HEALTHMARKETS, INC. – 10-Q – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Edgar Online, Inc. |
Cautionary Statements Regarding Forward-Looking Statements
In this report, unless the context otherwise requires, the terms "Company," "HealthMarkets," "we," "us," or "our" refer toHealthMarkets, Inc. and its subsidiaries. This report and other documents or oral presentations prepared or delivered by and on behalf of the Company contain or may contain "forward-looking statements" within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements based upon management's expectations at the time such statements are made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements are subject to risks and uncertainties that could cause the Company's actual results to differ materially from those contemplated in the statements. Readers are cautioned not to place undue reliance on the forward-looking statements. All statements, other than statements of historical information provided or incorporated by reference herein, may be deemed to be forward-looking statements. Without limiting the foregoing, when used in written documents or oral presentations, the terms "anticipate," "believe," "estimate," "expect," "may," "objective," "plan," "possible," "potential," "project," "will" and similar expressions are intended to identify forward-looking statements. In addition to the assumptions and other factors referred to specifically in connection with such statements, factors that could impact the Company's business and financial prospects include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year endedDecember 31, 2011 under the caption "Item 1 Business," "Item 1A. Risk Factors" and "Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations" and those discussed from time to time in the Company's various filings with theSecurities and Exchange Commission or in other publicly disseminated written documents.
Introduction
HealthMarkets, Inc. , aDelaware corporation incorporated in 1984, is a holding company, the principal asset of which is its investment in its wholly owned subsidiary,HealthMarkets, LLC .HealthMarkets, LLC's principal assets are its investments in its separate operating subsidiaries, including its regulated insurance subsidiaries. HealthMarkets conducts its insurance underwriting businesses through its indirect wholly owned insurance company subsidiaries,The MEGA Life and Health Insurance Company ("MEGA"), Mid-West National Life Insurance Company ofTennessee ("Mid-West"),The Chesapeake Life Insurance Company ("Chesapeake") andHealthMarkets Insurance Company ("HMIC"), and generally conducts its insurance distribution business primarily through its indirect insurance agency subsidiary,Insphere Insurance Solutions, Inc. ("Insphere"). The Company is generally focused on business opportunities that allow us to maximize the value of the Insphere independent agent sales force, with particular focus on the sale of supplemental insurance products underwritten by the Company's insurance subsidiaries and third-party health insurance products underwritten by non-affiliated insurance companies. In 2010, we discontinued the sale of the Company's traditional "scheduled benefit" health insurance products and discontinued marketing all health benefit plans underwritten by our insurance subsidiaries in all but a limited number of states in which Insphere does not have access to third-party health insurance products. We believe that this shift better positions the Company for the future, particularly in light of changes resulting from the enactment, inMarch 2010 , of the Patient Protection and Affordable Care Act and a reconciliation measure, the Health Care and Education Reconciliation Act of 2010 (collectively, the "Health Care Reform Legislation"). The Company continues to maintain a significant in-force block of health benefits plans and evaluates on an ongoing basis the impact of Health Care Reform Legislation on this block. Through our Commercial Health Division, we underwrite and administer a broad range of health insurance and supplemental insurance products for individuals, families, the self-employed and small businesses. Our plans are designed to accommodate individual needs and include basic hospital-medical expense plans, plans with preferred provider organization features, catastrophic hospital expense plans, as well as other supplemental types of coverage. We currently market these products through independent agents contracted with Insphere. As stated above, the Company discontinued marketing all of its health benefit plans in all but a limited number of states in which Insphere does not currently have access to third-party health benefit plans. Through our Commercial Health Division we also offer supplemental product lines designed to further protect against risks to which our customer is typically exposed. These products are sold to purchasers of the Company's health benefit plans, as well as to purchasers of third party products underwritten by non-affiliated insurance carriers. They are also sold on a stand-alone basis (primarily underwritten by Chesapeake). In late 2010, Chesapeake introduced an extensive supplemental product portfolio currently available in 46 states. Chesapeake's supplemental products are marketed primarily under the SureBridge Insurance brand and distributed by Insphere agents as well as other independent, third party producers. Insphere is a distribution company that specializes in meeting the life, health, long-term care,Medicare and retirement insurance needs of small businesses and middle-income individuals and families through its portfolio of products from nationally recognized insurance carriers. Insphere is an authorized agency in all 50 states and theDistrict of Columbia . As ofSeptember 30, 2012 , Insphere had approximately 2,900 independent agents, of which approximately 1,800 on average write health insurance applications each month, and offices in over 35 states. Insphere distributes products underwritten by the Company's insurance company subsidiaries, as well as non-affiliated insurance companies. Insphere has marketing agreements with a number of non-affiliated life, health, long-term care and retirement insurance carriers, including, but not limited to, Aetna, Humana,ING and UnitedHealthcare'sGolden Rule Insurance . 22
--------------------------------------------------------------------------------
Table of Contents
Results of Operations
The table below sets forth certain summary information about the Company's operating results for the three and nine months endedSeptember 30, 2012 and 2011: Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (Dollars in thousands) REVENUE Health premiums $ 112,228 $ 131,702 $ 350,144 $ 416,146 Life premiums and other considerations 332 357 1,167 1,213 112,560 132,059 351,311 417,359 Investment income 5,783 6,153 18,057 22,358 Other income 21,635 20,562 63,201 62,195 Realized gains, net 257 2,546 301 8,976 140,235 161,320 432,870 510,888 BENEFITS AND EXPENSES Benefits, claims, and settlement expenses 83,342 83,348 251,028 279,036 Underwriting, acquisition, and insurance expenses 16,707 21,331 55,406 74,753 Other expenses 43,310 40,517 124,120 119,856 Interest expense 2,713 4,745 9,948 17,290 146,072 149,941 440,502 490,935 Income (loss) from continuing operations before income taxes (5,837 ) 11,379 (7,632 ) 19,953 Federal income tax expense (1,796 ) 4,235 175 7,578
Income (loss) from continuing operations (4,041 ) 7,144
(7,807 ) 12,375 Income from discontinued operations, net 16 11 325 35 Net income (loss) $ (4,025 ) $ 7,155 $ (7,482 ) $ 12,410
National Health Care Reform Legislation
InMarch 2010 , Health Care Reform Legislation was signed into law, which will result in broad-based material changes tothe United States health care system. The Health Care Reform Legislation has, and is expected to continue to, significantly impact our business, including but not limited to the minimum medical loss ratio requirements applicable to our insurance subsidiaries as well to third party health insurance carriers doing business with Insphere. Provisions of the Health Care Reform Legislation become effective at various dates over the next several years and a number of additional steps are required to implement these requirements, including, without limitation, further guidance and clarification in the form of final implementing regulations for certain key aspects of the legislation. We have dedicated material resources, made material changes to our business, and incurred material expenses (including but not limited to additional claims expenses) as a result of Health Care Reform Legislation. With respect to the minimum loss ratio requirements effective beginning in 2011, a mandated minimum loss ratio of 80% for the individual and small group markets is expected to have a significant impact on the revenues of our insurance subsidiaries and our business generally, and has required us to issue rebates to customers. (See Note 9 Minimum Loss Ratio Rebate of the Notes to Consolidated Condensed Financial Statements included herein.) The 80% minimum medical loss ratio could, at an appropriate time in the future, compel us to discontinue the underwriting and marketing of individual health insurance and/or to non-renew coverage of our existing individual health customers in one or more states pursuant to applicable state and federal requirements. In addition, beginning in 2011, the mandated medical loss ratio requirements have adversely affected the level of base commissions and override commissions that Insphere receives from the Company's insurance subsidiaries and third 23
--------------------------------------------------------------------------------
Table of Contents
party insurance carriers. In order to comply with the 80% minimum medical loss ratio requirement, many of these carriers, including the Company's insurance subsidiaries, have reduced commissions and overrides. In the fourth quarter of 2010, Insphere received notice from a number of its third-party health insurance carriers that compensation levels in 2011 would be significantly lower than 2010 levels. As a result of these reductions, Insphere has lowered the level of commissions paid to its agents for the sale of products underwritten by these carriers. At this time, we are not able to project with certainty the full extent to which the minimum medical loss ratio requirement will impact our revenues and results of operations, but the impact may be material. To the extent required by the Health Care Reform Legislation, the Company has made the adjustments to its in-force block of business issued prior toMarch 24, 2010 , including but not limited to removal of lifetime maximums on benefits, extension of dependent coverage through age 26, meeting new HHS reporting requirements and adopting limitations on most policy rescissions. These changes generally became effective onJanuary 1, 2011 (for most of our plans - the effective date of the new plan year), although certain states may require an earlier effective date. In addition to the changes discussed above, plans issued on or afterMarch 24, 2010 are subject to more extensive benefit changes, including but not limited to first dollar preventive care benefits and no annual limits on essential benefits covered by the policies. The Company has made all state form and rate filings necessary to include these new requirements and effective inSeptember 2011 , made required rate and form changes for new policies marketed after that date. The Company's review of the requirements of the Health Care Reform Legislation, and its potential impact on the Company's health insurance product offerings, is ongoing. Due to the complexity of the Health Care Reform Legislation, gradual implementation and the pending status of certain guidance and regulations, the full impact of Health Care Reform Legislation on our business is not yet fully known. Depending on the outcome of certain potential developments with respect to the Health Care Reform Legislation, including but not limited to those mentioned above, certain elements of this legislation could, in the future, have a material adverse effect on our financial condition and results of operations, including but not limited to, impairment of goodwill and intangible assets. In addition, a number of state legislatures have enacted or are contemplating significant health insurance reforms, either in response to the Health Care Reform Legislation or independently (to the extent not addressed by federal legislation). The Health Care Reform Legislation, as well as state health insurance reforms, could further increase our costs, require us to further revise the way in which we conduct business, result in the elimination of certain products or business lines (including, potentially, non-renewal of our existing health benefit plan business in one or more states subject to applicable state and federal requirements), lead to lower revenues and expose us to an increased risk of liability. Any delay or failure to conform our business to the requirements of the Health Care Reform Legislation and state health insurance reforms could disrupt our operations, lead to regulatory issues, damage our relationship with existing customers and our reputation generally, adversely affect our ability to attract new customers and result in other adverse consequences. For additional information, see the caption entitled "Regulatory and Legislative Matters - National Health Care Reform Legislation" - in Part I, Item I of the Company's Annual Report on Form 10-K for the year endedDecember 31, 2011 .
Business Segments
We operate four business segments:Commercial Health , Insphere, Corporate, and Disposed Operations. Through our Commercial Health Division, we underwrite and administer a broad range of health insurance and supplemental insurance products. Insphere includes net commission revenue, agent incentives, marketing costs and other agency administration costs. Corporate includes investment income not allocated to the other segments, realized gains or losses, interest expense on corporate debt, our student loan business, general expenses relating to corporate operations and operations that do not constitute reportable operating segments. Disposed Operations includes the remaining run out of residual operations from the disposition and wind down of other businesses prior to 2011. Allocations of investment income and certain general expenses are based on a number of assumptions and estimates, and the business segments reported operating results would change if different allocation methods were applied. Certain assets are not individually identifiable by segment and, accordingly, have been allocated by formulas. Segment revenues include premiums and other policy charges and considerations, net investment income, commission revenue, fees and other income. Management does not allocate income taxes to segments. Transactions between reportable segments are accounted for under respective agreements, which provide for such transactions generally at cost.
Revenue from continuing operations and income (loss) from continuing operations before income taxes are set forth in the tables below:
Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (In thousands) Revenue from continuing operations: Commercial Health Division: $ 119,912 $ 141,867 $ 376,165 $ 448,538 Insphere: 23,421 18,423 65,548 52,687 Corporate: 4,186 5,573 10,783 21,640 Intersegment Eliminations: (7,314 ) (4,934 )
(19,755 ) (13,185 )
Total revenues excluding disposed operations 140,205 160,929
432,741 509,680 Disposed Operations: 30 391 129 1,208
Total revenue from continuing operations
$ 432,870 $ 510,888 24
--------------------------------------------------------------------------------
Table of Contents Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (In thousands) Income (loss) from continuing operations before federal income taxes: Commercial Health Division: $ 12,431 $ 31,411 $ 48,778 $ 79,223 Insphere: (11,362 ) (12,400 ) (32,935 ) (39,614 ) Corporate: (6,934 ) (8,299 ) (23,948 ) (20,949 ) Total operating income (loss) excluding disposed operations (5,865 ) 10,712 (8,105 ) 18,660 Disposed Operations: 28 667 473 1,293
Total income (loss) from continuing operations before federal income taxes $ (5,837 )
Commercial Health Division Set forth below is certain summary financial and operating data for the Company's Commercial Health Division for the three months endedSeptember 30, 2012 and 2011: Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (Dollars in thousands) Revenue Earned premium revenue $ 112,559 $ 132,068 $ 351,284 $ 417,366 Investment income 2,251 3,422 8,755 10,564 Other income 5,102 6,377 16,126 20,608 Total revenue 119,912 141,867 376,165 448,538 Benefits and Expenses Benefit expenses 83,350 83,801 251,579 279,525 Underwriting, acquisition and insurance expenses 23,075 25,015 72,114 84,104 Other expenses 1,056 1,640 3,694 5,686 Total expenses 107,481 110,456 327,387 369,315 Operating income $ 12,431 $ 31,411 $ 48,778 $ 79,223 Other operating data: Loss ratio 74.0 % 63.5 % 71.6 % 67.0 % Expense ratio 20.5 % 18.9 % 20.5 % 20.2 % Combined ratio 94.5 % 82.4 % 92.1 % 87.2 %
Loss Ratio. The loss ratio is defined as benefits expense as a percentage of earned premium revenue.
Expense Ratio. The expense ratio is defined as underwriting, acquisition and insurance expenses as a percentage of earned premium revenue.
Through our Commercial Health Division, we issue a broad range of health and supplemental insurance products for individuals, families, the self-employed and small businesses. Our plans are designed to accommodate individual needs and include basic hospital-medical expense plans, plans with preferred provider organization features, catastrophic hospital expense plans, as well as other supplemental types of coverage. The Commercial Health Division continues to report a decrease in earned premium revenue for both the three-months and nine-months endedSeptember 30, 2012 compared to the same periods in the prior year, due to the continued decrease in policies in force. Since 2010, the Company's emphasis has been primarily on the distribution of health insurance products underwritten by non-affiliated carriers and growing its supplemental insurance product sales underwritten primarily byThe Chesapeake Life Insurance Company . The Commercial Health Division reported a decrease in operating income which is generally attributable to the decrease in revenue as well as the increase in the loss ratio. The increase in the loss ratio is primarily the result of the minimum loss ratio ("MLR") requirements as enacted by Health Care Reform Legislation. During the third quarter of 2011, the Company updated its completion factors and the impact on the three months endedSeptember 30, 2011 was approximately$7.8 million recorded as a reduction in the claim liability. During the second quarter of 2012, the Company updated its loss reserve analysis including an update of the completion factors resulting in an increase in claim reserves of$2.1 million . The Company recorded$2.8 million of certain claims expenses relating to the first and second quarter of 2012 during the third quarter which is related to formulary rebates on prescription drug benefits. The decrease in underwriting, acquisition and insurance expense reflects the variable nature of commission expenses and premium taxes included in these amounts which generally vary in proportion to earned premium revenue. Additionally, the Company continues to address other cost saving measures to reduce fixed costs associated with this segment. Other income and other expenses both decreased in the current period compared to the prior year period. Other income largely consists of fee and other income received for sales of association memberships prior to the formation of Insphere, for which other expenses are incurred for bonuses and other compensation provided to the agents. The majority of these association memberships were sold along with health policies and as premium continues to decrease we expect the revenue and expense generated from these association memberships to also decrease. 25
--------------------------------------------------------------------------------
Table of Contents
Insphere
Insphere is an insurance agency authorized in 50 states and theDistrict of Columbia specializing in small business and middle-income market life, health, long-term care and retirement insurance. Insphere distributes products underwritten by our insurance subsidiaries, as well as non-affiliated insurance companies.
Set forth below is certain summary financial and operating data for Insphere for the three and nine months ended
Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (Dollars in thousands) Revenue
Commission revenue from non-affiliates
$ 37,952 $ 32,238 Commission revenue from affiliates 6,427 3,838 17,178 9,916 Commission revenue from association memberships 2,684 3,205 8,844 9,042 Investment income 298 257 859 752 Other income 261 265 715 739 Total revenue 23,421 18,423 65,548 52,687 Expenses Commission expenses 12,191 9,514 34,123 28,001 Agent incentives 6,793 6,885 19,869 19,519 Other expenses 15,799 14,424 44,491 44,781 Total expenses 34,783 30,823 98,483 92,301 Operating loss $ (11,362 ) $ (12,400 ) $ (32,935 ) $ (39,614 )
Insphere continues to report an increase in commission revenue with the majority of the increase attributable from the sale of our supplemental insurance products. Commission revenue from non-affiliates continues to increase over prior year primarily as a result of the increased renewal business.
Insphere also reported increases in commission expenses and agent incentives which is due primarily to the corresponding increases in commission revenues, especially on the supplemental insurance business. Commission expense as a percentage of commission revenue is generally higher on the supplemental products compared to health products during the first year. Commission expense includes commissions and overrides paid to our independent agents. Commissions are generally based on a percentage of the premiums paid by the insured to the carrier. Agent incentives primarily include production and agent recruiting bonuses paid to our independent agents as well as lead generation costs incurred to facilitate the production of commission revenue. These generally increase in tandem with commission revenue. Other expenses associated with Insphere are related to home office employee compensation, costs associated with our field offices, depreciation and amortization, and other administrative expenses. These costs increased from the prior year primarily as a result of administrative expenses associated with the purchase and ongoing activities of the insurance agency call center discussed below. OnJuly 17, 2012 , the Company's Insphere subsidiary closed an asset purchase agreement withRepp Gartner Financial, Inc. ("Repp Gartner") - aSan Diego, California based insurance agency call center - pursuant to which Insphere acquired certain assets of Repp Gartner. This transaction enables Insphere to add a call center distribution channel to its business. The initial purchase price for the purchased assets was approximately$6.1 million , with additional earn-out payments possible based on the achievement of commission revenue targets attributable to such new call center distribution channel. In addition to the purchase price, Insphere recorded a liability for unearned revenue in the amount of$925,000 and intangible assets in the amount of$7.0 million . The intangible assets may increase in the future as the Company refines its estimate for the acquisition date fair value of the contingent consideration of the additional earn-out payments discussed above. The Company anticipates to have this complete in the fourth quarter endingDecember 31, 2012 .
Corporate
Corporate includes investment income not otherwise allocated to the other segments, realized gains and losses on sales, interest expense on corporate debt, the Company's student loan business, general expense relating to corporate operations and operations that do not constitute reportable operating segments.
26
--------------------------------------------------------------------------------
Table of Contents
Set forth below is a summary of the components of operating loss at Corporate for the three and nine months ended
Three Months Ended Nine Months Ended September 30, September 30, 2012 2011 2012 2011 (In thousands) Operating loss: Investment income on equity $ 2,589 $ 1,603 $ 6,359 $ 8,312 Realized gains, net 257 2,546 336 8,976 Interest expense on corporate debt (2,709 ) (4,742 ) (9,939 ) (17,287 ) Student loan operations (43 ) (56 ) (165 ) (112 ) General corporate expenses and other (7,028 ) (7,650 ) (20,539 ) (20,838 ) Operating loss $ (6,934 ) $ (8,299 ) $ (23,948 ) $ (20,949 )
The change in operating loss is primarily due to the following items:
• The increase in investment income for the quarter resulted from a reduction in the amount allocated to the other segments. The reduction in the allocation was based on a decrease in the interest rates used in the allocation model. • The decrease in investment income and realized gains for the year resulted from the sales of various fixed maturities throughout 2011 as a result of cash requirements needed for the then pending maturity of our term loan. • Interest expense on corporate debt decreased as a result of the repayment of the Company's term loan inFebruary 2012 .
Additionally,
the Company had an interest rate swap agreement that expired onApril 11, 2011 which caused the Company to pay a fixed rate higher than the current variable rate incurred on the debt during the first quarter of 2011.
Liquidity and Capital Resources
Consolidated Operations
Historically, the Company's primary sources of cash on a consolidated basis have been premium revenue from policies issued, investment income, and fees and other income. The primary uses of cash have been payments for benefits, claims and commissions under those policies, servicing of the Company's debt obligations, and operating expenses.
The following table also sets forth additional information with respect to the Company's debt:
Wordcount: | 3944 |
Advisor News
Annuity News
Health/Employee Benefits News
Life Insurance News