SEC Company Response from INDEPENDENCE HOLDING CO (CIK 0000701869) — Dec 2, 2005
INDEPENDENCE HOLDING CO (CIK 0000701869)
Date: Dec. 2, 2005 · CIK: 0000701869 · Accession: 0000701869-05-000036
AI Filing Summary & Sentiment
File numbers found in text: 001-32244
Referenced dates: November 4, 2005
Letter
Securities and Exchange Commission Independence Holding Company Form 10-K for Fiscal Year Ended December 31, 2004 Filed March 16, 2005 File No. 001-32244
Re:
Dear Mr. Rosenberg:
This letter is in response to the comments of the staff of the Division of Corporation Finance (the “Staff”) contained in your letter (the "Comment Letter") dated November 4, 2005, regarding the above referenced filing of Independence Holding Company ("IHC" or the “Company”). Below are the Staff’s comments followed by our responses.
Q1.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of.....
Critical Accounting Policies
Insurance Reserves
Please expand the proposed disclosures you provided in response to prior comment one to discuss the potential impact of the judgments and uncertainties surrounding this estimate, consistent with Section V. of Financial Reporting Release 72 and as we had requested. In so doing, please provide quantitative and qualitative disclosure about the impact that reasonably likely changes in each of the ”key assumptions" cited in your response underlying the estimate of each segment's reserves would have on your results of operations, financial position, and liquidity. In addition, please provide disclosure to clarify how you determine each of these "key assumptions".
A1.
The following discussion sets forth the key assumptions underlying the estimate of each segment’s reserves, how the key assumptions are determined, and the effect that a hypothetical change in the overall loss ratio would have on the Company’s overall results of operations. The Company believes that discussing hypothetical changes in each key assumption underlying each segment’s reserves could result in disclosures that could be subject to varying interpretations by investors. However, the Company does believe it can reasonably quantify the impact that hypothetical changes in the loss ratio would have on reserves and related expenses for the health business as a whole. Accordingly, the Company proposes to include the disclosure set forth below in future Form 10-K filings under the heading “Critical Accounting Policies.” The Company believes it currently has sufficient sources of liquidity to fund reasonably likely increases in its insurance liabilities and will address this consideration in the “Liquidity” portion of MD&A in future filings.
"Insurance Reserves"
The Company maintains loss reserves to cover its estimated liability for unpaid losses and loss adjustment expenses (including legal, other fees, and costs not associated with specific claims but related to the claims payment function) for reported and unreported claims incurred as of the end of each accounting period. These loss reserves are based on actuarial assumptions and are maintained at levels that are in accordance with GAAP. Many factors could affect these reserves, including economic and social conditions, frequency and severity of claims, medical trend resulting from the influences of underlying cost inflation, changes in utilization and demand for medical services, and changes in doctrines of legal liability and damage awards in litigation. Therefore, the Company’s reserves are necessarily based on estimates, assumptions and analysis of historical experience. The Company’s results depend upon the variation between actual claims experience and the assumptions used in determining reserves and pricing products. Reserve assumptions and estimates require significant judgment and, therefore, are inherently uncertain. The Company cannot determine with precision the ultimate amounts that will be paid for actual claims or the timing of those payments. The Company’s estimate of loss reserves represents management’s best estimate of the Company’s liability as of December 31, 2004.
Loss reserves differ for short-duration and long-duration insurance policies, including annuities. Reserves are based on approved actuarial methods, but necessarily include assumptions about expenses, mortality, morbidity, lapse rates and future yield on related investments.
All of the Company’s short-duration contracts are generated from our accident and health business, and are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
The Company believes that its recorded insurance reserves are reasonable and adequate to satisfy its ultimate liability. The Company primarily uses its own loss development experience, but will also supplement that with data from its outside actuaries, reinsurers and industry loss experience as warranted. To illustrate the impact that projected loss ratios have on the Company’s loss reserves and related expenses, each hypothetical 1% change in the loss ratio for the health business (i.e., the ratio of benefits, claims and settlement expenses to earned health premiums) for the year ended December 31, 2004, would increase reserves (in the case of a higher ratio) or decrease reserves (in the case of a lower ratio) by approximately $1.4 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the Consolidated Statement of Operations. Depending on the circumstances surrounding a change in the loss ratio, other pre-tax amounts reported in the Consolidated Statement of Operations could also be affected, such as amortization of deferred acquisition costs and commission expense.
The Company’s health reserves by segment at December 31, 2004 are as follows (in thousands):
Policy Claims
IBNR
Claim Reserves
Total Health Reserves
Medical Stop-Loss
$
-
$
80,452
$
-
$
80,452
Group Disability
13,798
47,440
61,928
Credit A&H
1,026
-
5,814
6,840
Individual A&H and Other
8,383
10,200
19,362
$
2,495
$
102,633
$
63,454
$
168,582
Medical Stop-Loss
The Company’s Medical Stop-Loss segment is comprised of Employer Stop-Loss, HMO Reinsurance and Provider Excess. All of the Company’s Medical Stop-Loss policies are short-duration and are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims or open claims from prior periods, including losses incurred for claims that have not been reported (“IBNR”). Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
The two primary assumptions underlying the calculation of loss reserves for Medical Stop-Loss business are the projected net loss ratio and claim development patterns. Reserves for Medical Stop-Loss are first set at expected levels consistent with the underlying pricing assumptions – i.e. the “projected net loss ratio.” Projected loss experience used in pricing the Medical Stop-Loss business is developed using completed prior experience trended forward and is therefore the Company’s best estimate of future performance until such time as developing losses provide a better indication of ultimate results. Loss reserve estimates are more sensitive to changes in the projected net loss ratio than they are to claim development patterns. Claim development patterns are reviewed quarterly as reserve estimates are developed and are based on recent claim development history. The Company must determine whether changes in development represent true indications of the emerging experience or are simply due to random claim fluctuations.
Major factors that affect the projected net loss ratio assumption in reserving for Medical Stop-Loss relate to: (i) frequency and severity of claims; (ii) changes in medical trend resulting from the influences of underlying cost inflation, changes in utilization and demand for medical services, the impact of new medical technology and changes in medical treatment protocols; and (iii) the adherence by the MGUs that produce and administer this business to the Company’s underwriting guidelines.
Predicting ultimate claims and estimating reserves in Medical Stop-Loss is more complex than first dollar medical and disability business due to the excess of loss nature of these products with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. The level of these deductibles makes it more difficult to predict the amount and payment pattern of such claims. Fluctuations in results for specific coverage are primarily due to the severity and frequency of individual claims, whereas fluctuations in
aggregate coverage are largely attributable to frequency of underlying claims rather than severity. Liabilities for first dollar medical reserves and disability coverages are computed using completion factors and expected loss ratios derived from actual historical premium and claim data.
Due to the short-term nature of Medical Stop-Loss, redundancies or deficiencies will typically emerge during the course of the following year rather than over a number of years. For Employer Stop-Loss, the Company maintains its reserves based on underlying pricing assumptions until it determines that an adjustment is appropriate based on emerging experience from all of its MGUs for prior underwriting years. Reserves for HMO Reinsurance and Provider Excess are adjusted on a policy by policy basis. Because of the small number of HMO Reinsurance and Provider Excess policies it writes, the Company is able to evaluate each policy individually for potential liability by reviewing open claims with each HMO or provider group and applying completion factors using historical data.
Group Disability
The Company’s Group Disability segment is comprised of Long Term Disability (“LTD”) and Disability Benefits Law (“DBL”). The key assumptions on which Group Disability reserves are based relate to: (i) morbidity levels; and (ii) recovery rates. If morbidity levels increase, for example due to an epidemic or a recessionary environment, the Company would increase reserves. In regard to the assumed recovery rate, if disabled lives recover more quickly than anticipated reserves would be reduced; if less quickly, reserves would be increased. Advancements in medical treatments could affect future recovery, termination, and mortality rates. With respect to LTD only, other assumptions are: (i) changes in market interest rates; (ii) changes in offsets; (iii) advancements in medical treatments and (iv) cost of living (“COLA”). Changes in market interest rates could change reserve assumptions since the payout period could be as long as 40 years. Changes in offsets such as Social Security benefits, retirement plans and state disability plans will impact reserving.
As a result of the forgoing assumptions, it is possible that the historical trend may not be an accurate predictor of the future development of the block. As with most long term insurance reserves that require judgment, the reserving process is subject to uncertainty and volatility and fluctuations may not be indicative of the claim development overall. Ranges are not used to determine the ultimate amount of reported reserves for Group Disability. Based upon a review of all available information, the Company uses a single estimate, which is the best estimate in management’s opinion according to an interpretation of historical results and trends.
Credit Accident and Health (“A&H”)
The key assumptions used in estimating the Credit A&H reserves relate to: (i) the mix of ages of the insured; (ii) the rate of disability; and (iii) the rate of mortality of disabled lives. If the mix is skewed towards older age groups the probability of disability increases. If the rate of disability increases, the Company would increase reserves. If mortality of disabled lives improves, the Company would have to pay benefits for a longer period of time. Ranges are not used to determine the ultimate amount of reported reserves for Credit A&H. Management records its best estimate based on the Company’s experience. Credit A&H policies are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. The Company establishes reserves for benefit claims that (i) have been reported, but not paid; and (ii) have been incurred, but not reported.
Individual A&H and Other
This segment is a combination of closed lines of business as well as certain small existing lines. While the assumptions used in setting reserves vary between these different lines of business, the assumptions would generally relate to the following: (i) the rate of disability; (ii) the morbidity rates on specific diseases; and (iii) accident rates. The reported reserves are based on management’s best estimate for each line within this segment. Ranges are not used to determine the ultimate amount of reported reserves for Other A&H. General uncertainties that surround all insurance reserving methodologies would apply. However, since the Company has such few policies of this type, volatility may occur due to a small number of claims.”
Q2. As your response to prior comment two indicated that you had revised the prior year incurred amount for 2004, please illustrate for us how the following would need to be modified to reflect this revision and any other necessary revisions to the amounts for prior years: (a) the disclosures your provided pursuant to paragraph 11 of SOP 94-5 and (b) your discussion, in MD&A, about the effect of changes in the reserves on your results of operations.
In addition, based on the extent of the modifications that would need to be made, please provide us your analysis supporting your assertion that the effect of the revision was not material to the accuracy of your overall disclosures with respect to reserves or the changes in them.
A2.
a.
Paragraph 11 of SOP 94-5 includes a requirement to discuss the reasons for the change in incurred claims and claim adjustment expenses recognized in the income statement attributable to insured events of prior fiscal years. The Company disclosed that the increase in the prior year incurred amount primarily related to the Medical Stop-Loss and LTD lines, without quantifying the amount of the increase for any particular line based on materiality considerations. The Company believes that the revision in current versus prior year incurred amounts does not necessitate a change in this disclosure. After evaluating the revised prior year incurred amount for 2004, the Company believes the existing disclosure satisfies the requirements of SOP 94-5.
b.
Our discussion in MD&A for the December 31, 2004 Form 10-K explained that the increase in Medical Stop-Loss reserves was due to an increase in volume and an increase in claims experience. As noted in our response to Q1, the Medical Stop-Loss line of business is short term in nature. As a result, a substantial majority of the total amount incurred in a given year will relate to the current year. Accordingly, in 2004 the Company did not distinguish between amounts related to the current year development versus prior year development either on a treaty year or calendar year basis. The Company believes the MD&A disclosure as provided accurately explains the reasons for the increase in reserves and does not need to be modified.
In assessing the materiality of the revision in current vs. prior year incurred amounts in the context of the overall financial statement disclosures concerning rese
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December 2, 2005
Mr. Jim B. Rosenberg
Senior Assistant Chief Accountant
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C., 20549
Re:
Independence Holding Company
Form 10-K for Fiscal Year Ended December 31, 2004
Filed March 16, 2005
File No. 001-32244
Dear Mr. Rosenberg:
This letter is in response to the comments of the staff of the Division of Corporation Finance (the “Staff”) contained in your letter (the "Comment Letter") dated November 4, 2005, regarding the above referenced filing of Independence Holding Company ("IHC" or the “Company”). Below are the Staff’s comments followed by our responses.
Q1.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of.....
Critical Accounting Policies
Insurance Reserves
Please expand the proposed disclosures you provided in response to prior comment one to discuss the potential impact of the judgments and uncertainties surrounding this estimate, consistent with Section V. of Financial Reporting Release 72 and as we had requested. In so doing, please provide quantitative and qualitative disclosure about the impact that reasonably likely changes in each of the ”key assumptions" cited in your response underlying the estimate of each segment's reserves would have on your results of operations, financial position, and liquidity. In addition, please provide disclosure to clarify how you determine each of these "key assumptions".
A1.
The following discussion sets forth the key assumptions underlying the estimate of each segment’s reserves, how the key assumptions are determined, and the effect that a hypothetical change in the overall loss ratio would have on the Company’s overall results of operations. The Company believes that discussing hypothetical changes in each key assumption underlying each segment’s reserves could result in disclosures that could be subject to varying interpretations by investors. However, the Company does believe it can reasonably quantify the impact that hypothetical changes in the loss ratio would have on reserves and related expenses for the health business as a whole. Accordingly, the Company proposes to include the disclosure set forth below in future Form 10-K filings under the heading “Critical Accounting Policies.” The Company believes it currently has sufficient sources of liquidity to fund reasonably likely increases in its insurance liabilities and will address this consideration in the “Liquidity” portion of MD&A in future filings.
"Insurance Reserves"
The Company maintains loss reserves to cover its estimated liability for unpaid losses and loss adjustment expenses (including legal, other fees, and costs not associated with specific claims but related to the claims payment function) for reported and unreported claims incurred as of the end of each accounting period. These loss reserves are based on actuarial assumptions and are maintained at levels that are in accordance with GAAP. Many factors could affect these reserves, including economic and social conditions, frequency and severity of claims, medical trend resulting from the influences of underlying cost inflation, changes in utilization and demand for medical services, and changes in doctrines of legal liability and damage awards in litigation. Therefore, the Company’s reserves are necessarily based on estimates, assumptions and analysis of historical experience. The Company’s results depend upon the variation between actual claims experience and the assumptions used in determining reserves and pricing products. Reserve assumptions and estimates require significant judgment and, therefore, are inherently uncertain. The Company cannot determine with precision the ultimate amounts that will be paid for actual claims or the timing of those payments. The Company’s estimate of loss reserves represents management’s best estimate of the Company’s liability as of December 31, 2004.
Loss reserves differ for short-duration and long-duration insurance policies, including annuities. Reserves are based on approved actuarial methods, but necessarily include assumptions about expenses, mortality, morbidity, lapse rates and future yield on related investments.
All of the Company’s short-duration contracts are generated from our accident and health business, and are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
The Company believes that its recorded insurance reserves are reasonable and adequate to satisfy its ultimate liability. The Company primarily uses its own loss development experience, but will also supplement that with data from its outside actuaries, reinsurers and industry loss experience as warranted. To illustrate the impact that projected loss ratios have on the Company’s loss reserves and related expenses, each hypothetical 1% change in the loss ratio for the health business (i.e., the ratio of benefits, claims and settlement expenses to earned health premiums) for the year ended December 31, 2004, would increase reserves (in the case of a higher ratio) or decrease reserves (in the case of a lower ratio) by approximately $1.4 million with a corresponding increase or decrease in the pre-tax expense for insurance benefits, claims and reserves in the Consolidated Statement of Operations. Depending on the circumstances surrounding a change in the loss ratio, other pre-tax amounts reported in the Consolidated Statement of Operations could also be affected, such as amortization of deferred acquisition costs and commission expense.
2
The Company’s health reserves by segment at December 31, 2004 are as follows (in thousands):
Policy Claims
IBNR
Claim Reserves
Total Health Reserves
Medical Stop-Loss
$
-
$
80,452
$
-
$
80,452
Group Disability
690
13,798
47,440
61,928
Credit A&H
1,026
-
5,814
6,840
Individual A&H and Other
779
8,383
10,200
19,362
$
2,495
$
102,633
$
63,454
$
168,582
Medical Stop-Loss
The Company’s Medical Stop-Loss segment is comprised of Employer Stop-Loss, HMO Reinsurance and Provider Excess. All of the Company’s Medical Stop-Loss policies are short-duration and are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims or open claims from prior periods, including losses incurred for claims that have not been reported (“IBNR”). Short-duration contract loss estimates rely on actuarial observations of ultimate loss experience for similar historical events.
The two primary assumptions underlying the calculation of loss reserves for Medical Stop-Loss business are the projected net loss ratio and claim development patterns. Reserves for Medical Stop-Loss are first set at expected levels consistent with the underlying pricing assumptions – i.e. the “projected net loss ratio.” Projected loss experience used in pricing the Medical Stop-Loss business is developed using completed prior experience trended forward and is therefore the Company’s best estimate of future performance until such time as developing losses provide a better indication of ultimate results. Loss reserve estimates are more sensitive to changes in the projected net loss ratio than they are to claim development patterns. Claim development patterns are reviewed quarterly as reserve estimates are developed and are based on recent claim development history. The Company must determine whether changes in development represent true indications of the emerging experience or are simply due to random claim fluctuations.
Major factors that affect the projected net loss ratio assumption in reserving for Medical Stop-Loss relate to: (i) frequency and severity of claims; (ii) changes in medical trend resulting from the influences of underlying cost inflation, changes in utilization and demand for medical services, the impact of new medical technology and changes in medical treatment protocols; and (iii) the adherence by the MGUs that produce and administer this business to the Company’s underwriting guidelines.
Predicting ultimate claims and estimating reserves in Medical Stop-Loss is more complex than first dollar medical and disability business due to the excess of loss nature of these products with very high deductibles applying to specific claims on any individual claimant and in the aggregate for a given group. The level of these deductibles makes it more difficult to predict the amount and payment pattern of such claims. Fluctuations in results for specific coverage are primarily due to the severity and frequency of individual claims, whereas fluctuations in
3
aggregate coverage are largely attributable to frequency of underlying claims rather than severity. Liabilities for first dollar medical reserves and disability coverages are computed using completion factors and expected loss ratios derived from actual historical premium and claim data.
Due to the short-term nature of Medical Stop-Loss, redundancies or deficiencies will typically emerge during the course of the following year rather than over a number of years. For Employer Stop-Loss, the Company maintains its reserves based on underlying pricing assumptions until it determines that an adjustment is appropriate based on emerging experience from all of its MGUs for prior underwriting years. Reserves for HMO Reinsurance and Provider Excess are adjusted on a policy by policy basis. Because of the small number of HMO Reinsurance and Provider Excess policies it writes, the Company is able to evaluate each policy individually for potential liability by reviewing open claims with each HMO or provider group and applying completion factors using historical data.
Group Disability
The Company’s Group Disability segment is comprised of Long Term Disability (“LTD”) and Disability Benefits Law (“DBL”). The key assumptions on which Group Disability reserves are based relate to: (i) morbidity levels; and (ii) recovery rates. If morbidity levels increase, for example due to an epidemic or a recessionary environment, the Company would increase reserves. In regard to the assumed recovery rate, if disabled lives recover more quickly than anticipated reserves would be reduced; if less quickly, reserves would be increased. Advancements in medical treatments could affect future recovery, termination, and mortality rates. With respect to LTD only, other assumptions are: (i) changes in market interest rates; (ii) changes in offsets; (iii) advancements in medical treatments and (iv) cost of living (“COLA”). Changes in market interest rates could change reserve assumptions since the payout period could be as long as 40 years. Changes in offsets such as Social Security benefits, retirement plans and state disability plans will impact reserving.
As a result of the forgoing assumptions, it is possible that the historical trend may not be an accurate predictor of the future development of the block. As with most long term insurance reserves that require judgment, the reserving process is subject to uncertainty and volatility and fluctuations may not be indicative of the claim development overall. Ranges are not used to determine the ultimate amount of reported reserves for Group Disability. Based upon a review of all available information, the Company uses a single estimate, which is the best estimate in management’s opinion according to an interpretation of historical results and trends.
Credit Accident and Health (“A&H”)
The key assumptions used in estimating the Credit A&H reserves relate to: (i) the mix of ages of the insured; (ii) the rate of disability; and (iii) the rate of mortality of disabled lives. If the mix is skewed towards older age groups the probability of disability increases. If the rate of disability increases, the Company would increase reserves. If mortality of disabled lives improves, the Company would have to pay benefits for a longer period of time. Ranges are not used to determine the ultimate amount of reported reserves for Credit A&H. Management records its best estimate based on the Company’s experience. Credit A&H policies are accounted for based on actuarial estimates of the amount of loss inherent in that period’s claims, including losses incurred for which claims have not been reported. The Company establishes reserves for benefit claims that (i) have been reported, but not paid; and (ii) have been incurred, but not reported.
4
Individual A&H and Other
This segment is a combination of closed lines of business as well as certain small existing lines. While the assumptions used in setting reserves vary between these different lines of business, the assumptions would generally relate to the following: (i) the rate of disability; (ii) the morbidity rates on specific diseases; and (iii) accident rates. The reported reserves are based on management’s best estimate for each line within this segment. Ranges are not used to determine the ultimate amount of reported reserves for Other A&H. General uncertainties that surround all insurance reserving methodologies would apply. However, since the Company has such few policies of this type, volatility may occur due to a small number of claims.”
Q2. As your response to prior comment two indicated that you had revised the prior year incurred amount for 2004, please illustrate for us how the following would need to be modified to reflect this revision and any other necessary revisions to the amounts for prior years: (a) the disclosures your provided pursuant to paragraph 11 of SOP 94-5 and (b) your discussion, in MD&A, about the effect of changes in the reserves on your results of operations.
In addition, based on the extent of the modifications that would need to be made, please provide us your analysis supporting your assertion that the effect of the revision was not material to the accuracy of your overall disclosures with respect to reserves or the changes in them.
A2.
a.
Paragraph 11 of SOP 94-5 includes a requirement to discuss the reasons for the change in incurred claims and claim adjustment expenses recognized in the income statement attributable to insured events of prior fiscal years. The Company disclosed that the increase in the prior year incurred amount primarily related to the Medical Stop-Loss and LTD lines, without quantifying the amount of the increase for any particular line based on materiality considerations. The Company believes that the revision in current versus prior year incurred amounts does not necessitate a change in this disclosure. After evaluating the revised prior year incurred amount for 2004, the Company believes the existing disclosure satisfies the requirements of SOP 94-5.
b.
Our discussion in MD&A for the December 31, 2004 Form 10-K explained that the increase in Medical Stop-Loss reserves was due to an increase in volume and an increase in claims experience. As noted in our response to Q1, the Medical Stop-Loss line of business is short term in nature. As a result, a substantial majority of the total amount incurred in a given year will relate to the current year. Accordingly, in 2004 the Company did not distinguish between amounts related to the current year development versus prior year development either on a treaty year or calendar year basis. The Company believes the MD&A disclosure as provided accurately explains the reasons for the increase in reserves and does not need to be modified.
In assessing the materiality of the revision in current vs. prior year incurred amounts in the context of the overall financial statement disclosures concerning rese