| 2004 ANNUAL REPORT |
| L I V I N G |
| VALUES |
Since its foundation in 1959. Triple-S, Inc, has been a leader in the health insurance industry in Puerto Rico.
In order to keep pace with the community’s growth and needs, the Company experienced rapid expansion and diversification of its products and business lines, while maintaining its financial strength, giving way to the creation of the Triple-S Group.
Seguros de Vida Triple-S, Inc. was created to provide disability and life insurance, as well as annuities, to bring peace of mind. Seguros Triple-S, Inc. was created to provide practicing doctors with much needed malpractice insurance, while offering a wide variety of property and casualty products to the general public. Interactive Systems, Inc. works on technological solutions for the companies in the Group, in addition to operating the Electronic Health System that allows more than 10,000 physicians, laboratories, dentists, and hospitals – that are part of the Triple-S, Inc. provider network to speedily process their claims. Triple-C, Inc. was formed to manage the Health Reform with the goal of guaranteeing access to quality health services to those without access to medical care. It is developing its role as a Third-Party Administrator (TPA).
In order to coordinate the efforts of all of these subsidiaries, Triple-S Management Corporation was created in 1999 as a holding company. This restructuring has made it possible for Triple-S to remain the largest insurer with 100% Puerto Rican capital, making it possible to become the second largest company on the island.
Always committed to supporting the well-being of our people, we will continue to grow with Puerto Rico.
| L I V I N G |
| VALUES |
| MORE THAN SIMPLE BELIEFS, VALUES ARE A REFLECTION OF OUR OWN EXISTENCE. THEY ARE MANIFESTED IN EACH AND EVERY THING WE DO, BOTH IN OUR PERSONAL AND PROFESSIONAL LIVES. |
| At the Triple-S Group, we celebrate the values that guide our Corporation each day. We promote their understanding and acceptance convinced that, by doing so, we will get closer to our aspiration of becoming a more compassionate and competitive company. |
| We continuously search for different ways for values to become evident at all levels of our organization – from corporate culture, strategy and operation to relationship with our stakeholders – our providers, employees, shareholders, and the people and organizations we insure. |
| That’s how values are not mere words. At the Triple-S Group, these are deeply felt and shown in every gesture and every action of our people until they become Living Values. |
Triple-S Group
Financial Highlights
| (dollar amounts in thousands) | 2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||||||
| Gross premiums* | $ | 1,478,125 | $ | 1,424,522 | $ | 1,387,331 | $ | 1,289,773 | $ | 1,213,667 | |||||||||||||||
| Claims incurred* | 1,285,717 | 1,217,156 | 1,203,118 | 1,147,319 | 1,103,381 | ||||||||||||||||||||
| Operating expenses | 171,879 | 165,149 | 148,539 | 140,830 | 130,135 | ||||||||||||||||||||
| Net income (loss) | 45,803 | 26,229 | 48,249 | 21,715 | (1,512 | ) | |||||||||||||||||||
| Assets | 919,657 | 834,623 | 721,892 | 655,805 | 575,556 | ||||||||||||||||||||
| Capital | 301,433 | 254,255 | 231,664 | 186,028 | 159,693 | ||||||||||||||||||||
| Return on assets (ROA) | 5.0 | % | 3.1 | % | 6.7 | % | 3.3 | % | -0.3 | % | |||||||||||||||
| Return on equity (ROE) | 15.2 | % | 10.3 | % | 20.8 | % | 11.7 | % | -0.9 | % | |||||||||||||||
| Net income (loss) to premiums | 3.1 | % | 1.8 | % | 3.5 | % | 1.7 | % | -0.1 | % | |||||||||||||||
| Underwriting gain (loss) to premiums | 1.4 | % | 3.0 | % | 2.6 | % | 0.1 | % | -1.6 | % | |||||||||||||||
| * | Includes amounts attributable to self-funded arrangements. |
2 Living Values
2004 TRIPLE-S GROUP
Triple-S Management Corporation
Letter from the Chairman of the Board
ONE OF THE MOST IMPORTANT RESPONSIBILITIES OF A CORPORATION IS TO ADD VALUE TO THE PEOPLE AND THE MARKET IT SERVES.
In the case of Triple-S Management, the outstanding performance of 2004 is an indication of the care we have placed in living by our values. These values are reflected throughout this annual report as well as evident in the financial results we achieved in 2004.
Over the course of 2004, the Board of Directors has been steering the Corporation to a position where it can continue to develop each of the companies that make up our Group.
In line with the requirements of the Sarbanes-Oxley Act, the Corporation is well on its way to comply with all the dispositions of this federal legislation. We are guided by our commitment to comply with the strictest dispositions of good corporate governance. In complying with these parameters, we can offer greater value and peace of mind to our shareholders, our health plan members and policyholders, as well as to the marketplace we serve.
Fernando J. Ysern Borrás, MD
These initiatives are also needed to ensure orderly growth in the Corporation. In addition, we have been working to create the optimum conditions to lead Triple-S Management on a geographic expansion and continue to grow our business lines. In particular, we have supported the one-stop-shop strategy based on the three business lines we offer: health; property and casualty; and life insurance and affiliated products.
Our first incursion into the debt capital market last year is helping us to finance our continued growth. We obtained favorable rates on our debt issue, while the market response could not have been better. We feel proud of being one of the few non-bank companies in Puerto Rico that has issued $50 million in debt and obtained an excellent classification of A- from Standard & Poor’s.
Living Values 3
2004 TRIPLE-S GROUP
Letter, continued
In the area of product development, we continue to respond to the needs of the Puerto Rican population. We developed a new product, Medicare Óptimo, for those 65 years old and older, the segment of the population experiencing the greatest growth. Medicare Óptimo is the only certified Medicare Advantage Plan in Puerto Rico that offers the beneficiary freedom of choice from an ample network of doctors, with no gatekeepers.
As to the petition from many of our shareholders that we provide them with proposals to allow them to transfer their shares, we have continued to seek options to liberalize the existing limitations. In that sense, we hope to propose alternatives that are widely acceptable to our shareholders, and that allow them greater leeway with their assets, since the current By-Laws only permit shares to be transferred in inheritance to descendants who are physicians and dentists.
Since September of 2003, we have been restricted in considering options for corporate development due to the Sánchez lawsuit, which is pending in Federal Court, San Juan District. This suit establishes a legal claim on the Corporation’s capital. If the Court grants the motion to dismiss, we will be in a position to analyze and recommend to our shareholders options to continue Triple-S Management’s corporate development.
Meanwhile, our legal advisors have indicated that while the Sánchez case remains active in Court, we need to be prudent in terms of the steps we take as we address our needs for corporate development. Our responsibility in this scenario has been to protect the Corporation’s assets and continue to improve its capacity to generate value. Our increased value was also acknowledged by AM Best which granted us an excellent qualification of A- once more.
In terms of the directors who make up the Board, we deeply felt the loss of José Davison Lampón, Esq. We will remember him and are deeply appreciative of his numerous contributions and years of service to the Board. Before year end, Juan Rodríguez Díaz, Esq. was selected to fill the vacancy in accordance with our By-Laws. We thank him for accepting this mission as we welcome him to the Board. We trust that he too will contribute greatly to the Corporation’s development.
This is the last report that I subscribe as Chairman of the Board. It has been a period of transition for our Corporation, marked by difficult times and challenges in the marketplace. Nevertheless, the Triple-S Group has emerged stronger than ever and continues to add value to the relationships we have with all our stakeholders. Our commitment as we face the future is to continue living by our values in every one of our undertakings.
Fernando J. Ysern Borrás,
MD Chairman of the Board
4 Living Values
| RESPECT |
| We believe in respecting the individual and acknowledging each person’s contributions. |
| ETHICS |
| We act with integrity, and let ethical decision-making guide all our actions. |
2004 TRIPLE-S GROUP
Triple-S Management Corporation
Board of Directors
above, left to right: Fernando L. Longo, MD; José Arturo Álvarez Gallardo; Mario S Belaval; Ramón M. Ruiz Comas, CPA(President and CEO); Jesús R. Sánchez Colón, DMD(Secretary); Carmen Ana Culpeper; Wilfredo López Hernández, MD; Wilmer Rodríguez Silva, MD(Vice President); Porfirio E. Díaz Torres, MD; Arturo Córdova López, MD(Assistant Secretary).
below, left to right: Miguel Nazario; Vicente J. León Irizarry, CPA(Treasurer); Valeriano Alicea Cruz, MD; Fernando J. Ysern Borrás, MD(Chairman of the Board); Manuel Suárez Méndez, Eng.; Adamina Soto Martínez, CPA(Assistant Treasurer); Manuel Figueroa Collazo, Eng; Manuel A. Marcial Seoane, MD; Juan E. Rodríguez Díaz, Esq.
Living Values 7
| INNOVATION |
| We promote proactivity, creativity and innovation as competitive advantages. |
2004 TRIPLE-S GROUP
Triple-S Management Corporation
Letter from the President and Chief Executive Officer
OVER THE COURSE OF LAST YEAR, TRIPLE-S GROUP CONTINUED TO GENERATE EXCELLENT RESULTS AS AN OUTCOME OF OUR STRATEGY TO DIVERSIFY OUR OPERATIONS, AS WELL AS STEER OUR SUBSIDIARIES IN THE DIRECTION OF A “ONE-STOP SHOP.”
Triple-S Group increased its net income from $26.2 million in 2003 to $45.8 million in 2004. The year’s performance behaved as anticipated in terms of income as well as expenses, since there was no material event reflected such as in 2003, when a special payment in taxes was made. In spite of a persistent weakness in the economy, the Triple-S Group maintained its focus during the year. As a Group, we made progress in the marketplace by adding value to our products and services.
We made strides with our strategy in several ways. For the first time, Triple-S, Inc. went to the capital markets in Puerto Rico with an issue of $50 million that had an excellent reception. Standard & Poor’s classified the transaction as A-, which is considered excellent. With this classification, we became one of the few issuers of debt in Puerto Rico to obtain an evaluation of that caliber in its first transaction of this type.
Ramón M. Ruiz Comas, CPA
The product of this transaction served to repay short-term debt, finance the development of new products and services, and provide continued support for our corporate development plans. Our results for the year also show greater diversification. For the first time, Seguros Triple-S, our property and casualty subsidiary, was responsible for generating 24% of the Group’s net income; an extraordinary achievement.
The performance achieved in 2004 is a reflection of our strict adherence to the Group’s values. These values arose from a philosophy of service embraced by a visionary group of physicians who founded the Company in 1959. These values, beginning with respect for each individual, continue to guide our steps and have been instrumental in helping the Group achieve its results over the past few years.
Living Values 9
2004 TRIPLE-S GROUP
Letter, continued
In spite of a persistent soft market for insurance products, the Group was able to obtain important progress in each of its business lines: health, property and casualty, life and annuities, and technology.
Health
In the area of health, we entered the market segment with the largest growth potential, those aged 65 years and older. We launched Medicare Óptimo and Medicare Óptimo Plus under the guidelines set by the Medicare Modernization Act of 2003 for Medicare Advantage programs. Under these programs, private health insurers can offer products that compete with Medicare. In contrast to traditional Medicare, this new plan includes dental and optical services, hearing aides and other benefits. It is the only plan that allows the beneficiary to access providers, with no restrictions, from the wide network of Medicare Óptimo providers in Puerto Rico.
FOR 2005, WE ARE PROJECTING THAT 12,000 TO 15,000 PEOPLE WILL CHOOSE MEDICARE ÓPTIMO. THE PRODUCT, LAUNCHED IN DECEMBER, HAS HAD AN EXCELLENT RECEPTION AND HAS EXCEEDED OUR PROJECTIONS.
In the area of group health plans, we experienced an increase of 3%, which is considerable in a labor market that is characterized by a lack of growth. We were able to increase our very high retention rates from 95% to 96% and reported an increase in underwriting income for the third year in a row.
We took steps to offer our health plan customers added value through new service channels and improved efficiency in containing rising health costs. As a result, for the second straight year,
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10 Living Values
2004 TRIPLE-S GROUP
we were favored as the number one plan among health plans that serve federal employees in the U.S. in a satisfaction survey. The survey is a federal requirement for plans that serve federal employees.
During the year, we invested considerable effort in launching a new version of our website with the objective of providing greater functionality and interactivity for our health providers, customers, producers and employers. The website was tested during 2004. Its large-scale launch will be in 2005. We trust that once the website is widely available, it will become yet another added value that Triple-S offers its key stakeholders.
Also in 2004, it’s been ten years of intense work and dedication to the Health Reform. We continue to make adjustments in the model to better care for this segment of the population, which includes more than 600,000 people in the southwest, north and metro-north regions of Puerto Rico.
The Health Reform Program of the Commonwealth of Puerto Rico is managed by Triple-C, Inc., a third-party administrator. More than 90 cents of every dollar of premium is paid out for health services. The efficiency achieved in operating the Health Reform has also had a positive impact on the operation of Triple-S, Inc., the health insurer. It has helped Triple-S become one of most efficient health insurers in the United States.
Beyond its efficiency, the programs managed by Triple-C have helped to improve the quality of life of Health Reform beneficiaries. Since the Reform’s inception, there have been significant improvements in basic health parameters. Triple-C has contributed to establishing the standard of care with the incentives it has provided for preventive care. Today, Puerto Rico has the highest rate of vaccination for children under the age of 24 months in the United States.
Disease management programs, such asCuidado Especial, have helped patients with chronic conditions improve their health and reduce their hospitalizations and visits to emergency rooms. The personal attention given to these patients has generated savings per every dollar invested in the program.
Through an alliance with McKesson, Triple-C continues to offer phone health services to an increasing number of customers in Puerto Rico, as well as in Hispanic markets of the United States.
Living Values 11
2004 TRIPLE-S GROUP
Letter, continued
Property and Casualty
Seguros Triple-S, Inc. continued experiencing double-digit growth in 2004, exceeding the industry’s performance. The Company registered its best year in underwriting income since its foundation in 1987. During 2004, the Company maintained its leadership in commercial packages and became the leader in the very competitive market for mortgage insurance, once we established alliances with some of the leading mortgage bankers in Puerto Rico.
With the goal of adding more value to our products, the Company launched two innovative products that are in line with current needs. We designed a policy to protect our customers in the event of identity theft. For the commercial area, we designed a policy that offers coverage in the event that information systems malfunction, in view of how much businesses currently rely on these systems.
As for service, the Company continues to invest in an extensive reengineering program of all its information programs with the goal of providing better service to its customers, such as in reducing the time it takes to process a claim. This program, which will have wide-ranging effects, will take two or three more years to complete. In 2004, some of our efforts became evident when we began to decentralize our claim processing centers so that they will be more accessible to our customers. There are now offices located in Arecibo, Caguas and Canóvanas, in addition to those that already operate in San Juan, Ponce and Mayagüez. Seguros Triple-S is the only property and casualty insurance company that has a claim center in Plaza Las Américas, the largest mall in the Caribbean. In 2005, we will open a second center in Plaza Carolina. Soon, the Company will establish a network of affiliated auto body shops to facilitate the claim process for customers.
Life and Annuities
During the course of the year, Seguros de Vida Triple-S, Inc. maintained its leadership in group life and disability products. With the goal of increasing its productivity, Seguros de Vida Triple-S restructured key areas within the Company including customer service, sales and marketing. In doing so, in 2005, the Company will be better positioned to enter the personal insurance marketplace. We will launch new products for this market in 2005.
12 Living Values
| EXCELLENCE |
| We believe in providing excellence in service to all our constituents. We promote efficiency and effectiveness. We believe in financial soundness as a measure of success. |
| Living Values 13 |
2004 TRIPLE-S GROUP
Letter, continued
Technology
Throughout the years, Interactive Systems, Inc. has proved to be instrumental in adding value to the Group’s products and services by increasing the efficiency of more and more of its processes through the application of technology. It has helped each subsidiary increase the volume of information handled, as well as the speed and capacity of their claim processing.
At the Group level, Interactive Systems is seeking to apply technology in a uniform manner across all of the companies that make up the Group, in order to create a common platform to gradually make the one-stop shop possible. It has been and will continue to be the subsidiary that fully participates in the strategic planning processes of each member of the group in order to collaborate in finding ways to achieve greater efficacy in the operations and greater quality of service through the application of technology and the simplification of processes.
INTERACTIVE SYSTEMS CONTINUES TO PROVIDE SUPPORT FOR A COMPREHENSIVE REENGINEERING PROJECT THAT SEEKS TO SIMPLIFY THE COMPANY’S PROCESSES TO PROVIDE SPEEDIER CLAIM PROCESSING AND SERVICE.
At the health level, Interactive Systems is the company that allows us to operate the health programs for our customers, providers and employers with great efficiency. Interactive Systems was a key player in helping to enable Triple-S to launch Medicare Óptimo. Equally, its support has been important in disease management, case management and hospital reviews, all of these activities with the intention of achieving greater efficiencies in the service provided to our customers and the speed with which providers can obtain payment for their
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14 Living Values
2004 TRIPLE-S GROUP
services. In terms of Seguros Triple-S, Interactive Systems continues to provide support for a wide-ranging reengineering project that seeks to simplify the Company’s processes in order to provide speedier claim processing and service.
Social Responsibility
Our commitment to live by our values extends to the leadership that we exert in the area of corporate responsibility. Over the year, we launched the public service campaign¿Cuál es tu actitud?(What is your attitude?), which highlights the importance of having a positive attitude as a way of improving interpersonal relations in Puerto Rico. By being more positive, we can improve our lives as well as the lives of others with whom we interact in our workplace, our family and in the community.
With several other leading corporations in Puerto Rico, we led an initiative to support the first social responsibility corporate center that operates in the country, under the name of ConectaRSE (Connecting with Social Corporate Responsibility). We actively participated in the Chamber of Commerce’s Quality of Life Initiatives and those of the Puerto Rico Manufacturers Association. We also supported the efforts of Fondación Solidaridad (Solidarity Foundation), created by El Nuevo Día. And we continued to provide solid support to projects that promote education among health professionals, child and youth education, health, the environment, civism, sports and the arts.
We exercised our responsibility both as corporate citizens and in our market performance. Our success, in each of our subsidiaries and as a Group, continues to be closely linked to our capacity to generate value for our shareholders, customers, employers, providers and Puerto Rico’s health system, the economy and the general well-being of the population. In this manner, we reaffirm our commitment to live our values in each of the actions that we take, so that they can become Living Values.
Ramón M. Ruiz Comas, CPA
President and Chief Executive Officer
Triple-S Management Corporation
Living Values 15
| TEAMWORK |
| We share information, give each other support and motivation, and thrive together to reach further. |
| 16 Living Values |
2004 TRIPLE-S GROUP
Triple-S Management Corporation
Corporate Leadership Group
Eva G. Salgado
President and Chief Executive Officer
Seguros Triple-S, Inc.
Ramón M. Ruiz Comas, CPA
President and Chief Executive Officer
Triple-S Management Corporation
Carlos Torres
President and Chief Executive Officer
Interactive Systems, Inc.
Luis A. Marini Mir, DMD
President and Chief Executive Officer
Triple-C, Inc.
Socorro Rivas, CPA
President and Chief Executive Officer
Triple-S, Inc.
Roberto O. Morales, Esq.
President and Chief Executive Officer
Seguros de Vida Triple-S, Inc.
Living Values 17
2004 TRIPLE-S GROUP
Group Highlights
TRIPLE-S, INC.
| > | Solidified further its leadership as the leading health insurance company in Puerto Rico. | |
| > | Serves 1.3 million people in Puerto Rico. | |
| > | Contracts increased by 3% in spite of a stagnant labor market, and the contract retention rate rose to 96%. | |
| > | For the second year in a row, it retained its number one position as a provider of quality services among health plans that serve federal employees in the U.S. | |
| > | Holds the first place among health plans in the Blue Cross and Blue Shield network in six service categories. In Puerto Rico, the Company is number one in 9 out of 10 service categories. | |
| > | Completed its new website, providing greater interactivity to its users. | |
| > | Continues to be among the most efficient companies in the management of health plans in the U.S. It uses 89.5 cents out of each premium dollar to pay for direct services to its customers and 9.5 cents out every premium dollar for administrative costs. | |
| > | Opened a second Service Center in Plaza Carolina. The first one opened at Plaza Las Américas in 2003. | |
| > | Maintained an A- rating from AM Best and Standard & Poor’s. |
TRIPLE-C, INC.
| > | Administrates Health Reform services for the largest number of beneficiaries. | |
| > | It helped improve the quality of life of many patients who suffer from certain chronic conditions and are part of the Cuidado Especial program. As a result, hospitalizations have dropped, which has helped to control costs and allow improvements to service and provide better access. | |
| > | Jointly operates a health information line serviced by registered nurses with McKesson. From Puerto Rico, it serves the island market and 14 clients in the continental U.S. |
| > | Played a key role in helping improve health parameters through the administration of regions for the Puerto Rican government’s Health Reform program. |
18 Living Values
2004 TRIPLE-S GROUP
SEGUROS DE VIDA TRIPLE-S, INC.
| > | Celebrated its 20th anniversary of serving the Puerto Rican market in 2004. |
| > | Launched a new cancer policy with supplementary coverage and created a distribution channel to market this product by recruiting five general agencies that specialize in the sale of these types of insurance policies. | |
| > | Began to cross-sell life insurance to individual health plan customers, a project that is part of the integration strategy of Triple-S Group. | |
| > | Practically doubled its size in the past five years. | |
| > | Continues to be the leading company in life and disability group sales in Puerto Rico. | |
| > | Restructured the Company to better position it to enter the consumer life and disability insurance markets. | |
| > | Maintained an A- rating (Excellent) from AM Best. | |
| > | Stationed representatives at the Triple-S Service Center located in Plaza Las Américas to better service customers. |
SEGUROS TRIPLE-S, INC.
| > | Achieved double-digit growth for the sixth consecutive year, exceeding the market’s average performance. | |
| > | Reported its best year in underwriting income, despite being a year characterized by a soft market and a catastrophic event such as Tropical Storm Jeanne. | |
| > | Became the primary property and casualty insurer for mortgages on the Island when it formed an alliance with the three leading mortgage banks in Puerto Rico. | |
| > | Seguros Triple-S continues to be the leading company in the sale of commercial package insurance in Puerto Rico. |
| > | For the first time, it launched a public service campaign to help consumers reduce their losses during the hurricane season. | |
| > | Established several satellite offices that will be inaugurated during 2005 to offer better customer service in the areas of the sale of policies and claim processing. | |
| > | Signature Insurance Agency, Seguros Triple-S general agency, became the third largest general insurance agency in Puerto Rico during 2004. |
INTERACTIVE SYSTEMS, INC.
| > | Provides information technology and innovative solutions to the Triple-S Group. | |
| > | Manages one of the largest and most complex information technology centers in Puerto Rico and the Caribbean. |
| > | Processed a total of 22 million claims in 2004 for Triple-S, Inc.; 90.3% were processed electronically and 98.5% of total claims in the health area were processed in 30 days or less. | |
| > | It is the leading provider of electronic billing applications for the Puerto Rican health industry, with more than 8,000 installations in providers’ and participants’ offices. | |
| > | Launched SES Total, an electronic billing program that allows health providers and participants to bill health plans in Puerto Rico. | |
| > | Implemented information systems to support the launching of Medicare Óptimo, which helped diversify the products offered by the Group. | |
| > | Implemented applications that support individual case management and disease management programs to improve the quality of life of many patients. | |
| > | Continued to strengthen information security within the Corporation’s information systems. |
Living Values 19
| COMMITMENT |
| We promote the quality of life in the communities we serve. |
| 20 Living Values |
2004 TRIPLE-S GROUP
Triple-S Management Corporation
Our Community is Our Responsibility
At the Triple-S Group, we believe in social responsibility as a key strategy to promote business development and improve the well-being of our community.
As always, we sponsored efforts that promote the arts, culture, education, sports and the environment. We also contributed to the professional growth of our physicians, dentists and health providers by supporting scientific investigation and continuous education programs.
However, the Triple-S Group has adopted a new vision which entails a greater action ratio and more commitment than ever. We now go beyond traditional philanthropy to include other projects that allow us to get involved in the search of solutions to our problems and significantly impact the social transformation of our Island.
A case in point was our public service campaignWhat is your attitude?, that calls attention to the importance of having a positive attitude as a way of fostering a better social interaction among Puerto Ricans. By asking our people to put on their best face when facing difficult situations, we are looking for a change in conduct that will improve our individual lives and the lives of all those around us.
The Triple-S Group’s commitment to our community was more evident than ever through our employee’s volunteer program. They went beyond donating funds to charitable organizations to donate their time and effort to support a noble cause. This included events to care for the needs of children and their families who spend long periods of time at the Pediatric Hospital, fundraising campaigns for the Muscular Dystrophy Association, Relevo por la Vida, and Heart Walk; and collecting Christmas presents for many needy groups around the Island.
The innovative social responsibility model that the Triple-S Group is beginning to adopt is vital to ensure the success of businesses and the well-being of the community. As more companies follow it, the more Puerto Rico will benefit.
That is precisely why we are motivating other businesses to join this global trend. We actively participate in the Social Responsibility Committees of the Chamber of Commerce and the PR Manufacturers Association, as well as in the Solidarity Operation Foundation, which promotes initiatives that improve the quality of life in Puerto Rico.
Likewise, the Triple-S Group has joined other leading companies as a founding member of ConectarRSE, the first Social Responsibility Center in Puerto Rico. From here, we’ll educate the local business community about the benefits of this global vision on socio-economic development, and will contribute to redefining companies’ roles as agents of change and social transformation.
Through these and many other efforts, we want to make Puerto Rico a better place to live and the Triple-S Group a better corporation, where we can always feel our Living Values.
Living Values p21
Triple-S Management Corporation
Corporate Information
TRIPLE-S MANAGEMENT CORPORATION
1441 F. D. Roosevelt Avenue
San Juan, Puerto Rico 00920
787.749.4949
www.ssspr.com
TRIPLE-S, INC.
787.749.4949
TRIPLE-C, INC.
787.793.8383
SEGUROS DE VIDA TRIPLE-S, INC.
787.792.0909
SEGUROS TRIPLE-S, INC.
787.749.4600
INTERACTIVE SYSTEMS, INC.
787.749.4173
Production: Triple-S Advertising & Public Relations Office
Design: BD&E, Inc., Pittsburgh, Pennsylvania
Photography: Tomás Gual and Getty Images
Copy: Lisette Núñez, Ivonne Brown
Printing: Model Offset Printing
22 Living Values
Financial Information 2004
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Management’s Discussion and Analysis of Financial Condition and Results of Operations.
This financial discussion contains an analysis of the consolidated financial position and financial performance as of December 31, 2004 and 2003, and consolidated results of operations for 2004, 2003 and 2002. 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.
General
The Corporation (on a consolidated basis and for each reportable segment), along with most insurance entities, uses the loss ratio, the expense ratio and the combined ratio as measures of performance. The loss ratio is the claims incurred divided by the premiums earned, net and fee revenue. The expense ratio is the operating expenses divided by the premiums earned, net and fee revenue. The combined ratio is the sum of the loss ratio and the expense ratio. These ratios are relative measurements that describe for every $100 of premiums earned, net and fee revenue, the costs of claims and operating expenses, respectively. The combined ratio represents the total cost per $100 of premium production. A combined ratio below 100 demonstrates underwriting profit; a combined ratio above 100 demonstrates underwriting loss.
Consolidated Operating Results
The analysis in this section is included to provide an overall view of certain information, the consolidated statements of operations, and key financial information. Further details of the results of operations of each reportable segment are included in the respective segment’s section.
| (Dollar amounts in thousands) | 2004 | 2003 | 2002 | |||||||||
Years ended December 31, | ||||||||||||
Consolidated premiums earned, net and fee revenue: | ||||||||||||
| Health insurance - Commercial Program | $ | 720,789 | 699,365 | 683,513 | ||||||||
| Health insurance - Reform Program | 484,742 | 477,614 | 487,000 | |||||||||
| Property and casualty’ | 86,228 | 78,334 | 60,688 | |||||||||
| Other operating segments | 16,442 | 17,403 | 14,992 | |||||||||
| $ | 1,308,201 | 1,272,716 | 1,246,193 | |||||||||
Consolidated claims incurred | $ | 1,115,793 | 1,065,350 | 1,061,980 | ||||||||
Consolidated operating expenses | 171,879 | 165,149 | 148,539 | |||||||||
Consolidated underwriting costs | $ | 1,287,672 | 1,230,499 | 1,210,519 | ||||||||
Consolidated loss ratio | 85.3 | % | 83.7 | % | 85.2 | % | ||||||
Consolidated expense ratio | 13.1 | % | 13.0 | % | 11.9 | % | ||||||
Consolidated combined ratio | 98.4 | % | 96.7 | % | 97.1 | % | ||||||
Consolidated net investment income | $ | 26,499 | 24,679 | 24,778 | ||||||||
Consolidated net rcalized gain on sale of securities | 10,968 | 8,365 | 185 | |||||||||
Consolidated net unrealized gain (loss) on trading securities | 3,042 | 14,893 | (8,322 | ) | ||||||||
| $ | 40,509 | 47,937 | 16,641 | |||||||||
Consolidated income tax expense | $ | 14,014 | 65,397 | 2,549 | ||||||||
Net income (loss) per segment: | ||||||||||||
| Health insurance - Commercial Program | $ | 23,757 | 49,071 | 28,133 | ||||||||
| Health insurance - Reform Program | 9,250 | 14,034 | 9,770 | |||||||||
| Property and casualty | 11,085 | 9,677 | 6,223 | |||||||||
| Other operating segments and TSM | 1,711 | (46,553 | ) | 4,123 | ||||||||
Consolidated net income | $ | 45,803 | 26,229 | 48,249 | ||||||||
2
Year ended December 31, 2004 compared with the year ended December 31, 2003
Consolidated premiums earned, net and fee revenue increased by $35.5 million, or 2.8 %, during the year 2004 when compared to the premiums earned, net and fee revenue during 2003. This increase is mostly due to the fluctuation in premiums earned, net of both Health Insurance segments and the property and casualty insurance segment.
| • | The premiums earned, net and fee revenue corresponding to the Health Insurance - Commercial Program presented an increase of $21.4 million, or 3.1%, during this period. The increase in premiums earned, net of this segment is due to increases in premium rates and an increase in the average enrollment of Self-funded Employers accounts. | |||
| • | The premiums earned of the property and casualty insurance segment increased by $7.9 million, or 10.1%, during the year 2004. This increase is mostly the result of the segment’s increased volume of business, particularly in the Dwelling and Auto Physical Damage lines of business. | |||
| • | The premiums earned, net of the Health Insurance - Reform segment presented an increase of $7.1 million, or 1.5%, in 2004, as compared to the premiums earned, net in 2003. The increase in the premiums earned, net of this segment is due to increases in premium rates during the contract renegotiation process, net of a decrease in membership. | |||
The consolidated claims incurred during the year 2004 were $50.4 million, or 4.7%, higher than the consolidated claims incurred for the year 2003. The loss ratio reflects an increase of 1.6 percentage points during the same period. This increase is mostly driven by the fluctuations in the claims incurred and the loss ratio of the Health Insurance – Commercial Program and Reform segments, which is basically attributable to the following:
| • | During 2004, the Health Insurance – Commercial and Reform segments experienced higher costs per service and utilization trends when compared to the prior period. The increase was mainly noted in the cost and utilisation of prescription drugs, X-rays, and emergency room services as well as to an increase in the cost of surgical procedures and laboratory services. | |||
| • | During 2003, the claims incurred in the Health Insurance – Commercial and Reform segments were affected by the favorable development of their claims liabilities, which were attributed to better than expected utilization trends in that particular year. | |||
In addition, claims incurred in the Property and Casualty Insurance segment also increased during 2004. The increase in the claims incurred of this segment is mostly due to an increase in its volume of business and to approximately $2.0 million of net losses from claims incurred related to the passage of Tropical Storm Jeanne through Puerto Rico.
Consolidated operating expenses increased $6.7 million, or 4.1%, during 2004 when compared to 2003, which is basically attributable to the increased volume of business of its reportable segments. The consolidated expense ratio increased 0.1 percentage points during the year 2004, from 13.0% in 2003 to 13.1% in 2004.
The consolidated realized gain on sale of securities is the result of the sound and timely management of the investment portfolio in accordance with corporate investment policies and from normal portfolio turnover of the trading and available-for-sale securities. The consolidated realized gain during 2004 is mostly due to the sale of common stock of Popular, Inc., which generated a realized gain of approximately $6.2 million and also to normal portfolio turnover of the trading and available for sale securities.
The unrealized gain on trading securities is related to investments held by segments in corporate bonds and equity securities. The unrealized gain experienced during the year 2004 is mostly attributed to gains in the portfolios held by segments in equity securities that replicate the Standard & Poor’s 500 Index, the Russell 1000 Growth Index and the Russell 1000 Value Index. All Indexes experienced positive returns in 2004. These segments plan to continue their long-term strategy of passive management and diversification since historically, performance of these types of investments has outperformed other financial instruments.
The consolidated income tax expense during the year 2004 presented a decrease of $51.4 million when compared to 2003 and is basically attributable to the termination of TSI’s tax ruling in July 2003. As a result, TSM recognized an income tax expense in 2003 amounting to $51.8 million.
Year ended December 31, 2003 compared with the year ended December 31, 2002
Consolidated premiums earned, net and fee revenue increased by $26.5 million, or 2.1 %, during the year 2003 mostly due to the increased volume of business experienced by its reportable segments. This increase is mostly due to the fluctuation in premiums earned, net of the Health Insurance – Commercial Program and the property and casualty insurance segments.
3
| • | The premiums earned, net and fee revenue corresponding to the Health Insurance – Commercial Program present in increase of $15.9 million, or 2.3%, during this period. The increase in premiums earned, net of this segment is due to increases in premium rates net of a slight decrease in its average enrollment. | |||
| • | The premiums earned of the property and casualty insurance segment increased by $17.6 million, or 29.1%, during the year 2003. This increase is mostly the result of the segment’s increased volume of business. | |||
The premiums earned corresponding to the Health Insurance – Reform segment present a decrease of $9.4 million, or 1.9%, during this period. This decrease is basically the result of a net decrease in the average enrollment of the segment, net of an increase in premium rates.
The increase in the consolidated claims incurred during the year 2003 of $3.4 million, or 0.3%, is due to an increase in the volume of business. The loss ratio reflected a decline of 1.5 percentage points during the same period. This decline is mostly driven by declines in the loss ratio of the Health Insurance – Commercial Program segment and the Health Insurance – Reform segment, which decrease was the result of better than expected utilization trends. In addition, management has established several cost containment measures that have allowed cost and utilization trends to maintain levels consistent with pricing and margin objectives thus keeping the loss ratio under control.
Consolidated operating expenses increased $16.6 million, or 11.2%, during 2003 that is basically attributed to the increased volume of business of its reportable segments. The consolidated expense ratio increased of 1.0 percentage points during the year 2003 mostly due to the following contributing factors:
| • | The property and casualty segment experienced a decrease in the reinsurance commission income from reinsurance treaties due to the cancellation of certain reinsurance contracts and change in the mix of reinsurance treaties. In addition, the segment had increases in certain non-recurring expenses, such as an assessment from a guarantee association and consulting services, among others. | |||
| • | The Health Insurance – Commercial Program segment recorded a non-recurring pension assessment of $4.6 million resulting from the number of retirees selecting lump-sum benefits instead of annuities. | |||
The consolidated realized gain on sale of securities is the result of the sound and timely management of the investment portfolio in accordance with corporate investment policies and from normal portfolio turnover of the trading and available-for-sale securities. The consolidated realized gain during the year 2003 is mostly due to the sale of common stock of Popular, Inc., which generated a realized gain of approximately $8.9 million and also to normal portfolio turnover of the trading and available for sale securities.
The unrealized gain (loss) on trading securities is related to investments held by segments in corporate bonds and equity securities. The unrealized gain experienced during the year 2003 is mostly attributed to gains in the portfolios held by segments in equity securities that replicate the Standard & Poor’s 500 Index and the Russell 1000 Growth Index. Both Indexes experienced positive returns in 2003. In addition, during the first quarter of the year the Corporation sold certain investments with unrealized losses within such portfolios. This caused approximately $3.0 million in realized losses and had the effect of reducing the unrealized losses within the trading portfolio by the same amount. These segments plan to continue their long-term strategy of passive management and diversification since historically, performance of these types of investments has outperformed other financial instruments.
Consolidated income tax expense during 2003 increased $62.8 million mostly as the result of the following:
| • | On June I8, 2003, the Corporation was notified by the Puerto Rico Treasury Department (PRTD) that TSI’s tax exemption was terminated effective December 31, 2002. As a result, effective January 1, 2003 TSI was subject to Puerto Rico income taxes, the Health Insurance – Commercial Program and the Health Insurance Reform segments recorded $4.6 million and $6.9 million, respectively, as income tax expense for the year. | |||
| • | On July 31, 2003, TSM and TSI executed a closing agreement with the PRTD that stipulated; in accordance with the income recognition methodology determined in the income lax ruling, that the statutory net income accumulated while TSI operated under the tax ruling was deemed distributed to TSM. As a result, TSM recognised an income tax expense amounting to $51.8 million. | |||
4
Health Insurance — Commercial Program Operating Results
| (Dollar amounts in thousands) | 2004 | 2003 | 2002 | |||||||||
Years ended December 31, | ||||||||||||
Average enrollment: | ||||||||||||
| Corporate accounts | 302,634 | 305,100 | 313,557 | |||||||||
| Self-funded employers | 141,009 | 128,803 | 123,680 | |||||||||
| Individual accounts | 84,807 | 84,407 | 82,583 | |||||||||
| Federal employees | 51,917 | 53,993 | 55,999 | |||||||||
| Local government employees | 40,257 | 43,177 | 43,526 | |||||||||
Total average enrollment | 620,624 | 615,480 | 619,345 | |||||||||
| Premiums earned, net | $ | 711,906 | 691,484 | 675,930 | ||||||||
| Amount attributable to self-funded arrangements | 182,752 | 163,175 | 151,497 | |||||||||
| Less amounts attributable to claims under self-funded arrangements | (169,924 | ) | (151,806 | ) | (141,138 | ) | ||||||
Premiums earned, net and fee revenue | $ | 724,734 | 702,853 | 686,289 | ||||||||
Claims incurred | $ | 620,751 | 584,448 | 574,874 | ||||||||
Operating expenses | 94,930 | 92,264 | 86,321 | |||||||||
Total underwriting costs | $ | 715,681 | 676,712 | 661,195 | ||||||||
Underwriting income | $ | 9,053 | 26,141 | 25,094 | ||||||||
Loss ratio | 85.7 | % | 83.2 | % | 83.8 | % | ||||||
Expense ratio | 13.1 | % | 13.1 | % | 12.6 | % | ||||||
Combined ratio | 98.8 | % | 96.3 | % | 96.3 | % | ||||||
General
The Health Insurance — Commercial Program segment’s total revenues are primarily generated from premiums earned for risk-based healthcare services provided to its members, revenues generated from self-funded arrangements and investment income. Claims incurred include healthcare services and other benefit expenses consisting primarily of payments to physicians, hospitals and other service providers. A portion of the claims incurred for each period consists of an actuarial estimate of claims incurred but not reported to the segment during the period. Operating expenses arc comprised of general, selling, commissions, depreciation, payroll and other related expenses. The segment’s results of operations depend largely on its ability to accurately predict and effectively manage healthcare costs.
Year ended December 31, 2004 compared with the year ended December 31, 2003
During 2004, the Health Insurance — Commercial Program segment reported an increase of 3.1% in the amount of premiums earned, net and fee revenue. This increase is due to the following:
| • | The segment is constantly monitoring claims trends, particularly in the rated Corporate accounts and Individual lines of business. This practice assures adequate premium rates that reflect the actual claims trend of each particular business. On average, this segment increased premium rates by 4.5% during the year 2004. | |||
| • | The increase in total average enrollment of 5,144 members, or 0.8%, during the year 2004 when compared to 2003 is mainly the result of flat employment levels in Puerto Rico during the last three years. The most significant increase in enrollment is in the Self-funded Employers, which presents an increase of 12,206 members, or 9.5%. since during this period certain large Corporate accounts groups shifted from the rated business to self-funded arrangements, assuming the risk associated with insuring their employees. The increase experienced in this business is mitigated by the decrease experienced in 2004 in the Local government employees and Federal employees businesses, which present a decrease of 2,920 members, or 6.8%, and 2,076, or 3.8%, respectively. | |||
Approximately 73% on the increase in total premiums is due to increases in premium rates. The remaining 27% is attributable to an increase in the segment’s volume of business.
The claims incurred for the year 2004 were $36.3 million, or 6.2%, higher than 2003, mostly as a consequence of an increase in claims experience trends. The claims experience trends increased 5.7% and 3.9% during 2004 and 2003,
5
respectively, mostly due to higher costs per service and higher utilization levels. The segment’s loss ratio reflects an increase of 2.5 percentage points during the same period. The increase in the loss ratio is the result of the following:
| • | In 2004 the segment experienced increases in the cost and utilization of prescription drugs, emergency room services, X-ray services and major medical services. Total claims paid during 2004 for both medical services and prescription drug coverage increased by 8.6% and 8.2%, respectively, when compared to 2003. Claims paid during 2004 on major medical services present an increase S11.3 million, or 55.0%, when compared to 2003. | |||
| • | Also, in 2004 the segment experienced an unfavorable development of $2.5 million on the 2003 estimated claims liability mostly because of higher than expected cost per service and utilization trends. In 2003, on the other hand, the segment experienced a favorable development of the 2002 claim liabilities estimate of $7.1 million. | |||
The segment continues developing and implementing cost containment initiatives to control claims trends and to maintain them at levels consistent with pricing and margin objectives.
Operating expenses increased by $2.7 million, or 2.9%, during 2004, sustaining an expense ratio of 13.1% in 2004. The increase in operating expenses is mostly due to the effect of the following:
| • | The business growth experienced in 2004 resulted in an increase in payroll expenses and commissions due to agents and brokers by $2.3 million. | |||
| • | The increase in technology related expenses of $1.5 million is directly related the segment’s commitment to continuously enhance services to its members and service providers. | |||
| • | During 2004, legal expenses and professional services and consulting fees increased by $1.3 million and $1.5 million, respectively, mostly as a result of assistance related to legal, governmental and regulatory matters related to the segment’s business. | |||
| • | All of these increases in 2004 were offset by a reduction in pension expense due to non-recurring pension settlements of $4.6 million in 2003, resulting from the number of retirees selecting lump-sum benefits instead of annuities. | |||
Year ended December 31, 2003 compared with the year ended December 31, 2002
During 2003, the Health Insurance — Commercial Program segment reported an increase of 2.4% in the amount of premiums earned, net and fee revenue even when experiencing a slight decrease in its average enrollment. The increase in the amount of premiums earned, net and fee revenue is due to the following:
| • | The segment is constantly monitoring claims trends, particularly in the rated Corporate accounts and Individual lines of business. This practice assures adequate premium sales that reflect the actual claims trend of each particular business. On average, this segment increased premium rates by 3.9% during the year 2003. | |||
| • | In addition, management service fees increased by $l.0 million, or 9.7%, during the year 2003. This increase was due to an increase in membership in the Self-funded employers accounts. | |||
| • | The decrease in total average enrollment of 3,865 members, or 0.6%, during the year 2003 when compared to 2002 is the result of flat employment levels in Puerto Rico during the last three years, employers’ difficulty in coping with increased premium pricing and the segment’s continued elimination of unprofitable Corporate accounts groups. The most significant decrease in enrollment is in the Corporate accounts business, which decreased 8,457 members, or 2.7%, during this period. This decrease is the result of the loss of one major account with approximately 16,000 members, net of new groups acquired during the year. The decrease experienced in this business is somewhat mitigated by the increase experienced in 2003 in the Self-funded Employers of 5,123 members, or 4.1%, since during this period certain large Corporate accounts groups shifted from the rated business to self-funded arrangements, assuming the risk associated with insuring their employees. | |||
The increase in premiums earned, net and fee revenues is attributable primarily to increased premium sales.
The claims incurred for the year 2003 were $9.6 million, or 1.7%, higher than 2002 as a consequence of a claims trend increase of 3.9% during the same period. The segment’s loss ratio reflects a decline of 0.6 percentage points during the same period. The improvement in the loss ratio is the result of the following:
| • | The overall claims trends development for the year 2003, although higher than the trend experienced during the year 2002, was lower than expected. | |||
| • | In addition, the segment continues with cost containment measures that have allowed cost and utilization trends to maintain levels consistent with pricing and margin objectives. These cost containment initiatives | |||
6
| have allowed the segment to maintain better utilization controls over outpatient services and pharmacy benefits. | ||||
| • | Also, the segment experienced a favorable development of $7.1 million of the 2002 claim liabilities estimate mostly because of better than expected utilization trends. | |||
The increase in operating expenses of $5.9 million, or 6.9%, is mostly due to the recognition of non-recurring pension settlements of $4.6 million resulting from the number of retirees selecting lump-sum benefits instead of annuities. In addition, the segment experienced slight increases in the acquisition cost of business, such as marketing and commission expenses, and in payroll and payroll related expenses.
Health Insurance — Reform Program Operating Results
| (Dollar amounts in thousands) | 2004 | 2003 | 2002 | |||||||||
Years ended December 31, | ||||||||||||
Average enrollment: | ||||||||||||
| North Area | 232,956 | 236,766 | 251,002 | |||||||||
| Metro- North Area | 217,441 | 224,903 | 202,028 | |||||||||
| Southwest Area | 164,357 | 168,109 | 162,088 | |||||||||
| Northwest Area | — | — | 78,168 | |||||||||
Total average enrollment | 614,754 | 629,778 | 693,286 | |||||||||
Premiums earned, net | $ | 484,742 | 477,614 | 487,000 | ||||||||
Claims incurred | $ | 437,834 | 428,045 | 445,039 | ||||||||
Operating expenses | 35,777 | 34,637 | 36,109 | |||||||||
Total underwriting costs | $ | 473,611 | 462,682 | 481,148 | ||||||||
Underwriting income | $ | 11,131 | 14,932 | 5,852 | ||||||||
Loss ratio | 90.3 | % | 89.6 | % | 91.4 | % | ||||||
Expense ratio | 7.4 | % | 7.3 | % | 7.4 | % | ||||||
Combined ratio | 97.7 | % | 96.9 | % | 98.8 | % | ||||||
General
The Health Insurance — Reform segment’s total revenues are primarily generated from premiums earned according to the provisions of the Government’s Reform contracts and investment income. Claims incurred include health services and other benefit expenses consisting primarily of payments to physicians, hospitals and other service providers. A portion of the claims incurred for each period consists of an actuarial estimate of claims incurred but not reported during the period. Operating expenses consist of disease management program, general, depreciation, payroll and other related expenses. The segment’s results of operations depend largely on its ability to accurately predict and effectively manage healthcare costs.
Year ended December 31, 2004 compared with the year ended December 31, 2003
The premiums earned, net of the Reform segment increased S7.1 million, or 1.5%, during the year 2004. This increase is the result of the following:
| • | During the Reform contract renegotiation process, premium rates were increased, effective July 1, 2004, by approximately 4.4% for a twelve-month period ending June 30, 2005 and 4.2% for the twelve month period ended June 30, 2004. | |||
| • | The average enrollment for this segment decreased by 15,024 members, or 2.4%, during the year 2004. This decrease is attributed to the continuous review and screening performed by the Government of Puerto Rico over the lists of persons eligible to participate in the Reform. | |||
The increase experienced in premiums earned, net is attributable primarily to increases in premium rates.
The increase of $9.8 million, or 2.3%, in claims incurred during the year 2004 is attributed to the higher utilization and costs experienced by the segment. The segment experienced an increase in utilization and some of the risks assumed by TSI, particularly catastrophe risks such as cardiovascular services, dialysis and obstetrics, among others. Also,
7
during 2004, capitation payments to IPA’s increased when compared to the prior year. The segment’s loss ratio also experienced an increase (0.7 percentage points) when comparing the year 2004 with 2003. In addition, during 2003 the claims incurred of the segment were affected by the favorable development of its claim liabilities, which was attributed to better than expected utilization trends in that particular year.
Operating expenses for the year 2004 were $1.1 million, or 3.3%, higher than the operating expenses for the year 2003. The expense ratio also increased, from 7.3% during 2003 to 7.4% during 2004. This fluctuation is due to the normal inflationary effect in operational costs.
Year ended December 31, 2003 compared with the year ended December 31, 2002
The premiums earned, net of the Reform segment decreased $9.4 million, or 1.9%, during the year 2003. This decrease is the result of the following:
| • | The average enrollment for this segment decreased by 63,508 members during the year 2003. This decrease is due to the net effect of the following: the loss of the Northwest Area, which seven municipalities were merged into the West Area (served by another carrier) effective July 1, 2002, and the fact that six new municipalities were assigned into areas serviced by the segment effective July 1, 2002. In addition, the continuous review and screening performed by the Government of Puerto Rico over the lists of persons eligible to participate in the Reform also contributed to the decrease in membership during this period. | |||
| • | Premium rates were increased by approximately 4.2% during the Reform contract renegotiation process for the twelve-month period ended June 30, 2004. In addition, the premium rates for the areas in which the segment has experienced an increase in its average enrollment (the Metro-North and Southwest areas) have higher premium rates than the areas where the segment has experienced a decrease in average enrollment. | |||
The decrease experienced in premiums earned, net is attributable primarily to the decrease in membership.
The decrease of $17.0 million, or 3.8%, in claims incurred during the year 2003 is attributed to the decrease in volume of business of the segment. The loss ratio also experienced a decrease (1.8 percentage points) during the year 2003. The decline in the loss ratio during the year 2003 is the result of increased premiums rates that accurately reflect the actual claims trend of each area, a change in the mix of membership within the areas served by the segment and claims cost containment measures established throughout the years.
Operating expenses for the year 2003 were $1.5 million, or 4.1%, lower than the operating expenses for the year 2002. This decrease is the result of the segment’s decreased membership in the year 2003. The expense ratio for the year 2003 declined by 0.1 percentage points due to a reduction in certain non-recurring expenses incurred in the year 2002.
8
Property And Casualty Insurance Operating Results
| (Dollar amounts in thousands) | 2004 | 2003 | 2002 | |||||||||
Years ended December 31, | ||||||||||||
Premiums written: | �� | |||||||||||
| Commercial multiperil | $ | 56,506 | 54,986 | 48,640 | ||||||||
| Dwelling | 28,323 | 22,624 | 17,165 | |||||||||
| Auto physical damage | 18,922 | 15,821 | 16,918 | |||||||||
| Commercial auto liability | 14,082 | 12,753 | 10,823 | |||||||||
| Other liability | 8,485 | 6,522 | 5,532 | |||||||||
| Medical malpractice | 6,499 | 5,986 | 5,857 | |||||||||
| All other | 9,057 | 9,435 | 7,346 | |||||||||
| Total premiums written | 141,874 | 128,127 | 112,281 | |||||||||
| Premiums ceded | (52,215 | ) | (43,771 | ) | (39,806 | ) | ||||||
| Change in unearned premiums | (3,431 | ) | (6,022 | ) | (11,787 | ) | ||||||
Net premiums earned | $ | 86,228 | 78,334 | 60,688 | ||||||||
Claims incurred | $ | 45,977 | 43,390 | 34,334 | ||||||||
Operating expenses | 40,182 | 37,354 | 25,549 | |||||||||
Total underwriting costs | $ | 86,159 | 80,744 | 59,883 | ||||||||
Underwriting income (loss) | $ | 69 | (2,410 | ) | 805 | |||||||
Loss ratio | 53.3 | % | 55.4 | % | 56.6 | % | ||||||
Expense ratio | 46.6 | % | 47.7 | % | 42.1 | % | ||||||
Combined ratio | 99.9 | % | 103.1 | % | 98.7 | % | ||||||
General
The property and casualty insurance segment’s total revenues are primarily generated from net premiums earned and investment income. Claims incurred are composed of losses and loss-adjustment expenses. A portion of the claims incurred for each period consists of an estimate of unreported losses to the segment during the period. Operating expenses consist of general, commissions, depreciation, payroll and other related expenses.
Year ended December 31, 2004 compared with the year ended December 31, 2003
Total premiums written for the year ended December 31, 2004 increased by $13.7 million, or 10.7%, when compared to the total premiums written for the year 2003. This increase is mostly reflected in the premiums written for the dwelling, auto physical damage and other liability lines of business, which experienced an increase in premiums of $5.7 million, or 25.2%, $3.1 million, or 19.6%, and $2.0 million, or 30.1%, during this period, respectively. The strengthening of business relationships with financial institutions has resulted in additional growth in the dwelling line of business. The commercial auto, including auto physical damage coverage, and other liability lines of business have been targeted for growth through new business.
The increase experienced in net premiums earned is mainly attributable to an increase in the segment’s volume of business.
Premiums ceded to reinsurers during the year 2004 increased by $8.4 million, or 19.3%, when compared to 2003. The ratio of premiums ceded to total premiums written reflects an increase of 2.6 percentage points, from 34.2% in 2003 to 36.8% in 2004. The increase in the ratio of premiums ceded to total premiums written is the net result of several factors:
| • | In 2004, the segment experienced increased costs for catastrophe coverage as well as the need to compensate for the coverage increase in the property business. | |||
| • | The amount of premiums ceded in the 2003 period was reduced as a result of the cancellation of the property surplus treaty. This cancellation resulted in a reinsurance portfolio transfer resulting in net incoming business and a reduction in the amount of premiums ceded. | |||
9
| • | During 2003 the segment increased its retention in the personal lines quota share treaty from 70% to 95%. In addition, as a result of the increased retention, the segment received an incoming reinsurance portfolio transfer causing a reduction in the premiums ceded in the 2003 period. |
The decrease in the change in unearned premiums of $2.6 million is also primarily due to the effect of the reinsurance portfolio transfers done during the year 2003 as well as to the changes in the mix of the business subscribed.
Claims incurred increased by $2.6 million, or 6.0%, when comparing the claims incurred during 2004 with the claims incurred in the year 2003. This increase is primarily due to incurred losses from the passing of Tropical Storm Jeanne in September 2004. Net incurred losses reported for Tropical Storm Jeanne amounted to $2.1 million. The loss ratio, on the other hand, experienced a decrease of 2.1 percentage points during the year 2004 as compared to the prior year since the segment’s loss experience was lower in the commercial multiperil and auto insurance lines of business. The auto insurance lines of business experienced an improvement in its loss ratio in both the physical damage and liability business.
The operating expenses for the year 2004 increased by $2.8 million, or 7.6%, when compared to the operating expenses for the year 2003. The expense ratio however, experienced a decrease of 1.1 percentage point during the year 2004. The fluctuation in the operating expenses and the expense ratio is, among other things:
| • | The effect of an increase in commission expense due to the segment’s increased volume of business | |||
| • | During 2004, the segment recorded a guaranty fund assessment to cover liabilities of insolvent companies. This assessment, which amounted to $871 thousand, was charged to operations during 2004. | |||
| • | The experience refund received from the Compulsory Vehicle Liability Insurance Joint Underwriting Association increased by $202 thousand, from $633 thousand during 2003 to $840 thousand during 2004. This refund is recorded as a decrease to the operating expenses for the period. | |||
Year ended December 31, 2003 compared with the year ended December 31, 2002
Total premiums written for the year ended December 31, 2003 were $15.8 million, or 14.1%, higher than the total premiums written for the year 2002. This increase in total premiums written was mostly reflected in the growth experienced by the following lines of business:
| • | As planned by the segment, the line of business with the largest growth was the commercial multiple peril line, where premiums written increased by $6.3 million, or 13.0%, during the year 2003. This increase was due to the production of new business since premium rates for this line have remained consistent throughout the year. | |||
| • | Dwelling premiums also contributed to this year’s increase in premiums written, as the premiums of this line increased by $5.5 million, or 31.8%. During 2003, the property and casualty segment devoted great efforts to strengthen lies with its financial institution partners. As a consequence of the new environment resulting from the Graham, Leach, Bhley Act, financial institutions have established their presence in the marketplace as general agents and/or producers. The segment was actively involved with these institutions with specific and tailor-made initiatives that have produced positive results. | |||
Approximately 90.0% of the increase in total premiums written was due to an increase in the segment’s volume of business. The remaining 10.0% was attributable to increases in premium rates.
Premiums ceded to reinsurers during the year 2003 reflect an increase of $4.0 million, or 10.0% that was attributed to the segment’s increased volume of business. The ratio of premiums ceded to total premiums written, however, reflects a decrease of 1.3 percentage points. The decline in the ratio of premiums ceded to total premiums written was the net result of several factors:
| • | The segment changed its major reinsurance vehicle for its commercial property business from a property first surplus treaty to a quota share arrangement. | |||
| • | During the 2003 reinsurance contract renewal process, the segment cancelled a commercial surplus reinsurance treaty. This cancellation propitiated a reinsurance portfolio transfer that resulted in the reacquisition of business previously ceded, and, accordingly, a reduction in premiums ceded. | |||
| • | The segment altered its catastrophe reinsurance program establishing, up to certain layers of protection, separate towers for commercial and personal business. | |||
| • | In addition, the segment acquired additional catastrophe protection as a result of increased premium volume projections. | |||
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Claims incurred increased during 2003 $9.1 million, or 26.4% primarily as a result of the segment’s increased volume of business. The segment’s loss ratio however, declined by 1.2 percentage points during the same period. The decline in the loss ratio was mostly the result of favorable underwriting results in the commercial multiperil line of business (principally due to the portfolio quality and maturity), a change in the mix of business subscribed and an increased retention of the segment’s profitable lines of business, which increased the premiums earned base. Also, the auto liability line of business experienced an improvement in its loss ratio as a result of premium rate increases and reserve releases.
The operating expenses increased by $11.8 million during the year 2003. The expense ratio experienced an increase of 5.6 percentage points in 2003. The increase in the operating expenses and the expense ratio was, among other things, the net effect of an increase in commission expense due to the segment’s increased volume of business and a decrease in the reinsurance commission income from reinsurance treaties. In addition, during the year 2003 the segment experienced an increase in certain non-recurring expenses, such as an assessment from a guarantee association and consulting services, among others.
Liquidity And Capital Resources
Cash Flows
The Corporation maintains good liquidity measures due to the quality of its assets, the predictability of its liabilities, and the duration of its contracts. The liquidity of the Corporation is primarily derived from the operating cash flows of its insurance subsidiaries.
As of December 31, 2004 and 2003, the Corporation��s cash and cash equivalents amounted to $ 35.1 million and $47.7 million, respectively. Sources of funds considered in meeting the objectives of the Corporation’s operations include cash provided from operations, maturities and sales of securities classified within the trading and available-for-sale portfolios, securities sold under repurchase agreements, and issuance of long and short-term debt.
Net cash flows from operations are expected to sustain operations for the next year and thereafter, as long as the operations continue showing positive results. In addition, the Corporation monitors its premium rates and its claims incurred to ascertain proper cash flows and has the ability to increase premium rates throughout the year in the monthly renewal process.
Cash Flows from Operations
Most of the cash flows from operating activities are generated from the insurance subsidiaries. The basic components of the cash flows from operations are premium collections, claims payments less reinsurance premiums, maturities or sales and purchases of trading securities, and payment of operating expenses.
Net cash flows provided by operating activities amounted to $8.8 million, $10.1 million and $56.8 million as of December 31, 2004, 2003 and 2002, respectively, a decrease of $1.3 million and $46.7 million in 2004 and 2003, respectively. The fluctuation in cash flows provided by operating activities is mainly attributed to the net effect of the following:
| • | Increase in collections of premiums of $35.3 million in 2004 and $30.5 million in 2003. The increase in premium collections is the result of the increased premium rates and increased volume of business of the operating segments. | |||
| • | Increase of $13.2 million in 2004 and $17.8 million in 2003 in the amount of cash paid to suppliers and employees. This increase is basically attributed to additional commission expense generated from the acquisition of new business and general operating expenses. | |||
| • | Increase of $26.3 million and $15.5 million in 2004 and 2003, respectively, in the amount of claims losses and benefits paid. In both years the increase in the amount of claims losses and benefits paid is mostly the result of the segment’s increased volume of business as well to the Health Insurance segments increased costs per service and higher utilization trends. | |||
| • | Increase in income taxes paid of $5.4 million in 2004 and $38.9 million in 2003. The increase in the amount of income taxes paid is mostly the result of payments to the PRTD in accordance with the closing agreement executed in 2003. The first installment stipulated in the closing agreement, amounting to $37.0 million was made on July 31, 2003. The second installment of the closing agreement, amounting to $14.8 million, was made on April 15, 2004. In addition, during 2004 TSI made a payment of $17.8 million corresponding to its income tax liability for the year 2003 and estimated income tax payments amounting to $10.4 million. | |||
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| • | In addition, during the year 2004 the amount of net acquisitions of investments in the trading portfolio decreased by $12.3 million. In 2003, the amount of net acquisitions of investments in the trading portfolio increased by $ 14.2 million. | |||
| • | The contingency reserve funds payment from the Federal Employee Health Benefit Plan decreased by $7.8 million in 2004. During the year 2003, the contingency reserve funds payment was $7.0 million more than the payment received during the prior year. The amount collected from the contingency reserve funds of the FEHBP was $5.2 million, $13.0 million and $6.0 million during 2004, 2003 and 2002, respectively. This fluctuation is related to the results of operations of the program during each particular year. | |||
This excess liquidity is available, among other things, to invest in high quality and diversified fixed income securities and, to a lesser degree, to invest in marketable equity’ securities.
Cash Flows from Investing Activities
The basic components of the cash flows from investing activities is derived from acquisitions and proceeds from investments in the available-for-sale and held-to-maturity portfolios, and capital expenditures. The Corporation monitors the duration of its investment portfolio and executes purchases and sales of these investments with the objective of having adequate asset allocation within different sectors and to have funds available, when necessary, to satisfy any maturing liability.
Net cash flows used in investing activities amounted to $45.0 million, $90.6 million and $43.5 million as of December 31, 2004, 2003 and 2002, respectively. The cash flows used in investing activities during these years was mainly due to the investment of the excess cash generated from the operations and reinvestment of securities called or matured during the same period. Total acquisition of investments exceeded the proceeds from investments sold or matured by $41.5 million and $87.5 million during the years 2004 and 2003, respectively.
Cash Flows from Financing Activities
Net cash flows provided by (used in) financing activities amounted to $23.5 million, $45.5 million and $(11.5) million for the years ended December 31, 2004, 2003 and 2002, respectively. The decrease of $22.0 million during the year 2004 and the increase of $57.0 million during the year 2003 in the cash flows from financing activities are due to the effect of the following fluctuations:
| • | The change in outstanding checks in excess of bank balances increased by $9.5 million during the year 2004 and decreased by $1.7 during the year 2003. This represents a timing difference between the issuance of checks and the cash balance in the bank account at one point in time. | |||
| • | Total debt repayments amounted to $39.6 million, $1.6 million and $5.6 million during the years 2004, 2003 and 2002, respectively. The increase of $38.0 million in debt repayments during 2004 is due to the repayment of short-term borrowings amounting to $37.0 million as well as to the scheduled payment of $1.0 million that was done on one of the credit agreements. The decrease of $4.0 million in debt repayments during 2003 is due to the additional repayments made during the year 2002 over the scheduled principal payments of the credit agreements. During the year 2003, the Corporation made only the principal payments scheduled in the credit agreements. | |||
| • | Total debt proceeds amounted to $50.0 million and $38.7 million during the years 2004 and 2003. There were no debt proceeds during the year 2002. In 2004, the Corporation received proceeds from the senior unsecured notes amounting to $50.0 million. In 2003, the Corporation received $38.7 million from the issuance of short-term borrowings. This represents an increase of $11.3 million in the amount of proceeds received from the issuance of debt. | |||
| • | The amount of net proceeds (surrenders) of annuity contracts during the years 2004, 2003 and 2002 amounted to $6.4 million, $11,2 million and $(l.5) million, respectively. This fluctuation is basically due to the Corporation’s new deferred annuity product introduced in late 2002. | |||
Financing and Financing Capacity
The Corporation has significant short-term liquidity supporting its businesses. It also has available short-term borrowings that from time to time address timing differences between cash receipts and disbursements. These short-term borrowings are mostly in the form of securities sold under repurchase agreements. As of December 31, 2004, the Corporation had $227.5 million in available credit on these agreements. Outstanding short-term borrowings as of December 31, 2004 amount to $1.7 million. The amount due under outstanding short-term borrowings is expected to be paid out of the operating and investing cash flows of the Corporation.
In September 30, 2004 TSI issued and sold $50.0 million of its 6.30% senior unsecured notes due September 2019 (the notes). The notes are unconditionally guaranteed as to payment of principal, premium, if any, and interest by the
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Corporation. The notes were privately placed to various institutional investors under a note purchase agreement among TSI, the Corporation and the investors. The notes pay interest semiannually beginning on March 2005, until such principal becomes due and payable. The notes contain certain covenants with which TSI and the Corporation have complied with at December 31, 2004. Most of the proceeds obtained from this issuance were used to repay $37.0 million of short-term borrowings made by TSI. The remaining proceeds were used for general business purposes.
In addition, the Corporation has two credit agreements with a commercial bank, FirstBank Puerto Rico. These credit agreements bear interest rates determined by the London Interbank Offered Rate (LIBOR) plus a margin specified at the time of the agreement. As of December 31, 2004, the two credit agreements have outstanding balances of $30.7 million and $15.0 million and average annual interest rates of 3.30% and 3.32%, respectively. The first agreement stipulates monthly principal repayment of $137 thousand. The second agreement stipulates repayments of principal amounts of not less than $250 thousand and in integral multiples of $50 thousand. The aggregate principal amounts of this credit agreement shall be reduced annually to the amounts specified on or before the dates described below:
| Required Principal | ||||
| Outstanding | ||||
| Date | Balance | |||
| (amounts in thousands) | ||||
| August 1, 2005 | $ | 13,500 | ||
| August 1, 2006 | 12,000 | |||
| August 1, 2007 | — | |||
These credit agreements are guaranteed by a first position on the Corporation’ land, building, and substantially all leasehold improvements, as collateral for the term of the agreements under a continuing general security agreement. These credit facilities contain certain covenants which are normal in this type of facility. As of December 31, 2004, management believes the Corporation is in compliance with these covenants. Failure to meet these covenants may trigger the accelerated payment of the credit agreements’ outstanding balance. Principal repayments on these loans are expected to be paid out from the operating and investing cash flows of the Corporation.
The Corporation continually monitors existing and alternative financing sources to support its capital and liquidity needs.
Planned Capital Expenditures
To provide for the future growth of its operations, the Corporation is planning the construction, on land already owned, of a new six-floor building that will basically house the operations of some divisions of TSI and STS and the operations of ISI, including its mainframe facilities. ISI’s mainframe facilities are currently located in leased property that will be vacated once the project is completed. In addition, as part of this project the Corporation is also planning the construction of a multi-level parking building which will add approximately 500 parking spaces. This project is expected to be completed during the year 2007-2008. The cost of this project is estimated at approximately $22.0 million and is expected to be financed using credit facilities available to the Corporation.
Contractual Obligations
The Corporation’s contractual obligations impact its short and long-term liquidity and capital resource needs. However, the Corporation’s future cash flow prospects cannot be reasonably assessed based 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), the reality is that most are dependent on future events (such as the payout pattern of claim liabilities which have been incurred but not reported).
The following table includes the aggregated information about the Corporation’s contractual obligations. The information presented in the table includes payments due under specified contractual obligations, aggregated by type of contractual obligation, including the maturity profile of the Corporation’s debt, operating leases and other long-term liabilities. The table below excludes an estimate of the future cash outflows related to the following long-term liabilities:
| • | Annuity contracts — The cash outflows related to these instruments are not included since these annuities do not have defined maturities, such that the timing of payments and withdrawals is uncertain. There are currently no annuities in paying status. |
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| • | Pension plan contributions – Pension plan contributions arc excluded from the following table since the estimated amount of pension contributions are 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. | |||
| • | Other long-term liabilities – Due to the indeterminate nature of their cash outflows, certain categories of other long-term liabilities are not included in the following table. These include deferred tax liability and other miscellaneous long-term liabilities. | |||
| Contractual Obligations by year | ||||||||||||||||||||||||||||
| (Dollar amounts in thousands) | Total | 2005 | 2006 | 2007 | 2008 | 2009 | Thereafter | |||||||||||||||||||||
| Long-term borrowings (1) | $ | 142,193 | 6,290 | 6,290 | 16,790 | 4,790 | 4,790 | 103,243 | ||||||||||||||||||||
| Operating leases | 9,029 | 3,441 | 2,393 | 1 ,693 | 481 | 266 | 755 | |||||||||||||||||||||
| Purchase obligations (2) | 18,998 | 16,271 | 1,052 | 984 | 437 | 254 | — | |||||||||||||||||||||
| Claim liabilities (3) | 252,770 | 190,278 | 26,779 | 11,684 | 8,754 | 7,768 | 7,507 | |||||||||||||||||||||
| $ | 422,990 | 216,280 | 36,514 | 31,151 | 14,462 | 13,078 | 111,505 | |||||||||||||||||||||
| (1) | As of December 31, 2004, the Corporation’s long-term borrowings consist of $50.0 million of the senior unsecured notes payable and $45.7 million of loans payable to a commercial bank. Total contractual obligations for long-term borrowings include the current maturities of long term debt. The $50.0 million senior unsecured notes have a fixed interest rate of 6.30%; scheduled interest payments (amounting to $46.5 million) were included in the total contractual obligations for long-term borrowings until the notes due date in 2019. According to the terms of the notes, prepayments can be made from September 2007 on; however no prepayment is considered in this schedule. No interest payments were included for the Corporation’s loans payable due to its variable interest rate structure. | |||
| (2) | Purchase obligations represent payments required by the Corporation 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 are excluded from the table above. Any amounts for which the Corporation is liable under purchase orders are reflected in the audited consolidated balance sheets as accounts payable and accrued liabilities. | |||
| (3) | Claim liabilities represent the amount of claims processed and incomplete of the Corporation 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, 2004. The expected claims payments of the health insurance, property and casualty insurance and group life insurance were estimated using claims payment experience. The expected claims payments of the long-term disability insurance were estimated using actuarial estimates of expected pay-outs of those policies on which we already are making periodic payments. The expected claims payments are an estimate and may not necessarily present the actual claims payments to be made by the Corporation. Also, the estimated claims payments included in the table above do not include $26.6 million of reserves ceded under reinsurance contracts. As of December 31, 2004, the Corporation’s ceded reserves are included within the reinsurance recoverable balance in the consolidated financial statements. Since reinsurance contracts do not relieve the Corporation from its obligations to policyholders, in the event that any of the reinsurance companies is unable to meet its obligations under the existing reinsurance agreements, the Corporation would be liable for such defaulted amounts. The Corporation monitors the solvency of its reinsurance carriers and does not believe the risk of insolvency is significant. | |||
As of December 31, 2004, the Corporation had $227.5 million in available credit in various financial institutions, all of which expire within one year. These short-term borrowings are mostly in the form of securities sold under repurchase agreements. As of December 31, 2004, outstanding short-term borrowings under these agreements amount to $ 1.7 million and are expected to be paid out of the operating and investing cash flows of the Corporation. Since the commitment associated with these financing arrangements may expire unused, other than the outstanding balance as of year-end, these amounts do not necessarily reflect actual future cash outflow requirements.
Off-Balnnce Sheet Arrangements
The Corporation does not have any material off-balance sheet arrangements, trading activities involving non-exchange related contracts accounted for at fair value or relationships with persons or entities that derive benefits from a non-independent relationship with the Corporation or the Corporation’s related parties.
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Restriction on Certain Payments by the Corporation
The Corporation has not distributed dividends by virtue of resolution of its shareholders. However, on April 27, 2003, at its Annual Meeting, a resolution was approved by the Shareholders acknowledging that the Board of Directors (the Board) may declare dividends subject to the Board’s determination that in their best judgment the payment of dividends is financially and legally feasible.
TSM’s insurance subsidiaries are subject to the regulations of the Commissioner of Insurance of the Commonwealth of Puerto Rico. These regulations, among other things, require insurance companies to maintain certain levels of capital; therefore, restricting the amount of earnings that can be distributed. As of December 31, 2004, the insurance subsidiaries were in compliance with such minimum capital requirements. These regulations are not directly applicable to TSM, as a holding company, since it is not an insurance company. The regulations applicable to insurance subsidiaries are not expected to affect their ability to distribute dividends to TSM.
The credit agreements restrict the amount of dividends that TSM and its subsidiaries can declare or pay to stockholders. According to the credit agreements, the dividend payment cannot exceed the accumulated retained earnings of the paying entity.
None of the previously described dividend restrictions are expected to have a significant effect on TSM’s ability to meet its cash obligations.
Solvency Regulation
To monitor the solvency of the operations, the Blue Cross and Blue Shield Association (BCBSA) requires TSM and TSI 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 (RBC ratio). The RBC ratio reflects the risk profile of insurance companies. At December 31, 2004, both entities had a RBC ratio above the level required by BCBSA.
Other Contingencies
| (1) | Legal Proceedings Various litigation claims and assessments against the Corporation have arisen in the course of the Corporation’s business, including but not limited to, its activities as an insurer and employer. Furthermore, the Commissioner of Insurance of the Commonwealth of Puerto Rico, as well as other Federal and Puerto Rico government authorities regularly make inquiries and conduct audits concerning the Corporation’s compliance with applicable insurance and other laws and regulations. |
Based on the information currently known by the Corporation’s management, in its opinion, the outcomes of such pending investigations and legal proceedings are not likely to have a material adverse effect on the Corporation’s 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 the Corporation’s operating results and/or cash flows (see “Item 3. Legal Proceedings”).
| (2) | Guarantee Association – To operate in Puerto Rico, insurance companies, such as TSM’s insurance subsidiaries, are required to participate in guarantee associations, which are organized to pay policyholders contractual benefits on behalf of insurers declared to be 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. During the years 2004, 2003 and 2002, the Corporation paid assessments in connection with insurance companies declared insolvent in the amount of $1.1 million, $500 thousand and $654 thousand, respectively. It is the opinion of management that any possible future guarantee association assessments will not have a material effect on the Corporation’s operating results and/or cash flows. | |||
| (3) | Pursuant to the Puerto Rico Insurance Code, the property and casualty insurance segment is a member of Sindicato de Aseguradores para la Suscripción Conjunta de Seguros de Responsabilidad Profesional Médico-Hospitalaria (SIMED) and of the Sindicato de Ascguradores de Responsabilidad Professional para Médicos. Both syndicates were organised for the purpose of underwriting medical-hospital professional liability insurance. As a member, the segment shares risks with other member companies and, accordingly, is contingently liable in the event the previously mentioned syndicates cannot meet their obligations. During 2004, 2003 and 2002, no assessment or payment was made for this contingency. | |||
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In addition, pursuant to Article 12 o Rule LXIX of the Insurance Code, the property and casualty insurance segment is a member of the Compulsory Vehicle Liability Insurance Joint Underwriting Association (the Association). The Association was organized during 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 three-year period ended December 31, 2004, the Association distributed experience refunds. The segment received refunds amounting to $840, $638, and $565 in 2004, 2003, and 2002, respectively.
Critical Accounting Estimates
The Corporation’s consolidated financial statements and accompanying notes have been prepared in accordance with generally accepted accounting principles applied on consistent basis. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.
The Corporation continually evaluates the accounting policies and estimates it uses to prepare the consolidated financial statements. In general, management’s estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the facts and circumstances. Actual results could differ from those estimates made by management.
The policies discussed below are considered by management to be critical to an understanding of the Corporation’s 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 forecast, and that the best estimates routinely require adjustment. Management believes that the amounts provided for these critical accounting estimates are adequate.
Claim Liabilities
The Corporation recognizes claim liabilities for all its insurance subsidiaries as follows:
| • | Claims processed and incomplete for the health insurance segments represent the estimated amounts to be paid to providers based on experience, modified to reflect current trends, and accumulated statistical data. Loss-adjustment expenses related to such claims are accrued based on estimated future expenses necessary to process such claims. | |||
| • | Claims processed and incomplete and loss-adjustment expenses of the property and casualty insurance segment represents the individual case estimate for reported claims and estimates for unreported losses, net of any salvage and subrogation as well as an estimate of expenses for investigating and settling claims. These estimates are based on analysis of prior loss experience modified for current trends. | |||
| • | Claims processed and incomplete of the life and disability insurance segment are based on the amount of benefits contractually determined for reported claims and on estimates for unreported claims. These estimates are based on analysis of prior loss experience modified for current trends. | |||
Claim liabilities amounted to $279.3 million as of December 31, 2004; of that total, $127.3 million are related to unreported losses and $14.7 million are related to unpaid loss-adjustment expenses. The remaining balance corresponds to claims processed and incomplete.
Management continually evaluates the potential for changes in its claim liabilities estimates, both positive and negative, and uses the results of these evaluations both to adjust recorded claim liabilities and to adjust underwriting criteria. The Corporation’s profitability depends in large part on accurately predicting and effectively managing the amount of claims incurred, particularly those of the health insurance segments and the losses arising from the property and casualty insurance segment. Management regularly reviews its premiums and benefits structure to reflect the Corporation’s underlying claims experience and revised actuarial data, however, several factors could adversely affect the Corporation’s underwriting. Some of these factors are beyond management 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, the advent of natural disasters, and malpractice litigation. Costs in excess of those anticipated could have a material adverse effect on the Corporation’s results of operations.
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Impairment of Investments
A decline in the estimated fair value of any available for sale or held to maturity security below cost, which is deemed to be other than temporary, results in a reduction of the carrying amount to its fair value. The impairment is charged to operations and a new cost basis for the security is established. Management regularly reviews each investment security for impairment based on criteria that include the extent to which cost exceeds estimated fair value, the duration of the estimated fair value decline and the financial health and specific prospects for the issuer. Management regularly performs market research and monitors market conditions in order to minimize impairment risk. Investment in securities amounted to $677.1 million as of December 31, 2004. Gross unrealized gains and losses included in that carrying amount related to fixed maturity securities amounted to $4.7 million and $2.5 million, respectively. Gross unrealized gains and losses on equity securities, classified as securities held for trading and securities held as available for sale, amounted to $38.4 million and $1.8 million, respectively. Management believes that none of the securities whose carrying amount exceeds its estimated fair value at December 31, 2004 is permanently impaired as of that date; however, several factors are beyond management’s control such as the following: financial condition of the issuer, movement of interest rates, among others. During the year 2002, the Corporation recognized an other than temporary impairment on one of its available for sale securities amounting to $311 thousand. No other than temporary impairment was recognized in during the years 2004 and 2003. A detail of the gross unrealized losses on investment securities and the estimated fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2004 and 2003 is included in note 3 to the consolidated financial statements.
Allowance for Doubtful Receivables
The Corporation estimates the amount of uncollectible receivables in each period and establishes an allowance for doubtful receivables. The amount provided is based on management’s continuous evaluation of the aging of accounts receivable and such other factors that deserve current recognition. A change in the level of uncollectible accounts could have a significant effect on the Corporation’s results of operations. The allowance for doubtful receivables amounted to $ 11.2 million and $9.0 million as of December 31, 2004 and 2003, respectively.
Other Significant Accounting Policies
The Corporation has other significant accounting policies that do not involve the same degree of measurement uncertainty as those discussed above, that are nevertheless important to an understanding of the financial statements. These significant accounting policies are disclosed in note 2 of the notes to the audited consolidated financial statements.
Recently Issued Accounting Standards
FASB Statement No. 153,Exchanges of Nonmonetary Assets, an Amendment of APB Opinion No.29, was issued in December 2004. This Statement amends APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges on nonmonetary assets that do not have commercial substance. The Corporation is required to adopt this Statement on January 1, 2006. The adoption of this Statement is not expected to have any impact on the Corporation’s financial statements.
Quantitative and Qualitative Disclosures About Market Risk.
The Corporation is exposed to certain market risks that are inherent in the Corporation’s financial instruments, which arise from transactions entered into in the normal course of business. The Corporation does not enter into derivative financial instrument transactions to manage or reduce market risk or for speculative purposes, but is subject to market risk on certain of its financial instruments. The Corporation must effectively manage, measure, and monitor the market risk associated with its invested assets and interest rate sensitive liabilities. It has established and implemented comprehensive policies and procedures to minimize the effects of potential market volatility.
Market Risk Exposure
The Corporation has exposure to market risk mostly in its 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.
As in other insurance companies, investment activities are an integral part of the Corporation’s business. Insurance statutes regulate the type of investments that the insurance segments are permitted to make and limit the amount of funds that may be invested in some types of securities. The Corporation has a well-diversified investment portfolio with good asset quality and a large portion invested in Investment-grade, fixed income securities.
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The Corporation’s investment philosophy is to maintain a largely investment-grade fixed income portfolio, provide adequate liquidity for expected liability durations and other requirements, and maximize total return through active investment management.
The Corporation evaluates the interest rate risk of its assets and liabilities regularly, as well as the appropriateness of investments relative to its internal investment guidelines. The Corporation operates within these guidelines by maintaining a well-diversified portfolio, both across and within asset classes. Investment decisions are centrally managed by investment professionals based on the guidelines established by management. The Corporation has a Finance Committee, composed of members of the Board of Directors, which monitors and approves investment policies and procedures. The investment portfolio is managed following those policies and procedures.
The Corporation’s investment portfolio is predominantly comprised of U.S. treasury securities, obligations of U.S. government instrumentalities, obligations of state and political subdivisions, and obligations of the Commonwealth of Puerto Rico and its instrumentalities, which comprise approximately 70% of the total portfolio value in the year 2004. Of this 70% of total portfolio value, approximately 9% is composed of U. S. agency-backed mortgage backed securities and collateralized mortgage obligations. The remaining balance of the investment portfolio consists of an equity securities portfolio that replicates the S&P 500 Index, a large-cap growth index, a large-cap value index, a corporate bonds portfolio, mutual funds, and investments in strong local stocks from well-known financial institutions.
The Corporation measures market risk related to its holdings of invested assets and other financial instruments utilizing a sensitivity analysis. This analysis estimates the potential changes in fair value of the instruments subject to market, risk. The sensitivity analysis was performed separately for each of the Corporation’s market risk exposures related to its trading and other than trading portfolios. This sensitivity analysis is an estimate and should not be viewed as predictive of the Corporation’s future financial performance. The Corporation cannot assure that its actual losses in any particular year will not 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; | |||
| • | The model assumes that the composition of assets and liabilities remains unchanged throughout the year. | |||
Accordingly, the Corporation uses such models as tools and not as a substitute for the experience and judgment of its management and Board of Directors.
Interest Rate Risk
The Corporation’s exposure to interest rate changes results from its significant holdings of fixed maturity securities. Fixed maturities include U.S. and Puerto Rico government bonds, securities issued by government agencies, corporate bonds and mortgage-backed securities. Investments subject to interest rates risk are located within the Corporation’s trading and other-than-trading portfolios. The Corporation is also exposed to interest rate risk from its two variable interest credit agreements and from its annuity contracts.
Equity Price Risk
The Corporation’s investments in equity securities expose it to equity price risks, for which potential losses could arise from adverse changes in the value of equity securities. Financial instruments subject to equity prices risk are located within the Corporation’s trading and other-than-trading portfolios.
Risk Measurement
Trading Portfolio
The Corporation’s trading securities are a source of market risk. As of December 31, 2004, the Corporation’s trading portfolio is composed of investments in publicly traded common stock (approximately 54% of total trading portfolio value) and investments in corporate bonds (approximately 30% of total trading portfolio value). The remaining balance of the trading portfolio is comprised of U.S. Treasury securities and obligations of U.S. government instrumentalities. The securities in the trading portfolio are high quality, diversified across industries and readily marketable. Trading securities are recorded at fair value; changes in the fair value of these securities are included in operations. The fair value of the investments in trading securities is exposed to both interest rate risk and equity price risk.
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| (1) | Interest Rate Risk – The Corporation has evaluated the net impact to the fair value of its fixed income investments 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 an instantaneous 100, 200 and 300 basis points (bp) 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 under the aforementioned scenarios include mostly 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, 2004 and 2003. |
| (Dollar amounts in thousands) | ||||||||||||
| Expected | Amount of | % | ||||||||||
Change in Interest Rates | Fair Value | Decrease | Change | |||||||||
December 31, 2004: | ||||||||||||
| Base Scenario | $ | 72,423 | ||||||||||
| +100bp | $ | 68,862 | (3,561 | ) | (4.92 | )% | ||||||
| +200 bp | $ | 65,655 | (6,768 | ) | (9.35 | )% | ||||||
| +300 bp | $ | 62,751 | (9,672 | ) | (13.35 | )% | ||||||
December 31, 2003: | ||||||||||||
| Base Scenario | $ | 68,681 | ||||||||||
| +100 bp | $ | 65,095 | (3,586 | ) | (5.22 | )% | ||||||
| +200 bp | $ | 61,821 | (6,860 | ) | (9.99 | )% | ||||||
| +300 bp | $ | 58,816 | (9,865 | ) | (14.36 | )% | ||||||
| The Corporation believes that an interest rate shift in a 12-month period of 100 bp represents a moderately adverse outcome, while a 200 bp shift is significantly adverse and a 300 bp shift is unlikely given historical precedents. | ||||
| (2) | Equity Price Risk – The Corporation’s equity securities in the trading portfolio are comprised primarily of publicly traded common stock. Assuming an immediate decrease of 10% in the market value of these securities as of December 31, 2004 and 2003, the hypothetical loss in the fair value of these investments is estimated to be approximately $8.7 million and $6.7 million, respectively. | |||
Other than Trading Portfolio
The Corporation’s available-for-sale and held-to-maturity securities are also a source of market risk. As of December 31, 2004 approximately 88% and 100% of the Corporation’s investments in available-for-sale and held-to-maturity securities, respectively, consisted of fixed income securities. The remaining balance of the available-for-sale portfolio is comprised of equity securities. Available-for-sale securities are recorded at fair value, changes in the market 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 until realized. Held-to-maturity securities are recorded at
amortized cost, adjusted for the amortization, or accretion of premiums or discounts. The fair value of the investments in the other than trading portfolio is exposed to both interest rate risk and equity price risk.
| (1) | Interest Rate Risk – The Corporation has evaluated the net impact to the fair value of its fixed income investments 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 an instantaneous 100, 200 and 300 bp 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 under the aforementioned scenarios include, as it relates to the Corporation, 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, 2004 and 2003. |
19
| (Dollar amounts in thousands) | ||||||||||||
| Expected | Amount of | % | ||||||||||
| Change in Interest Rates | Fair Value | Decrease | Change | |||||||||
December 31, 2004: | ||||||||||||
| Base Scenario | $ | 482,019 | ||||||||||
| +100 bp | $ | 465,335 | (16,684 | ) | (3.46 | )% | ||||||
| +200 bp | $ | 446,588 | (35.431 | ) | (7.35 | )% | ||||||
| +300 bp | $ | 428,419 | (53,600 | ) | (11.12 | )% | ||||||
December 31, 2003: | ||||||||||||
| Base Scenario | $ | 434,041 | ||||||||||
| +100bp | $ | 419,490 | (14,551 | ) | (3.35 | )% | ||||||
| +200 bp | $ | 398,357 | (35,684 | ) | (8.22 | )% | ||||||
| +300 bp | $ | 373,374 | (60,667 | ) | (13.98 | )% | ||||||
| The Corporation believes that an interest rate shift in a 12-month period of 100 bp represents a moderately adverse outcome, while a 200 bp shift is significantly adverse and a 300 bp shift is unlikely given historical precedents. Although the Corporation classifics 84% of its fixed income securities as available-for-sale, the Corporation’s cash flows and the intermediate duration of its investment portfolio should allow it to hold securities until their maturity, thereby avoiding the recognition of losses, should interest rates rise significantly. | ||||
| (2) | Equity Price Risk– The Corporation’s equity securities in the available-for-sale portfolio are comprised primarily of stock of several Puerto Rico financial institutions and mutual funds. Assuming an immediate decrease of 10% in the market value of these securities as of December 31, 2004 and 2003, the hypothetical loss in the fair value of these investments is estimated to be approximately $5.9 million and $5.6 million, respectively. | |||
Other Risk Measurement
The Corporation is subject to interest rate risk on its two credit agreements, its annuity contracts and on its short-term borrowings. Shifting interest rates do not have a material effect on the fair value of these instruments. The two credit agreements have a variable interest rate structure, which reduces the potential exposure to interest rate risk. The annuity contracts have short-term interest rate guarantees, which also reduce the accounts’ exposure to interest rate risk. In addition, the brief maturity of the Corporation’s short-term borrowings reduces the instrument’s exposure to interest rate risk.
The Corporation has an interest-rate related derivative instrument to manage the variability caused by interest rate changes in the cash flows of one of its credit agreements. The Corporation does not enter into derivative instruments for any purpose other than cash flow hedging purposes. That is, the Corporation does not speculate using derivative instruments. This swap changes the variable-rate cash flow exposure on the debt obligations to fixed-rate cash flows. Shifting interest rates have an effect in the fair value of the interest rate swap agreement.
The Corporation assesses interest rate risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact the fair value of the interest rate swap agreement. The Corporation monitors interest rate risk attributable to both the Corporation’s outstanding or forecasted debt obligations as well as the Corporation’s offsetting hedge position. As of December 31, 2004 and 2003, $142 thousand and $601 thousand, respectively, of deferred loss on the derivative instrument was included within the accounts payable and accrued liabilities in the consolidated balance sheets. Assuming an immediate decrease of 10% in period end rates as of December 31, 2004 and 2003, the hypothetical loss in the fair value of the derivative instrument is estimated to be approximately $14 thousand and $60 thousand, respectively.
20
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(With Independent Auditors’ Report Thereon)
21
KPMG LLP
American International Plaza
Suite 1100
250 Muñoz Rivera Avenue
San Juan, PR 00918-1819
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Triple-S Management Corporation and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Triple-S Management Corporation and Subsidiaries (the Company) as of December 31, 2004 and 2003, and the related consolidated statements of earnings, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Triple-S Management Corporation and Subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.
March 4, 2005
San Juan, Puerto Rico
Stamp No. 1988689 of the Puerto Rico
Society of Certified Public Accountants
was affixed to the record copy of this report.
[ILLEGIBLE]
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
| 2004 | 2003 | |||||||
Assets | ||||||||
| Investments and cash: | ||||||||
| Securities held for trading, at fair value: | ||||||||
| Fixed maturities (amortized cost of $70,668 in 2004 and $66,919 in 2003) | $ | 72,423 | 68,681 | |||||
| Equity securities (cost of $74,824 in 2004 and $58,101 in 2003) | 86,596 | 66,824 | ||||||
| Securities available for sale, at fair value: | ||||||||
| Fixed maturities (amortized cost of $444,135 in 2004 and $405,547 in 2003) | 444,637 | 407,530 | ||||||
| Equity securities (cost of $34,309 in 2004 and $33,877 in 2003) | 59,186 | 56,040 | ||||||
| Securities held to maturity, at amortized cost: | ||||||||
| Fixed maturities (fair value of $14,503 in 2004 and $5,591 in 2003) | 14,280 | 5,478 | ||||||
| Cash and cash equivalents | 35,115 | 47,743 | ||||||
| Total investments and cash | 712,237 | 652,296 | ||||||
| Premiums and other receivables, net | 113,323 | 93,491 | ||||||
| Deferred policy acquisition costs | 18,712 | 16,671 | ||||||
| Property and equipment, net | 32,364 | 34,212 | ||||||
| Other assets | 43,021 | 37,953 | ||||||
| Total assets | $ | 919,657 | 834,623 | |||||
Liabilities and Stockholders’ Equity | ||||||||
| Claim liabilities: | ||||||||
| Claims processed and incomplete | $ | 137,282 | 121,015 | |||||
| Unreported losses | 127,324 | 112,449 | ||||||
| Unpaid loss-adjustment expenses | 14,719 | 14,456 | ||||||
| Total claim liabilities | 279,325 | 247,920 | ||||||
| Unearned premiums | 84,583 | 78,704 | ||||||
| Annuity contracts | 34,071 | 26,661 | ||||||
| Liability to Federal Employees’ Health Benefits Program | 9,791 | 7,471 | ||||||
| Accounts payable and accrued liabilities | 100,388 | 88,342 | ||||||
| Short-term borrowings | 1,700 | 38,700 | ||||||
| Income tax payable | 1,827 | 32,222 | ||||||
| Net deferred tax liability | 1,969 | 1,892 | ||||||
| Additional minimum pension liability | 8,840 | 10,081 | ||||||
| Long-term borrowings | 95,730 | 48,375 | ||||||
| Total liabilities | 618,224 | 580,368 | ||||||
| Stockholders’ equity: | ||||||||
| Common stock, $40 par value. Authorized 12,500 shares; issued and outstanding 8,904 and 9,030 shares at December 31, 2004 and 2003, respectively | 356 | 361 | ||||||
| Additional paid-in capital | 150,408 | 150,407 | ||||||
| Retained earnings | 134,531 | 88,728 | ||||||
| Accumulated other comprehensive income | 16,138 | 14,759 | ||||||
| 301,433 | 254,255 | |||||||
| Commitments and contingencies | ||||||||
| Total liabilities and stockholders’ equity | $ | 919,657 | 834,623 | |||||
See accompanying notes to consolidated financial statements.
23
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
| 2004 | 2003 | 2002 | ||||||||||
| Revenue: | ||||||||||||
| Premiums earned, net | $ | 1,296,423 | 1,262,234 | 1,236,647 | ||||||||
| Amounts attributable to self-funded arrangements | 181,702 | 162,288 | 150,684 | |||||||||
| Less amounts attributable to claims under self-funded arrangements | (169,924 | ) | (151,806 | ) | (141,138 | ) | ||||||
| 1,308,201 | 1,272,716 | 1,246,193 | ||||||||||
| Net investment income | 26,499 | 24,679 | 24,778 | |||||||||
| Net realized investment gains | 10,968 | 8,365 | 185 | |||||||||
| Net unrealized investment gain (loss) on trading securities | 3,042 | 14,893 | (8,322 | ) | ||||||||
| Other income, net | 3,360 | 4,703 | 2,075 | |||||||||
| Total revenue | 1,352,070 | 1,325,356 | 1,264,909 | |||||||||
| Benefits and expenses: | ||||||||||||
| Claims incurred | 1,115,793 | 1,065,350 | 1,061,980 | |||||||||
| Operating expenses, net of reimbursement for services | 171,879 | 165,149 | 148,539 | |||||||||
| Interest expense | 4,581 | 3,231 | 3,592 | |||||||||
| Total benefits and expenses | 1,292,253 | 1,233,730 | 1,214,111 | |||||||||
| Income before taxes | 59,817 | 91,626 | 50,798 | |||||||||
| Income tax expense: | ||||||||||||
| Current | 14,285 | 70,793 | 1,316 | |||||||||
| Deferred | (271 | ) | (5,396 | ) | 1,233 | |||||||
| Total income taxes | 14,014 | 65,397 | 2,549 | |||||||||
| Net income | $ | 45,803 | 26,229 | 48,249 | ||||||||
| Net income available to stockholders and basic net income per share (note 23): | ||||||||||||
| Net income available to stockholders | $ | 45,803 | 26,229 | 10,346 | ||||||||
| Basic net income per share | 5,135 | 2,857 | 1,085 | |||||||||
See accompanying notes to consolidated financial statements.
24
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
| Accumulated | ||||||||||||||||||||
| Additional | other | Total | ||||||||||||||||||
| Common | paid-in | Retained | comprehensive | stockholders’ | ||||||||||||||||
| stock | capital | earnings | income | equity | ||||||||||||||||
| Balance, December 31, 2001 | $ | 389 | 150,405 | 14,250 | 20,984 | 186,028 | ||||||||||||||
| Stock redemption | (16 | ) | 1 | — | — | (15 | ) | |||||||||||||
| Comprehensive income: | ||||||||||||||||||||
| Net income | — | — | 48,249 | — | 48,249 | |||||||||||||||
| Net unrealized change in investment securities | — | — | — | 5,986 | 5,986 | |||||||||||||||
| Net change in minimum pension liability | — | — | — | (8,114 | ) | (8,114 | ) | |||||||||||||
| Net change in fair value of cash-flow hedges | — | — | — | (470 | ) | (470 | ) | |||||||||||||
| Total comprehensive income | 45,651 | |||||||||||||||||||
| Balance, December 31, 2002 | 373 | 150,406 | 62,499 | 18,386 | 231,664 | |||||||||||||||
| Stock redemption | (12 | ) | 1 | — | — | (11 | ) | |||||||||||||
| Comprehensive income: | ||||||||||||||||||||
| Net income | — | — | 26,229 | — | 26,229 | |||||||||||||||
| Net unrealized change in investment securities | — | — | — | (6,022 | ) | (6,022 | ) | |||||||||||||
| Net change in minimum pension liability | — | — | — | 2,292 | 2,292 | |||||||||||||||
| Net change in fair value of cash-flow hedges | — | — | — | 103 | 103 | |||||||||||||||
| Total comprehensive income | 22,602 | |||||||||||||||||||
| Balance, December 31, 2003 | 361 | 150,407 | 88,728 | 14,759 | 254,255 | |||||||||||||||
| Stock redemption | (5 | ) | 1 | — | — | (4 | ) | |||||||||||||
| Comprehensive income: | ||||||||||||||||||||
| Net income | — | — | 45,803 | — | 45,803 | |||||||||||||||
| Net unrealized change in investment securities | — | — | — | 1,101 | 1,101 | |||||||||||||||
| Net change in minimum pension liability | — | — | — | (3 | ) | (3 | ) | |||||||||||||
| Net change in fair value of cash-flow hedges | — | — | — | 281 | 281 | |||||||||||||||
| Total comprehensive income | 47,182 | |||||||||||||||||||
| Balance, December 31, 2004 | $ | 356 | 150,408 | 134,531 | 16,138 | 301,433 | ||||||||||||||
See accompanying notes to consolidated financial statements.
25
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
| 2004 | 2003 | 2002 | ||||||||||
| Cash flows from operating activities: | ||||||||||||
| Premiums collected | $ | 1,302,383 | 1,267,127 | 1,236,667 | ||||||||
| Cash paid to suppliers and employees | (182,333 | ) | (169,160 | ) | (151,376 | ) | ||||||
| Claim losses and benefits paid | (1,092,817 | ) | (1,066,527 | ) | (1,051,019 | ) | ||||||
| Interest received | 27,065 | 25,139 | 23,069 | |||||||||
| Income taxes paid | (44,680 | ) | (39,287 | ) | (499 | ) | ||||||
| Proceeds from trading securities sold or matured: | ||||||||||||
| Fixed maturities | 50,330 | 77,582 | 103,012 | |||||||||
| Equity securities | 26,523 | 28,924 | 11,804 | |||||||||
| Acquisition of investments in trading portfolio: | ||||||||||||
| Fixed maturities | (54,550 | ) | (96,237 | ) | (112,879 | ) | ||||||
| Equity securities | (38,700 | ) | (38,956 | ) | (16,471 | ) | ||||||
| Interest paid | (3,578 | ) | (2,866 | ) | (4,220 | ) | ||||||
| Expense reimbursement from Medicare | 13,980 | 11,387 | 12,743 | |||||||||
| Contingency reserve funds from FEHBP | 5,217 | 13,023 | 5,976 | |||||||||
| Net cash provided by operating activities | 8,840 | 10,149 | 56,807 | |||||||||
| Cash flows from investing activities: | ||||||||||||
| Proceeds from investments sold or matured: | ||||||||||||
| Securities available for sale: | ||||||||||||
| Fixed maturities sold | 86,112 | 129,868 | 64,465 | |||||||||
| Fixed maturities matured | 69,258 | 196,961 | 173,853 | |||||||||
| Equity securities | 8,436 | 16,778 | 3,681 | |||||||||
| Securities held to maturity: | ||||||||||||
| Fixed maturities matured | 1,322 | 1,010 | 1,458 | |||||||||
| Acquisition of investments: | ||||||||||||
| Securities available for sale: | ||||||||||||
| Fixed maturities | (194,016 | ) | (416,759 | ) | (270,104 | ) | ||||||
| Equity securities | (2,435 | ) | (14,824 | ) | (7,991 | ) | ||||||
| Securities held to maturity: | ||||||||||||
| Fixed maturities | (10,154 | ) | (537 | ) | (3,621 | ) | ||||||
| Capital expenditures | (3,494 | ) | (3,205 | ) | (6,601 | ) | ||||||
| Proceeds from sale of property and equipment | 15 | 63 | 1,376 | |||||||||
| Net cash used in investing activities | $ | (44,956 | ) | (90,645 | ) | (43,484 | ) | |||||
| 26 | (Continued) | |||
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows, continued
Years ended December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2004 | 2003 | 2002 | ||||||||||
| Cash flows from financing activities: | ||||||||||||
| Change in outstanding checks in excess of bank balances | $ | 6,730 | (2,739 | ) | (4,416 | ) | ||||||
| Repayments of short-term borrowings | (37,000 | ) | — | — | ||||||||
| Proceeds from short-term borrowings | — | 38,700 | — | |||||||||
| Repayments of long-term borrowings | (2,645 | ) | (1,640 | ) | (5,635 | ) | ||||||
| Proceeds from long-term borrowings | 50,000 | — | — | |||||||||
| Redemption of common stock | (4 | ) | (11 | ) | (15 | ) | ||||||
| Proceeds from annuity contracts | 11,002 | 13,471 | 2,809 | |||||||||
| Surrenders of annuity contracts | (4,595 | ) | (2,318 | ) | (4,260 | ) | ||||||
| Net cash provided by (used in) financing activities | 23,488 | 45,463 | (11,517 | ) | ||||||||
| Net (decrease) increase in cash and cash equivalents | (12,628 | ) | (35,033 | ) | 1,806 | |||||||
| Cash and cash equivalents, beginning of year | 47,743 | 82,776 | 80,970 | |||||||||
| Cash and cash equivalents, end of year | $ | 35,115 | 47,743 | 82,776 | ||||||||
See accompanying notes to consolidated financial statements.
27
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
| (1) | Organization |
| (a) | Nature of Business | |||
| Triple-S Management Corporation (the Company or TSM) was incorporated under the laws of the Commonwealth of Puerto Rico on January 17, 1997 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 to the regulations of the Commissioner of Insurance of the Commonwealth of Puerto Rico (the Commissioner of Insurance): (1) Triple-S, Inc. (TSI) which provides hospitalization and health benefits to subscribers through contracts with hospitals, physicians, dentists, laboratories, and other organizations located mainly in Puerto Rico; (2) Seguros de Vida Triple-S, Inc. (SVTS), which is engaged in the underwriting of life and disability insurance policies and the administration of annuity contracts; and (3) Seguros Triple-S, Inc. (STS), which is engaged in the underwriting of property and casualty insurance policies. “The Company and TSI are members of the Blue Cross and Blue Shield Association (BCBSA). | ||||
| The Company also has two other wholly owned subsidiaries, Interactive Systems, Inc. (1SI) and Triple-C, Inc. (TC). ISI is mainly engaged in providing data processing services to the Company and its subsidiaries. TC is mainly engaged as a third-party administrator for TST in the administration of the Commonwealth of Puerto Rico Health Care Reform’s business (the Reform). Also, TC provides health care advisory services to TSI and other health insurance-related services to the health insurance industry. | ||||
| TSI is engaged in three principal underwriting activities, which are its Regular Commercial Plan, the Reform Program, and the Federal Employees’ Health Benefits Program (FEHBP). The operations of FEHBP do not result in any excess or deficiency of revenue or expenses as this program has a special account available to compensate any excess or deficiency on its operations accruing to the benefit or detriment of the federal government (see note 9). TSI also processes and pays claims as fiscal intermediary for the Medicare – Part B Program in Puerto Rico and is reimbursed for operating expenses (see note 15). | ||||
| A substantial majority of the Company’s business activity is with insureds located throughout Puerto Rico, and as such, the Company is subject to the risks associated with the Puerto Rico economy. | ||||
| (b) | Reorganization of the Business | |||
| On December 6, 1996, the Commissioner of Insurance issued an order to annul the sale of 1,582 shares of common stock that TSI repurchased from the estate of deceased stockholders. TSI contested such order through administrative and judicial review processes. Consequently, the sale of 1,582 shares was cancelled and the amounts paid returned to each former stockholder. During the year 2000, the Commissioner of Insurance issued a pronouncement providing further clarification of the content and effect of the order. This order also required that all corporate decisions undertaken by TSI through the vote of its stockholders of record, be ratified in a stockholders’ meeting or in a subsequent referendum. In November 2000, TSM, as the sole stockholder of TSI, ratified all such | ||||
| 28 | (Continued) | |||
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
decisions. Furthermore, on November 19, 2000, TSM held a special stockholders’ meeting, where a ratification of these decisions was undertaken except for the resolutions related to the approval of the reorganization of TSI and its subsidiaries. This resolution did not reach the two-thirds majority required by the order because the number of shares that were present and represented at the meeting was below such amount (total shares present and represented in the stockholders’ meeting was 64%). As stipulated in the order, TSM began the process to conduct a referendum among its stockholders in order to ratify such resolution. The process was later suspended because upon further review of the scope of the order, the Commissioner of Insurance issued an opinion in a letter dated January 8, 2002, which indicated that the ratification of the corporate reorganization was not required.
In another letter to TSI dated March 14, 2002, the Commissioner of Insurance stated that the ratification of the corporate reorganization was not required and that TSI had complied with the Commissioner of Insurance’s order of December 6, 1996 related to the corporate reorganization. Thereafter, two of TSM’s stockholders filed a petition for review of the Commissioner of Insurance’s determination before the Puerto Rico Circuit Court of Appeals. Such petition was opposed by TSI and by the Commissioner of Insurance.
Pursuant to that review, on September 24, 2002, the Puerto Rico Circuit Court of Appeals issued an order requiring the Commissioner of Insurance to order that a meeting of shareholders be held to ratify TSI’s corporate reorganization and the change of name of TSI from Seguros de Servicios de Salud de Puerto Rico, Inc. to Triple-S, Inc. The Puerto Rico Circuit Court of Appeals based its decision on administrative and procedural issues directed at the Commissioner of Insurance. The Commissioner of Insurance filed a motion of reconsideration with the Puerto Rico Circuit Court of Appeals on October 11, 2002. TSM and TSI also filed a motion of reconsideration.
On October 25, 2002, the Puerto Rico Circuit Court of Appeals dismissed the Commissioner of Insurance’s Motion for Reconsideration. In addition, the Puerto Rico Circuit Court of Appeals ordered the two stockholders who filed the petition for review to reply within 20 days to TSI’s and TSM’s Motion of Reconsideration.
On May 18, 2003, the Puerto Rico Circuit Court of Appeals granted TSI’s and TSM’s Motion of Reconsideration. The Puerto Rico Circuit Court of Appeals held that the Commissioner of Insurance had the authority to waive the celebration of a referendum to ratify TSI’s reorganization and that therefore the reorganization of TSI, inasmuch as the 1,582 shares annulled were not decisive, was approved by the stockholders.
On June 26, 2003, the two shareholders presented a writ of certiorari before the Supreme Court of Puerto Rico. TSI and TSM filed a motion opposing the issuance of the writ. The Supreme Court of Puerto Rico issued the writ on August 22, 2003, when it ordered that the Puerto Rico Circuit Court of Appeals transmit the record of the case. Notice of the receipt of the record by the Supreme Court of Puerto Rico was issued. On December 1, 2003, the two shareholders filed a motion submitting their case on the basis of their original petition. TSI filed its brief on December 30, 2003, while the Commissioner of Insurance, in turn, filed a separate brief on December 31, 2003. On June 24, 2004, the Supreme Court of Puerto Rico ordered the plaintiffs to file a brief in support of their allegations.
| 29 | (Continued) | |||
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| The outcome of the case is pending before the Supreme Court of Puerto Rico. It is the opinion of the management and its legal counsels that the corporate reorganization as approved is in full force and effect. |
| (2) | Significant Accounting Policies | |||
| The following are the significant accounting policies followed by the Company and its subsidiaries: | ||||
| (a) | 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). These principles are established primarily by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants. The preparation of the consolidated financial statements in conformity with GAAP requires the Company to make estimates when recording transactions resulting from business operations, based on information currently available. | ||||
| 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. | ||||
| (b) | Cash Equivalents | |||
| Cash equivalents of $3.617 and $620 at Deccmber31, 2004 and 2003, respectively, consist principally of certificates of deposit, securities purchased under agreements to resell and obligations of the Commonwealth of Puerto Rico and the U.S. Treasury with an initial term of less than three months. For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. | ||||
| (c) | Investments | |||
| Investment in securities at December 31, 2004 and 2003 consists mainly of U.S. Treasury securities and obligations of U.S. government instrumentalities, obligations of the Commonwealth of Puerto Rico and its instrumentalities, obligations of state and political subdivisions, mortgage-backed securities, collateralized mortgage obligations, corporate debt, 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. | ||||
| Trading and available-for-sale securities are recorded at fair value. Held-to-maturity debt securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums and discounts. Unrealized holding gains and losses on trading securities are included in operations. Unrealized holding gains and losses, net of the related tax effect, on available-for-sale securities are excluded from operations and are reported as a separate component of other comprehensive income until realized. Transfers of securities between categories are recorded at fair value at the date of transfer. | ||||
| 30 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003. and 2002
(Dollar amounts in thousands, except per share data)
| Unrealized holding gains and losses are recognized in operations 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 operations 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. | ||||
| 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 a reduction in 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 security and duration of the impairment, market conditions, changes in value subsequent to period-end and forecasted performance of the investee. | ||||
| 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. | ||||
| Realized gains and losses from the sale of available-for-sale securities are included in operations and are determined on a specific-identification basis. | ||||
| (d) | Revenue Recognition | |||
| Subscriber premiums on health and life insurance policies are billed in advance of their respective coverage period and the related revenue is recorded as earned during the coverage period. The premiums of TSI and SVTS are billed in the month prior to the effective date of the policy with a grace period of one month. If the insured fails to pay, the policy can be canceled at the end of the grace period at the option of the companies. Health and life insurance premiums are reported as earned when due. | ||||
| Certain groups have health insurance contracts that provide for the group to be at risk for all or a portion of their claims experience. Most 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. Under the Company’s self-funded arrangements, revenue and amounts due are recognized based on incurred claims plus administrative and other fees and any slop-loss premiums. In addition, accounts for certain self-insured groups are charged or credited with interest expense or income as provided by the group’s contracts. | ||||
| 31 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| Premiums on property and casualty contracts 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. | ||||
| (e) | 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 results could differ from these estimates. Receivables are charged against their respective allowance accounts when deemed to be uncollectible. | ||||
| (f) | Deferred Policy Acquisition Costs | |||
| Certain costs for acquiring property and casualty, and life and disability insurance business are deferred by the Company. In the property and casualty business these costs mainly relate to commissions incurred during the production of business and are deferred and amortized ratably over the terms of the policies. In the life and disability insurance business these costs mainly relate to the production of annuity contracts and are deferred and amortized in a constant relationship over the expected GAAP profit margins emerging over the life of the policies. | ||||
| The method used in calculating deferred policy acquisition costs limits the amount of such deferred costs to actual costs or their estimated realizable value, whichever is lower. In determining estimated realizable value, the method considers the premiums to be earned, losses and loss-adjustment expenses, and certain other costs expected to be incurred as the premiums are earned. | ||||
| Amortization of deferred policy acquisition costs in 2004, 2003, and 2002 was $22,454, $19,580, and $13,728, respectively. | ||||
| Acquisition costs related to health insurance policies are expensed as incurred. | ||||
| (g) | 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. Costs of systems in operation are amortized over their estimated useful lives. | ||||
| (h) | Claim Liabilities | |||
| Claims processed and incomplete and unreported losses for health insurance 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 accrued currently based on estimated future expenses necessary to process such claims. | ||||
| TSI’s Reform business division contracts with various independence practice associations (IPAs) for certain medical care services provided to the Reform’s subscribers. The IPAs are compensated based | ||||
| 32 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| on a capitation basis. TSI retains a portion of the capitation payments to provide for incurred but not reported losses. At December 31, 2004 and 2003, total withholdings and capitation payable amounted to $27,924 and $27,312, respectively, which are recorded as part of the liability for claims processed and incomplete in the accompanying consolidated balance sheets. | ||||
| The liability for losses and loss-adjustment expenses for STS 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. | ||||
| The liability for policy and contract claims of SVTS 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. | ||||
| The above 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. | ||||
| (i) | Annuity Contracts | |||
| Amounts received for annuity contracts are considered deposits and recorded as a liability. Interest accrued on such annuities, which amounted to $1,004, $721, and $711 during the years ended December 31, 2004, 2003, and 2002, respectively, is recorded as interest expense in the accompanying consolidated statements of earnings. | ||||
| (j) | 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. Commission and expense allowances received by STS 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. | ||||
| 33 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| (k) | Derivative Instruments and Hedging Activities | |||
| The Company accounts for derivative instruments and hedging activities in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 133,Accounting for Derivative Instruments and Certain Hedging Activities,and SFAS No. 138,Accounting for Certain Derivative Instruments and Certain Hedging Activities,an Amendment to SFAS No. 133. SFAS No. 133 and SFAS No. 138 require that all derivative instruments be recorded on the balance sheet at their respective fair values. | ||||
| On the date the derivative contract is entered into, the Company designates the derivative as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair-value hedge), a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash-flow hedge), a foreign currency fair value or cash-flow hedge (foreign-currency hedge), or a hedge of a net investment in a foreign operation. For all hedging relationships the Company formally documents the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the item, the nature of the risk being hedged, how the hedging instrument’s effectiveness in offsetting the hedged risk will be assessed, and a description of the method of measuring ineffectiveness. This process includes linking all derivatives that are designated as fair-value, cash-flow, or foreign-currency hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. | ||||
| Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair-value hedge, along with the loss or gain on the hedged asset or liability or unrecognized firm commitment of the hedged item that is attributable to the hedged risk, are recorded in earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash-flow hedge are recorded in other comprehensive income to the extent that the derivative is effective as hedge, until earnings are affected by the variability in cash flows of the designated hedged item. Changes in the fair value of derivatives that are highly effective as hedges and that are designated and qualify as foreign-currency hedges are recorded in either earnings or other comprehensive income, depending on whether the hedge transaction is a fair-value hedge or a cash-flow hedge. However, if a derivative is used as a hedge of a net investment in a foreign operation, its changes in fair value, to the extent effective as a hedge, are recorded in the cumulative translation adjustments account within other comprehensive income. The ineffective portion of the change in fair value of a derivative instrument that qualifies as either a fair-value hedge or a cash-flow hedge is reported in earnings. Changes in the fair value of derivative trading instruments are reported in current period earnings. | ||||
| The Company discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative expires or is sold, terminated, or exercised, the derivative is de-designated as a hedging instrument, because it is unlikely that a forecasted transaction will occur, a hedged firm commitment | ||||
| 34 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| no longer meets the definition of a firm commitment, or management determines that designation of the derivative as a hedging instrument is no longer appropriate. | ||||
| When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the Company continues to carry the derivative on the balance sheet at its fair value, and no longer adjusts the hedged asset or liability for changes in fair value. The adjustment of the carrying amount of the hedged asset or liability is accounted for in the same manner as other components of the carrying amount of that asset or liability. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the Company continues to carry the derivative on the balance sheet at its fair value, removes any asset or liability that was recorded pursuant to recognition of the firm commitment from the balance sheet, and recognizes any gain or loss in earnings. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the Company continues to carry the derivative on the balance sheet at its fair value with subsequent changes in fair value included in earnings, and gains and losses that were accumulated in other comprehensive income are recognized immediately in earnings. In all other situations in which hedge accounting is discontinued, the Company continues to carry the derivative at its fair value on the balance sheet and recognizes any changes in its fair value in earnings. | ||||
| (l) | 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. | ||||
| (m) | Insurance-Related Assessments | |||
| The Company accounts for insurance-related assessments in accordance with the provisions of Statement of Position (SOP) No. 97-3,Accounting by Insurance and Other Enterprises for Insurance-Related Assessments.This SOP prescribes liability recognition when the following three conditions are met: (l) 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. Also, this SOP provides for the recognition of an asset when the paid or accrued assessment is recoverable through either premium taxes or policy surcharges. | ||||
| (n) | Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of | |||
| In accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets,long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to | ||||
| 35 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 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 disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheets. | ||||
| Goodwill and intangible assets not subject to amortization 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. | ||||
| (o) | Use of Estimates | |||
| Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities to prepare these consolidated financial statements in conformity with GAAP. 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 future are the claim liabilities and the allowance for doubtful receivables. As additional information becomes available (or actual amounts are determinable), the recorded estimates will be revised and reflected in operating results. Although some variability is inherent in these estimates, the Company believes the amounts provided are adequate. | ||||
| (p) | Fair Value of Financial Instruments | |||
| Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of investments in corporate bonds, premiums receivable, accrued interest receivable, and other receivables. | ||||
| The fair value information of financial instruments in the accompanying consolidated financial statements was determined as follows: | ||||
| (i) | Cash and Cash Equivalents | |||
| The carrying amount approximates fair value because of the short-term nature of such instruments. | ||||
| (ii) | Investment in Securities | |||
| 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 4. | ||||
| 36 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| (iii) | Receivables, Accounts Payable, and Accrued Liabilities | |||
| The carrying amount of receivables, accounts payable and accrued liabilities approximates fair value because they mature and should be collected or paid within 12 months after December 31. | ||||
| (iv) | Annuity Contracts | |||
| The fair value of annuity contracts is the amount payable on demand at the reporting date, and accordingly, the carrying value amount approximates fair value. | ||||
| (v) | Short-Term Borrowings | |||
| The carrying amount of securities sold under agreements to repurchase is a reasonable estimate of fair value due to its short-term nature. | ||||
| (vi) | Long-Term Borrowings | |||
| The carrying amounts and fair value of the Company’s long-term borrowings are as follows: | ||||
| 2004 | 2003 | |||||||||||||||
| Carrying | Fair | Carrying | Fair | |||||||||||||
| amount | value | amount | value | |||||||||||||
| Loans payable to bank | $ | 45,730 | 45,730 | 48,375 | 48,375 | |||||||||||
| Senior unsecured notes payable | 50,000 | 50,000 | — | — | ||||||||||||
| Totals | $ | 95,730 | 95,730 | 48,375 | 48,375 | |||||||||||
| The carrying amount of the loans payable to bank approximates fair value due to its floating interest-rate structure. The fair value of the senior unsecured notes payable was determined using market quotations. Additional information pertinent to long-term borrowings is included in note 11. | ||||
| (vii) | Interest-Rate Swaps | |||
| Current market pricing models were used to estimate fair value of interest-rate swap agreement. | ||||
| (q) | Earnings Per Share | |||
| The Company calculates and presents earnings per share in accordance with SFAS No. 128,Earnings per Share.Basic earnings per share exclude dilution and are computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding for the period (see note 23). There is no potential dilution that could affect basic earnings per share. | ||||
| 37 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| (r) | Recently Issued Accounting Standards | |||
| SFAS No. 153,Exchanges of Nonmonetary Assets,an Amendment of APB Opinion No. 29, was issued in December 2004. This statement amends APB Opinion No. 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges on nonmonetary assets that do not have commercial substance. The Company is required to adopt SFAS No. 153 on January 1, 2006. The adoption of SFAS No. 153 is not expected to have any impact on the Company’s consolidated financial statements. | ||||
| (s) | Reclassifications | |||
| Certain amounts in the 2003 and 2002 financial statements were reclassified to conform with the 2004 presentation. | ||||
| (3) | Segment Information | |||
| The operations of the Company are conducted principally through three business segments. Business segments were identified according to the type of insurance products offered. These segments and a description of their respective operations are as follows: | ||||
| • | Health Insurance – Commercial Program–This type of insurance is provided by TSI and comprises the health insurance coverage subscribed to all commercial groups and some government entities. The Commercial Program offers a fee-for-service type plan through five distinct markets: corporate sector; individual sector; local government sector, covering the employees of the Commonwealth of Puerto Rico; federal government program, covering federal government employees within Puerto Rico; and the Medicare supplement plan (Medigap). The premiums for this segment are mainly originated through TSI’s internal sales force and a network of brokers and independent agents. TSI is a qualified contractor to provide health insurance coverage to federal government employees within Puerto Rico. The contract with the U.S. Office of Personnel Management (OPM) is subject to termination in the event of noncompliance not corrected to the satisfaction of OPM (see note 9). Under its Commercial Program, TSI provides health insurance coverage to certain employees of the Commonwealth of Puerto Rico and its instrumentalities. Earned premium revenue related to such health plans amounted to $67,082, $65,947, and $64,578 for the three-year period ended December 31, 2004, 2003, and 2002, respectively. | |||
| • | Health Insurance – Reform Program–This type of insurance is also provided by TSI and the business subscribed within this segment is awarded periodically by the Commonwealth of Puerto Rico’s central government. The Reform program provides health coverage to medically indigent citizens in Puerto Rico, as defined by the laws of the Commonwealth of Puerto Rico. The Reform consists of a single policy with the same benefits for each qualified medically indigent citizen. The government segregates Puerto Rico by areas or regions. Each area is awarded to an insurance company through a bidding process. On June 30, 2002, the government redistributed the geographical areas, merging two of the existing areas with the remaining ones, thus reducing geographical areas to eight. Commencing on July 1, 2002, TSI was awarded three of the eight geographical areas; North, Metro-North, and Southwest. All Reform contracts are subject to termination, with a prior written notice of 90 days, in the event of noncompliance not corrected or | |||
| 38 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| cured to the satisfaction of the Commonwealth of Puerto Rico or in the event the government determines that there are not enough funds for the payment of premiums. In addition, the Reform contracts stipulate that in the event that the net income for any given contract year, as defined, exceeds 2.5% of the premiums collected for the related contract year, TSI, through the Reform program, would need to return 75% of this excess to the Government of Puerto Rico. | ||||
| • | Property and Casualty Insurance–This type of insurance is provided by STS. 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 STS, net of commissions. Remittances are due 60 days after the closing date of the general agent’s account current. | |||
| The Company’s Life and Disability Insurance segment did not meet any of the quantitative thresholds determined by SFAS No. 131,Disclosures about Segments of an Enterprise and Related Information,that require separate disclosure of an operating segment. Thus, the Life and Disability Insurance segment is no longer presented as a reportable segment in the year ended December 31, 2004. The segment information for the years ended December 31, 2003 and 2002 has been restated to present the results of operations and financial position of the Life and Disability operating segment within the Company’s other nonreportable operating segments. | ||||
| 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 Company evaluates performance based primarily on the net income of each segment. Services provided between reportable segments are done at transfer prices which approximate fair value. 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 asset use 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 the three-year period ended December 31, 2004, 2003, and 2002. | ||||
| 39 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2004 | ||||||||||||||||||||
| Operating segment | ||||||||||||||||||||
| Health | Health | |||||||||||||||||||
| Insurance | Insurance | Property | ||||||||||||||||||
| Commercial | Reform | and Casualty | ||||||||||||||||||
| Program | Program | Insurance | Other* | Total | ||||||||||||||||
| Premiums earned, net | $ | 709,011 | 484,742 | 86,228 | 16,442 | 1,296,423 | ||||||||||||||
| Amounts attributable to self-funded arrangements | 181,702 | — | — | — | 181,702 | |||||||||||||||
| Less amounts attributable to claims under self-funded arrangements | (169,924 | ) | — | — | — | (169,924 | ) | |||||||||||||
| Intersegment premiums/service revenue | 3,945 | — | — | 47,971 | 51,916 | |||||||||||||||
| 724,734 | 484,742 | 86,228 | 64,413 | 1,360,117 | ||||||||||||||||
| Net investment income | 12,590 | 3,109 | 7,668 | 2,778 | 26,145 | |||||||||||||||
| Net realized investment gains | 9,040 | 128 | 1,087 | 713 | 10,968 | |||||||||||||||
| Net unrealized investment gain on trading securities | 1,879 | — | 801 | 362 | 3,042 | |||||||||||||||
| Other income, net | 269 | (30 | ) | 2,675 | 240 | 3,154 | ||||||||||||||
| Total revenue | $ | 748,512 | 487,949 | 98,459 | 68,506 | 1,403,426 | ||||||||||||||
| Net income | $ | 23,757 | 9,250 | 11,085 | 1,359 | 45,451 | ||||||||||||||
| Claims incurred | 620,751 | 437,834 | 45,977 | 11,231 | 1,115,793 | |||||||||||||||
| Operating expenses, net of reimbursment for services | 94,930 | 35,777 | 40,182 | 54,203 | 225,092 | |||||||||||||||
| Depreciation expense, included in operating expenses | 2,841 | 789 | 418 | 177 | 4,225 | |||||||||||||||
| Interest expense | 1,928 | 428 | 4 | 1,004 | 3,364 | |||||||||||||||
| Income tax expenses | 7,146 | 4,660 | 1,211 | 709 | 13,726 | |||||||||||||||
| Segment assets | 443,710 | 84,627 | 282,393 | 90,713 | 901,443 | |||||||||||||||
| Significant noncash items: | ||||||||||||||||||||
| Net change in unrealized gain on securities available for sale | 523 | (151 | ) | 867 | (156 | ) | 1,083 | |||||||||||||
| Net change in minimum pension liability | 313 | — | (60 | ) | (314 | ) | (61 | ) | ||||||||||||
| * | Includes segments which are not required to be reported separately. These segments include the life and disability insurance segment, the data processing services organization as well as the third-party administrator of health insurance services. |
| 40 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2003 | ||||||||||||||||||||
| Operating segment | ||||||||||||||||||||
| Health | Health | |||||||||||||||||||
| Insurance | Insurance | Property | ||||||||||||||||||
| Commercial | Reform | and Casualty | ||||||||||||||||||
| Program | Program | Insurance | Other* | Total | ||||||||||||||||
| Premiums earned, net | $ | 688,883 | 477,614 | 78,334 | 17,403 | 1,262,234 | ||||||||||||||
| Amounts attributable to self-funded arrangements | 162,288 | — | — | — | 162,288 | |||||||||||||||
| Less amounts attributable to claims under self-funded arrangements | (151,806 | ) | — | — | — | (151,806 | ) | |||||||||||||
| Intersegment premiums/service revenue | 3,488 | — | — | 45,989 | 49,477 | |||||||||||||||
| 702,853 | 477,614 | 78,334 | 63,392 | 1,322,193 | ||||||||||||||||
| Net investment income | 10,734 | 4,476 | 6,824 | 2,345 | 24,379 | |||||||||||||||
| Net realized investment gains | 6,345 | 53 | 722 | 595 | 7,715 | |||||||||||||||
| Net unrealized investment gain (loss) on trading securities | 11,157 | 1,848 | 2,045 | (157 | ) | 14,893 | ||||||||||||||
| Other income, net | 196 | (30 | ) | 4,154 | 74 | 4,394 | ||||||||||||||
| Total revenue | $ | 731,285 | 483,961 | 92,079 | 66,249 | 1,373,574 | ||||||||||||||
| Net income | $ | 49,071 | 14,034 | 9,677 | 4,954 | 77,736 | ||||||||||||||
| Claims incurred | 584,448 | 428,045 | 43,390 | 9,467 | 1,065,350 | |||||||||||||||
| Operating expenses, net of reimbursement for services | 92,264 | 34,637 | 37,354 | 50,574 | 214,829 | |||||||||||||||
| Depreciation expense, included in operating expenses | 3,106 | 945 | 423 | 125 | 4,599 | |||||||||||||||
| Interest expense | 862 | 366 | — | 721 | 1,949 | |||||||||||||||
| Income tax expense | 4,640 | 6,879 | 1,658 | 533 | 13,710 | |||||||||||||||
| Segment assets | 407,031 | 86,535 | 239,478 | 74,530 | 807,574 | |||||||||||||||
| Significant noncash items: | ||||||||||||||||||||
| Net change in unrealized gain on securities available for sale | (5,226 | ) | — | (527 | ) | 220 | (5,533 | ) | ||||||||||||
| Net change in minimum pension liability | 2,385 | — | (23 | ) | (55 | ) | 2,307 | |||||||||||||
| * | Includes segments which are not required to be reported separately. These segments include the life and disability insurance segment, the data processing services organization as well as the third-party administrator of health insurance services. |
| 41 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2002 | ||||||||||||||||||||
| Operating segment | ||||||||||||||||||||
| Health | Health | |||||||||||||||||||
| Insurance | Insurance | Property | ||||||||||||||||||
| Commercial | Reform | and Casualty | ||||||||||||||||||
| Program | Program | Insurance | Other* | Total | ||||||||||||||||
| Premiums earned, net | $ | 673,967 | 487,000 | 60,688 | 14,992 | 1,236,647 | ||||||||||||||
| Amounts attributable to self-funded arrangements | 150,684 | — | — | — | 150,684 | |||||||||||||||
| Less amounts attributable to claims under self-funded arrangements | (141,138 | ) | — | — | — | (141,138 | ) | |||||||||||||
| Intersegment premiums/service revenue | 2,776 | — | — | 46,308 | 49,084 | |||||||||||||||
| 686,289 | 487,000 | 60,688 | 61,300 | 1,295,277 | ||||||||||||||||
| Net investment income | 10,577 | 5,106 | 6,579 | 2,253 | 24,515 | |||||||||||||||
| Net realized investment (losses) gains | (313 | ) | 77 | 243 | 67 | 74 | ||||||||||||||
| Net unrealized investment loss on trading securities | (6,533 | ) | (495 | ) | (1,294 | ) | — | (8,322 | ) | |||||||||||
| Other income, net | 136 | (38 | ) | 1,475 | 114 | 1,687 | ||||||||||||||
| Total revenue | $ | 690,156 | 491,650 | 67,691 | 63,734 | 1,313,231 | ||||||||||||||
| Net income | $ | 28,133 | 9,770 | 6,223 | 4,279 | 48,405 | ||||||||||||||
| Claims incurred | 574,874 | 445,039 | 34,334 | 7,733 | 1,061,980 | |||||||||||||||
| Operating expenses, net of reimbrusement for services | 86,321 | 36,109 | 25,549 | 50,298 | 198,277 | |||||||||||||||
| Depreciation expense, included in operating expenses | 3,376 | 1,385 | 397 | 78 | 5,236 | |||||||||||||||
| Interest expense | 829 | 731 | — | 711 | 2,271 | |||||||||||||||
| Income tax expense | — | — | 1,585 | 713 | 2,298 | |||||||||||||||
| Segment assets | 324,628 | 115,499 | 201,967 | 52,987 | 695,081 | |||||||||||||||
| Significant noncash items: | ||||||||||||||||||||
| Net change in unrealized gain on securities available for sale | 3,928 | 598 | 652 | 613 | 5,791 | |||||||||||||||
| Net change in minimum pension liability | (6,961 | ) | — | (231 | ) | (735 | ) | (7,927 | ) | |||||||||||
| * | Includes segments which are not required to be reported separately. These segments include the life and disability insurance segment, the data processing services organization as well as the third-party administrator of health insurance services. |
| 42 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
Reconciliation of Reportable Segment Totals with Financial Statements
| Total revenue | 2004 | 2003 | 2002 | |||||||||
| Revenue for reportable segments | $ | 1,334,920 | 1,307,325 | 1,249,497 | ||||||||
| Revenue for other segments | 68,506 | 66,249 | 63,734 | |||||||||
| 1,403,426 | 1,373,574 | 1,313,231 | ||||||||||
| Elimination of intersegment earned premiums | (3,945 | ) | (3,488 | ) | (2,776 | ) | ||||||
| Elimination of intersegment service revenue | (47,971 | ) | (45,989 | ) | (46,308 | ) | ||||||
| Unallocated amount: | ||||||||||||
| Revenue from external sources | 560 | 1,259 | 762 | |||||||||
| (51,356 | ) | (48,218 | ) | (48,322 | ) | |||||||
| Total consolidated revenue | $ | 1,352,070 | 1,325,356 | 1,264,909 | ||||||||
| Net income | 2004 | 2003 | 2002 | |||||||||
| Net income for reportable segments | $ | 44,092 | 72,782 | 44,126 | ||||||||
| Net income for other segments | 1,359 | 4,954 | 4,279 | |||||||||
| 45,451 | 77,736 | 48,405 | ||||||||||
| Elimination of TSM charges: | ||||||||||||
| Rent expense | 6,084 | 6,283 | 6,203 | |||||||||
| Interest expense | 734 | 658 | 829 | |||||||||
| 6,818 | 6,941 | 7,032 | ||||||||||
| Unallocated amounts related to TSM: | ||||||||||||
| General and administrative expenses | (4,787 | ) | (6,080 | ) | (5,549 | ) | ||||||
| Income tax expense | (288 | ) | (51,687 | ) | (251 | ) | ||||||
| Interest expense | (1,951 | ) | (1,940 | ) | (2,150 | ) | ||||||
| Other revenue from external sources | 560 | 1,259 | 762 | |||||||||
| (6,466 | ) | (58,448 | ) | (7,188 | ) | |||||||
| Consolidated net income | $ | 45,803 | 26,229 | 48,249 | ||||||||
43
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| Assets | 2004 | 2003 | ||||||
| Total assets for reportable segments | $ | 810,730 | 733,044 | |||||
| Total assets for other segments | 90,713 | 74,530 | ||||||
| 901,443 | 807,574 | |||||||
| Elimination entries intersegment receivables and others | (21,717 | ) | (9,565 | ) | ||||
| Unallocated amounts related to TSM: | ||||||||
| Cash, cash equivalents, and investments | 12,236 | 9,665 | ||||||
| Property and equipment, net | 25,577 | 26,656 | ||||||
| Other assets | 2,118 | 293 | ||||||
| 39,931 | 36,614 | |||||||
| Consolidated assets | $ | 919,657 | 834,623 | |||||
| 2004 | ||||||||||||
| Segment | Consolidated | |||||||||||
| Other Significant Items | totals | Adjustments (*) | totals | |||||||||
| Claims incurred | $ | 1,115,793 | — | 1,115,793 | ||||||||
| Operating expenses | 225,092 | (53,213 | ) | 171,879 | ||||||||
| Depreciation expense | 4,225 | 1,118 | 5,343 | |||||||||
| Interest expense | 3,364 | 1,217 | 4,581 | |||||||||
| Income taxes | 13,726 | 288 | 14,014 | |||||||||
| Significant noncash items: | ||||||||||||
| Net change in unrealized gain on securities available for sale | 1,083 | 18 | 1,101 | |||||||||
| Net change in minimum pension liability | (61 | ) | 58 | (3 | ) | |||||||
| 2003 | ||||||||||||
| Segment | Consolidated | |||||||||||
| totals | Adjustments (*) | totals | ||||||||||
| Claims incurred | $ | 1,065,350 | — | 1,065,350 | ||||||||
| Operating expenses | 214,829 | (49,680 | ) | 165,149 | ||||||||
| Depreciation expense | 4,599 | 1,110 | 5,709 | |||||||||
| Interest expense | 1,949 | 1,282 | 3,231 | |||||||||
| Income taxes | 13,710 | 51,687 | 65,397 | |||||||||
| Significant noncash items: | ||||||||||||
| Net change in unrealized gain on securities available for sale | (5,533 | ) | (489 | ) | (6,022 | ) | ||||||
| Net change in minimum pension liability | 2,307 | (15 | ) | 2,292 | ||||||||
| 2002 | ||||||||||||
| Segment | Consolidated | |||||||||||
| totals | Adjustments (*) | totals | ||||||||||
| Claims incurred | $ | 1,061,980 | — | 1,061,980 | ||||||||
| Operating expenses | 198,277 | (49,738 | ) | 148,539 | ||||||||
| Depreciation expense | 5,236 | 2,359 | 7,595 | |||||||||
| Interest expense | 2,271 | 1,321 | 3,592 | |||||||||
| Income taxes | 2,298 | 251 | 2,549 | |||||||||
| Significant noncash items: | ||||||||||||
| Net change in unrealized gain on securities available for sale | 5,791 | 195 | 5,986 | |||||||||
| Net change in minimum pension liability | (7,927 | ) | (187 | ) | (8,114 | ) | ||||||
| * | Adjustments represent principally TSM operations and eliminations of intersegment charges. |
| 44 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| (4) | Investment in Securities | |||
| The amortized cost for debt and equity securities, gross unrealized gains, gross unrealized losses, and estimated fair value for trading, available-for-sale, and held-to-maturity securities by major security type and class of security at December 31, 2004 and 2003, were as follows: | ||||
| 2004 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Amortized cost | unrealized gains | unrealized losses | Estimated fair value | |||||||||||||
| Trading securities: | ||||||||||||||||
| U.S. Treasury securities and obligations of U.S. government instrumentalities | $ | 23,978 | 601 | (41 | ) | 24,538 | ||||||||||
| Corporate debt securities | 46,690 | 1,444 | (249 | ) | 47,885 | |||||||||||
| Total fixed maturities | 70,668 | 2,045 | (290 | ) | 72,423 | |||||||||||
| Equity securities | 74,824 | 13,496 | (1,724 | ) | 86,596 | |||||||||||
| Totals | $ | 145,492 | 15,541 | (2,014 | ) | 159,019 | ||||||||||
| 2003 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Amortized cost | unrealized gains | unrealized losses | Estimated fair value | |||||||||||||
| Trading securities: | ||||||||||||||||
| U.S. Treasury securities and obligations of U.S. government instrumentalities | $ | 1,370 | 9 | (1 | ) | 1,378 | ||||||||||
| Corporate debt securities | 65,549 | 2,255 | (501 | ) | 67,303 | |||||||||||
| Total fixed maturities | 66,919 | 2,264 | (502 | ) | 68,681 | |||||||||||
| Equity securities | 58,101 | 9,823 | (1,100 | ) | 66,824 | |||||||||||
| Totals | $ | 125,020 | 12,087 | (1,602 | ) | 135,505 | ||||||||||
| 45 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2004 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Amortized | unrealized | unrealized | Estimated | |||||||||||||
| cost | gains | losses | fair value | |||||||||||||
| Securities available for sale: | ||||||||||||||||
| U.S. Treasury securities and obligations of U.S. government instrumentalities | $ | 337,045 | 1,012 | (967 | ) | 337,090 | ||||||||||
| Obligations of the Commonwealth of Puerto Rico and its instrumentalities | 62,331 | 1,231 | (971 | ) | 62,591 | |||||||||||
| Obligations of state and political subdivisions | 500 | 2 | — | 502 | ||||||||||||
| Corporate bonds | 5,771 | 48 | (3 | ) | 5,816 | |||||||||||
| Mortgage-backed securities | 12,430 | 160 | (43 | ) | 12,547 | |||||||||||
| Collateralized mortgage obligations | 26,058 | 206 | (173 | ) | 26,091 | |||||||||||
| Total fixed maturities | 444,135 | 2,659 | (2,157 | ) | 444,637 | |||||||||||
| Equity securities | 34,309 | 24,913 | (36 | ) | 59,186 | |||||||||||
| Totals | $ | 478,444 | 27,572 | (2,193 | ) | 503,823 | ||||||||||
| 46 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2003 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Amortized | unrealized | unrealized | Estimated | |||||||||||||
| cost | gains | losses | fair value | |||||||||||||
| Securities available for sale: | ||||||||||||||||
| U.S. Treasury securities and obligations of U.S. government instrumentalities | $ | 290,348 | 1,860 | (926 | ) | 291,282 | ||||||||||
| Obligations of the Commonwealth of Puerto Rico and its instrumentalities | 61,539 | 1,278 | (709 | ) | 62,108 | |||||||||||
| Obligations of state and political subdivisions | 10,069 | 34 | (114 | ) | 9,989 | |||||||||||
| Corporate debt | 1,765 | 40 | (3 | ) | 1,802 | |||||||||||
| Mortgage-backed securities | 17,055 | 280 | (33 | ) | 17,302 | |||||||||||
| Collateralized mortgage obligations | 24,771 | 439 | (163 | ) | 25,047 | |||||||||||
| Total fixed maturities | 405,547 | 3,931 | (1,948 | ) | 407,530 | |||||||||||
| Equity securities | 33,877 | 22,203 | (40 | ) | 56,040 | |||||||||||
| Totals | $ | 439,424 | 26,134 | (1,988 | ) | 463,570 | ||||||||||
| 2004 | ||||||||||||||||
| Gross | Gross | |||||||||||||||
| Amortized | unrealized | unrealized | Estimated | |||||||||||||
| cost | gains | losses | fair value | |||||||||||||
| Securities held to maturity: | ||||||||||||||||
| U.S. Treasury securities and obligations of U.S. government instrumentalities | $ | 5,991 | 24 | — | 6,015 | |||||||||||
| Mortgage-backed securities | 5,126 | 4 | (22 | ) | 5,108 | |||||||||||
| Corporate bonds | 2,007 | — | (2 | ) | 2,005 | |||||||||||
| Certificates of deposit | 156 | — | — | 156 | ||||||||||||
| Index, linked certificate of deposit | 1,000 | 219 | — | 1,219 | ||||||||||||
| Totals | $ | 14,280 | 247 | (24 | ) | 14,503 | ||||||||||
| 47 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2003 | ||||||||||||||||
| Amortized cost | Gross unrealized gains | Gross unrealized losses | Estimated fair value | |||||||||||||
| Securities held to maturity: | ||||||||||||||||
| Mortgage-backed securities | $ | 3,766 | 11 | (5 | ) | 3,772 | ||||||||||
| Collateralized mortgage obligations | 175 | — | — | 175 | ||||||||||||
| Certificates of deposit | 537 | — | — | 537 | ||||||||||||
| Index linked certificate of deposit | 1,000 | 107 | — | 1,107 | ||||||||||||
| Totals | $ | 5,478 | 118 | (5 | ) | 5,591 | ||||||||||
Fair values for debt securities were determined using market quotations provided by outside securities consultants or prices provided by market makers. The fair values for equity securities were determined using market quotations on the principal public exchange markets.
| 48 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(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, 2004 and 2003 were as follows:
| 2004 | ||||||||||||||||||||||||
| Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||
| Grass | Gross | Gross | ||||||||||||||||||||||
| Estimated | unrealized | Estimated | unrealized | Estimated | unrealized | |||||||||||||||||||
| fair value | losses | fair value | losses | fair value | losses | |||||||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||
| U.S. Treasury securities and obligations of U.S. government instrumentalities | $ | 79,145 | (368 | ) | 70,249 | (599 | ) | 149,394 | (967 | ) | ||||||||||||||
| Obligations of the Commonwealth of Puerto Rico and its instrumentalities | 15,648 | (415 | ) | 19,129 | (556 | ) | 34,777 | (971 | ) | |||||||||||||||
| Corporate bonds | — | — | 497 | (3 | ) | 497 | (3 | ) | ||||||||||||||||
| Mortgage-backed securities | 4,649 | (32 | ) | 3,311 | (11 | ) | 7,960 | (43 | ) | |||||||||||||||
| Collateralized mortgage obligations | 9,493 | (94 | ) | 6,997 | (79 | ) | 16,490 | (173 | ) | |||||||||||||||
| Total fixed maturities | 108,935 | (909 | ) | 100,183 | (1,248 | ) | 209,118 | (2,157 | ) | |||||||||||||||
| Equity securities | 2,416 | (20 | ) | 2,734 | (16 | ) | 5,150 | (36 | ) | |||||||||||||||
| Totals for securities available for sale | $ | 111,351 | (929 | ) | 102,917 | (1,264 | ) | 214,268 | (2,193 | ) | ||||||||||||||
| Securities held to maturity: | ||||||||||||||||||||||||
| Mortgage-backed securities | $ | 2,138 | (13 | ) | 2,131 | (9 | ) | 4,269 | (22 | ) | ||||||||||||||
| Corporate bonds | 2,005 | (2 | ) | — | — | 2,005 | (2 | ) | ||||||||||||||||
| Totals for securities held to maturity | $ | 4,143 | (15 | ) | 2,131 | (9 | ) | 6,274 | (24 | ) | ||||||||||||||
| 49 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2003 | ||||||||||||||||||||||||
| Less than 12 months | 12 months or longer | Total | ||||||||||||||||||||||
| Grass | Gross | Gross | ||||||||||||||||||||||
| Estimated | unrealized | Estimated | unrealized | Estimated | unrealized | |||||||||||||||||||
| fair value | losses | fair value | losses | fair value | losses | |||||||||||||||||||
| Securities available for sale: | ||||||||||||||||||||||||
| U.S. Treasury securities and obligations of U.S. government instrumentalities | $ | 91,971 | (926 | ) | — | — | 91,971 | (926 | ) | |||||||||||||||
| Obligations of the Commonwealth of Puerto Rico and its instrumentalities | 31,069 | (712 | ) | — | — | 31,069 | (712 | ) | ||||||||||||||||
| Obligations of state and political subdivisions | 4,683 | (114 | ) | — | — | 4,683 | 114 | ) | ||||||||||||||||
| Mortgage-backed securities | 6,709 | (33 | ) | — | — | 6,709 | (33 | ) | ||||||||||||||||
| Collateralized mortgage obligations | 10,880 | (159 | ) | 1,256 | (4 | ) | 12,136 | (163 | ) | |||||||||||||||
| Total fixed maturities | 145,312 | (1,944 | ) | 1,256 | (4 | ) | 146,568 | (1,948 | ) | |||||||||||||||
| Equity securities | 8,581 | (40 | ) | — | — | 8,581 | (40 | ) | ||||||||||||||||
| Totals for securities available for sale | $ | 153,893 | (1,984 | ) | 1,256 | (4 | ) | 155,149 | (1,988 | ) | ||||||||||||||
| Securities held to maturity: | ||||||||||||||||||||||||
| Mortgage-backed securities | $ | — | — | 2,318 | (5 | ) | 2,318 | (5 | ) | |||||||||||||||
The Company 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 the length of time and the extent to which cost exceeds fair value, the prospects and financial condition of the issuer, and the Company’s intent and ability to retain the investment to allow for recovery in fair value, among other factors. 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 fair value solely due to changes in interest rates, impairment may not be appropriate. If after monitoring and analyzing, the Company 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. The impairment is charged to operations and a new cost basis for the security is established. During the year ended December 31, 2002, the Company recognized an other-than-temporary impairment amounting to $311 on one of its equity securities classified as available for sale. No impairments were identified nor recognized by the Company during the years 2004 and 2003.
The unrealized losses on investments were mainly caused by interest rate increases. Because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired.
| 50 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
Maturities of investment securities classified as available for sale and held to maturity were as follows at December 31,2004:
| Amortized | Estimated | |||||||
| cost | fair value | |||||||
| Securities available for sale: | ||||||||
| Due in one year or less | $ | 3,350 | 3,453 | |||||
| Due after one year through five years | 189,530 | 189,472 | ||||||
| Due after five years through ten years | 188,279 | 188,855 | ||||||
| Due after ten years | 24,488 | 24,219 | ||||||
| Collateralized mortgage obligations | 26,058 | 26,091 | ||||||
| Mortgage-backed securities | 12,430 | 12,547 | ||||||
| $ | 444,135 | 444,637 | ||||||
| Securities held to maturity: | ||||||||
| Due in one year or less | $ | 156 | 156 | |||||
| Due after five years through ten years | 8,998 | 9,239 | ||||||
| Mortgage-backed securities | 5,126 | 5,108 | ||||||
| $ | 14,280 | 14,503 | ||||||
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 $2,763 and $2,516 (fair value of $2,967 and $2,747) at December 31, 2004 and 2003, respectively, were deposited with the Commissioner of Insurance to comply with the deposit requirements of the Insurance Code the Commonwealth of Puerto Rico (the Insurance Code).
The following investments were held as collateral by financial institutions:
| • | Investments with a face value of $1,800 and $40,070 (fair value of $1,792 and $40,336) at December 31, 2004 and 2003, respectively, were held as collateral for the short-term borrowings of the Company (note 10). | |||
| • | Investments with a face value of $2,010 and $2,722 (fair value of $1,979 and $2,772) at Decembcr31, 2004 and 2003, respectively, were held as collateral for the Company’s interest-rate swap agreement (see note 11). | |||
| 51 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
Information regarding realized and unrealized gains and losses from investments for the years ended December 31, 2004, 2003, and 2002 is as follows:
| 2004 | 2003 | 2002 | ||||||||||
| Realized gains (losses): | ||||||||||||
| Fixed maturity securities: | ||||||||||||
| Trading securities: | ||||||||||||
| Gross gains from sales | $ | 594 | 1,480 | 1,492 | ||||||||
| Gross losses from sales | (492 | ) | (257 | ) | (1,058 | ) | ||||||
| 102 | 1,223 | 434 | ||||||||||
| Available for sale: | ||||||||||||
| Gross gains from sales | 123 | 971 | 110 | |||||||||
| Gross losses from sales | (241 | ) | (632 | ) | — | |||||||
| (118 | ) | 339 | 110 | |||||||||
| Total debt securities | (16 | ) | 1,562 | 544 | ||||||||
| Equity securities: | ||||||||||||
| Trading securities: | ||||||||||||
| Gross gains from sales | 5,608 | 2,739 | 1,594 | |||||||||
| Gross losses from sales | (1,056 | ) | (6,529 | ) | (2,026 | ) | ||||||
| 4,552 | (3,790 | ) | (432 | ) | ||||||||
| Available for sale: | ||||||||||||
| Gross gains from sales | 6,432 | 10,593 | 391 | |||||||||
| Gross losses from sales | — | — | (318 | ) | ||||||||
| 6,432 | 10,593 | 73 | ||||||||||
| Total equity securities | 10,984 | 6,803 | (359 | ) | ||||||||
| Net realized gains on securities | $ | 10,968 | 8,365 | 185 | ||||||||
| 52 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2004 | 2003 | 2002 | ||||||||||
| Changes in unrealized gains (losses): | ||||||||||||
| Recognized in income: | ||||||||||||
| Fixed maturities - trading | $ | (7 | ) | (1,068 | ) | 2,036 | ||||||
| Equity securities - trading | 3,049 | 15,961 | (10,358 | ) | ||||||||
| $ | 3,042 | 14,893 | (8,322 | ) | ||||||||
| Recognized in accumulated other comprehensive income: | ||||||||||||
| Fixed maturities - available for sale | (1,481 | ) | (3,783 | ) | 1,094 | |||||||
| Equity securities - available for sale | 2,714 | (4 | ) | 5,195 | ||||||||
| $ | 1,233 | (3,787 | ) | 6,289 | ||||||||
| Not recognized in the consolidated financial statements: | ||||||||||||
| Fixed maturities - held to maturity | $ | 110 | 119 | 50 | ||||||||
Deferred tax expense on unrealized gains and losses recognized in accumulated other comprehensive income during the years 2004, 2003, and 2002 aggregated $3,330, $3,198, and $963, respectively.
As of December 31, 2004, investments in obligations that are payable from and secured by the same source of revenue or taxing authority, other than investment instruments of the U.S. and the Commonwealth of Puerto Rico governments, did not exceed 10% of stockholders’ equity. As of December 31, 2004, no investment in equity securities individually exceeded 10% of stockholders’ equity.
(5) Net Investment Income
Components of net investment income were as follows:
| Year ended December 31 | ||||||||||||
| 2004 | 2003 | 2002 | ||||||||||
| Mortgage -backed securities | $ | 1,023 | 1,495 | 937 | ||||||||
| Zero coupons | 428 | 731 | 736 | |||||||||
| Bonds and notes | 20,108 | 16,443 | 17,394 | |||||||||
| Securities purchased under agreement to resell | — | 72 | 814 | |||||||||
| Collateralized mortgage obligations | 930 | 2,367 | 2,519 | |||||||||
| Common and preferred stocks | 2,799 | 2,385 | 1,895 | |||||||||
| Others | 1,532 | 1,434 | 716 | |||||||||
| Subtotal | 26,820 | 24,927 | 25,011 | |||||||||
| Less investment expenses | 321 | 248 | 233 | |||||||||
| Total | $ | 26,499 | 24,679 | 24,778 | ||||||||
| 53 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| (6) | Premiums and Other Receivables, Net | |||
| Premiums and other receivables as of December 31 were as follows: | ||||
| 2004 | 2003 | |||||||
| Premiums | $ | 45,451 | 37,936 | |||||
| Self-funded group receivables | 17,717 | 15,790 | ||||||
| FEHBP | 9,346 | 7,832 | ||||||
| Accrued interest | 5,080 | 5,098 | ||||||
| Reinsurance recoverable on paid losses | 30,496 | 22,067 | ||||||
| Other | 16,406 | 13,783 | ||||||
| 124,496 | 102,506 | |||||||
| Less allowance for doubtful receivables: | ||||||||
| Premiums | 6,456 | 4,300 | ||||||
| Other | 4,717 | 4,715 | ||||||
| 11,173 | 9,015 | |||||||
| Premiums and other receivables, net | $ | 113,323 | 93,491 | |||||
| (7) | Property and Equipment, Net | |||
| Property and equipment as of December 31 are composed of the following: | ||||
| 2004 | 2003 | |||||||
| Land | $ | 6,531 | 6,531 | |||||
| Buildings and leasehold improvements | 33,272 | 32,228 | ||||||
| Office furniture and equipment | 10,298 | 16,394 | ||||||
| Computer equipment | 24,867 | 29,307 | ||||||
| Automobiles | 250 | 274 | ||||||
| 75,218 | 84,734 | |||||||
| Less accumulated depreciation and amortization | 42,854 | 50,522 | ||||||
| Property and equipment, net | $ | 32,364 | 34,212 | |||||
| 54 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| (8) | Claim Liabilities |
The activity in the total claim liabilities during 2004, 2003, and 2002 is as follows:
| 2004 | 2003 | 2002 | ||||||||||
| Claim liabilities at beginning of year | $ | 247,920 | 244,582 | 229,440 | ||||||||
| Reinsurance recoverable on claim liabilities | (19,357 | ) | (13,589 | ) | (10,062 | ) | ||||||
| Net claim liabilities at beginning of year | 228,563 | 230,993 | 219,378 | |||||||||
| Incurred claims and loss-adjustment expenses: | ||||||||||||
| Current period insured events | 1,112,325 | 1,081,570 | 1,079,237 | |||||||||
| Prior period insured events | 3,468 | (16,220 | ) | (17,257 | ) | |||||||
| Total | 1,115,793 | 1,065,350 | 1,061,980 | |||||||||
| Payments of losses and loss-adjustnient expenses: | ||||||||||||
| Current period insured events | 920,173 | 906,098 | 894,945 | |||||||||
| Prior period insured events | 171,413 | 161,682 | 155,420 | |||||||||
| Total | 1,091,586 | 1,067,780 | 1,050,365 | |||||||||
| Net claim liabilities at end of year | 252,770 | 228,563 | 230,993 | |||||||||
| Reinsurance recoverable on claim liabilities | 26,555 | 19,357 | 13,589 | |||||||||
| Claim liabilities at end of year | $ | 279,325 | 247,920 | 244,582 | ||||||||
As a result of changes in estimates of insured events in prior years, the amounts included as incurred claims for prior period insured events differ from anticipated claims incurred.
The amount in the incurred claims and loss-adjustment expenses for prior period insured events for the year 2004 is due to an unfavorable development of the claim liabilities attributed to higher than expected cost per service and utilization trends. The credits in the incurred claims and loss-adjustment expenses for prior period insured events for the years 2003, and 2002 are due to a favorable development of the claim liabilities attributed to better than expected utilization trends.
Reinsurance recoverable on unpaid claims is reported as other assets in the accompanying consolidated financial statements.
| (9) | Federal Employees’ Health Benefits Program |
TSI entered into a contract, renewable annually, with OPM as authorized by the Federal Employees’ Health Benefits Act of 1959, as amended, to provide the FEHBP. The FEHBP covers postal and federal employees resident in the Commonwealth of Puerto Rico as well as retirees and eligible dependents. The FEHBP is financed through a negotiated contribution made by the federal government and employees’ payroll deductions.
| 55 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
The accounting policies for the FEHBP are the same as those described in the summary of significant accounting policies. Premium rates are determined annually by TSI 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 TSI’s operations to the FEHBP based on applicable allocation guidelines (such as, the number of claims processed for each program).
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.
The contract with OPM allows for the payment of service fees as negotiated between TSI and OPM. Service fees, which are included within the other income, net in the accompanying consolidated statements of earnings, amounted to $778, $626, and $625, respectively, for each of the years in the three-year period ended December 31, 2004.
The following summarizes the operations of the FEHBP for each of the years in the three-year period ended December 31, 2004:
| 2004 | 2003 | 2002 | ||||||||||
| Premiums earned: | ||||||||||||
| Billed | $ | 105,246 | 91,241 | 92,616 | ||||||||
| Transfer from special account | 2,897 | 12,618 | 11,040 | |||||||||
| 108,143 | 103,859 | 103,656 | ||||||||||
| Underwriting costs: | ||||||||||||
| Claims incurred | 102,126 | 97,428 | 97,911 | |||||||||
| Operating expenses | 5,521 | 6,054 | 5,505 | |||||||||
| Total underwriting costs | 107,647 | 103,482 | 103,416 | |||||||||
| Underwriting gain | $ | 496 | 377 | 240 | ||||||||
| Interest income | $ | 282 | 249 | 385 | ||||||||
| Other expense | (778 | ) | (626 | ) | (625 | ) | ||||||
| Total interest income and other expense, net | $ | (496 | ) | (377 | ) | (240 | ) | |||||
| 56 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
The changes in the special account during 2004 and 2003 are as follows:
| 2004 | 2003 | |||||||
| Funds payable at beginning of year | $ | 7,471 | 7,066 | |||||
| Transfer to premiums earned by the FEHBP | (2,897 | ) | (12,618 | ) | ||||
| Contingency reserve payments | 5,217 | 13,023 | ||||||
| Funds payable at end of year | $ | 9,791 | 7,471 | |||||
The account for the FEHBP is related to the following accounts in the consolidated balance sheets as of December 31, 2004 and 2003:
| 2004 | 2003 | |||||||
| Cash, cash equivalents, and investments | $ | 17,154 | 19,018 | |||||
| Premiums, accrued interest and other receivables | 9,381 | 7,855 | ||||||
| Claim liabilities, including related unpaid loss-adjustment expenses | (9,920 | ) | (9,708 | ) | ||||
| Due to TSI | (6,824 | ) | (9,694 | ) | ||||
| $ | 9,791 | 7,471 | ||||||
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 accompanying balance sheets. The balance of such reserve as of December 31, 2004 and 2003 was $18,415 and $18,584, respectively. The Company received $5,217, $13,023, and $5,976, of payments made from the contingency reserve fund of OPM during 2004, 2003, and 2002, 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 1998 by OPM.
(10) Short-Term Borrowings
Short-term borrowings of $1,700 and $38,700 at December 31, 2004 and 2003, respectively, represent securities sold under agreements to repurchase. The agreement outstanding at December 31, 2004 matures in March 2005 and accrues interest at London Interbank Offered Rate (LIBOR) (interest rate of 2.6% at December 31,2004).
The investment securities underlying such agreements were delivered to the dealers with whom the agreements were transacted. The dealers may have sold, loaned, or otherwise disposed of such securities in the normal course of business operations, but have agreed to resell to the Company substantially the same securities on the maturity dates of the agreements.
| 57 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
At December 31, 2004 and 2003, investment securities available for sale with fair value of $1,792 and $40,336 (amortized cost of $1,800 and $40,070) were pledged as collateral under these agreements.
| (11) | Long-Term Borrowings |
A summary of long-term borrowings entered by the Company at December 31, 2004 and 2003 is as follows:
| 2004 | 2003 | |||||||
| Secured note payable of $20,000, payable in various different installments up to August 31, 2007, with interest payable on a monthly basis at a rate reset periodically of 130 basis points over L1BOR selected (which was 3.32% and 2.45% at December 31, 2004 and 2003, respectively). | $ | 15,000 | 16,005 | |||||
| Senior unsecured notes payable of $50,000 due September 2019. Interest is payable semiannually at a fixed rate of 6.30%. | 50,000 | — | ||||||
| Secured loan payable of $41,000, payable in monthly installments of $137 up to July 1, 2024, plus interest at a rate reset periodically of 100 basis points over LIBOR selected (which was 3.30% and 2.17% at December 31, 2004 and 2003, respectively). | 30,730 | 32,370 | ||||||
| Total long-term borrowings | $ | 95,730 | 48,375 | |||||
Aggregate maturities of the Company’s long-term borrowings as of December 31, 2004 are summarized as follows:
| 2005 | $ | 3,140 | ||
| 2006 | 3,140 | |||
| 2007 | 13,640 | |||
| 2008 | 1,640 | |||
| 2009 | 1,640 | |||
| Thereafter | 72,530 | |||
| $ | 95,730 | |||
On September 30, 2004, TS1 issued and sold $50,000 of its 6.30% senior unsecured notes due September 2019 (the notes). The notes are unconditionally guaranteed as to payment of principal, premium, if any, and interest by the Company. The notes were privately placed to various institutional investors under a note purchase agreement among TSI, the Company and the investors. The notes pay interest semiannually beginning on March 2005, until such principal becomes due and payable. The notes contain certain covenants with which TSI and the Company have complied with at December 31, 2004.
| 58 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
Debt issuance costs amounting to $600 were deferred and will be amortized over the term of the notes and are reported as other assets in the accompanying consolidated balance sheets.
The proceeds of the $41,000 loan and of the $20,000 note payable were used by the Company for the purchase of real estate properties from subsidiaries and for working capital needs.
The credit agreement related to the $20,000 secured note payable calls for repayments of principal amount of not less than $250 and in integral multiples of $50. The aggregate principal amounts shall be reduced annually to the amounts specified on or before the dates described below:
| Required | ||||
| principal | ||||
| outstanding | ||||
| Date | balance | |||
| August 1,2005 | $ | 13,500 | ||
| August 1,2006 | 12,000 | |||
| August 1, 2007 | — | |||
The loan and note payable previously described are guaranteed by a first position held by the bank on the Company’s land, building, and substantially all leasehold improvements, as collateral for the term of the loans under a continuing general security agreement. These credit facilities contain certain covenants, which are normal in this type of credit facility, which the Company has complied with at December 31, 2004 and 2003.
Interest expense on the above long-term borrowings amounted to $2,005, $1,302, and $2,150 for the years ended December 31, 2004, 2003, and 2002, respectively.
| (12) | Derivative Instruments and IIedging Activities |
The Company has invested in an interest-rate related derivative instruments to manage its exposure on Its debt instruments. The Company does not enter into derivative instruments for any purpose other than cash flow hedging purposes. That is, the Company does not speculate using derivative instruments.
By using derivative financial instruments to hedge exposures to changes in interest rates, the Company exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty is obligated to the Company, which creates credit risk for the Company. When the fair value of a derivative contract is negative, the Company owes the counterparty and, therefore, it does not possess credit risk. The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality counterparties.
Market risk is the adverse effect on the value of a financial instrument that results from a change in interest rates, currency exchange rates, or commodity prices. The market risk associated with interest-rate contracts is managed by establishing and monitoring parameters that limit the types and degree of market risk that may be undertaken.
| 59 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
The Company assesses interest rate cash flow risk by continually identifying and monitoring changes in interest rate exposures that may adversely impact expected future cash flows and by evaluating hedging opportunities. The Company maintains risk management control systems to monitor interest rate cash flow risk attributable to both the Company’s outstanding or forecasted debt obligations as well as the Company’s offsetting hedge positions. The risk management control systems involve the use of analytical techniques to estimate the expected impact of changes in interest rates on the Company’s future cash flows.
The Company has a variable-rate debt that was used to finance the acquisition of real estate from subsidiaries (see note 11). The debt obligations expose the Company to variability in interest payments due to changes in interest rates. Management believes it is prudent to limit the variability of a portion of its interest payments. To meet this objective, on December 6, 2002, management entered into an interest-rate swap agreement, with effective date of April 1, 2003, to manage fluctuations in cash flows resulting from interest rate risk. This swap economically changes the variable-rate cash flow exposure on the debt obligations to fixed cash flows. Under the terms of the interest-rate swap, the Company receives variable interest rate payments and makes fixed interest rate payments, thereby creating the equivalent of fixed-rate debt.
Changes in the fair value of the interest-rate swap, designated as a hedging instrument that effectively offsets the variability of cash flows associated with the variable-rate of the long-term debt obligation, are reported in accumulated other comprehensive income, net of the related tax effect. This amount is subsequently reclassified into interest expense as a yield adjustment of the hedged debt obligation in the same period in which the related interest affects earnings. During the years ended December 31, 2004 and 2003, the Company reclassified $734 and $639 into interest expense, not including any amount representing cash-flow hedge ineffectiveness since the terms of the swap agreement allow the Company to assume no ineffectiveness in the agreement.
As of December 31, 2004, $142 of deferred loss on the derivative instrument was included within the accounts payable and accrued liabilities in the accompanying consolidated balance sheets and is expected to be reclassified to earnings during the next 12 to 18 months. Transactions and events expected to occur over the next 12 months that will necessitate reclassifying the derivatives loss to earnings is the repricing of variable-rate debt. There were no cash-flow hedges discontinued during 2004.
| (13) | Retained Earnings and Stockholders’ Equity |
As members of the BCBSA, the Company and TSI 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.
| 60 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| (14) | Comprehensive Income |
The accumulated balances for each classification of comprehensive income are as follows:
| Accumulated | ||||||||||||||||
| Unrealized | Minimum | other | ||||||||||||||
| gains on | pension | Cash-flow | comprehensive | |||||||||||||
| securities | liability | hedges | income | |||||||||||||
| Beginning balance | $ | 20,948 | (5,822 | ) | (367 | ) | 14,759 | |||||||||
| Net current period change | 7,998 | (3 | ) | 281 | 8,276 | |||||||||||
| Reclassification adjustments for gains and losses reclassified in income | (6,897 | ) | — | — | (6,897 | ) | ||||||||||
| Ending balance | $ | 22,049 | (5,825 | ) | (86 | ) | 16,138 | |||||||||
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 2004 and 2003 are as follows:
| 2004 | ||||||||||||
| Deferred tax | ||||||||||||
| Before-tax | (expense) | Net-of-tax | ||||||||||
| amount | benefit | amount | ||||||||||
| Unrealized holding gains on securities arising during the period | $ | 7,547 | 451 | 7,998 | ||||||||
| Less reclassification adjustment for gains and losses realized in income | (6,314 | ) | (583 | ) | (6,897 | ) | ||||||
| Net change in unrealized gain | 1,233 | (132 | ) | 1,101 | ||||||||
| Minimum pension liability adjustment | 35 | (38 | ) | (3 | ) | |||||||
| Cash-flow hedges | 459 | (178 | ) | 281 | ||||||||
| Net current period change | $ | 1,727 | (348 | ) | 1,379 | |||||||
| 61 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2003 | ||||||||||||
| Deferred tax | ||||||||||||
| Before-tax | (expense) | Net-of-tax | ||||||||||
| amount | benefit | amount | ||||||||||
| Unrealized holding gains on securities arising during the period | $ | 7,145 | (3,575 | ) | 3,570 | |||||||
| Less reclassification adjustment for gains and losses realized in income | (10,932 | ) | 1,340 | (9,592 | ) | |||||||
| Net change in unrealized gain | (3,787 | ) | (2,235 | ) | (6,022 | ) | ||||||
| Minimum pension liability adjustment | (681 | ) | 2,973 | 2,292 | ||||||||
| Cash-flow hedges | 81 | 22 | 103 | |||||||||
| Net current period change | $ | (4,387 | ) | 760 | (3,627 | ) | ||||||
| 2002 | ||||||||||||
| Deferred tax | ||||||||||||
| Before-tax | (expense) | Net-of-tax | ||||||||||
| amount | benefit | amount | ||||||||||
| Unrealized holding gains on securities arising during the period | $ | 6,472 | (365 | ) | 6,107 | |||||||
| Less reclassification adjustment for gains and losses realized in income | (183 | ) | 62 | (121 | ) | |||||||
| Net change in unrealized gain | 6,289 | (303 | ) | 5,986 | ||||||||
| Minimum pension liability adjustment | (8,755 | ) | 641 | (8,114 | ) | |||||||
| Cash-flow hedges | (682 | ) | 212 | (470 | ) | |||||||
| Net current period change | $ | (3,148 | ) | 550 | (2,598 | ) | ||||||
Deferred tax expenses or benefits are related to the unrealized holding gains on investments classified as available for sale held by the Company and its wholly owned subsidiaries. A deferred tax benefit was also recognized for the deferred loss related to the Company’s cash-flow hedges (see note 12) and the minimum pension liability adjustment (see note 18).
(15) Agency Contract and Expense Reimbursement
TSI processes and pays claims as fiscal intermediary for the Medicare – Part B Program. Claims from this program, which are excluded from the accompanying consolidated statements of earnings, amounted to $625,841, $579,300, and $574,720 for each of the years in the three-year period ended December 31, 2004.
TSI is reimbursed for administrative expenses incurred in performing this service. For the years ended December 31, 2004, 2003, and 2002, TSI was reimbursed by $13,980, $11,387, and S12,743, respectively,
| 62 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
for such services which are deducted from operating expenses in the accompanying consolidated statements of earnings.
The operating expense reimbursements in connection with processing Medicare claims have been audited through 1997 by federal government representatives. Management is of the opinion that no significant adjustments will be made affecting cost reimbursements through December 31, 2004.
| (16) | Reinsurance Activity |
STS and SVTS, 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.
STS 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. During 2004 and 2003, STS placed 9% and 11%, respectively, of its reinsurance business with one reinsurance company. Under these treaties, STS ceded premiums of $52,214, $43,770, and $39,806 in 2004, 2003, and 2002, 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. Only 37.5% of this treaty was placed with reinsurers. The remaining exposure was covered by a property per risk excess of loss treaty, which provides reinsurance in excess of $500 up to a maximum of $12,500 or the remaining 62.5% for any one risk. STS also has an additional property catastrophe excess of loss contract, which provides protection for losses in excess of $5,000 resulting from any catastrophe, subject to a maximum loss of $10,000. | |||
| • | 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 $110,000. | |||
| • | Commercial 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 $180,000. | |||
| • | Property catastrophe excess of loss. This treaty provides protection for losses in excess of $110,000 and $180,000 with respect to personal and commercial lines, respectively, resulting from any catastrophe, subject to a maximum loss of $75.000, | |||
| • | Personal lines quota share. This treaty provides protection of 7.5% on all ground-up losses, subject to a limit of $1,000 for any one risk. | |||
| 63 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| • | Reinstatement Premium Protection. This treaty provides a maximum limit of $2,400 in personal lines and $5,500 in commercial lines to cover the necessity of reinstating the catastrophe program in the event it is activated. | |||
| • | Casualty excess of loss treaty. This treaty provides reinsurance for losses in excess of $150 up to a maximum of $11,850. | |||
| • | 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 $5,000 for a maximum of $7,500 for any one risk. | |||
| • | Surety quota share treaty covering contract and miscellaneous surety bond business. This treaty provides reinsurance of up to $3,000 for contract surety bonds, subject to an aggregate of $7,000 per contractor and $2,000 per miscellaneous surety bond. | |||
Facultative reinsurance is obtained when coverage per risk is required, on a proportional basis. All reinsurance contracts are for a period of one year on a calendar basis and arc subject to modifications and negotiations in each renewal.
SVTS cedes insurance with seven reinsurers. Insurance is ceded on pro rata, facultative excess of loss and catastrophic bases. Under the pro rata agreement, SVTS reinsures 50% of the risk up to $250 on the life of any participating individual of certain groups insured. Under this treaty, SVTS ceded premiums of $2,291 in 2004, $2,236 in 2003, and $2,085 in 2002.
The life insurance facultative excess of loss agreements provide for SVTS to retain a portion of the losses on the life of any participating individual of certain groups insured. Any excess will be recovered from the reinsurer. This agreement provides for various retentions ($25, $50, and $75) of the losses. Under this facultative treaty, SVTS ceded premiums of approximately $908 in 2004, $756 in 2003, and $661 in 2002.
SVTS also has facultative pro rata agreements for the long-term disability insurance risk as follows:
| • | A long-term disability insurance treaty where SVTS reinsures 65% of the risk. Premiums ceded under this agreement amount to $4,521 and $4,507 in 2004 and 2003, respectively. No premiums were ceded under this agreement during the year 2002. | |||
| • | A long-term disability insurance treaty where SVTS reinsures 75% of the risk. Premiums ceded under this agreement amounted to $118, $133, and $3,594 during the years 2004, 2003, and 2002, respectively. | |||
The accidental death catastrophic reinsurance covers each and every accident arising out of one event or occurrence resulting in the death or dismemberment of five or more persons. SVTS’s retention for each event is $250 with a maximum of $1,000 for each event and $2,000 per year. Under this treaty, the Company ceded premiums of $82 in 2004, $90 in 2003, and $68 in 2002.
| 64 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
The ceded unearned reinsurance premiums on STS arising from these reinsurance transactions amounted to $13,751 and $12,114 at December 31, 2004 and 2003, respectively and are reported as other assets in the accompanying consolidated balance sheets.
The effect of reinsurance on premiums earned and claims incurred is as follows:
| Premiums earned | Claims incurred | |||||||||||||||||||||||
| 2004 | 2003 | 2002 | 2004 | 2003 | 2002 | |||||||||||||||||||
| Gross | $ | 1,356,604 | 1,313,820 | 1,285,459 | 1,133,238 | 1,080,207 | 1,071,751 | |||||||||||||||||
| Ceded | (60,181 | ) | (51,586 | ) | (48,812 | ) | (17,445 | ) | (14,857 | ) | (9,771 | ) | ||||||||||||
| Net | $ | 1,296,423 | 1,262,234 | 1,236,647 | 1,115,793 | 1,065,350 | 1,061,980 | |||||||||||||||||
| (17) | Income Taxes |
Under Puerto Rico income tax law, the Company is not allowed to file consolidated tax returns with its subsidiaries.
TSI was exempt through 2002 from Puerto Rico income taxes under a ruling issued by the Department of the Treasury. On June 18, 2003, the Department of the Treasury notified the Company that the ruling recognizing TSI’s tax exemption was terminated effective December 31, 2002. The termination of the ruling responds to a new public policy set by the Department of the Treasury according to which tax exemptions under Section 1101(6) of the Puerto Rico Code (P.R. Code) will not apply to corporations organized as for-profit, which is TSI’s case.
On July 31, 2003, TSM and TSI executed a closing agreement with the Department of the Treasury. In general, the terms of the closing agreement established the termination of TSI’s tax exemption effective December 31, 2002. Accordingly, since TSI’s tax status changed effective January 1, 2003, TSI is subject to Puerto Rico income taxes as an other-than-life insurance entity, as defined in the P.R. Code.
The closing agreement also stipulates that TSM will pay taxes (Department of the Treasury tax assessment) on TSI’s accumulated statutory net income, in accordance with the income recognition methodology applied by the Secretary of the Treasury in the closing agreement and the ruling mentioned above. This tax ruling established the following methodology for TSM to determine its tax liability:
| • | TSI’s accumulated statutory net income while operating under the tax exemption, amounting to $132,763, was deemed distributed to TSM. | |||
| • | For tax purposes, TSM recognized the exempt accumulated statutory net income as gross income. On this amount, TSM recognized an income tax liability amounting to $51,774, which was determined by applying a tax rate of 39% to the exempt accumulated statutory net income deemed distributed to TSM. The income tax was recorded by TSM within the current income tax expense presented in the consolidated statements of earnings. Of this tax, $37,000 was paid on July 31, 2003, the date of the closing agreement, and $14,774 on April 15, 2004. | |||
| 65 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
STS is taxed essentially the same as other corporations, with taxable income determined on the basis of the statutory annual statements filed with the insurance regulatory authorities. Also, operations are 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.
TSI, STS, and SVTS are also subject to federal income taxes for foreign source dividend income. No federal income taxes were recognized for 2004, 2003, and 2002.
SVTS operates as a qualified domestic life insurance company and is subject to the alternative minimum tax and taxes on its capital gains.
TSM, TCI, and ISI are subject to Puerto Rico income taxes as a regular corporation, as defined in the P.R. Code, as amended.
| 66 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(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:
| 2004 | 2003 | 2002 | ||||||||||
| Income before taxes | $ | 59,817 | 91,626 | 50,798 | ||||||||
| Less net income corresponding to TSI operations, which were exempt from Puerto Rico income taxes until December 31, 2002 | — | — | 37,903 | |||||||||
| 59,817 | 91,626 | 12,895 | ||||||||||
| Statutory tax rate | 39 | % | 39 | % | 39 | % | ||||||
| Income tax expense at statutory rate of 39% | 23,329 | 35,734 | 5,029 | |||||||||
| Increase (decrease) in taxes resulting from: | ||||||||||||
| Exempt interest income | (6,322 | ) | (5,689 | ) | (2,723 | ) | ||||||
| Alternative minimum tax | — | 320 | 264 | |||||||||
| Excess of regular tax over capital gain tax on SVTS | (327 | ) | — | — | ||||||||
| Excess of regular tax over alternative minimum tax on SVTS | — | (1,164 | ) | (1,095 | ) | |||||||
| Effect of using earnings under statutory accounting principles instead of GAAP earnings for TSI and STS tax computations | (658 | ) | (7,026 | ) | 900 | |||||||
| Effect of taxing capital gains at a preferential rate | (2,594 | ) | (1,897 | ) | — | |||||||
| Department of the Treasury tax assessment | — | 51,774 | — | |||||||||
| Dividends received deduction | (498 | ) | (145 | ) | (68 | ) | ||||||
| Effect of change in TSI tax status | 1,172 | (5,023 | ) | — | ||||||||
| Other disallowances, net | 956 | 369 | 149 | |||||||||
| Other | (1,044 | ) | (1,856 | ) | 93 | |||||||
| Total income tax expense | $ | 14,014 | 65,397 | 2,549 | ||||||||
| 67 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(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 liability at December 31, 2004 and 2003 of the Company and its subsidiaries is composed of the following:
| 2004 | 2003 | |||||||
| Deferred tax assets: | ||||||||
| Allowance for doubtful receivables | $ | 4,258 | 3,368 | |||||
| Cash-flow hedges | 56 | 234 | ||||||
| Nondeductible depreciation | 423 | 468 | ||||||
| Employee benefits plan | 2,759 | 2,749 | ||||||
| Postretirement benefits | 1,447 | 1,299 | ||||||
| Deferred compensation | 2,071 | 1,314 | ||||||
| Contingency reserves | 133 | 367 | ||||||
| Additional minimum pension liability | 3,576 | 3,614 | ||||||
| Other | 419 | 80 | ||||||
| Total gross deferred tax assets | 15,142 | 13,493 | ||||||
| Deferred tax liabilities: | ||||||||
| Deferred policy acquisition costs | (5,347 | ) | (4,854 | ) | ||||
| Unamortized bond issue costs | (230 | ) | — | |||||
| Unrealized gain on securities available for sale | (3,330 | ) | (3,198 | ) | ||||
| Unrealized gain on trading securities | (3,331 | ) | (2,659 | ) | ||||
| Catastrophe loss reserve trust fund | (4,873 | ) | (4,674 | ) | ||||
| Gross deferred tax liabilities | (17,111 | ) | (15,385 | ) | ||||
| Net deferred tax liability | $ | (1,969 | ) | (1,892 | ) | |||
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.
| (18) | Pension Plan |
The Company sponsors a noncontributory defined-benefit pension plan for all of its employees and for the employees of its subsidiaries who are age 21 or older and have completed one year of service. 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 measures for the pension plan is December 31.
| 68 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(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, 2004 and 2003, accordingly:
| 2004 | 2003 | |||||||
| Change in benefit obligation: | ||||||||
| Projected benefit obligation at beginning of year | $ | 61,336 | 53,993 | |||||
| Service cost | 4,100 | 3,631 | ||||||
| Interest cost | 3,843 | 3,778 | ||||||
| Benefit payments | (4,266 | ) | (215 | ) | ||||
| Actuarial losses | 6,065 | 10,568 | ||||||
| Settlements | — | (10,419 | ) | |||||
| Projected benefit obligation at end of year | $ | 71,078 | 61,336 | |||||
| Accumulated benefit obligation at end of year | $ | 51,412 | 44,847 | |||||
At December 31, 2004 and 2003, the Company recognized an additional minimum pension liability of $9,999 and $10,081, respectively, in order to bring the accrued pension liability up to the level of the plan’s unfunded accumulated benefit obligation. This amount is offset by an intangible asset amounting to $598 and $645 as of December 31, 2004 and 2003, respectively that is based on the outstanding unrecognized prior service cost. The net amount of the additional minimum pension liability and the intangible asset was recorded through a charge to accumulated other comprehensive income, net of a deferred tax asset of $3,576 and $3,614 at December 31, 2004 and 2003, respectively.
| 2004 | 2003 | |||||||
| Change in plan assets: | ||||||||
| Fair value of plan assets at beginning of year | $ | 32,142 | 25,275 | |||||
| Actual return on assets (net of expenses) | 3,765 | 5,501 | ||||||
| Employer contributions | 10,931 | 12,000 | ||||||
| Benefit payments | (4,266 | ) | (215 | ) | ||||
| Settlements | — | (10,419 | ) | |||||
| Fair value of plan assets at end of year | $ | 42,572 | 32,142 | |||||
| Reconciliation of funded status: | ||||||||
| Funded status | $ | (28,507 | ) | (29,193 | ) | |||
| Unrecognized prior service cost | 598 | 645 | ||||||
| Unrecognized actuarial loss | 29,068 | 25,924 | ||||||
| Prepaid (accrued) benefit cost | $ | 1,159 | (2,624 | ) | ||||
| 69 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
The components of net periodic benefit cost for 2004, 2003, and 2002 were as follows:
| 2004 | 2003 | 2002 | ||||||||||
| Components of net periodic benefit cost: | ||||||||||||
| Service cost | $ | 4,100 | 3,631 | 3,115 | ||||||||
| Interest cost | 3,843 | 3,778 | 3,369 | |||||||||
| Expected return on assets | (2,549 | ) | (2,494 | ) | (2,754 | ) | ||||||
| Amortization of prior service cost | 48 | 48 | 57 | |||||||||
| Amortization of actuarial loss | 1,706 | 1,569 | 392 | |||||||||
| Settlement loss | — | 4,404 | — | |||||||||
| Net periodic benefit cost | $ | 7,148 | 10,936 | 4,179 | ||||||||
Net periodic pension expense 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.
The following assumptions were used on a weighted average basis to determine benefit obligations of the plan as of December 31, 2004, 2003, and 2002:
| 2004 | 2003 | 2002 | ||||||||||
| Discount rate | 5.75 | % | 6.25 | % | 6.75 | % | ||||||
| Expected return on plan assets | 8.50 | % | 8.50 | % | 8.50 | % | ||||||
| Rate of compensation increase | Graded; 3.00% | Graded; 3.00% | Graded; 3.00% | |||||||||
| to 6.50 | % | to 6.50 | % | to 6.50 | % | |||||||
The assumptions used in computing net periodic benefit cost-for the years ended December 31, 2004, 2003, and 2002 were as follows:
| 2004 | 2003 | 2002 | ||||||||||
| Assumptions used in computing net periodic benefit cost: | ||||||||||||
| Discount rate | 6.25 | % | 6.75 | % | 7.25 | % | ||||||
| Expected return on plan assets | 8.50 | % | 8.50 | % | 9.00 | % | ||||||
| Rate of compensation increase | Graded; 3.00% | Graded; 3.00% | Graded; 3.00% | |||||||||
| to 6.5 | % | to 6.5 | % | to 6.5 | % | |||||||
The basis used to determine the overall expected long-term rate of return on assets assumption was an analysis of the historical rate of return for a portfolio with a similar asset allocation. The assumed long-term asset allocation for the plan is as follows: 53%-67% equity securities; 26%-36% debt securities; 4%-12% real estate; and 0%-4% cash.
| 70 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
Using historical investment returns, the plan’s expected asset mix, and adjusting for the difference between expected inflation and historical inflation, the 25th to 75th percentile range of annual rates of return is 7.1%-8.9%.
The Company selected a rate from within this range of 8.50%, which reflects our best estimate for this assumption based on the historical 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 0.25% reduction for other administrative expenses charged to the trust.
| (a) | Plan Assets | |||
| The Company’s weighted average asset allocations at December 31, 2004 and 2003 by asset category were as follows: | ||||
| Asset category | 2004 | 2003 | ||||||
| Equity securities | 62 | % | 62 | % | ||||
| Debt securities | 28 | 29 | ||||||
| Real estate | 8 | 4 | ||||||
| Other | 2 | 5 | ||||||
| Total | 100 | % | 100 | % | ||||
| 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 Blue Cross Blue Shield Association 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 followed by institutional investors and 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. | |||
| • | Risk can be controlled through diversification of assets 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. | |||
| • | 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. | |||
| 71 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
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:
| • | Ensure assets are available to meet current and future obligations of the participating programs when due. | |||
| • | Earn a minimum rate of return no less than the actuarial interest rate. | |||
| • | 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. | |||
| • | Invest the assets with the care, skill, and diligence that a prudent person acting in a like capacity would undertake. The Committee acknowledges that, in the process, it has the objective of controlling the costs involved with administering and managing the investments of the National Retirement Trust. | |||
The target asset allocation for the Company is as follows: 53%-67% equity securities; 26%-36% debt securities; 4%-12% real estate; and 0%-4% cash.
| (b) | Cash Flows | |||
| The Company expects to contribute $7,900 to its pension program in 2005. | ||||
| The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid: | ||||
| 2005 | $ | 2,288 | ||
| 2006 | 2,519 | |||
| 2007 | 3,042 | |||
| 2008 | 3,292 | |||
| 2009 | 4,088 | |||
| Years 2010 -2014 | 27,902 | |||
| $ | 43,131 | |||
| (19) | Catastrophe Loss Reserve Trust Fund | |||
| In accordance with the Act No. 73 of August 12, 1994, and Chapter 25 of the Insurance Code, STS is required to establish and maintain a trust fund for the payment of catastrophe losses. The establishment of this trust fund will increase the financial capacity in order to offer protection for those insurers exposed to catastrophe losses. 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 gain (loss) on investment transactions becomes part of the reserve for catastrophic insurance losses and income (expense) of the Company. The assets in this fund, which are reported as other assets in the accompanying consolidated balance sheets, will be used solely and exclusively to pay catastrophe losses covered under policies written in Puerto Rico. | ||||
| 72 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
The retained earnings of STS are restricted in the accompanying consolidated balance sheets by the total catastrophe loss reserve balance.
In addition, pursuant to Article 8 of Rule LXXII of October 15, 1999, of the Insurance Code, STS is required to make a current year deposit to the fund, if any, on or before January 30 of the following year. Contributions are determined by a rate (1.0% for 2004 and 2003), imposed by the Commissioner of Insurance for the catastrophe policies written in that year. The amount deposited in the trust fund is deductible for income tax purposes.
In January 2005 and 2004, the Company deposited to the trust fund $663 and $621, respectively, corresponding to the contributions for catastrophic policies written in 2004 and 2003, respectively. The amount deposited in the trust fund may be reimbursed in the case that STS ceases to underwrite risks subject to catastrophe losses.
As of December 31, 2004 and 2003, the movement of the catastrophe loss reserve is as follows:
| 2004 | 2003 | |||||||
| Catastrophe loss reserve at beginning of year | $ | 22,418 | 20,824 | |||||
| Investment income | 1,042 | 973 | ||||||
| Catastrophe loss reserve trust fund at end of year | 23,460 | 21,797 | ||||||
| Contribution payable | 663 | 621 | ||||||
| Restricted retained earnings | $ | 24,123 | 22,418 | |||||
The trust fund assets are composed of the following:
| 2004 | 2003 | |||||||
| U.S. Treasury securities, at amortized cost (fair value of $376 in 2003) | $ | — | 370 | |||||
| Federal Home Loan Bank notes, at amortized cost (fair value of $16,269 and $18,991 in 2004 and 2003, respectively) | 16,598 | 19,273 | ||||||
| Federal Farm Credit Bank note, at amortized cost (fair value of $5,035 in 2004) | 5,035 | — | ||||||
| Obligations of the Commonwealth of Puerto Rico and its instrumentalities, at amortized cost (fair value of $1,575 and $1,553 in 2004 and 2003, respectively) | 1,500 | 1,500 | ||||||
| Accrued interest receivable | 219 | 277 | ||||||
| Cash and cash equivalents | 108 | 377 | ||||||
| $ | 23,460 | 21,797 | ||||||
| 73 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
Maturities of investments held in the catastrophe loss reserve trust fund were as follows at December 31, 2004:
| Amortized | Estimated | |||||||
| cost | fair value | |||||||
| Due after one year through five years | $ | 7,829 | 7,941 | |||||
| Due after five years through ten years | 10,276 | 10,226 | ||||||
| Due after ten years | 5,028 | 4,712 | ||||||
| $ | 23,133 | 22,879 | ||||||
| (20) | Commitments |
The Company leases its regional offices, certain equipment, and warehouse facilities under noncancelable operating leases. Minimum annual rental commitments at December 31, 2004 under existing agreements are summarized as follows:
| Year ending December 31 : | ||||
| 2005 | $ | 3,441 | ||
| 2006 | 2,393 | |||
| 2007 | 1,693 | |||
| 2008 | 481 | |||
| 2009 | 266 | |||
| Thereafter | 755 | |||
| Total | $ | 9,029 | ||
Rental expense for 2004, 2003, and 2002 was $1,653, $1,460, and $1,459, respectively, after deducting the amount of $489, $689, and $441, respectively, reimbursed by Medicare (see note 15).
| (21) | Contingencies |
| (a) | Legal Proceedings |
| (i) | At December 31, 2004, the Company is defendant in various lawsuits arising in the ordinary course of business. In the opinion of management, with the advice of its legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position and results of operations of the Company. | |||
| (ii) | The Company and others are defendants in a class action complaint alleging violations under the Racketeer Influenced and Corrupt Organizations Act. The suit, among other allegations, alleges a scheme to defraud the plaintiffs by acquiring control of TSI through illegally capitalizing TSI and later converting it into a for-profit organization and depriving the shareholders of TSI of their ownership rights. The plaintiffs base their later allegations on the supposed decisions of TSl’s board of directors and shareholders, allegedly made in 1979, to | |||
| 74 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
operate with certain restrictions in order to turn TSI into a charitable corporation, basically forever. While the case is still in the very early stages of litigation and the case has not been certified as a class action, a motion to dismiss was filed by defendants. On March 15, 2004, plaintiffs filed a response to this motion. On April 30, 2004, defendants filed a reply in support of motion to dismiss. On March 4, 2005, the Court issued an Opinion and Order. In this Opinion and Order, of the twelve counts included in the complaint, eight counts were dismissed for failing to assert an actionable injury; six for lack of standing; and two for failing to plead with sufficient particularity in compliance with the Rules. All shareholder allegations, including those described above, were dismissed in the Opinion and Order. The remaining four counts were found standing, in a limited way, in the Opinion and Order. Finally, the Court ordered that by March 24, 2005 one of the counts left standing be replead to conform to the Rules and that by March 28, 2005 a proposed schedule for discovery and other submissions be filed. This case is still pending before the United States District Court for the District of Puerto Rico. In the opinion of management, with the advice of its legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position and results of operations of the Company.
| (iii) | TSM, TSI and others are defendants in a complaint where the plaintiffs allege that the defendants, among other things, violated provisions of the Insurance Code, anti-monopolistic practices and unfair business practices. After a preliminary review of the complaint, it appears that many of the allegations brought by the plaintiffs have been resolved in favor of TSM and TSI in previous cases brought by the same plaintiffs in the U.S. District Court for the District of Puerto Rico and by most of the plaintiffs in the local courts. The defendants, including TSM and TSI answered the complaint, filed a counter-claim and filed several motions to dismiss this claim. The case has recently been reassigned to a new judge. In the opinion of management, with the advice of its legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position and results of operations of the Company. | |||
| (iv) | On May 22, 2003, a class action suit was filed by Kenneth A. Thomas, MD and Michael Kutell, MD, on behalf of themselves and all other similarly situated and the Connecticut State Medical Society against the BCBSA and multiple other insurance companies including TSI. The individual plaintiffs bring this action on behalf of themselves and a class of similarly situated physicians seeking redress for alleged illegal acts of the defendants, which they allege have resulted in a loss of their property and a detriment to their business, and for declaratory and injunctive relief to end those practices and prevent further losses. Plaintiffs alleged that the defendants, on their own and as part of a common scheme, systematically deny, delay, and diminish the payments due to doctors so that they are not paid in a timely manner for the covered, medically necessary services they render. The class action complaint alleges that the health care plans are the agents of Blue Cross and Blue Shield licensed entities, and as such have committed the acts alleged above and acted within the scope of their agency, with the consent, permission, authorization, and knowledge of the others, and in furtherance of both their interest and the interests of other defendants. Management believes that TSI was brought to this litigation for the sole reason of being associated with BCBSA. However, on June 18, | |||
| 75 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
2004, the Plaintiffs moved to amend the complaint to include the Colegio de Medicos Cirujanos de Puerto Rico (a compulsory association grouping all physicians in Puerto Rico), Marissel Velazquez, MD, President of the Colegio de Medicos y Cirujanos de Puerto Rico, and Andres Melendez, MD, as plaintiffs against TSI. Later Marissel Velazquez, MD) voluntarily dismissed her complaint against TSI. TSI, along with the other defendants, moved to dismiss the complaint under multiple grounds, including but not limited to arbitration and applicability of the McCarran Ferguson Act. In the opinion of management, with the advice of its legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position and results of operations of the Company.
| (v) | On December 8, 2003, a putative class action was filed by Jeffrey Solomon, MD, and Orlando Armstrong, MD, on behalf of themselves and all other similarly situated and the American Podiatric Medical Association, Florida Chiropractic Association, California Podiatric Medical Association, Florida Podiatric Medical Association, Texas Podiatric Medical Association, and Independent Chiropractic Physicians, against the BCBSA and multiple other insurance companies, including TSI, all members of the BCBSA. The individual plaintiff’s bring this action on behalf of themselves and a class of similarly situated physicians seeking redress for alleged illegal acts of the defendants, which are alleged to have resulted in a loss of Plaintiffs property and a detriment to their business, and for declaratory and injunctive relief to end those practices and prevent further losses. Plaintiffs alleged that the defendants, on their own and as part of a common scheme, systematically deny, delay and diminish the payment due to the doctors so that they are not paid in a timely manner for the covered, medically necessary services they render. The class action complaint alleges that the health care plans are the agents of BCBSA licensed entities, and as such have committed the acts alleged above and acted within the scope of their agency, with the consent, permission, authorization and knowledge of the others, and in furtherance of both their interest and the interests of other defendants. On June 25, 2004, plaintiffs amended the complaint but the allegations against TSI did not vary. Management believes that TSI was made a party to this litigation for the sole reason that TSI is associated with the BCBSA. TSI, along with the other defendants, moved to dismiss the complaint under multiple grounds, including but not limited to arbitration and applicability of the McCarran Ferguson Act. In the opinion of management, with the advice of its legal counsel, the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position and results of operations of the Company. |
| (b) | Guarantee Associations |
Pursuant to the Insurance Code, STS is a member of Sindicato de Aseguradores para la Suscripcion Conjunta de Seguros de Responsabilidad Profesional Medico-Hospitalaria (SIMED) and of the Sindicato de Aseguradores de Responsabilidad Profesional para Medicos. Both syndicates were organized for the purpose of underwriting medical-hospital professional liability insurance. As a member, the subsidiary shares risks with other member companies and, accordingly, is contingently liable in the event that the above-mentioned syndicates cannot meet their obligations. During 2004 and 2003, no assessments or payments were made for this contingency.
| 76 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
Additionally, pursuant to Article 12 of Rule LXIX of the Insurance Code, STS is a member of the Compulsory Vehicle Liability Insurance Joint Underwriting Association (the Association). The Association was organized during 1997 to underwrite insurance coverage of motor vehicle property damage liability risks effective January 1, 1998. As a participant, STS shares the risk, proportionately with other members, based on a formula established by the Insurance Code. During the three-year period ended December 31, 2004, the Association distributed experience refunds. STS received refunds amounting to $840, $638, and $565 in 2004, 2003, and 2002, respectively.
STS is a member of the Asociación de Garantia de Seguros de Todas Clases, excepto Vida, Incapacidad y Salud and TSI and SVTS are members of the Asociación de Garantia de Seguros de Vida, Incapacidad y Salud. As members, they are required to provide funds for the payment of claims and unearned premiums reimbursements for policies issued by insurance companies declared insolvent. At December 31, 2003, STS had accrued $250 for future assessments. No accrual was made at December 31, 2004, since STS has not been informed of any further assessments. During 2004, 2003, and 2002, STS paid assessments of $1,121, $500, and $654, respectively. Moreover, no assessments were attributable to TSI and SVTS during 2004, 2003, and 2002.
| (22) | Statutory Accounting |
TSI, SVTS, and STS (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 differ from GAAP.
The principal differences resulting between the financial statements of the regulated subsidiaries under statutory accounting practices with GAAP are as follows:
| • | The accounting basis of investments in debt and equity securities are based upon the rules promulgated by NAIC Statutory Accounting Principles (SAP). | |||
| • | Certain assets (primarily prepaid expenses, furniture and equipment, and premiums’ balances not collected within 90 days) are classified as nonadmitted and are excluded from the balance sheets by a charge to unassigned capital and surplus. | |||
| • | Certain notes payable are classified as surplus notes under statutory accounting practices. | |||
| • | Policy acquisitions costs (mainly commissions) are not deferred over the periods in which the premiums are earned but charged to operations as incurred. | |||
The NAIC recodified SAP to promote standardization throughout the industry and effective January 1, 2001, the Company adopted these new statutory accounting principles. The Commissioner of Insurance adopted NAIC SAP as long as it does not contradict the provisions of the Insurance Code. This results in the situation that various accounting practices prescribed or permitted by the Commissioner of Insurance depart from NAIC SAP.
In terms of permitted accounting practices, the Commissioner of Insurance through a circular letter dated September 14, 2001, permits property and casualty insurance companies in Puerto Rico to not record the tax liability that otherwise would have resulted from the contributions made to the catastrophe reserve fund
| 77 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
(see notes 17 and 19). The use of this permitted statutory accounting practice relieves STS in 2004 and 2003 of recording a charge to operations of approximately $ 199 and $ 186, respectively, and a charge to the statutory surplus of approximately $4,900 and $4,700 in 2004 and 2003, respectively, which otherwise would have been recorded under the prescribed statutory accounting practices.
The accumulated earnings of TSI, SVTS, and STS are restricted as to the payment of dividends by statutory limitations applicable to domestic insurance companies. Such limitations restrict the payment of dividends by insurance companies generally to unrestricted unassigned surplus funds reported for statutory purposes. As more fully described in note 19, a portion of the accumulated earnings of STS are also restricted by the catastrophe loss reserve balance (amounting to $24,123 and $22,418 as of December 31, 2004 and 2003, respectively) as required by the Insurance Code.
The net admitted assets, unassigned surplus, and capital and surplus of the insurance subsidiaries at December 31, 2004 and 2003 are as follows:
| 2004 ( Unaudited) | ||||||||||||
| TSI | STS | SVTS | ||||||||||
| Net admitted assets | $ | 494,199 | 225,684 | 71,551 | ||||||||
| Unassigned surplus | 164,698 | 36,831 | 20,045 | |||||||||
| Capital and surplus | 191,239 | 69,455 | 21,245 | |||||||||
| 2003 | ||||||||||||
| TSI | STS | SVTS | ||||||||||
| Net admitted assets | $ | 467,153 | 195,030 | 60,616 | ||||||||
| Unassigned surplus | 149,393 | 28,102 | 19,872 | |||||||||
| Capital and surplus | 175,934 | 59,020 | 21,072 | |||||||||
The net income of the insurance subsidiaries for the years ended December 31, 2004, 2003, and 2002 is as followss:
| TSI | STS | SVTS | ||||||||||
| 2004 (unaudited) | $ | 31,045 | 9,589 | 607 | ||||||||
| 2003 | 41,321 | 6,207 | 3,990 | |||||||||
| 2002 | 36,988 | 3,481 | 3,442 | |||||||||
| (23) | Net Income Available to Stockholders and Basic Net Income per Share |
The Company presents only basic earnings per share, which is comprised of the net income that could be available to common stockholders divided by the weighted average number of common shares outstanding for the period.
| 78 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
The following table sets forth the net income available for distribution to stockholders for the three-year period ended December 31, 2004. The amount presented as available for distribution to stockholders for the year 2002 exclude TSI’s results of operations due to TSI’s prohibition to declare dividends, as required in its tax exemption ruling. Due to TSI’s change in tax status effective January 1, 2003 (see note 17), TSI’s earnings are now available for distribution to shareholders.
| 2004 | 2003 | 2002 | ||||||||||
| Net income | $ | 45,803 | 26,229 | 48,249 | ||||||||
| Less TSI result of operations | — | — | 37,903 | |||||||||
| Net income available to stockholders | $ | 45,803 | 26,229 | 10,346 | ||||||||
The following table sets forth the computation of basic earnings per share for the three-year period ended 31, 2004.
| 2004 | 2003 | 2002 | ||||||||||
| Numerator for basic earnings per share: | ||||||||||||
| Net income available to stockholders | $ | 45,803 | 26,229 | 10,346 | ||||||||
| Denominator for basic earnings per share: | ||||||||||||
| Weighted average of common shares outstanding | 8,919 | 9,180 | 9,531 | |||||||||
| Basic net income per share | $ | 5,135 | 2,857 | 1,086 | ||||||||
| 79 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| (24) | Quarterly Financial Information (Unaudited) |
| 2004 | ||||||||||||||||||||
| March 31 | June 30 | September 30 | December 31 | Total | ||||||||||||||||
| Revenue: | ||||||||||||||||||||
| Premiums earned, net | $ | 318,646 | 322,896 | 325,926 | 328,955 | 1 ,296,423 | ||||||||||||||
| Amounts attributable to self-funded arrangements | 43,038 | 46,045 | 46,044 | 46,575 | 181,702 | |||||||||||||||
| Less amounts attributable to claims under self-funded arrangements | (40,582 | ) | (42,485 | ) | (42,925 | ) | (43,932 | ) | (169,924 | ) | ||||||||||
| 321,102 | 326,456 | 329,045 | 331,598 | 1,308,201 | ||||||||||||||||
| Net investment income | 6,582 | 6,393 | 6,516 | 7,008 | 26,499 | |||||||||||||||
| Net realized investment gains | 1,383 | 1,365 | 4,237 | 3,983 | 10,968 | |||||||||||||||
| Net unrealized investment gain (loss) on trading securities | 1,819 | (3,252 | ) | (435 | ) | 4,910 | 3,042 | |||||||||||||
| Other income, net | 566 | 1,120 | 728 | 946 | 3,360 | |||||||||||||||
| Total revenue | 331,452 | 332,082 | 340,091 | 348,445 | 1,352,070 | |||||||||||||||
| Benefits and expenses: | ||||||||||||||||||||
| Claims incurred | 275,748 | 286,246 | 283,946 | 269,853 | 1,115,793 | |||||||||||||||
| Operating expenses, net of reimbursement for services | 39,838 | 42,635 | 40,416 | 48,990 | 171,879 | |||||||||||||||
| Interest expense | 901 | 931 | 1,018 | 1,731 | 4,581 | |||||||||||||||
| Total benefits and expenses | 316,487 | 329,812 | 325,380 | 320,574 | 1,292,253 | |||||||||||||||
| Income before taxes | 14,965 | 2,270 | 14,711 | 27,871 | 59,817 | |||||||||||||||
| Income tax expense: | ||||||||||||||||||||
| Current | 3,298 | 1,248 | 2,756 | 6,983 | 14,285 | |||||||||||||||
| Deferred | 511 | (457 | ) | (139 | ) | (186 | ) | (271 | ) | |||||||||||
| Total income taxes | 3,809 | 791 | 2,617 | 6,797 | 14,014 | |||||||||||||||
| Net income | $ | 11,156 | 1,479 | 12,094 | 21,074 | 45,803 | ||||||||||||||
| Basic net income per share | $ | 1,239 | 166 | 1,361 | 2,371 | 5,137 | ||||||||||||||
| 80 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2003 | ||||||||||||||||||||
| March 31 | June30 | September 30 | December 31 | Total | ||||||||||||||||
| Revenue: | ||||||||||||||||||||
| Premiums earned, net | $ | 315,556 | 313,789 | 314,043 | 318,846 | 1,262,234 | ||||||||||||||
| Amounts attributable to self-funded arrangements | 40,003 | 40,181 | 40,790 | 41,314 | 162,288 | |||||||||||||||
| Less amounts attributable to claims under self-funded arrangements | (37,359 | ) | (37,191 | ) | (38,410 | ) | (38,846 | ) | (151,806 | ) | ||||||||||
| 318,200 | 316,779 | 3 1 6,423 | 321,314 | 1,272,716 | ||||||||||||||||
| Net investment income | 6,098 | 6,286 | 5,868 | 6,427 | 24,679 | |||||||||||||||
| Net realized investment (losses) gains | (3,023 | ) | 6,644 | 3,669 | 1,075 | 8,365 | ||||||||||||||
| Net unrealized investment gain (loss) on trading securities | 2,092 | 7,276 | (345 | ) | 5,870 | 14,893 | ||||||||||||||
| Other income, net | 850 | 1,524 | 532 | 1,797 | 4,703 | |||||||||||||||
| Total revenue | 324,217 | 338,509 | 326,147 | 336,483 | 1,325,356 | |||||||||||||||
| Benefits and expenses: | ||||||||||||||||||||
| Claims incurred | 270,831 | 259,172 | 264,202 | 271,145 | 1,065,350 | |||||||||||||||
| Operating expenses, net of reimbursement for services | 38,490 | 39,917 | 37,301 | 49,441 | 165,149 | |||||||||||||||
| Interest expense | 703 | 765 | 776 | 987 | 3,231 | |||||||||||||||
| Total benefits and expenses | 310,024 | 299,854 | 302,279 | 321,573 | 1,233,730 | |||||||||||||||
| Income before taxes | 14,193 | 38,655 | 23,868 | 14,910 | 91,626 | |||||||||||||||
| Income tax expense: | ||||||||||||||||||||
| Current | 377 | 63,909 | 6,967 | (461 | ) | 70,792 | ||||||||||||||
| Deferred | 339 | (1,968 | ) | 139 | (3,905 | ) | (5,395 | ) | ||||||||||||
| Total income taxes | 716 | 61,941 | 7,106 | (4,366 | ) | 65,397 | ||||||||||||||
| Net income (loss) | $ | 13,477 | (23,286 | ) | 16,762 | 19,276 | 26,229 | |||||||||||||
| Basic net income (loss) per share | $ | 451 | (2,514 | ) | 1,844 | 2,136 | 2,857 | |||||||||||||
| 81 | (Continued) |
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
(25)Reconciliation of Net Income to Net Cash Provided by Operating Activities
A reconciliation of net income to net cash provided by operating activities follows:
| 2004 | 2003 | 2002 | ||||||||||
| Net income | $ | 45,803 | 26,229 | 48,249 | ||||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 5,343 | 5,709 | 7,595 | |||||||||
| Net amortization of investments premiums | 1,035 | 1,866 | 2 | |||||||||
| Accretion in value of securities | (464 | ) | (1,188 | ) | (1,664 | ) | ||||||
| Increase (decrease) in provision for doubtful receivables | 2,158 | (4,779 | ) | 2,116 | ||||||||
| (Decrease) increase in net deferred tax liability | (271 | ) | (5,396 | ) | 1,233 | |||||||
| Gain on sale of securities | (10,968 | ) | (8,365 | ) | (185 | ) | ||||||
| Unrealized (gain) loss of trading securities | (3,042 | ) | (14,893 | ) | 8,322 | |||||||
| Proceeds from trading securities sold or matured: | ||||||||||||
| Fixed maturities sold | 50,330 | 77,582 | 103,012 | |||||||||
| Equity securities | 26,523 | 28,924 | 11,804 | |||||||||
| Acquisition of securities in trading portfolio: | ||||||||||||
| Fixed maturities | (54,550 | ) | (96,237 | ) | (112,879 | ) | ||||||
| Equity securities | (38,700 | ) | (38,956 | ) | (16,471 | ) | ||||||
| Gain on sale of property and equipment | (16 | ) | (58 | ) | (1 | ) | ||||||
| (Increase) decrease in premiums receivable | (10,956 | ) | 4,809 | (5,881 | ) | |||||||
| (Increase) decrease in accrued interest receivable | 18 | (218 | ) | (47 | ) | |||||||
| Increase in other receivables | (11,052 | ) | (9,062 | ) | (9,066 | ) | ||||||
| Increase in deferred policy acquisition costs | (2,041 | ) | (2,901 | ) | (4,220 | ) | ||||||
| (Increase) decrease in other assets | (5,138 | ) | (3,188 | ) | 240 | |||||||
| Increase (decrease) in claims processed and incomplete | 16,267 | (6,613 | ) | 13,029 | ||||||||
| increase in unreported losses | 14,875 | 9,139 | 70 | |||||||||
| Increase in loss-adjustment expenses | 263 | 812 | 2,043 | |||||||||
| Increase (decrease) on annuity contracts | 1,003 | 365 | (832 | ) | ||||||||
| Increase in unearned premiums | 5,879 | 7,743 | 12,655 | |||||||||
| Increase (decrease) in liability to FEHBP | 2,320 | 405 | (5,064 | ) | ||||||||
| Increase in accounts payable and accrued liabilities | 4,616 | 6,914 | 2,136 | |||||||||
| (Decrease) increase in income tax payable | (30,395 | ) | 31,506 | 611 | ||||||||
| Net cash provided by operating activities | $ | 8,840 | 10,149 | 56,807 | ||||||||
(Continued)
82
TRIPLE-S MANAGEMENT CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004, 2003, and 2002
(Dollar amounts in thousands, except per share data)
| 2004 | 2003 | 2002 | ||||||||||
| Supplementary information on noncash transactions affecting cash flows activities: | ||||||||||||
| Change in net unrealized gain on securities available for sale, including deferred income tax liability of $3,330, $3,198, and $963, in 2004, 2003, and 2002, respectively | $ | 1,101 | 6,022 | 5,986 | ||||||||
| Retirement of fully depreciated items | 13,054 | 1,594 | 1,258 | |||||||||
| Change in cash-flow hedges, including deferred income tax asset of $56 and $234 in 2004 and 2003, respectively | 281 | 103 | 470 | |||||||||
| Change in minimum pension liability, including related intangible asset of $598 and $645 and deferred income tax asset of $3,576 and $3,614 in 2004 and 2003, respectively | 3 | 2,292 | 8,114 | |||||||||
83