Item 1. Business
General Description of Business and Recent Developments
Triple-S Management Corporation (“Triple-S”, “TSM”, the “Company”, the “Corporation”, “we”, “us” or “our”) is one of the most significant players in the managed care industry in Puerto Rico, serving approximately 2,139,000 members across all regions, with a 29% market share in terms of premiums written in Puerto Rico for the nine-month period ended September 30, 2014. We have the exclusive right to use the Blue Cross and Blue Shield (“BCBS”) name and mark throughout Puerto Rico, the U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla and over 50 years of experience in the managed care industry. We offer a broad portfolio of managed care and related products in the commercial and Medicare markets. We market our managed care products through an extensive network of independent agents and brokers located throughout Puerto Rico as well as an internal salaried sales force. We provide administration services only or self insured (“ASO”) managed care services to Plan de Salud del Gobierno (similar to Medicaid) (“PSG”or “Medicaid”) island-wide and beginning on April 1, 2015 we will resume our participation in this sector as a fully insured provider in two regions of Puerto Rico. PSG is a government of Puerto Rico-funded managed care program for the medically indigent that is similar to the Medicaid program in the U.S.
We also offer complementary products and services, including life insurance, accident and disability insurance and property and casualty insurance. We are one of the leading providers of life insurance policies in Puerto Rico.
A substantial mayority of premiums generated by our insurance subsidiaries are from customers within Puerto Rico. In addition, mostly all of our long-lived assets, other than financial instruments, including deferred policy acquisition costs and value of business acquired, goodwill and other intangibles, and the deferred tax assets are related to Puerto Rico.
In December 2014, our subsidiaries Triple-S Salud, Inc. (“TSS”) and Triple-S Advantage, Inc. (“TSA”) entered into a novation agreement after obtaining approval from Centers for Medicare and Medicaid Services (“CMS”), whereby all the assets and liabilities of TSS’s Medicare Advantage business were transferred to TSA and TSA assumed all the obligations of the policies and all obligations that may exist under the policies and contracts.
In October 2014, our Board of Directors authorized a $50.0 million share repurchase program of our Class B common stock. Repurchases are being 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 2014, the Company repurchased and retired 228,525 shares of Class B common stock under this program at an average per share price of $23.55, for an aggregate cost of approximately $5.3 million.
On November 7, 2013, our subsidiary Triple-S Vida, Inc. (“TSV”) completed the acquisition of 100% of the outstanding capital stock of Atlantic Southern Insurance Company (“ASICO"). Effective March 27, 2014 this entity changed its name to Triple-S Blue, Inc. (“Triple-S Blue” or “TSB”), a life insurance company authorized to do business in Puerto Rico, Costa Rica, Anguilla and British Virgin Islands. The cost of this acquisition was approximately $9.4 million and was funded with unrestricted cash. Our consolidated results of operating and financial condition included in this Annual Report on Form 10-K reflect TSB’s acquisition in periods subsequent to the effective date of the transaction, and included within the Life Insurance segment.
In July 2013, we announced the immediate commencement of an $11.5 million share repurchase program, as authorized by our Board of Directors. This program was conducted in accordance with Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934.
On May 17, 2013, the Company converted $6.7 million of the $9.0 million outstanding Class A shares into Class B shares and concurrently conducted a marketed secondary public offering for a substantial majority of the converted shares. As part of this transaction the Company repurchased and retired 1,000,000 shares at a price of $18.25.
In January 2012, we acquired a controlling interest in a health clinic in Puerto Rico, as part of our strategic approach in our Managed Care segment.
On February 7, 2011, TSS completed the acquisition of 100% of the outstanding capital stock of Socios Mayores en Salud Holdings, Inc., the indirect parent company of American Health, Inc. (effective January 4, 2014 this entity changed its name from American Health, Inc. to Triple-S Advantage, Inc., from now on referred to as “Triple-S Advantage” or “TSA”), a provider of Medicare Advantage services. The cost of this acquisition was approximately $84.8 million, and was funded with unrestricted cash. The consolidated results of operations and financial condition of the Corporation included in this Annual Report on Form 10-K reflect the results of operations of TSA in periods subsequent to the effective date of the transaction and were included within our Managed Care segment.
In this Annual Report on Form 10-K, references to “shares” or “common stock” refer collectively to our Class A and Class B common stock, unless the context indicates otherwise.
Industry Overview
Managed Care
In response to an increasing focus on health care costs by employers, the government and consumers, there has been a growth in alternatives to traditional indemnity health insurance, such as Health Maintenance Organizations (“HMOs”) and Preferred Provider Organizations (“PPOs”). Through the introduction of these alternatives the managed care industry has attempted to contain the cost of health care by negotiating contracts with hospitals, physicians and other providers to deliver health care to plan members at favorable rates. These products usually feature medical management and other quality and cost optimization measures such as pre-admission review and approval for certain non-emergency services, pre-authorization of certain outpatient surgical procedures, network credentialing to determine that network doctors and hospitals have the required certifications and expertise, and various levels of care management programs to help members better understand and navigate the medical system. In addition, providers may have incentives to achieve certain quality measures or may share medical cost risk. Members generally pay co-payments, coinsurance and deductibles when they receive services. While the distinctions between the various types of plans have lessened over recent years, PPO products generally provide reduced benefits for out-of-network services, while traditional HMO products generally provide little to no reimbursement for non-emergency out-of-network utilization. An HMO plan may also require members to select one of the network primary care physicians (“PCPs”) to coordinate their care and approve any specialist or other services.
The government of the United States of America (the “U.S. government” or “federal government”) provides hospital and medical insurance benefits to eligible people aged 65 and over as well as certain other qualified persons through the Medicare program, including the Medicare Advantage program. The federal government also offers prescription drug benefits to Medicare eligibles, both as part of the Medicare Advantage program and on a stand-alone basis, pursuant to Medicare Part D (also referred to as “PDP stand-alone product” or “PDP”). In addition, the government of the Commonwealth of Puerto Rico (the “Government of Puerto Rico”) provides managed care coverage to the medically indigent population of Puerto Rico.
We have noticed that economic factors and greater consumer awareness have resulted in (a) the increasing popularity of products that offer larger, more extensive networks, more member choice related to coverage, physicians and hospitals, greater access to preventive care and wellness programs, and a desire for greater flexibility for customers to assume larger deductibles and co-payments in return for lower premiums and (b) products with lower benefits and a narrower network in exchange for lower premiums. We believe we are well positioned to respond to these market preferences due to the breadth and flexibility of our product offering and size of our provider networks.
We are licensed by the Blue Cross and Blue Shield Association (“BCBSA”) to use the Blue Cross Blue Shield (“BCBS”) name and mark in Puerto Rico, the U.S. Virgin Islands, Costa Rica and the British Virgin Islands and Anguilla. The BCBSA had 37 independent licensees as of December 31, 2014. BCBS membership stood at approximately 105 million members at December 31 2014, which represents approximately 33% of the U.S. population. The BCBS plans work cooperatively in a number of ways that create significant market advantages, especially when competing for very large, multi-state employer groups. For example, all BCBS plans participate in the BlueCard program, which effectively creates a national “Blue” network. Each plan is able to take advantage of other BCBS plans’ broad provider networks and negotiated provider reimbursement rates where a member covered by a policy in one state or territory lives or travels outside such state or territory. The BlueCard program is a source of revenue from services provided in Puerto Rico to individuals who are customers of other BCBS plans and also provides us a significant network in the U.S, creating a significant competitive advantage for us because Puerto Ricans frequently travel to the continental United States.
Life Insurance
Total annual premiums in Puerto Rico for the year ended December 31, 2013 for the life insurance market approximated $1.4 billion. The main products in this market are ordinary life, cancer and other dreaded diseases, term life, disability and annuities. The main distribution channels are independent agents. Banks have established general agencies to cross sell life insurance products, such as term life and credit life.
Property and Casualty Insurance
The total property and casualty market in Puerto Rico in terms of gross premiums written for the nine months ended September 30, 2014 was approximately $1.4 billion. Property and casualty insurance companies compete for the same accounts through aggressive pricing, more favorable policy terms and better quality of services. The main lines of business in Puerto Rico are personal and commercial auto, commercial multi-peril, fire and allied lines and other general liabilities. Approximately 73% of the market is written by the top six companies in terms of market share, and approximately 87% of the market is written by companies incorporated under the laws of and which operate principally in Puerto Rico.
The Puerto Rican property and casualty insurance market is highly dependent on reinsurance.
Puerto Rico’s Economy
Description
Puerto Rico’s economy entered a recession in the fourth quarter of fiscal year 2006. For fiscal years 2007, 2008, 2009, 2010 and 2011 the real gross national product (“GNP”) contracted by 1.2%, 2.9%, 3.8%, 3.6%, and 1.7% respectively. GNP grew by 0.9% and 0.3% in fiscal years 2012 and 2013, respectively. According to the Puerto Rico Planning Board’s (the “Planning Board”) latest projections, made in April of 2014, it is projected that Puerto Rico’s real GNP for fiscal years 2014 and 2015 will grow by 0.1% and 0.2%, respectively. However, the monthly economic indicators for the fiscal year 2014 indicate that the final GNP figures for the fiscal year may end up lower than the projection presented by the Planning Board. The Planning Board is expected to publish a revision of this forecast during the second quarter of fiscal year 2015.
In fiscal year 2013, aggregate personal income was $63.4 billion and personal income per capita was $17,413. Personal income includes transfer payments to individuals in Puerto Rico under various social programs. Total United States federal transfer payments to individuals amounted to $15.6 billion in fiscal year 2013 and $15.7 billion in fiscal year 2012.
Total employment decreased at an average annual rate of 0.9% from 1,150,291 to 1,006,646 from fiscal year 2000 to fiscal year 2014. A reduction in total employment began in the fourth quarter of fiscal year 2007 and has continued consistently through fiscal year 2014 due to the current recession and contractionary fiscal adjustment measures. According to the Household Survey, during fiscal year 2014, total employment fell by 2.2% when compared to the prior fiscal year, and the unemployment rate averaged 14.3% compared to 14.0% for the prior fiscal year. Furthermore, for the first quarter of fiscal year 2015, total employment decreased by 3.3% with respect the first quarter of fiscal year 2014.
The dominant sectors of the Puerto Rico economy in terms of production and income are manufacturing and services. The manufacturing sector has undergone fundamental changes over the years as a result of the phase out of Section 936 of the United States Internal Revenue Code, which provided certain tax incentive for U.S. corporation doing business in Puerto Rico, and an increased emphasis on higher wages, high technology industries, such as pharmaceuticals, biotechnology, computers, microprocessors, professional and scientific instruments, and certain high technology machinery and equipment. At the present time, almost 90% of manufacturing is generated by chemical and electronic products. The services sector, which includes finance, insurance, real estate, wholesale and retail trade, transportation, communications and public utilities, and other services, plays a major role in the economy. It ranks second to manufacturing in contribution to the gross domestic product and leads all sectors in providing employment.
The economy of Puerto Rico is affected by external factors determined by the U.S. economy and the policies, and results of the U.S. government. These external factors include exports, direct investment, the amount of federal transfer payments, the level of interest rates, the rate of inflation, and revenues derived from tourism coming from the U.S. Generally, the economy of Puerto Rico has followed the economic trends of the U.S. economy. However, economic growth in Puerto Rico has not been consistent with the performance of the United States economy recently. The government has faced a number of fiscal challenges, including an imbalance between its general fund revenues and expenditures, reaching its highest level in fiscal year 2009 with a deficit of $3.3 billion. Recurrent budget deficits have substantially increased the amount of public sector debt. The total outstanding public sector debt amounted to $71.4 billion as of July 31, 2014.
Recent Measures
The Government of Puerto Rico is been focused on implementing a fiscal plan and other measures aimed to improve its fiscal situation, restoring economic growth and finding solutions for its underfunded pension system. The fiscal plan consists of the following measures: (1) enhancing liquidity through market transactions, such as the $3.5 billion issuance of general obligation bonds and the planned issuance of a significant amount of bonds through the Puerto Rico Infrastructure Financing Authority, (2) providing a balanced budget without deficit financing through initiatives such as the enactment of the Fiscal Sustainability Act in order to ensure compliance with austerity measures and implement appropriations controls, (3) making the public corporations self-sufficient by raising rates, providing for new revenues and providing for an orderly debt adjustment process through the enactment on June 28, 2014 of the Puerto Rico Public Corporation Debt Enforcement and Recovery Act (the “Recovery Act”), and (4) reforming the tax code in order to increase government revenues and provide a sustainable economic growth.
The Recovery Act is intended to provide a legal framework for restructuring public corporation debt. The Central Government, municipalities and related agencies (including senior lien bonds issued by the Sales Tax Financing Corporation, “COFINA”) were explicitly excluded from seeking relief under the provisions of the Recovery Act. In other words, the Recovery Act made a clear distinction between the central Government, including its related entities, and the agencies or public corporations.
On February 6, 2015, the U.S. District Court of Puerto Rico ruled the Recovery Act unconstitutional, noting that it overstepped federal law and enjoined Commonwealth officials from enforcing it. As a response, the Resident Commissioner of Puerto Rico, a non-voting member of the U.S. House of Representatives, filed a bill seeking to allow the public corporations to restructure their debt under Chapter 9 of the federal bankruptcy code, if needed.
On February 11, 2015, in an attempt to raise additional revenue, encourage savings and stimulate economic development, the Governor of Puerto Rico presented a comprehensive tax reform bill that proposes to replace the 7% sales and use tax with a 16% value added tax in combination with lower income tax rates and other fiscal measures. As proposed, the new value added tax would apply to services such as medical services paid by commercial health plans and business to business transactions not included in the current sales and use tax.
Rating Agencies
Since 2014, Standard & Poor’s (S&P) and Moody’s Investors Service (“Moody’s”) have taken several ratings actions, affecting both Puerto Rico general obligation, guaranteed bonds, and the ratings of its public corporations’ issued debt. The Company’s main exposure to Puerto Rico currently resides in its holdings of COFINA.
There have been three rounds of ratings downgrades by crediting agencies of certain Puerto Rico government bonds since 2014. The first round began on February 4, 2014, when S&P lowered its rating for Puerto Rico general obligation bonds from “BBB-” to “BB+” noting liquidity constraints as the main reason for the downgrade. On February 7, 2014 Moody’s downgraded Puerto Rico’s general obligation bonds from “Baa3” to “Ba2,” combined with a negative outlook, noting a high debt load and fixed costs, narrow liquidity and constrained market access.
The second round of ratings downgrades was during July 2014, after the enactment of the Recovery Act. On July 1, 2014, Moody’s downgraded Puerto Rico’s general obligation bonds to “B2” and maintained a negative outlook. According to Moody’s, the Recovery Act marked the end of the Commonwealth’s long history of taking actions needed to support its debt. The rating agency further noted that it signals a depleted capacity for revenue increases and austerity measures, and a new preference for shifting fiscal pressures to creditors. Also on July 1, 2014, Moody’s downgraded COFINA senior bonds to “Ba3,” maintaining a negative outlook. The rating agency also positioned the COFINA ratings closer to the rating of Puerto Rico general obligation bonds, reflecting their increased susceptibility to any action that impairs bondholders’ claims on sales tax revenues. On July 11, 2014, S&P downgraded Puerto Rico general obligation bonds to “BB,” combined with a negative outlook and took similar action with the COFINA’s senior bonds downgrading them to “BBB,” maintaining a negative outlook. The downgrade positioned COFINA’s rating closer to that of the Puerto Rico’s general obligation bonds, as a result of the view that the Recovery Act raised the risk that Puerto Rico could seek additional changes in statutory law that could potentially reduce the separation in credit quality of the sales tax pledge from the central government’s finances, should financial stress on the general fund increase significantly.
During February 2015, a third round of ratings downgrades took place. On February 12, 2015, S&P downgraded Puerto Rico’s general obligation bonds to “B,” maintaining a negative outlook, noting the potential inability to meet debt commitments. Also on February 12, 2015, S&P lowered the rating of COFINA senior lien bonds to “B,” maintaining a negative outlook, noting that the value added tax proposed by the Government of Puerto Rico in a recently introduced legislation would create increased uncertainty as to the timing of receipts of pledged revenues and whether bond covenants separating the tax revenue from that of the central government may be maintained. On its part, on February 19, 2015, Moody’s lowered its rating of Puerto Rico’s general obligation bonds to “Caa2,” maintaining a negative outlook, noting tax revenue shortfalls, narrow liquidity and the substantial growth in debt payments in the upcoming fiscal year. Also on February 19, 2015, Moody’s lowered the rating of COFINA senior lien bonds to “B3”, maintaining a negative outlook.
See “Item 1A.
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 risks 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 immaterial 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.
Risks Relating to our Capital Stock
Certain of our current and former providers may bring materially dilutive claims against us.
Beginning with our founding in 1959 and until 1994, we encouraged, and at times required, the doctors and dentists that comprised our provider network to acquire our shares. Between approximately 1985 and 1994, our predecessor managed care subsidiary, Seguros de Servicios de Salud de Puerto Rico, Inc. (“SSS”) generally entered into an agreement with each new physician or dentist who joined our provider network to sell the provider shares of SSS at a future date (each agreement, a “share acquisition agreement”). These share acquisition agreements were necessary because there were not enough authorized shares of SSS available during this period and afterwards for issuance to all new providers. Each share acquisition agreement committed SSS to sell, and each new provider to purchase, five $40-par-value shares of SSS at $40 per share after SSS had increased its authorized share capital in compliance with the Puerto Rico Insurance Code and was in a position to issue new shares. Despite repeated efforts in the 1990s, SSS was not successful in obtaining shareholder approval to increase its share capital, other than in connection with the Corporation’s reorganization in 1999, when SSS was merged into a newly-formed entity having authorized capital of 25,000 $40-par-value shares, or twice the number of authorized shares of SSS. SSS’s shareholders did not, however, authorize the issuance of the newly formed entity’s shares to providers or any other third party. In addition, subsequent to the reorganization, our shareholders did not approve attempts to increase our share capital in 2002 and 2003.
Notwithstanding the fact that TSS and its predecessor, SSS, were never in a position to issue new shares to providers as contemplated by the share acquisition agreements because shareholder approval for such issuance was never obtained, and the fact that SSS on several occasions in the 1990s offered providers the opportunity to purchase shares of its treasury stock and such offers were accepted by very few providers, providers who entered into share acquisition agreements may claim that the share acquisition agreements entitled them to acquire our or TSS’s shares at a subscription price equivalent to that provided for in the share acquisition agreements. SSS entered into share acquisition agreements with approximately 3,000 providers, the substantial majority of whom never came to own shares of SSS. Such share acquisition agreements provide for the purchase and sale of approximately 15,000 shares of SSS. If we or TSS were required to issue a significant number of shares in respect of these agreements, the interest of our existing shareholders would be substantially diluted. As of the date of this Annual Report on Form 10-K, only one judicial claim to enforce any of these agreements has been brought against the Company. The case was settled by the parties and, on August 2013, dismissed by the court with prejudice. Additionally, we have received several inquiries with respect to share acquisition agreements. Those agreements do not include anti-dilution protections and we do not believe that the amounts of any claims under the agreements with SSS should be multiplied to reflect the 3,000-for-one stock split effected by us on May 1, 2007. We cannot provide assurances, however, that claimants will not successfully seek to increase the size of their claims by reference to the stock split.
We have been advised by our counsel that, on the basis of a reasoned analysis, while the matter is not free from doubt and there are no applicable controlling precedents, we should prevail in any litigation of these claims because, among other defenses, the condition precedent to SSS’s obligations under the share acquisition agreements never occurred, and any obligation it may, or we may be deemed to, have had under the share acquisition agreements should be understood to have expired prior to our corporate reorganization, which took effect in 1999, although the share acquisition agreements do not expressly provide for any expiration.
We believe that we should prevail in any litigation with respect to these matters; however, we cannot predict the outcome of any such litigation, including with respect to the magnitude of any claims that may be asserted by any plaintiff, and the interests of our shareholders could be materially diluted to the extent that claims under the share acquisition agreements are successful.
Heirs of certain of our former shareholders may bring materially dilutive claims against us.
For much of our history, we and our predecessor entity have restricted the ownership or transferability of our shares, including by reserving to us or our predecessor a right of first refusal with respect to share transfers and by limiting ownership of such shares to physicians and dentists. In addition, we and our predecessor, consistent with the requirements of our and our predecessor’s bylaws, have sought to repurchase shares of deceased shareholders at the amount originally paid for such shares by those shareholders. Nonetheless, former shareholders’ heirs who were not eligible to own or be transferred shares because they were not physicians or dentists at the time of their purported inheritance (“non-medical heirs”), may claim an entitlement to our shares or to damages with respect to the repurchased shares notwithstanding applicable transfer and ownership restrictions. Our records indicate that there may be as many as approximately 450 former shareholders whose non-medical heirs may claim to have inherited up to 10,500,000 shares after giving effect to the 3,000-for-one stock split. As of the date of this Annual Report on Form 10-K, we are defending various judicial claims by non-medical heirs of former shareholders whose shares were repurchased upon their death seeking the return of or compensation. See “Item 3. Legal Proceedings - Claims by Heirs of Former Shareholders”. In addition, from time to time, we receive inquiries from non-medical heirs with respect to shares we had redeemed.
We believe that we should prevail in litigation with respect to these matters; however, we cannot predict the outcome of any such litigation regarding these non-medical heirs. The interests of our existing shareholders could be materially diluted to the extent that any such claims are successful.
The dual class structure may not successfully protect against significant dilution of your shares of Class B common stock.
We designed our dual class structure of capital stock to offset the potential impact on the value of our Class B common stock attributable to any issuance of shares of common stock for less than market value in respect of a successful claim against us under any share acquisition agreement or by a non-medical heir. We believe that this mechanism will effectively protect investors in our shares of Class B common stock against any potential dilution attributable to the issuance of any shares in respect of such claims at below market prices. We cannot, however, provide any assurances that this mechanism will be effective under all circumstances.
While we expect to prevail against any such claims brought against us and, to the extent that we do not prevail, would expect to issue Class A common stock in respect of any such claim, there can be no assurance that the claimants in any such lawsuit will not seek to acquire Class B common stock. The issuance of a significant number of shares of Class B common stock, if followed by a material further issuance of shares of common stock to separate claimants could impair the effectiveness of the anti-dilution protections of the Class B common stock. In addition, we cannot provide any assurances that the anti-dilution protections afforded our Class B common stock will not be challenged by share acquisition providers and/or non-medical heir claimants to the extent that these protections limit the percentage ownership of us that may be acquired by such claimants. We believe that such a challenge should not prevail, but cannot provide any assurances of the outcome.
In the event that claimants acquire shares of our managed care subsidiary, TSS, at less than fair value, we will not be able to prevent dilution of the value of the Class B shareholders’ ownership interest in us to the extent that the net value received by such claimants exceeds the value of our outstanding shares of Class A common stock. Finally, the anti-dilution protection afforded by the dual class structure may cease to be of further effect at any time because all remaining shares of Class A common stock may, at the sole discretion of our board of directors and after considering relevant factors, including market conditions at the time, be converted into shares of Class B common stock. On May 17, 2013, the Company converted 6,660,423 shares of Class A common stock to Class B common stock. Concurrently with the conversion, 6,210,423 of such converted shares were sold in a registered secondary public offering.
Future sales of our Class B common stock, or the perception that such future sales may occur, may have an adverse impact on its market price.
Sales of a substantial number of shares of our common stock in the public market, or the perception that large sales could occur, could cause the market price of our Class B common stock to decline. Either of these limits our future ability to raise capital through an offering of equity securities. As of December 31, 2014 there were 24,654,497 shares of Class B common stock and 2,377,689 shares of Class A common stock. Our Class A common stock is no longer subject to contractual lockup; thus, such shares are freely tradable without restriction or further registration under the Securities Act by persons other than our ‘‘affiliates’’ within the meaning of Rule 144 under the Securities Act, although such shares will continue not to be listed on the NYSE and will not be fungible with our listed shares of Class B common stock. All or any portion of our shares of Class A common stock may at the sole discretion of our board of directors and after considering relevant factors, including market conditions at the time, be converted to shares of Class B common stock.
The price of our Class B stock may be volatile and may be affected by market conditions beyond our control.
Our share price is likely to fluctuate in the future because of the volatility of the stock market in general and a variety of factors, including those discussed under “Risk Factors” herein, many of which are beyond our control. Market fluctuations could result in volatility in the price of shares of our Class B common stock. In addition, if our operating results fail to meet the expectations of stock analysts or investors, or if we are perceived by the market to suffer material business or reputational damage, we may experience a significant decline in the trading price of our Class B common stock.
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 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 as a result of risk score adjustments for member acuity in the case of the Medicare Advantage products, we will be unable to increase the premiums we receive under these contracts during the then-current terms. As a result, our profitability in any year depends, to a significant degree, on our ability to adequately 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 favorable provider contracts with hospitals, physicians and other health care providers. The aging of the population and other demographic characteristics and advances in medical technology continue to contribute to rising health care costs. Government-imposed limitations on Medicare reimbursement have also caused the private sector to bear a greater share of increasing health care costs. Also, we have in the past and may in the future enter into new lines of business in which it may be difficult to estimate 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, the cost of prescription drugs, clusters of high cost cases, changes in the regulatory environment including the implementation of ACA, may adversely affect our ability to predict and manage managed care costs, as well as our business, financial condition and results of operations.
Our inability to implement increases in premium rates on a timely basis may adversely affect our business and profitability.
In addition to the challenge of managing managed care costs, we face pressure to contain premium rates. Our customers may move to a competitor at policy renewal to obtain more favorable premiums. Also, the Office of the Commissioner of Insurance may disapprove proposed rate increases in the individual and small business markets. Future Medicare premium rate levels may be affected by continuing government efforts to contain medical expense or other budgetary constraints. CMS has recently announced projected Medicare Advantage plan rates for contract year 2016, which would, if implemented, functionally reduce the overall payments to our Medicare Advantage plans, largely due to the continued transitional phase-in required under the ACA to align Medicare Advantage benchmarks with the traditional fee-for-service Medicare. Continued changes in the Medicare Advantage program, including with respect to funding, which cuts are expected to continue to be phased in through 2017, may lead to continued reductions in the amount of reimbursement, elimination of coverage for certain benefits, or reductions in the number of persons enrolled in or eligible for Medicare. A limitation on our ability to increase or maintain our premium levels could materially adversely affect our business, financial condition and results of operations.
The property and casualty insurance industry is under soft market conditions for commercial lines and consequently is highly competitive, and we believe that it will remain highly competitive for the foreseeable future. Competitors may offer products at prices and on terms that are not consistent with economic standards in an effort to maintain or increase their business. The property and casualty insurance industry has historically been cyclical, with periods characterized by intense price competition and less restrictive underwriting standards followed by periods of higher premium rates and more selective underwriting standards. The competitive environment in which we operate is also impacted by current general economic conditions, which could reduce the volume of business available to us, as well as to our competitors.
Our profitability may be adversely affected if we are unable to maintain our current provider agreements and to enter into other appropriate agreements.
Our profitability is dependent upon our ability to contract on favorable terms with hospitals, physicians and other managed care providers. We face heavy competition from other managed care plans to enter into contracts with hospitals, physicians and other providers in our provider networks. Consolidation in our industry, both on the provider side and on the managed care side, only exacerbates this competition. In recent years some groups of providers have been pressing for legislation that would allow them to collectively negotiate certain contract terms through cooperatives. Although such legislation has not been passed, the Public Corporation for the Supervision and Insurance of Cooperatives in Puerto Rico has adopted rules that allow certain providers to negotiate collectively service fees through cooperatives, on a voluntary basis, with insurance companies and healthcare organizations. To the extent collective negotiations with providers become mandatory or we otherwise are required to enter into collective negotiations with providers, we expect that maintaining or securing new cost-effective managed care provider contracts would become more difficult, which could result in a loss in membership or higher medical costs and could adversely affect our business.
A reduction in the enrollment in our managed care programs could have an adverse effect on our business and profitability.
A reduction in the number of enrollees in our managed care programs could adversely affect our business, financial condition and results of operations. Factors that could contribute to a reduction in enrollment include: failure to obtain new customers or retain existing customers; suspension or loss of our ability to enroll new customers; premium increases and benefit changes; our exit from a specific market; reductions in workforce by existing customers; negative publicity and news coverage; failure to maintain the BCBS license; and any general economic downturn that results in business failures.
We are dependent on a small number of government contracts to generate a significant amount of the revenues of our managed care business.
Our managed care business participates in government contracts that generate a significant amount of our consolidated operating revenues, including:
• 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 each year. Each of our contracts with CMS is 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, 2014, 2013 and 2012, contracts with CMS represented 47.6%, 47.0% and 47.6% of our consolidated premiums earned, net, respectively, and -5.5%, 52.5% and 5.0% of our consolidated operating income, respectively.
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Commercial: One of our managed care subsidiaries is a qualified contractor to provide 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, 2014, 2013 and 2012 premiums generated under this contract represented 7.2%, 7.0% and 6.4% of our consolidated premiums earned, net, respectively. The operating income generated under this contract represented 2.2%, 2.6% and 1.6% of our consolidated operating income during the years ended December 31, 2014, 2013 and 2012, respectively. Under the commercial business, we also provide health coverage to certain employees of the Commonwealth of Puerto Rico and its instrumentalities. Earned premium revenue related to such health plans represented 5.8%, 6.4% and 7.5% of our consolidated premiums earned, net, respectively.
• Medicaid: We participate in the government of Puerto Rico Health Reform Program (similar to Medicaid) to provide health coverage to medically indigent citizens in Puerto Rico. Under the current agreement, TSS is a third party administrator responsible for the provision of administrative services to subscribers in all service regions which currently services approximately 1,420,000 members. The administrative services we provide under the current agreement include case, disease and utilization management, network management and credentialing, enrollment and enrollee services and claims administration, among others. Our current contract for the Medicaid business is subject to termination in the event of any non-compliance by TSS that is not corrected or cured to the satisfaction of ASES, the government entity overseeing this program, or on 90 days’ prior written notice in the event that ASES determines that there is an insufficiency of funds to finance the program.
ASES executed an agreement with TSS, dated January 21, 2015 (the “2015 Contract”), for the offering of health care services for the Medicaid subscribers in the Metro North and West regions of the government of Puerto Rico’s health insurance program (the “Service Regions”), which we believe includes approximately 430,000 subscribers. Under the terms of the 2015 Contract, TSS is responsible for providing of medical, mental, pharmacy and dental healthcare services to Medicaid subscribers in the Service Regions on an at-risk basis, commencing April 1, 2015 and continuing until June 30, 2017.
Under the 2015 Contract, and as a result of a separate letter agreement signed on January 14, 2015 to reflect an adjustment in co-payments (the “Letter Agreement”), ASES will pay TSS a revised rate per member per month of $174.16 for the Metro North Region and $140.61 for the West Region. The 2015 Contract also provides for the payment of civil monetary penalties or liquidated damages by TSS to the extent it does not meet its obligations, which damages vary in amount depending on the nature of TSS’s default. In lieu of imposing any liquidated damages, penalties or sanctions against TSS, ASES may withhold an amount not to exceed 10% of the per member per month payment for certain limited events of non-compliance, until such event is cured. Moreover, the 2015 Contract contains representations and warranties and indemnity, termination and default provisions customary for these types of transactions with the Government of Puerto Rico. Also, the 2015 Contract contains certain termination rights for both TSS and ASES, including ASES’s right to terminate the 2015 Contract as a result of insufficient government funds to pay ASES’s obligations under the 2015 Contract. For the years ended December 31, 2014, 2013 and 2012, operating income generated under our current agreement represented 37.1%, 32.5% and 45.8% of our consolidated operating income, respectively.
If any of these contracts is terminated for any reason, including by reason of any noncompliance by us, or not renewed or replaced by a comparable contract, our consolidated premiums and profitability earned could be materially adversely affected. See “-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, and our Medicare Advantage contracts may be terminated or our operations may be required to change in a manner that has a material impact on our business” and “-Risks Relating to the Regulation of our Industry- If we fail to comply with our corrective action plans with CMS and ASES regarding our provider credentialing and re-credentialing procedures, we may be subject to CMS compliance actions and ASES sanctions, ranging in each case from monetary penalties to contract termination” for more information on the risk of termination of our contracts. In addition, if the liquidity of the Government of Puerto Rico, its agencies, municipalities and public corporations becomes significantly affected by the recent downgrades by the rating agencies or as a result of the inability to raise funding in the market or generate enough revenues, we may face credit losses in our premium and fees receivable from these and other government related entities, which could be significant.
Local government administration may implement a new regional pilot program in an effort to increase access to healthcare through the addition of new beneficiaries of the Health Reform Program, and the creation of a standard basic coverage aimed to promote the use of preventive health services and organ transplant benefits.
The Government of Puerto Rico has announced its intention to request CMS approval to begin a pilot program in an effort to bring universal healthcare coverage to Puerto Rico. As of the date of this Annual Report on Form 10-K, the details of this pilot program have not been detailed. However, the Department of Health of Puerto Rico has indicated its intention to implement this program during 2015. This new initiative may impact utilization of health care services and the medical loss ratio. As of the date of this Annual report on Form 10-K, there is uncertainty on how this initiative, if approved by CMS, will be implemented and its likelihood of success. Also, unfavorable changes in the number of beneficiaries under the program design of the standard basic coverage could have a material adverse effect on our business, financial condition and results of operations.
A change in our managed care commercial product mix may impact 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. There has been a trend in recent years among our Commercial customers of moving from fully-insured plans to ASO, or self-funded arrangements. As of December 31, 2014 and 2013, 68% of our managed care commercial customers had fully insured arrangements and 32% 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.
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 and adjust anticipated claims with respect to 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 U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla. We believe that the Blue Cross and Blue Shield name and mark are valuable identifiers of our products and services in the marketplace. The termination of these license agreements or changes in their terms and conditions could adversely affect our business, financial condition and results of operations.
Our license agreements with the BCBSA contain certain requirements and restrictions regarding our operations and our use of the BCBS name and mark. Failure to comply with any of these requirements and restrictions could result in the termination of a license agreement. The standards under a license agreement may be modified in certain instances by the BCBSA. From time to time there have been proposals considered by the BCBSA to modify the terms of a license agreement to restrict various potential business activities of licensees. To the extent that such amendments to a license agreement are adopted in the future, they could have a material adverse effect on our future expansion plans or results of operations.
Upon any event causing termination of the license agreements, we would no longer have the right to use the BCBS name and mark in Puerto Rico, the U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla. Furthermore, the BCBSA would be free to issue a license to use the BCBS name and marks in Puerto Rico, the U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla to another entity. 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. Accordingly, termination of a license agreement could have a material adverse effect on our business, financial condition and results of operations.
In addition, the BCBSA requires us to comply with certain specified levels of risk based capital (“RBC”). RBC is designed to identify weakly capitalized companies by comparing each company’s adjusted surplus to its required surplus (the “RBC ratio”). Although we are currently in compliance with these requirements, we may be unable to continue to comply in the future. Failure to comply with these requirements could result in the revocation or loss of our BCBS licenses.
Upon termination of a license agreement, the BCBSA would impose a “Re-establishment Fee” upon us, which would allow the BCBSA to “re-establish” a BCBSA presence in the vacated service area with another managed care company. The fee is currently $98.33 per licensed enrollee. If the re-establishment fee were applied to our total BCBS enrollees as of December 31, 2014, we would be assessed approximately $210.4 million by the BCBSA.
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 insurance businesses 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. In the year ended December 31, 2014, 36.9%, or $52.1 million, of the premiums written in the property and casualty insurance segment and 5.8%, or $5.5 million, of the premiums written in the life insurance segment were ceded to reinsurers. In the year ended December 31, 2013, 37.9%, or $57.6 million, of the premiums written in the property and casualty insurance segment and 6.3%, or $8.7 million, of the premiums written in the life insurance segment were ceded to reinsurers. 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.
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 Business¾Large 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 unforeseen losses 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 or our inability to increase 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 A.M. Best are an important factor influencing the competitive position of the property and casualty insurance companies in Puerto Rico. In 2014, A.M. Best maintained our property and casualty insurance subsidiary’s rating of “A-” (the fourth highest of A.M. Best’s 16 financial strength ratings) with a stable outlook. A.M. 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. A.M. Best reviews its ratings periodically and we may not be able to maintain our current ratings in the future. A downgrade of our property and casualty subsidiary’s rating could severely limit or prevent us from writing desirable property business or from renewing our existing business. The lines of business that property and casualty subsidiary writes and the market in which it operates are particularly sensitive to changes in A.M. Best financial strength ratings.
Significant competition could negatively affect our ability to maintain or increase our profitability.
Managed Care
The managed care industry in Puerto Rico is very competitive. If we are unable to compete effectively while appropriately pricing the business subscribed, our business and financial condition could be materially affected. 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 the profitability of our managed care company. In addition, the managed care market in Puerto Rico is mature. According to the U.S. Census Bureau, Puerto Rico’s population decreased by 2.2% between 2000 and 2010, however the national population rate grew 9.7% during the same period. According to the US Census Bureau, the older population is an important and growing segment of the United States population. In fact, more people were 65 years and older in 2010 than in any previous census. Between 2000 and 2010, the population 65 years and older increased at a faster rate (15.1%) than the total U.S. population. In Puerto Rico, for the same period, the population 65 years and older increased by 27.5 %. As a result, in order to increase our profitability we must increase our membership in the Medicare Advantage program, increase market share in the commercial sector, improve our operating profit margins, make acquisitions or expand geographically. In Puerto Rico, several managed care plans and other entities were awarded contracts for Medicare Advantage or stand-alone Medicare prescription drug plans. These other plans entered that market in 2006 and 2007. We anticipate that they can aggressively market their benefits to our current and our prospective members. Although we believe that we market an attractive offering, there are no assurances that we will be able to compete successfully with these other plans for new members, or that our current members will not choose to terminate their relationship with us and enroll in these other plans. Concentration in our industry also 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 managed care companies, which can create downward price pressures on premium rates. We may not be able to compete successfully against current and future competitors. Competitive pressures faced by us may adversely affect our business, financial condition and results of operations.
Future legislation at the federal and local levels also may result in increased competition in our market. 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.
Complementary Products
The property and casualty insurance market in Puerto Rico is extremely competitive. Due to Puerto Rico’s stagnant economy, there are few new sources of business in this segment. As a result, property and casualty insurance companies compete for the same accounts through pricing, policy terms and quality of services. We also face heavy competition in the life and disability insurance market.
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, although 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.
Our insurance subsidiaries are subject to the regulations of the Commissioner of Insurance. 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.” These regulations, among other things, require insurance companies to maintain certain levels of capital, thereby restricting the amount of earnings that can be distributed. 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.
In addition, we are subject to RBC requirements by the BCBSA. 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 conditions and results of operations.”
Our results may fluctuate as a result of many factors, including cyclical changes in the insurance industry.
Results of companies in the insurance industry, and particularly the property and casualty 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 of 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.
If we do not effectively manage the growth of our operations, we may not be able to achieve our profitability targets.
Our growth strategy includes enhancing our market share in Puerto Rico, entering new geographic markets, introducing new insurance products and programs, further developing our relationships with independent agencies or brokers and pursuing acquisition opportunities. Our strategy is subject to various risks, including risks associated with our ability to:
• successfully implement our underwriting, pricing, claims management and product strategies over a larger operating region;
• properly design and price new and existing products and programs and reinsurance facilities for markets in which we have no direct experience;
• identify, train and retain qualified employees;
• identify, recruit and integrate new independent agencies and brokers and expand the range of Triple-S products carried by our existing agents and brokers;
• develop a network of physicians, hospitals and other managed care providers that meets our requirements and those of applicable regulators; and
• augment our internal monitoring and control systems as we expand our business.
Any such risks or difficulties could limit our ability to implement our growth strategies or result in diversion of senior management time and adversely affect our financial results.
We are expanding our business operations outside of Puerto Rico and the United States.
Current and potential business operations outside Puerto Rico and the United States may be affected by our ability to identify profitable new geographic markets to enter and our ability to operate in any such new geographic markets. 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 local laws prohibiting corrupt payments. We may be also affected by our ability to obtain licenses in new areas where we wish to market our products. Deterioration of social, political, labor or economic conditions in a specific country or region and difficulties in managing foreign operations may also adversely affect our operations or financial results. Also, fluctuations in foreign currency rates could affect our financial results.
We face intense competition to attract and retain employees and independent agents and brokers.
We are dependent on retaining existing employees, attracting and retaining additional qualified employees to meet current and future needs and achieving productivity gains. Our life insurance subsidiary, TSV, has historically experienced a very high level of turnover in its home service agents, through which it places a majority of its premiums, and we expect this trend to continue. Our inability to retain existing employees or attract additional employees could have a material adverse effect on our business, financial condition and results of operations.
In addition, in order to market our products effectively, we must continue to recruit, retain and establish relationships with qualified independent agents and brokers. We may not be able to recruit, retain and establish relationships with agents and brokers. Independent agents and brokers are typically not exclusively dedicated to us and may frequently also market our competitors’ managed care products. We face intense competition for the services and allegiance of independent agents and brokers. If such agents and brokers do not help us to maintain our current customer accounts or establish new accounts, our business and profitability could be adversely affected.
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 owned by us. 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. 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, mortgage loans, and real estate and equity investments, among others, which could generate higher returns on our investments. If we fail to comply with these laws and regulations, any investments exceeding regulatory limitations would be treated as non-admitted assets for purposes of measuring statutory surplus and risk-based capital.
The securities and credit markets could experience extreme volatility and disruption.
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 that is comprised particularly of debt securities of issuers located in the U.S. As a result, the income we earn from our investment portfolio is largely driven by the level of interest rates 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. Theses 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 the debt securities we hold in our investment portfolio, and creating net realized capital losses that reduce our operating results and/or net unrealized capital losses that reduce our shareholders’ equity.
• 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, which could lead to significant period-to-period changes in our estimates of the fair values of those securities and cause period-to-period volatility in our operating results and shareholders’ equity.
• Reducing our ability to issue other securities.
We evaluate our investment securities for other-than-temporary impairment on a quarterly basis. This review is subjective and requires a high degree of judgment. It also requires us to make certain assessments about the potential recovery of the assets we hold. For the purpose of determining gross realized gains and losses, the cost of investment securities is based upon specific identification.
During the years ended December 31, 2014 and 2013, there were $1.2 million and $1.0 million, respectively, of realized losses associated with other-than-temporary impairments. During the year ended December 31, 2012, there were no realized losses associated with other-than-temporary impairments.
The gross unrealized losses of our available-for-sale and held-to-maturity securities were $0.3 million and $11.8 million at December 31, 2014 and 2013, respectively. The gross unrealized gains of our available-for-sale and held-to-maturity securities were $117.9 million and $88.8 million at December 31, 2014 and 2013, respectively. Given current market conditions, there is a continuing risk that declines in fair value may occur and material realized losses from sales or other-than-temporary impairments may be recorded in future periods.
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.
Our business is geographically concentrated in Puerto Rico and weakness in the economy and the the fiscal health of the government has adversely impacted and may continue to adversely impact us.
We are exposed to geographical risk because our principal lines of business are concentrated in Puerto Rico. We are also exposed to government risk due to our contract with ASES in connection with the government health plan.
Puerto Rico’s gross national product contracted in real terms in every year between fiscal year 2007 and fiscal year 2011 (inclusive), and grew by 0.9% (revised figures) and 0.3% (preliminary) in fiscal years 2012 and 2013. Puerto Rico’s fiscal year begins on July 1 and ends on June 30 of the following year. According to the Planning Board, for fiscal years 2014 and 2015, gross national product is projected to increase by only 0.1% and 0.2%. However, the monthly economic indicators for fiscal year 2014 indicate that the final gross national product figures for fiscal year 2014 may be lower than the last projection presented by the Planning Board. This persistent contraction or minimal growth has had an adverse effect on employment and tax revenues, and has significantly contributed to central government budget deficits. Factors that can adversely affect Puerto Rico’s ability to increase the level of economic activity include the high cost of energy, the loss of patent protection of several products manufactured in Puerto Rico and global economic and trade conditions.
The weakness of Puerto Rico’s economy has adversely affected employment. Total employment in Puerto Rico decreased at an average annual rate of 0.9% from 1,150,291 to 1,006,646 from fiscal year 2000 to fiscal year 2014. A reduction in total employment began in the fourth quarter of fiscal year 2007 and has continued consistently through fiscal year 2014 due to the current recession and the fiscal adjustment measures implemented by the government. According to the Household Survey, during fiscal year 2014, total employment fell by 2.2% when compared to the prior fiscal year, and the unemployment rate averaged 14.3% compared to 14.0% for the prior fiscal year. Furthermore, for the first quarter of fiscal year 2015, total employment decreased by 3.3% with respect the first quarter of fiscal year 2014.
In February 2014, the credit ratings of the Puerto Rico government’s general obligation bonds and guaranteed bonds, as well as the ratings of most of the Puerto Rico public corporations, were lowered (more than once in most cases) to non-investment grade by Moody’s, S&P, and Fitch Ratings (“Fitch”). The continued weakness of the Puerto Rico economy, liquidity constraints and market access were generally cited as the reasons for the downgrades.
On June 28, 2014, the Governor of Puerto Rico signed into law Act 71-2014, known as the Recovery Act. In light of the general inapplicability of Chapters 9 and 11 of the United States Bankruptcy Code to Puerto Rico public corporations, the Recovery Act is intended to provide a legal process governing the enforcement and restructuring of the debts and other obligations of these types of government entities. The Recovery Act specifically excludes the government of Puerto Rico and COFINA (which senior lien bonds comprise the majority of the Company’s Puerto Rico exposure) from its application. However, the Puerto Rico Health Insurance Administration, our counterparty in connection with the services provided under the Government Health Plan, may seek relief under the Recovery Act. As a result of the enactment of the Recovery Act, the rating agencies further downgraded Puerto Rico’s credit rating and that of the majority of its public corporations.
During June and July 2014, certain holders of bonds issued by Puerto Rico Electric Power Authority (“PREPA”) and an investment manager, on behalf of funds that own PREPA bonds, filed a lawsuit in the United States District Court for the District of Puerto Rico seeking a declaratory judgment that the Recovery Act violates multiple provisions of the United States Constitution. On February 10, 2015, the District Court entered judgment that the Recovery Act is preempted by the federal Bankruptcy Code and is therefore void pursuant to the Supremacy Clause of the United States Constitutions. The District Court also permanently enjoined Puerto Rico officers from enforcing the Recovery Act. Puerto Rico has filed a notice of appeal and has indicated its intent to vigorously defend the constitutionality of the Recovery Act.
On February 11, 2015, the Governor filed with the Legislative Assembly a comprehensive tax reform bill. As currently presented, the bill would significantly lower income tax rates and replace the 7% sales and use tax with a 16% value added tax. As proposed, the new tax would apply to services such as medical services paid by commercial health plans and business to business transactions not included in the current sales and use tax. The Governor’s proposal seeks to shift the emphasis from taxing productivity to taxing consumption, while increasing revenues to the government by reducing tax evasion through a broadening of the tax base and simplifying the code. The bill is currently being evaluated by the Legislative Assembly and it too early to determine what changes, if any, will be incorporated and effect the bill, if enacted, will have on the economy and our business.
After the Governor presented his tax reform proposal, both S&P and Moody’s downgraded the credit rating of Puerto Rico and its public corporations. Both rating agencies cited concerns with the weakness in the Puerto Rico economy and current market conditions. They also cited the implementation risk surrounding a comprehensive tax reform of this nature.
Continued weakness in the Puerto Rico economy or the failure of the Puerto Rico government to manage its fiscal problems in an orderly manner could have an adverse effect on our insured customers, which may be required to forego insurance coverage or scale back on the amount of insurance coverage purchased. In turn, if this trend continues or worsens, our results of operations or financial condition may be adversely impacted.
We may not be able to retain our executive officers and significant employees, and the loss of any one or more of these officers and their expertise could adversely affect our business.
Our operations are highly dependent on the efforts of our senior executives, each of whom has been instrumental in developing our business strategy and forging our business relationships. While we believe that we could find replacements, the loss of the leadership, knowledge and experience of our executive officers could adversely affect our business. Replacing many of our executive officers might be difficult or take an extended period of time because a limited number of individuals in the industries in which we operate have the breadth and depth of skills and experience necessary to successfully operate and expand a business such as ours. We do not currently maintain key-man life insurance on any of our executive officers. We only have non-competition agreements in place with three executive officers, including our chief executive officer and chief financial officer.
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 and 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, contribute to customer and provider disputes, result in regulatory violations and possible liability, increase administrative expenses or lead to other adverse consequences. 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 require an ongoing commitment of significant resources to maintain, upgrade and enhance existing systems and develop new systems in order to keep pace with continuing changes in information processing technology, evolving industry and regulatory standards, compliance with legal requirements (such as a new set of standardized diagnostic codes, known as ICD-10), and changing operational needs. 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. If we are unable to maintain effective and efficient information systems, or our failure to efficiently and effectively consolidate our information systems to eliminate redundant or obsolete applications, could have a material adverse effect on our business, financial condition and results of operations. If the information we rely upon to run our business were found to be inaccurate or unreliable or if we fail to maintain our information systems and data integrity effectively we could suffer from, among other things, operational disruptions, such as the inability to pay claims or to make claims payments on a timely basis, have problems in determining medical cost estimates and establishing appropriate pricing and reserves, loss of members, and difficulty in attracting new members, regulatory problems, increases in operating expenses or suffer other adverse consequences.
In addition, federal regulations, as amended by the Protecting Access to Medicare Act of 2014, require that we begin using ICD-10 by October 1, 2015, which will require significant information technology investment. In order to become ICD-10 compliant, we changed TSS’s core business application, which we implemented in the third quarter of 2012. In addition, we completed the version upgrade process of such business application in the third quarter of 2013. If we fail to adequately implement ICD-10, we may incur losses with respect to the resources invested and have other material adverse effects on our business and results of operations.
Our business requires the secure transmission of confidential information over public networks. Advances in computer capabilities, new discoveries in the field of cryptography or other events or developments could result in compromises or breaches of our security system and patient data stored in our information systems. Anyone who circumvents our security measures could misappropriate our confidential information or cause interruptions in services or operations. The internet is a public network and data is sent over this network from many sources. 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. Because of the confidential health information we store and transmit, security breaches could expose us to a risk of regulatory action, litigation, possible liability and loss. We are taking all needed security measures to prevent security breaches, and ensure our business operations won’t be adversely affected by potential security breaches.
We face risks related to litigation.
In addition to the litigation risks discussed above in ‘‘Risks Relating to Our Capital Stock’’, we are, or may be in the future, a party to a variety of legal actions that affect any business, such as employment and employment discrimination-related suits, employee benefit claims, breach of contract actions, tort claims and intellectual property-related litigation. In addition, because of the nature of our business, we may be subject to a variety of legal actions relating to our business operations, including the design, management and offering of our products and services. These could include:
• claims relating to the denial of managed care benefits or insurance coverage;
• medical malpractice actions;
• allegations of anti-competitive and unfair business activities;
• provider disputes over compensation and termination of provider contracts;
• broker and agents dispute over fees and term of their respective agreements;
• disputes related to self-funded business;
• disputes over co-payment calculations;
• claims related to the failure to disclose certain business practices;
• claims relating to customer audits and contract performance; and
• claims by regulatory agencies or whistleblowers for regulatory non-compliance, including but not limited to fraud and health information privacy (including HIPAA).
We are a defendant in various lawsuits, some of which involve claims for substantial and/or indeterminate amounts and the outcome of which is unpredictable. While we are defending these suits vigorously, we will incur expenses in the defense of these suits. Any adverse judgment against us resulting in damage awards could have an adverse effect on our cash flows, results of operations and financial condition. See “Item 3. Legal Proceedings.”
Large-scale natural disasters may have a material adverse effect on our business, financial condition and results of operations.
Puerto Rico has historically been at 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, property and casualty and life insurance 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.
Non-financial covenants in our secured term loans and note purchase agreements may restrict our operations.
We are a party to a secured loan with a commercial bank of $41.0 million, for which we have an outstanding balance of $14.5 million as of December 31, 2014. Also, we have outstanding a senior unsecured note with an aggregate principal amount of $35.0 million, this note bears interest at a fixed rate of 6.60% and is due in 2020. The secured term loan and the note purchase agreements governing the notes 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 note purchase agreements governing the notes 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 or note purchase agreements to become immediately due and payable, together with accrued and unpaid interest and, in the case of the secured term loans, cease to make further extensions of credit. If the indebtedness under our secured term loans or note purchase agreements is accelerated, we may be unable to repay or re-finance the amounts due and our business may be materially adversely affected.
We may incur additional indebtedness in the future. Covenants related to such indebtedness could also adversely affect our ability to pursue desirable business opportunities.
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 or 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 note purchase agreements 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.
We may pursue acquisitions in the future.
We may acquire additional companies or assets if consistent with our strategic plan for growth. The following are some of the potential risks associated with acquisitions that could have a material adverse effect on our business, financial condition and results of operations:
• disruption of on-going business operations, distraction of management, diversion of resources and difficulty in maintaining current business standards, controls and procedures;
• difficulty in integrating information technology of an acquired entity and unanticipated expenses related to such integration;
• difficulty in the integration of an acquired entity’s accounting, financial reporting, management, information, human resources and other administrative systems and the lack of control if such integration is delayed or not implemented;
• difficulty in the implementation of controls, procedures and policies appropriate for filers with the SEC at companies that prior to acquisition lacked such controls, policies and procedures;
• potential unknown or under-estimated liabilities associated with the acquired company;
• failure of acquired businesses to achieve anticipated revenues, earnings or cash flow;
• dilutive issuances of equity securities and incurrence of additional debt to finance acquisitions;
• establish goodwill or other intangible assets as a result of a future business combination, which may be incorrectly valued or become non-recoverable;
• other acquisition-related expenses, including amortization of intangible assets and write-offs; and
• competition with other firms, some of which may have greater financial and other resources, to acquire attractive companies.
In addition, we may not successfully realize the intended benefits of any acquisition or investment.
If our goodwill or intangible assets become impaired, it may adversely affect our financial condition and future results of operations.
As of December 31, 2014 we had approximately $25.4 million and $9.2 million of goodwill and intangible assets recorded on our balance sheet, primarily related to the TSA acquisition, that represent 1.6% of our total consolidated assets and 4.0% of our consolidated stockholders’ equity. If we make additional acquisitions it is likely that we will record additional goodwill and intangible assets on our consolidated balance sheet.
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 impairment losses against 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 in 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 impacted 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 for U.S. federal income tax purposes, U.S. persons that own 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 such company’s insurance customers and the extent of such company’s 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. If we were a RPII CFC in any taxable year, certain adverse tax consequences could apply to U.S. persons that own the Company’s shares of Class B common stock.
If we are considered to be a passive foreign investment company for U.S. federal income tax purposes, U.S. persons that own the Company’s shares of Class B common stock could be subject to adverse tax consequences.
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 percent 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 it 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 the Company were 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.
Legislative and other measures that may be taken by Puerto Rico governmental authorities could materially increase our tax burden or otherwise adversely affect our financial condition, results of operations or cash flows.
It is expected that during the second quarter of 2015, a new comprehensive tax reform is implemented in the Commonwealth of Puerto Rico. Among others, it is expected that the additional tax on gross income is repealed and the maximum corporate income tax rate is reduced. In addition, it is expected that a broad based value added tax of 16% is implemented replacing the current sales and use tax of 7%. As proposed, the new value added tax would apply to services such as medical services paid by commercial health plans and business to business transactions not included in the current sales and use tax.
Risks Relating to the Regulation of Our Industry
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, changes in interpretation of these laws or changes in enforcement of these 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 plan or to be funded through taxes or other negative financial levy on health plans;
• payments to health plans that are tied to achievement of certain quality performance measures and by health plans that do not satisfy applicable medical loss ratio requirements;
• other efforts or specific legislative changes to the Medicare or Medicaid programs, including changes in the bidding process or other means of materially reducing premiums;
• local government regulatory changes;
• increased government enforcement, or changes in interpretation or application, of fraud and abuse and health information privacy laws; and
• regulations that increase the operational burden on health plans 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, among other things, influence how our insurance subsidiaries conduct business and solicit subscriptions for shares of capital stock, and place limitations on investments and dividends. Possible penalties for violations of such regulations include fines, orders to cease or change practices or behavior and possible suspension or termination of licenses. The regulatory powers of the Commissioner of Insurance are 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 of insurance policies, limit our ability to obtain rate increases in those cases where rates are regulated, 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 additional operating expenses in order to comply with new legislation and may be required to revise the ways in which we conduct our business.
Future regulatory actions by the Commissioner of Insurance or other governmental agencies, including federal regulations, 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 and the implementation of that 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, which are being phased in at various stages through 2018. The legislation imposes an annual insurance industry assessment of $8 billion in 2014, which will increase to $14.3 billion by 2018, with increasing annual amounts thereafter based on premium growth. Such assessment may not be deductible for income tax purposes. If the cost of the federal premium tax is not included in the calculation of our rates, or if we are unable to otherwise adjust our business model to address this new tax, our results of operations, financial position and liquidity may be materially adversely affected. Also, 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 or 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 reforms provisions were enacted in Puerto Rico as part of amendments made to the Health Insurance Code of Puerto Rico. 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.
There are numerous outstanding steps required to implement the legislation, including the promulgation of a substantial number of new and potentially more onerous federal regulations. Further, various health insurance reform proposals are also emerging at the state level. This legislation could impact us through potential disruption to the employer-based market, potential cost shifting in the health care delivery system to insurance companies and limitations on the ability to increase premiums to meet costs. Because of the unsettled nature of these reforms and numerous steps required to implement them, we cannot predict what additional health insurance requirements will be implemented at the federal or state level, or the effect that any future legislation or regulation will have on our business or our growth opportunities.
Although we believe the legislation may provide us with significant opportunities to grow our business, the implementation of enacted reforms, such as the continued cuts in the effective Medicare Advantage rates applicable to our plans which are expected to be phased in for our plans through 2017, and the expected sunset of the adittional federal funding of Medicaid granted to Puerto Rico and the other US Territories under ACA in 2019, as well as future regulations and legislative changes, may in fact 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, and our Medicare Advantage contracts may be terminated or our operations may be required to change in a manner that has a material impact 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 non-compliance. If we fail to comply with these laws and regulations, we could be subject to criminal fines, 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. For example, recently adopted CMS regulations effective in 2016 will require Medicare Advantage plans to develop, maintain, and implement a business continuity plan that meets certain minimum standards.
Under CMS regulations to implement certain ACA requirements that became effective on June 1, 2012, CMS has the authority not to renew our contracts the 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 five stars) for at least one of the three consecutive contract years. See the subcaption “Federal regulations” in Item 1 of this annual report on Form 10-K for detailed information of the Stars Ratings. By memorandum to select Medicare Advantage organizations and Part D plans dated September 8, 2014, CMS stated that it would not exercise its discretionary authority to terminate contracts held by a Medicare Advantage organization or Part D plan on this basis for 2015. However, CMS indicated that it does intend to exercise this authority to terminate contracts at the end of 2015 with any Medicare Advantage or Part D plan that does not meet this Star Rating requirement with respect to contract year 2016.
Effective December 31, 2014, TSS entered into a novation agreement with CMS and TSA to transfer their three Medicare Advantage contracts to TSA. As part of this corporate reorganization, TSA currently has two Medicare Advantage plans. Historically, the TSA plans have received annual Star Ratings of three or more stars. As a result, in certain years the TSA plans have received a quality bonus from CMS.
We are devoting the resources and management attention we believe necessary to improve our Star Ratings of all our plans in order to avoid termination, but may not be successful in maintaining TSA plans’ Star Ratings at 3 stars or higher. In case any of our Medicare Advantage contracts with CMS is terminated, we are identifying alternatives consistent with the direction provided by CMS regulation to retain lives by offering them enrollment in similar or superior products. Our failure to achieve Star Ratings of 3 or higher for each of our Medicare Advantage plans, or to otherwise improve our administration of these plans, would jeopardize our ability to attract and retain members in these plans, as well as our ability to continue to participate in these federal programs and to successfully bid for future CMS contracts in these programs.
In addition, CMS has the existing authority to terminate any of our Medicare Advantage contracts if it determines that any of these plans has 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. Any termination or non-renewal of our Medicare Advantage plans would have a material adverse effect on our business and financial results.
From April 30, 2012 through May 4, 2012, the Medicare Advantage programs of TSS and TSA were audited by CMS. This full performance audit review focused on our organization performance in Part D formulary and benefit administration, Part D coverage determinations, appeals and grievances, Part C organizational determinations, appeals and grievances, and dismissals, agent/broker oversight, Part C access to care, Part C and Part D enrollment, disenrollment, late enrollment penalty and compliance program effectiveness. On May 10, 2012, as part of these audits, CMS notified Triple-S Salud that it was noncompliant with multiple CMS drug formulary administration requirements and beneficiary coverage determination, appeals and grievances requirements. On October 9, 2012, CMS imposed a $350,000 civil monetary penalty on TSS for the formulary and benefit administration violations discovered during the audit, as well as for noncompliance with CMS disenrollment requirements. The TSA plan was not subject to any sanctions.
CMS conducted several validation studies to determine whether the immediate corrective action plans (“CAPs”) were effective in remedying the deficiencies discovered at TSS during the audit. On October 17, 2012 CMS notified TSS that it passed the second validation study for the CAP related to Part D coverage determinations, appeals and grievances. Also on October 17, 2012, CMS issued a draft report of its TSS and TSA plan audits. The report contained various findings in all five plans. Our response to the report was issued on January 30, 2013.
During 2013, CMS issued engagement letters to TSS and TSA to review the validation processes for their respective Medicare Advantage products, including TSS’s Part D product. CMS review went through the corrective measures we implemented in connection with the findings issued during CMS’s audit in 2012. This review on the validation processes was completed and we are waiting CMS’s closing letter on this matter.
We may be subject to government audits, regulatory proceedings or investigative actions, which may find that our policies, procedures, practices or contracts are not compliant with, or are in violation of, applicable healthcare regulations.
Federal and Puerto Rico 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, beginning in Medicare contract year 2016, CMS will have the right to require Medicare Advantage plan sponsors such as us to hire an independent auditor, working 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 the audit findings. If, in the future, we were required by CMS to hire an independent auditor, such 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 non-routine 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 criminal penalties, fines or other sanctions on us and/or our key employees;
• loss or non-renewal of our government contracts or loss of our ability to participate in Medicare or other federal or local governmental payor programs; damage to our reputation;
• increased difficulty in marketing our products and services;
• inability to obtain approval for future services or geographic expansions; and
• 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.
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.
Effective prevention, detection and control systems are critical to maintain regulatory compliance and prevent fraud and failure of these systems could adversely affect the Company.
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 it 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 its 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 fraudulent claims volume which may lead to additional costs because of an increase in disputed claims 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 or detect and prevent privacy and security incidents, 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 which may disrupt or impact efficiency of operations.
Compliance with new privacy and security laws, regulations and requirements may result in increased operating costs, and may constrain our ability to manage our business model. For example, final HHS regulations released in January 2013 implementing the ARRA amendments to HIPAA may further restrict our ability to collect, disclose and use sensitive personal information and may impose additional compliance requirements on our business. In addition, HHS has announced that it will continue its audit program to assess HIPAA compliance efforts by covered entities. Although we are not aware of HHS plans to audit any of our covered entities, 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 Puerto Rico Act No. 194 of August 25, 2000, also known as the Patient’s Rights and Responsibilities Act, including provisions more stringent than HIPAA. There is uncertainty regarding many aspects of such state requirements which make compliance with applicable health information laws more difficult. For these reasons, our total compliance costs may increase in the future.
On February 11, 2014, ASES notified TSS of its intention to impose a civil monetary penalty of $6.8 million dollars with respect to a breach involving the inadvertent display of protected health information of Medicare Advantage beneficiaries. OCR has an open investigation on this matter. See, “Item 3. Legal Proceedings-Unauthorized Disclosure of Protected Health Information” for more information.
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, including 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.
The revised rate calculation system for Medicare Advantage, the payment system for the 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 of 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. In addition, under the ACA, Medicare Advantage plan payment rates are subject to transitionally phased in reductions intended to bring Medicare Advantage rates more in line with Medicare fee-for-service rates, which are being phased in between 2012 and 2017. Medicare generally will rebate a portion of the amount by which the benchmark amount exceeded the accepted bid for certain plans. For plans achieving star rating of at least 3.5 stars, the portion of the savings retained by the plan is higher. For plans achieving star ratings of at least 4 stars, the starting benchmark amount from which the savings is computed is also higher (a “quality bonus”). However, Medicare’s three year Quality Bonus Payment Demonstration, under which bonuses for some plans were higher than required by the ACA, and under which Medicare would also rebate a quality bonus to certain plans achieving star ratings of 3.0 or 3.5 stars, ended in 2014. 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. For example, on February 20, 2015, CMS projected Medicare Advantage plan rates for contract year 2016, which would, if implemented, functionally reduce the overall payments to our Medicare Advantage plans, largely due to the continued transitional phase-in under the ACA intended to align Medicare Advantage payments with traditional fee-for-service Medicare, as noted above. The implementation of the proposed Medicare Advantage rates, if adopted, as well as the continued implementation of the ACA reduction of Medicare Advantage funding, which is expected to continue to be phased in through 2017, may have a material adverse effect on our revenue, financial position, results of operations or cash flow.
A number of legislative proposals, as well as ACA, include efforts to save federal funds by implementing significant rate reductions to Medicare Advantage plans through changes in the competitive bidding process, tying the country benchmarks to Medicare fee for service expenditures, or other means.
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, which may have a material adverse effect on our financial position, results of operations or cash flows. 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 profitability difficult 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. CMS phased in this payment methodology with a risk adjustment model that bases a portion of the total CMS reimbursement payments mainly on demographic and the health severity of enrollees. 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, which are 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.
CMS may make changes to the manner in which it determines risk adjustment payments. For example, in 2014, CMS asked Medicare Advantage plans to submit additional information indicating whether medical conditions were diagnosed in a clinical setting and CMS has indicated that it intends to publish further guidance as to the treatment of risk adjustment data in early 2015. Also, CMS has indicated that it intends to modify member-level risk scored for 2016. 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. Finally, we generally rely on providers, including certain network providers who are 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. Further, the continued implementation of the ACA reduction of Medicare Advantage funding, which is expected to continue to be phased in through 2017, may have a material adverse effect on our premium revenues.
If during the open enrollment season our Medicare Advantage members enroll in another Medicare Advantage plan, 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 such time as we fail to receive reimbursement from CMS in respect of such member, which may occur sometime after the disenrollment. As a result, 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.
Medicare and Medicaid spending by the federal government could be decreased as part of the spending cuts associated with the debt ceiling.
The Sequestration Transparency Act of 2012 (P.L. 112-155) requires President Obama to submit to Congress a report on the potential sequestration triggered by the failure of the Joint Selective Committee on Deficit Reduction to propose, and Congress to enact, a plan to reduce the deficit by $1.2 trillion, as required by the Budget Control Act of 2011. The sequestration resulted in cuts of 2% in aggregate Medicare payments beginning in 2013 and will remain in effect through 2024, unless additional Congressional action is taken.
We cannot predict whether Congress will take any action to change the automatic spending cuts. Further, we cannot predict how states will react to any changes that occur at the federal level.
If we are deemed to have violated the insurance company change of control statutes in Puerto Rico, we may suffer adverse consequences.
We are subject to change of control statutes applicable to insurance companies. These statutes regulate, among other things, the acquisition of control of an insurance company or a holding company of an insurance company. Under these statutes, 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 the issued and outstanding stock of an insurance company, or of the total stock issued and outstanding of a holding company of an insurance company, or solicit or receive funds in exchange for the issuance of new shares of the holding company’s or its insurance subsidiaries’ capital stock, without the prior approval of the Commissioner of Insurance. Our amended and restated articles of incorporation (the articles) prohibit any institutional investor from owning 10% or more of our voting power and any person that is not an institutional investor from owning 5% or more of our voting power. We cannot, however, assure you that ownership of our securities will remain below these thresholds. To the extent that a person, including an institutional investor, acquires shares in excess of these limits, our articles provide that we will have the power to take certain actions, including refusing to give effect to a transfer or instituting proceedings to enjoin or rescind a transfer, in order to avoid a violation of the ownership limitation in the articles. If the Commissioner of Insurance determines that a change of control has occurred, we could be subject to fines and penalties, and in some instances the Commissioner of Insurance would have the discretion to revoke our operating licenses.
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 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 the prior approval of the BCBSA and the vote of holders of at least 75% of our common stock.
Our insurance subsidiaries are subject to minimum capital requirements. Our failure to meet these standards could subject us to regulatory actions.
Puerto Rico insurance laws and the regulations promulgated by the Commissioner of Insurance, among other things, require insurance companies to maintain certain levels of capital, thereby restricting the amount of earnings that can be distributed by our insurance subsidiaries to us. Although we 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 action, including government supervision or liquidation, or require us to provide financial assistance, either through subordinated loans or capital infusions, to our subsidiaries 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 and provisions of our articles and bylaws could delay, deter or prevent a takeover attempt that shareholders might consider to be in their best interests and may 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, and our 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 license agreements with the BCBSA require that our articles contain certain provisions, including ownership limitations. See “Risks Relating to the Regulation of Our Industry-If we are deemed to have violated the insurance company change of control statutes in Puerto Rico, we may suffer adverse consequences.”
Other provisions included in our articles and bylaws may also 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.
See also “Risks Relating to the Regulation of Our Industry-If we are deemed to have violated the insurance company change of control statutes in Puerto Rico, we may suffer adverse consequences.”
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 issue 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.
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.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
We own a seven story building located at 1441 F.D. Roosevelt Avenue, in San Juan, Puerto Rico, and two adjacent buildings, as well as the adjoining parking lot. In addition, we own five floors of a fifteen-story building located at 1510 F.D. Roosevelt Avenue, in Guaynabo, Puerto Rico. We also own a multi-segment customer service center in the municipality of Mayagüez, Puerto Rico. In addition, through a health clinic in which we have a controlling interest, we own land and a two-story medical facility in the municipality of Bayamón. These properties are subject to liens under our credit facilities. In connection with our entrance to the Costa Rican market, we acquired a two-story building located in the city of San José, Costa Rica. See “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation - Liquidity and Capital Resources”.
We also own land in the municipality of Ponce, Puerto Rico, in which we have begun to build a multi-segment customer service center. In addition to the properties described above, we or our subsidiaries are parties to operating leases that are entered into in the ordinary course of business.
We believe that our facilities are in good condition and that the facilities, together with capital improvements and additions currently underway, are adequate to meet our operating needs for the foreseeable future. The need for expansion, upgrading and refurbishment of facilities is continually evaluated in order to keep facilities aligned with planned business growth and corporate strategy.
Item 3.
Item 3. Legal Proceedings
Our business is subject to numerous laws and regulations promulgated by Federal, Puerto Rico, USVI, Costa Rica, BVI, and Anguilla governmental authorities. Compliance with these laws and regulations can be subject to government review and interpretation, as well as regulatory actions unknown and unasserted at this time. The Commissioner of Insurance of Puerto Rico, as well as other Federal, Puerto Rico, USVI, Costa Rica, BVI, and Anguilla government authorities, regularly make inquiries and conduct audits concerning the Company's compliance with such laws and regulations. Penalties associated with violations of these laws and regulations include significant fines and penalties, and exclusion from participating in certain publicly funded programs.
We are involved in various legal actions arising in the ordinary course of business. We are also defendants in various other litigations and proceedings, some of which are described below. Where the Company believes that a loss is both probable and estimable, such amounts have been recorded. Although we believe our estimates of such losses are reasonable, these estimates could change as a result of further developments in these matters. In other cases, it is at least reasonably possible that the Company may incur a loss related to one or more of the mentioned pending lawsuits or investigations, but the Company is unable to estimate the range of possible loss which may be ultimately realized, either individually or in the aggregate, upon their resolution. The outcome of legal proceedings is inherently uncertain and pending matters for which accruals have not been established have not progressed sufficiently to enable us to estimate a range of possible loss, if any. Given the inherent unpredictability of these matters, it is possible that an adverse outcome in one or more of these matters could have a material adverse effect on the consolidated financial condition, operating results and/or cash flows of the Company.
Additionally, we may face various potential litigation claims that have not been asserted to date, including claims from persons purporting to have rights to acquire shares of the Corporation on favorable terms pursuant to agreements previously entered by our predecessor managed care subsidiary, Seguros de Servicios de Salud de Puerto Rico, Inc. (SSS), with physicians or dentists who joined our provider network to sell such new provider shares of SSS at a future date (“Share Acquisition Agreements”) or to have inherited such shares notwithstanding applicable transfer and ownership restrictions. See “Item 1A. Risks Factors-Risks Relating to our Capital Stock.”
Claims by Heirs of Former Shareholders
The Company and TSS are defending eight individual lawsuits, all filed in state court, from persons who claim to have inherited a total of 113 shares of the Company or one of its predecessors or affiliates (before giving effect to the 3,000-for-one stock split). While each case presents unique facts and allegations, the lawsuits generally allege that the redemption of the shares by the Company pursuant to transfer and ownership restrictions contained in the Company's (or its predecessors' or affiliates') articles of incorporation and bylaws was improper.
In one of these cases, entitled Vera Sánchez, et al, v. Triple-S, the plaintiffs argued that the redemption of shares was fraudulent and was not subject to the two-year statute of limitations contained in the local securities law. The Puerto Rico’s Court of First Instance dismissed the claim and determined it was time barred under the local securities law. On January 2012, Puerto Rico’s Court of Appeals upheld the dismissal. On March 28, 2012 the plaintiffs filed a petition for writ of certiorari before the Puerto Rico’s Supreme Court that was granted on May 31, 2012, and on October 1, 2013, reversed the dismissal, holding that the two-year statute of limitations contained in the local securities law did not apply and returning it to the Court of First Instance. Discovery is ongoing. Continuance of hearings is set for June 24, 2015.
In the second case, entitled Olivella Zalduondo, et al, v. Seguros de Servicios de Salud, et al, Puerto Rico’s Court of First Instance granted the Company’s motion to dismiss on grounds that the complaint was time-barred under the two-year statute of limitations of the local securities laws. On appeal, the Court of Appeals affirmed the decision of the lower court. Plaintiffs filed a petition for certiorari before the Puerto Rico’s Supreme Court which was granted on January 20, 2012. On January 8, 2013, Puerto Rico’s Supreme Court ruled that the applicable statute of limitations is the fifteen-year period of the Puerto Rico’s Civil Code for collection of monies. On January 28, 2013, the Company filed a motion for reconsideration which was subsequently denied. On March 26, 2013, plaintiffs amended the complaint for the second time and the Company answered on April 16, 2013. Discovery is ongoing.
In the third case, entitled Heirs of Dr. Juan Acevedo, et al, v. Triple-S Management Corporation, et al, the Puerto Rico’s Court of First Instance denied our motion for summary judgment based on its determination that there are material issues of fact in controversy. In response to our appeal, the Puerto Rico’s Court of Appeals confirmed the decision of the Puerto Rico’s Court of First Instance. Our request for reconsideration was denied in December 2011. A pretrial conference is set for August 10, 2015.
The fourth case, entitled Montilla López, et al, v. Seguros de Servicios de Salud, et al, was filed on November 29, 2011. The Company filed a motion to dismiss on the grounds that the claim is time barred under the local securities laws. On October 15, 2012, while the motion to dismiss was pending, plaintiffs amended their complaint. The court denied our motion to dismiss on January 24, 2013. The Company answered the complaint on March 8, 2013. Subsequently, plaintiffs amended their complaint and the Company filed its response on June 13, 2013. Discovery is ongoing and pretrial conference is set for May 27, 2015.
The fifth case, entitled Cebollero Santamaría v. Triple-S Salud, Inc., et al, was filed on March 26, 2013, and the Company filed its response on May 16, 2013. On October 29, 2013, the Company filed a motion for summary judgment on the grounds that the claim is time-barred under the fifteen-year statute of limitations of the Puerto Rico Civil Code for collection of monies and, in the alternative, that plaintiff failed to state a claim for which relief can be granted. The court allowed plaintiff to conduct limited discovery in connection with plaintiff’s opposition to our motion for summary judgment. On November 6, 2014, plaintiffs filed their opposition and a motion for summary judgment. On February 3, 2015, TSS replied the opposition and opposed to the motion for summary judgment. The limited discovery is currently ongoing and the parties are awaiting court’s decision on their respective pleads.
The sixth case, entitled Irizarry Antonmattei, et al, v. Seguros de Servicios de Salud, et al, was filed on April 16, 2013 and the Company filed its response on June 21, 2013. On June 28, 2013, the Puerto Rico’s Court of First Instance ordered plaintiffs to reply to the Company’s response specifically on the matter of the statute of limitations applicable to the complaint. Plaintiffs failed to timely respond and the Company moved to dismiss. Plaintiffs subsequently moved to amend the complaint, which was granted by the court. On November 5, 2013, the Company moved to dismiss the first amended complaint on the grounds that it is time-barred under the fifteen-year statute of limitations of the Puerto Rico Civil Code for collection of monies. On December 16, 2013, plaintiffs filed an opposition, which the Company replied on January 7, 2014. On February 19, 2014, the court ordered plaintiffs to file a memorandum of law by April 22, 2014 regarding the validity of the restrictions on transfer applicable to the shares. On May 16, 2014, plaintiffs filed a motion for summary judgment, which the Company opposed on May 28, 2014. On June 16, 2014, the court ordered plaintiffs to file the memoranda of law and struck plaintiff’s motion for summary judgment. On September 18, 2014, the court denied our motion to dismiss. On September 29, 2014, the Company filed a motion for reconsideration, which was denied by the court on November 4, 2014. On December 4, 2014, the Company filed a petition of Certiorari to the Court of Appeals of Puerto Rico. Discovery is ongoing.
The seventh case, entitled Allende Santos, et al, v. Triple-S Salud, et al, was filed on March 28, 2014. On July 2, 2014, the Company filed its response. Discovery is set to begin on or before April 30, 2015. A hearing is set for August 5, 2015.
The eighth case, entitled Gallardo Mendez, et al, v. Triple-S Management Corporation, was filed on December 30, 2014. The Company will file its response and will defend this case vigorously.
Management believes the aforesaid claims are time barred under one or more statutes of limitations and will vigorously defend them on these grounds; however, as a result of the Puerto Rico Supreme Court’s decision to deny the applicability of the statute of limitations contained in the local securities law, some of these claims will likely be litigated on their merits.
Joint Underwriting Association Litigations
On August 19, 2011, plaintiffs, purportedly a class of motor vehicle owners, filed an action in the United States District Court for the District of Puerto Rico against the Puerto Rico Joint Underwriting Association (“JUA”) and 18 other defendants, including TSP, alleging violations under the Puerto Rico Insurance Code, the Puerto Rico Civil Code, the Racketeer Influenced and Corrupt Organizations Act (“RICO”) and the local statute against organized crime and money laundering. JUA is a private association created by law to administer a compulsory public liability insurance program for motor vehicles in Puerto Rico (“CLI”). As required by its enabling act, JUA is composed of all the insurers that underwrite private motor vehicle insurance in Puerto Rico and exceed the minimum underwriting percentage established in such act. TSP is a member of JUA.
In this lawsuit, entitled Noemí Torres Ronda, et al v. Joint Underwriting Association, et al., plaintiffs allege that the defendants illegally charged and misappropriated a portion of the CLI premiums paid by motor vehicle owners in violation of the Puerto Rico Insurance Code. Specifically, they claim that because the defendants did not incur acquisition or administration costs allegedly totaling 12% of the premium dollar, charging for such costs constitutes the illegal traffic of premiums. Plaintiffs also claim that the defendants, as members of JUA, violated RICO through various inappropriate actions designed to defraud motor vehicle owners located in Puerto Rico and embezzle a portion of the CLI premiums for their benefit.
Plaintiffs seek the reimbursement of funds for the class amounting to $406.6 million treble damages under RICO, and equitable relief, including a permanent injunction and declaratory judgment barring defendants from their alleged conduct and practices, along with costs and attorneys’ fees.
On December 30, 2011, TSP and other insurance companies filed a joint motion to dismiss, arguing, among other things, that plaintiffs’ claims are barred by the filed rate doctrine, inasmuch as a suit cannot be brought, even under RICO, to amend the compulsory liability insurance rates that were approved by the Puerto Rico Legislature and the Commissioner of Insurance of Puerto Rico.
On February 17, 2012, plaintiffs filed their opposition. On April 4, 2012, TSP filed a reply in support of our motion to dismiss, which was denied by the court. On October 2, 2012, the court issued an order certifying the class. On October 12, 2012, several defendants, including TSP, filed an appeal before the U.S. Court of Appeals for the First District, requesting the court to vacate the District Court's certification order. The First Circuit denied the authorization to file the writ of appeals. Discovery has been completed. On November 3, 2014, all defendants, including TSP, filed a joint motion to decertify the class and, on November 17, 2014, a joint motion for summary judgment requesting the dismissal of the claim. We are awaiting plaintiffs’ response and further court proceedings.
Dentists Association Litigation
On February 11, 2009, the Puerto Rico Dentists Association (“Colegio de Cirujanos Dentistas de Puerto Rico,” in Spanish) filed a complaint in the Court of First Instance against 24 health plans operating in Puerto Rico that offer dental health coverage. The Company and two of its subsidiaries, TSS and Triple-C, Inc. (“TCI”), were included as defendants. This litigation purports to be a class action filed on behalf of Puerto Rico dentists who are similarly situated.
The complaint alleges that the defendants, on their own and as part of a common scheme, systematically deny, delay and diminish the payments due to dentists so that they are not paid in a timely and complete manner for the covered medically necessary services they render. The complaint also alleges, among other things, violations to the Puerto Rico Insurance Code, antitrust laws, the Puerto Rico racketeering statute, unfair business practices, breach of contract with providers, and damages in the amount of $150.0 million. In addition, the complaint claims that the Puerto Rico Insurance Companies Association is the hub of an alleged conspiracy concocted by the member plans to defraud dentists.
Two codefendant plans, whose main operations are outside Puerto Rico, removed the case to federal court in Florida, which the plaintiffs and the other codefendants, including the Company, opposed. On February 8, 2011, the federal district court in Puerto Rico decided to retain jurisdiction. The defendants filed a joint motion to dismiss the case on the merits. On August 31, 2011, the District Court dismissed all of plaintiffs' claims except for its breach of contract claim, and ordered the parties to brief the issue of whether the court still has federal jurisdiction under the Class Action Fairness Act of 2005 (“CAFA”). Plaintiffs moved the court to reconsider its August 31, 2011 decision and the defendants did the same, arguing that the breach of contract claim failed to state a claim upon which relief can be granted. On May 2, 2012, the court denied the plaintiffs' motion. On May 31, 2012, plaintiffs appealed the District Court's dismissal of their complaint and the denial of plaintiffs’ motion for reconsideration. The U.S. Court of Appeals for the First Circuit dismissed the appeal for lack of jurisdiction. On September 25, 2012 the District Court denied without prejudice the defendants’ motion for reconsideration. On October 10, 2012 the parties filed their briefs with respect to class certification. On March 13, 2013, the district court denied plaintiffs’ request for class certification and ordered the parties to brief the court on whether jurisdiction still exists under CAFA following such denial. On April 24, 2013, all parties briefed the court on this issue. On September 6, 2013, the District Court dismissed the Dentist Association for lack of associational standing, leaving only the individual dentists as plaintiffs. The court also granted plaintiffs’ leave to amend, on or before September 23, 2013, their complaint to address mediation or settlement negotiations and, to cure deficiencies pertaining to the breach-of-contract claims. On December 23, 2013, five plaintiffs filed a Second Amended Complaint (“SAC”) seeking damages in the amount of $30 thousand in which the dentists alleged that defendants altered the coding of the claims billed by the dentist, resulting in a lower payment. Only one of the five plaintiffs presented a claim against the Company. On January 31, 2014, the Company answered the complaint. On April 11, 2014, TSS filed a motion to compel arbitration, as provided by the claimant’s provider contract. Court’s decision on this motion is still pending. On April 24, 2014, the Company and the claimant filed a voluntary dismissal with prejudice, TSS and TCI continuing as defendants. On June 4, 2014, TSS, TCI, and the remaining plaintiff filed a joint notice of settlement and a request for dismissal. On June 6, 2014 the court dismissed the claim as requested by the parties. On June 26, 2014, the court entered an amended judgment to indicate that dismissal of the case was with prejudice.
In re Blue Cross Blue Shield Antitrust Litigation
TSS is a co-defendant with multiple Blue Plans and the BCBSA in a multi-district class action litigation filed on July 24, 2012 that alleges that the exclusive service area (“ESA”) requirements of the Primary License Agreements with Plans violate antitrust law, and the plaintiffs in these suits seek monetary awards and in some instances, injunctive relief barring ESAs. Those cases have been centralized in the United States District Court for the Northern District of Alabama. Prior to centralization, motions to dismiss were filed by several plans, including TSS. Plaintiffs opposed TSS’ motion to dismiss. On April 9, 2014, the Court held an argumentative hearing to discuss the motions to dismiss. During the hearing, the Court did not issue a ruling on the motions to dismiss thus, decision on said motions are still pending. On June 18, 2014, the court denied TSS’ motion to dismiss. Discovery is ongoing. The Company has joined BCBSA in vigorously contesting these claims.
Claims Relating to the Provision of Health Care Services
TSS is defendant in several claims for collection of monies in connection with the provision of health care services. Among them are individual complaints filed before the Puerto Rico Health Insurance Administration (ASES) by six community health centers alleging TSS’ breached their contracts with respect to certain capitation payments and other monetary claims. Such claims have an aggregate value of approximately $9.6 million. Discovery is ongoing, and given their early stage, the Company cannot assess the probability of an adverse outcome or the reasonable financial impact that any such outcome may have on the Company. TSS believes these complaints are time-barred and intends to vigorously defend them on these and other grounds.
Also, on June 5, 2014, ASES initiated an administrative hearing against TSS moved by a primary medical group for alleged outstanding claims related to services provided to Medicaid beneficiaries from 2005 to 2010, totaling approximately $3.0 million. On June 19, 2014, TSS filed its response and intends to vigorously defend this claim.
Intrusions into TCI’s Internet IPA Database
On September 21, 2010, the Company learned from a competitor that a specific internet database containing information pertaining to individuals insured at the time by TSS under the Government of Puerto Rico Medicaid program and to independent practice associations that provided services to those individuals, had been accessed without authorization by certain of its employees.
The Company reported these events to the appropriate Puerto Rico and federal government agencies. It then received and complied with requests for information from ASES and the Office for Civil Rights (“OCR”) of the U.S. Department of Health and Human Services, which entities are conducting reviews of these data breaches and TSS' and TCI's compliance with applicable security and privacy rules. ASES levied a fine of $100 thousand on TSS in connection with these incidents, but following the Company’s request for reconsideration, ASES withdrew the fine pending the outcome of the review by the OCR. The OCR has not issued its determination on this matter. The Company at this time cannot reasonably assess the impact of these proceedings on the Company.
Unauthorized Disclosure of Protected Health Information
On September 20, 2013, TSS mailed a pamphlet to our approximately 70,000 Medicare Advantage beneficiaries that inadvertently displayed the receiving beneficiary’s Medicare Health Insurance Claim Number (“HICN”). The HICN is the unique number assigned by the Social Security Administration to each Medicare beneficiary and is considered protected health information under HIPAA. TSS conducted an investigation and reported the incident to the appropriate Puerto Rico and federal government agencies. It then received and complied with requests for information from these agencies, ASES and OCR, concerning this matter. In accordance with itls legal obligations under HIPAA, TSS issued a breach notification through the local media and notified all affected beneficiaries by mail, notifying them of certain protective measures as well.
On April 16, 2014, ASES received a complaint submitted by an American Health Medicare (now “TSA”) Platino product beneficiary alleging that a pamphlet distributed by TSA had Protected Health Information (“PHI”) visible on its external cover. TSA conducted the investigation of this allegation and discovered that the external cover of the pamphlets mailed to Platino members displayed the unique contract number randomly assigned by TSA to its members. This number combined with the name and address of the member identified each individual as an TSA Platino beneficiary and the use of the unique contract number on the outside of the pamphlets may be viewed as a violation of the HIPAA minimum necessary rule set forth in regulation. A total of 39,944 members were affected by the incident, from which 28,413 were Platino members. We treated this as a separate HIPAA-related incident. Therefore, we reported the incident to concerned local and federal regulators. Similarly, we issued a letter by mail and posted a substitute notice on our webpage to the affected individuals and notified the breach through the local media.
On February 11, 2014, ASES notified TSS of its intention to impose a civil monetary penalty of $6.8 million and other administrative sanctions with respect to the September 2013 breach described above involving 13,336 dual eligible Medicare/Medicaid beneficiaries. The sanctions include the suspension of all new enrollments of dual eligible Medicare/Medicaid beneficiaries and the obligation to notify affected individuals of their right to disenroll. In its letter, ASES alleged TSS has failed to take all required steps in response to the breach. After TSS submitted a corrective action plan and, on February 21, 2014, ASES requested TSS to provide additional information in connection with the corrective action plan and, on February 26, 2014, ASES temporarily lifted the sanctions related to the enrollment of dual eligible Medicare beneficiaries. On March 6, 2014, ASES confirmed its determination lifting the enrollment sanction and notified its intention to provide TSS with corrective action plan. On March 11, 2014, TSS filed an answer challenging the monetary civil monetary penalty and requesting an administrative hearing and simultaneously filed a notice of removal in the federal District Court for the District of Puerto Rico. On April 10, 2014, ASES filed a motion to remand, and, on April 24, 2014 TSS filed its opposition. This matter is pending court’s resolution.
While TSS is collaborating with ASES on these matters, it intends to vigorously contest the monetary fine and other sanctions which are the subject of ASES’ notices. At this time, the Company is unable to determine the ultimate outcome of its challenge to ASES’ sanctions, the incident’s ultimate financial impact on TSS or what measures, if any, will be taken by the OCR or other regulators regarding this matter.
In connection with the September 30, 2013 event, four individuals have filed suit against TSS in the Court of First Instance of Puerto Rico. In the first case, filed on February 10, 2014, one individual, on his behalf and on behalf of his spouse asserts emotional damages due the disclosure of his protected health information. Discovery is ongoing. In the second case, filed on February 24, 2014, another individual filed a class-action suit claiming approximately $20.0 million in damages. With respect with this class-action suit, on February 27, 2014, TSS filed a motion to dismiss the class-action suit based on several grounds, including lack of standing. The court ordered plaintiff to submit an opposition to TSS’ motion to dismiss, subject to the dismissal of the claim if plaintiff failed to comply. Plaintiff filed its opposition on March 12, 2014 and, on April 14, 2014, TSS replied. The Court’s ruling on the motions is pending. In the third case, filed on April 23, 2014, another individual asserts emotional damages and identity theft. Discovery is ongoing. In the fourth case, filed on September 19, 2014, an individual asserts emotional damages in connection with this matter. The Company filed its response and discovery is ongoing.
ASES Audits
On July 2, 2014, ASES notified TSS that it conducted an audit reflecting an overpayment of premium in the amount of $7.9 million corresponding to payments made to TSS pursuant to prior contracts with ASES for the provision of services under the government health plan as a result of audits conducted by ASES covering several periods from October 2005 to September 2013. TSS contends that ASES request for reimbursement has no merits on several grounds, including a 2011 settlement between both parties covering the majority of the amount claimed by ASES. In connection with ASES allegations, ASES withheld $4.8 million in service fees corresponding to services provided for the period from October 2005 to September 2010. On August 29, 2014, ASES delivered the $4.8 million previously withheld. On December 30, 2014, ASES sent a letter to TSS requesting the reimbursement of approximately $1.3 and, consequently, withheld service fees. On January 16, 2015, the Company filed suit and a preliminary injunction on the Court of First Instance of Puerto Rico requesting the payment of service fees and asserting various claims, including the validity of the agreement signed by the parties in 2011. On January 29, 2015, a hearing was held in which ASES committed to deliver TSS services fees until March 31, 2015 in consideration of the negotiations being conducted by the parties.
Item 4.
Item 4. Mine Safety Disclosures
None.
Part II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our Class B common stock is listed and began trading on the New York Stock Exchange (the “NYSE”) on December 7, 2007 under the trading symbol “GTS”. Prior to this date our Class B common stock had no established public trading market. There is no established public trading market for our Class A common stock.
The following table presents high and low closing prices of our Class B common stock for each quarter of the years ended December 31, 2014 and 2013:
On March 13, 2015 the closing price of our Class B common stock on the NYSE was $20.34.
Holders
As of March 3, 2015, there were 2,377,689 and 25,129,270 shares of Class A and Class B common Stock outstanding, respectively. The number of our holders of Class A common stock as of March 3, 2015 was 756. The number of our holders of Class B common stock as of March 3, 2015 was 5,230.
Dividends
Subject to the limitations under Puerto Rico corporation law and any preferential dividend rights of outstanding preferred stock, of which there is currently none outstanding, holders of common stock are entitled to receive their pro rata share of such dividends or other distributions as may be declared by our board of directors out of funds legally available therefore.
Our ability to pay dividends is dependent on cash dividends from our subsidiaries. Our subsidiaries are subject to regulatory surplus requirements and additional regulatory requirements, which may restrict their ability to declare and pay dividends or distributions to us. In addition, our secured term loan restricts our ability to pay dividends if a default thereunder has occurred and is continuing. Please refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Restriction on Certain Payments by the Corporation’s Subsidiaries”. Also, see note 18 of the audited consolidated financial statements for the years ended December 31, 2014, 2013 and 2012.
We did not declare any dividends during the two most recent fiscal years and do not expect to pay any cash dividends for the foreseeable future. We currently intend to retain future earnings, if any, to finance operations and expand our business. The ultimate decision to pay a dividend, however, remains within the discretion of our board of directors and may be affected by various factors, including our earnings, financial condition, capital requirements, level of indebtedness, statutory and contractual limitations and other considerations our board of directors deems relevant.
Securities Authorized for Issuance Under Equity Compensation Plan
See note 20 of the audited consolidated financial statements for the years ended December 31, 2014, 2013 and 2012.
Performance Graph
The following graph compares the price performance of our Class B common stock for the period from January 1, 2010 through December 31, 2014, with the price performance over such period of (i) the Standard and Poor’s 500 Stock Index (the “S&P 500 Index”) and (ii) the Standard & Poor’s Managed Health Care Index (the “S&P MHC Index”). The comparison assumes an investment of $100 on January 1, 2010 in each of our Class B common stock, the S&P 500 Index, and the S&P MHC Index. The performance graph is not necessarily indicative of future performance.
The comparisons shown in the graph are based on historical data and the Corporation cautions that the stock price in the graph below is not indicative of, and is not intended to forecast, the potential future performance of our Class B common stock. Information used in the preparation of the graph was obtained from Bloomberg; a source we believe to be reliable, however, the Corporation is not responsible for any errors or omissions in such information.
Recent Sales of Unregistered Securities
Not applicable.
Purchases of Equity Securities by the Issuer
1 In October 2014, the Company's Board of Directors authorized a $50.0 million share repurchase program of its Class B common stock.
Item 6.
Item 6. Selected Financial Data
Statement of Earnings Data
Balance Sheet Data
Additional Managed Care Data (2)
(1) Further details of the calculation of basic earnings per share are set forth in notes 2 and 21 of the audited consolidated financial statements for the years ended December 31, 2014, 2013 and 2012.
(2) Does not reflect inter-segment eliminations.
Item 7.
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, 2014 and 2013, and consolidated results of operations for 2014, 2013 and 2012. 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:
I. Overview
We are one of the most significant players in the managed care industry in Puerto Rico and have over 50 years of experience in this industry. We offer a broad portfolio of managed care and related products in the Commercial and the Medicare (including Medicare Advantage and the Part D stand-alone prescription drug plans (“PDP”)) 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 Reform (a government of Puerto Rico-funded managed care program for the medically indigent that is similar to the Medicaid program in the U.S.) (“Medicaid”), by administering the provision of the physical health component in designated service regions in Puerto Rico.
We have the exclusive right to use the BCBS name and mark throughout Puerto Rico, the U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla. As of December 31, 2014 we serve approximately 2,139,000 members across all regions of Puerto Rico. For the years ended December 31, 2014 and 2013 respectively, our managed care segment represented approximately 89.0% and 89.5% of our total consolidated premiums earned, net, and approximately 57.3% and 73.4% of our operating income. We also have significant positions in the life insurance and property and casualty insurance markets. Our life insurance segment had a market share of approximately 12% (in terms of premiums written) for 2013. Our property and casualty segment had a market share of approximately 8% (in terms of direct premiums) during the nine-month period ended September 30, 2014.
We participate in the managed care market through our subsidiaries, TSS and TSA. TSS, TSA and TSB are BCBSA licensees, which provide us with exclusive use of the Blue Cross and Blue Shield name and mark throughout Puerto Rico, the U.S. Virgin Islands, Costa Rica, the British Virgin Islands and Anguilla.
We participate in the life insurance market through our subsidiary, TSV, and in the property and casualty insurance market through our subsidiary, TSP. TSV and TSP represented 6.7% and 4.3%, respectively, of our consolidated premiums earned, net for the year ended December 31, 2014 and 41.2% and 18.2%, respectively, of our operating income for that period.
In December 2014, Triple-S Salud, Inc. (“TSS”) and Triple-S Advantage, Inc. (“TSA”) entered into a novation agreement after obtaining approval from Centers for Medicare and Medicaid Services (“CMS”), whereby all the assets and liabilities of TSS’s Medicare Advantage business were transferred to TSA and TSA assumed all the obligations of the policies and all obligations that may exist under the contracts.
In October 2014, our Board of Directors authorized a $50.0 million share repurchase program of our Class B common stock. Repurchases are being 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 2014, the Company repurchased and retired 228,525 shares of Class B common stock under this program at an average per share price of $23.55, for an aggregate cost of approximately $5.3 million.
On November 7, 2013, our subsidiary TSV completed the acquisition of 100% of the outstanding capital stock of ASICO (effective March 27, 2014 this entity changed its name from ASICO to Triple-S Blue, Inc. ,“Triple-S Blue” or “TSB”), a life insurance company authorized to do business in Puerto Rico, Costa Rica, Anguilla and the British Virgin Islands. The cost of this acquisition was approximately $9.4 million and was funded with unrestricted cash. Our consolidated results of operations and financial condition included in this Annual Report on Form 10-K reflect TSB’s acquisition in periods subsequent to the effective date of the transaction and were included within the Life Insurance segment.
In January 2012, we acquired a controlling interest in a health clinic in Puerto Rico, as part of our strategic approach in our Managed Care segment.
The Commissioner of Insurance of the Commonwealth of Puerto Rico (“Commissioner of Insurance of Puerto Rico”) 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 24 to our audited consolidated financial statements.
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 net fee revenue 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:
Revenue
General. Our revenue consists primarily of (i) premium revenue we generate from our managed care business, (ii) administrative service fees we receive for services provided to self-insured employers, (iii) premiums we generate from our life insurance and property and casualty insurance businesses and (iv) investment income.
Managed Care Premium Revenue. Our revenue primarily consists of premiums earned from the sale of managed care products to the Commercial market sector, including corporate accounts, federal government employees, local government employees, individual accounts and Medicare Supplement, as well as to the Medicare Advantage (including PDP). 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 business 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.
Premiums are set prospectively, meaning that a fixed premium rate is determined at the beginning of each contract year and revised at renewal. We renegotiate the premiums of different groups as their existing annual contracts become due. Our Medicare Advantage contracts entitle us to premium payments from CMS on behalf of each Medicare beneficiary enrolled in our plans, generally on a per member per month (“PMPM”) basis. We submit rate proposals to CMS in June for each Medicare Advantage product that will be offered beginning January 1 of the subsequent year in accordance with the competitive bidding process under the MMA. Retroactive rate adjustments are made periodically with respect to our Medicare Advantage plans based on the aggregate health status and risk scores of our plan participants.
Premium payments from CMS in respect of our Medicare Part D prescription drug plans are based on written bids submitted by us which include the estimated costs of providing the prescription drug benefits.
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 administrative services only (“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. TSS has a contract with the Government of Puerto Rico, to administer the provision of the physical health component of the Medicaid program in designated service regions in Puerto Rico. On July 1, 2013, TSS extended this contract for a 12-month period. This amendment also transferred the administration of the three remaining service regions to TSS upon completion of a transition period, which ended on October 1, 2013. In 2014 the Government of Puerto Rico commenced an RFP process for the Medicaid business and announced its intention to convert the current program to a managed care organization model, under which the selected contractors will be at risk for the provision of the physical and behavioral health components of the program. TSS submitted bids for the Metro north and West regions, which were subsequently awarded on October 14, 2014. Additionally TSS is expected to continue to serve as a third party administrator until December 31, 2015 in order to process all claims incurred on or before March 31, 2015.
Other Premium Revenue. Other premium revenue includes premiums generated from the sale of life insurance and property and casualty insurance products. Premiums on traditional life insurance policies are reported as earned when due. Premiums on accident and health and other short-term contracts are recognized as earned, primarily on a pro rata basis over the contract period. Premiums on credit life policies are recognized as earned in proportion to the amounts of insurance in force. Group insurance premiums are billed one month in advance and a grace period of one month is provided for premium payment. If the insured fails to pay within the one-month grace period, we may cancel the policy. We recognize premiums on property and casualty contracts as earned on a pro rata basis over the policy term. Property and casualty policies are subscribed through general agencies, which bill policy premiums to their clients in advance or, in the case of new business, at the inception date and remit collections to us, net of commissions. The portion of premiums related to the period prior to the end of coverage is recorded in the consolidated balance sheet as unearned premiums and is transferred to premium revenue as earned.
Investment Income. Investment income consists of interest and dividend income from investment securities. See note 4 to our audited consolidated financial statements.
Expenses
Claims Incurred. Our largest expense is 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 and other service providers, and to policyholders. We generally pay our providers on one of three bases: (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 insurance businesses. 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 medical loss ratio (“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 healthcare 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 healthcare costs and to make various business decisions, including what plans or benefits to offer and our selection of healthcare 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 and administrative service fees. A significant portion of our operating expenses are fixed costs. Accordingly, it is important that we maintain certain level of volume of business 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 volume of business.
II. 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 and general market conditions.
TSS has a contract with the Government of Puerto Rico to administer the provision of the physical health component of the Medicaid program (similar to Medicaid) in designated service regions in Puerto Rico. On July 1, 2013, TSS extended this contract for a 12-month period. This amendment also transferred the administration of the three remaining service regions to TSS upon completion of a transition period, which ended on October 1, 2013.
The following table sets forth selected membership data as of the dates set forth below:
(1) Commercial membership includes corporate accounts, self-funded employers, individual accounts, Medicare Supplement, Federal government employees and local government employees.
(2) Includes Medicare Advantage as well as stand-alone PDP plan membership.
(3) All are self-funded members.
III. Results of Operations
Consolidated Operating Results
The following table sets forth our consolidated operating results for the years ended December 31, 2014, 2013 and 2012. Further details of the results of operations of each reportable segment are included in the analysis of operating results for the respective segments.
Year ended December 31, 2014 compared with the year ended December 31, 2013
Operating Revenues
Consolidated premiums earned, net decreased by $74.4 million, or 3.4%, to $2.1 billion during the year ended December 31, 2014 compared to the year ended December 31, 2013. The decrease was mostly the result of lower member month enrollment in the Commercial and Medicare businesses and the receipt of lower risk score adjustments from CMS in 2014 as compared to 2013.
The consolidated administrative service fees increased by $10.6 million, or 9.8%, to $119.3 million for the year ended December 31, 2014 when compared with the year ended December 31, 2013, mostly as the result of the increased enrollment after the addition of the three new Medicaid regions effective October 1, 2013.
Net Realized Investment Gains
Consolidated net realized investment gains of $18.2 million during the year ended December 31, 2014 are the result of net realized gains from the sale of debt and equity securities classified as available for sale, following our asset/liability management and tax planning strategies. The net realized gains were partially offset by a $1.2 million other-than-temporary impairments.
Other Income, Net
Consolidated other income decreased by $13.0 million during the year ended December 31, 2014 when compared to the year ended December 31, 2013, mostly due to a special distribution received the year ended December 31, 2013 from the Puerto Rico Joint Underwriting Association (“JUA”) in the Property and Casualty segment of $12.8 million, net of a special tax.
Claims Incurred
Consolidated claims incurred during the year ended December 31, 2014 decreased by $88.6 million, or 4.8%, to $1.7 billion when compared to the claims incurred during the year ended December 31, 2013. This decrease is mostly in the Commercial business of the Managed Care segment primarily as a result of lower member month enrollment in the 2014 period. Property and Casualty claims also decreased reflecting a favorable loss experience, particularly in the Commercial Multi-peril and Commercial Auto lines of business, partially offset with an unfavorable loss experience in the Medical Malpractice line of business. These decreases were partially offset by an increase in claims of the Life segment of $4.1 million reflecting the addional claims related to the recent ASICO acquisition, which was effective November 2013. The consolidated loss ratio decreased by 120 basis points to 82.1%.
Operating Expenses
Consolidated operating expenses during the year ended December 31, 2014 increased by $19.0 million, or 4.0%, to $497.2 million as compared to the operating expenses during the year ended December 31, 2013. For the year ended December 31, 2014, the consolidated operating expense ratio increased by 140 basis points to 22.1%. The higher operating expenses and operating expenses ratio are mainly related to $27.7 million of Health Insurance Providers Fee that became effective January 1, 2014, an increase of $4.4 million in premium taxes and incremental expenses related to the administration of the three new service regions of the Medicaid program effective October 1, 2013. The effect of new taxes and fees and the increased Medicaid enrollment was partly offset by the impact of cost containment initiatives in place during 2014.
Income tax expense
Consolidated income tax expense during the year ended December 31, 2014 decreased by $1.6 million, or 69.6%, to $0.7 million when compared to the income tax expense during the year ended December 31, 2013. This decrease is primarily due to an income tax benefit of $17.0 million that principally results from the enactment of a local law that provided a temporary preferential tax rate in capital asset transactions during the last quarter of 2014, together with the execution of a Closing Agreement between TSM and its subsidiaries and the Puerto Rico Treasury Department in connection with this law. These events allowed the Company to benefit from the enacted lower taxable rate and to reassess deferred taxes upon the changes in the tax bases of some assets and tax attributes that became realizable. This benefit was offset by an additional tax expense of $6.3 million resulting from the increase in the corporate tax rate over long-term capital gains from 15% to 20% for all transactions occurring after June 30, 2014.
Year ended December 31, 2013 compared with the year ended December 31, 2012
Operating Revenues
Consolidated premiums earned, net decreased by $50.4 million, or 2.2%, to $2.2 billion during the year ended December 31, 2013 compared to the year ended December 31, 2012. The decrease was mostly the result of lower member month enrollment in the Medicare and Commercial businesses and the receipt of lower risk score adjustments from CMS in 2013 as compared to 2012.
The consolidated administrative service fees decreased by $1.4 million, or 1.3%, to $108.7 million for the year ended December 31, 2013 when compared with the year ended December 31, 2012. This fluctuation primarily reflects the effect of the amended Medicaid contract, which includes lower per-member per-month fees, offset in part by the increased enrollment after the addition of the three new regions effective October 1, 2013. The new rate per-member per-month fees were effective July 1, 2013.
Net Realized Investment Gains
Consolidated net realized investment gains of $2.6 million during the year ended December 31, 2013 are the result of net realized gains from the sale of debt and equity securities classified as available for sale, following our asset/liability management and tax planning strategies. The net realized gains were partially offset by a $1.0 million other-than-temporary impairments related to certain equity securities that have been at an unrealized loss for a period exceeding six months.
Other Income, Net
Consolidated other income increased by $13.1 million during the year ended December 31, 2013 compared with to the year ended December 31, 2012 mostly due to the JUA special distribution received from the Property and Casualty segment of $12.8 million, net of a special tax.
Claims Incurred
Consolidated claims incurred during the year ended December 31, 2013 decreased by $83.6 million, or 4.4%, to $1.8 billion when compared to the claims incurred during the year ended December 31, 2012. This decrease in the claims incurred primarily results from the lower Managed Care member month enrollment and lower utilization and cost trends in the Medicare and Commercial businesses year over year. This decrease was partially offset by an increase in claims of the Life and Property and Casualty segments. The consolidated loss ratio decreased by 190 basis points to 83.3%.
Operating Expenses
Consolidated operating expenses during the year ended December 31, 2013 increased by $53.0 million, or 12.5%, to $478.2 million as compared to the operating expenses during the year ended December 31, 2012. For the year ended December 31, 2013, the consolidated operating expense ratio increased by 270 basis points to 20.7%, The higher operating expenses and operating expenses ratio are mainly related to special technology initiatives, expenses related to the reorganization of the Medicare business, higher payroll and related expenses mostly as a result of recruitment of additional Medicare sales force, and additional expenses incurred to serve the additional three Medicaid regions effective October 1, 2013. Professional services also reflect an increase related to our CMS star ratings efforts. Operating expenses for the year ended December 31, 2013 also include approximately $5.0 million in premium taxes. These premium taxes became effective on July 1, 2013.
Income tax expense
Consolidated income tax expense during the year ended December 31, 2013 decreased by $10.2 million, or 81.6%, to $2.3 million as compared to the income tax expense during the year ended December 31, 2012. This decrease is primarily due to the effect of a $7.7 million adjustment to the consolidated net deferred tax assets after an increase in the enacted tax rate from 30% to 39% and the lower income before taxes during the year 2013, net of additional tax expense due to the aforementioned tax rate increase that was effective January 1, 2013. The effective tax rate decreased from 18.8% in 2012 to 4.0% in 2013 primarily reflecting the net effect of the change in the enacted tax rate.
Managed Care Operating Results
We offer our products in the managed care segment to three distinct market sectors in Puerto Rico: Commercial, Medicare (including Medicare Advantage and PDP) and Medicaid. For the year ended December 31, 2014, the Commercial sector represented 41.4% and 28.2% of our consolidated premiums earned, net and operating income, respectively. Premiums earned, net and operating income generated from our Medicare contracts (including PDP) during the year ended December 31, 2014 represented 47.5% and -11.2%, respectively, of our consolidated earned premiums, net and operating income, respectively. The operating income of the Medicaid sector represented 35.7% of the consolidated operating income for the year ended December 31, 2014.
Year ended December 31, 2014 compared with the year ended December 31, 2013
Medical Operating Revenues
Medical premiums earned for the year ended December 31, 2014 decreased by $78.6 million, or 4.0%, to $1.9 billion when compared to the medical premiums earned during the year ended December 31, 2013. This decrease is principally the result of the following:
• Medical premiums generated by the Commercial business decreased by $53.4 million, or 5.7%, to $882.4 million during the year ended December 31, 2014 as compared to the year ended December 31, 2013. This fluctuation is primarily the result of a decrease in fully-insured member month enrollment by 477,997, or 8.7%, mainly in our rated groups and individual accounts products and reflecting pricing sensitivity, cancellation of several commercial accounts and attrition in existing accounts as a result of Puerto Rico’s challenging economic situation. The effect of the decreased membership is partially offset by a 3.3% year over year increase in average premium rates.
• Medical premiums generated by the Medicare business decreased by $25.2 million, or 2.4%, to $1.0 billion during the year ended December 31, 2014 as compared to the year ended December 31, 2013. This fluctuation primarily results from lower risk score adjustments when compared to the 2013 period, a decrease in risk score revenue when compared to last year, and the decline in 2014 premiums mandated by CMS and a change in membership mix in 2014.
Administrative service fees increased by $10.8 million, or 9.6%, to $123.6 million during the year ended December 31, 2014. This is primarily a result of higher Medicaid enrollment after the addition of three regions effective October 1, 2013.
Medical Claims Incurred
Medical claims incurred during the year ended December 31, 2014 decreased by $83.8 million, or 4.9%, to $1.6 billion, when compared to the prior year. The MLR of the segment was 85.9%, decreasing by 80 basis points during the year ended December 31, 2014. These fluctuations are primarily attributed to the effect of the following:
• The medical claims incurred of the commercial business decreased by $85.6 million, or 10.2%, during the 2014 period mostly reflecting a lower fully-insured member month enrollment. The 2014 Commercial MLR was 85.3%, which is 430 basis points lower than the prior year. Excluding the effect of prior period reserve developments in 2014 and 2013, the MLR would have increased by 100 basis points, mostly reflecting higher cost trends, particularly for pharmacy benefits.
• The medical claims incurred of the Medicare business increased by $1.7 million, or 0.2%, during the 2014 period and its MLR was 86.3%, which is 230 basis points higher than the MLR for the prior year. Excluding the effect of risk-score premium adjustments and prior period reserve developments in the 2014 and 2013 periods, the MLR increased by 440 basis points, primarily reflecting higher pharmacy costs and lower risk score revenue.
Medical Operating Expenses
Medical operating expenses for the year ended December 31, 2014 increased by $19.4 million, or 5.5%, to $374.2 million when compared to the year ended December 31, 2013. The operating expense ratio increased by 150 basis points, from 17.0% in 2013 to 18.5% in 2014. This increase is mainly related to $27.7 million of Health Insurance Providers Fee that became effective January 1, 2014, increase of $3.3 million of premium taxes that became effective July 1, 2013 and incremental expenses related to the administration of the three new service regions of the Medicaid program effective October 1, 2013. The effect of new taxes and fees and the increased Medicaid enrollment was partially offset by the impact of cost containment initiatives in place during the 2014 period.
Year ended December 31, 2013 compared with the year ended December 31, 2012
Medical Operating Revenues
Medical premiums earned for the year ended December 31, 2013 decreased by $58.8 million, or 2.9%, to $2.0 billion when compared to the medical premiums earned during the year ended December 31, 2012. This decrease is principally the result of the following:
• Medical premiums generated by the Medicare business decreased by $34.6 million, or 3.2%, to $1.0 billion. This fluctuation is the result of an overall decrease in the member month enrollment of this business by 83,828, or 5.8%, when compared with the same period in 2012. Decrease in member month enrollment was attributed to lower sales of our non-dual offerings. This fluctuation also results from the receipt of a lower risk score adjustments from CMS in 2013 as compared to 2012. The 2013 and 2012 periods include the net effect of approximately $2.9 million and $12.6 million, respectively, related to CMS final risk scores adjustments corresponding to prior periods.
• Medical premiums generated by the Commercial business decreased by $24.2 million, or 2.5%, to $935.8 million during the year ended December 31, 2013 as compared to the year ended December 31, 2012. This fluctuation is primarily the result of a decrease in member month enrollment by 313,728, or 5.4%, which was partially offset by an increase in average premium rates of approximately 3.0%. The decrease in member month enrollment is mostly due to the non-renewal of one large commercial account and a higher level of attrition, due to the prevailing economic conditions in the island.
Administrative service fees decreased by $2.0 million, or 1.7%, to $112.8 million during the year ended December 31, 2013 when compared with the year ended December 31, 2012. This fluctuation primarily reflects the effect of the amended Medicaid contract, which includes lower per-member per-month fees, offset in part by the increased enrollment after the addition of the three new regions effective October 1, 2013. The new rate per-member per-month fees were effective July 1, 2013.
Medical Claims Incurred
Medical claims incurred during the year ended December 31, 2013 decreased by $93.5 million, or 5.2%, to $1.7 billion, when compared to the year ended December 31, 2012. The MLR of the segment was 86.7%, decreasing by 210 basis points during the year ended December 31, 2013. These fluctuations are primarily attributed to the effect of the following:
• The medical claims incurred of the Medicare business decreased by $79.9 million, or 8.4%, during the 2013 period and its MLR was 84.0%, which is 480 basis points lower than the MLR for the prior year. The lower member month enrollment in this sector contributed to the decrease in claims incurred. Excluding the effect of risk-score premium adjustments and prior period reserve developments in the 2013 and 2012 periods, the MLR decreased by 460 basis points, mostly as the result of lower utilization and cost trends. The decrease also reflects improved drug costs after the new PBM contract in TSA and the impact of changes in 2013 product design.
• The medical claims incurred of the Commercial business decreased by $12.6 million, 1.5%, during the 2013 period mostly reflecting a lower fully-insured member month enrollment. The Commercial MLR was 89.5%, which is 90 basis points higher than the MLR for the prior year. Excluding the effect of prior period reserve developments in 2013 and 2012, the MLR would have increased by 170 basis points, mostly reflecting higher utilization, plus a higher loss ratio in our USVI operation, principally as a result of higher cost and utilization trends during the year.
Medical Operating Expenses
Medical operating expenses for the year ended December 31, 2013 increased by $43.5 million, or 14.0%, to $354.8 million when compared to the year ended December 31, 2012. The operating expense ratio increased by 250 basis points, from 14.5% in 2012 to 17.0% in 2013. This increase is mainly related to on-going special project initiatives related to TSS’s core system upgrade to QNXT 5.0, the implementation of a new financial system, expenses related to the reorganization of the Medicare business, higher payroll and related expenses mostly as a result of recruitment of additional Medicare sales force, an increase in professional services related to our Medicare risk scoring and CMS star ratings efforts, consultants’ fees for the Medicare integration process, premium taxes amounting to $3.8 million, and incremental expenses related to the administration of the three new service regions of the Medicaid program effective October 1, 2013. These premium taxes became effective on July 1, 2013.
Life Insurance Operating Results
Year ended December 31, 2014 compared with the year ended December 31, 2013
Operating Revenues
Premiums earned, net for the year ended December 31, 2014 increased by $11.9 million, or 9.1%, to $142.5 million as compared to the year ended December 31, 2013, mostly as result of $7.0 million of additional life premiums provied by the ASICO acquisition which was effective as of November 2013. Premiums from the Cancer and Individual Life lines of business increased by $2.4 million as the result of new sales of home service products, while the premiums from the Group Life line of business increased $2.5 million year over year.
Policy Benefits and Claims Incurred
Policy benefits and claims incurred for the year ended December 31, 2014 increased by $4.0 million, or 5.6%, to $74.8 million when compared to the year ended December 31, 2013 mostly reflecting the segment’s increased volume of business, including the additional $2.5 million in claims related to the ASICO business. The loss ratio for the period decreased from 54.2% in 2013 to 52.5% in 2014, or 170 basis points.
Underwriting and Other Expenses
Underwriting and other expenses for the segment increased by $3.0 million, or 4.6%, to $68.8 million during the year ended December 31, 2014, mostly related to the additional $2.4 million in operating expenses related to the newly acquired ASICO business and a lower amount of net expenses capitalized as Deferred Policy Acquisition Costs. As a result of the segment’s proportionally higher increase in premiums during this period, the operating expense ratio decreased by 210 basis points from 50.4% in 2013 to 48.3% in 2014.
Year ended December 31, 2013 compared with the year ended December 31, 2012
Operating Revenues
Premiums earned, net for the segment increased by $5.9 million, or 4.7%, to $130.6 million during the year ended December 31, 2013 as compared to the year ended December 31, 2012, primarily as the result of new sales in the Cancer and Individual Life businesses during the period. Of the increase experienced year over year, $1.4 million is related to premiums earned by TSB, the insurance company acquired by TSV in November 2013.
Policy Benefits and Claims Incurred
Policy benefits and claims incurred increased by $4.4 million, or 6.6%, to $70.8 million during the year ended December 31, 2013. This increase is the result of claims received in the 2013 period, reflecting the growth of the segment’s inforce portfolio and the addition $0.8 million of claims related to the ASICO acquisition. The loss ratio for the period increased from 53.2% in 2012 to 54.2% in 2013, or 100 basis points.
Underwriting and Other Expenses
Underwriting and other expenses for the segment increased by $3.4 million, or 5.4%, to $65.8 million during the year ended December 31, 2013, mostly related to a lower amount of expenses capitalized as Deferred Policy Acquisition Costs, primarily resulting from lower commission expenses, premium taxes and approximately $0.9 million of expenses related to the ASICO acquisition. As a result, the operating expense ratio slightly increased 40 basis points, from 50.0% in 2012 to 50.4% in 2013.
Property and Casualty Insurance Operating Results
Year ended December 31, 2014 compared with the year ended December 31, 2013
Operating Revenues
Total premiums written during the year ended December 31, 2014 decreased by $11.2 million, or 7.4%, to $141.1 million, mostly resulting from lower sales of commercial products, primarily package, liability, and auto insurance products.
Premiums ceded to reinsurers during the year ended December 31, 2014 decreased by approximately $5.5 million, or 9.5%, to $52.1 million. The ratio of premiums ceded to premiums written decreased by 90 basis points, from 37.8% in 2013 to 36.9% in 2014. The lower amount of premiums ceded primarily results from a change in the commercial quota share agreement where the cession was changed from 37% to 30% in 2014.
Lower volume of premiums written in the current year generated lower unearned premiums resulting in a favorable change in unearned premiums of $3.1 million. Prior year change in unearned premium was $5.6 million. As a result of the above fluctuations net premiums earned for the year ended December 31, 2014 decreased by $8.2 million, or 8.2%, to $92.1 million.
Claims Incurred
Claims incurred during the year ended December 31, 2014 decreased by $8.8 million, or 16.0%, to $46.3 million. The loss ratio decreased by 460 basis points, to 50.3% in 2014, primarily as a result of a favorable loss experience, mostly in the Commercial Multi-peril and Commercial and Personal Auto lines of business, which was offset with an unfavorable loss experience in the Medical Malpractice line of business.
Underwriting and Other Expenses
Underwriting and other operating expenses for the year ended December 31, 2014 decreased by $6.9 million, or 13.5%, to $44.4 million primarily due to a lower net commission expense resulting from the decrease in net premiums earned, favorable variance in salaries and benefits after the implementation of changes in employee benefits and headcount reduction, and recoveries resulting from premium surcharges to recover assessments paid to the Puerto Rico Guarantee Fund. The operating expense ratio decreased by 290 basis points during the same period, to 48.2% in 2014.
Year ended December 31, 2013 compared with the year ended December 31, 2012
Operating Revenues
Total premiums written during the year ended December 31, 2013 decreased by $10.4 million, or 6.4%, to $152.3 million, mostly resulting from lower sales of Dwelling and Commercial insurance products. The commercial business remains under soft market conditions with strong competition.
Premiums ceded to reinsurers during the year ended December 31, 2013 decreased by approximately $5.9 million, or 9.3%, to $57.6 million. The ratio of premiums ceded to premiums written decreased by 120 basis points, to 37.8% in 2013, mostly resulting from a change in the mix of business subscribed and lower volume of premiums during 2013.
The change in unearned premiums presented an increase of $7.1 million, to $5.6 million during the year ended December 31, 2013, primarily as the result of the lower volume of premiums written during this period.
Claims Incurred
Claims incurred during the year ended December 31, 2013 increased by $5.8 million, or 11.8%, to $55.1 million. The loss ratio increased by 440 basis points, to 54.9% in 2013, as a result of unfavorable loss experience in the Commercial Package, General Liability and Auto Insurance lines of business. The increase also responds to a lower proportion of Dwelling business in our portfolio.
Underwriting and Other Expenses
Underwriting and other operating expenses for the year ended December 31, 2013 increased by $0.8 million, or 1.6%, to $51.3 million. The increase is mainly related to an assessment received from the Puerto Rico Guarantee Fund and recorded as a charge to operations of $0.6 million to cover the insolvencies of insurers under liquidation. The operating expense ratio decreased by 60 basis points during the same period, to 51.1% in 2013.
IV. 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:
Year ended December 31, 2014 compared to year ended December 31, 2013
Cash flows from operating activities decreased by $74.9 million for the year ended December 31, 2014 as compared to the year ended December 31, 2013, principally due to the effect of a decrease in premiums collected of $79.9 million and higher cash paid to suppliers and employees of $57.3 million, offset in part by lower claims paid of $46.0 million. The increase in payments to suppliers and employees is primarily related to the higher Medicaid ASO enrollment, the Health Insurance Providers Fee Assessment of approximately $27.7 million that was paid for the first time during the 2014 period and the collection in 2013 of the $12.8 million JUA special distribution. The decrease in premiums collected is principally the result of lower Managed Care membership enrollment. The decrease in claims mostly results from the lower enrollment in the Managed Care membership.
During the year ended December 31, 2014 we received $9.6 million in policyholder deposits. This represents an increase of $0.4 million when compared to the prior year and is the result of higher sales of annuity products.
Net proceeds of investment securities were $34.0 million during the year ended December 31, 2014, primarily resulting from the net cash flows received from the sales, net of purchases, of investment securities during 2014. During the year ended December 31, 2013 we had net purchases of investments of $66.2 million, primarily resulting from higher excess cash flows from operations.
Net capital expenditures decreased by $7.0 million for the year ended December 31, 2014, as compared to the year ended December 31, 2013, principally due to special projects initiatives related to information technology during 2013.
Payments of long-term borrowings of $14.8 million during the year ended December 31, 2014 are primarily the result of a $12.9 million payment of one secured loan that was due in 2014.
Payments of short-term borrowings decreased by $30.0 million during the year ended December 31, 2014.
Repurchase and retirement of common stock decreased by $6.9 million mainly due to the repurchase and retirement of 1,000,000 shares of common stock as part of the secondary public offering conducted during the year ended December 31, 2013. During 2014, the corporation repurchased and retired 596,225 with a total cost of $11.3 million.
On November 7, 2013, we completed the acquisition of 100% of the outstanding shares of capital stock of ASICO for an aggregate purchase price of approximately $4.8 million, net of $4.6 million of cash acquired.
During the year ended December 31, 2014, we had $4.9 million of other uses of cash, while in the 2013 period we had a net balance of other sources of cash of $15.1 million. The fluctuation in the other uses/sources of cash is attributed to changes in the amount of outstanding checks over bank balances.
Year ended December 31, 2013 compared to year ended December 31, 2012
Cash flows from operating activities increased by $3.2 million for the year ended December 31, 2013 as compared to the year ended December 31, 2012, principally due to the effect of lower claims paid by $70.6 million, offset in part by lower premiums collections by $53.6 million and higher cash paid to suppliers and employees by $9.0 million. The decrease in premiums collected is principally the result of the lower Managed Care membership enrollment. The decrease in claim payments mostly results from the lower enrollment in the Managed Care membership. This decrease also reflects improved drug costs after the new PBM contract in TSA and the impact of changes in 2013 product design.
During the year ended December 31, 2013 we received $9.2 million in policyholder deposits. This represents a decrease of $30.5 million when compared to the prior year and is the result of lower sales of annuity products. The Corporation has reduced the pricing for this product due to the current interest rate scenario.
Net proceeds from short-term borrowings decreased by $30.0 million during the year ended December 31, 2013, addressing timing differences between cash receipts and disbursements.
The increase in other sources of cash for the year ended December 31, 2013 is attributed to changes in the amount of outstanding checks in excess of bank balances.
Net purchases of investment securities were $66.2 million during the year ended December 31, 2013, $24.9 million lower than last year, primarily resulting from the investment of lower excess cash flows from operations.
Payments of long-term borrowings of $12.0 million during the year ended December 31, 2013 are primarily the result of a $10.0 million prepayment of one of our senior unsecured notes. The $14.9 million decrease in payments of long-term debt is due to the prepayment of another senior unsecured note of $25.0 million during the year ended December 31, 2012.
Repurchase and retirement of common stock increased by $15.9 million mainly due to the repurchase and retirement of 1,000,000 shares of common stock as part of the completed secondary public offering conducted during the year ended December 31, 2013.
On November 7, 2013, we completed the acquisition of 100% of the outstanding shares of capital stock of TSB for an aggregate purchase price of approximately $4.8 million, net of $4.6 million of cash acquired. On January 18, 2012, we acquired a controlling stake in a health clinic in Puerto Rico at a cost of $2.7 million, net of $0.8 million of cash acquired. On February 7, 2011, we acquired TSA at a cost of $54.0 million, net of $30.1 million of cash acquired.
The decrease in other uses of cash is attributed to changes in the amount of outstanding checks over bank balances in the 2013 period.
Share Repurchase Program
On September 29, 2010, we announced the immediate commencement of the 2010 stock repurchase program. The program was conducted using available cash through open-market purchases and privately-negotiated transactions of Class B shares only, in accordance with Rules 10b-18 and 10b5-1 under the Securities Exchange Act of 1934, as amended. On March 23, 2013, we discontinued our 2010 stock repurchase program.
On March 6, 2013, the Company’s Board authorized the repurchase of up to $30.0 million of Class B shares concurrent with the conversion of 7 million Class A shares into Class B shares and the public offering of a substantial majority of such convertible shares. As part of the Offering, on May 17, 2013, the Company repurchased and retired 1,000,000 shares at a price of $18.25 per share.
On July 29, 2013 the Company’s Board of Directors authorized an $11.5 million repurchase program of its Class B common stock. On October 28, 2014, we discontinued our 2013 stock repurchase program. During the year ended December 31, 2014, under this program the Company repurchased and retired 367,700 of our Class B Common Stock shares at an average per share price of $16.32, for an aggregate cost of $6.0 million.
In October 2014 the Company’s Board of Directors authorized a $50.0 million repurchase program of our Class B common stock. 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 2014, the Company repurchased and retired 228,525 shares of our Class B Common Stock at an average per share price of $23.55, for an aggregate cost of $5.4 million.
Financing and Financing Capacity
We have several short-term facilities available to address timing differences between cash collections and disbursements. These short-term facilities are mostly in the form of arrangements to sell securities under repurchase agreements. As of December 31, 2014, we had $135.0 million of available credit under these facilities. There are no outstanding short-term borrowings under these facilities as of December 31, 2014.
On December 21, 2005, we issued and sold $60.0 million of our 6.6% senior unsecured notes due December 2020 (the “6.6% notes”). The 6.6% notes were privately placed to various institutional accredited investors. The notes pay interest each month until the principal becomes due and payable. These notes can be redeemed after five years at par, in whole or in part, as determined by us. On October 1, 2010 we repaid $25.0 million of the principal of these senior unsecured notes. The 6.6% notes contain certain non-financial covenants. At December 31, 2014, we are in compliance with these covenants.
On November 1, 2010, we entered into a $25.0 million arrangement to sell securities under repurchase agreements that matures on November 2015. The repurchase agreement pays interest quarterly at 1.96%. The investment securities underlying such agreements were delivered to the financial institution with whom the agreement was transacted. The dealers may have loaned, or used as collateral such securities in the normal course of business operations. We maintain effective control over the investment securities pledged as collateral and accordingly, such securities continue to be carried on our consolidated balance sheet. At December 31, 2014 investment securities available for sale with fair value of $27.1 million (face value of $27.1 million) were pledged as collateral under this agreement. The proceeds obtained from this agreement were used to repay $25.0 million of the 6.6% notes.
In addition, we are a party to a secured term loan with a commercial bank in Puerto Rico. This secured loan, with original principal balance of $41.0 million, bears interest at a rate equal to the London Interbank Offered Rate (LIBOR) plus 100 basis points and requires monthly principal repayments of $0.1 million. As of December 31, 2014, this secured loan had an outstanding balance of $14.5 million and average annual interest rate of 1.24%. This secured loan is guaranteed by a first lien on our land, buildings and substantially all leasehold improvements, as collateral for the term of the agreements under a continuing general security agreement. This secured loan contains certain non-financial covenants which are customary for this type of facility, including, but not limited to, restrictions on the granting of certain liens, limitations on acquisitions and limitations on changes in control. As of December 31, 2014, we are in compliance with these covenants. Failure to meet these non-financial covenants may trigger the accelerated payment of the secured loan’s outstanding balances.
As part of the acquisition of the controlling stake in a health clinic during 2012, we assumed a secured term loan with original principal balance of $14.1 million that was paid in full on December 23, 2014. This loan was guaranteed by a first position held by the bank on the health clinic’s premises (land and building) and all of the health clinic's assets as collateral for the term of the loan under a continuing general security agreement. The secured loan contained certain financial and non-financial covenants, which are customary for this type of facility, including but not limited to, restrictions on the granting of certain liens, limitations on acquisitions and limitations on changes in control.
We anticipate that we will have sufficient liquidity to support our currently expected needs.
Planned Capital Expenditures
The federal regulations that require that we begin using a new set of standardized diagnostic codes, known as ICD-10, were postponed to October 01, 2015. This delayed some of the tasks and investments associated with this project, as well as required investment to implement the additional changes incorporated to existing software during the course of 2014-2015. The task of mapping ICD-9 codes to ICD-10 and uploading them to the system was completed in 2014, save for the ongoing maintenance which is to be done through October 2015. In order to become ICD-10 compliant, in September 2013 TSS upgraded the versions of its core business applications that were previously implemented in the third quarter of 2012. The cost of the core business application upgrade and ICD-10 compliance efforts was approximately $6.0 million. Additional software and efforts have and are being invested in defining the mapping of current ICD-9 codes to ICD-10 in order to load that mapping in the recently-upgraded systems. The Company believes that these additional efforts to comply with ICD-10 requirements will represent an additional investment of approximately $1.4 million.
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 liabilities:
• 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, 2014, we had $82.7 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, 2014, our policyholder deposits had a carrying amount of $118.9 million.
• Other long-term liabilities - Due to the indeterminate nature of their cash outflows, $133.1 million of other long-term liabilities are not reflected in the following table, including $86.7 million of liability for pension benefits, $30.7 million in deferred tax liabilities, and $15.7 million in liabilities to the Federal Employees’ Health Benefits Plan Program.
(1) As of December 31, 2014, our long-term borrowings consist of our 6.6% senior unsecured notes payable, and a $25.0 million arrangement to sell securities under repurchase agreements which requires quarterly interest payments at 1.96%. Total contractual obligations for long-term borrowings include the current maturities of long term debt. For the 6.6% senior unsecured notes and the arrangement to sell securities under repurchase agreements, scheduled interest payments were included in the total contractual obligations for long-term borrowings until the maturity dates of the notes in 2020, and 2015 respectively. We may redeem the senior unsecured note starting five years after issuance; however no redemption is considered in this schedule. See the “Financing and Financing Capacity” section for additional information regarding our long-term borrowings.
(2) 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 $8.0 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.
(3) 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, 2014. 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 $41.2 million of reserves had been ceded at December 31, 2014.
(4) 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, 2014 and are gross of any reinsurance recoverable. The $396.1 million total estimated cash flows for all years in the table is different from the liability of future policy benefits of $328.3 million included in our audited 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.
Restriction on Certain Payments by the Corporation’s Subsidiaries
Our insurance subsidiaries are subject to the regulations of the Commissioner of Insurance of Puerto Rico. 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.
Since 2009, local insurers and health organizations are required by the Insurance Code to submit to the Commissioner of Insurance Puerto Rico RBC reports following the NAIC’s RBC Model Act and accordingly are subject to the relevant measures and actions as required based on their capital levels in relation to the determined risk based capital. In February 2010 Insurance Regulation No. 92 (“Rule 92”) entered into effect establishing guidelines to implement the RBC requirements. Rule 92 provides for a gradual compliance and a five-year transition period, including dividend payment restriction and exemption to comply with requirements.
As of December 31, 2014, our insurance subsidiaries were in compliance with such minimum capital requirements.
These regulations are not directly applicable to us, as a holding company, since we are not an insurance company.
Our secured term loan, with original principal balance of $41,000, restricts the amount of dividends that we and our subsidiaries can declare or pay to shareholders. Under this secured term loan, dividend payments cannot be made in excess of the accumulated retained earnings of the paying entity.
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 and TSA 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, 2014, TSM and TSS estimated RBC ratio was above the minimum BCBSA RBC requirement of 200% and the 375% of RBC level required by the BCBSA to avoid monitoring. At December 31, 2014, TSA estimated RBC ratio was above the minimum BCBSA RBC requirement of 100% for smaller controlled affiliate.
Starting 2015, BCBSA’s primary licensees could be subject to monitoring if, over a 6 or 12 month period, its RBC ratio declines by 80 or more points and which results in a level that is below 500%.
Other Contingencies
Legal Proceedings
Various litigation claims and assessments against us have arisen in the course of our business, including but not limited to, our activities as an insurer and employer. Furthermore, the Commissioner of Insurance, as well as other Federal and Puerto Rico government authorities, regularly make inquiries and conduct audits concerning our compliance with applicable insurance and other laws and regulations.
Based on the information currently known by our management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have a material adverse effect on our financial position, results of operations and cash flows. However, 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. See “Item 3. Legal Proceedings.”
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 2013, the property and casualty segment paid $0.6 million for an assessment imposed by the Puerto Rico Guaranty Association for Property and Casualty Insurers. In accordance with insurance laws and regulations assessments are recoverable through policy surcharges. In 2014 and 2013, the property and casualty segment has recorded recoveries of assessments for $0.5 million and $15 thousand. During the year ended December 31, 2012, no assessment or payment was made in connection with insurance companies declared insolvent. 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.
Pursuant to the Puerto Rico Insurance Code, our property and casualty insurance 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 insurance segment shares risks with other member companies and, accordingly, is contingently liable in the event the syndicate cannot meet their obligations. During 2014, 2013 and 2012, 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 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 2014, 2013 and 2012, the Association distributed the Company a distribution based on the good experience of the business amounting to $0.9 million, $1.2 million and $1.2 million, respectively. In September 2013, the Association declared a special distribution to its members for $200 million. This distribution was subject to a special and unique tax rate of 50%. The property and casualty then received $12.8 million, net of tax, from this distribution.
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 and $3 thousand in 2014 and 2013, respectively. No assessment was received in 2012.
V. Critical Accounting Policies
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 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 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.
Claim Liabilities
Claim liabilities by segment as of December 31, 2014 were as follows:
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 property and casualty and life insurance segment. 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, healthcare costs, the advent of natural disasters, and malpractice litigation. 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, 2014, claim liabilities for the managed care segment amounted to $248.9 million and represented 63.8% of our total consolidated claim liabilities and 19.3% 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 financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the total expected claims incurred. The majority of unpaid claims, 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 unpaid claims, 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 unpaid claims 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.
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 90% of the claims are paid within three months after the last day of the month in which they were incurred and about 7% 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 statement of earnings and financial position could be impacted 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 determination of our claim liabilities. The following example provides the estimated impact on our December 31, 2014 claim liabilities, assuming the indicated hypothetical changes in completion and trend factors:
(Dollar amounts in millions)
(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.
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 10 to the audited consolidated financial statements). This table shows that the segments’ estimates of this liability have approximated the actual development.
(1) Includes total claims incurred less adjustments for prior year reserve development.
Management expects that substantially all of the development of the 2014 estimate of medical claims payable will be known during 2015 and that the variance of the total incurred claims on a retrospective basis when compared to reported incurred claims will be similar to the prior years.
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 that from time to time address differences between cash receipts and disbursements.
For additional information on our credit facilities, see section “Financing and Financing Capacity” of this Item.
Life Insurance Segment
At December 31, 2014, claim liabilities for the life insurance segment amounted to $43.7 million and represented 11.2% of total consolidated claim liabilities and 3.4% 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 on estimates based on past experience modified for current trends, for unreported claims. 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 with regard to 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 Insurance Segment
At December 31, 2014, claim liabilities for the property and casualty insurance segment amounted to $97.5 million and represented 25.0% of the total consolidated claim liabilities and 7.6% of our total consolidated liabilities.
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.
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 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 that could affect the reserve estimates.
Key assumptions are based on the consideration that past emergence of paid losses and case reserves is credible and likely indicative of future emergence and ultimate losses. A key assumption is the expected loss ratio for the current accident year. This expected loss ratio is generally determined through a review of the loss ratios of prior accident years and expected changes to earned pricing, loss costs, mix of business, and other factors that are expected to impact the loss ratio for the current accident year. Another key assumption is the development patterns for paid and reported losses (also referred to as the loss emergence and settlement patterns). The reserves for unreported claims for each year are determined after reviewing the indications produced by each actuarial projection method, which, in turn, rely on the expected paid and reported development patterns and the expected loss ratio for that year.
At December 31, 2014, the actuarial reserve range determined by the actuaries was from $93 million to $108 million. 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 $5.8 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 dies or 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 ranging from 4.90% to 5.75% and withdrawal, mortality, morbidity and maintenance expense assumptions appropriate at the time the policies were issued (or when a block of business was purchased, as applicable). Accident and health unpaid claim reserves are stated at amounts determined by estimates on individual claims and estimates of unreported claims based on past experience. Liabilities for universal life policies are stated at policyholder account values before surrender charges. Deferred annuity reserves are carried at the account value.
The liabilities for all products, except for universal life and deferred annuities, 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. These are reviewed 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 universal life and deferred annuities, 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 for acquiring life and property and casualty insurance business are deferred. Acquisition costs related to the managed care business are expensed as incurred.
The costs of acquiring new life business, principally commissions, and certain variable underwriting, agency 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 GA Life (now 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 of revisions to estimated gross profits is reported in earnings in the period such estimated gross profits are revised.
The schedules of amortization of life insurance deferred policy acquisition costs (“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 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 anticipated universal life claims, investment yield rates and contract persistency. Based upon the most recent actuarial reviews of all of the assumptions, we do not currently anticipate material changes to the level of these amortization schedules.
The property and casualty business acquisition costs consist of commissions incurred 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
Impairment of an investment exists if a decline in the estimated fair value is below the amortized cost of the security. Management regularly monitors and evaluates the difference between the cost and estimated fair value of investments. For investments with a fair value below cost, the process includes evaluating: (1) the length of time and the extent to which the estimated fair value has been less than amortized cost for fixed maturity securities, or cost for equity securities, (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 for fixed maturity securities, or cost for equity securities, and (5) other factors, as applicable. This process is not exact and further requires 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, other-than temporary impairment may not be appropriate. Due to the subjective nature of our analysis, along with the judgment that must be applied in the analysis, it is possible that we could reach a different conclusion whether or not 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 we determined during its analysis, which may lead to a different impairment conclusion in future periods. If after monitoring and analyzing impaired securities, management determines that a decline in the estimated fair value of any available-for-sale or held-to-maturity security below cost is other than temporary, the carrying amount of the security is reduced to its fair value according to current accounting guidance. The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment. For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted into net investment income in future periods based on prospective changes in cash flow estimates, to reflect adjustments to the effective yield.
Our process for identifying and reviewing invested assets for other-than temporary impairments during any quarter includes the following:
• Identification and evaluation of securities that have possible indications of other-than-temporary impairment, which includes an analysis of all investments with gross unrealized investments losses that represent 20% or more of cost and all investments with an unrealized loss greater than $100 thousand.
• Review and evaluation of any other security based on the investee’s current financial condition, liquidity, near-term recovery prospects, implications of rating agency actions, the outlook for the business sectors in which the investee operates and other factors. This evaluation is in addition to the evaluation of those securities with a gross unrealized investment loss representing 20% or more of their cost.
• Consideration of evidential matter, including an evaluation of factors or triggers that may or may not cause individual investments to qualify as having other-than-temporary impairments; and
• Determination of the status of each analyzed security as other-than-temporary or not, with documentation of the rationale for the decision.
• Equity securities are considered to be impaired when a position is at an unrealized loss for a period longer than 6 months.
Management continues to review the investment portfolios under our impairment review policy. Given the current market conditions and the significant judgments involved, there is a continuing risk that further declines in fair value may occur and additional material other-than-temporary impairments may be recorded in future periods.
During the year ended December 31, 2014, we recognized other-than-temporary impairments amounting to $1.2 million on fixed income securities issued by the Commonwealth of Puerto Rico. During the year ended December 31, 2013, we recognized other-than-temporary impairments amounting to $1.0 million on equity securities classified as available for sale that had been in an unrealized loss position for a period longer than six months. During the year ended December 31, 2012, there were no realized losses associated with other-than-temporary impairments.
As of December 31, 2014, the investment in securities of approximately $1.3 billion is classified as either available-for-sale or held-to-maturity and consists of high-quality investments. Our investment portfolio is predominantly comprised of obligations of U.S. government-sponsored enterprises, U.S. Treasuries, U. S. agency-backed mortgage securities and U.S. municipal bonds. These investments comprise approximately 67.1% of the total portfolio value as of December 31, 2014. Obligations of the Commonwealth of Puerto Rico represent 2.7% of the total portfolio. Corporate bonds and private label mortgage securities account for 15.0%. The remaining balance of the investment portfolio consists of mutual funds (14.0%) and investments in partnerships (1.2%). The gross unrealized gains and losses as of December 31, 2014 of the available-for-sale and held-to-maturity portfolios amounted to $118.2 million and $1.2 million, respectively.
The impairment analysis as of December 31, 2014 indicated that, other than those securities for which an other-than-temporary impairment was recognized, none of the securities whose carrying amount exceeded its estimated fair value was considered other-than-temporarily 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 realized losses related to other-than-temporary declines being 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.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks that are inherent in our financial instruments, which arise from transactions entered into in the normal course of business. We are also subject to additional market risk with respect to certain of our financial instruments. We must effectively manage, measure, and monitor the market risk associated with our invested assets and interest rate sensitive liabilities. We have established and implemented comprehensive policies and procedures to minimize the effects of potential market volatility.
Market Risk Exposure
We have exposure to market risk mostly in our investment activities. For purposes of this disclosure, “market risk” is defined as the risk of loss resulting from changes in interest rates and equity prices. Analytical tools and monitoring systems are in place to assess each one of the elements of market risks.
Our investment portfolio consists mainly of investment grade fixed income and a smaller portion is held in equity securities. The investment portfolio is conservative, diversified across and within asset classes, and has the following objectives, in order of importance: capital preservation, liquidity, income generation and capital appreciation. The interest rate risk of both our investments and liabilities is regularly evaluated.
The investment portfolio is centrally managed by investment professionals and decisions are taken based on the guidelines and limitations described in the Statement of Investment Policy and Guidelines (SIPG) and the Puerto Rico Insurance Code. The SIPG is approved by the Board of Directors following the recommendation of the Investment and Financing Committee of the Board of Directors (the “Investment and Financing Committee”). The Investment and Financing Committee establishes guidelines to ensure the SIPG is adhered to and any exception must be reported to the Investment and Financing Committee.
Our investment portfolio is predominantly comprised of obligations of U.S. government-sponsored enterprises, U.S. Treasuries, U. S. agency-backed mortgage securities and U.S. municipal bonds. These investments comprise 67.1% of the total portfolio value as of December 31, 2014. Obligations of the Commonwealth of Puerto Rico represent 2.7% of the total portfolio. Corporate bonds and private label mortgage securities account for 15.0%. The remaining balance of the investment portfolio consists of mutual funds (14.0%) and investments in partnerships (1.2%).
We use a sensitivity analysis to measure the market risk related to our holdings of invested assets and other financial instruments. This analysis estimates the potential changes in fair value of the instruments subject to market risk. This sensitivity analysis is an estimate and should not be viewed as predictive of our future financial performance. Our actual losses in any particular year could exceed the amounts indicated in the following paragraphs. Limitations related to this sensitivity analysis include:
• the market risk information is limited by the assumptions and parameters established in creating the related sensitivity analysis, including the impact of prepayment rates on mortgages; and
• the model assumes that the composition of assets and liabilities remains unchanged throughout the year.
Accordingly, we use such models as tools and not as a substitute for the experience and judgment of our management.
Interest Rate Risk
Our exposure to interest rate changes results from our significant holdings of fixed maturity securities. We are also exposed to interest rate risk from our variable interest secured term loan and from our policyholder deposits.
Equity Price Risk
Our investments in equity securities expose us to equity price risks, for which potential losses could arise from adverse changes in the value of equity securities.
Risk Measurement
Our available-for-sale and held-to-maturity securities are a source of market risk. As of December 31, 2014 approximately 85% and 100% of our investments in available-for-sale and held-to-maturity securities, respectively, consisted of fixed maturity securities. The remaining balance of the available-for-sale portfolio is comprised of equity securities and alternative investments. Available-for-sale securities are recorded at fair value and changes in the fair value of these securities, net of the related tax effect, are excluded from operations and are reported as a separate component of other comprehensive income (loss) until realized. Held-to-maturity securities are recorded at amortized cost and adjusted for the amortization or accretion of premiums or discounts. The fair value of the investments in our available-for-sale and held-to-maturity portfolios is exposed to both interest rate risk and equity price risk.
Interest Rate Risk
We have evaluated the net impact to the fair value of our fixed income investments of a significant one-time change in interest rate risk using a combination of both statistical and fundamental methodologies. From these shocked values a resultant market price appreciation/depreciation can be determined after portfolio cash flows are modeled and evaluated over instantaneous 100, 200 and 300 basis point rate shifts. Techniques used in the evaluation of cash flows include Monte Carlo simulation through a series of probability distributions over 200 interest rate paths. Necessary prepayment speeds are compiled using Salomon Brothers Yield Book, which sources numerous factors in deriving speeds, including but not limited to: historical speeds, economic indicators, street consensus speeds, etc. Securities evaluated by us under these scenarios include mortgage pass-through certificates and collateralized mortgage obligations of U.S. agencies, and private label structures, provided that cash flows information is available. The following table sets forth the result of this analysis for the years ended December 31, 2014 and 2013. The analysis does not consider any action that management can take to mitigate the impact of changes in market rates.
(Dollar amounts in millions)
We believe that an interest rate shift in a 12-month period of 100 basis points represents a moderately adverse outcome, while a 200 basis point shift is significantly adverse and a 300 basis point shift is unlikely given historical precedents. Although we classify 99.8% of our fixed maturity securities as available-for-sale, our cash flows and the intermediate duration of our investment portfolio should allow us to hold securities until maturity, thereby avoiding the recognition of losses, should interest rates rise significantly.
Equity Price Risk
Our equity securities in the available-for-sale portfolio are comprised of mutual funds whose underlying assets are comprised of domestic equity securities, international equity securities and higher risk fixed income instruments. The fixed income mutual funds invest in loan participations, high yield debt and emerging market debt. The fixed income funds invest primarily in debt securities issued or guaranteed by corporations, financial institutions and governmental entities that are either unrated or have non-investment grade ratings from either Standard & Poor’s or Moody’s.
Our investments in mutual funds exposes us to equity price risk and, because of the underlying assets included in these mutual funds, result in an indirect exposure to credit risk. We manage this indirect exposure to credit risk by closely monitoring the performance of these mutual funds.
Assuming an immediate decrease of 10% in the market value of our equity securities as of December 31, 2014 and 2013, the hypothetical loss in the fair value of these investments would have been approximately $19.8 million and $24.0 million, respectively.
Other Risk Measurement
We are subject to interest rate risk on our variable interest secured term loan and our policyholder deposits. Shifting interest rates do not have a material effect on the fair value of these instruments. The secured term loan has a variable interest rate structure, which reduces the potential exposure to interest rate risk. The policyholder deposits have short-term interest rate guarantees, which also reduce the accounts’ exposure to interest rate risk.
Item 8.
Item 8. Financial Statements and Supplementary Data
Financial Statements
For our audited consolidated financial statements as of December 31, 2014 and 2013 and for each of the three years ended December 31, 2014 see Index to financial statements in “Item 15. Exhibits and Financial Statements Schedules” to this Annual Report on Form 10-K.
Selected Quarterly Financial Data
During the three months ended June 30, 2013, we recorded an out-of-period adjustment that affected our consolidated results of operations of the previous quarter as well as those of our Managed Care segment, related to the recording of incentives to providers. The effect of this out-of-period adjustment in previous periods was that the claims incurred would have increased by $1.9 million during the three months ended March 31, 2013.
As a result of this out-of-period adjustment the consolidated income before tax was overstated by $1.9 million during the three months ended March 31, 2013 and understated by the same amount during the three months ended June 30, 2013.
We assessed the impact of the adjustment needed to account for this error in their appropriate period and concluded that recording this adjustment in the consolidated results of operations in the three months ended June 30, 2013, rather than restating the quarters affected, was quantitatively and qualitatively not material to the results of operations, financial position, or cash flows corresponding to each of the quarters that comprise the year ended December 31, 2013. This out-of-period adjustment involves only reported quarterly results and, because they were corrected during the year, have no effect on the results of operations, financial position and cash flows for the year ended December 31, 2013.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
There have been no changes in or disagreements with our independent registered public accounting firm on accounting or financial disclosures.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
In connection with the preparation of this Annual Report on Form 10-K, management, under the supervision and with the participation of the chief executive officer and the chief financial officer, conducted an evaluation of the effectiveness of our “disclosure controls and procedures” as of the end of this period (as such term is defined under Exchange Act Rule 13a-15(e)) of the Corporation and its subsidiaries. Disclosure controls and procedures are designed to ensure that information required to be disclosed by the issuer in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to management, including the chief executive officer and chief financial officer, to allow timely decisions regarding required disclosures. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility that judgments in decision-making can be faulty, and breakdowns as a result of simple errors or mistake. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Based on this evaluation, our chief executive officer and chief financial officer have concluded that as of December 31, 2014, which is the end of the period covered by this Annual Report on Form 10-K, our disclosure controls and procedures are effective to a reasonable level of assurance.
There were no significant changes in our disclosure controls and procedures, or in factors that could significantly affect internal controls, subsequent to the date the chief executive officer and chief financial officer completed the evaluation referred to above.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting and for the assessment of the effectiveness of “internal control over financial reporting,” as defined under Exchange Act Rule 13a-15(f). The Company’s internal control over financial reporting is a process designed by, or under the supervision of, the Company’s chief executive officer and chief financial officer, and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external purposes in accordance with generally accepted accounting principles (“GAAP”), and includes those policies and procedures that:
• pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
• provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
• provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management, under the supervision and with the participation of the chief executive officer and chief financial officer, assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2014 based on criteria described in the “Internal Control-Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) on May 14, 2013. Based on that assessment and those criteria, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2014 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s consolidated financial statements for external reporting purposes in accordance with GAAP.
The effectiveness of our internal control over financial reporting as of December 31, 2014 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included in this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting
No changes in our internal control over financial reporting (as such term is defined in the Exchange Act Rule 13a-15(f)) occurred during the fiscal quarter ended December 31, 2014 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
9B. Other Information
None.
Part III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The Board has established a code of business conduct and ethics that applies to our employees, agents, independent contractors, consultants, officers and directors. The complete text of the Code of Business Conduct and Ethics is available at the Corporation’s website at www.triplesmanagement.com.
The information required by this Item is incorporated herein by reference from our definitive Proxy Statement for our 2015 Annual Meeting of Shareholders, which will be filed with the SEC pursuant to Regulation 14A within 120 days after the end of our last fiscal year.
Item 11.
Item 11. Executive Compensation
The information required by this Item is incorporated herein by reference from our definitive Proxy Statement for our 2015 Annual Meeting of Shareholders, which will be filed with the SEC pursuant to Regulation 14A within 120 days after the end of our last fiscal year.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item is incorporated herein by reference from our definitive Proxy Statement for our 2015 Annual Meeting of Shareholders, which will be filed with the SEC pursuant to Regulation 14A within 120 days after the end of our last fiscal year.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this Item is incorporated herein by reference from our definitive Proxy Statement for our 2015 Annual Meeting of Shareholders, which will be filed with the SEC pursuant to Regulation 14A within 120 days after the end of our last fiscal year.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated herein by reference from our definitive Proxy Statement for our 2015 Annual Meeting of Shareholders, which will be filed with the SEC pursuant to Regulation 14A within 120 days after the end of our last fiscal year.
Item 15.
Item 15. Exhibits and Financial Statements Schedules
Financial Statements and Schedules
Schedule I - Summary of Investments was omitted because the information is disclosed in the notes to the audited consolidated financial statements. Schedule VI - Supplemental Information Concerning Property Casualty Insurance Operations was omitted because the schedule is not applicable to the Corporation.
Exhibits
All other exhibits for which provision is made in the applicable accounting regulation of the SEC are not required under the related instructions or are inapplicable, and therefore have been omitted.
* Filed herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Triple-S Management Corporation
Registrant
By:
/s/ Ramón M. Ruiz-Comas
Date:
March 18, 2015
Ramón M. Ruiz-Comas
President and Chief Executive Officer
By:
/s/ Amílcar Jordán-Pérez
Date:
March 18, 2015
Amílcar Jordán-Pérez
Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By:
/s/ Luis A. Clavell-Rodríguez
Date:
March 18, 2015
Luis A. Clavell-Rodríguez
Director and Chairman of the Board
By:
/s/ Adamina Soto-Martínez
Date:
March 18, 2015
Adamina Soto-Martínez
Director and Vice-Chairman of the Board
By:
/s/ Jesús R. Sánchez-Colón
Date:
March 18, 2015
Jesús R. Sánchez-Colón
Director and Assistant Secretary of the Board
By:
/s/ David H. Chafey, Jr.
Date:
March 18, 2015
David H. Chafey, Jr.
Director
By:
/s/ Jorge L. Fuentes-Benejam
Date:
March 18, 2015
Jorge L. Fuentes-Benejam
Director
By:
/s/ Antonio F. Faría-Soto
Date:
March 18, 2015
Antonio F. Faría-Soto
Director
By:
/s/ Manuel Figueroa-Collazo
Date:
March 18, 2015
Manuel Figueroa-Collazo
Director
By:
/s/ Cari M. Domínguez
Date:
March 18, 2015
Cari M. Domínguez
Director
By:
/s/ Joseph A. Frick
Date:
March 18, 2015
Joseph A. Frick
Director
By:
/s/ Francisco J. Toñarely-Barreto
Date:
March 18, 2015
Francisco J. Toñarely-Barreto
Director
Triple-S Management Corporation
Consolidated Financial Statements
December 31, 2014, 2013, and 2012
Page(s)
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Triple-S Management Corporation
In our opinion, the consolidated financial statements listed in the index appearing under Item 15 present fairly, in all material respects, the financial position of Triple-S Management Corporation and its subsidiaries (the Company) at December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 15 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ PricewaterhouseCoopers LLP
San Juan, Puerto Rico
March 17, 2015
CERTIFIED PUBLIC ACCOUNTANTS
(OF PUERTO RICO)
License No. LLP-216 Expires Dec. 1, 2016
Stamp E139787 of the P.R. Society of
Certified Public Accountants has been
affixed to the file copy of this report
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
1.
Nature of Business
Triple-S Management Corporation (the Corporation, the Company or TSM) was incorporated under the laws of the Commonwealth of Puerto Rico to engage, among other things, as the holding company of entities primarily involved in the insurance industry.
The Company has the following wholly owned subsidiaries that are subject directly or indirectly to the regulations of the Commissioner of Insurance of the Commonwealth of Puerto Rico (the Commissioner of Insurance), the Division of Banking and Insurance of the Office of the Lieutenant Governor of the U.S. Virgin Islands (USVI Division of Banking and Insurance), the General Superintendence of Insurance of Costa Rica, the British Virgin Islands (BVI) Financial Services Commission, and the Anguilla Financial Services Commission: (1) Triple-S Salud, Inc. (TSS) and Socios Mayores en Salud Holdings, Inc. (from now on referred to as Triple-S Advantage or TSA), managed care organizations that provide health benefits services to subscribers through contracts with hospitals, physicians, dentists, laboratories, and other organizations; (2) Triple-S Vida, Inc. (TSV) and Triple-S Blue, Inc. (TSB) (formerly known as Atlantic Southern Insurance Company (ASICO)), which are engaged in the underwriting of life and accident and health insurance policies and the administration of annuity contracts; and (3) Triple-S Propiedad, Inc. (TSP), which is engaged in the underwriting of property and casualty insurance policies. The Company, TSS and TSA are members of the Blue Cross and Blue Shield Association (BCBSA).
In January 2012, we acquired a controlling interest in a health clinic in Puerto Rico, as part of our strategic initiatives. The clinic became a member of the Mayo Clinic network on 2013.
On November 7, 2013, the Company, through its subsidiary TSV, completed the acquisition of 100% of the outstanding shares of capital stock of ASICO, now Triple-S Blue, a life insurance company authorized to do business in Puerto Rico, the Republic of Costa Rica, Anguilla, and the British Virgin Islands. The results of operations and financial condition of this acquisition are included in the accompanying consolidated financial statements for the periods following the effective date of the acquisition.
Through our subsidiary TSS, we provide services to participants of the Commonwealth of Puerto Rico Health Insurance Plan (similar to Medicaid) (Medicaid). On October 17, 2011, TSS entered into a contract with the Commonwealth of Puerto Rico (the government of Puerto Rico), effective November 1, 2011, to administer the provision of the physical health component of this program in designated service regions in Puerto Rico. On July 1, 2013, TSS amended its contract extending the administration of the provision of the physical health component of the Medicaid program in service regions in the Commonwealth of Puerto Rico currently administered by TSS for a 12-month period expiring on June 30, 2014. This amendment also transferred the administration of the three remaining service regions to TSS upon completion of a transition period, which ended on October 1, 2013. On June 30, 2014, the contract was extended for a nine-month period expiring March 31, 2015. In accordance with the terms of this new contract with the government of Puerto Rico, TSS receives a monthly per-member, per-month administrative fee for its services and does not bear the insurance risk of the program.
The Company also has two other wholly owned subsidiaries, Interactive Systems, Inc. (ISI) and Triple-C, Inc. (TC). ISI is mainly engaged in providing data processing services to the Company and its subsidiaries. TC was engaged as a third-party administrator for TSS in the administration of the Medicaid business and is currently inactive.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
A substantial majority of the Company’s business activity is within Puerto Rico, and as such, the Company is subject to the risks associated with the Puerto Rico economy.
2.
Significant Accounting Policies
The following are the significant accounting policies followed by the Company and its subsidiaries:
Basis of Presentation
The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP).
The consolidated financial statements include the financial statements of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP requires the Company to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the period. Actual results could differ from those estimates. The most significant items on the consolidated balance sheets that involve a greater degree of accounting estimates and actuarial determinations subject to changes in the near future are the assessment of claim liabilities, the liability for future policy benefits, other-than-temporary impairments, allowance for doubtful receivables, deferred policy acquisition costs and value of business acquired, goodwill, intangible assets, and liability for pension benefits. As additional information becomes available (or actual amounts are determinable), the recorded estimates are revised and reflected in operating results of the period they are determined. Although some variability is inherent in these estimates, the Company believes the amounts provided represent management’s best estimate.
Cash Equivalents
The Company considers all highly liquid debt instruments with maturities of three months or less at the date of acquisition to be cash equivalents. Cash equivalents of $26,091 and $32,646 at December 31, 2014 and 2013, respectively, consist principally of money market funds, obligations of government-sponsored enterprises and certificates of deposit with original maturities of three months or less.
Investments
Investment in securities at December 31, 2014 and 2013 consists mainly of obligations of government-sponsored enterprises, U.S. Treasury securities and obligations of U.S. government instrumentalities, obligations of the Commonwealth of Puerto Rico and its instrumentalities, municipal securities, corporate bonds, residential mortgage-backed securities, collateralized mortgage obligations, and equity securities. The Company classifies its debt and equity securities in one of three categories: trading, available for sale, or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Securities classified as held to maturity are those securities in which the Company has the ability and intent to hold the security until maturity. All other securities not included in trading or held to maturity are classified as available for sale.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Trading and available-for-sale securities are recorded at fair value. The fair values of debt securities (both available for sale and held to maturity investments) and equity securities are based on quoted market prices for those or similar investments at the reporting date. Held-to-maturity debt securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums and discounts, respectively. Unrealized holding gains and losses on trading securities are included in earnings. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of other comprehensive income until realized. Realized gains and losses from the sale of available-for-sale securities are included in earnings and are determined on a specific-identification basis.
Transfers of securities between categories are recorded at fair value at the date of transfer. Unrealized holding gains and losses are recognized in earnings for transfers into trading securities. Unrealized holding gains or losses associated with transfers of securities from held to maturity to available for sale are recorded as a separate component of other comprehensive income. The unrealized holding gains or losses included in the separate component of other comprehensive income for securities transferred from available for sale to held to maturity, are maintained and amortized into earnings over the remaining life of the security as an adjustment to yield in a manner consistent with the amortization or accretion of premium or discount on the associated security.
If a fixed maturity security is in an unrealized loss position and the Company has the intent to sell the fixed maturity 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 decline in value is deemed to be other-than-temporary and is recorded to other-than-temporary impairment losses recognized in earnings in the Company’s consolidated statements of earnings. For impaired fixed maturity securities that the Company does not intend to sell or it is more likely than not that such securities will not have to be sold, but the Company expects not to fully recover the amortized cost basis, the credit component of the other-than temporary impairment is recognized in other-than-temporary impairment losses recognized in earnings in the Company’s consolidated statements of earnings and the non-credit component of the other-than-temporary impairment is recognized in other comprehensive income. Furthermore, unrealized losses entirely caused by non-credit related factors related to fixed maturity securities for which the Company expects to fully recover the amortized cost basis continue to be recognized in accumulated other comprehensive income.
The credit component of an other-than-temporary 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.
The unrealized gains or losses on the Company’s equity securities classified as available-for-sale are included in accumulated other comprehensive income as a separate component of stockholders’ equity, unless the decline in value is deemed to be other-than-temporary and the Company does not have the intent and ability to hold such equity securities until their full cost can be recovered, in which case such equity securities are written down to fair value and the loss is charged to other-than-temporary impairment losses recognized in earnings.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
A decline in the fair value of any available-for-sale or held-to-maturity security below cost that is deemed to be other-than-temporary results in an impairment to reduce the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. To determine whether an impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, the severity and duration of the impairment, market conditions, changes in value subsequent to year-end, forecasted performance of the investee, and the general market condition in the geographic area or industry the investee operates in.
Premiums and discounts are amortized or accreted over the life of the related held-to-maturity or available-for-sale security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned.
The Company regularly invests in mortgaged-backed securities and other securities subject to prepayment and call risk. Significant changes in prevailing interest rates may adversely affect the timing and amount of cash flows on such securities. In addition, the amortization of market premium and accretion of market discount for mortgaged-backed securities is based on historical experience and estimates of future payment speeds on the underlying mortgage loans. Actual prepayment speeds may differ from original estimates and may result in material adjustments to amortization or accretion recorded in future periods.
Revenue Recognition
a. Managed Care
Subscriber premiums on the managed care business are billed in advance of their respective coverage period and the related revenue is recorded as earned during the coverage period. Managed care premiums are billed in the month prior to the effective date of the policy with a grace period of up to two months. If the insured fails to pay, the policy can be canceled at the end of the grace period at the option of the Company. Managed care premiums are reported as earned when due.
Premiums for the Medicare Advantage (MA) business are based on a bid contract with the Centers for Medicare and Medicaid Services (CMS) and billed in advance of the coverage period. MA contracts provide for a risk factor to adjust premiums paid for members that represent a higher or lower risk to the Company. Retroactive rate adjustments are made periodically based on the aggregate health status and risk scores of the Company’s MA membership. These risk adjustments are evaluated quarterly, based on actuarial estimates. Actual results could differ from these estimates. As additional information becomes available, the recorded estimate is revised and reflected in operating results in the period in which it becomes available.
Prescription drug coverage is offered to Medicare eligible beneficiaries as part of MA plans (MA-PD) and on a stand-alone basis (stand-alone PDP). Premiums are based on a bid contract with CMS that considers the estimated costs of providing prescription drug benefits to enrolled participants. MA-PD and stand-alone PDP premiums are subject to adjustment, positive or negative, based upon the application of risk corridors that compare the estimated prescription drug costs included in the bids to CMS to actual prescription drug costs. Variances exceeding certain thresholds may result in CMS making additional payments or in CMS requesting a refund for a portion of the premiums collected. The Company estimates and records adjustments to earned premiums related to estimated risk corridor payments based upon actual prescription drug costs for each reporting period as if the annual contract were to end at the end of each reporting period.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Administrative service fees include revenue from certain groups which have managed care contracts that provide for the group to be at risk for all or a portion of their claims experience. For these groups, the Company is not at risk and only handles the administration of managed care coverage for an administrative service fee. The Company pays claims under commercial self-funded arrangements from its own funds, and subsequently receives reimbursement from these groups. The claims related to the administration of the Medicaid business are paid from a bank account owned and funded by the Government of Puerto Rico. Claims paid under self-funded arrangements are excluded from the claims incurred in the accompanying consolidated financial statements. Administrative service fees under the self-funded arrangements are recognized based on the group’s membership or incurred claims for the period multiplied by an administrative fee rate plus other fees. In addition, some of these self-funded groups purchase aggregate and/or specific stop-loss coverage. In exchange for a premium, the group’s aggregate liability or the group’s liability on any one episode of care is capped for the year. Premiums for the stop-loss coverage are actuarially determined based on experience and other factors and are recorded as earned over the period of the contract in proportion to the coverage provided. This fully insured portion of premiums is included within the premiums earned, net in the accompanying consolidated statements of earnings. The Medicaid contract with the Government of Puerto Rico contains a savings-sharing provision whereby the Government of Puerto Rico shares with TSS a portion of the medical cost savings obtained with the administration of the regions served on an administrative service basis. Any savings-sharing amount is recorded when earned as administrative service fees in the accompanying consolidated statements of earnings.
b. Life and Accident and Health Insurance
Premiums on life insurance policies are billed in advance of their respective coverage period and the related revenue is recorded as earned when due. Premiums on accident and health and other short-term policies are recognized as earned primarily on a pro rata basis over the contract period. Premiums on credit life policies are recognized as earned in proportion to the amounts of insurance in-force. Revenues from universal life and interest sensitive policies represent amounts assessed against policyholders, including mortality charges, surrender charges actually paid, and earned policy service fees. The revenues for limited payment contracts are recognized over the period that benefits are provided rather than on collection of premiums.
c. Property and Casualty Insurance
Premiums on property and casualty contracts are billed in advance of their respective coverage period and they are recognized as earned on a pro rata basis over the policy term. The portion of premiums related to the period prior to the end of coverage is recorded in the consolidated balance sheets as unearned premiums and is transferred to premium revenue as earned.
Allowance for Doubtful Receivables
The allowance for doubtful receivables is based on management’s evaluation of the aging of accounts and such other factors, which deserve current recognition. Actual losses could differ from these estimates. Receivables are charged-off against their respective allowance accounts when deemed to be uncollectible.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Deferred Policy Acquisition Costs and Value of Business Acquired
Certain direct costs for acquiring successful life and accident and health, and property and casualty insurance business are deferred by the Company. Substantially all acquisition costs related to the managed care business are expensed as incurred.
In the life and accident and health business deferred acquisition costs consist of commissions and certain expenses related to the production of life, annuity, accident and health, and credit business. In the event that future premiums, in combination with policyholder reserves and anticipated investment income, could not provide for all future maintenance and settlement expenses, the amount of deferred policy acquisition costs would be reduced to provide for such amount. The related amortization is provided over the anticipated premium-paying period of the related policies in proportion to the ratio of annual premium revenue to expected total premium revenue to be received over the life of the policies. Interest is considered in the amortization of deferred policy acquisition cost and value of business acquired. For these contracts interest is considered at a level rate at the time of issue of each contract, 4.90% for 2014, 2013 and 2012, and, in the case of the value of business acquired, at the time of any acquisition. For certain other long-duration contracts, deferred amounts are amortized at historical and forecasted credited interest rates. Expected premium revenue is estimated by using the same mortality and withdrawal assumptions used in computing liabilities for future policy benefits. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated net realizable value. In determining estimated net realizable value, the computations give effect to the premiums to be earned, related investment income, losses and loss-adjustment expenses, and certain other costs expected to be incurred as the premium is earned. Costs deferred on universal life and interest sensitive products are amortized as a level percentage of the present value of anticipated gross profits from investment yields, mortality, expenses and surrender charges. Estimates used are based on the Company’s experience as adjusted to provide for possible adverse deviations. These estimates are periodically reviewed and compared with actual experience. When it is determined that future expected experience differs significantly from that assumed, the estimates are revised for current and future issues.
The value assigned to the life insurance in-force at the date of the acquisition is amortized using methods similar to those used to amortize the deferred policy acquisition costs of the life and accident and health business.
In the property and casualty business, acquisition costs consist of commissions incurred during the production of business and are deferred and amortized ratably over the terms of the policies.
Property and Equipment
Property and equipment are stated at cost. Maintenance and repairs are expensed as incurred. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets. Costs of computer equipment, programs, systems, installations, and enhancements are capitalized and amortized straight-line over their estimated useful lives. The following is a summary of the estimated useful lives of the Company’s property and equipment:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Software Development Costs
Costs related to software developed or obtained for internal use that is incurred in the preliminary project stage are expensed as incurred. Once capitalization criteria are met, directly attributable development costs are capitalized and amortized over the expected useful life of the software. Upgrade and maintenance costs are expensed as incurred. During the year ended December 31, 2013, the Company capitalized approximately $3,811 associated with the implementation of new software. During the year ended December 31, 2014, there were no development costs capitalized associated with the implementation of new software.
Long-Lived Assets, including goodwill
Long-lived assets, such as property and equipment, and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance sheets and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset and liability sections of the consolidated balance sheets.
During 2014, the Company identified events that indicate that the carrying amount of the intangible assets purchased as part of the health clinic acquisition may not be recoverable. As such, the Company performed an impairment analysis on those intangible assets and based on the results of the test, an impairment charge of $2,221 was recorded caused by the carrying value being greater than its fair value. After the impairment charge, which is included within the consolidated operating expenses, there is no remaining carrying value of the acquired intangible asset as of December 31, 2014. During 2013 and 2012, annual impairment tests on intangible assets were performed and based on the results of the tests no impairment was recorded.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Goodwill and intangible assets that have indefinite useful lives are tested annually for impairment, and are tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. For goodwill, the impairment determination is made at the reporting unit level. The Company first assesses qualitative factors to determine whether it is necessary to perform the two-step goodwill impairment test. The Company assesses qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, including goodwill. If determined to be necessary, the two-step impairment test is used to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized (if any). First, the Company determines the fair value of a reporting unit and compares it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.
The 2014 and 2012 annual goodwill impairment tests were performed and based on the results of the tests no impairment was recorded. If the Company does not achieve its earnings objectives or the cost of capital raises significantly, the assumptions and estimates underlying these impairment tests could be adversely affected and result in future impairment charges that would negatively impact its operating results.
The Company performed its annual goodwill impairment analysis in the fourth quarter of year 2013 and based on the results of the test, an impairment charge for the health clinic reporting unit disclosed below was recorded.
The Company concluded that fair value was below carrying value for the health clinic reporting unit acquired in January 2012. The fair value of the health clinic reporting unit was based on the income approach. The decline in the estimated fair value of the health clinic reporting unit results from lower projected revenue growth rates and profitability levels used to calculate the discounted cash flows. The lower projected operating results reflect changes in assumptions related to organic revenue growth rates, market trends, business mix, cost structure, expected deal synergies and other expectations about the anticipated short-term and long-term operating results of the health clinic business. The decline in the fair value of the health clinic reporting unit in the step two goodwill impairment test, resulted in an implied fair value that indicated the book value should be reduced to zero. As a result, the Company recorded a goodwill impairment charge of $2,369 during the year December 31, 2013. The goodwill impairment charge is included within the consolidated operating expenses.
Claim Liabilities
Claim liabilities for managed care policies represent the estimated amounts to be paid to providers based on experience and accumulated statistical data. Loss-adjustment expenses related to such claims are currently accrued based on estimated future expenses necessary to process such claims.
The Company contracts with various independent practice associations (IPAs) for certain medical care services provided to some policies subscribers. The IPAs are compensated on a capitation basis. In the Medicaid business and certain MA policies, a portion of the capitation payments is retained to provide for incurred but not reported losses. At December 31, 2014 and 2013, total withholdings and capitation payable amounted to $40,072 and $42,298, respectively, which are recorded as part of the claim liabilities in the accompanying consolidated balance sheets.
Claim liabilities include unpaid claims and loss-adjustment expenses of the life and accident and health business based on a case-basis estimate for reported claims, and on estimates, based on experience, for unreported claims and loss-adjustment expenses. The liability for policy and contract claims and claims expenses has been established to cover the estimated net cost of insured claims.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Also included within the claim liabilities is the liability for losses and loss-adjustment expenses for the property and casualty business which represents individual case estimates for reported claims and estimates for unreported losses, net of any salvage and subrogation based on past experience modified for current trends and estimates of expenses for investigating and settling claims.
Claim liabilities are necessarily based on estimates and, while management believes that the amounts are adequate, the ultimate liability may be in excess of or less than the amounts provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed, and any adjustments are reflected in the consolidated statements of earnings in the period determined.
Future Policy Benefits
The liability for future policy benefits has been computed using the level-premium method based on estimated future investment yield, mortality, morbidity and withdrawal experience. The interest rate assumption ranges between 4.90% and 5.75% for all years in issue. Mortality has been calculated principally on select and ultimate tables in common usage in the industry. Withdrawals have been estimated principally based on industry tables, modified by Company’s experience.
Policyholder Deposits
Amounts received for annuity contracts are considered deposits and recorded as a liability along with the accrued interest and reduced for charges and withdrawals. Interest incurred on such deposits, which amounted to $3,510, $3,217, and $2,889, during the years ended December 31, 2014, 2013, and 2012, respectively, is included within the interest expense in the accompanying consolidated statements of earnings.
Reinsurance
In the normal course of business, the insurance-related subsidiaries seek to limit their exposure that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk in various areas of exposure with other insurance enterprises or reinsurers.
Reinsurance premiums, commissions, and expense reimbursements, related to reinsured business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Accordingly, reinsurance premiums are reported as prepaid reinsurance premiums and amortized over the remaining contract period in proportion to the amount of insurance protection provided.
Premiums ceded and recoveries of losses and loss-adjustment expenses have been reported as a reduction of premiums earned and losses and loss-adjustment expenses incurred, respectively. Property and casualty commission and expense allowances received in connection with reinsurance ceded have been accounted for as a reduction of the related policy acquisition costs and are deferred and amortized accordingly. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the consolidated statements of earnings in the period that includes the enactment date. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in circumstances occurs.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The Company records any interest and penalties related to unrecognized tax benefits within the operating expenses in the consolidated statement of earnings.
The holding company within the TSA group of companies is a U.S.-based company that has not recorded a U.S. deferred tax liability for the excess of the book basis over the tax basis of its investments in Puerto Rico corporations. TSA has not recorded a deferred tax liability to the extent that the basis difference results from outside basis difference created as a result of the business combination and earnings that meet the indefinite reversal criteria. The indefinite reversal criteria is met if the Puerto Rico subsidiary has invested, or will invest, the undistributed earnings indefinitely. The decision as to the amount of undistributed earnings intended to be maintained in Puerto Rico corporations takes into account several items including, but not limited to, actual results of operations, forecasts and budgets of financial needs of cash for working capital, liquidity plans, capital improvement programs, merger and acquisition plans as well as expected cash requirements in the U.S. or in other Puerto Rico subsidiaries from the U.S.-based company.
Insurance-Related Assessments
The Company records a liability for insurance-related assessments when the following three conditions are met: (1) the assessment has been imposed or the information available prior to the issuance of the financial statements indicates it is probable that an assessment will be imposed; (2) the event obligating an entity to pay (underlying cause of) an imposed or probable assessment has occurred on or before the date of the financial statements; and (3) the amount of the assessment can be reasonably estimated. A related asset is recognized when the paid or accrued assessment is recoverable through either premium taxes or policy surcharges.
Commitments and Contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred. Recoveries of costs from third parties, which are probable of realization, are separately recorded as assets, and are not offset against the related liability.
Share-Based Compensation
Share-based compensation is measured at the fair value of the award and recognized as an expense in the financial statements over the vesting period. The Company recognizes compensation expense for its stock options based on estimated grant date fair value using the Black-Scholes option-pricing model.
Earnings Per Share
Basic earnings per share excludes dilution and is computed by dividing net income available to all classes of common stockholders by the weighted average number of all classes of common shares outstanding for the period, excluding non-vested restricted stocks. Diluted earnings per share is computed in the same manner as basic earnings per share except that the number of shares is increased to include the number of additional common shares that would have been outstanding if the potentially dilutive common shares had been issued. Dilutive common shares are included in the diluted earnings per share calculation using the treasury stock method.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Recently Issued Accounting Standards
In July 2011, the FASB issued guidance to address questions about how health insurers should recognize and classify in their income statements fees mandated by the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act. A health insurer’s portion of the annual fee becomes payable to the U.S. Treasury once the entity provides health insurance for any U.S. health risk for each applicable calendar year. We adopted the provisions of this guidance on January 1, 2014 and upon implementation recorded a liability in the consolidated accounts payable and accrued liabilities of approximately $28,500 representing an estimate of the fee for 2014. A corresponding deferred cost was recorded in the consolidated other assets. The Corporation updated this estimate for adjustment in subsequent quarters to reflect the final annual fee assessment of $27,700 paid during the year 2014 and recognized within the consolidated operating expenses.
On July 18, 2013, the FASB issued guidance regarding the presentation in the statement of financial position of an unrecognized tax benefit when a net operating loss carry-forward or a tax credit carry-forward exists. In particular, the guidance provides that an entity's unrecognized tax benefit, or a portion of its unrecognized tax benefit, should be presented in its financial statements as a reduction to a deferred tax asset for a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward, with one exception. That exception states that, to the extent a net operating loss carry-forward, a similar tax loss, or a tax credit carry-forward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position, or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. This guidance is effective for public companies for fiscal years and interim periods within such years beginning after December 15, 2013. The Company adopted this guidance on January 1, 2014; there was no significant impact on our financial position or results of operations as a result of the adoption.
On March 14, 2014, the FASB issued guidance that amended the Master Glossary of the Accounting Standards Codification (“ASC”), including technical corrections related to glossary links, glossary term deletions, and glossary term name changes. In addition, this guidance included more substantive, limited-scope improvements to reduce instances of the same term appearing multiple times in the Master Glossary with similar, but not entirely identical, definitions. These are items that represent narrow and incremental improvements to U.S. GAAP and are not purely technical corrections and affect a wide variety of Topics in the ASC. The amendments in this guidance apply to all reporting entities within the scope of the affected accounting guidance and are effective upon issuance for both public entities and nonpublic entities. The Company adopted this guidance upon issuance with no impact on our financial position and results of operations.
On June 12, 2014, the FASB issued guidance that amends current accounting and disclosures for repurchase agreements and similar transactions. This guidance is effective for public companies for the first interim or annual period beginning after December 15, 2014. We are currently evaluating the impact, if any, the adoption of this guidance will have on the financial position or results of operations.
On June 19, 2014, the FASB issued updated guidance on the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This guidance seeks to resolve the diversity in practice that exists when accounting for share-based payments. In particular, this guidance requires a performance target that affects vesting and that could be achieved after the requisite service period to be treated as a performance condition. For all entities, this guidance is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, with earlier adoption permitted. We are currently evaluating the impact, if any, the adoption of this guidance will have on our financial position or results of operations.
Other than the accounting pronouncements disclosed above, there were no other new accounting pronouncements issued that could have a material impact in the Company’s financial position, operating results or financials statement disclosures.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
3.
Investment in Securities
The amortized cost for debt securities and cost for equity securities, gross unrealized gains, gross unrealized losses, and estimated fair value for available-for-sale and held-to-maturity securities by major security type and class of security at December 31, 2014 and 2013, were as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
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, 2014 and 2013 were as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The Corporation regularly monitors and evaluates the difference between the amortized cost and estimated fair value of investments. For investments with a fair value below amortized cost, the process includes evaluating: (1) the length of time and the extent to which the estimated fair value has been less than amortized cost for fixed maturity securities, or cost for equity securities, (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 for fixed maturity securities, or cost for equity securities, 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, other-than temporary impairment may not be appropriate.
Due to the subjective nature of the Corporation’s analysis, along with the judgment that must be applied in the analysis, it is possible that the Corporation could reach a different conclusion whether or not 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 Corporation determined during its analysis, which may lead to a different impairment conclusion in future periods.
If after monitoring and analyzing impaired securities, the Corporation determines that a decline in the estimated fair value of any available-for-sale or held-to-maturity security below cost is other-than-temporary, the carrying amount of the security is reduced to its fair value in accordance with current accounting guidance. The new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value. In periods subsequent to the recognition of an other-than-temporary impairment, the impaired security is accounted for as if it had been purchased on the measurement date of the impairment. For debt securities, the discount (or reduced premium) based on the new cost basis may be accreted into net investment income in future periods based on prospective changes in cash flow estimates, to reflect adjustments to the effective yield.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The Corporation’s process for identifying and reviewing invested assets for other-than temporary impairments during any quarter includes the following:
• Identification and evaluation of securities that have possible indications of other-than-temporary impairment, which includes an analysis of all investments with gross unrealized investment losses that represent 20% or more of their cost and all investments with an unrealized loss greater than $100.
• Review and evaluation of any other security based on the investee’s current financial condition, liquidity, near-term recovery prospects, implications of rating agency actions, the outlook for the business sectors in which the investee operates and other factors. This evaluation is in addition to the evaluation of those securities with a gross unrealized investment loss representing 20% or more of their cost.
• Consideration of evidential matter, including an evaluation of factors or triggers that may or may not cause individual investments to qualify as having other-than-temporary impairments.
• Determination of the status of each analyzed security as other-than-temporary or not, with documentation of the rationale for the decision; and
• Equity securities are considered to be impaired when a position is in an unrealized loss for a period longer than 6 months.
The Corporation reviews the investment portfolios under the Corporation’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 other-than-temporary impairments may be recorded in future periods. The Corporation 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.
Obligations of Government-Sponsored Enterprises, and Obligations of U.S. Government Instrumentalities: The unrealized losses on the Corporation’s investments in obligations of Government Sponsored Enterprises and U.S. Government Instrumentalities were mainly caused by fluctuations in interest rates and general market conditions. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investment. In addition, these investments have investment grade ratings. Because the decline in fair value is attributable to changes in interest rates and not credit quality; because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost basis, which may be maturity; and because the Corporation expects to collect all contractual cash flows, these investments are not considered other-than-temporarily impaired.
Obligations of the Commonwealth of Puerto Rico and its Instrumentalities: Our holdings in Puerto Rico municipals can be divided in (1) escrowed bonds with a fair value of $22,335 and a gross unrealized gain of $5, (2) bonds issued by the Puerto Rico Sales Tax Financing Corporation (Cofina) with a fair value of $11,269; a gross unrealized gain of $65, and (3) bonds of various other Puerto Rico issuers with a fair value of $1,649 and a gross unrealized gain of $68.
Besides holdings in escrowed bonds, which are backed by US Government securities and therefore have an implicit AA+/Aaa rating, our largest positions are in senior lien bonds issued by Cofina. These sales tax bonds are secured by a 7% sales tax levied on the island, of which 1.5% is allocated to municipalities. Of the remaining 5.5%, the largest of 3.5% or a base amount is pledged to these sales tax bonds. The percentage pledged to the sales tax bonds was increased in October 2013 from 2.75% to 3.5%. In terms of flow of funds, the 5.5% remaining revenue is first used for debt service on the senior lien bonds, then for debt service on the subordinated bonds and the excess flows into the General Fund.
On June 28, 2014, Act 71-2014, known as the Puerto Rico Public Corporations Debt Enforcement and Recovery Act (“the Recovery Act”) was signed into law to provide a legal framework for restructuring public corporation debt. The Central Government, municipalities and related agencies (including Cofina and Puerto Rico’s Government Development Bank (GDB)) are explicitly not eligible, i.e. these cannot be restructured under this new act. In other words, the Act makes a clear distinction between the central Government and its related entities versus the agencies and public corporations. Both Moody’s and Standard & Poor’s (S&P) have taken various ratings actions on the back of this new legislation, including on those credits that were explicitly excluded under the new Act. The rating agencies have positioned their ratings of bonds issued by Cofina closer to that of General Obligation debt.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
S&P notes that the proposal is indicative of the growing economic and fiscal challenges for the Commonwealth as a whole, which could lead to additional liquidity pressures. S&P also mentions that this legislation may also signal a potential shift in the Commonwealth’s historically strong willingness to continue to meet its obligations to bondholders. On July 11, 2014, S&P lowered its Cofina rating for senior lien bonds from AA- to BBB, combined with a negative outlook. According to Moody’s, the new law marks the end of the Commonwealth’s long history of taking actions needed to support its debt. The rating agency notes that it signals a depleted capacity for revenue increases and austerity measures, and a new preference for shifting fiscal pressures to creditors. In Moody’s view this has implications for all of Puerto Rico’s debt, i.e. not only of the public corporations but also of the central Government. On July 1, 2014, Moody’s lowered its Cofina ratings from Baa1 to Ba3 for senior lien bonds, combined with a negative outlook.
The market price of longer dated Cofina bonds dropped below their par value in the second quarter of 2013. The bonds registered a further drop to current levels in July 2014, after the downgrades by both rating agencies. Some of our positions were acquired during this period, as part of a strategy to reduce the maturity of our Cofina holdings. This means that some of our positions have been at an unrealized loss for a shorter period, even though the Cofina credit has been under pressure for more than 6 quarters.
In the fourth quarter of 2014, the Corporation decided to sell a net amount of $8,627 (fair value) in order to reduce Cofina exposure, realizing a loss of $1,843.
The Corporation considered the Cofina positions other-than-temporary impaired as of December 31, 2014 because: (a) the decision to reduce exposure constitutes a change in intent, triggering an other-than-temporary impairment on any remaining positions at an unrealized loss, (b) the remaining positions have been at an unrealized loss for around 6 months, prices for longer Cofina bonds in general have been below par for more than 6 quarters, and we do not expect a recovery to book value in the near future, (c) the Cofina credit could be affected if the financial position of the Commonwealth of Puerto Rico as a whole does not show signs of improvement soon. As a result, the Corporation registered an other-than-temporary impairment for a total amount of $1,170.
The bonds of various other Puerto Rico issuers, which are mentioned above, consist of General Obligation bonds insured by National Public Finance Guarantee (AA- stable outlook, A3 negative outlook) and GDB notes (BB-, B3 negative outlook). The position in GDB notes was at an unrealized loss of $27 as of December 31, 2014. In order to be consistent among the Puerto Rico credits, this amount was included in the impairment adjustment mentioned above.
Municipal Securities: The unrealized losses on the Corporation’s investments in U.S. municipal securities were mainly caused by fluctuations in interest rates and general market conditions. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the par value of the investment. In addition, these investments have investment grade ratings. Because the decline in fair value is attributable to changes in interest rates and not credit quality; because the Corporation does not intend to sell the investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost basis, which may be maturity; and because the Corporation expects to collect all contractual cash flows, these investments are not considered other-than-temporarily impaired.
Corporate Bonds: The unrealized losses of these bonds were principally caused by fluctuations in interest rates and general market conditions. All corporate bonds with an unrealized loss have investment grade ratings. Because the decline in estimated fair value is principally attributable to changes in interest rates; because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity; and because the Company expects to collect all contractual cash flows, these investments are not considered other-than-temporarily impaired.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Mutual Funds: As of December 31, 2014, investments in mutual funds with unrealized losses are not considered other-than-temporarily impaired because the funds have been in an unrealized loss position for less than six months or the unrealized loss is small (less than $100 and/or 20%).
Maturities of investment securities classified as available for sale and held to maturity at December 31, 2014 were as follows:
Expected maturities may differ from contractual maturities because some issuers have the right to call or prepay obligations with or without call or prepayment penalties.
Investments with an amortized cost of $4,383 and $5,389 (fair value of $4,582 and $4,487) at December 31, 2014 and 2013, respectively, were deposited with the Commissioner of Insurance to comply with the deposit requirements of the Insurance Code of the Commonwealth of Puerto Rico (the Insurance Code). Investment with an amortized cost of $515 and $511 (fair value of $515 and $511) at December 31, 2014 and 2013, respectively, was deposited with the USVI Division of Banking and Insurance.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Information regarding realized and unrealized gains and losses from investments for the years ended December 31, 2014, 2013, and 2012 is as follows:
The other-than-temporary impairments on fixed maturity securities are attributable to credit losses.
The deferred tax asset (liability) on unrealized gains change recognized in accumulated other comprehensive income during the years 2014, 2013, and 2012 was $(4,717), $6,604, and $(4,548), respectively.
As of December 31, 2014 and 2013 no individual investment in securities exceeded 10% of stockholders’ equity.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
4.
Net Investment Income
Interest and/or dividend income from:
5.
Premium and Other Receivables, Net
Premium and other receivables, net as of December 31 were as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
6.
Deferred Policy Acquisition Costs and Value of Business Acquired
The movement of deferred policy acquisition costs (DPAC) and value of business acquired (VOBA) for the years ended December 31, 2014, 2013, and 2012 is summarized as follows:
The VOBA addition in 2013 is related to the TSB acquisition. The amortization expense of the deferred policy acquisition costs and value of business acquired is included within the operating expenses in the accompanying consolidated statement of earnings.
The estimated amount of the year-end VOBA balance expected to be amortized during the next five years is as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
7.
Property and Equipment, Net
Property and equipment, net as of December 31 are composed of the following:
8.
Intangible Asset
Intangible assets, included within other assets, at December 31, 2014 and 2013 consist of:
Trade name and provider networks are amortized over the expected life of 3 and 5 years, respectively. Membership base is amortized over the expected life between 1 and 13 years, or using determined percentages, ranging from 25% to 30%.
Amortization expense of intangible assets recorded for the years ended December 31, 2014, 2013, and 2012 amounted to $5,745, $8,638, and $10,443, respectively.
Estimated amortization expense for the following five years is as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
9.
Fair Value Measurements
Assets recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Level inputs, as defined by current accounting guidance for fair value measurements and disclosures, are as follows:
Level Input Definition:
Level 1 Inputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
Level 2 Inputs other than quoted prices included in Level 1 that are observable for the asset or liability through corroboration with market data at the measurement date.
Level 3 Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.
The Corporation uses observable inputs when available. Fair value is based upon quoted market prices when available. The Corporation limits valuation adjustments to those deemed necessary to ensure that the security’s fair value adequately represents the price that would be received or paid in the marketplace. Valuation adjustments may include consideration of counterparty credit quality and liquidity as well as other criteria. The estimated fair value amounts are subjective in nature and may involve uncertainties and matters of significant judgment for certain financial instruments. Changes in the underlying assumptions used in estimating fair value could affect the results. The fair value measurement levels are not indicative of risk of investment.
The fair value of investment securities is estimated based on quoted market prices for those or similar investments. Additional information pertinent to the estimated fair value of investment in securities is included in note 3.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The following table summarizes fair value measurements by level at December 31, 2014 and 2013 for assets measured at fair value on a recurring basis:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The fair value of fixed maturity and equity securities included in the Level 2 category were based on market values obtained from independent pricing services, which utilize evaluated pricing models that vary by asset class and incorporate available trade, bid and other market information and for structured securities, cash flow and when available loan performance data. Because many fixed income securities do not trade on a daily basis, the models used by independent pricing service providers to prepare evaluations apply available information, such as benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. For certain equity securities, quoted market prices for the identical security are not always available and the fair value is estimated by reference to similar securities for which quoted prices are available. The independent pricing service providers monitor market indicators, industry and economic events, and for broker-quoted only securities, obtain quotes from market makers or broker-dealers that they recognize to be market participants. The fair value of the investments in partnerships included in the Level 3 category was based on the net asset value (NAV) which is affected by the changes in the fair market value of the investments held in these partnerships.
Transfers into or out of the Level 3 category occur when unobservable inputs, such as the Company’s best estimate of what a market participant would use to determine a current transaction price, become more or less significant to the fair value measurement. Transfers between levels, if any, are recorded as of the actual date of the event or change in circumstance that caused the transfer. There were no transfers between Levels 1 and 2 during the years ended December 31, 2014 and 2013.
A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2014 and 2013 is as follows:
In addition to the preceding disclosures on assets recorded at fair value in the consolidated balance sheets, accounting guidance also requires the disclosure of fair values for certain other financial instruments for which it is practicable to estimate fair value, whether or not such values are recognized in the consolidated balance sheets.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Non-financial instruments such as property and equipment, other assets, deferred income taxes and intangible assets, and certain financial instruments such as claim liabilities are excluded from the fair value disclosures. Therefore, the fair value amounts cannot be aggregated to determine our underlying economic value.
The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, receivables, accounts payable and accrued liabilities, and short-term borrowings approximate fair value because of the short term nature of these items. These assets and liabilities are not listed in the table below.
The following methods, assumptions and inputs were used to estimate the fair value of each class of financial instrument:
(i) Policy Loans
Policy loans have no stated maturity dates and are part of the related insurance contract. The carrying amount of policy loans approximates fair value because their interest rate is reset periodically in accordance with current market rates.
(ii) Policyholder Deposits
The fair value of policyholder deposits is the amount payable on demand at the reporting date, and accordingly, the carrying value amount approximates fair value.
(iii) Long-term Borrowings
The carrying amount of the loans payable to bank - variable approximates fair value due to its floating interest-rate structure. The fair value of the loans payable to bank - fixed and senior unsecured notes payable was determined using broker quotations.
(iv) Repurchase Agreement
The value of the repurchase agreement with a long term maturity is based on the discontinued value of the contractual cash flows using current estimated market discount rates for instruments with similar terms.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
A summary of the carrying value and fair value by level of financial instruments not recorded at fair value on our consolidated balance sheet at December 31, 2014 and 2013 are as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
10.
Claim Liabilities
The activity in claim liabilities during 2014, 2013, and 2012 is as follows:
As a result of differences between actual amounts and estimates of insured events in prior years, the amounts included as incurred claims for prior period insured events differ from anticipated claims incurred.
The credits in the claims incurred and loss-adjustment expenses for prior period insured events for 2014, 2013 and 2012 are due primarily to better than expected utilization trends. Reinsurance recoverable on unpaid claims is reported as premium and other receivables, net in the accompanying consolidated financial statements.
The claims incurred disclosed in this table exclude the portion of the change in the liability for future policy benefits amounting to $23,807, $22,990, and $22,784 that is included within the consolidated claims incurred during the years ended December 31, 2014, 2013 and 2012, respectively.
11.
Federal Employees’ Health Benefits Program (FEHBP)
TSS entered into a contract, renewable annually, with the Office of Personnel Management (OPM) as authorized by the Federal Employees’ Health Benefits Act of 1959, as amended, to provide health benefits under the FEHBP. The FEHBP covers postal and federal employees residing in the Commonwealth of Puerto Rico and the United States Virgin Islands as well as retirees and eligible dependents. The FEHBP is financed through a negotiated contribution made by the federal government and employees’ payroll deductions.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The accounting policies for the FEHBP are the same as those described in the Company’s summary of significant accounting policies. Premium rates are determined annually by TSS and approved by the federal government. Claims are paid to providers based on the guidelines determined by the federal government. Operating expenses are allocated from TSS’s operations to the FEHBP based on applicable allocation guidelines (such as, the number of claims processed for each program) and are subject to contractual expense limitations.
The operations of the FEHBP do not result in any excess or deficiency of revenue or expense as this program has a special account available to compensate any excess or deficiency on its operations to the benefit or detriment of the federal government. Any transfer to/from the special account necessary to cover any excess or deficiency in the operations of the FEHBP is recorded as a reduction/increment to the premiums earned. The contract with OPM provides that the cumulative excess of the FEHBP earned income over health benefits charges and expenses represents a restricted fund balance denoted as the special account. Upon termination of the contract and satisfaction of all the FEHBP’s obligations, any unused remainder of the special reserve would revert to the Federal Employees Health Benefit Fund. In the event that the contract terminates and the special reserve is not sufficient to meet the FEHBP’s obligations, the FEHBP contingency reserve will be used to meet such obligations. If the contingency reserve is not sufficient to meet such obligations, the Company is at risk for the amount not covered by the contingency reserve.
The contract with OPM allows for the payment to the Company of service fees as negotiated between TSS and OPM. Service fees, which are included within the other income, net in the accompanying consolidated statements of earnings, for each of the years in the three-year period ended December 31, 2014 amounted to $1,229, $1,204, and $1,117, respectively.
The Company also has funds available related to the FEHBP amounting to $39,835 and $31,326 as of December 31, 2014 and 2013, respectively and are included within the cash and cash equivalents in the accompanying consolidated balance sheets. Such funds must only be used to cover health benefits charges, administrative expenses and service charges required by the FEHBP.
A contingency reserve is maintained by the OPM at the U.S. Treasury, and is available to the Company under certain conditions as specified in government regulations. Accordingly, such reserve is not reflected in the consolidated balance sheets. The balance of such reserve as of December 31, 2014 and 2013 was $24,824 and $31,328, respectively. The Company received $12,766, $634, and $3,463, of payments made from the contingency reserve fund of OPM during 2014, 2013, and 2012, respectively.
The claim payments and operating expenses charged to the FEHBP are subject to audit by the U.S. government. Management is of the opinion that an adjustment, if any, resulting from such audits will not have a significant effect on the accompanying financial statements. The claim payments and operating expenses reimbursed in connection with the FEHBP have been audited through 2011 by OPM.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
12.
Long-Term Borrowings
A summary of the borrowings entered by the Company at December 31, 2014 and 2013 is as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Aggregate maturities of the Company’s borrowings as of December 31, 2014 are summarized as follows:
All of the Company’s senior notes may be prepaid at par, in total or partially, five years after issuance as determined by the Company. The Company’s senior unsecured notes contain certain non-financial covenants with which the Company has complied at December 31, 2014. During 2013 and 2012, we repaid $10,000 and $25,000, respectively of the principal of the 6.70% senior unsecured note.
Debt issuance costs related to each of the Company’s senior unsecured notes were deferred and are being amortized over the term of its respective senior note. Unamortized debt issuance costs related to these senior unsecured notes as of December 31, 2014 and 2013 amounted to $132 and $157, respectively and are included within other assets in the accompanying consolidated balance sheets.
The secured loan payable with original principal balance of $41,000 is guaranteed by a first mortgage held by the bank on the Company’s land, building, and substantially all leasehold improvements, as collateral for the term of the loan under a continuing general security agreement. This secured loan contains certain non-financial covenants, which are customary for this type of facility, including but not limited to, restrictions on the granting of certain liens, limitations on acquisitions and limitations on changes in control.
The secured loan payable with original principal balance of $14,138 was paid in full on December 23, 2014 and was guaranteed by a first position held by the bank on the health clinic’s premises (land and building) and all of the health clinic's assets as collateral for the term of the loan under a continuing general security agreement. This secured loan contained certain financial and non-financial covenants, which are customary for this type of facility, including but not limited to, restrictions on the granting of certain liens, limitations on acquisitions and limitations on changes in control.
The repurchase agreement has pledged as collateral investment securities available for sale with fair value of $27,135 (face value of $27,110) and $27,915 (face value of $27,835) as of December 31, 2014 and 2013, respectively. The investment securities underlying such agreements were delivered to the financial institution with whom the agreement was transacted. The dealers may have loaned, or used as collateral securities in the normal course of business operations. We maintain effective control over the investment securities pledged as collateral and accordingly, such securities continue to be carried on the accompanying consolidated balance sheets.
Interest expense on the above borrowings amounted to $3,639, $4,106, and $5,554, for the years ended December 31, 2014, 2013, and 2012, respectively.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
13.
Agency Contract and Expense Reimbursement
On March 1, 2009, the Centers for Medicare and Medicaid Services (CMS) awarded to First Coast Service Options (FCSO), a non-affiliated third party organization based in Jacksonville, Florida, the Medicare Administrative Contract (MAC) for Jurisdiction 9 (Florida, Puerto Rico and the U.S. Virgin Islands). FCSO proposed TSS as a subcontractor in MAC Jurisdiction 9 to perform certain provider customer service functions, subject to terms and conditions negotiated between FSCO and TSS. Pursuant to this, TSS billed reimbursements of expenses of $2,644, $2,663 and $2,982 for performing the customer service functions during the years ended December 31, 2014, 2013 and 2012, respectively.
The operating expense reimbursements in connection with processing Medicare claims have been audited through 2009 by federal government representatives. Management is of the opinion that no significant adjustments will be made affecting cost reimbursements through December 31, 2014.
14.
Reinsurance Activity
The effect of reinsurance on premiums earned and claims incurred is as follows:
(1) The claims incurred disclosed in this table exclude the portion of the change in the liability for future policy benefits amounting to $23,806, $22,990, and $22,784 that is included within the consolidated claims incurred during the years ended December 31, 2014, 2013 and 2012, respectively.
TSS, TSP and TSV, in accordance with general industry practices, annually purchase reinsurance to protect them from the impact of large unforeseen losses and prevent sudden and unpredictable changes in net income and stockholders’ equity of the Company. Reinsurance contracts do not relieve any of the subsidiaries from their obligations to policyholders. In the event that all or any of the reinsuring companies might be unable to meet their obligations under existing reinsurance agreements, the subsidiaries would be liable for such defaulted amounts. During 2014, 2013, and 2012 TSP placed 13.26%, 12.54%, and 11.47% of its reinsurance business with one reinsurance company.
TSS has excess of loss reinsurance treaties whereby it cedes a portion of its premiums to third parties. Reinsurance contracts are primarily for periods of one year, and are subject to modifications and negotiations in each renewal date. Premiums ceded under these contracts amounted to $4,901, $10,930, and $11,119, in 2014, 2013 and 2012, respectively. Claims ceded amounted to $5,487, $9,745, and $8,303, in 2014, 2013 and 2012, respectively. Principal reinsurance agreements include an organ transplant excess of loss treaty, which covers:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
· For group policies, 80% of the claims up to a maximum of $800 (80% of $1,000), per person, per life. For other group policies with other options, the agreement covers 80% of the claims up to a maximum of $400 (80% of $500), per person, per life, or 80% of the claims up to a maximum of $200 (80% of $250), per person, per life.
· For policies provided to the active and retired employees of the Commonwealth of Puerto Rico and its instrumentalities, the treaty covers 100% of the claims up to a maximum of $500 per person, per life with a basic coverage, and $1,000 per person, per life with Major medical coverage.
· For policies provided to the municipalities of Puerto Rico, the treaty covers 100% of the claims up to a maximum of $250 with plans with lifetime limits and all other plans 100% of the claims up to a maximum of $1,000.
· For U.S. Virgin Islands policies, the treaty covers 100% of the claims up to a maximum of $2,000 per person, per life. The first $150 are retained by Triple-S and the excess up to $1,850 are reinsured.
TSP has a number of pro rata and excess of loss reinsurance treaties whereby the subsidiary retains for its own account all loss payments for each occurrence that does not exceed the stated amount in the agreements and a catastrophe cover, whereby it protects itself from a loss or disaster of a catastrophic nature. Under these treaties, TSP ceded premiums of $52,058, $57,643, and $63,515, in 2014, 2013, and 2012, respectively.
Reinsurance cessions are made on excess of loss and on a proportional basis. Principal reinsurance agreements are as follows:
· Property quota share treaty covering for a maximum of $20,000 for any one risk. Under this treaty 30% of the risk is ceded to reinsurers. The remaining exposure is covered by a property per risk excess of loss treaty that provides reinsurance in excess of $500 up to a maximum of $14,000, or the remaining 70% for any one risk. In addition, TSP has an additional property catastrophe excess of loss contract that provides protection for losses in excess of $8,000 resulting from any catastrophe, subject to a maximum loss of $15,000.
· Personal property catastrophe excess of loss. This treaty provides protection for losses in excess of $5,000 resulting from any catastrophe, subject to a maximum loss of $40,000.
· Commercial property catastrophe excess of loss. This treaty provides protection for losses in excess of $10,000 resulting from any catastrophe, subject to a maximum loss of $150,000.
· Property catastrophe excess of loss. This treaty provides protection in excess of $40,000 and $150,000 with respect to personal and commercial lines, respectively, resulting from any catastrophe, subject to a maximum loss of $165,000 in respect of the ceded portion of the Commercial Lines Quota Share.
· Reinstatement premium protection. This treaty provides a maximum limit of approximately $2,300 for personal lines and $12,000 in commercial lines to cover the necessity of reinstating the catastrophe program in the event it is activated.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
· Casualty excess of loss treaty. This treaty provides reinsurance for losses in excess of $225 up to a maximum of $12,000.
· Medical malpractice excess of loss. This treaty provides reinsurance in excess of $150 up to a maximum of $1,500 per incident.
· Builders’ risk quota share and first surplus covering contractors’ risk. This treaty provides protection on a 20/80 quota share basis for the initial $2,500 and a first surplus of $12,500 for a maximum of $14,500 for any one risk.
· Surety quota share treaty covering contract and miscellaneous surety bond business. This treaty provides reinsurance of up to $5,000 for contract surety bonds, subject to an aggregate of $10,000 per contractor and $3,000 per miscellaneous surety bond.
Facultative reinsurance is obtained when coverage per risk is required. All principal reinsurance contracts are for a period of one year, on a calendar basis, and are subject to modifications and negotiations in each renewal.
The ceded unearned reinsurance premiums on TSP arising from these reinsurance transactions amounted to $11,374 and $14,009 at December 31, 2014 and 2013, respectively, and are reported as other assets in the accompanying consolidated balance sheets.
TSV also cedes insurance with various reinsurance companies under a number of pro rata, excess of loss and catastrophe treaties. Under these treaties, TSV ceded premiums of $10,328, $8,874, and $7,954, in 2014, 2013, and 2012, respectively. Principal reinsurance agreements are as follows:
· Group life insurance facultative agreement, reinsuring risk in excess of $25 of certain group life policies and a combined pro rata and excess of loss agreement effective July 1, 2008, reinsuring 50% of the risk up to $200 and ceding the excess.
· Facultative pro rata agreements for the long-term disability insurance, reinsuring 65% of the risk.
· Several reinsurance agreements, mostly on an excess of loss basis up to a maximum retention of $50. For certain new life products that have been issued after 1999, the retention limit is $175.
· A quota share agreement for group major medical and an excess of loss agreements for group and individual major medical, where TSV cedes 65% of the premiums and benefits.
15.
Income Taxes
The Company and its subsidiaries are subject to Puerto Rico income taxes. Under Puerto Rico income tax law, the Company is not allowed to file consolidated tax returns with its subsidiaries. The Company’s insurance subsidiaries are also subject to U.S. federal income taxes for foreign source dividend income.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Managed Care and Property and Casualty corporations are taxed essentially the same as other corporations, with taxable income primarily determined on the basis of the statutory annual statements filed with the insurance regulatory authorities. The corporations are also subject to an alternative minimum income tax, which is calculated based on the formula established by existing tax laws. Any alternative minimum income tax paid may be used as a credit against the excess, if any, of regular income tax over the alternative minimum income tax in future years.
The Company, through one of its Managed Care corporations, has a branch in the United States Virgin Islands that is subject to a 5% premium tax on policies underwritten therein. As a qualified foreign insurance company, the Company is subject to income taxes in the U.S. Virgin Islands, which has implemented a mirror tax law based on the U.S. Internal Revenue Code. The branch operations in the U.S. Virgin Islands had certain net operating losses for U.S. Virgin Islands tax purposes for which a valuation allowance has been recorded.
Companies within our Life Insurance segment operate as qualified domestic life insurance companies and are subject to the alternative minimum tax and taxes on its capital gains.
Federal income taxes recognized by the Company’s insurance subsidiaries amounted to approximately $451, $790, and $820, in 2014, 2013, and 2012, respectively.
All other corporations within the group are subject to Puerto Rico income taxes as regular corporations, as defined in the P.R. Internal Revenue Code, as amended. The holding company within the TSA group of companies is a U.S.-based corporation and is subject to U.S. federal income taxes. This U.S-based corporation within our group has not provided U.S. deferred taxes on an outside basis difference created as a result of the business combination of TSA and cumulative earnings of its Puerto Rico-based subsidiaries that are considered to be indefinitely reinvested. The total outside basis difference at December 31, 2014 and 2013 is estimated at $54,000 and $56,000, respectively. We do not intend to repatriate earnings to fund U.S. and Puerto Rico operations nor do any transaction that would cause a reversal of that outside basis difference. Because of the availability of U.S. foreign tax credits, it is not practical to determine the U.S. federal income tax liability if such outside basis difference was reversed.
On June 30, 2013 the Governor of Puerto Rico signed into law Puerto Rico’s Act No.40, known as the “Tax Burden Adjustment and Redistribution Act’’ and other Acts, which among other things, increased the maximum corporate income tax rate from 30% to 39%. This tax rate applies to fiscal years starting after December 31, 2012. These new laws also include some amendments to the computations of the corporate alternative minimum tax, including the consideration of an additional tax on gross revenues. In addition, the law established a premium tax of 1% on premiums earned after June 30, 2013, except for annuity deposits and premiums derived from Medicare Advantage and Medicaid programs.
On October 14, 2013, the Governor of Puerto Rico signed into law Act No.117 that provided additional changes and transitional provisions in connection with Act 40 and clarified that gross income does not include dividends received from a 100% controlled domestic subsidiary and income attributable to a trade or business outside of Puerto Rico.
On July 1, 2014, the Governor of Puerto Rico signed into law Act No. 77 including multiple amendments to the Puerto Rico tax code that had a direct impact on the tax liabilities of individual and corporate taxpayers. The amendments to the Puerto Rico tax code include, among others, changes to the corporate tax rate on long-term capital gains, which was increased from 15% to 20% for all transactions occurring after June 30, 2014. During the year ended December 31, 2014, the Company recognized a one-time charge to operations of approximately $6,300 as a consequence of this change in the enacted rate to account for the effect of the increase in rate in the unrealized gain on its investment portfolio.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Act No. 77 of 2014 also included changes to the gross receipts tax, (1) eliminating the additional gross receipts tax as a component of the corporate alternative minimum tax commencing on January 1, 2014 and thereafter, and (2) adding a new gross receipts tax. Although the new gross receipts tax will be an additional tax on the Corporation’s gross income, it will be deductible for purposes of computing taxable income, but only to the extent that the new gross receipts tax is paid on or before the filing date of the income tax return. The impact of the amendments to the gross receipts tax was not significant to the results of operations.
Act No. 77 also allowed corporations to elect, during the period running from July 1, 2014 to October 31, 2014, to prepay at a reduced income tax rate of 12% the increase in value of long-term capital assets. On December 22, 2014, the Governor of Puerto Rico signed into law Act No. 238 providing further amendments to the provisions set forth by Act No.77, extending the period to prepay at the reduced tax rate of 12%, the increase in value of long-term capital assets until January 31, 2015. In connection with this law, December 31, 2014, the group of corporations that comprise TSM entered into a Closing Agreement with the Puerto Rico Department of Treasury. The Closing Agreement, among other matters, was related with the payment of the preferential tax rate on the increase in value of some of its long-term capital assets, as permitted by Act No. 238 of 2014. The agreement also covered certain attributes of the Corporation. As a result of the aforementioned tax laws and the Closing Agreement, the Company benefited from the lower tax rate provided under these statutes, reassessed the realizability of some of its deferred taxes and recorded a tax benefit of $17,049 in 2014.
Pursuant to the provisions of the Puerto Rico Insurance Code and Regulations, TSP is a member of the Compulsory Vehicle Liability Insurance Joint Underwriting Association (the Association). As a participant, TSP shares the risk, proportionately with other members, based on a formula established by the Puerto Rico Insurance Code, of the results and financial condition of the Association, and accordingly, may be subject to assessments to cover obligations of the Association or may receive refund distributions for good experience. On July 15, 2013, the Governor of Puerto Rico signed into law Act No. 60, which authorized the Association to declare during the year 2013 an extraordinary dividend to its members of up to $200,000 subject to the payment of a special tax rate of 50%. During the year ended December 31, 2013, TSP received from the Association a special distribution of $12,811, net of a tax of $12,811, which is included as other income in the accompanying consolidated statements of earnings.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The income tax expense differs from the amount computed by applying the Puerto Rico statutory income tax rate to the income before income taxes as a result of the following:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Deferred income taxes reflect the tax effects of temporary differences between carrying amounts of assets and liabilities for financial reporting purposes and income tax purposes. The net deferred tax asset at December 31, 2014 and 2013 of the Company and its subsidiaries is composed of the following:
The net deferred tax asset shown in the table above at December 31, 2014 and 2013 is reflected in the consolidated balance sheets as $68,695 and $33,519, respectively, in deferred tax assets and $28,456 and $20,783, in deferred tax liabilities, respectively, reflecting the aggregate deferred tax assets or liabilities of individual tax-paying subsidiaries of the Company.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management believes that it is more likely than not that the Company will realize the benefits of these deductible differences. The valuation allowance is mostly related with the net operating losses generated by the Company’s U.S Virgin Islands and health clinic’s operations that based on the available evidence are not considered to be realizable at the reporting dates.
At December 31, 2014, the Company and its subsidiaries has net operating loss carry-forwards for Puerto Rico income tax purposes of approximately $21,260, which are available to offset future taxable income for up to December 2024. Except for the valuation allowance described in the previous paragraph, the corporation concluded that as of December 31, 2014, it is more likely than not that the entities that have these net operating loss carry-forwards will generate sufficient taxable income within the applicable net operating loss carry-forward periods to realize its deferred tax asset. This conclusion is based on the historical results of each entity, adjusted to exclude non recurring conditions, and the forecast of future profitability. Management will continue to evaluate, on a quarterly basis, if there are any significant events that will affect the corporation’s ability to utilize these deferred tax assets.
16.
Pension Plans
Noncontributory Defined-Benefit Pension Plan
The Company sponsors a noncontributory defined-benefit pension plan for its employees and for the employees of certain subsidiaries. Pension benefits begin to vest after five years of vesting service, as defined, and are based on years of service and final average salary, as defined. The funding policy is to contribute to the plan as necessary to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, as amended, plus such additional amounts as the Company may determine to be appropriate from time to time. The measurement date used to determine pension benefit for the pension plan is December 31.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The following table sets forth the plan’s benefit obligations, fair value of plan assets, and funded status as of December 31, 2014 and 2013, accordingly:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The following assumptions were used on a weighted average basis to determine benefits obligations of the plan as of December 31, 2014 and 2013.
The assumed discount rate of 4.25% at December 31, 2014 reflects the hypothetical rate at which the projected benefit obligations could be effectively settled or paid out to participants on that date. The Company determined the discount rate based on a range of factors, including a yield curve comprised of the rates of return on high-quality, fixed-income corporate bonds available at the measurement date and the related expected duration for the obligations.
The amounts recognized in the balance sheets as of December 31, 2014 and 2013 consist of the following:
The components of net periodic benefit cost for 2014, 2013, and 2012 were as follows:
Net periodic benefit cost may include settlement charges as a result of retirees selecting lump-sum distributions. Settlement charges may increase in the future if the number of eligible participants deciding to receive distributions and the amount of their benefits increases. There were no settlement charges during the years ended December 31, 2014, 2013 and 2012.
The estimated net loss and prior service benefit that will be amortized from accumulated other comprehensive loss into net periodic pension benefits cost during the next twelve months is as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The following assumptions were used on a weighted average basis in computing the periodic benefit cost for the years ended December 31, 2014, 2013, and 2012:
The basis of the overall expected long-term rate of return on assets assumption is a forward-looking approach based on the current long-term capital market outlook assumptions of the assets categories in which the trust invests and the trust’s target asset allocation. At December 31, 2014, the assumed target asset allocation for the program is: 44% to 56% in equity securities, 34% to 46% in debt securities, and 6% to 14% in other securities. Using a mean-variance model to project returns over a 30-year horizon under the target asset allocation, the 35% to 65% percentile range of annual rates of return is 5.7% to 7.4%. The Company selected a rate from within this range of 7.00% for 2014 and 2013, which reflects the Company’s best estimate for this assumption based on the data described above, information on the historical returns on assets invested in the pension trust, and expected future conditions. This rate is net of both investment related expenses and a 0.10% reduction for other administrative expenses charged to the trust.
Plan Assets
Plan assets recorded at fair value are categorized based upon the level of judgment associated with the inputs used to measure their fair value. For level inputs and input definition, see note 9.
The following table summarizes fair value measurements by level at December 31, 2014 and 2013 for assets measured at fair value on a recurring basis:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2014 and 2013 is as follows:
The Company’s plan assets are invested in the National Retirement Trust. The National Retirement Trust was formed to provide financial and legal resources to help members of the BCBSA offer retirement benefits to their employees.
The investment program for the National Retirement Trust is based on the precepts of capital market theory that are generally accepted and followed by institutional investors, who by definition are long-term oriented investors. This philosophy holds that:
· Increasing risk is rewarded with compensating returns over time, and therefore, prudent risk taking is justifiable for long-term investors.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
· Risk can be controlled through diversification of asset classes and investment approaches, as well as diversification of individual securities.
· Risk is reduced by time, and over time the relative performance of different asset classes is reasonably consistent. Over the long-term, equity investments have provided and should continue to provide superior returns over other security types. Fixed-income securities can dampen volatility and provide liquidity in periods of depressed economic activity. Lengthening duration of fixed income securities may reduce surplus volatility.
· The strategic or long-term allocation of assets among various asset classes is an important driver of long-term returns.
· Relative performance of various asset classes is unpredictable in the short-term and attempts to shift tactically between asset classes are unlikely to be rewarded.
Investments will be made for the sole interest of the participants and beneficiaries of the programs participating in the National Retirement Trust. Accordingly, the assets of the National Retirement Trust shall be invested in accordance with these objectives:
· To ensure assets are available to meet current and future obligations of the participating programs when due.
· To earn the maximum return that can be realistically achieved in the markets over the long-term at a specified and controlled level of risk in order to minimize future contributions.
· To invest assets with consideration of the liability characteristics in order to better align assets and liabilities.
· To invest the assets with the care, skill, and diligence that a prudent person acting in a like capacity would undertake. In the process, the Administration of the Trust has the objective of controlling the costs involved with administering and managing the investments of the National Retirement Trust.
Cash Flows
The Company expects to contribute $8,000 to its pension program in 2015.
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
Noncontributory Supplemental Pension Plan
In addition, the Company sponsors a noncontributory supplemental pension plan. This plan covers employees with qualified defined benefit retirement plan benefits limited by the U.S. Internal Revenue Code maximum compensation and benefit limits. At December 31, 2014 and 2013, the Company has recorded a pension liability of $9,570 and $7,937, respectively. The charge to accumulated other comprehensive loss related to the noncontributory pension plan at December 31, 2014 and 2013 amounted to $2,087 and $1,348, respectively, net of a deferred tax asset of $1,339 and $866, respectively.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
17.
Catastrophe Loss Reserve and Trust Fund
In accordance with Chapter 25 of the Puerto Rico Insurance Code, as amended, TSP is required to record a catastrophe loss reserve. This catastrophe loss reserve is supported by a trust fund for the payment of catastrophe losses. The reserve increases by amounts determined by applying a contribution rate, not in excess of 5%, to catastrophe written premiums as instructed annually by the Commissioner of Insurance, unless the level of the reserve exceeds 8% of catastrophe exposure, as defined. The reserve also increases by an amount equal to the resulting return in the supporting trust fund and decreases by payments on catastrophe losses or authorized withdrawals from the trust fund. Additions to the catastrophe loss reserve are deductible for income tax purposes.
This trust may invest its funds in securities authorized by the Insurance Code, but not in investments whose value may be affected by hazards covered by the catastrophic insurance losses. The interest earned on these investments and any realized gains (loss) on investment transactions are part of the trust fund and are recorded as income (expense) of the Company. An amount equal to the investment returns is recorded as an addition to the trust fund.
The interest earning assets in this fund, which amounted to $42,324 and $40,127 as of December 31, 2014 and 2013, respectively, are to be used solely and exclusively to pay catastrophe losses covered under policies written in Puerto Rico.
TSP is required to contribute to the trust fund, if needed or necessary, on or before January 31 of the following year. Contributions are determined by a rate determined or established by the Commissioner of Insurance for the catastrophe policies written in that year. No contribution was required for 2014 and 2013 since the level of the catastrophe reserve exceeds 8% of the catastrophe exposure.
The amount in the trust fund may be withdrawn or released in the case that TSP ceases to underwrite risks subject to catastrophe losses. Also, authorized withdrawals are allowed when the catastrophe loss reserve exceeds 8% of the catastrophe exposure, as defined.
Retained earnings are restricted in the accompanying consolidated balance sheets by the total catastrophe loss reserve balance, which as of December 31, 2014 and 2013 amounted to $40,457 and $39,463, respectively.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
18.
Stockholders’ Equity
a.
Common Stock
On December 8, 2008, the Company converted 7 million issued and outstanding Class A shares into Class B shares, in conjunction with the expiration of the lockup agreements signed by holders of Class A shares at the time of the Company’s initial public offering.
For a period of five years after the completion of the Initial Public Offering (IPO) on December 7, 2007, each holder of Class B common stock benefits from anti-dilution protections provided in the Company’s amended and restated certificate of incorporation.
On May 16, 2013, the Company, in connection with a registered underwritten secondary public offering of its Class B common stock (the Offering), entered into an underwriting agreement (the Underwriting Agreement) with certain shareholders of the Corporation (the Selling Shareholders), pursuant to which the Selling Shareholders sold to the underwriters an aggregate of 6,210,423 shares (the Shares) of Class B common stock at a price of $18.25 per share. The Shares included 810,055 shares of Class B common stock purchased pursuant to the over-allotment option granted to the Underwriters pursuant to the Underwriting Agreement.
b.
Stock Repurchase Programs
In September 2010, the Company’s Board approved a repurchase program (“2010 stock repurchase program”) of its common stock amounting to $30,000. 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. On March 23, 2013, we discontinued our 2010 stock repurchase program. During 2012, the Company repurchased and retired 136,222 shares at an average per share price of $16.88, for an aggregate cost of $2,299. During 2011, the Company repurchased and retired 653,399 shares at an average per share price of $17.28, for an aggregate cost of $11,289. During 2010, the Company repurchased and retired 352,791 shares at an average per share price of $17.67, for an aggregate cost of $6,235.
On March 6, 2013, the Company’s Board authorized the repurchase of up to $30,000 of Class B shares concurrent with the conversion of 7 million Class A shares into Class B shares and the public offering of a substantial majority of such converted shares. As part of the Offering, on May 17, 2013, the Company repurchased and retired 1,000,000 shares at a price of $18.25 per share.
In July 2013 the Company’s Board of Directors authorized a $11,500 repurchase program (“2013 stock repurchase program”) of its Class B common stock. 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. On October 28, 2014, we discontinued our 2013 stock repurchase program. During 2014, the Company repurchased and retired under this program 367,700 shares at an average per share price of $16.32, for an aggregate cost of $5,995.
In October 2014 the Company’s Board of Directors authorized a $50,000 repurchase program of its Class B common stock. Repurchases are 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 2014, the Company repurchased and retired under this program 228,525 shares at an average per share price of $23.55, for an aggregate cost of $5,341.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
c.
Preferred Stock
Authorized capital stock includes 100,000,000 of preferred stock with a par value of $1.00 per share. As of December 31, 2014 and 2013, there are no issued and outstanding preferred shares.
d.
Liquidity Requirements
As members of the BCBSA, the Company, TSS, and TSA are required by membership standards of the association to maintain liquidity as defined by BCBSA. That is, to maintain net worth exceeding the Company Action Level as defined in the National Association of Insurance Commissioners’ (NAIC) Risk-Based Capital for Insurers Model Act. The companies are in compliance with this requirement.
e.
Dividends
As a holding company, the Company’s most significant assets are the common shares of its subsidiaries. The principal sources of funds available to the Company are rental income and dividends from its subsidiaries, which are used to fund our debt service and operating expenses.
The Company is subject to the provisions of the General Corporation Law of Puerto Rico, which restricts the declaration and payment of dividends by corporations organized pursuant to the laws of Puerto Rico. These provisions provide that Puerto Rico corporations may only declare dividends charged to their retained earnings or, in the absence of retained earnings, net profits of the fiscal year in which the dividend is declared and/or the preceding fiscal year.
The Company’s ability to pay dividends is dependent, among other factors, on its ability to collect cash dividends from its subsidiaries, which are subject to regulatory requirements, which may restrict their ability to declare and pay dividends or distributions. In addition, an outstanding secured term loan restricts our ability to pay dividends in the event of default (see note 13).
The accumulated earnings of TSS, TSA, TSV, and TSP are restricted as to the payment of dividends by statutory limitations applicable to domestic insurance companies. Under Puerto Rico insurance regulations, the regulated subsidiaries are permitted, without requesting prior regulatory approval, to pay dividends as long as the aggregate amount of all such dividends in any calendar year does not exceed the lesser of: (i) 10% of its surplus as of the end of the immediately preceding calendar year; or (ii) its statutory net gain from operations for the immediately preceding calendar year (excluding realized capital gains). Regulated subsidiaries will be permitted to pay dividends in excess of the lesser of such two amounts only if notice of its intent to declare such a dividend and the amount thereof is filed with the Commissioner of Insurance and such dividend is not disapproved within 30 days of its filing. As of December 31, 2014, the dividends permitted to be distributed in 2014 by the regulated subsidiaries without prior regulatory approval from the Commissioner of Insurance amounted to approximately $34,100. This amount excludes any dividend from TSA because as stated in note 15, we do not intend to repatriate earnings from this subsidiary nor do any transaction that would cause a reversal on an outside basis difference created as a result of the business combination of TSA and cumulative earnings of its Puerto Rico-based subsidiaries that are considered to be indefinitely reinvested.
The Company has not declared any dividends subsequent to its IPO on December 7, 2007.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
19.
Comprehensive Income
The accumulated balances for each classification of other comprehensive income (loss) are as follows:
The related deferred tax effects allocated to each component of other comprehensive income in the accompanying consolidated statements of stockholders’ equity and comprehensive income in 2014, 2013 and 2012 are as follows:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
20.
Share-Based Compensation
In December 2007 the Company adopted the 2007 Incentive Plan (the Plan), which permits the Board to grant stock options, restricted stock awards and performance awards to eligible officers, directors and employees. The Plan authorizes the granting of up to 4,700,000 of Class B common shares of authorized but unissued stock. At December 31, 2014 and 2013, there were 2,174,711 and 2,584,863 shares available for the Company to grant under the Plan, respectively. Stock options can be granted with an exercise price at least equal to the stock’s fair market value at the grant date. The stock option awards vest in equal annual installments over 3 years and their expiration date cannot exceed 7 years. The restricted stock and performance awards are issued at the fair value of the stock on the grant date with vesting periods ranging from one to three years. Restricted stock awards vest in installments, as stipulated in each restricted stock agreement. Performance awards vest on the last day of the performance period, provided that at least minimum performance standards are achieved.
The fair value of each option award is estimated on the grant date using the Black-Scholes option-pricing model that uses the weighted average assumptions in the following table. In absence of adequate historical data, the Company estimates the expected life of the option using the simplified method allowed by Staff Accounting Bulletin (SAB) No. 107. Since the Company was a newly public entity, expected volatility was computed based on the average historical volatility of similar entities with publicly traded shares. The risk-free rate for the expected term of the option was based on the U.S. Treasury zero-coupon bonds yield curve in effect at the time of grant.
Stock option activity during the year ended December 31, 2014 is as follows:
No options were granted during the three years ended December 31 2014, 2013 and 2012. There were 199,002, 21,724 and 206,896 exercised options during 2014, 2013 and 2012, respectively. No cash was received from stock options exercises during the years ended December 31, 2014 and 2013. During the year ended December 31, 2012, cash received from stock options exercises was $316 and is presented within the cash flows from financing activities in the accompanying consolidated statement of cash flows. During the years ended December 31, 2014, 2013 and 2012, 174,090, 14,095 and 140,666 shares, respectively, were repurchased and retired as a result of non-cash exercise of stock options.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
A summary of the status of the Company’s nonvested restricted and performance shares as of December 31, 2014, and changes during the year ended December 31, 2014, are presented below:
The weighted average grant date fair value of restricted shares granted during the year 2014, 2013 and 2012 were $16.46, $18.43, and $21.98, respectively. Total fair value of restricted stock vested during the year ended December 31, 2014, 2013 and 2012 was $1,146, $865 and $685, respectively.
At December 31, 2014 there was $4,613 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted average period of 1.03 years. The Company currently uses authorized and unissued Class B common shares to satisfy share award exercises.
21.
Net Income Available to Stockholders and Basic Net Income per Share
The following table sets forth the computation of basic and diluted earnings per share for the three-year period ended December 31, 2014:
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
22.
Commitments
The Company leases its regional offices, certain equipment, and warehouse facilities under non-cancelable operating leases. Minimum annual rental commitments at December 31, 2014 under existing agreements are summarized as follows:
Rental expense for 2014, 2013, and 2012 was $8,738, $10,287, and $12,517 respectively, after deducting the amount of $50, $21, and $117, respectively, reimbursed by CMS for the administration of the Medicare Part B Program (see note 13).
23.
Contingencies
Our business is subject to numerous laws and regulations promulgated by Federal, Puerto Rico, USVI, Costa Rica, BVI, and Anguilla governmental authorities. Compliance with these laws and regulations can be subject to government review and interpretation, as well as regulatory actions unknown and unasserted at this time. The Commissioner of Insurance of Puerto Rico, as well as other Federal, Puerto Rico, USVI, Costa Rica, BVI, and Anguilla government authorities, regularly make inquiries and conduct audits concerning the Company's compliance with such laws and regulations. Penalties associated with violations of these laws and regulations may include significant fines and exclusion from participating in certain publicly funded programs.
As of December 31, 2014, we are involved in various legal actions arising in the ordinary course of business. We are also defendants in various other litigations and proceedings, some of which are described below. Where the Company believes that a loss is both probable and estimable, such amounts have been recorded. Although we believe our estimates of such losses are reasonable, these estimates could change as a result of further developments in these matters. In other cases, it is at least reasonably possible that the Company may incur a loss related to one or more of the mentioned pending lawsuits or investigations, but the Company is unable to estimate the range of possible losses which may be ultimately realized, either individually or in the aggregate, upon their resolution. The outcome of legal proceedings is inherently uncertain and pending matters for which accruals have not been established have not progressed sufficiently to enable us to estimate a range of possible losses, if any. Given the inherent unpredictability of these matters, it is possible that an adverse outcome in one or more of these matters could have a material adverse effect on the consolidated financial condition, operating results and/or cash flows of the Company.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Additionally, we may face various potential litigation claims that have not been asserted to date, including claims from persons purporting to have contractual rights to acquire shares of the Company on favorable terms pursuant to agreements previously entered by our predecessor managed care subsidiary, Seguros de Servicios de Salud de Puerto Rico, Inc. (SSS), with physicians or dentists who joined our provider network to sell such new provider shares of SSS at a future date (“Share Acquisition Agreements”) or to have inherited such shares notwithstanding applicable transfer and ownership restrictions.
Claims by Heirs of Former Shareholders
The Company and TSS are defending eight individual lawsuits, all filed in state court, from persons who claim to have inherited a total of 113 shares of the Company or one of its predecessors or affiliates (before giving effect to the 3,000-for-one stock split). While each case presents unique facts and allegations, the lawsuits generally allege that the redemption of the shares by the Company pursuant to transfer and ownership restrictions contained in the Company's (or its predecessors' or affiliates') articles of incorporation and bylaws was improper.
In one of these cases, entitled Vera Sánchez, et al, v. Triple-S, the plaintiffs argued that the redemption of shares was fraudulent and was not subject to the two-year statute of limitations contained in the local securities law. The Puerto Rico’s Court of First Instance dismissed the claim and determined it was time barred under the local securities law. On January 2012, Puerto Rico’s Court of Appeals upheld the dismissal. On March 28, 2012 the plaintiffs filed a petition for writ of certiorari before the Puerto Rico’s Supreme Court that was granted on May 31, 2012, and on October 1, 2013, reversed the dismissal, holding that the two-year statute of limitations contained in the local securities law did not apply and returning it to the Court of First Instance. Discovery is ongoing. Continuance of hearings is set for June 24, 2015.
In the second case, entitled Olivella Zalduondo, et al, v. Seguros de Servicios de Salud, et al, Puerto Rico’s Court of First Instance granted the Company’s motion to dismiss on grounds that the complaint was time-barred under the two-year statute of limitations of the local securities laws. On appeal, the Court of Appeals affirmed the decision of the lower court. Plaintiffs filed a petition for certiorari before the Puerto Rico’s Supreme Court which was granted on January 20, 2012. On January 8, 2013, Puerto Rico’s Supreme Court ruled that the applicable statute of limitations is the fifteen-year period of the Puerto Rico’s Civil Code for collection of monies. On January 28, 2013, the Company filed a motion for reconsideration which was subsequently denied. On March 26, 2013, plaintiffs amended the complaint for the second time and the Company answered on April 16, 2013. Discovery is ongoing.
In the third case, entitled Heirs of Dr. Juan Acevedo, et al, v. Triple-S Management Corporation, et al, the Puerlo Rico's Court of First Instance denied our motion for summary judgment based on its determination that there are material issues of fact in controversy. In response to our appeal, the Puerlo Rico's Court of Appeals confirmed the decision of the Puerlo Rico's Court of First Instance Our request for reconsideration was denied in December 2011. A pretrial conference is set for August 10, 2015.
The fourth case, entitled Montilla López, et al, v. Seguros de Servicios de Salud, et al, was filed on November 29, 2011. The Company filed a motion to dismiss on the grounds that the claim is time barred under the local securities laws. On October 15, 2012, while the motion to dismiss was pending, plaintiffs amended their complaint. The court denied our motion to dismiss on January 24, 2013. The Company answered the complaint on March 8, 2013. Subsequently, plaintiffs amended their complaint and the Company filed its response on June 13, 2013. Discovery is ongoing and pretrial conference is set for May 27, 2015.
The fifth case, entitled Cebollero Santamaría v. Triple-S Salud, Inc., et al, was filed on March 26, 2013, and the Company filed its response on May 16, 2013. On October 29, 2013, the Company filed a motion for summary judgment on the grounds that the claim is time-barred under the fifteen-year statute of limitations of the Puerto Rico Civil Code for collection of monies and, in the alternative, that plaintiff failed to state a claim for which relief can be granted. The court allowed plaintiff to conduct limited discovery in connection with plaintiff’s opposition to our motion for summary judgment. On November 6, 2014, plaintiffs filed their opposition and a motion for summary judgment. On February 3, 2015, TSS replied the opposition and opposed to the motion for summary judgment. The limited discovery is currently ongoing and the parties are awaiting court’s decision on their respective pleads.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The sixth case, entitled Irizarry Antonmattei, et al, v. Seguros de Servicios de Salud, et al, was filed on April 16, 2013 and the Company filed its response on June 21, 2013. On June 28, 2013, the Puerto Rico’s Court of First Instance ordered plaintiffs to reply to the Company’s response specifically on the matter of the statute of limitations applicable to the complaint. Plaintiffs failed to timely respond and the Company moved to dismiss. Plaintiffs subsequently moved to amend the complaint, which was granted by the court. On November 5, 2013, the Company moved to dismiss the first amended complaint on the grounds that it is time-barred under the fifteen-year statute of limitations of the Puerto Rico Civil Code for collection of monies. On December 16, 2013, plaintiffs filed an opposition, which the Company replied on January 7, 2014. On February 19, 2014, the court ordered plaintiffs to file a memorandum of law by April 22, 2014 regarding the validity of the restrictions on transfer applicable to the shares. On May 16, 2014, plaintiffs filed a motion for summary judgment, which the Company opposed on May 28, 2014. On June 16, 2014, the court ordered plaintiffs to file the memoranda of law and struck plaintiff’s motion for summary judgment. On September 18, 2014, the court denied our motion to dismiss. On September 29, 2014, the Company filed a motion for reconsideration, which was denied by the court on November 4, 2014. On December 4, 2014, the Company filed a petition of Certiorari to the Court of Appeals of Puerto Rico. Discovery is ongoing.
The seventh case, entitled Allende Santos, et al, v. Triple-S Salud, et al, was filed on March 28, 2014. On July 2, 2014, the Company filed its response. Discovery is set to begin on or before April 30, 2015. A hearing is set for August 5, 2015.
The eighth case, entitled Gallardo Mendez, et al, v. Triple-S Management Corporation, was filed on December 30, 2014. The Company will file its response and will defend this case vigorously.
Management believes the aforesaid claims are time barred under one or more statutes of limitations and will vigorously defend them on these grounds; however, as a result of the Puerto Rico Supreme Court’s decision to deny the applicability of the statute of limitations contained in the local securities law, some of these claims will likely be litigated on their merits.
Joint Underwriting Association Litigations
On August 19, 2011, plaintiffs, purportedly a class of motor vehicle owners, filed an action in the United States District Court for the District of Puerto Rico against the Puerto Rico Joint Underwriting Association (“JUA”) and 18 other defendants, including TSP, alleging violations under the Puerto Rico Insurance Code, the Puerto Rico Civil Code, the Racketeer Influenced and Corrupt Organizations Act (“RICO”) and the local statute against organized crime and money laundering. JUA is a private association created by law to administer a compulsory public liability insurance program for motor vehicles in Puerto Rico (“CLI”). As required by its enabling act, JUA is composed of all the insurers that underwrite private motor vehicle insurance in Puerto Rico and exceed the minimum underwriting percentage established in such act. TSP is a member of JUA.
In this lawsuit, entitled Noemí Torres Ronda, et al v. Joint Underwriting Association, et al., plaintiffs allege that the defendants illegally charged and misappropriated a portion of the CLI premiums paid by motor vehicle owners in violation of the Puerto Rico Insurance Code. Specifically, they claim that because the defendants did not incur acquisition or administration costs allegedly totaling 12% of the premium dollar, charging for such costs constitutes the illegal traffic of premiums. Plaintiffs also claim that the defendants, as members of JUA, violated RICO through various inappropriate actions designed to defraud motor vehicle owners located in Puerto Rico and embezzle a portion of the CLI premiums for their benefit.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Plaintiffs seek the reimbursement of funds for the class amounting to $406,600 treble damages under RICO, and equitable relief, including a permanent injunction and declaratory judgment barring defendants from their alleged conduct and practices, along with costs and attorneys’ fees.
On December 30, 2011, TSP and other insurance companies filed a joint motion to dismiss, arguing, among other things, that plaintiffs’ claims are barred by the filed rate doctrine, inasmuch as a suit cannot be brought, even under RICO, to amend the compulsory liability insurance rates that were approved by the Puerto Rico Legislature and the Commissioner of Insurance of Puerto Rico.
On February 17, 2012, plaintiffs filed their opposition. On April 4, 2012, TSP filed a reply in support of our motion to dismiss, which was denied by the court. On October 2, 2012, the court issued an order certifying the class. On October 12, 2012, several defendants, including TSP, filed an appeal before the U.S. Court of Appeals for the First District, requesting the court to vacate the District Court's certification order. The First Circuit denied the authorization to file the writ of appeals. Discovery has been completed. On November 3, 2014, all defendants, including TSP, filed a joint motion to decertify the class and, on November 17, 2014, a joint motion for summary judgment requesting the dismissal of the claim. We are awaiting plaintiffs’ response and further court proceedings.
In re Blue Cross Blue Shield Antitrust Litigation
TSS is a co-defendant with multiple Blue Plans and the BCBSA in a multi-district class action litigation filed on July 24, 2012 that alleges that the exclusive service area (“ESA”) requirements of the Primary License Agreements with Plans violate antitrust law, and the plaintiffs in these suits seek monetary awards and in some instances, injunctive relief barring ESAs. Those cases have been centralized in the United States District Court for the Northern District of Alabama. Prior to centralization, motions to dismiss were filed by several plans, including TSS. Plaintiffs opposed TSS’ motion to dismiss. On April 9, 2014, the Court held an argumentative hearing to discuss the motions to dismiss. During the hearing, the Court did not issue a ruling on the motions to dismiss thus, decision on said motions are still pending. On June 18, 2014, the court denied TSS’ motion to dismiss. Discovery is ongoing. The Company has joined BCBSA in vigorously contesting these claims.
Claims Relating to the Provision of Health Care Services
TSS is defendant in several claims for collection of monies in connection with the provision of health care services. Among them are individual complaints filed before the Puerto Rico Health Insurance Administration (ASES) by six community health centers alleging TSS’ breached their contracts with respect to certain capitation payments and other monetary claims. Such claims have an aggregate value of approximately $9,600. Discovery is ongoing, and given their early stage, the Company cannot assess the probability of an adverse outcome or the reasonable financial impact that any such outcome may have on the Company. TSS believes these complaints are time-barred and intends to vigorously defend them on these and other grounds.
Also, on June 5, 2014, ASES initiated an administrative hearing against TSS moved by a primary medical group for alleged outstanding claims related to services provided to Medicaid beneficiaries from 2005 to 2010, totaling approximately $3,000. On June 19, 2014, TSS filed its response and intends to vigorously defend this claim.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Intrusions into TCI’s Internet IPA Database
On September 21, 2010, the Company learned from a competitor that a specific internet database containing information pertaining to individuals insured at the time by TSS under the Government of Puerto Rico Medicaid program and to independent practice associations that provided services to those individuals, had been accessed without authorization by certain of its employees.
The Company reported these events to the appropriate Puerto Rico and federal government agencies. It then received and complied with requests for information from ASES and the Office for Civil Rights (“OCR”) of the U.S. Department of Health and Human Services, which entities are conducting reviews of these data breaches and TSS' and TCI's compliance with applicable security and privacy rules. ASES levied a fine of $100 on TSS in connection with these incidents, but following the Company’s request for reconsideration, ASES withdrew the fine pending the outcome of the review by the OCR. The OCR has not issued its determination on this matter. The Company at this time cannot reasonably assess the impact of these proceedings on the Company.
Unauthorized Disclosure of Protected Health Information
On September 20, 2013, TSS mailed a pamphlet to our approximately 70,000 Medicare Advantage beneficiaries that inadvertently displayed the receiving beneficiary’s Medicare Health Insurance Claim Number (“HICN”). The HICN is the unique number assigned by the Social Security Administration to each Medicare beneficiary and is considered protected health information under HIPAA. TSS conducted an investigation and reported the incident to the appropriate Puerto Rico and federal government agencies. It then received and complied with requests for information from these agencies, ASES and OCR, concerning this matter. In accordance with its legal obligations under HIPAA, TSS issued a breach notification through the local media and notified all affected beneficiaries by mail, notifying them of certain protective measures as well.
On April 16, 2014, ASES received a complaint submitted by an American Health Medicare (now “TSA”) Platino product beneficiary alleging that a pamphlet distributed by TSA had Protected Health Information (“PHI”) visible on its external cover. TSA conducted the investigation of this allegation and discovered that the external cover of the pamphlets mailed to Platino members displayed the unique contract number randomly assigned by TSA to its members. This number combined with the name and address of the member identified each individual as an TSA Platino beneficiary and the use of the unique contract number on the outside of the pamphlets may be viewed as a violation of the HIPAA minimum necessary rule set forth in regulation. A total of 39,944 members were affected by the incident, from which 28,413 were Platino members. We treated this as a separate HIPAA-related incident. Therefore, we reported the incident to concerned local and federal regulators. Similarly, we issued a letter by mail and posted a substitute notice on our webpage to the affected individuals and notified the breach through the local media.
On February 11, 2014, ASES notified TSS of its intention to impose a civil monetary penalty of $6,778 and other administrative sanctions with respect to the September 2013 breach described above involving 13,336 dual eligible Medicare/Medicaid beneficiaries. The sanctions include the suspension of all new enrollments of dual eligible Medicare/Medicaid beneficiaries and the obligation to notify affected individuals of their right to disenroll. In its letter, ASES alleged TSS has failed to take all required steps in response to the breach. After TSS submitted a corrective action plan and, on February 21, 2014, ASES requested TSS to provide additional information in connection with the corrective action plan and, on February 26, 2014, ASES temporarily lifted the sanctions related to the enrollment of dual eligible Medicare beneficiaries. On March 6, 2014, ASES confirmed its determination lifting the enrollment sanction and notified its intention to provide TSS with corrective action plan. On March 11, 2014, TSS filed an answer challenging the monetary civil monetary penalty and requesting an administrative hearing and simultaneously filed a notice of removal in the federal District Court for the District of Puerto Rico. On April 10, 2014, ASES filed a motion to remand, and, on April 24, 2014 TSS filed its opposition. This matter is pending court’s resolution.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
While TSS is collaborating with ASES on these matters, it intends to vigorously contest the monetary fine and other sanctions which are the subject of ASES’ notices. At this time, the Company is unable to determine the ultimate outcome of its challenge to ASES’ sanctions, the incident’s ultimate financial impact on TSS or what measures, if any, will be taken by the OCR or other regulators regarding this matter.
In connection with the September 30, 2013 event, four individuals have filed suit against TSS in the Court of First Instance of Puerto Rico. In the first case, filed on February 10, 2014, one individual, on his behalf and on behalf of his spouse asserts emotional damages due the disclosure of his protected health information. Discovery is ongoing. In the second case, filed on February 24, 2014, another individual filed a class-action suit claiming approximately $20,000 in damages. With respect with this class-action suit, on February 27, 2014, TSS filed a motion to dismiss the class-action suit based on several grounds, including lack of standing. The court ordered plaintiff to submit an opposition to TSS’ motion to dismiss, subject to the dismissal of the claim if plaintiff failed to comply. Plaintiff filed its opposition on March 12, 2014 and, on April 14, 2014, TSS replied. The Court’s ruling on the motions is pending. In the third case, filed on April 23, 2014, another individual asserts emotional damages and identity theft. Discovery is ongoing. In the fourth case, filed on September 19, 2014, an individual asserts emotional damages in connection with this matter. The Company filed its response and discovery is ongoing.
ASES Audits
On July 2, 2014, ASES notified TSS that it conducted an audit reflecting an overpayment of premium in the amount of $7,950 corresponding to payments made to TSS pursuant to prior contracts with ASES for the provision of services under the government health plan as a result of audits conducted by ASES covering several periods from October 2005 to September 2013. TSS contends that ASES request for reimbursement has no merits on several grounds, including a 2011 settlement between both parties covering the majority of the amount claimed by ASES. In connection with ASES allegations, ASES withheld $4,800 in service fees corresponding to services provided for the period from October 2005 to September 2010. On August 29, 2014, ASES delivered the $4,800 previously withheld.
On December 30, 2014, ASES sent a letter to TSS requesting the reimbursement of approximately $1,300 and, consequently, withheld service fees. On January 16, 2015, the Company filed suit and a preliminary injunction on the Court of First Instance of Puerto Rico requesting the payment of service fees and asserting various claims, including the validity of the agreement signed by the parties in 2011. On January 29, 2015, a hearing was held in which ASES committed to deliver TSS services fees until March 31, 2015 in consideration of the negotiations being conducted by the parties.
24.
Statutory Accounting
TSS, TSA, TSV and TSP (collectively known as the regulated subsidiaries) are regulated by the Commissioner of Insurance. The regulated subsidiaries are required to prepare financial statements using accounting practices prescribed or permitted by the Commissioner of Insurance, which uses a comprehensive basis of accounting other than GAAP. Specifically, the Commissioner of Insurance has adopted the NAIC’s Statutory Accounting Principles (NAIC SAP) as the basis of its statutory accounting practices, as long as they do not contravene the provisions of the Puerto Rico Insurance Code, its regulations and the Circular Letters issued by the Commissioner of Insurance. The Commissioner of Insurance may permit other specific practices that may deviate from prescribed practices and NAIC SAP. Statutory accounting principles that are established by state laws and permitted practices mandated by the Commissioner of Insurance may cause the statutory capital and surplus of the regulated subsidiaries to differ from that calculated under the NAIC SAP.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
Prescribed statutory accounting practices in Puerto Rico allow TSP to disregard a deferred tax liability resulting from additions to the catastrophe loss reserve trust fund that would otherwise be required under NAIC SAP. The use of prescribed and permitted accounting practices, both individually and in the aggregate, did not change significantly the combined statutory capital and surplus that would have been reported following NAIC SAP, which as of December 31, 2014 and 2013 is approximately 1.1% lower than the combined reported statutory capital and surplus.
The regulated subsidiaries are required by the NAIC and the Commissioner of Insurance to submit risk-based capital (RBC) reports following the NAIC’s RBC Model Act and accordingly, are subject to certain regulatory actions if their capital levels do not meet minimum specific RBC requirements. RBC is a method developed by the NAIC to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The RBC is calculated by applying capital requirement factors to various assets, premiums and reserve items. The factor is higher for those items with greater underlying risk and lower for less risky items. The adequacy of an organization’s actual capital can then be measured by a comparison to its RBC as determined by the formula.
The RBC Model Act requires increasing degrees of regulatory oversight and intervention as an organization’s risk-based capital declines. The level of regulatory oversight ranges from requiring organizations to inform and obtain approval from the domiciliary insurance commissioner of a comprehensive financial plan for increasing its RBC, to mandatory regulatory intervention requiring an insurance company to be placed under regulatory control, in a rehabilitation or liquidation proceeding.
The Commissioner of Insurance adopted in 2009 an RBC policy that requires that the regulated entities maintain statutory reserves at or above the “Company Action Level,” which is currently equal to 200% of their RBC, in order to avoid regulatory monitoring and intervention. In addition, at the time of adoption the Commissioner of Insurance established five-year gradual compliance provisions for those entities whose RBC was below the 200% requirement. As of December 31, 2014 and 2013 all regulated subsidiaries comply with minimum statutory reserve requirements.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The following table sets forth the combined net admitted assets, capital and surplus, RBC requirement, which is our statutory capital and surplus requirement, and net income for the regulated subsidiaries at December 31, 2014, 2013 and 2012:
As more fully described in note 17, a portion of the accumulated earnings and admitted assets of TSP are restricted by the catastrophe loss reserve and the trust fund balance as required by the Insurance Code. The total catastrophe loss reserve and trust fund amounted to $40,457 and $42,324 as of December 31, 2014, respectively. The catastrophe loss reserve and trust fund balances were $39,463 and $40,127 as of December 31, 2013, respectively. In addition, the admitted assets of the regulated subsidiaries are restricted by the investments deposited with the Commissioner of Insurance to comply with requirements of the Insurance Code (see note 3). Investments with an amortized cost of $4,383 and $5,389 (fair value of $4,582 and $4,487) at December 31, 2014 and 2013, respectively, were deposited with the Commissioner of Insurance. Investment with an amortized cost of $515 and $511 (fair value of $515 and $511) at December 31, 2014 and 2013, respectively, was deposited with the USVI Division of Banking and Insurance. As a result, the combined restricted assets for our regulated subsidiaries were $47,222 and $46,027 as of December 31, 2014 and 2013, respectively.
25.
Supplementary Information on Cash Flow Activities
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
26.
Business Combination
2013 Acquisition
Effective November 7, 2013, the Company’s subsidiary TSV completed the acquisition of 100% of the outstanding capital stock of ASICO (now TSB), an insurer dedicated to the sale of individual life and cancer insurance in Puerto Rico, as well as individual and group health insurance in the U.S. Virgin Islands, British Virgin Islands, Anguilla and Costa Rica. After this acquisition the Company expects to solidify its position in the life insurance business in Puerto Rico. The Company accounted for this acquisition in accordance with the provisions of Accounting Standard Codification Topic 805, Business Combinations. The results of operations and financial condition of this acquisition are included in the accompanying consolidated financial statements for the period following the effective date of the acquisition. The aggregate purchase price of the acquired entity was $9,413. Direct costs related to the acquisition amounted to $435 and were included in the consolidated operating expenses during the year ended December 31, 2013.
Although the closing date of the transaction was November 7, 2013, the consideration amount was determined using TSB’s financial position as of October 31, 2013. Therefore, we have recorded an allocation of the purchase price to TSB’s tangible and intangible assets acquired and liabilities assumed based on their fair value as of October 31, 2013. No goodwill was recorded on the acquisition since the purchase price was equal to the fair value of the net assets acquired. The following table summarizes the consideration paid to acquire TSB as of December 31, 2013 and the allocation of the purchase price to the assets acquired and liabilities assumed at the acquisition.
On October 31, 2013, we recognized a VOBA asset of $4,499 in the consolidated balance sheet, resulting from the TSB transaction. During the years ended December 31, 2014 and 2013, we recognized $616 and $108, respectively, of amortization expense related to the VOBA asset.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
The consolidated statement of earnings for the year ended December 31, 2013 includes $1,511 in operating revenues and a $187 net loss related to TSB. The following unaudited pro forma financial information presents the combined results of operations of the Company and TSB as if the acquisition had occurred at the beginning of 2012. The unaudited pro forma financial information is not intended to represent or be indicative of the Company’s consolidated results of operations that would have been reported had the acquisition been completed as of the beginning of the periods presented and should not be taken as indicative of the Company’s future consolidated results of operations.
The above unaudited pro forma operating revenues and net income considers the following estimated acquisition adjustments: (1) Amortization of VOBA asset - we considered an amortization expense of $365 and $459 for the years ended December 31, 2013 and 2012, respectively; (2) Acquisition costs - we recognized $435 of expenses for the year ended December 31, 2012 related to the acquisition.
2012 Acquisition
On January 18, 2012, TSM completed the acquisition of 90.8% of the outstanding capital stock of a health clinic in Puerto Rico. The cost of this acquisition was approximately $3,501, funded with unrestricted cash. The following table summarizes the net assets acquired as a result of this acquisition:
The acquisition is being accounted for under the purchase method of accounting and the health clinic is included in the Company's consolidated financial statements from the January 18, 2012 acquisition date. The allocation of purchase price to the fair value of the acquired assets less the liabilities assumed indicated goodwill of approximately $2,369. Goodwill will not be deductible for tax purposes and is attributable to synergies and economies of scale expected from the acquisition. During the year 2013, the Company recorded a goodwill impairment charge of $2,369, and there is no remaining carrying value of the health clinic goodwill as of December 31, 2013. The goodwill impairment charge is included within the consolidated operating expenses.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
During the year 2014, the Company recorded an intangible asset impairment charge of $2,221, and there is no remaining carrying value of the acquired intangible asset as of December 31, 2014. The intangible asset impairment charge is included within the consolidated operating expenses.
27.
Segment Information
The operations of the Company are conducted principally through three business segments: Managed Care, Life Insurance, and Property and Casualty Insurance. Business segments were identified according to the type of insurance products offered and consistent with the information provided to the chief operating decision maker. These segments and a description of their respective operations are as follows:
· Managed Care segment - This segment is engaged in the sale of managed care products to the Commercial, Medicare and Medicaid market sectors. The Commercial accounts sector includes corporate accounts, U.S. federal government employees, individual accounts, local government employees, and Medicare supplement. The following represents a description of the major contracts by sector:
- The segment is a qualified contractor to provide health coverage to federal government employees within Puerto Rico. Earned premiums revenue related to this contract amounted to $152,659, $155,302, and $143,287 for the three-year period ended December 31, 2014, 2013, and 2012, respectively (see note 11).
- Under its commercial business, the segment also provides health coverage to certain employees of the Commonwealth of Puerto Rico and its instrumentalities. Earned premium revenue related to such health plans amounted to $37,748, $43,211, and $46,969 for the three-year period ended December 31, 2014, 2013, and 2012, respectively.
- The segment provides services through its Medicare health plans pursuant to a limited number of contracts with CMS. Earned premium revenue related to the Medicare business amounted to $1,013,746, $1,038,852, and $1,073,454 for the three-year period ended December 31, 2014, 2013, and 2012, respectively.
- The segment also participates in the Medicaid program to provide health coverage to medically indigent citizens in Puerto Rico, as defined by the laws of the government of Puerto Rico. Effective November 1, 2011, the segment commenced the administration of the physical health component of this program in designated service regions in Puerto Rico. On July 1, 2013, the segment amended and restated its contract extending the administration of the provision of the physical health component of the Medicaid program in service regions in the Commonwealth of Puerto Rico currently administered by TSS for a 12-month period. This amendment also transferred the administration of the three remaining service regions to TSS upon completion of a transition period, which ended on October 1, 2013. In accordance with the terms of the contract, TSS receives a monthly per-member, per-month administrative fee for its services and does not bear the insurance risk of the program. Administrative service fees for each of the years in the three-year period ended December 31, 2014, 2013, and 2012 amounted to $95,908, $83,180, and $86,565, respectively.
· Life Insurance segment - This segment offers primarily life and accident and health insurance coverage, and annuity products. The premiums for this segment are mainly subscribed through an internal sales force and a network of independent brokers and agents.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
· Property and Casualty Insurance segment -The predominant insurance lines of business of this segment are commercial multiple peril, auto physical damage, auto liability, and dwelling. The premiums for this segment are originated through a network of independent insurance agents and brokers. Agents or general agencies collect the premiums from the insureds, which are subsequently remitted to the segment, net of commissions. Remittances are due 60 days after the closing date of the general agent’s account current.
The Company evaluates performance based primarily on the operating revenues and operating income of each segment. Operating revenues include premiums earned, net, administrative service fees and net investment income. Operating costs include claims incurred and operating expenses. The Company calculates operating income or loss as operating revenues less operating costs.
The accounting policies for the segments are the same as those described in the summary of significant accounting policies included in the notes to consolidated financial statements. The financial data of each segment is accounted for separately; therefore no segment allocation is necessary. However, certain operating expenses are centrally managed, therefore requiring an allocation to each segment. Most of these expenses are distributed to each segment based on different parameters, such as payroll hours, processed claims, or square footage, among others. In addition, some depreciable assets are kept by one segment, while allocating the depreciation expense to other segments. The allocation of the depreciation expense is based on the proportion of assets used by each segment. Certain expenses are not allocated to the segments and are kept within TSM’s operations.
The following tables summarize the operations by operating segment for each of the years in the three-year period ended December 31, 2014, 2013, and 2012.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
*
Includes segments that are not required to be reported separately, primarily the data processing services organization and the health clinic.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
*
Includes segments that are not required to be reported separately, primarily the data processing services organization and the health clinic.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
*
Includes segments that are not required to be reported separately, primarily the data processing services organization and the health clinic.
Triple-S Management Corporation
Notes to Consolidated Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands, except per share data)
28.
Subsequent Events
The Company evaluated subsequent events through the date the financial statements were issued. No events, other than those described in these notes, have occurred that require adjustment or disclosure pursuant to current Accounting Standard Codification.
Triple-S Management Corporation
Schedule II
Condensed Financial Information of Triple-S Management Corporation
(Registrant)
Balance Sheets
(in thousands)
The accompanying notes are an integral part of these condensed financial statements
Triple-S Management Corporation
Schedule II
Condensed Financial Information of Triple-S Management Corporation
Triple-S Management Corporation
Statements of Earnings
(in thousands)
The accompanying notes are an integral part of these condensed financial statements
Triple-S Management Corporation
Schedule II
Condensed Financial Information of Triple-S Management Corporation
(Registrant)
Statements of Cash Flows
(in thousands)
The accompanying notes are an integral part of these condensed financial statements
Triple-S Management Corporation
(Parent Company Only)
Notes to Condensed Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands)
The accompanying notes to the condensed financial statements should be read in conjunction with the consolidated financial statements and the accompanying notes thereto included in Item 15 to the Annual Report on Form 10-K.
(1)
For purposes of these condensed financial statements, Triple-S Management Corporation’s (the Company or TSM) investment in its wholly owned subsidiaries is recorded using the equity method of accounting.
(2)
Significant Accounting Policies
The significant accounting policies followed by the Company are set forth in the notes to the consolidated financial statements and the accompanying notes thereto. Refer to Item 15 to the Annual Report of Form 10-K.
(3)
Long-Term Borrowings
A summary of the long-term borrowings entered into by the Company at December 31, 2014 and 2013 follows:
Triple-S Management Corporation
(Parent Company Only)
Notes to Condensed Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands)
Aggregate maturities of the Company’s long term borrowings as of December 31, 2014 are summarized as follows:
All of the Company’s senior notes may be prepaid at par, in total or partially, five years after issuance as determined by the Company.
Debt issuance costs related to each of the Company’s senior unsecured notes were deferred and are being amortized over the term of its respective senior note. Unamortized debt issuance costs related to these senior unsecured notes as of December 31, 2014 and 2013 amounted to $132 and $155, respectively and are included within other assets in the accompanying condensed balance sheets.
The secured loan payable previously described is guaranteed by a first position held by the bank on the Company’s and its subsidiaries land, building, and substantially all leasehold improvements, as collateral for the term of the loan under a continuing general security agreement. This secured loan contains certain non-financial covenants, which are customary for this type of facility, including but not limited to, restrictions on the granting of certain liens, limitations on acquisitions and limitations on changes in control.
The repurchase agreement has pledged as collateral investment securities available for sale with fair value of $27,135 (face value of $27,110) and $27,915 (face value of $27,835) as of December 31, 2014 and 2013, respectively. The investment securities underlying such agreements were delivered to the financial institution with whom the agreement was transacted. The dealers may have loaned, or used as collateral securities in the normal course of business operations. We maintain effective control over the investment securities pledged as collateral and accordingly, such securities continue to be carried on the accompanying condensed balance sheets.
(4)
Transactions with Related Parties
The following are the significant related parties transactions made for the three-year period ended December 31, 2014, 2013 and 2012:
Triple-S Management Corporation
(Parent Company Only)
Notes to Condensed Financial Statements
December 31, 2014, 2013 and 2012
(dollar amounts in thousands)
As of December 31, 2014 and 2013 the Company has three notes receivable from subsidiaries amounting to $44,250 and $53,500, respectively, pursuant to the provisions of Article 29.30 of the Puerto Rico Insurance Code. The notes receivable from subsidiaries are due on demand; however, pursuant to the requirements established by the Commissioner of Insurance, the parties agreed that no payment of the total principal nor the interest due on the loans will be made without first obtaining written authorization from the Commissioner of Insurance within at least 60 days prior to the proposed payment date. These notes bear interest at 4.7% at December 31, 2014 and 2013. Accrued interest at December 31, 2014 and 2013 amounted to $2,961 and $2,264, respectively.
In addition, as of December 31, 2014, the Company has various notes receivable from a subsidiary amounting to $15,328. These notes are due in different years, which due dates range from 2015 to 2017, bears interest at 4.7%. Accrued interest at December 31, 2014 amounted to $188.
As of December 31, 2014 and 2013 the Company has a note payable to a subsidiary amounting to $15,000. The note is due on December 31, 2017 and bears interest at 4.7%. There was no accrued interest at December 31, 2014. Accrued interest at December 31, 2013 amounted to $729.
Triple-S Management Corporation and Subsidiaries
Schedule III - Supplementary Insurance Information
For the years ended December 31, 2014, 2013 and 2012
See accompanying independent registered public accounting firm’s report and notes to financial statements.
Triple-S Management Corporation and Subsidiaries
Schedule IV - Reinsurance
For the years ended December 31, 2014, 2013 and 2012
(Dollar amounts in thousands)
(1)
Gross premiums amount is presented net of intercompany eliminations of $4,354, $3,014 and $3,906 for the years ended December 31, 2014, 2013, and 2012, respectively.
See accompanying independent registered public accounting firm’s report and notes to financial statements.
Triple-S Management Corporation and Subsidiaries
Schedule V - Valuation and Qualifying Accounts
For the years ended December 31, 2014, 2013 and 2012
(Dollar amounts in thousands)
(1)
Represents premiums adjustment to provide for unresolved reconciliation items with the Government of Puerto Rico and other entities.
(2)
Deductions represent the write-off of accounts deemed uncollectible.
See accompanying independent registered public accounting firm’s report and notes to financial statements.