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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO_____________
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COMMISSION FILE NUMBER 0-49762
TRIPLE-S MANAGEMENT CORPORATION
PUERTO RICO 66-0555678
(STATE OF INCORPORATION) (I.R.S. ID)
1441 F.D. ROOSEVELT AVENUE, SAN JUAN, PR 00926
(787) 749-4949
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $40.00 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [ ]
The aggregate market value of common stock held by non-affiliates of the
registrant as of December 31, 2002 was $373,450.00.
The number of shares outstanding of the registrant's common stock as of
December 31, 2002 was 9,337.
DOCUMENTS INCORPORATED BY REFERENCE
(1) Portions of the Corporation's Annual Report to Shareholders
for the fiscal year ended December 31, 2002 are incorporated herein by
reference in response to Item 1 of Part I, and Item 6 of Part II and
Item 15 of Part VI.
(2) Portions of the definitive Proxy Statement to be delivered to
shareholders in connection with the Annual Meeting of Shareholders to be held
April 27, 2003 are incorporated by reference into Parts II and III.
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TRIPLE-S MANAGEMENT CORPORATION
FORM 10-K
For The Fiscal Year Ended December 31, 2002
INDEX
PART I
Item 1. Business 3
Item 2. Properties 12
Item 3. Legal Proceedings 12
Item 4. Submission of Matters to a Vote of Security Holders 13
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters 13
Item 6. Selected Financial Data 14
Item 7. Management's Discussion and Analysis of Results of Operations and Financial
Condition 14
Item 7a. Quantitative and Qualitative Disclosures about Market Risk 31
Item 8. Financial Statements and Supplementary Data 35
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures 36
PART III
Item 10. Directors and Executive Officers of the Registrant 36
Item 11. Executive Compensation 36
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 36
Item 13. Certain Relationships and Related Transactions 37
Item 14. Controls and Procedures 37
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 37
Signatures 39
Certifications 42
Page 2
PART I
ITEM 1. BUSINESS.
GENERAL DESCRIPTION OF BUSINESS AND RECENT DEVELOPMENTS
Triple-S Management Corporation (TSM) is incorporated under the laws of the
Commonwealth of Puerto Rico. It is the holding company of several entities,
through which it offers a wide range of insurance products and services. These
products and services are offered through the following TSM's subsidiaries:
- Triple-S, Inc. (TSI), a health insurance company serving two
major segments: the Commercial Program and the Commonwealth
of Puerto Rico Healthcare Reform Program (the Healthcare
Reform) of the Commonwealth of Puerto Rico;
- Seguros Triple-S, Inc. (STS), a property and casualty
insurance company; and
- Seguros de Vida Triple-S, Inc. (SVTS), a life and disability
insurance and annuity products company.
TSM's insurance subsidiaries, as well as other insurers doing business in
Puerto Rico, are subject to the regulations and supervision of the Office of
the Commissioner of Insurance of the Commonwealth of Puerto Rico (the
Commissioner of Insurance). The regulation and supervision of the Commissioner
of Insurance consist primarily of: the approval of policy forms and rates, when
applicable, the standards of solvency that must be met and maintained by
insurers and their agents, and the nature of and limitations on investments,
deposits of securities for the benefit of policyholders, methods of accounting,
periodic examinations and the form and content of reports of financial
condition required to be filed, among others. In general, such regulations are
for the protection of policyholders rather than security holders.
In addition to the insurance subsidiaries mentioned above, TSM has the
following other subsidiaries: Interactive Systems, Inc. (ISI) and Triple-C,
Inc. (TCI). ISI provides data processing services to Triple-S Management
Corporation and its subsidiaries (the Corporation). Effective October 1, 2001,
TCI was activated and commenced operations as part of a strategic positioning
in the health industry to take advantage of new market opportunities. It is
currently engaged as the third-party administrator in the administration of the
Healthcare Reform. The Healthcare Reform business was administered through a
division of TSI until September 30, 2001. It also provides healthcare advisory
services to TSI and other health-related services.
All of the premiums generated by the insurance subsidiaries are generated from
customers within Puerto Rico. In addition, long-lived assets, other than
financial instruments, including deferred policy acquisition costs and deferred
tax assets of the Corporation are located in Puerto Rico.
TSM started to do business as the holding company on January 4, 1999, the
effective date of the corporate reorganization described below. Before the
reorganization (as defined herein), Triple-S, Inc. (SSS), a health insurance
company, was the parent company of the existing subsidiaries previously
described.
Effective January 4, 1999, SSS and its subsidiaries completed a tax-exempt
corporate reorganization with the approval of the Department of Treasury and
the Commissioner of Insurance of the Commonwealth of Puerto Rico (the
Reorganization). According with the Reorganization, the following transactions
occurred:
- The stockholders of SSS exchanged in the same proportion
their common stocks held for common shares of TSM.
- SSS transferred to TSM its investment in former wholly-owned
subsidiaries, amounting to $50.2 million. Such balance was
comprised of SSS's capital contribution to its former wholly
owned subsidiaries of $9.8 million, as well as the
accumulated operating reserves and unrealized gains on
securities classified as available-for-sale of the former
wholly owned subsidiaries of $35.4 million and $4.9 million,
respectively.
- SSS sold to TSM its real estate at their carrying value of
$22.5 million at the date of the Reorganization. No gain or
loss was recognized by SSS in relation to this transaction.
- SSS merged into Triple-S Salud, Inc. (TSI) (a wholly-owned
subsidiary of TSM) and transferred to TSI its net assets of
$139.4 million (excluding its investment in former
subsidiaries), that include its accumulated
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operating reserves of $105 million and unrealized gains on
securities classified as available-for-sale of $33.8 million.
- SSS ceased to exist and TSI changed its legal name to
Triple-S, Inc.
The purpose of the reorganization was to allow the Corporation to participate
in activities that may better position it in the health services market without
the limitations inherent to an insurance company. Since the new corporation
(TSM) is not an insurance company, it is not subject to the limitations of the
Puerto Rico Insurance Code. Thus, providing the Corporation increased
flexibility to diversify into other lines of business. During the
reorganization there were no significant changes in the management of the
entities within the Corporation; the President and Chief Executive Officer of
TSI was named President and Chief Executive Officer of TSM while retaining the
position and responsibilities of the Presidency of TSI.
The Reorganization was structured as a tax-exempt reorganization under the
Puerto Rico Income Tax Code and the Puerto Rico Income Tax Act of 1954, as
amended. A favorable determination letter approving the tax-exempt status of
this reorganization was obtained from the Puerto Rico Treasury Department,
subject to the Corporation's compliance with certain conditions (see note 16 of
audited consolidated financial statements attached as Exhibit 1).
TSI, although legally incorporated as a for-profit organization, operates as if
it were a non-for-profit organization, whose principal purpose is to offer
affordable healthcare coverage in the Puerto Rico community. TSI is exempt from
Puerto Rico income taxes under a ruling issued by the Department of Treasury of
the Commonwealth of Puerto Rico before and after the corporate reorganization
described above. This exemption requires TSI to comply with the following
significant conditions:
- TSI, the Company, and the stockholders of the Company, should
make annual representations to the Department of Treasury of
the Commonwealth of Puerto Rico ratifying the status of TSI
operating as a non-profit organization and the conditions
provided by the ruling.
- TSI must annually ratify to the Department of Treasury that
it operated exclusively for the promotion of social welfare
in Puerto Rico.
- TSI's assets (as defined in the ruling) should be used
primarily for purposes related to its health insurance
business.
- Dividends cannot be paid on its common stock.
- In the event that TSI elects not to continue with this tax
exemption or it is revoked by the Secretary of Treasury of
the Commonwealth of Puerto Rico, there are two options
regarding the possible distribution of the operating reserve.
One of the options requires specific distribution to
non-profit organizations in the health field and the other
will require the payment of taxes. In the event of
liquidation of stocks, the Company is entitled to an amount
not in excess of the amount paid for the common stock when
they were originally issued. Any assets not distributed to
the Company will be distributed to non-profit organizations
in the health field.
- Any net income should be used exclusively for:
- Expanding and improving the health insurance
services
- Contributions to promote health insurance related
activities
- Increasing operating reserve until they reach a
balance equivalent to six months of claims expenses.
TSI's compliance with the requirements of the tax ruling is currently being
audited by representatives of the Department of the Treasury. Management is of
the opinion that TSI is in compliance with the aforementioned requirements
during the years ended December 31, 2002, 2001 and 2000.
TSM is a for-profit organization that operates as a not-for-profit organization
by virtue of the affirmative vote of its stockholders. As a result, TSM does
not distribute dividends. This resolution could be altered anytime by the
affirmative vote of stockholders and thus, dividends could be available for
distribution subject to the applicable obligations and responsibilities. The
decision to make dividends available for distribution does not require a
specific vote of the shareholders of the Corporation. Non-payment of dividends
is the result of the adoption of a not-for-profit operating philosophy affirmed
by the shareholders upon the approval of the 1998 corporate reorganization that
can be
Page 4
changed by a simple majority vote. The Board of Directors ("the Board")
presented a resolution to acknowledge that the Board may declare dividends,
subject to the determination of the Board that in their best judgment the
payment of such dividends is financially and legally feasible and that in
determining the amount of dividends to declare, the Board does not take into
consideration TSM's investment in TSI nor TSI's operating reserves. This
resolution was submitted in the definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on April 27, 2003.
In the event that stockholders decide to operate as a for-profit organization
and the Board decides to pay dividends, the amount of net income (loss) that
could be available for distribution would exclude TSI's net income due to TSI's
tax exempt status obtained through the above mentioned income tax ruling. For
purposes of computing the basic earnings per share presented in the
consolidated statements of operations and selected financial data, TSM
considers the operations of TSI as if TSI operated as a for-profit
organization, without the tax exemption. Under this scenario, in order to
determine the net income (loss) that could be available to stockholders, TSM
estimates the Puerto Rico income taxes that would have otherwise resulted and
deducts it from the results of operations of each year. TSI's estimate of
Puerto Rico income taxes, computed for such purposes, was determined as for an
other than life insurance entity, as defined in the Puerto Rico Income Tax
Code, as amended. The effective tax rate used was 39% for the three years ended
December 31, 2002, 2001, and 2000. No tax effect was considered for the
accumulated earnings since the tax grant does not provide any guideline for
this event.
The Corporation's filings with the Securities and Exchange Commission are not
available in its website address (ssspr.com) since the Corporation's stock has
no established public trading market. The Corporation will provide free of
charge copies of its filings to any shareholder that requests them at the
following address: Triple-S Management Corporation; Office of the Secretary of
the Board; PO Box 363628; San Juan, P.R. 00936-3628.
The consolidated net income (loss) per business segment presented in the
consolidated operating results of the Management's Discussion and Analysis of
Financial Condition and Results of Operations in this Form 10-K, for the Health
Insurance Commercial Program and Healthcare Reform are not available for
distribution to stockholders, as explained above.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This form and other publicly available documents may include statements that
may constitute "forward looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995, including, among other things:
statements concerning financial condition, results of operations and business
of the Corporation. These statements are not historical, but instead represent
the Corporation's belief regarding future events, many of which, by their
nature, are inherently uncertain and outside of the Corporation's control.
These statements may address, among other things, financial results, strategy
for growth, and market position. It is possible that the Corporation's actual
results and financial condition may differ, possibly materially, from the
anticipated results and financial conditions indicated in these forward-looking
statements. The factors that could cause actual results to differ from those in
the forward-looking statements are discussed throughout this Form 10-K. The
Corporation is not under any obligation to update or alter any forward-looking
statement (and expressly disclaims any such obligations), whether as a result
of new information, future events or otherwise. Factors that may cause actual
results to differ materially from those contemplated by such forward looking
statements include, but are not limited to, rising healthcare costs, business
conditions and competition in the different insurance segments, government
action and other regulatory issues.
PUERTO RICO'S ECONOMY
Economic indicators showed a definite slowdown in the Puerto Rico economy,
which intensified during the year 2002, which ended with slow economic activity
and new threats of recessionary pressures. The economic recovery that was
expected by mid-2002 did not materialize as anticipated. The sluggish
performance of the Puerto Rico economy during the last year is due to several
factors. First, the slow growth of the United States has had a direct impact in
the Puerto Rican economy. On a local level, the fiscal crisis of the Government
of Puerto Rico has led to tax increases, which is not only a discouraging
factor for economic growth but also creates reservations that tend to slow
investments. In addition, the loss of tax incentives has led to a decline in
the competitiveness of the industrial sector, which has limited the ability of
the Island economy to retain and create new jobs.
The overall growth of the U.S. economy is the most important variable exerting
an impact on Puerto Rico's economy. The U. S. government reported that its
economy grew 2.4% during the year 2002, following a growth of 0.3% during 2001,
when its economy was experiencing its first formal recession in a decade.
Economists' forecasts show the U.S. economy growing at a 2.6% rate during the
year 2003. After the year 2003, the U.S. economy is expected to maintain a
growth path, but at lower rates than during the extraordinary expansion of the
second half of the nineties. Even when some economists argue that the economy
will rebound by the end of the year 2003, the uncertainties of the war with
Iraq need to be cleared before any economic rebound is seen in both the U.S.
and Puerto Rico economies.
Page 5
Despite the slow growth of the U.S. economy, the deterioration of the job
market, and continued recessionary pressures, the economy of Puerto Rico is
expected to start growing during the year 2003. Some sectors of the Puerto
Rican economy are beginning to show signs of a slow recovery. This is the case
of the construction, tourism, commercial and auto sales sectors. Island
economists believe that the deceleration of the Puerto Rican economy has hit
bottom and that its rebound will be noticeable during 2003. However, economic
indicators suggest that most of the impetus toward economic recovery will come
from public-sector investment and construction, since the 2003 agenda of the
Puerto Rico's government includes several large construction projects. This
investment should have a significant multiplying effect on the Island's
economic activity in general. The Puerto Rico Planning Board expects the Puerto
Rico economy to grow by 1.7% during the year 2003.
The realization of the expected recovery of the Puerto Rico economy is
particularly dependent upon the course of the U.S. economy. Several factors
have contributed to the restraint in the economic growth of the U. S. that also
cast doubts about the viability of short-term forecasts. Some of these factors
are the following: the uncertainty created by the stock-market volatility,
corporate scandals, and the rise in oil prices. In addition to these factors,
the short-run economic outlook is aggravated by the uncertainty created by the
war with Iraq. The war with Iraq may trigger greater terrorist activities and
will also exert an upward pressure upon oil prices. If a more pessimistic
scenario for the U.S. materializes, the real growth rate of the economy in
Puerto Rico will be negatively affected, at least reducing the growth prospects
for the years 2003 and 2004.
INSURANCE INDUSTRY
The insurance industry in Puerto Rico is highly competitive and is comprised of
both local and foreign entities. The approval of the Gramm-Leach-Bliley Act of
1999, which applies to Puerto Rico, has opened the insurance market to new
competition since financial institutions are permitted to enter into the
insurance business. At the moment, several banks in Puerto Rico have
established subsidiaries that operate as insurance agencies.
Natural disasters, which have affected Puerto Rico greatly over the past ten
years, have prompted local Government to create property and casualty insurance
reserves through legislation in order to provide coverage for catastrophic
events. The auto insurance market has also been affected by Government
regulation, with the Compulsory Auto Insurance Law. This law requires vehicle
owners to maintain a minimum of $3,000 in public liability insurance.
Additionally, the healthcare insurance sector has experienced significant
changes in the past ten years due to the implementation of the Healthcare
Reform Program. This Program provides healthcare coverage to Puerto Rico's
medically indigent population (as defined by the law), estimated at over 1.6
million lives as of December 31, 2002.
The Corporation is the leader in the insurance industry in Puerto Rico. The
Corporation's health insurance company, TSI, is the leader in the health
insurance industry. TSI's participation in the health insurance industry,
considering both the Commercial and Healthcare Reform segments, provide this
subsidiary with a market share of approximately 41.8% as of December 31, 2002.
The property and casualty and the life insurance subsidiaries also have
important positions in their respective markets. As of December 31, 2001, STS
has a market share of approximately 7.8% in the property and casualty insurance
industry in Puerto Rico. As of December 31, 2001 SVTS has a market share of
approximately 15.0% in the group life insurance market in Puerto Rico.
Almost all of the Corporation's business is done within Puerto Rico and as
such, it is subject to the risks associated with Puerto Rico's economy and its
geographic location.
HEALTH INSURANCE - COMMERCIAL SEGMENT
The Corporation participates in the commercial health insurance marketplace
through its wholly owned subsidiary, TSI. Total premiums in the Commercial
Program segment represent 54.6%, 54.9% and 53.8% of consolidated total premiums
for the years 2002, 2001 and 2000, respectively.
TSI is a Blue Cross and Blue Shield Association sub-licensee, which allows the
subsidiary to use the Blue Shield brand in Puerto Rico. TSI's participation in
the health insurance industry with the Commercial and Healthcare Reform
segments provide this subsidiary with a market share of approximately 41.8% as
of December 31, 2002. TSI offers a variety of health insurance products, and is
the leader in almost every market sector. Its market share is almost twice as
large as its nearest competitor (Medical Card Systems, which has a market share
of approximately 17.3%) and over three times larger than that of its second
nearest competitor (La Cruz Azul de Puerto Rico, which has a market share of
approximately 10.4%). TSI offers its products to six distinct market segments
in Puerto Rico. During 2002, TSI had the following market share within each
segment: Corporate Accounts (groups), 45.0%; Healthcare Reform, 37.6%; Federal
Employees, 99.6%; Local Government Employees, 19.8%; Individual Accounts,
56.7%; and about 68.6% in the Medicare supplemental segment. Within the
Corporate Accounts segment, employer groups may choose various
Page 6
funding options ranging from fully insured to self-funded financial
arrangements. While self-funded clients participate in TSI's networks, the
clients bear the claims risk. Through a contract with the United States Office
of Personnel Management (OPM), TSI provides health benefits to federal
employees in Puerto Rico under the Federal Employees Health Benefits Program.
This contract is subject to termination in the event of a noncompliance not
corrected to the satisfaction of OPM. TSI provides health insurance coverage to
certain employees of the government of Puerto Rico and its instrumentalities.
Earned premium revenue related to such health plans amounted to $64.6 million,
$59.0 million and $57.5 million for the three year-period ended December 31,
2002, 2001 and 2000, respectively. In addition, TSI processes and pays claims
as carrier for the Medicare - Part B Program in Puerto Rico and the United
States Virgin Islands. As a carrier for Medicare-Part B, TSI allocates
operating expenses to determine reimbursement due for services rendered in
accordance with the contract.
TSI's premiums are generated from customers within Puerto Rico. The premiums
for this segment are mainly originated through TSI's internal sales force and a
network of brokers and independent agents. For purposes of segment reporting,
the Healthcare Reform sector is considered a different segment and is
separately analyzed.
TSI's business is subject to changing federal and local legal, legislative and
regulatory environments. Some of the more significant current issues that may
affect TSI's business include:
- efforts to expand the tort liability of health plans
- initiatives to increase healthcare regulation
- local government initiatives for mandatory benefits.
Current initiatives to increase healthcare regulation at the federal level
include new legislative proposals for "patients' bill of rights". Such
legislation was passed by the United States Senate in June 2001 and would
expand tort liability for health plans and change the practices for deciding
medical necessity. In August 2001, the United States House of Representatives
passed similar legislation in an effort to resolve differences between the two
bills. Given the political process, it is not possible to determine what, if
any, federal and local legislation or regulation will ultimately be enacted or
what would be the effect on TSI.
In 2000, the United States Department of Health and Human Services issued two
significant regulations as required by the Health Insurance Portability and
Accountability Act of 1996 (HIPAA): one of them addresses the standardization
of electronic transactions while the other addresses the privacy of
individually identifiable health information.
The final regulation governing security standards for the maintenance and
transmission of health information is expected to be effective during 2003. TSI
has assessed the effect of the HIPAA regulation on standard transactions on its
operations. The original compliance date for this regulation was October 2002,
but the President of the United States signed legislation in late 2001 giving
covered entities the opportunity, as TSI, to apply for a one-year extension.
TSI filed for this extension and is already working on the implementation of
said regulation and expects to comply with the required dates.
Given that the HIPAA security regulation has not been finalized and that
further changes to the privacy regulation were recently issued, TSI continues
evaluating the effect of HIPAA regulations on its operations. Notwithstanding,
TSI is moving forward with implementation efforts to comply with current
regulations on the required dates.
The private health insurance market in Puerto Rico experienced a moderate
increase in premiums in 2002. Premiums in the private health insurance market
increased by 1.2% in the year 2002 and 2.5% in the year 2001. The moderate
premium growth was the result of the slowdown in Puerto Rico's economy, a
reduction in the employment of the manufacturing sector due to temporary and
permanent plant closings, and to reductions in the Government's Healthcare
Reform expenditures. In the coming years, TSI expects moderate premium growth
to take place mostly as the result of a mature health insurance market and
moderate increases in total employment. Total employment in Puerto Rico is
expected to rise from fiscal year 2002 to 2007 at an average annual rate of
0.84%.
In recent years, the health insurance market as a whole has been affected by
rising healthcare costs, particularly those related to pharmacy benefit costs,
new medical technology, the current weak economy and a growing sense of
consumerism in health benefits. Rising negative consumer perception about
managed care caused many consumers to transfer from Health Maintenance
Organization (HMO) type products to companies offering open access and greater
choice of healthcare providers. These trends have moved the health insurance
industry to adopt strategies that emphasize benefits management (such as
defined contribution) from a more restrictive medical management (as
pre-authorization of certain procedures).
Page 7
The constantly changing health care costs inflation trend generally rules the
profitability of health insurers. Thus, the greatest challenge for the health
insurance industry is to maintain affordable premiums in a sluggish economy
while providing for the yearly increases in healthcare costs. These costs are
constantly driven upwards by an aging population, new prescription drugs and
advances in medical technology. In the years 2002 and 2001, most of the
insurers did a good job of estimating increases in health care costs, as
indicated by solid profitability. The focus of the underwriting process has
shifted from top-line and market share growth to increased profitability.
Margins used in the underwriting of policies have widened, since pricing often
assumes inflation rates higher than estimated. This strong premium growth
across the health insurance industry has not been accompanied by enrollment
growth, as insurers have dropped coverage for unprofitable accounts and in some
cases refused to negotiate for premiums. Industry experts expect health
insurers to reflect solid profitability again during the year 2003 however,
beginning in the year 2004 health insurers are expected to experience
increasing difficulty in raising premiums. At this time, the profitability of
health insurers will depend on their ability to increase the efficiency of the
health care delivery model.
The underwriting results of the segment have been affected by the
ever-increasing healthcare costs. To cope with this situation, TSI has
established new strategies for pricing of contracts and is implementing several
healthcare management programs.
During the years 1998 and 1999, TSI was subject to higher than expected
increases in costs and a decrease in investment income due to interest rate
fluctuations. As a result, TSI began implementing premium rate increases. In
spite of the increases, TSI has achieved and exceeded projected retention
rates. Current retention rates were 94.4% in 2002 and 95.2% in 2001. In
addition, TSI has maintained its market share during the last three years.
TSI has established healthcare management program strategies that seek to
control claims costs while striving to fulfill the needs of highly informed and
demanding healthcare consumers. Among these strategies is the implementation of
disease and case management programs. These programs empower consumers by
providing them with education and engaging them in actively maintaining or
improving their own health. Early identification of patients and inter-program
referrals are the milestones of these programs, which provide for integrated
and optimal service. Other strategies include innovative partnerships and
business alliances with other entities to provide new products and services
such as: a 24-hour telephone based triage and health information service; an
employee assistance program (EAP); and, the promotion of evidence-based
protocols and patient safety programs among our providers. TSI has also
implemented a hospital concurrent review program, whose goal is to monitor the
adequacy of high admission rate diagnoses and high cost stays. To stem the
rising tide in pharmacy benefit costs, TSI has implemented a three-tier
formulary product, which has proved to be very effective, an exclusive provider
organization (EPO) and benefits design changes.
TSI expects to remain competitive in the market in which it operates,
particularly the Corporate Groups segment. TSI's quality of services is
considered strong enough to enable it to maintain a competitive position in the
marketplace.
HEALTH INSURANCE - HEALTHCARE REFORM SEGMENT
The Corporation participates in the medically indigent health insurance market
through its wholly owned subsidiary TSI. The Health Insurance - Healthcare
Reform segment comprises TSI's participation in the Healthcare Reform. The
Healthcare Reform segment premiums represent 39.3%, 39.2% and 40.3% of the
consolidated total premiums for the years 2002, 2001 and 2000, respectively.
In 1994, the Government of the Commonwealth of Puerto Rico (the Government)
privatized the delivery of services to the medically indigent population in
Puerto Rico, as defined by the Government, by contracting with private health
insurance companies instead of providing health services directly to such
population. The Government divided the Island into ten geographical areas.
Starting in 1994 the Government began to shift its role, instead of directly
providing healthcare services to Puerto Rico's medically indigent population
through its facilities and medical providers it contracted health insurance
companies who in turn contracted private health providers to treat the health
needs of this population. By December 31, 2001, the Healthcare Reform had been
fully implemented in each of the geographical areas. Each geographical area is
awarded to a health insurer doing business in Puerto Rico through a competitive
process requesting proposals from the industry.
The Government has been asking insurers to reduce or, at least, control the
increase of Healthcare Reform expenditures, which represent approximately 13.0%
of total Government expenditures. Several measures have been undertaken by the
Government to control Healthcare Reform costs. Some of these measures include
closer and continuous scrutiny of participant's (members) qualifications and
the carve-out of mental health benefits from the policy. Mental health benefits
are currently offered to the Healthcare Reform beneficiaries by behavioral
healthcare and mental healthcare companies. The Government is considering
carving-out additional benefits provided by the insurers. On March 2003 the
Government announced that, effective July 1, 2003, it will begin a pilot
project where it
Page 8
will be contracting directly with some of the medical groups, instead of
through the health insurance companies. This change is expected to decrease the
segment's enrollment by approximately 45 thousand members and the annualized
premiums by approximately $30.0 million.
All of the Government Healthcare Reform contracts expired on June 30, 2002.
After the expiration of these contracts, the Commonwealth redistributed the
geographical areas, merging two of the existing areas with the remaining ones,
thus reducing geographical areas to eight. As a result of the reorganization of
the geographical areas, the Northwest area (previously administered by TSI) was
merged into the West area. In addition, and as a result of the same
reorganization, six new municipalities were merged into areas administered by
TSI. TSI participated in the bidding process and submitted proposals to renew
each of the existing contracts and also to serve additional geographical areas.
Commencing on July 1, 2002, TSI was awarded three of the eight geographical
areas: North, Metro-North and Southwest. On this date, after the reorganization
of the geographical areas and the granting of the three areas, TSI experienced
a decrease in average enrollment of approximately 5.7% when compared to the
average enrollment as of June 30, 2002. This decrease in enrollment was not
significant and since premium rates were increased by approximately 6.3%, total
revenues are expected to be similar to the previous year. All Healthcare Reform
contracts were negotiated for a term of three years; the contracts expire on
June 30, 2005. The premium rates of each contract, however, will be negotiated
annually. The contracts include a clause where the net income for any given
contract year, as defined, cannot exceed 2.5% of earned premiums. If it is over
2.5%, the insurance companies have to return 75.0% of this excess to the
Government of Puerto Rico. In case the contract renewal process is not
completed by its expiration date, the contract may be extended by the
Government, upon acceptance by TSI, for any subsequent period of time if deemed
in the best interest of the beneficiaries and the Government. The terms of the
contract, including premiums, can be renegotiated if the term of the contracts
is extended. The contract for each area is subject to termination in the event
of any non-compliance not corrected or cured to the satisfaction of the
Government entity overseeing the Healthcare Reform, or in the event that the
Government determines there is an insufficiency of funds to finance the
Healthcare Reform. This last event will require prior written notice of at
least ninety days. As of filing date, management has not received any
Healthcare Reform contract cancellation notice from the Government of Puerto
Rico. The loss of any or all of the Healthcare Reform contracts would have a
material effect on the Corporation's operating results. This could include the
downsizing of certain personnel, the cancellation of lease agreements of
certain premises and of certain contracts, and severance payments, among
others. Also, this will result in a significant decrease in the volume of
premiums, claims, and operating expenses.
As of December 31, 2002, three local insurance companies were participating in
the Healthcare Reform. The three insurance companies participating in the
Healthcare Reform and their related market share during the year ended December
31, 2002 are the following: TSI (37.6%), Medical Card System (30.4%) and Humana
(27.6%). La Cruz Azul de Puerto Rico (4.4%) participated in the Healthcare
Reform sector until June 30, 2002. Once the Healthcare Reform was fully in
place, any participating insurance company's growth in this segment depends on
winning a geographical area serviced by another insurance company or through
the restructuring of the geographical areas. The health insurance companies
that decide to participate in this business compete against each other during
the adjudication processes. TSI's Healthcare Reform segment competing strengths
are its highly efficient administrative structure and superior quality of
services.
To provide services to its medically indigent membership, TSI established a
managed care program similar to a Health Maintenance Organization (HMO) that
integrates both the financing and delivery of services in order to manage the
accessibility, cost and quality of care. The established managed care model
includes disease and demand management as well as preventive healthcare
services. All of these programs and its effective administrative structure have
made TSI's product and pricing structure the most attractive and convenient.
TSI has established a network of Independent Practice Associations (IPA) to
provide service to its Healthcare Reform beneficiaries in the Healthcare Reform
areas serviced by TSI. TSI believes it has designed the economic model that
best suits the IPA's and the primary care physicians (PCP). The risks covered
by the Healthcare Reform policy are divided among those assumed by the IPA's
and those retained by TSI. The IPA receives an amount per capita, and it
assumes the costs of services provided and referred by its PCP's, including
procedures and in-patient services not related to risks assumed by TSI. As part
of its services, TSI retains a portion of the capitation payments to the IPA's
as a reserve to provide for incurred, but not reported claims (IBNR) for
services rendered by providers other than PCP's. TSI retains the risk
associated with services provided to the beneficiaries with special healthcare
needs, such as: neonatal, obstetrical, AIDS, cancer, cardiovascular, and dental
services, among others. Effective October 1, 2001, mental healthcare services
were carved-out by the Government and contracted with behavioral healthcare
companies. This represented a decrease in monthly premiums income of
approximately $3 million.
As of December 31, 2002, TSI's Healthcare Reform segment provided coverage to
beneficiaries in the following geographical areas: North, Metro-North and
Southwest (awarded to TSI effective October 1, 2001). TSI administered the
Northwest Area until June 30, 2001 and the West Area until June 30, 2000. As of
December 31, 2002, the three
Page 9
areas administered by TSI have a total enrollment of approximately 655 thousand
beneficiaries, which represented approximately 38.5% of the total eligible
beneficiaries of the population.
Healthcare Reform contracts have generally been for twelve-month periods.
Premiums need to be determined taking into consideration future costs of
services. Since premium levels are determined on a yearly basis and for a
significant block of business, TSI is exposed to a significant underwriting
risk.
Effective October 1, 2001, TSI entered into a service agreement with TCI, a
previously inactive affiliated organization that operated as a de facto
division of TSI, for the administration of the Healthcare Reform segment
operations in exchange for a service fee that will cover the operating expenses
plus a profit.
Since the year ended December 31, 2001, the Healthcare Reform segment had
experienced underwriting income. During the years 2000 and 1999, the segment
experienced underwriting losses as a result of over-utilization of certain
services by the enrolled beneficiaries. In 2001, and thereafter, this situation
was corrected by increasing premium rates and by controlling costs through the
utilization, demand and quality management programs.
PROPERTY AND CASUALTY INSURANCE SEGMENT
The Corporation participates in the property and casualty insurance market
through its wholly owned subsidiary STS. The property and casualty segment
premiums represent 4.9%, 4.7% and 4.9% of the consolidated total premiums for
the years 2002, 2001 and 2000, respectively.
STS is a multiple line insurer that substantially underwrites all lines of
property and casualty insurance. Its predominant lines of business are
commercial multiple peril, auto physical damage, auto liability and dwelling.
Business is exclusively subscribed in Puerto Rico through approximately twenty
general agencies and independent insurance agents and brokers. Signature
Insurance Agency, Inc., STS's wholly owned subsidiary, underwrote about 45% of
its total premium volume for the years ended December 31, 2002 and 2001.
STS is ranked sixth in the property and casualty insurance industry in Puerto
Rico, with a market share of approximately 7.8% as of December 31, 2001. Its
nearest competitors and their related market share are Royal and Sunalliance
Insurance PR, Inc. (9.3%) and Integrand Assurance Co. (7.7%). The market leader
in the property and casualty insurance industry in Puerto Rico is the Universal
Insurance Group, with a market share of 18.7% as of December 31, 2001.
The property and casualty insurance market has been affected by the increased
costs of reinsurance. The international reinsurance market has been
experiencing difficult times and has raised its reinsurance premium rates over
the last two years. Recent worldwide catastrophes have, in effect,
significantly altered the balance as to negotiating rates, terms and other
conditions. The Puerto Rico property and casualty insurance market must pass on
these additional costs to its customers, in spite of a recession and an
economic slowdown. On the positive side, the industry, for the most part, has
begun an effort to increase premium rates.
Due to its geographical location, the property and casualty insurance
operations in Puerto Rico are subject to natural catastrophic activity. Puerto
Rico is exposed to two major natural perils (hurricanes and earthquakes), which
lead local insurers to rely on the international reinsurance market in order to
provide enough capacity. Other issues that have plagued the industry over the
years, such as asbestos and pollution, have not affected the segment's
portfolio. STS maintains a comprehensive reinsurance program protecting its
surplus in the event of a catastrophe.
In addition to its catastrophic reinsurance coverage, STS is required by local
regulatory authorities to establish and maintain a trust fund (the Trust) to
protect STS from its dual exposure to hurricanes and earthquakes. The Trust is
intended to be used as the company's first layer of catastrophe protection. As
of December 31, 2002 and 2001, STS had $20.8 million and $19.7 million,
respectively, invested in securities deposited in the Trust (see note 18 of the
audited consolidated financial statements).
Considering the significance of reinsurance in protecting its capital base and
ensuring ongoing operations, STS is aware of the need to exercise its best
business judgment in the selection and approval of its reinsurers. A
comprehensive and sound reinsurance program has been established to provide the
level of protection that STS desires. These reinsurance arrangements do not
relieve STS from its direct obligations to its insureds. However, STS strongly
believes that the credit risk arising from recoverable balances of reinsurance,
if any, is immaterial. STS' policy is to only transact with reinsurers
considered to be financially sound.
The property and casualty insurance market in Puerto Rico is extremely
competitive. There are no new sources within the economy providing continued
growth; thus, property and casualty insurance companies tend to compete for the
Page 10
same accounts through price and/or more favorable conditions. STS competes by
reasonably pricing its products and providing efficient services to producers
and agents. The current level of expertise within the segment is also an
incentive for professional producers to conduct business with STS.
Effective January 2002, the Office of the Commissioner of Insurance of Puerto
Rico suspended filing requirements of rates for certain classes, subdivisions
or combinations of insurance in the interest to promote the economic activity
of the insurance industry in Puerto Rico. The classes, subdivisions or
combinations of insurance covered by this deregulation are related to
commercial property and liability insurance.
As of late 2001, pricing began to affect somewhat the local property and
casualty insurance market, but at a lower pace than for its United States of
America peers. However, the increase in reinsurance costs affected the property
and casualty insurance market in Puerto Rico in the same degree as affected in
the United States of America. STS' prompt reaction to these factors, as well as
the continued careful underwriting of property risks, should help preserve
strong results while accommodating the higher reinsurance costs.
The property and casualty insurance segment has experienced strong operating
results over the past years, and its profitability measures have outperformed
industry averages and larger size peers within the local insurance market. Such
results have been achieved in spite of unfavorable market conditions, including
soft demand, increased competition, a closed marketplace and rising reinsurance
costs affecting Puerto Rico over the last few years.
STS' commitment to sound underwriting practices, efficient claims reserve
monitoring, extensive catastrophe reinsurance programs, and underwriting
expense controls, have enabled it to maintain one of the best combined ratios
in the local industry. STS, as well as most of its property and casualty peers,
uses the loss ratio, the expense ratio and the combined ratio as measures of
performance. A controlled business expansion in the commercial market and
better underwriting performance of its auto business, evidenced by declining
loss ratios, have also contributed to such favorable results. In addition,
prudent reinsurance utilization through a sound strategy to control exposures
by means of a strict underwriting criteria and protection of retained exposures
have also enhanced underwriting results.
LIFE AND DISABILITY INSURANCE SEGMENT
The Corporation participates in the life and disability insurance marketplace
by means of its wholly owned subsidiary SVTS. The life and disability segment
premiums represent 1.2%, 1.2% and 1.1% of consolidated total premiums for the
years 2002, 2001 and 2000, respectively.
SVTS offers a wide variety of life, disability and investment products. Among
these are: group life insurance, group long and short-term disability, credit
life insurance, and the administration of individual retirement accounts and
flexible premium deferred annuities. Group life insurance represents the bulk
of the business. SVTS' insurance products are mainly offered to consumers in
Puerto Rico through its own network of brokers and independent agents.
SVTS insures more than 1,500 groups, which represent approximately 360 thousand
lives. This makes SVTS the second largest provider of group life insurance in
Puerto Rico, with a market share of approximately 15% in 2001. The segment's
nearest competitors in the group life insurance market in Puerto Rico and their
related market share as of December 31, 2001 are Cooperativa de Seguros de Vida
de Puerto Rico (39%) and National Life Insurance Co. (7%). Cooperativa de
Seguros de Vida de Puerto Rico is also the leader in the group life insurance
market.
To continue its growth in the life insurance market in Puerto Rico, SVTS plans
to introduce new products and services within the group and individual
insurance business in the coming years. During the year 2003, SVTS plans to
market and sell several individual insurance products, such as cancer, term
life, and accident insurance policies. To distribute its individual insurance
products, SVTS created a wholly owned subsidiary, Smart Solutions Insurance
Agency Corporation, which began operations during 2002.
FINANCIAL INFORMATION ABOUT SEGMENTS
Total revenue (with intersegment premiums/service revenues shown separately),
underwriting income or loss, net income or loss and total assets attributable
to reportable segments are set forth in note 3 to the consolidated financial
statements for the years ended December 31, 2002, 2001 and 2000, which are
attached hereto in Exhibit 1.
TRADEMARKS
The Corporation considers its trademark of "Triple-S" and the three "SSS" very
important and material to all segments in which it is engaged. In addition to
these, other trademarks used by the subsidiaries that are considered important
Page 11
have been duly registered with applicable authorities. It is the Corporation's
policy to register all its important and material trademarks in order to
protect its rights under applicable corporate and intellectual property laws.
HUMAN RESOURCES AND LABOR MATTERS
As of February 28, 2003, the Corporation had 1,363 full-time employees and 266
temporary employees. TSI has a collective bargaining agreement with the Union
General de Trabajadores, which represents 377 of TSI's 761 regular employees.
Said collective bargaining agreement expires on July 31, 2006. The Corporation
considers its relations with employees to be good.
ITEM 2. PROPERTIES
TSM owns a seven story (including the basement floor) building located at 1441
F.D. Roosevelt Avenue, in San Juan, Puerto Rico where the main offices of TSM,
TSI and ISI are located, and the adjacent two buildings, one that houses TCI
and certain offices of TSI, and the adjacent parking lot. In addition, TSM is
the owner of five floors of a fifteen-story building located at 1510 F.D.
Roosevelt Avenue, in Guaynabo, Puerto Rico. These floors house the Internal
Auditing Office of the Corporation, SVTS, STS and some divisions of TSI.
In addition to the properties described above, TSM or its subsidiaries are
parties to operating leases that are entered into in the ordinary course of
business.
The Corporation believes that its facilities are in good condition and that the
facilities, together with anticipated capital improvements and additions, are
adequate to meet its operating needs for the foreseeable future. The need for
expansion and upgrading and refurbishment of facilities is continually
evaluated in order to remain competitive and to take advantage of market
opportunities.
ITEM 3. LEGAL PROCEEDINGS.
(a) As of December 31, 2002, the Corporation was a defendant in
various lawsuits arising out of the ordinary course of
business. In the opinion of management and legal counsel, the
ultimate disposition of these matters will not have a
material adverse effect on the Corporation's consolidated
financial position and results of operations.
(b) On December 6, 1996, the Commissioner of Insurance issued an
order to annul the sale of 1,582 shares of common stock held
as treasury 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 stocks was cancelled and the amount paid
was returned to each former stockholder of the aforementioned
stocks. During the year 2000, the Commissioner of Insurance
issued a pronouncement providing further clarification of the
content and effect of the order. The order also required that
all corporate decisions undertaken by TSI through the vote of
its stockholders on 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 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 SSS and its
subsidiaries. This resolution did not reach the two-thirds
majority required by the order because the number of stocks
that were present and represented at the meeting were below
such amount (total stocks present and represented in the
stockholders' meeting were 64%). As stipulated in the order,
TSM began the process to conduct a referendum among its
stockholders 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 indicating that the ratification
of the corporate reorganization was not required.
In a letter to TSI, dated March 14, 2002, the Commissioner of
Insurance of Puerto Rico stated that the ratification of the
corporate reorganization was not required, and that TSI had
complied with the Commissioner's order of October 6, 1999
related to the corporate reorganization. Thereafter, two
stockholders of TSM filed a petition for review of the
Commissioner's determination before the Puerto Rico Circuit
Court of Appeals, which 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,
Page 12
Inc." to "Triple-S, Inc.". The 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 Circuit
Court of Appeals on October 11, 2002. TSI and TSM also filed
a motion of reconsideration.
On October 25, 2002 the Circuit Court of Appeals dismissed
the Commissioner of Insurance's Motion for Reconsideration.
In addition, the Circuit Court of Appeals ordered the two
stockholders who filed the petition for review to reply
within twenty (20) days to TSI's and TSM's Motion of
Reconsideration. This situation is still pending resolution
from the Circuit Court of Appeals.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Corporation held a special meeting of shareholders on October 13, 2002 (the
"Special Meeting") to vote on a series of amendments to the Corporation's
Articles of Incorporation and By-Laws, relating to changes to its capital
structure in order to allow TSM to expand its base of shareholders. At the
Special Meeting, 57.3% of total shares outstanding were represented, but more
than 75.0% were required in order to take a vote to implement the proposals to
amend TSM's capital structure. Therefore, a resolution to recess the Special
Meeting and continue it at a later date was put to a vote. This Resolution
received 5,190 votes in favor, 165 votes against and 3 abstentions and,
therefore, it was approved.
On February 23, 2003, the Corporation held the continuation of the Special
Meeting commenced October 13, 2002. In the continuation of the Special Meeting
98.4% of the shares present and represented voted in favor of continuing the
meeting at a later date. This was necessary since 69% of total shares
outstanding were represented at the Special Meeting and 75% or more was
required in order to take a vote to implement the proposals to amend TSM's
capital structure. Therefore, a resolution to recess the Special Meeting and
continue it at a later date was approved with 6,302 votes in favor, 81 votes
against and 21 abstentions.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDERS
MATTERS.
MARKET INFORMATION
There is no established public trading market for TSM's Common Stock. Sporadic
sales of TSM's Common Stock are limited to redemption sales with TSM at the
shares' $40.00 par value or at the amount originally paid for the stock, since
the Common Stock of TSM is generally not transferable to the general public.
HOLDERS
The only outstanding voting securities of TSM are shares of its Common Stock,
par value $40.00 per share. As of March 20, 2003, there were 9,337 shares of
Common Stock outstanding. The number of holders of the Corporation's common
stock as of March 20, 2003 is 1,817.
DIVIDENDS
TSM has not declared nor paid any dividends since its incorporation. The Board
of Directors ("the Board") presented a resolution to acknowledge that the Board
may declare dividends, subject to the determination of the Board that in their
best judgment the payment of such dividends is financially and legally feasible
and that in determining the amount of dividends to declare, the Board does not
take into consideration TSM's investment in TSI nor TSI's operating reserves.
This resolution was submitted in the definitive Proxy Statement for the Annual
Meeting of Shareholders to be held on April 27, 2003. For further details on
the Corporation's restrictions on the payment of dividends, see the section
"Restriction on Certain Payments by the Corporation" included in "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" of this Form 10-K.
RECENT SALES OF UNREGISTERED SECURITIES
Not applicable.
Page 13
ITEM 6. SELECTED FINANCIAL DATA.
(Dollar amounts in thousands,
except per share data) 2002 2001 2000 1999 1998 (1)
----------- ---------- ---------- ---------- --------
STATEMENT OF OPERATIONS DATA
Years ended December 31,
Premiums earned, net $ 1,230,671 1,151,173 1,088,163 967,510 807,067
Amounts attributable to claims under
self-funded arrangements 150,684 134,374 117,542 105,183 85,065
Less amounts attributable to claims under
self-funded arrangements (141,138) (126,295) (113,248) (96,441) (79,500)
----------- ---------- ---------- ---------- --------
Premiums earned, net and fee revenue 1,240,217 1,159,252 1,092,457 976,252 812,632
----------- ---------- ---------- ---------- --------
Net investment income 24,778 25,405 24,338 22,464 22,174
Net realized investments gains 185 4,655 6,377 6,690 2,495
Net unrealized investment gain (loss)
on trading securities (8,322) (3,625) (3,737) 1,807 4,116
Other income, net 8,051 4,709 7,552 276 4,765
----------- ---------- ---------- ---------- --------
Total revenue $ 1,264,909 1,190,396 1,126,987 1,007,489 846,182
=========== ========== ========== ========== ========
Net income (loss) $ 48,249 21,715 (1,512) (5,953) 20,064
=========== ========== ========== ========== ========
Basic earnings (loss) per share (2):
If the Corporation operated as a for-profit
organization $ 3,766 1,545 (70) (267) 1,637
----------- ---------- ---------- ---------- --------
If TSI operated as a not-for-profit
organization $ 1,085 1,052 929 639 738
----------- ---------- ---------- ---------- --------
BALANCE SHEET DATA
December 31,
Total assets $ 725,678 656,058 562,153 550,578 582,276
=========== ========== ========== ========== ========
Loans payable to bank $ 50,015 55,650 58,040 60,317 --
=========== ========== ========== ========== ========
Total stockholders' equity $ 231,664 186,028 159,693 159,247 189,587
=========== ========== ========== ========== ========
(1) Financial figures for this year are for TSM's predecessor company,
SSS.
(2) Further details of the calculation of basic earnings per share are set
forth in notes 2 and 22 of the consolidated financial statements for
the years ended December 31, 2002, 2001 and 2000. Consolidated
financial statements are attached hereto as Exhibit I.
ITEM 7. 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, 2002 and 2001, and
consolidated results of operations for 2002, 2001 and 2000. This analysis
should be read in its entirety and in conjunction with the consolidated
financial statements, notes and tables included elsewhere in this Form 10-K.
This financial discussion has been prepared pursuant to the rules and
regulations adopted by the U.S. Securities and Exchange Commission.
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
Page 14
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) 2002 2001 2000
----------- ---------- ----------
Years ended December 31,
CONSOLIDATED PREMIUMS EARNED, NET AND FEE REVENUE:
Health insurance - Commercial Program $ 677,537 636,566 587,614
Health insurance - Healthcare Reform 487,000 454,923 439,774
Property and casualty 60,688 54,337 53,493
Life and disability 14,992 13,426 11,576
----------- ---------- ----------
$ 1,240,217 1,159,252 1,092,457
=========== ========== ==========
CONSOLIDATED CLAIMS INCURRED $ 1,061,980 1,021,024 990,133
CONSOLIDATED OPERATING COSTS 148,539 140,830 130,135
----------- ---------- ----------
CONSOLIDATED UNDERWRITING COSTS $ 1,210,519 1,161,854 1,120,268
=========== ========== ==========
CONSOLIDATED LOSS RATIO 85.6% 88.1% 90.6%
CONSOLIDATED EXPENSE RATIO 12.0% 12.1% 11.9%
----------- ---------- ----------
CONSOLIDATED COMBINED RATIO 97.6% 100.2% 102.5%
=========== ========== ==========
CONSOLIDATED NET INVESTMENT INCOME $ 24,778 25,405 24,338
CONSOLIDATED NET REALIZED GAIN ON SALE OF SECURITIES 185 4,655 6,377
CONSOLIDATED NET UNREALIZED LOSS ON TRADING SECURITIES (8,322) (3,625) (3,737)
----------- ---------- ----------
CONSOLIDATED NET INVESTMENT INCOME $ 16,641 26,435 26,978
=========== ========== ==========
CONSOLIDATED INCOME TAX EXPENSE $ 2,549 1,342 1,176
=========== ========== ==========
NET INCOME (LOSS) PER SEGMENT:
Health insurance - Commercial Program $ 28,133 6,776 (3,090)
Health insurance - Healthcare Reform 9,770 4,563 (7,614)
Property and casualty 6,223 6,529 6,282
Life and disability 3,585 3,366 3,334
Other 538 481 (424)
----------- ---------- ----------
CONSOLIDATED NET INCOME (LOSS) $ 48,249 21,715 (1,512)
=========== ========== ==========
Year ended December 31, 2002 compared with the year ended December 31, 2001
Consolidated premiums earned, net and fee revenue during 2002 increased by
$81.0 million, or 7.0%, when compared to the consolidated premiums earned, net
and fee revenue for 2001. This increase is mostly due to a combined increase of
$73.1 million in the premiums earned, net and fee revenue of the Health
Insurance - Commercial Program and the Health Insurance - Healthcare Reform
segments and to the increase in earned premiums of the property and casualty
insurance segment.
- The premiums earned, net and fee revenue corresponding to the
Health Insurance - Commercial Program reflect an increase of
$41.0 million, or 6.4%, during this period. Increases in
premium rates as well as a net increase in the average
enrollment account for the increase in the segment's earned
premiums net, and fee revenue.
- The premiums earned corresponding to the Health Insurance -
Healthcare Reform segment increased by $32.1 million, or
7.1%, during this period. This increase is basically the
result of increases in premium rates,
Page 15
a net increase in the average enrollment offset by the effect
of the exclusion of mental health and substance abuse
services.
- The premiums earned of the property and casualty insurance
segment increased by $6.4 million, or 11.7%, during the year
2002. This increase is mostly the result of increases in
premium rates due to the deregulation of the commercial
property and liability lines of business and to the segment's
increased volume of business.
During the year 2002 the consolidated claims incurred increased by $40.9
million, or 4.0%, due to an increase in the volume of business. However, the
loss ratio reflects a decrease of 2.5 percentage points when compared to the
prior year. This decrease is mostly attributed to fluctuations in the claims
incurred of the Health Insurance - Commercial Program segment and the Health
Insurance - Healthcare Reform segment. The decrease in loss ratio is 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. The consolidated expense
ratio has remained similar to that for the year 2001, reflecting an increase of
0.1 percentage points.
The consolidated realized gain on sale of securities of $185 thousand and $4.7
million for the years 2002 and 2001, respectively, 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
2001 is mostly due to the sale of common stocks of Popular, Inc., which
generated a realized gain of approximately $2.3 million and also to normal
portfolio turnover of the trading and available for sale securities.
The unrealized loss on trading securities of $8.3 and $3.6 million for the
years 2002 and 2001, respectively, are related to investments held by the
Health Insurance - Commercial Program, Health Insurance - Healthcare Reform and
the Property and Casualty Insurance segments. This unrealized loss is mostly
attributed to losses in the portfolios held by such segments in equity holdings
that replicate the Standard & Poor's 500 Index (S&P 500 Index). This Index
experienced a negative return in 2002 and 2001. 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 for the year ended December 31, 2002
increased by $1.2 million when compared to the same amount for the prior year.
This increase is mostly noted in the income tax expense of the property and
casualty insurance segment, which reflect an increase of $685 thousand during
the year 2002 that is attributed to the segment's increased volume of business
and profitability.
Year ended December 31, 2001 compared with the year ended December 31, 2000
Consolidated premiums earned, net and fee revenue during 2001 increased by
$66.8 million, or 6.1%, when compared to the consolidated premiums earned, net
and fee revenue for 2000. This increase is mostly due to a combined increase of
$64.1 million in the premiums earned, net and fee revenue of the Health
Insurance - Commercial Program and the Health Insurance - Healthcare Reform
segments.
- The premiums earned, net and fee revenue corresponding to the
Health Insurance - Commercial Program reflect an increase of
$49.0 million, or 8.3%, during this period. Increased premium
rates as well as a net increase in the average enrollment
account for the increase in the segment's earned premiums
net, and fee revenue.
- The premiums earned corresponding to the Health Insurance -
Healthcare Reform segment increased by $15.1 million, or
3.4%, during this period. This increase is basically the net
result of increases in premium rates, a net decrease in the
average enrollment offset by the effect of the exclusion of
mental health and substance abuse services.
- The premiums earned of the remaining segments increased by
$2.7 million, or 4.1%, during this period.
During the year 2001 the consolidated claims incurred increased by $30.9
million, or 3.1%, due to an increase in the volume of business. However, the
loss ratio reflects a decrease of 2.5 percentage points when compared to the
prior year. This decrease is mostly attributed to fluctuations in the claims
incurred of the Health Insurance - Commercial Program segment and the Health
Insurance - Healthcare Reform segment. The decrease in loss ratio is the result
of management's ability to adjust its pricing strategy to cope with the
increase in claims costs and several measures for cost containment. This
process commenced during 1999 and the first half of 2000, and its effect
impacted the loss ratio during the second half of 2000 and 2001. The
consolidated expense ratio has remained similar to that for the year 2000,
reflecting an increase of 0.2 percentage points.
Page 16
The consolidated net investment income for 2001 increased by $1.1 million or
4.4% when compared to that for the year 2000. This increase is mostly due to a
higher average investment balance during the year 2001, partially offset by a
reduction on the average interest yield of the fixed income portfolio.
The consolidated realized gain on sale of securities of $4.7 million 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. This consolidated
realized gain during the year 2001 is mostly due to the sale of common stocks
of Popular, Inc., which generated a realized gain of approximately $2.3 million
and also to normal portfolio turnover of the trading and available for sale
securities.
The unrealized loss on trading securities of $3.6 million are related to
investments held by the Health Insurance - Commercial Program, Health Insurance
- - Healthcare Reform and the Property and Casualty Insurance segments. This
unrealized loss is attributed to losses in certain portfolios held by such
segments in equity holdings that replicate the Standard & Poor's 500 Index (S&P
500 Index). This Index experienced a negative return in 2001 and 2000. 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.
HEALTH INSURANCE - COMMERCIAL PROGRAM OPERATING RESULTS
(Dollar amounts in thousands) 2002 2001 2000
--------- -------- --------
Years ended December 31,
AVERAGE ENROLLMENT:
Corporate accounts 313,557 322,369 328,029
Self-funded employers 123,680 118,866 119,069
Individual accounts 82,583 77,352 73,322
Federal employees 55,999 55,819 54,014
Local government employees 43,526 41,694 38,695
--------- -------- --------
TOTAL AVERAGE ENROLLMENT 619,345 616,100 613,129
========= ======== ========
Premiums earned, net $ 669,954 628,704 583,536
Amount attributable to self-funded arrangements 151,497 135,002 118,078
Less amounts attributable to claims under
self-funded arrangements (141,138) (126,295) (113,248)
--------- -------- --------
PREMIUMS EARNED, NET AND FEE REVENUE $ 680,313 637,411 588,366
========= ======== ========
CLAIMS INCURRED $ 574,874 560,809 531,187
OPERATING COSTS 86,321 83,771 77,990
--------- -------- --------
TOTAL UNDERWRITING COSTS $ 661,195 644,580 609,177
========= ======== ========
UNDERWRITING INCOME (LOSS) $ 19,118 (7,169) (20,811)
========= ======== ========
LOSS RATIO 84.5% 88.0% 90.3%
EXPENSE RATIO 12.7% 13.1% 13.3%
--------- -------- --------
COMBINED RATIO 97.2% 101.1% 103.5%
========= ======== ========
NET INVESTMENT INCOME $ 10,577 10,428 9,993
NET REALIZED (LOSS) GAIN ON SALE OF SECURITIES (312) 3,643 5,566
NET UNREALIZED LOSS ON TRADING SECURITIES (6,533) (2,908) (3,228)
--------- -------- --------
TOTAL NET INVESTMENT INCOME $ 3,732 11,163 12,331
========= ======== ========
NET INCOME (LOSS) $ 28,133 6,776 (3,090)
========= ======== ========
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, hospital 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. Administrative expenses
Page 17
comprise 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.
This segment has a well-diversified investment portfolio with good asset
quality and a large portion invested in investment-grade, fixed income
securities. The segment's investment portfolio is predominantly held in U.S.
Treasury securities, obligations of the U.S. and P.R. government
instrumentalities and obligations of state and political subdivisions, which
comprise over 60% of the total portfolio value as of December 31, 2002. The
remaining investment portfolio consists of an equity securities portfolio that
replicates the S&P 500 Index, a corporate bonds portfolio, and investments in
strong local stocks of financial institutions. Due to market price
appreciation, the segment has a large single issuer equity concentration in
Popular, Inc., which is the holding company of Banco Popular de Puerto Rico,
the largest local commercial bank in Puerto Rico. As of December 31, 2002 and
2001, the carrying value of the Corporation's investment in Popular, Inc.
amounted to $25.8 million and $22.2 million, respectively. This investment
represents 11.6% for the year 2002 and 11.4% for the year 2001 of the segments'
total investments.
Year ended December 31, 2002 compared with the year ended December 31, 2001
Premiums earned, net and fee revenue for the year ended December 31, 2002,
reflect an increase of $42.9 million, or 6.7%, when compared to the premiums
earned, net and fee revenue for the year 2001. This increase is the result of
the following:
- This segment has been successful in monitoring premium rates,
particularly in the rated Corporate Accounts business,
assuring adequate premium rates that reflect actual claims
experience.
- The segment's enrollment increased by 3,245 members, or 0.5%,
when comparing the average enrollment as December 31, 2002
with the average enrollment as of December 31, 2001. This
increment is mostly reflected in the Individual Accounts,
Self-funded Employers and Local Government Employees
membership, where average enrollment increased by 5,231, or
6.8%, 4,814, or 4.1%, and 1,832, or 4.4%, during the year,
respectively. The average enrollment of the Corporate
Accounts groups decreased by 8,812 members, or 2.7%, during
the year 2002.
- In addition, management service fees increased by $1.7
million, or 19.0%, when compared to the same amount for the
year 2001. This increase was due to increases of claims
incurred under the self-funded agreements mostly as the
result of the increase in membership.
Approximately 89.7% of the total premiums increase is attributed to increases
in premium rates, while the remaining 10.3% is attributed to increases in
membership.
Claims incurred during the year 2002 increased by $14.1 million, or 2.5%, when
compared to the claims incurred during the year 2001. This increase is due to
the segment's increased volume of business, together with a decrease in the
loss ratio of 3.5 percentage points during the year. The improvement in the
loss ratio is the result of the following:
- Overall claims trends utilization development for the year
2002 was approximately 12.3% 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 have caused
some utilization indicators to exhibit a downward trend.
- Also, the segment experienced a favorable development of
$10.9 million of the 2001 claim liabilities estimate mostly
because of better than expected utilization trends.
Operating expenses increased by $2.6 million, or 3.0%, when comparing the
balances of the years 2002 and 2001. The operating expense ratio decreased by
0.4 percentage points during the year 2002. The lower operating expense ratio
for 2002 is mostly due to economies associated with premium revenue growth in
relation to fixed company operating expenses. In addition the segment has made
technology investments (increase in electronic claims submissions, virtual
storage technology, and interactive voice response, among others) that have
also resulted in increased efficiency. These economies were mitigated by the
increase in the acquisition cost of business, such as marketing and commission
expenses and the increase in payroll and payroll related expenses.
Year ended December 31, 2001 compared with the year ended December 31, 2000
Premiums earned, net and fee revenue for the year 2001 reflect an increase of
$49.0 million, or 8.3%, when compared to those for the year 2000. This increase
is the result of the combined effect of increases in premium rates and net
increases in enrollment.
Page 18
- Due to prior years' experience and to cope with increases in
health services cost, TSI was required to increase premium
rates to better reflect expected claims costs. This effort
was made gradually as contracts were renewed, and commenced
in the last semester of 1999. TSI was able to implement these
increases and retain the majority of its accounts because of
its products and services, and its position in the health
insurance market. The segment continues monitoring premium
rates increases, particularly in the rated Corporate Accounts
sector. This monitoring will make sure that premium rates
reflect the actual claims experience of the groups.
- Total enrollment increased by 8,675 members or 1.4% during
the year 2001. This increase is mostly attributed to the
increase in membership observed in the Individual Accounts of
7,303 members or 10.0%.
Approximately 81.5% of the total premiums increase is attributed to increases
in premium rates, while the remaining 18.5% is attributed to increases in
membership.
Claims incurred increased by $29.6 million or 5.6% when compared to 2000. This
increase is due to the net effect of the increase in membership net of a
decrease in loss ratio of 2.3 percentage points during the year 2001. The
improvement in the loss ratio is the result of better premium pricing and cost
containment measures for claims. As a result of the segment's cost containment
initiatives, cost and utilization trends have been maintained at levels
consistent with pricing and margin objectives. Due to the various initiatives,
average length of hospital stays and emergency room visits continue to exhibit
a downward trend. In addition, the implementation of certain pharmacy programs
maintained the pharmacy cost trends at single digit numbers during 2001. For
additional details of claims costs containment measures see Item 1 in the
section "Health Insurance Commercial Program Segment".
The expense ratio for 2001 remained at the same level as the year 2000 levels.
The amount of operating expenses increased by $5.8 million, or 7.4%, during the
year 2001. This increase is mostly attributed to increases in normal costs
incurred in the acquisition of new business, such as marketing and commission
expenses, expenses related to compliance with the federal HIPAA, and in payroll
and payroll related expenses. The expense ratio for the year 2001 decreased by
0.2 percentage points when compared to the expense ratio of the year 2000.
HEALTH INSURANCE - HEALTHCARE REFORM OPERATING RESULTS
(Dollar amounts in thousands) 2002 2001 2000
--------- ------- -------
Years ended December 31,
AVERAGE ENROLLMENT:
North Area 251,002 272,564 277,121
Northwest Area 78,168 165,123 163,609
Metro-North Area 202,028 177,065 169,288
Southwest Area 162,088 37,866 --
West Area -- -- 63,209
--------- ------- -------
TOTAL AVERAGE ENROLLMENT 693,286 652,618 673,227
========= ======= =======
PREMIUMS EARNED, NET $ 487,000 454,923 439,774
========= ======= =======
CLAIMS INCURRED $ 445,039 420,953 420,476
OPERATING COSTS 36,109 32,646 30,350
--------- ------- -------
TOTAL UNDERWRITING COSTS $ 481,148 453,599 450,826
========= ======= =======
UNDERWRITING INCOME (LOSS) $ 5,852 1,324 (11,052)
========= ======= =======
LOSS RATIO 91.4% 92.5% 95.6%
EXPENSE RATIO 7.4% 7.2% 6.9%
--------- ------- -------
COMBINED RATIO 98.8% 99.7% 102.5%
========= ======= =======
NET INVESTMENT INCOME $ 5,106 4,547 4,633
NET REALIZED GAIN ON SALE OF SECURITIES 76 6 252
NET UNREALIZED (LOSS) GAIN ON TRADING SECURITIES (495) (132) 76
--------- ------- -------
TOTAL NET INVESTMENT INCOME $ 4,687 4,421 4,961
========= ======= =======
NET INCOME (LOSS) $ 9,770 4,563 (7,614)
========= ======= =======
Page 19
General
The Health Insurance - Healthcare Reform segment's total revenues are primarily
generated from premiums earned according to the provisions of the Government's
Healthcare 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 to the segment during the period. Administrative expenses
consist of 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.
This segment has a well-diversified investment portfolio with good asset
quality and a large portion invested in investment-grade, fixed income
securities. The segment's investment portfolio is predominantly held in United
States Treasury securities, obligations of United States government
instrumentalities and obligations of state and political subdivisions, which
comprise over 45% of the total portfolio value as of December 31, 2001. The
remaining balance of the investment portfolio consists of an equity securities
portfolio that replicates the S&P 500 Index, a corporate bonds portfolio, as
well as investments in strong local stocks of sound financial institutions.
Year ended December 31, 2002 compared with the year ended December 31, 2001
Premiums earned, net of the Healthcare Reform segment for the year 2002
increased by $32.1 million, or 7.1%, when compared to the year 2001. This
increase is the result of the following:
- The average enrollment for this segment reflects an increase
of 40,668 members when comparing to the average enrollment
for the year 2001. This increase is due to the net effect of
the following: the acquisition of the Southwest Area
effective October 1, 2001, the merger of six (6) new
municipalities into existing areas effective July 1, 2002 and
the loss of the Northwest Area, which municipalities were
merged into the West Area (served by another carrier)
effective July 1, 2002.
- Premium rates were increased by approximately 13.2% during
the Healthcare Reform contract renegotiation process. New
premium rates were negotiated effective October 1, 2001 for a
nine-month period and effective July 1, 2002 for a
twelve-month period ending on June 30, 2003.
- Effective October 1, 2001, the Government of Puerto Rico
excluded mental health and substance abuse benefits from the
risks managed by the health insurance carrier. The exclusion
of these benefits represented a decrease of approximately $36
million in premiums earned during the year ended December 31,
2002. These services will continue to be directly contracted
by the Government with specialized mental health service
providers.
Approximately 89.0% of the total premiums increase is attributed to increases
in membership, while the remaining 11.0% is attributed to increases in premium
rates.
Claims incurred during the year 2002 increased by $24.1 million, or 5.7%, when
compared to the claims incurred during the year 2001. The increase is
attributed to the increase in volume of business, net of the exclusion of
mental health services and substance abuse benefits from the coverage of the
policy. During the year ended 2002, the loss ratio decreased when compared with
the year 2001, as a result of the increase in premiums rates, as well as to a
reduction in the coverage of the Healthcare Reform policy.
Operating expenses for the year 2002, increased by $3.5 million, or 10.6%, when
compared to the year 2001. This increase is due to the segment's increase in
membership. The expense ratio for the year 2002 increased by 0.2 percentage
points when compared to the expense ratio for the year 2001.
Year ended December 31, 2001 compared with the year ended December 31, 2000
Premiums earned, net for the year 2001 increased by $15.1 million or 3.4% when
compared to the same amount for the year 2000. This increase is basically the
net result of increases in premium rates offset by a decrease in members and
the exclusion of mental health and substance abuse services from the Health
Reform insurance policy.
- New premium rates were negotiated effective October 1, 2001
for a nine-month period ending on June 30, 2002.
- The average enrollment for this segment reflects a decrease
of 20,609 members when compared to the average enrollment for
the year 2000. This decrease is attributed to the net effect
of the loss of the West Area effective July 1, 2000 and the
acquisition of the Southwest Area effective October 1, 2001.
The decrease in membership represented about $14.0 million in
premiums earned.
Page 20
- Effective October 1, 2001, the Government of Puerto Rico
excluded mental health and substance abuse benefits from the
coverage offered in the policy. The exclusion of the mental
health and substance abuse benefits from the coverage of the
Healthcare Reform insurance policy represented a decrease of
approximately $9.0 million in premiums earned during 2001.
These services will continue to be directly contracted by the
Government with specialized mental health service providers.
The total increase experienced in earned premiums is attributed to increased
premium rates.
Claims incurred increased by $477 thousand or 0.1% when compared to the year
2000. This increase is attributed to the growth in capitation payments to IPA's
and in the cost of risks assumed by the segment, net of the exclusion of mental
health services and substance abuse benefits and the decrease in membership.
During 2001, the loss ratio for the Health Insurance - Healthcare Reform
segment decreased by 3.1 percentage points when compared to the loss ratio for
2000. This decrease is mainly due to increases in premium rates, particularly
in the Metro-North Area, as well as to a reduction in the coverage of the
Healthcare Reform policy. Effective September 30, 2001, the Healthcare Reform
policy did not cover mental health and substance abuse benefits. The Government
now directly assumes the risk for these benefits.
Operating expenses for the year 2001 increased by $2.3 million, or 7.6%, when
compared to the operating expenses for the year 2000. This increase is
attributed to the increased volume of business of the segment. The expense
ratio increased by 0.3 percentage points when compared to the expense ratio for
the year 2000.
PROPERTY AND CASUALTY INSURANCE OPERATING RESULTS
(Dollar amounts in thousands) 2002 2001 2000
--------- ------- -------
Years ended December 31,
PREMIUMS WRITTEN:
Commercial multiperil $ 48,640 41,013 31,082
Dwelling 17,165 18,051 17,046
Auto physical damage 16,918 13,961 14,173
Commercial auto liability 10,823 8,274 9,348
Medical malpractice 5,857 5,456 4,067
All other 12,878 10,061 11,508
--------- ------- -------
Total premiums written 112,281 96,816 87,224
--------- ------- -------
Premiums ceded (39,806) (39,608) (31,208)
Change in unearned premiums (11,787) (2,871) (2,523)
========= ======= =======
NET PREMIUMS EARNED $ 60,688 54,337 53,493
========= ======= =======
CLAIMS INCURRED $ 34,334 32,348 32,692
OPERATING COSTS 25,549 22,548 20,569
--------- ------- -------
TOTAL UNDERWRITING COSTS $ 59,883 54,896 53,261
========= ======= =======
UNDERWRITING INCOME (LOSS) $ 805 (559) 232
========= ======= =======
LOSS RATIO 56.6% 59.5% 61.1%
EXPENSE RATIO 42.1% 41.5% 38.5%
--------- ------- -------
COMBINED RATIO 98.7% 101.0% 99.6%
========= ======= =======
NET INVESTMENT INCOME $ 6,579 7,564 6,996
NET REALIZED GAIN ON SALE OF SECURITIES 243 967 539
NET UNREALIZED LOSS ON TRADING SECURITIES (1,294) (585) (585)
--------- ------- -------
TOTAL NET INVESTMENT INCOME $ 5,528 7,946 6,950
========= ======= =======
NET INCOME $ 6,223 6,529 6,282
========= ======= =======
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
Page 21
incurred for each period consists of an estimate of unreported losses to the
segment during the period. Administrative expenses consist of general,
commissions, depreciation, payroll and other related expenses.
STS has a well-diversified investment portfolio with good asset quality and a
large portion invested in investment-grade, fixed income securities. The
segment's investment portfolio is predominantly held in U.S. Treasury
securities, obligations of U.S. government instrumentalities and obligations of
state and political subdivisions, which comprise over 80% of the total
portfolio value as of December 31, 2002. The remaining balance of the
investment portfolio consists of an equity securities portfolio that replicates
the S&P 500 Index, a corporate bonds portfolio, and investments in strong local
stocks of financially sound financial institutions. Due to market value
increase, the segment has a large single issuer equity concentration in
Popular, Inc. As of December 31, 2002 and 2001, the carrying value of the
Corporation's investment in Popular, Inc. amounted to $2.3 million and $4.2
million, respectively. This investment represents 2.2% for the year 2002, and
4.2% for the year 2001 of the segments total investments.
Year ended December 31, 2002 compared with the year ended December 31, 2001
Total premiums written for the year ended December 31, 2002 increased by $15.5
million, or 16.0%, when compared to the year 2001. This increase is reflected
in the premiums written for the following lines of business:
- The commercial multiple peril line accounted for the
principal increase in premiums volume, increasing by $7.6
million, or 18.6%, during the year 2002. This increase is due
to increases in premium rates as a result of the commercial
lines deregulation. Also, during the year 2002 the segment
subscribed new business with higher average premium rates
that substituted other accounts with average premium rates
below desired levels. As in the previous years, the increase
in average premium rates of the commercial business is the
primary contributor to the fluctuation experienced in total
premiums written.
- The auto business also contributed to this year's increase,
where the auto physical damage lines and the commercial auto
liability line increased by $3.0 million, or 21.2%, and $2.5
million, or 30.8%, respectively. These increases are also
attributed to the deregulation of premium rates, mostly as a
result of the elimination of credits or discounts in the
commercial accounts.
- The amount of premiums written in the general liability
business (included within the "All Other" caption in the
above summary) reflect an increase of $2.0 million during the
year 2002. This increase is due to the acquisition of one
significant account within this line of business, with
premiums written of approximately $1.6 million.
- On the contrary, dwelling premiums reflect a decrease of $886
thousands, or 4.9%, during the year 2002. This decrease is
basically the result of a decrease in new business from
financial institutions. This segment's management has been
devoting additional efforts to increase its client base in
this financial sector to mitigate the effect of such
fluctuation.
Approximately 60.0% of the increase in total premiums written is due to
increases in premium rates. The remaining 40.0% is attributed to an increase in
the volume of business.
Premiums ceded to reinsurers for the year ended December 31, 2002 remained
similar to the same amount for the year 2001, reflecting an increase of $198
thousand, or 0.5%. The ratio of premiums ceded to total premiums written,
however, reflects a decrease of 5.4 percentage points. This fluctuation is the
net result of several factors:
- STS has increased its retention of the commercial property
portfolio. The increased retention, which decreases the
amounts or premiums ceded to reinsurers, allows the segment
to keep more premiums on profitable business.
- During the reinsurance contract renewal process, the segment
cancelled a commercial quota share 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.
- An increase of over 30% in catastrophe reinsurance costs due
to recent worldwide catastrophes.
- Acquisition of additional catastrophe protection as a result
of a shortfall on the property first surplus treaty.
During the year ended December 31, 2002 the property and casualty segment loss
ratio decreased by 2.9 percentage points as compared to the loss ratio for the
year 2001. This decrease is mostly the result of favorable underwriting results
in the commercial multiperil line of business (resulting from increases in
premium rates as a consequence of deregulation) and an increased retention of
the segment's profitable lines of business, which has increased the premiums
earned base. Also, the professional liability line experienced an improvement
in its loss ratio as a result of premium rate increases of approximately 60%
(which were effective April 2001) and strict adherence to underwriting
practices and reinsurance constraints. In addition, the loss ratio of the auto
physical damage line of business shows a decrease of 7.8 percentage points,
mostly due to the net effect of increased premium rates and reserve releases.
Page 22
The operating expenses for the year ended December 31, 2002 increased by $3.0
million, or 13.3%, when compared to the operating expenses for the year ended
December 31, 2001. This increase is directly related to the segment's increase
in its volume of business. The expense ratio experienced an increase of 0.6
percentage points during the year 2002. The increase in the expense ratio is
the result of a reduction in the reinsurance commission income, which is
presented netting the commission expense of the segment. The decrease in the
reinsurance commission income is due to the restructuring of the reinsurance
program during the contract renewal process.
Year ended December 31, 2001 compared with the year ended December 31, 2000
Gross premiums written in the property and casualty insurance segment for the
year 2001 increased by $9.6 million, or 11.0%, when compared to the year 2000.
This increase is reflected in the premiums written for the following lines of
business:
- Premiums written in the commercial multiple peril line
increased by $9.9 million, or 32.0%, during the year 2001.
This increase in volume is due to STS' efforts to establish
itself as the island's leader in the commercial package
business.
- Premiums written in the professional liability line increased
by $1.4 million, or 34.2%, during the year 2001. This is the
result of rate increases of 59.9% for physicians and surgeons
and 85.6% for hospitals. These increases were effective April
1, 2001.
Over 80% of the increase experienced in premiums written is attributed to
increased volume of business and the remaining 20% is attributed to increased
premium rates.
Premiums ceded to reinsurers during 2001 increased by $8.4 million or 26.9%
when compared to 2000. This increase is due to the effect of the following:
- Most of the increase in premiums ceded is concentrated in
catastrophe reinsurance premiums and attributed to recent
worldwide catastrophes, which influence the global condition
on the cost and availability of catastrophe coverage. In STS
this situation resulted in an increase in catastrophe
coverage costs of 44% in the 2002 treaty renewal, which is
expected to be recovered through an average increase in
property risks rates of approximately 35% and a reduction in
acquisition costs.
- In addition, STS' growth in the commercial property sector
caused a proportional increase in aggregate levels needed to
be covered by catastrophic and proportional treaties.
During 2001, property and casualty loss ratio decreased by 1.6 percentage
points, primarily as a result of favorable underwriting results in the auto
business and premium rate increases of approximately 60% that were effective
April 2001. Operating expenses increased by $2.0 million, or 9