the threat of security breaches or to alleviate problems caused by breaches.
We face risks related to litigation.
We are subject to a variety of legal actions that affect any business, such as employment-related suits, employee benefitclaims, breach of contract actions, tort claims and intellectual property-related litigation. In addition, because of the nature of our business, we are subject to a variety of legal actions relating to our business operations, including the design, management and offering of our products and services, claims relating to the denial of benefits or coverage, medical malpractice actions, allegations of anti-competitive and unfair business activities, provider disputes, broker and agent disputes, and regulatory action claims by agencies for noncompliance, among others. We may also be subject to increases in litigation in connection with insureds’ claims following large scale natural disasters. For example, we experienced an increase in litigation in our Property and Casualty segment in connection with insureds’ Hurricanes Irma and Maria claims. See Risks Related to Our Business ― Large-scale natural disasters may have a material adverse effect on our business, financial condition and results of operations . Legal proceedings are inherently unpredictable and we cannot ascertain their outcome. We have insurance to cover liabilities relating to litigation; however, insurance coverage may not be sufficient to cover any such liability or our insurers could deny or dispute coverage. Results of regulatory actions could require us to change our business practices and may affect our profitability. Substantial liability relating to legal or regulatory actions could adversely affect our cash flow, results of operations, and financial condition. See Item 3. Legal Proceedings .
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Large-scale natural disasters may have a material adverse effect on our business, financial condition and results of operations.
Puerto Rico has historically had a relatively high risk of natural disasters, such as hurricanes and earthquakes. If Puerto Rico were to experience a large-scale natural disaster, claims incurred by our Managed Care, Life Insurance and Property and Casualty segments would likely increase and our properties may incur substantial damage, which could have a material adverse effect on our business, financial condition and results of operations. Puerto Rico has recently experienced consecutive large-scale natural disasters, such as Hurricane Maria in September 2017, and a series of earthquakes affecting certain areas in the southern portion of the island in January 2020. If the severity of any such natural disaster exceeds what our catastrophe reinsurance protection, as was the case of Hurricane Maria in September 2017, we may potentially incur material losses. Furthermore, unforeseen major public health issues following these catastrophic events, such as pandemics and epidemics, like mosquito-borne epidemics (Dengue, Zika, etc.), where conditions for vaccines may not exist, are not effective, or have not been widely administered, could have a material adverse effect on our business, financial condition and results of operations.
The Puerto Rico Insurance Code requires the Company to resolveclaims within a period of 90 days. Due to the substantial increase in the volume of claims following a catastrophic event, there is a business risk that not all claims will be resolved within the timeframe stipulated in the Puerto Rico Insurance Code, which may result in penalties imposed by the Commissioner of Insurance of Puerto Rico. Claims in our Property and Casualty segment increased in 2017 and 2018 as a result of the losses caused by Hurricanes Irma and Maria in Puerto Rico. Furthermore, following a large-scale catastrophic event, there is a risk of an increase in the volume of litigations by insureds who are not satisfied with the insurance payout or adjustments. In fact, lawsuits against our Property and Casualty segment increased in 2018 and 2019. As of December 31, 2020, our Property and Casualty segment had been served in a total of 477 lawsuits, of which 300 remained opened as of December 31, 2020. After a review of all cases, we have determined that our reserves as of December 31, 2020 are adequate. However, there is a risk that litigation results in payments and expenses may materially exceed our reserved amount. 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.
Pandemics, like the COVID-19 pandemic and local, state and federal governments’ response to the pandemics may have a material adverse effect on our business, financial condition and results of operations.
On March 11, 2020, the World Health Organization characterized the outbreak of a novel strain of coronavirus (COVID-19) as a global pandemic. In response, the Puerto Rico Governor issued a stay at home order (as amended and extended, the Order) from March 15, 2020 until June 16, 2020. The Order required the closure of non-essential businesses for the same period of time. On May 1, 2020, the Governor issued a new order providing for the gradual reopening of the economy beginning on May 4, 2020. The Governor has issued several other executive orders establishing the rules to continue the gradual reopening of the economy, the latest of which is effective until March 14, 2021.
Although a number of COVID-19 vaccines have been approved by the U.S. and several other countries, at this point it is not possible to reliably estimate the speed and effectiveness of inoculation efforts worldwide, and therefore the length or severity of this outbreak, the length and effectiveness of government and private sector mitigation measures, and other variables that will determine the ultimate financial impact of the pandemic on the Company. However, certain risks discussed in our Annual Report on Form 10-K may increase or materialize. We are closely monitoring the development of the situation to assess its impact on our business. New sales were affected in all our segments and lines of business during the lockdown given that sales functions of all our businesses were not considered essential under the Order and therefore had to be performed remotely. Even though the government-mandated lockdown has been relaxed and most of our sales force has returned to our offices, new sales continue to be affected as social distancing measures continue to restrict certain sales activities. We also experienced a temporary decrease in utilization caused by postponement or cancelation of elective services and medical appointments driven by the Order, which caused our MLR to temporarily drop. Conversely, the pandemic could result in a material increase in medical claims as COVID-19 cases rise and deferred utilizations return. In addition, the postponement or cancellation of medical appointments, treatments and evaluations in our High Cost High Needs (HCHN) Medicaid membership during the pandemic has and may continue to affect our ability to provide qualifying encounter or utilization data to certify them as such, which has and may continue to result in assignment of such members to a different rate cell with lower premium payments and retroactive premium adjustments by ASES. See Item 1A. Risk Factors – Risks Relating to the Regulation of Our Industry – ASES’s risk-adjustment payment system and payment structure, and its dependence on scarce or unavailable data, make our revenue and profitabilitydifficult to predict and could result in material retroactive adjustments to our results of operations .
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Furthermore, COVID-19 related federal and state legislation and regulation may adversely impact our business, financial condition and results of operations. For example, the U.S. and Puerto Rico legislatures have enacted or are contemplating measures requiring health care insurers to cover and/or waive pre-authorization and cost-sharing for COVID-19 related testing, vaccines, treatment or services, which may adversely affect our profitability. In addition, any legislation requiring insurance companies to make advance payments to providers not linked to services previously provided increases our credit risk and could have a material impact on our financial condition and results of operations. See Item 1A. Risk Factors – Risks Related to our Business – Our inability to contain managed care costs may adversely affect our business and profitability . Our Property & Casualty business interruption policies include an exclusion of coverage due to virus or bacteria. However, there have been federal and local legislative efforts to retroactively eliminate such exclusions or otherwise require property and casualty insurers to cover COVID-19 losses under their business interruption policies. While such efforts have not prospered, and if enacted, we believe this type of legislative measure could be challenged on constitutional and other grounds, if successfully implemented, such measures would have a material adverse effect on our Property and Casualty Insurance segment. With respect to our Life Insurance segment, there is a risk that the pandemic could result in a higher number of deaths, and therefore a higher number of claims for death benefits than assumed in our actuarial models. See Item 1A. Risk Factors – Risks Related to our Business – Large-scale natural disasters may have a material adverse effect on our business, financial condition and results of operations . Finally, while estimates vary, the COVID-19 pandemic is widely considered to have had and continue to have a significant effect on the Puerto Rico, U.S. and global economies. Financial market volatility caused by the pandemic may decrease the value of our investment portfolios, including our pension plan asset portfolio. Furthermore, as the financial capacity of our customers is adversely affected, we may experience delinquency in premium payments and ultimately a decrease in insured customers in our commercial line of business and premiums earned, net, or other adverse effects. See Item 1A. Risk Factors – Risks Related to our Business – Our investment portfolios are subject to varying economic and market conditions . See also Our business is geographically concentrated in Puerto Rico and weakness in the economy and the fiscal health of the government has adversely affected and may continue to adversely affect us . These and other risks, some of which we may be unable to identify at this time due to the evolving and highly uncertain nature of this event, could adversely impact our business, financial condition and results of operations.
Present and future covenants in our secured term loans and note purchase agreements may restrict our operations and adversely affect our ability to pursue desirable business opportunities.
The secured term loans contain financial and non-financial covenants that restrict, among other things, the granting of certain liens, limitations on acquisitions and limitations on changes in control. These non-financial covenants could restrict our operations. In addition, if we fail to make any required payment under our secured term loans or to comply with any of the non-financial covenants included therein, we would be in default and the lenders or holders of our debt, as the case may be, could cause all of our outstanding debt obligations under our secured term loans to become immediately due and payable, together with accrued and unpaid interest, and cease to make further extensions of credit. If the indebtedness under our secured term loans is accelerated, we may be unable to repay or refinance the amounts due and our business may be materially adversely affected.
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We may incur additional indebtedness in the future. Our debt service obligations may require us to use a portion of our cash flow to pay interest and principal on debt instead of for other corporate purposes, including funding future expansion. If our cash flow and capital resources are insufficient to service our debt obligations, we may be forced to seek extraordinary dividends from our subsidiaries, sell assets, seek additional equity or debt capital or restructure our debt. However, these measures might be prohibited by applicable regulatory requirements, unsuccessful or inadequate in permitting us to meet scheduled debt service obligations. We may also incur future debt obligations that might subject us to restrictive covenants that could affect our financial and operational flexibility.
Our breach or failure to comply with any of these covenants could result in a default under our secured term loan and the acceleration of amounts due thereunder. Indebtedness could also limit our ability to pursue desirable business opportunities and may affect our ability to maintain an investment grade rating for our indebtedness.
If we do not effectively manage the organic and inorganic growth of our operations, we may not be able to achieve our profitability targets.
Our growth strategy includes expanding our health care delivery business, expanding our participation in Puerto Rico’s health and insurance industry, introducing new products and operating models, further developing our relationships with customers, care delivery providers, independent agencies and brokers and pursuing acquisition opportunities. Our growth strategy exposes us to additional risks, including our ability to:
Identify profitable growth opportunities in current and new markets where we do not presently participate;
Transact successful acquisitions, capital investments and other growth initiatives;
Determine the correct value of assets and investments;
Implement adequate pricing and operational models and structures, including underwriting and claim management processes;
Design attractive and profitable insurance and health care products and services;
Implement new, or modify existing operating models and implement internal monitoring and control systems to manage them;
Recruit required personnel for expanded operations, including officers, agents, brokers, medical providers, and other key personnel;
Obtain regulatory permission required to operate in other jurisdictions or lines of business;
Comply with regulatory requirements;
Integrate acquired businesses into our operations, including integration of information technology, management and personnel, culture and administrative systems;
Acquire business and regulatory knowledge and expertise necessary to manage new lines of business; and
Create the expected return over time.
Additionally, our management and other key personnel may expend considerable time and effort which may distract them from their core activities. We may face risks associated with unknown or unidentified liabilities resulting from our investments or acquisitions, or new products, services, business models and markets, and the processes we implement to materialize them. We may also be subject to changes in trade protection laws, policies and measures, and other regulatory requirements affecting our business, including the Foreign Corrupt Practices Act and laws prohibiting corrupt payments.
If our goodwill or intangible assets become impaired, our financial condition and future results of operations may be adversely affected.
As of December 31, 2020, we had approximately $28.6 million and $1.4 million of goodwill and intangible assets recorded on our Balance Sheet, primarily related to the TSA acquisition, that represent 1.0% of our total consolidated assets and 3.1% of our consolidated stockholders’ equity. In an effort to expand the health clinics reporting unit, the Company purchased various health clinics across different municipalities in Puerto Rico, resulting in a recognition of goodwill of approximately $3.2 million in 2019. The fair values initially assigned to the assets acquired and liabilities assumed are preliminary and are subject to refinement for up to one year after the closing date of the acquisition, as new information becomes available. If we make additional acquisitions, it is likely that we will record additional goodwill and intangible assets on our consolidated balance sheet.
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In accordance with applicable accounting standards, we periodically evaluate our goodwill and other intangible assets to determine the recoverability of their carrying values. Goodwill and other intangible assets with indefinite lives are tested for impairment at least annually. Impairment testing requires us to make assumptions and judgments regarding the estimated fair value of our reporting units, including goodwill and other intangible assets (with indefinite lives). 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 equity and other intangible assets (with indefinite lives) in future impairment tests, or if significant impairment indicators are noted relative to other intangible assets subject to amortization, we may be required to record significant impairmentlossesagainst future income. Factors that may be considered a change in circumstances, indicating that the carrying value of the goodwill or amortizable intangible assets may not be recoverable, include reduced future cash flow estimates and slower growth rates than the industry.
Any future evaluations requiring an impairment of our goodwill and other intangible assets could adversely affect our results of operations and stockholders’ equity in the period in which the impairment occurs. A material decrease in stockholders’ equity could, in turn, negatively impact our debt ratings or potentially impact our compliance with existing debt covenants.
In addition, the estimated value of our reporting units may be affected as a result of the implementation of various Health Care Reform regulations. Such regulations could have significant effects on our future operations, which in turn could unfavorably affect our ability to support the carrying value of certain goodwill and other intangible assets, and result in significant impairment charges in future periods. See Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations ― Critical Accounting Estimates ― Goodwill and Other Intangible Assets .
Risks Relating to Taxation
If we are considered to be a controlled foreign corporation under the related person insurance income rules or a passive foreign investment company for U.S federal income tax purposes, U.S. persons owning our shares of Class B common stock could be subject to adverse tax consequences.
We do not expect that we will be considered a controlled foreign corporation under the related person insurance income rules (a RPII CFC) for U.S. federal income tax purposes. However, because RPII CFC status depends in part upon the correlation between an insurance company’s shareholders and its insurance customers and the extent of insurance business outside its country of incorporation, there can be no assurance that we will not be a RPII CFC in any taxable year. We do not intend to monitor whether we generate RPII or becomes a RPII CFC.
Based on our current business assets and operations, we do not expect that we will be considered a passive foreign investment company (a PFIC) for U.S. federal income tax purposes. However, because PFIC status depends upon the composition of our income and assets and the market value of our assets (including, among others, less than 25% owned equity investments) in each year, which may be uncertain and may vary substantially over time, there can be no assurance that we will not be considered a PFIC for any taxable year. Our belief that our Company is not a PFIC is based, in part, on the fact that the PFIC rules include provisions intended to provide an exception for bona fide insurance companies predominately engaged in an insurance business. However, the scope of this exception is not entirely clear and there are no administrative pronouncements, judicial decisions or Treasury regulations that provide guidance as to the application of the PFIC rules to insurance companies.
If we were a RPII CFC in any taxable year or if the Company was treated as a PFIC for any taxable year, certain adverse consequences could apply to certain U.S. persons that own our shares of Class B common stock.
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Legislative and other measures that may be taken by local and federal government taxing authorities could materially increase our tax burden.
Our business is subject to substantial federal and local tax regulation and frequent changes to the applicable legislative and regulatory schemes could have a material impact in our business, cash flows, financial position or operating results.
Risks Relating to the Regulation of Our Industry
Changes in public policy, enactment of new laws, changes in governmental regulations, or the application thereof, may adversely affect our business, financial condition and results of operations.
Our business is subject to substantial federal and local regulation and frequent changes to the applicable legislative and regulatory schemes, including general business regulations and laws relating to taxation, privacy, data protection, pricing, insurance, Medicare and health care fraud and abuse laws. Please refer to Item 1. Business – Regulation . Changes in these laws, enactment of new laws or regulations, shifts in public policy, changes in interpretation of existing laws or changes in enforcement of existing laws and regulations may materially impact our business. Such changes include without limitation:
Initiatives to provide greater access to coverage for uninsured and under-insured populations without adequate funding to health plans, or to be funded through taxes or other negative financial levy on health plans;
Initiatives to limit health plans’ ability to review courses of treatment of patients;
Payments to health plans that are tied to the achievement of certain quality performance measures and medical loss ratio requirements;
Specific legislative or regulatory changes to the Medicare or Medicaid programs, including changes in the bidding process or other means to materially reduce premiums;
Local government regulatory changes;
Increased government enforcement actions, or changes in the interpretation or application, of fraud and abuse of health information privacy laws; and
Regulations that increase the operational burden on health plans, or that increase a health plan’s exposure to liabilities, including efforts to expand the tort liability of health plans.
Regulations promulgated by the Commissioner of Insurance and CMS and other agencies, among other things, influence how our insurance subsidiaries conduct business and place limitations on investments and dividends. Possible penalties for violations of such regulations include fines, orders to cease and desist, and possible suspension or termination of licenses. The regulatory powers of the Commissioner of Insurance are mainly designed to protect policyholders, not shareholders. While we cannot predict the terms of future regulation, the enactment of new legislation could affect the cost or demand for insurance policies, limit our ability to obtain rates or premiums, when needed, otherwise restrict our operations, limit the expansion of our business, expose us to expanded liability or impose additional compliance requirements. In addition, we may incur increased operating expenses in order to comply with new legislation.
Future regulatory actions by the Commissioner of Insurance or other governmental agencies, including federal authorities, could have a material adverse effect on the profitability or marketability of our business, financial condition and results of operations, which in turn could impact the value of our business model and result in potential impairments of our goodwill and other intangible assets.
The health care reform law, changes in laws related to the health care system, and the implementation of such law could have a material adverse effect on our business, financial condition, cash flows or results of operations.
The ACA provides comprehensive changes to the U.S. health care system.
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For example, health plans serving the individual market are subject to the guaranteed issue provisions under which the plans are required to issue coverage to individuals without regard to their health status of pre-existing conditions, which could lead to adverse selection by consumers. On July 16, 2014, the Department of Health and Human Services sent a letter to the Commissioner of Insurance of Puerto Rico notifying that guarantee issue provisions under ACA are not applicable to U.S. territories. However, on July 22, 2013, similar guarantee issue and other market reform provisions were enacted in Puerto Rico as part of amendments made to the Health Insurance Code of Puerto Rico. Although the Puerto Rico legislature is considering additional legislation to provide insurance companies more flexibility to comply with the additional requirements enacted in 2013, it is uncertain whether such legislation will in fact be enacted or the effect of any such additional legislation may have on our business. If we are unable to adapt our premium structure to address the guaranteed issue requirement, our results of operations, financial position and liquidity may be materially adversely affected.
In the years since its enactment, there have been, and continue to be, significant developments in and continued legislative activity around ACA, including attempts to repeal or repeal and replace the ACA. For example, on October 12, 2017, President Trump signed an executive order requiring the implementation of regulations that would exempt certain association plans from complying with ACA requirements, easing restrictions on certain short-term health plans and health reimbursement arrangements and limiting hospital and insurance company consolidation while promoting competition and choice. In August 2018 the Administration adopted a final rule to support short-term, limited duration scope policies. Additional activity related to the individual market is anticipated through state waivers although the Biden administration may seek to change this.
The Further Consolidated Appropriations Act of 2020 provides up to approximately $5.342 billion in Medicaid funding to Puerto Rico through September 30, 2021. Although we believe this legislation, together with the ACA and any changes thereto, may provide us with significant opportunities to grow our business, the implementation of enacted reforms, as well as future regulations and legislative changes, may have a material adverse effect on our results of operations, financial position or liquidity. If we fail to effectively implement our operational and strategic initiatives with respect to the implementation of health care reform, or do not do so as effectively as our competitors, our business may be materially adversely affected.
As a Medicare Advantage program participant, we are subject to complex regulations. If we fail to comply with these regulations, we may be exposed to criminal sanctions and significant civil penalties. Our Medicare Advantage contracts may also be terminated or our operations may be required to change in a manner that has a material effect on our business.
The laws and regulations governing Medicare Advantage program participants are complex, subject to interpretation and frequent change and can expose us to penalties for noncompliance. If we fail to comply with these laws and regulations, we could be subject to criminalfines, civil penalties or other sanctions, including the termination of our Medicare Advantage contracts. In addition, maintaining compliance with such laws and regulations as they change may, in some cases, entail substantial direct costs.
Under CMS regulations to implement certain ACA requirements that became effective on June 1, 2012, CMS has the authority not to renew our contracts beginning in 2015 based solely on the Star Ratings of our Medicare Advantage plans if their respective ratings do not achieve three or more stars (out of 5.0 stars) for three consecutive contract years. See the subcaption Federal Regulation in Item 1 of this Annual Report on Form 10-K for detailed information of the Stars Ratings. In the final call letter to Medicare Advantage organizations dated April 6, 2015, CMS stated that it would not delay contract terminations based on a plan’s Star Ratings.
CMS provides an increase to the rebate share in the bid from 50% to 65% when a program reaches 3.5 Stars, and to 70% when a plan reaches 4.5 Stars. Also, a 5% quality bonus is provided to plans with Star Ratings of 4.0 or more. As of December 31, 2020, TSA’s HMO plan achieved 4.0 Stars overall on a 5.0 Star rating system and TSA’s PPO plan achieved an overall rating of 3.5 Stars on a 5.0-Star rating system effective for product offerings in the year 2021.
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The Company is subject, and will likely continue to be subject, to audits from CMS in connection with the Medicare Advantage contracts. A CMS audit may review the effectiveness of multiple matters, including the performance of the benefit administration, coverage determinations, claims processing and payment, process of appeals and grievances, dismissals, oversight of agents and brokers, and enrollment process. CMS may impose civil monetary penalties as a result of their findings or require changes to our business practices that may adversely affect our profitability. CMS may also prevent us from subscribing new members or terminate any of our Medicare Advantage contracts if it determines that any of these plans have failed to substantially carry out the contract or is carrying out the contract in a manner that is inconsistent with the efficient or effective administration of the Medicare Advantage program. Compliance with CMS requirements may require us to divert resources that may affect the results of our operations and financial condition. Any termination or nonrenewal of our Medicare Advantage plans would have a material adverse effect on our business and financial results.
We may be subject to government audits, regulatory proceedings or investigative actions, that, may find that our policies, procedures, practices or contracts are not compliant with, or are in violation of, applicable health care regulations.
Federal, Puerto Rico, and Costa Rica government authorities, including but not limited to the Commissioner of Insurance, ASES, CMS, the OIG, the Office of the Civil Rights of HHS, the U.S. Department of Justice, the U.S. Department of Labor, and the OPM, regularly make inquiries and conduct audits concerning our compliance with applicable insurance and other laws and regulations. In addition, CMS has the right to require Medicare Advantage plan sponsors such as ourselves to self-disclose instances of noncompliance, enter into a corrective action plan, and/or hire an independent auditor to work in accordance with CMS specifications to validate if the deficiencies that were found during a CMS full or partial program audit have been corrected and provide CMS with a copy of their audit findings. If, in the future, we are required by CMS to hire an independent auditor, such an audit would entail direct costs to us, in addition to potential penalties in the event of negative audit findings. We may also become the subject of nonroutine regulatory or other investigations or proceedings brought by these or other authorities, and our compliance with and interpretation of applicable laws and regulations may be challenged. In addition, our regulatory compliance may also be challenged by private citizens under the whistleblower provisions of applicable laws. The defense of any such challenge could result in substantial cost, diversion of resources, and a possible material adverse effect on our business.
An adverse action could result in one or more of the following:
Recoupment of amounts we have been paid pursuant to our government contracts;
Mandated changes in our business practices;
Imposition of significant civil or criminalpenalties, fines or other sanctions on us and/or our key employees;
Additional reporting requirements and oversight and mandated corrective action or remediation plans;
Loss or nonrenewal of our government contracts or loss of our ability to participate in Medicare or other federal or local governmental payer programs;
Damage to our reputation;
Increased difficulty in marketing our products and services;
Inability to obtain approval for future services or geographic expansions;
Loss of one or more of our licenses to act as an insurance company, preferred provider or managed care organization or other licensed entity or to otherwise provide a service; and
Suspension of ability to subscribe members.
Our failure to maintain an effective corporate compliance program may increase our exposure to civil damages and penalties, criminal sanctions and administrative remedies, such as program exclusion, resulting from an adverse review. Any adverse review, audit or investigation could reduce our revenue and profitability and otherwise adversely affect our operating results.
Effectiveprevention, detection and control systems are critical to maintaining regulatory compliance and preventingfraud. Failure of these systems could adversely affect the Company.
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Failure to prevent, detect or control systems related to regulatory compliance or the failure of employees to comply with our internal policies, including data systems security or unethical conduct by managers and employees, could adversely affect our reputation and also expose us to litigation and other proceedings, fines and penalties. Federal and state governments have made investigating and prosecuting health care and other insurance fraud and abuse a priority. Fraud and abuse prohibitions encompass a wide range of activities, including kickbacks for referral of members, billing for unnecessary medical services, improper marketing, and violations of patient privacy rights. The regulations and contractual requirements applicable to the Company are complex and subject to change. In addition, ongoing vigorous law enforcement, a highly technical regulatory scheme and the Dodd-Frank legislation and related regulations being adopted that enhance regulators’ enforcement powers and whistleblower incentives and protections, mean that the compliance efforts in this area will continue to require significant resources.
In addition, provider or member fraud that is not prevented or detected could impact our medical costs or those of our self-insured customers. Further, during an economic downturn, our segments, including our Life Insurance and Property and Casualty segments may see increased fraudulentclaims volume which may lead to additional costs because of increased disputedclaims and litigation.
If we fail to comply with applicable privacy and security laws, regulations and standards, including with respect to third-party service providers that utilize sensitive personal information on our behalf; or if we fail to address emerging security threats, including cybersecurity threats, or fail to detect and prevent privacy and security incidents, including those related to cybersecurity, our business, reputation, results of operations, financial position and cash flows could be materially and adversely affected.
The collection, maintenance, protection, use, transmission, disclosure and disposal of sensitive personal information are regulated at the federal, state, international and industry levels and requirements are imposed on us by contracts with customers. HIPAA regulations also provide access rights and other rights for health plan beneficiaries with respect to their health information. These regulations include standards for certain electronic transactions, including encounter and claims information, health plan eligibility and payment information. Health plans are also subject to beneficiary notification and remediation obligations in the event of an authorized use or disclosure of personal health information. HIPAA also requires business associates as well as covered entities to comply with certain privacy and security requirements. Even though we provide for appropriate protections through our contracts with our third-party service providers and, in certain cases assess their security controls, we still have limited oversight or control over their actions and practices.
Our facilities and systems and those of our third-party service providers may be vulnerable to privacy and security incidents, security attacks and breaches, acts of vandalism or theft, computer viruses, coordinated attacks by activist entities, emerging cybersecurity risks, misplaced or lost data, programming and/or human errors or other similar events. Emerging and advanced security threats, including coordinated attacks, require additional layers of security that may disrupt or impact efficiency of operations.
Compliance with multiple and/or new privacy and security laws, regulations and requirements may result in increased operating costs, and may constrain our ability to manage our business model. In addition, HHS has expanded its HIPAA audit program to assess compliance efforts not only by covered entities, but also business associates. Although we are not aware of HHS plans to audit any of our covered entities or business associates, an audit resulting in findings or allegations of noncompliance could have a material adverse effect on our results of operations, financial position and cash flows. We are also subject to stricter breach notification requirements than those imposed on covered entities by virtue of HIPAA in terms of having to provide ASES with notice of a breach within 24 hours. These and other regulatory aspects make compliance with applicable health information laws more difficult. For these reasons, our total compliance costs may increase in the future.
Noncompliance or findings of noncompliance with applicable laws, regulations or requirements, or the occurrence of any privacy or security breach involving the misappropriation, loss or other unauthorized disclosure of sensitive personal information, whether by us or by one of our third-party service providers, could have a material adverse effect on our reputation and business. This includes mandatory disclosure to the media, significant increases in the cost of managing and remediating privacy or security incidents and material fines, penalties and litigation awards, among other consequences, any of which could have a material and adverse effect on our results of operations, financial position and cash flows.
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The revised rate calculation system for Medicare Advantage, the payment system for Medicare Part D, and changes in the methodology and payment policies used by CMS to establish rates could reduce our profitability and the benefits we offer our beneficiaries.
Medicare Advantage managed care plans are paid based off a CMS-calculated benchmark amount, and plans submit competitive bids that reflect the costs they expect to incur in providing the base Medicare benefits. A Medicare Advantage plan’s actual payment rate is based on a complex statutory formula that takes into account a number of factors, including the relationship between the plan’s bid and the benchmark. Medicare generally will rebate a portion of the amount by which the benchmark amount exceeded the accepted bid for certain plans. For plans achieving a Star rating of at least 3.5 Stars, the portion of the savings retained by the plan is higher. For plans achieving a Star rating of at least 4 Stars, the starting benchmark amount from which the savings is computed is also higher (a quality bonus). If the bid is greater than the benchmark, the plan will be required to charge a premium to enrollees equal to the difference between the bid and the benchmark, which could affect our ability to attract enrollees. CMS reviews the methodology and assumptions used in bidding with respect to medical and administrative costs, profitability and other factors. CMS could challenge such methodology or assumptions or seek to cap or limit plan profitability. CMS also could administratively seek to implement certain methodological changes to the Medicare Advantage rate calculations that could result in functionally lower payment rates, and may have a material adverse effect on our revenue, financial position, results of operations or cash flow .
We also face the risk of reduced or insufficient government funding and we may need to terminate our Medicare Advantage contracts with respect to unprofitable markets. In addition, as a result of the competitive bidding process, our ability to participate in the Medicare Advantage program is affected by the pricing and design of our competitors’ bids. Moreover, we may in the future be required to reduce benefits or charge our members an additional premium in order to maintain our current level of profitability, either of which could make our health plans less attractive to members and adversely affect our membership.
CMS’s risk-adjustment payment system and other Medicare Advantage funding pressures make our revenue and profitabilitydifficult to predict and could result in material retroactive adjustments to our results of operations.
CMS has implemented a risk-adjustment payment system for Medicare Advantage plans to improve the accuracy of payments and establish incentives for such plans to enroll and treat less healthy Medicare beneficiaries. The risk-adjusted premiums we receive are based on claims and encounter data that we submit to CMS within prescribed deadlines. We develop our estimates for risk-adjusted premiums utilizing historical experience, or other data, and predictive models as sufficient member risk score data becomes available over the course of each CMS plan year. We recognize periodic changes to risk-adjusted premiums as revenue when the amounts are determinable and collection is reasonably assured. This is possible as additional diagnosis code information is reported to CMS, when the ultimate adjustment settlements are received from CMS, or we receive notification of such settlement amounts. CMS adjusts premiums on two separate occasions on a retrospective basis. The first retrospective adjustment for a given plan year generally occurs during the third quarter of that year. This initial settlement represents the update of risk scores for the current plan year based on the severity of claims incurred in the prior plan year. CMS then issues a final retrospective risk adjusted premium settlement for that plan year in the following year. The data provided to CMS to determine members’ risk scores is subject to audit by CMS even after the annual settlements occur, which may result in the refund of premiums to CMS. The result of these audits could materially reduce premium revenue in the year in which CMS determines a refund is required and could be material to our result of operations, financial position and cash flows.
CMS is making significant changes to the manner in which it determines risk-adjustment payments, including possible retroactive recoveries. CMS introduced a new model for 2020 and continues to shift towards encounter-based risk scores (EDS). As a result of the risk-adjustment process and CMS’s ability to modify the manner in which it applies such risk-adjustments, it is difficult to predict with certainty our future revenue or profitability. In addition, our own risk scores for any period may result in favorable or unfavorable adjustment to payment from CMS and our Medicare payment revenue.
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Finally, we generally rely on providers, including certain network providers who are not our employees, to appropriately document all medical data, including the diagnosis codes submitted with claims, as the basis for our risk scores under the program. Thus, our ability to meet our premium revenue estimates depends largely on the success of third-party efforts to collect and properly reflect medical data, including diagnosis codes that must be submitted with claims. There is no assurance that our providers will be successful in accurately collecting such medical data and diagnosis codes and, to the extent their efforts are not successful, such failure may have a material adverse effect on our premium revenues.
ASES’s risk-adjustment payment system and payment structure, and its dependence on scarce or unavailable data, make our revenue and profitabilitydifficult to predict and could result in material retroactive adjustments to our results of operations.
ASES has implemented a risk-adjustment payment system for the Vital Program plan to reflect the differences in morbidity of enrolled members and differences in the regional cost of care. The risk adjusted payment transfers are based on claims and encounter data that is submitted to ASES. The risk-adjustment factors are based on a prospective model, whereby the data for the prior year is used to establish the risk-adjustment payments for the current year. For example, the risk scores are assigned to each member for the contract year ending October 31, 2019 using claims data for those members during the year ending October 31, 2018. We have been unable to develop reliable estimates for risk-adjusted premiums due to the lack of available data from prior periods which are the basis for risk scores. We were instructed of a final risk-adjustment transfer payment for the fiscal period ending October 31, 2019, but have not received any notification for the second fiscal period ending June 30, 2020. We have not recognized any expected risk-adjustment payment or receipt and the final risk-adjustment calculations may result in an unfavorable adjustment. ASES has not provided a timeline for the communication of the risk transfer payments.
Furthermore, the premium rates for the second contract year, which represents the period November 1, 2019 to June 30, 2020, will be adjusted by a morbidity factor that will reflect the change in the overall morbidity of the population from the base period (July 1, 2016 to June 30, 2017) and the contract year. This adjustment may result in unfavorable adjustment to payments from ASES and our Medicaid premium revenue.
ASES has additionally implemented a payment structure for the program that assigns members to one of 37 rate cells based on their age, gender, eligibility category and health conditions. Members assigned to High Cost High Needs (HCHN) rate cells receive premium payments that are much higher than those assigned based only on age and gender. If our enrollees are not assigned to the adequate rate cell, the premium we receive may not be sufficient to cover their utilization, particularly in the case of HCHN members.
Finally, ASES may recover premiums paid for non-eligible participants. However, we are dependent on ASES, which is in turn dependent on the local Medicaid office, for eligibility data. Historically, ASES has not received updated eligibility data from the local Medicaid office in a timely manner. Therefore, if we are not provided with timely eligibility data and we bill ASES for non-eligible members, ASES could attempt to recoup premiums from us, which could have a significant impact on our consolidated premiums and profitability.
If our Medicare Advantage members enroll in another Medicare Advantage plan during the open enrollment season, they will be automatically disenrolled from our plan, possibly without our immediate knowledge.
Pursuant to the MMA, members enrolled in one insurer’s Medicare Advantage program will be automatically disenrolled from that program if they enroll in another insurer’s Medicare Advantage program. If our members enroll in another insurer’s Medicare Advantage program, we may not discover that such member has been disenrolled from our program until we fail to receive reimbursement from CMS in respect of such member, which may occur sometime after the disenrollment. Therefore, we may discover that a member has disenrolled from our program after we have already provided services to such individual. Our profitability would be reduced as a result of such failure to receive payment from CMS, if we had made related payments to providers and were unable to recoup such payments from them.
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Our insurance subsidiaries are subject to minimum capital requirements. Our failure to meet these standards could expose us to regulatory actions.
Puerto Rico insurance laws and the regulations promulgated by the Commissioner of Insurance, among other things, impose minimum capital requirements on our insurance subsidiaries. Although our insurance subsidiaries are currently in compliance with these requirements, there can be no assurance that we will continue to comply in the future. Failure to maintain required levels of capital or to otherwise comply with the reporting requirements of the Commissioner of Insurance could subject our insurance subsidiaries to corrective actions, including involuntary rehabilitation or liquidation processes, or require us to provide financial assistance, either through subordinated loans or capital infusions, to ensure they maintain their minimum statutory capital requirements.
We are also subject to minimum capital requirements pursuant to our BCBSA license agreements. See Risks Related to Our Business ― The termination or modification of our license agreements to use the BCBS name and mark could have a material adverse effect on our business, financial condition and results of operations .
Puerto Rico insurance laws and regulations, our license agreement with the BCBSA, and provisions of our Articles of incorporation and bylaws could delay, deter or prevent a takeover attempt that shareholders might consider to be in their best interests. It may also make it more difficult to replace members of our Board of Directors and have the effect of entrenching management.
Puerto Rico insurance laws and the regulations promulgated thereunder, in addition to our amended and restated Articles of Incorporations (Articles) and bylaws, may delay, defer, prevent or render more difficult a takeover attempt that our shareholders might consider to be in their best interests. For instance, they may prevent our shareholders from receiving the benefit from any premium to the market price of our common stock offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging takeover attempts in the future.
Our Articles and bylaws have anti-takeover effects and may delay, defer or prevent a takeover attempt that our shareholders might consider to be in their best interests. In particular, our Articles and bylaws:
Permit our Board of Directors to issue one or more series of preferred stock;
Divide our Board of Directors into three classes serving staggered three-year terms;
Limit the ability of shareholders to remove Directors;
Impose restrictions on shareholders’ ability to fill vacancies on our Board of Directors;
Impose advance notice requirements for shareholder proposals and nominations of Directors to be considered at meetings of shareholders; and
Impose restrictions on shareholders’ ability to amend our Articles and bylaws.
Puerto Rico insurance laws and the regulations promulgated by the Commissioner of Insurance may also delay, defer, prevent or render more difficult a takeover attempt that our shareholders might consider to be in their best interests. For instance, the Commissioner of Insurance must review any merger, consolidation or new issuance of shares of capital stock of an insurer or its parent company and make a determination as to the fairness of the transaction. Also, a Director of an insurer must meet certain requirements imposed by Puerto Rico insurance laws.
Furthermore, change of control statutes that apply to insurance companies provide that no person may make an offer to acquire or to sell the issued and outstanding voting stock of an insurance company, which constitutes 10% or more of its issued and outstanding stock, or of the total issued and outstanding stock of an insurance holding company, without the prior approval of the Commissioner of Insurance. We are also subject to change of control limitations pursuant to our BCBSA license agreements. The BCBSA ownership limits restrict beneficial ownership of our voting capital stock to less than 10% for an institutional investor and less than 5% for a non-institutional investor, both as defined in our amended and restated Articles. In addition, no person may beneficially own shares of our common stock or other equity securities, or a combination thereof, representing a 20% or more ownership interest, whether voting or non-voting, in our company. This provision in our Articles cannot be changed without prior approval of the BCBSA and the vote of holders of at least 75% of our common stock.
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These voting and other restrictions may operate to make it more difficult to replace members of our Board of Directors and may have the effect of entrenching management regardless of their performance.
General Risk Factors
The effectiveness of our Company’s strategy, our ability to align talent to our business needs and risks, and our ability to manage and safeguard our brand and reputation present overarching risks for our Company.
Effectiveness of our enterprise strategy, talent management and alignment of talent to our business needs and risks to our brand and reputation present overarching risks to our Company. There can be no assurance regarding the effectiveness of our enterprise strategy, our ability to manage and align our talent to our business needs or our ability to avoid harm to our brand and reputation. In addition, there can be no assurance that U.S. government fiscal policy, the implementation of the ACA, repeal or other changes to the ACA or additional changes to the U.S. health care system will not require us to revise the ways in which we conduct business, put us at risk of loss of business or materially adversely affect our business, cash flows, financial position or operating results.
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 claims incurred for each period consists of claims reported but not paid during the period, as well as a management and actuarial estimate of claims 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 betterloss 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 litigationclaims 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 unpaidclaims 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 malpracticelitigation. Costs in excess of those anticipated could have a material adverse 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 unpaidclaims, both reported and unreported, for any period, are those claims which are incurred in the final months of the period. Since the percentage of claims paid during the period with respect to claims 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 unpaidclaims, historical completion factors and payment patterns are applied to incurred and paid claims for the most recent twelve months and compared to the prior twelve month period. Incurred claims for the most recent twelve months also take into account recent claims expense levels and health care trend levels (trend factors). Using all of the above methodologies, our actuaries determine based on the different circumstances the unpaidclaims 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 adversedeviation, which is an estimate for known environmental factors that are reasonably likely to affect the required level of reserves. This provision for adversedeviation 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 unreportedclaims, 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 loss information emerges, claims 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 loss experience for unreported, potential development, and loss 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 unreportedclaims 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 loss 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 unreportedclaims 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 impairmentloss 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 uncollectible 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 impairmentloss 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 impairmentloss 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 impairmentlossesagainst 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.
