UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

 

OR

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______________ to _________________

 

COMMISSION FILE NUMBER 1-16477

 

COVENTRY HEALTH CARE, INC.

(Exact name of registrant as specified in its charter)

 

 

6705 Rockledge Drive, Suite 900, Bethesda, Maryland 20817

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code:(301) 581-0600

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

 

 

COVENTRY HEALTH CARE, INC.

FORM 10-Q

TABLE OF CONTENTS

 

 

 

 

 

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1: Financial Statements

 

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

 

See accompanying notes to the condensed consolidated financial statements.

 

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The condensed consolidated financial statements of Coventry Health Care, Inc. and its subsidiaries (“Coventry” or the “Company”) contained in this report are unaudited but reflect all normal recurring adjustments which, in the opinion of management, are necessary for the fair presentation of the results of the interim periods reflected. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Therefore, it is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10–K for the year ended December 31, 2008. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. The year end balance sheet data included in this report was derived from audited financial statements but does not include all disclosures required by GAAP.

As a result of the change in its executive leadership, the Company realigned its organizational structure during the first quarter of 2009. The Company’s new organizational structure brings enhanced focus to areas of anticipated growth opportunities. As a result, the Company’s reportable segments have changed to the following three reportable segments: Health Plan and Medical Services, Specialized Managed Care, and Workers’ Compensation. Each of these segments, which the Company also refers to as “Divisions,” is separately managed and provides separate operating results that are evaluated by the Company’s chief operating decision maker.

The Health Plan and Medical Services Division is primarily comprised of the Company’s traditional health plan risk businesses and products and its Medicare Advantage Private Fee-for-Service (“PFFS”) business. Additionally, through this Division the Company contracts with various federal employee organizations to provide health insurance benefits under the Federal Employees Health Benefits Program (“FEHBP”) and offers managed care and administrative products to businesses that self-insure the health care benefits of their employees. This Division also contains the dental services business.

The Specialized Managed Care Division is comprised of its Medicare Part D program, its network rental business (“Network Rental”) and its mental-behavioral health benefits business. As discussed in Note C, Discontinued Operations, to the consolidated financial statements, on July 31, 2009 the Company sold its Medicaid/Public entity business, First Health Services Corporation (“FHSC”). FHSC was a reporting unit within the Specialized Managed Care Division. FHSC operations are recognized within the line item “(Loss) income from discontinued operations, net of tax” in the Company’s consolidated statements of operations and have been excluded from the segment results presented below.

The Workers’ Compensation Division is comprised of the Company’s workers’ compensation services businesses, which provides fee-based, managed care services such as access to our provider networks, pharmacy benefit management, and care management to underwriters and administrators of workers’ compensation insurance.

The table below summarizes the results from continuing operations of the Company’s reportable segments through the gross margin level, as that is the measure of profitability used by the chief operating decision maker to assess segment performance and make decisions regarding the allocation of resources. A reconciliation of gross margin to operating earnings at a consolidated continuing operations level is also provided. Total assets by reportable segment are not disclosed as these assets are not reviewed separately by the Company’s chief operating decision maker. The dollar amounts in the segment tables are presented in thousands. The Company’s segment results for the 2008 periods have been reclassified to conform to the 2009 presentation.

 

 

 

 

 

 

		Quarter Ended September 30, 2008
		Health Plan and Medical Services			Specialized Managed Care			Workers’ Comp.			Elim.			Continuing Operations Total
Operating revenues
Managed care premiums	$	2,448,520		$	189,420		$	-		$	(10,595	)	$	2,627,345
Management services		86,672			23,253			190,546			(2,095	)		298,376
Total operating revenues		2,535,192			212,673			190,546			(12,690	)		2,925,721
Medical costs		2,065,590			145,016			-			(10,201	)		2,200,405
Cost of sales		-			-			54,289			-			54,289
Gross margin	$	469,602		$	67,657		$	136,257		$	(2,489	)	$	671,027
Selling, general and administrative														478,973
Depreciation and amortization														35,617
Operating earnings													$	156,437

 

		Nine Months Ended September 30, 2009
		Health Plan and Medical Services			Specialized Managed Care			Workers’ Comp.			Elim.			Continuing Operations Total
Operating revenues
Managed care premiums	$	8,376,653		$	1,269,138		$	-		$	(49,919	)	$	9,595,872
Management services		249,146			68,283			569,846			(7,768	)		879,507
Total operating revenues		8,625,799			1,337,421			569,846			(57,687	)		10,475,379
Medical costs		7,159,914			1,151,108			-			(49,920	)		8,261,102
Cost of sales		-			-			178,280			-			178,280
Gross margin	$	1,465,885		$	186,313		$	391,566		$	(7,767	)	$	2,035,997
Selling, general and administrative														1,607,142
Depreciation and amortization														110,309
Operating earnings													$	318,546

 

 

 

		Nine Months Ended September 30, 2008
		Health Plan and Medical Services			Specialized Managed Care			Workers’ Comp.			Elim.			Continuing Operations Total
Operating revenues
Managed care premiums	$	7,215,028		$	697,668		$	-		$	(20,995	)	$	7,891,701
Management services		255,261			67,360			548,559			(5,395	)		865,785
Total operating revenues		7,470,289			765,028			548,559			(26,390	)		8,757,486
Medical costs		6,026,176			624,584			-			(19,810	)		6,630,950
Cost of sales		-			-			139,038			-			139,038
Gross margin	$	1,444,113		$	140,444		$	409,521		$	(6,580	)	$	1,987,498
Selling, general and administrative														1,411,163
Depreciation and amortization														109,401
Operating earnings													$	466,934

 

On July 31, 2009, the Company completed the sale of its fee-based Medicaid services subsidiary FHSC to Magellan Health Services, Inc. (“Magellan”) for $117.5 million in cash, which includes adjustments for changes in working capital. FHSC was a component of the Company’s business operations within its Specialized Managed Care operating segment. In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 205-20 “Discontinued Operations,” FHSC’s operations and disposal costs are presented as (loss) income from discontinued operations, net of tax in the Company’s consolidated statements of operations.

The following table presents select FHSC discontinued operations information (in thousands):

 

  

         The Company considered the then pending sale of FHSC a potential indicator of impairment and in accordance with ASC Topic 350, “Intangibles – Goodwill and Other,” it was determined that the carrying value of the reporting unit was in excess of fair value. Fair value was based on the sales price, which is level 3 in the fair value hierarchy. Accordingly, the Company performed a preliminary estimate of the probable impairment loss and recorded a gross impairment charge of $72.4 million during the nine-months ended September 30, 2009.

 

 

 

 

The table below shows the carrying amounts of the major classes of assets and liabilities of FHSC as of December 31, 2008, that were included as part of the disposal group on the July 31, 2009 sale to Magellan (in thousands):

 

 

 

The decreases in the carrying amount of goodwill for the nine months ended September 30, 2009, primarily driven by the sale of FHSC, are as follows (in thousands):

 

 

In June 2009, the FASB established the FASB ASC, or Codification, which on July 1, 2009 became the single official source of authoritative, nongovernmental GAAP, superseding existing FASB, AICPA, EITF, and related literature. Prospectively, only one level of authoritative GAAP will exist, excluding the guidance issued by the SEC. All other literature will be non-authoritative. The Codification does not change GAAP but instead reorganizes the U.S. GAAP pronouncements into accounting topics, and displays all topics using a consistent structure. As the Codification does not change GAAP, it did not have a material impact on the Company’s financial statements. Previous references to applicable literature via the Company’s disclosures have been updated with references to the new Codification section.

In May 2009, the FASB issued ASC Topic 855,“Subsequent Events,” which required the Company to evaluate subsequent events through the date the financial statements are issued. This standard requires an entity to recognize in its financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the balance sheet date (recognized subsequent events) and prohibits an entity from recognizing the effects of subsequent events that provide evidence about conditions that did not exist at the balance sheet date (non-recognized subsequent events). The Company adopted the provisions of this standard as of June 30, 2009. The adoption of this standard did not impact the Company’s financial position or results of operations. The disclosures required by this standard are presented in Note M, Subsequent Events, to the condensed consolidated financial statements.

 

 

       In April 2009, the FASB issued ASC 320-10-65-1, “Transition Related to FASB Staff Position FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments.” This guidance relates to fixed maturity securities that requires that other-than-temporary impairment losses related to credit deterioration be included in the statements of operations and that losses related to other market factors be included as a component of other comprehensive income. The Company adopted the provisions of this update as of April 1, 2009. The portion of the Company’s impairment charge that was recorded prior to 2009 that was not either related to credit deterioration or to securities that the Company had made the decision to sell was insignificant. Accordingly, the Company did not record a cumulative effect transition adjustment and therefore the adoption of pronouncement did not impact the Company’s financial position or results of operations. The disclosures required by this update are presented in Note I, Investments and Fair Value Measurements, to the condensed consolidated financial statements.

In April 2009, the FASB issued ASC 825-10-65-1, “Transition Related to FASB Staff Position FAS 107-1 and APB 128-1, Interim Disclosures about Fair Value of Financial Instruments.” This guidance requires disclosing qualitative and quantitative information about the fair value of all financial instruments on a quarterly basis, including methods and significant assumptions used to estimate fair value during the period. These disclosures were previously only done annually. The disclosures required by this update are effective for the quarter ending June 30, 2009 and are included in Note I, Investments and Fair Value Measurements, to the condensed consolidated financial statements.

In April 2009, the FASB issued ASC 820-10-65-4, “Transition Related to FASB Staff Position FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” This guidance reaffirms that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. This update also reaffirms the need to use judgment in determining if a formerly active market has become inactive and in determining fair values when the market has become inactive. The adoption of this update did not impact the Company’s financial position or results of operations.

The Company’s outstanding debt consisted of the following (in thousands):

 

 

During the third quarter of 2009 the Company repaid a total of $8 million in senior notes for an immaterial gain. During the nine months ended September 30, 2009 the Company repaid a total of $68.9 million of outstanding senior notes for principal payments of $59.9 million, resulting in a gain of $8.4 million. These gains were net of the write off of deferred financing costs. The funds for the repayments were provided by cash from operations.

During the third quarter of 2009, the Company repaid $90 million on its Revolving Credit Facility, bringing the total amount repaid during the nine months ended September 30, 2009 to $125 million. The remaining outstanding balance at September 30, 2009, of $490 million will be used to optimize the Company’s liquidity position and for other general corporate purposes.

The Company’s senior notes and credit facility contain certain covenants and restrictions regarding additional debt, dividends or other restricted payments, transactions with affiliates, asset dispositions, and consolidations or mergers. Additionally, the Company’s credit facility requires compliance with a leverage ratio of 3 to 1. As of September 30, 2009, the Company was in compliance with all applicable covenants and restrictions under its senior notes and credit facility.

 

 

 

As described in the Company's Annual Report on Form 10-K for the year ended December 31, 2008, the Company was a defendant in the provider track of the In Re: Managed Care Litigation filed in the United States District Court for the Southern District of Florida, Miami Division, Multi-District Litigation (“MDL”), No. 1334, in the action captioned, Charles B. Shane., et al., vs. Humana, Inc., et al. The trial court granted summary judgment in favor of the Company on all claims asserted in the litigation. The Eleventh Circuit Court of Appeals affirmed the trial court’s order granting summary judgment. The Shane lawsuit has triggered the filing of copycat class action complaints by other health care providers such as chiropractors, podiatrists, acupuncturists and other licensed health care professionals. Each of these actions has been transferred to the MDL and has been designated as a “tag-along” action. There are three tag-along actions currently filed against the Company. On July 14, 2008, the MDL trial court entered an order in the Harrison vs. Coventry Health Care of Georgia, Inc. (“CHCGA”) tag along action which dismissed all of the plaintiffs’ claims except their breach of contract claim which the court ordered to arbitration. In addition, the court deferred to the arbitrator for decision, the Company’s affirmative defenses that the plaintiffs waived their right to arbitration and/or their claim is barred by the doctrines of collateral estoppel and res judicata. On March 13, 2009, the plaintiffs in The Harrison tag-along action filed their Demand for Arbitration. The Demand, which is a purported class action on behalf of all Georgia physicians who had written provider contracts with CHCGA, alleges that CHCGA breached those contracts by not paying statutory interest on claims not adjudicated in compliance with Georgia’s prompt pay statute and by applying certain claim edits which reduced the amount of reimbursement paid to the plaintiffs. CHCGA denies the allegations and has filed a motion to dismiss the class action and prompt pay claims. In the two (2) other tag along actions, Blue Springs Internal Medicine, P.C. et al., vs. Coventry Health Care of Kansas, Inc. and James Mirabile, M.D. et.al., vs. Coventry Health Care of Kansas, Inc., the MDL trial court referred each of the plaintiffs’ motion to remand the actions back to state court to a magistrate judge for a Report and Recommendation. The magistrate judge issued a Report and Recommendation which denied the motion to remand in both the Blue Springs and Mirabile actions. The district court then issued an order in both actions adopting the magistrate judge's Report and Recommendation. Then, by orders dated March 27, 2009, the magistrate judge granted, without prejudice, Coventry’s motion to dismiss all nine causes of actions in both the Blue Springs and Mirabile actions. In response to those orders, the plaintiffs in both the Blue Springs and Mirabile actions filed a Second Amended Complaint alleging a one count claim for breach of contract. The Company filed a motion to dismiss the Second Amended Complaint in both actions and by order dated July 8, 2009, the MDL trial court dismissed the Second Amended Complaint in the Mirabile and Blue Springs actions with leave to refile after the plaintiffs have exhausted all administrative remedies. In its order, the MDL court exercised its supplemental jurisdiction over any remaining state law claims and placed both actions in civil suspense. Although the Company can not predict the outcome, it believes that the tag-along actions will not have a material adverse effect on its financial position or the results of operations. The Company also believes that the claims asserted in these lawsuits are without merit and intends to defend its position.

The Company has received a subpoena from the U.S. Attorney for the District of Maryland, Northern Division, requesting information regarding the operational process for confirming Medicare eligibility for its Workers Compensation set-aside product. The Company is fully cooperating and is providing the requested information. The Company can not predict what, if any, actions may be taken by the U.S. Attorney. However, based on the information known to date, the Company does not believe that the outcome of this inquiry will have a material adverse effect on its financial position or results of operations.

First Health Group Corp, Inc. (“FHGC”), a subsidiary of the Company, is a party to various lawsuits filed in the state and federal courts of Louisiana involving disputes between providers and workers compensation payors who access FHGC’s contracts with these providers to reimburse them for services rendered to injured workers. FHGC has written contracts with providers in Louisiana which expressly state that the provider agrees to accept a specified discount off their billed charges for services rendered to injured workers. The discounted rate set forth in the FHGC provider contract is less than the reimbursement amount set forth in the Louisiana Workers Compensation Fee Schedule. For this reason, workers compensation insurers and third party administrators (“TPAs”) for employers who self insure worker compensation benefits, contract with FHGC to access the FHGC provider contracts. Thus, when a FHGC contracted provider renders services to an injured worker, the workers compensation insurer or the TPA reimburses the provider for those services in accordance with the discounted rate in the provider’s contract with FHGC. These workers compensation insurers and TPAs are referred to as “payors” in the FHGC provider contract and the contract expressly states that the discounted rate will apply to those payors who access the FHGC contract. Thus, the providers enter into these contracts with FHGC knowing that they will be paid the discounted rate by every payor who chooses to access the FHGC contract. So that its contracted providers know which payors are accessing their contract, FHGC sends regular written notices to its contracted providers and maintains a provider website which lists each and every payor who is accessing the FHGC contract.

 

 

        Four providers who have contracts with FHGC filed a state court class action lawsuit against FHGC and certain payors alleging that FHGC violated Louisiana’s Any Willing Provider Act, which requires a payor accessing a preferred provider network contract to give a one time notice 30 days before that payor uses the discounted rate in the preferred provider network contract to pay the provider for services rendered to a member insured under that payor’s health benefit plan. These provider plaintiffs allege that the Any Willing Provider Act applies to medical bills for treatment rendered to injured workers and that the Act requires point of service written notice in the form of a benefit identification card. If a payor is found to have violated the Act’s notice provision, the court may assess up to $2,000 in damages for each instance when the provider was not given proper notice that a discounted rate would be used to pay for the services rendered. In response to the state court class action, FHGC and certain payors filed a suit in federal court against the same four provider plaintiffs in the state court class action seeking a declaratory judgment that FHGC’s contracts are valid and enforceable, that its contracts are not subject to the Any Willing Provider Act since that Act does not apply to medical services rendered to injured workers and that FHGC is exempt from the notice requirements of the Act because it has contracted directly with each provider in its network. The federal district court ruled in favor of FHGC and declared that its contracts are not subject to the Any Willing Provider Act, that FHGC was exempt from the Act’s notice provision because it contracted directly with the providers, and that FHGC’s contracts were valid and enforceable, i.e., the four provider plaintiffs were required to accept the discounted rate in accordance with the terms of their written contracts with FHGC. Despite the federal court’s decision, the provider plaintiffs continued to pursue their state court class action against FHGC and filed a motion for partial summary judgment seeking damages of $2,000 for each provider visit where the provider was not given a benefit identification card at the time the service was performed. In response to the motion for partial summary judgment filed in the state court action, FHGC obtained an order from the federal court which enjoined, barred and prevented any of the four provider plaintiffs or their counsel from pursuing any claim against FHGC before any court or tribunal arising under Louisiana’s Any Willing Provider Act. Despite the issuance of this federal court injunction, the provider plaintiffs and their counsel pursued their motion for partial summary judgment in the state court action. Before the state court held a hearing on the motion for partial summary judgment, FHGC moved to decertify the class on the basis that the four named provider plaintiffs had been enjoined by the federal court from pursuing their claims against FHGC. The state court denied the motion to decertify the class but did enter an order permitting FHGC to file an immediate appeal of the state court’s denial of the motion. Even though FHGC had filed its appeal and there were no class representatives since all four named plaintiffs had been enjoined from pursuing their claims against FHGC, the state court held a hearing and granted the plaintiffs’ motion for partial summary judgment. The trial court granted the motion despite the fact that (1) the court lacked jurisdiction due to the appeal filed by FHGC challenging the denial of its motion to decertify the class; (2) there were no named class representatives because all four named plaintiffs had been enjoined from pursuing their claims against FHGC; (3) none of the providers in the class ever submitted a claim for payment to FHGC and therefore FHGC never made any discounted payments to any of the providers in the class in the absence of notice; (4) FHGC has contracted directly with every provider in the class and therefore, under the Act’s express language, FHGC was exempt from giving notice under the Act; and (5) the claims of the provider plaintiffs are time barred. The amount of the partial judgment was for $262 million. FHGC has taken an immediate appeal from the entry of that judgment seeking to vacate its entry as invalid as a matter of law and will file a motion with the federal court for sanctions against the provider plaintiffs and their counsel for violating the injunction issued by the federal district court which barred and enjoined them from pursuing their claims against FHGC in the state court action. The Company believes that FHGC will be successful in its efforts to overturn the partial summary judgment, has accrued an adequate reserve for its potential exposure, and that the actions will not have a material adverse effect on its financial position or the results of operations.

In a related matter, FHGC has filed another lawsuit in Louisiana federal district court against 85 Louisiana providers seeking a declaratory judgment that its contracts are valid and enforceable, that its contracts are not subject to the Louisiana’s Any Willing Provider Act because its contracts pertain to payment for services rendered to injured workers, and FHGC is exempt from the notice provision of the Any Willing Provider Act because it has contracted directly with the providers. This lawsuit is assigned to the same federal district court judge who issued the decision and injunction in the lawsuit filed by FHGC against the four provider plaintiffs in the state court action.

On September 3, 2009, a shareholder, who owns less than 5,000 shares, filed a putative securities class action against the Company and three of its current and former officers in the federal district court of Maryland. The purported class period is February 9, 2007 to October 22, 2008. The complaint alleges that the Company’s public statements contained false, misleading and incomplete information regarding the Company’s profitability, particularly the profit margins for its Medicare PFFS products. The Company believes there is no merit to the lawsuit and will vigorously defend it. Although it can not predict the outcome, the Company believes this lawsuit will not have a material adverse effect on its financial position or results of operations.

For additional information regarding certain contingencies, refer to Note M, Subsequent Events, to the condensed consolidated financial statements.

 

 

 

 

Comprehensive income was as follows (in thousands):

 

 

The principal drivers of the Company’s unrealized holding gain on its investment portfolio during the quarter and nine months ended September 30, 2009 were the decline in Treasury yields combined with continued compression in yield spreads.

Investments

The Company adopted ASC 320-10-65-1 related to its fixed maturity securities as of April 1, 2009. The portion of the Company’s impairment charge that was recorded prior to 2009 that was not either related to a belief that the entire amortized cost basis would not be recovered, credit deterioration of the specific security or to securities that the Company has made the decision to sell was insignificant. Accordingly, the Company did not record a cumulative effect transition adjustment upon adoption.

The Company considers all of its investments as available-for-sale securities and, accordingly, records unrealized gains and losses, except for those determined to be other-than-temporary impairments, as accumulated other comprehensive income (loss) in the stockholders’ equity section of its consolidated balance sheets. Certain prior year investment balances have been reclassified in the tables below to conform to the 2009 presentation requirements.

 

 

 

 

 

 

 

The amortized cost, gross unrealized gain or loss and estimated fair value of short-term and long-term investments by security type were as follows at September 30, 2009 and December 31, 2008 (in thousands):

 

 

The amortized cost and estimated fair value of available for sale debt securities by contractual maturity were as follows at September 30, 2009 and December 31, 2008 (in thousands):

 

Investments with no stated maturities are included as contractual maturities of over 10 years.  Actual maturities may differ due to call or prepayment rights.

Gross investment gains of $10.1 million and gross investment losses of $2.4 million were realized on sales and the other than temporary impairment of investments for the nine months ended September 30, 2009. This compares to gross investment gains of $5.9 million and gross investment losses of $37.0 million that were realized on sales and the other-than-temporary impairment of investments for the nine months ended September 30, 2008. The Company’s other-than-temporary impairment charge and its realized gains and losses are recorded in other income, net in the Company’s consolidated statement of operations.

During the quarter ended September 30, 2008, the Company recognized a $33.5 million other-than-temporary impairment charge related to its investments in Lehman Brothers Holdings, Inc., certain corporate financial holdings, auction rate securities and mortgage backed and asset-backed securities. The Company recognized impairments related to 31 securities during the quarter ended September 30, 2008.

The following table shows the Company’s investments’ gross unrealized losses and fair value, at September 30, 2009 and December 31, 2008, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands).

 

 

 

The unrealized losses presented in this table do not meet the criteria for an other-than-temporary impairment. The unrealized losses are the result of interest rate movements and significant increases in volatility and liquidity concerns in the securities and credit markets. The Company evaluates these losses for an other-than-temporary impairment in accordance with FASB provisions.

The Company continues to review its investment portfolios under its impairment review policy. Given the current market conditions and the significant judgments involved, there is a continuing risk that further declines in fair value may occur and additional other-than-temporary impairments may be recorded in future periods.

Fair Value Measurements

ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value and requires a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value based on the quality and reliability of the inputs or assumptions used in fair value measurements. These tiers include: Level 1 – defined as observable inputs such as quoted prices in active markets; Level 2 – defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3 – defined as unobservable inputs in which little or no market data exists, therefore requiring the Company to develop its own assumptions.

 

The following table presents the fair value hierarchy for the Company’s financial assets measured at fair value on a recurring basis at September 30, 2009 and December 31, 2008 (in thousands):

 

 

 

The following table provides a summary of changes in the fair value of the Company’s Level 3 financial assets for the quarters and nine months ended September 30, 2009 and 2008 (in thousands):

 

 

 

 

Quarter Ended September 30, 2009

Quarter Ended September 30, 2008

Nine Months Ended September 30, 2009

Nine Months Ended September 30, 2008

 

Stock Options

The Company granted 3.4 million stock options during the nine months ended September 30, 2009. The Company recorded compensation expense related to stock options of approximately $8.1 million and $8.6 million for the quarters ended September 30, 2009 and 2008, respectively, and $21.8 million and $26.7 million for the nine months ended September 30, 2009 and 2008, respectively. The total intrinsic value of options exercised was $0.5 million and $0.9 million for the quarters ended September 30, 2009 and 2008, respectively, and $1.1 million and $9.6 million for the nine months ended September 30, 2009 and 2008, respectively. As of September 30, 2009, there was $53.8 million of total unrecognized compensation cost (net of expected forfeitures) related to non-vested stock option grants which is expected to be recognized over a weighted average period of 2.1 years.

The following table summarizes stock option activity for the nine months ended September 30, 2009:

 

 

The Company continues to use the Black-Scholes-Merton option pricing model and amortizes compensation expense over the requisite service period of the grant. The methodology used in 2009 to derive the assumptions used in the valuation model is consistent with that used in 2008. The following average values and weighted-average assumptions for the quarters and nine months ended September 30, 2009 and 2008 were used for option grants.

 

 

The Company awarded 1.7 million shares of restricted stock in the nine months ended September 30, 2009. The value of the restricted shares is amortized over various vesting periods through 2013. The Company recorded compensation expense related to restricted stock grants, including restricted stock granted in prior periods, of approximately $5.5 million and $5.3 million for the quarters ended September 30, 2009 and 2008, respectively, and $15.5 million and $18.9 million for the nine months ended September 30, 2009 and 2008, respectively. The total unrecognized compensation cost (net of expected forfeitures) related to the restricted stock was $48.9 million at September 30, 2009, and is expected to be recognized over a weighted average period of 2.4 years. The total fair value of shares vested during the nine months ended September 30, 2009 and 2008 was $7.6 million and $16.5 million, respectively.

 

 

 

The following table summarizes restricted stock award activity for the nine months ended September 30, 2009:

Performance Share Units

During the nine months ended September 30, 2009, the Company granted performance share units (“PSUs”) to key employees pursuant to the Company’s Amended and Restated 2004 Incentive Plan. The PSUs represent hypothetical shares of the Company’s common stock. The holders of PSUs have no rights as shareholders with respect to the shares of the Company’s common stock to which the awards relate. The PSUs will vest based upon the achievement of certain performance goals and vest over various periods through 2010. All PSUs that vest will be paid out in cash based upon the price of the Company’s common stock and therefore are classified as a liability by the Company.

The following table summarizes PSU activity for the nine months ended September 30, 2009 (in thousands):

The Company recorded compensation expense related to the PSUs of approximately $5.0 million and $7.1 million for the quarter and nine months ended September 30, 2009, respectively.

The Company’s Board of Directors has approved a program to repurchase its outstanding common shares. Share repurchases may be made from time to time at prevailing prices on the open market, by block purchase or in private transactions. Under the share repurchase program, the Company repurchased a total of 1.5 million shares of its common stock during the three and nine month periods ended September 30, 2009, at an aggregate cost of $30.0 million, $9.2 million of which were settled and paid for by the Company as of September 30, 2009. The remaining shares costing $20.8 million were settled and paid by October 2, 2009. As of September 30, 2009, the total remaining number of common shares the Company is authorized to repurchase under this program is 5.2 million.

Earnings Per Share

Basic earnings per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share assumes the exercise of all options and the vesting of all restricted stock using the treasury stock method. Potential common stock equivalents to purchase 11.7 million and 9.0 million shares for the quarters ended September 30, 2009 and 2008, respectively, and 12.5 million and 7.1 million shares for the nine months ended September 30, 2009 and 2008, respectively, were excluded from the computation of diluted earnings per share because the potential common stock equivalents were anti-dilutive. Earnings per share amounts may not foot due to rounding.

Other Income, net

Other income, net includes interest income of $14.7 million and $23.2 million for the quarters ended September 30, 2009 and 2008, respectively, and $49.8 million and $77.9 million for the nine months ended September 30, 2009 and 2008, respectively. The decreases in interest income during the current periods primarily resulted from lower interest rates on the large percentage of the portfolio invested in Treasury instruments and money market funds. This investment strategy was used to ensure liquidity and safeguard principal.

 

Other income, net includes gains of $41 thousand and $8.4 million on the repayment of outstanding debt during the quarter and nine months ended September 30, 2009, respectively.

For the quarter and nine months ended September 30, 2008, other income, net included a change of $36.2 million that consisted of $33.5 million for the other-than-temporary impairment of investment securities and $2.7 million in realized losses on the sale of securities.

The Company has evaluated subsequent events through November 6, 2009, the date of issuance of the financial statements.

The Company announced on October 5, 2009 that it signed a definitive agreement to acquire Preferred Health Systems, Inc., (“PHS”), a wholly-owed subsidiary of Via Christi Health System, Inc. (“Via Christi”). PHS, based in Wichita, Kansas, is a commercial health plan serving more than 100,000 commercial group risk members and 20,000 commercial self-funded members. As part of the transaction, the Company will enter into a long-term provider and customer relationship with Via Christi and its affiliates.

On October 15, 2009, two employees who have been participants in the Company’s 401(k) Plan filed an ERISA action on behalf of all participants and beneficiaries of the Plan against the Company, all of its current directors, four current and former officers and the Plan’s Investment Committee to recover losses to the Plan. The complaint alleges that each of the defendants were Plan fiduciaries and that they breached their purported fiduciary duties to the Plan’s participants by failing to provide complete and accurate information to the participants regarding the Company’s financial condition and the prudence of investing in the Company’s stock. The allegations used by the plaintiffs to plead their claim for breach of fiduciary duties are copied verbatim from the allegations asserted in the shareholder action that is disclosed in Note G, Contingencies, to the condensed consolidated financial statements. The Company believes there is no merit to the lawsuit and will vigorously defend it. Although it can not predict the outcome, the Company believes this lawsuit will not have a material adverse effect on its financial position or results of operations.

 

ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

General Information

This Form 10–Q contains forward–looking statements which are subject to risks and uncertainties in accordance with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically include assumptions, estimates or descriptions of our future plans, strategies and expectations, and are generally identifiable by the use of the words “anticipate,” “will,” “believe,” “estimate,” “expect,” “intend,” “seek,” or other similar expressions. Examples of these include discussions regarding our operating and growth strategy, projections of revenue, income or loss and future operations. Unless this Form 10–Q indicates otherwise or the context otherwise requires, the terms “we,” “our,” “our Company,” “the Company” or “us” as used in this Form 10-Q refer to Coventry Health Care, Inc. and its subsidiaries.

These forward–looking statements may be affected by a number of factors, including, but not limited to, the “Risk Factors” contained in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10–K for the year ended December 31, 2008. Actual operations and results may differ materially from those forward-looking statements expressed in this Form 10–Q.

The following discussion and analysis relates to our financial condition and results of operations for the quarters and nine months ended September 30, 2009 and 2008. This discussion should be read in conjunction with our condensed consolidated financial statements and other information presented herein as well as the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10–K for the year ended December 31, 2008, including the critical accounting policies discussed therein.

Summary of Third Quarter 2009 Performance  

New Accounting Standards

For this information, refer to Note E, New Accounting Standards, to the condensed consolidated financial statements.

Membership

The following table presents our membership (in thousands):

 

 

Total Health Plan membership decreased 131,000 primarily due to membership losses in Commercial Risk. During the current quarter, the growth in national unemployment resulted in an acceleration of “in group” Health Plan Commercial Risk membership attrition compared to the same period in 2008. Additionally, the Commercial Risk membership declined as a result of premium pricing increases related to the higher medical cost experienced in 2008. The increase in Medicare Advantage CCP membership is primarily due to the result of our successful annual election period and open enrollment period for 2009 and also due to age-ins. Other National ASO membership decreased by 74,000 primarily due to the attrition of membership associated with our mail handlers benefit plan client and losses of National Accounts business compared to 2008.

The increases in Medicare Part D membership of 726,000 and Medicare Advantage Private Fee-for-Service (“PFFS”) of 93,000 were primarily the result of our successful annual election period and open enrollment period for 2009.

Results of Continuing Operations

As discussed in Note C, Discontinued Operations, to the condensed consolidated financial statements, on July 31, 2009 the Company sold its Medicaid/Public entity business First Health Services Corporation (“FHSC”) and therefore its operations are classified as “discontinued” on the Company’s consolidated statements of operations and excluded from the information below. Accordingly, the information and discussion below relates to the Company’s results from continuing operations.

The following table is provided to facilitate a discussion regarding the comparison of our consolidated results of continuing operations for the quarters and nine months ended September 30, 2009 and 2008 (dollars in thousands, except diluted earnings per share amounts):

 

 

Comparison of Quarters Ended September 30, 2009 and 2008

Managed care premium revenue increased primarily as a result of higher membership in our Medicare lines of business in Part D, PFFS, and CCP as a result of successful enrollment for 2009. Medicaid premium revenue has also increased due to higher rates and higher membership as a result of changes in eligibility due to current economic conditions. Partially offsetting this increase was lower revenue for our Commercial business due to membership declines.

Medical costs increased primarily as a result of the increase in Medicare membership, as discussed above. Total medical costs as a percentage of premium revenue, “medical loss ratio,” or “MLR” increased over the prior year quarter as a result of a change in our mix of business due to the increase in membership for the Medicare products which have a higher MLR. The increased medical costs were partially offset by an improved MLR on our PFFS and Commercial lines of business.

Selling, general and administrative expense increased due to higher wage expense primarily due to the growth in the Medicare business as well as annual incentive compensation accruals made in the current year quarter but not made in the prior year quarter. Additionally, during the current year there was an increase in broker commissions and other member related costs due to the higher Medicare membership. Selling, general and administrative expense as a percentage of revenue declined slightly as a result of the large increase in operating revenues in the current quarter, while expenses were controlled at a rate lower than the increase in revenue.

Depreciation and amortization expense increased in the current year quarter as a result of a write down in value of $5.3 million for certain long-lived assets.

 

Interest expense decreased due to the repurchase of senior notes during 2009 as well as lower interest rates on the Company’s revolving credit facility during the current quarter.

Other income, net for the current quarter increased compared with the prior year quarter due to a charge in the prior year quarter of $36.2 million, consisting primarily of $33.5 million for the other-than-temporary impairment of investment securities and $2.7 million in realized losses on the sale of securities.

The effective tax rate on continuing operations decreased to 33.1% as compared to 36.3% for the prior year quarter, due to resolution of various tax uncertainties.

Comparison of Nine Months Ended September 30, 2009 and 2008

Managed care premium revenue increased primarily as a result of higher membership in our Medicare business in Part D, PFFS, and CCP as a result of successful enrollment for 2009. The revenue increases were also a result of increased Individual membership. Partially offsetting this increase was lower revenue for our Commercial Risk and Medicaid business due to membership declines. Effective July 1, 2008, our Medicaid risk membership decreased due to the termination of our Pennsylvania Medicaid behavioral health contract representing approximately 107,000 members. This was a capitated pass-through arrangement we had with a local provider group. Given the nature of this globally capitated contract, we earned a low single digit operating margin.

Management services revenue increased primarily due to the growth of our pharmacy benefit management program in the Workers’ Compensation Division.

Medical costs increased primarily as a result of the increase in Medicare membership, as discussed above. MLR increased over the prior year nine months as a result of a change in our mix of business primarily related to Medicare Advantage, Part D, and Commercial Risk.

Cost of sales increased due to the growth of the pharmacy benefit management program revenues in the Workers’ Compensation Division as noted above.

Selling, general and administrative expense increased due to higher wage expense related to the growth in the Medicare business, new executive hires as well as severance expense related to terminated employees in 2009, and annual incentive compensation accruals in the current year nine month period but not in the prior year nine month period. Additionally, during the current year there was an increase in broker commissions and other member related costs due to the higher Medicare membership. Selling, general and administrative expense as a percentage of revenue declined as a result of the large increase in operating revenues in the current quarter while expenses were controlled at a rate lower than the increase in revenue.

Depreciation and amortization expense were consistent between the current and prior year nine month periods.

Interest expense decreased due to the repurchase of senior notes during 2009 as well as lower interest rates on the Company’s revolving credit facility during the current year nine month period.

Other income, net increased for the current nine month period due to a charge of $36.2 million in the third quarter of 2008, consisting primarily of $33.5 million for the other-than-temporary impairment of investment securities and $2.7 million in realized losses on the sale of securities. Additionally, other income, net increased due to gains of $8.4 million on the repayment of outstanding debt during the period. Partially offsetting the increases was a $28 million current year-to-date interest income decrease as a result of lower interest rates.

The effective tax rate on continuing operations decreased to 36.3% as compared to 37.5% for the prior nine months, due to resolution of various tax uncertainties.

Segment Results from Continuing Operations

As a result of the change in our executive leadership, we realigned our organizational structure during the first quarter of 2009. The new organizational structure brings enhanced focus to areas of growth opportunities. Accordingly, our reportable segments have changed to the following three reportable segments: Health Plan and Medical Services, Specialized Managed Care, and Workers’ Compensation. The Company’s segment results for the 2008 periods have been reclassified to conform to the 2009 segment presentation.

 

 

 

 

 

 

 

 

 

 

 

Health Plan and Medical Services Division

Quarters and Nine Months Ended September 30, 2009 and 2008

Health Plan and Medical Services revenue increased over the prior year quarter and nine months ended September 30, 2009 primarily due to membership growth in the Medicare PFFS products. The increase was also a result of an increase in the average realized premium yield per member per month for the Medicare PFFS product. With the effect of the ceded revenue being included in the Medicare Advantage risk premium yield, the premium yield per member per month for the nine month period ending September 30 increased to $796.92 in 2009 from $741.62 in 2008. The increase is a result of a smaller portion of our Medicare PFFS business in 2009 being ceded to external parties through quota share arrangements. When reviewing the premium yield for Medicare Advantage business, we believe that adjusting for the ceded revenue is useful for comparisons to competitors that may not have similar ceding arrangements. Additionally, the Medicare Advantage risk premium yields have increased as a result of risk score improvement. The improvement in risk scores were partially offset by reserves recorded associated with potential CMS risk adjustment data validation audits.

CMS uses a risk adjustment model that incorporates the use of hierarchical condition category (“HCC”) codes to determine premium payments to health plans. We estimate risk adjustment revenues based on the HCC data submitted to CMS. Changes in revenue from CMS resulting from the periodic changes in risk adjustments scores for our membership are recognized when the amounts become determinable and the collectability is reasonably assured.

CMS periodically performs risk adjustment data validation audits and may seek return of payments made to the company if risk adjustment factors are not properly supported by medical record data. We estimate and record reserves for CMS audits based on information available at the time the estimates are made.  The judgments and uncertainties affecting the application of these policies include significant estimates related to the amount of HCC revenue subject to audit and anticipated error rates. Although we feel the Company is appropriately reserved for its exposure to the risk adjustment data validation audits, actual results could differ materially from those estimates. Reserves for CMS audits will be adjusted as new information becomes available.

Medicaid premium yields increased as a result of rate increases in Missouri, our largest Medicaid market, effective July 1, 2008 and July 1, 2009 as well as rate increases in Virginia and West Virginia effective July 1, 2009. The yields also increased due to the termination of our Pennsylvania Medicaid behavioral health contract, which had a lower premium yield. These increases in revenue were offset by declines in the membership of the Medicaid Risk and Commercial Risk products.

Gross margin increased primarily due to the growth in the Medicare Advantage business as well as the improved medical loss ratios for the Medicare PFFS product. The Medicare PFFS medical loss ratios decreased over the prior year quarter and nine months ended as the prior year included unfavorable IBNR reserve development on our PFFS business. The Commercial risk MLR for the nine months ended September 30, 2009 is slightly higher. The current period includes estimates for the effects of increased COBRA membership and increased flu related costs. The Medicaid MLR for the nine months ended September 30, 2009 is higher than the corresponding period in 2008 as a result of higher medical cost trends, higher inpatient utilization, and increasing estimates for the effects of increased flu related costs.

Specialized Managed Care Division

Quarters and Nine Months Ended September 30, 2009 and 2008

Specialized Managed Care revenue experienced a significant increase over the prior year quarter and nine months ended September 30, 2009, due to the large increase in membership for the Medicare Part D product. Medicare Part D premium yields for the period ending September 30, 2009, excluding the effect of CMS risk sharing premium adjustments and revenue ceded to external parties, decreased in 2009 compared to 2008, primarily due to the mix of products sold in 2009. The majority of the Medicare Part D growth was in the lower cost, leaner benefit plans, which have a lower premium. Including the effect of the CMS risk sharing premium adjustments as well as the ceded revenue, the premium yields were $85.25 for the 2009 nine month period compared to $82.48 in 2008. The increase is a result of a smaller portion of our Medicare Part D business in 2009 being ceded to external parties through quota share arrangements.

When reviewing the premium yield for Medicare Part D business, we believe that adjusting for the ceded revenue is useful for comparisons to competitors that may not have similar ceding arrangements. When reviewing the Medicare Part D business, adjusting for the risk share amounts is useful to understand the results of the Part D business because of our expectation that the risk sharing revenue will eventually be insignificant on a full year basis.

 

The gross margin for the Specialized Managed Care Division improved for the quarter and nine months ended September 30, 2009, compared to the same period in 2008. This increase in gross margin is primarily the result of increased Part D membership during the current periods while maintaining a relatively consistent medical loss ratio.

Workers’ Compensation Division

Quarters and Nine Months Ended September 30, 2009 and 2008

Revenue in the Workers’ Compensation Division increased over the nine months ended September 30, 2009 primarily due to the growth of our pharmacy benefit management program. The increase was partially offset by lower revenue in the other business lines as a result of lower claim volume.

Workers’ Compensation gross margin decreased over the prior year quarter and nine months ended periods due to the decline in claims volume which is a higher margin product, partially offset by the growth in the pharmacy benefit management program which operates at a lower margin.

 

Liquidity and Capital Resources

Liquidity

Our investment guidelines require our fixed income securities to be investment grade in order to provide liquidity to meet future payment obligations and minimize the risk to the principal. The fixed income portfolio includes government and corporate securities with an average quality rating of “AA+” and a modified duration of 3.00 years as of September 30, 2009. Typically, the amount and duration of our short-term assets are more than sufficient to pay for our short-term liabilities, and we do not anticipate that sales of our long-term investment portfolio will be necessary to fund our claims liabilities.

We account for investments in accordance with ASC Topic 320, “Investments – Debt and Equity Securities.” We invest primarily in fixed income securities and classify all of our investments as available-for-sale. Investments are evaluated on an individual security basis at least quarterly to determine if declines in value are other-than-temporary. In making that determination, we consider all available evidence relating to the realizable value of a security. This evidence includes, but is not limited to, the following:

 

Temporary declines in value of investments classified as available-for-sale are netted with unrealized gains and reported as a net amount in a separate component of stockholders’ equity. A decline in fair value below amortized cost that is judged to be other-than-temporary is accounted for as a realized loss and the write down is included in earnings. Realized gains and losses on the sale of investments are determined on a specific identification basis.

Our cash and investments, consisting of cash and cash equivalents and short-term and long-term investments, but excluding deposits of $75.5 million at September 30, 2009 and $66.5 million at December 31, 2008 that are restricted under state regulations, increased $756 million to $3.9 billion at September 30, 2009, from $3.1 billion at December 31, 2008.

We have classified all of our investments as available-for-sale. Maturities (in thousands) based upon their contractual terms are as disclosed in Note I, Investments and Fair Value Measurements, to the condensed consolidated financial statements.

 

 

         The demand for our products and services is subject to many economic fluctuations, risks and uncertainties that could materially affect the way we do business. Please refer to Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10–K for the year ended December 31, 2008, for more information. Management believes that the combination of our ability to generate cash flows from operations, our cash and investments on hand and the excess funds held in certain of our regulated subsidiaries will be sufficient to fund continuing operations, capital expenditures, debt interest costs, debt principal repayments and other reasonably likely future cash requirements.

Cash Flows

Net cash flows from operating activities for the nine months ended September 30, 2009 was a result of net earnings plus non-cash adjustments to earnings, including the impairment of FHSC goodwill, as well as increases in medical liabilities and accounts payable and other accrued liabilities. The increase in medical liabilities during the nine months ended September 30, 2009 can be attributed to the growth in membership across the Medicare business. The accounts payable and other accrued liabilities increase is largely due to accruals for annual incentive compensation programs and Medicare payables.

Our net cash from operating activities for the nine months ended September 30, 2009 was $207 million higher than the corresponding 2008 period. Contributing to the increase was the strong cash inflow from accounts payable and other accrued liabilities of $213 million during the 2009 period due to annual incentive compensation accruals in the current year nine month period but not in the prior year nine month period, audit reserves included in Medicare payables, and the tax provision in the 2009 period exceeding the tax payments. Other receivables were also a cash inflow when comparing the same periods due to the receipt of cash related to the pharmacy rebate and Medicare receivables. Offsetting this increase was the lower net earnings in 2009.

Net cash from investing activities for the nine months ended September 30, 2009 was an outflow primarily due to a large amount of investment purchases during the period. This outflow was almost entirely offset by the proceeds received from the sales and maturities of investments and also from the proceeds received from the disposal of FHSC.

Projected capital expenditures for fiscal 2009 are estimated at $50 to $60 million and consist primarily of computer hardware, software and other equipment.

The smaller outflow in net cash from financing activities during the nine months ended September 30, 2009 was a result of fewer share repurchases under our share repurchase program and less debt repayments during the current period. During the prior year nine months we paid $323 million for share repurchases and $315 million in debt repayments, compared to $12 million for share repurchase and $185 million for debt repayments in the current period. The prior year period also included $125 million of proceeds from debt issuances.

Health Plans

Our regulated Health Maintenance Organization (“HMO”) and insurance company subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends our parent Company may receive from our regulated subsidiaries. During the nine months ended September 30, 2009, we received $89.0 million in dividends from our regulated subsidiaries and we made $170.9 million in capital contributions to them. We had $1.4 billion of regulated capital and surplus at September 30, 2009 and met all minimum surplus balance requirements.

We believe that all of our subsidiaries that incur medical claims maintain more than adequate liquidity and capital resources to meet these short-term obligations as a matter of both Company policy and state insurance regulations.

Excluding funds held by entities subject to regulation and excluding our equity method investments, we had cash and investments of approximately $859.7 million and $549.9 million at September 30, 2009 and December 31, 2008, respectively. The increase primarily resulted from the proceeds received from the disposal of FHSC, earnings from non-regulated businesses, and dividends from our regulated subsidiaries. These increases are partially offset by capital contributions made to the regulated entities.

Outlook

Excluding the Effects of the FHSC Transaction

 

Health Plan and Medical Services Division – We expect our Commercial Group Risk membership to decline by approximately 11% for the 2009 year. This decline primarily reflects the impact of the national recession, including a higher level of “in-group” terminations due to employer layoffs and other cutbacks, and eligible employees choosing not to select health insurance coverage at all. Although we will actively pursue retaining and acquiring new customer groups, we will also maintain our pricing discipline. We still expect the Commercial Group Risk MLR to be in the range of 82.0% to 82.5% for 2009.

 

 

 

 

As expected, in the third quarter our national Medicare PFFS product slowed its growth to a net 7,000 members, compared to the 75,000 new net members in the first quarter, before the open enrollment period ended March 31, 2009 and 11,000 net members for the second quarter. Our health plan based CCP membership grew by a net 3,000 in the third quarter, primarily due to “age ins.” Our first quarter net CCP membership growth, during open enrollment, was a net 39,000 members while the second quarter added 6,000 net members. With our Medicare products, we remain committed for the long term with our CCP and Part D programs. Our national PFFS product will be fully supported through the remainder of 2009, and through claims run out in 2010. The Company has decided not to renew its national PFFS product for the 2010 plan year. We expect our Medicare Advantage program MLR for the fourth quarter to be consistent with our results through the second quarter year-to-date.

 

Specialized Managed Care Division – Our Medicare Part D product grew by a net 80,000 members in the third quarter and 705,000 net members for the year. The vast majority of this growth was with our low income/auto assign product and our two leaner designed, better performing retail products. Accordingly, we believe that the 2009 MLR for this product will be in the mid-80s.

 

Workers’ Compensation Division – As with our Health Plan and Medical Services Division, unfavorable macro-economic forces will make revenue growth for our Workers’ Compensation Division challenging for the year, although we expect a small increase. Accordingly, our focus will be on providing a superior customer value proposition, related revenue retention, identification of new areas of revenue growth for the future, and expense management.

 

Regarding our balance sheet and liquidity, we ended the third quarter with approximately $570 million in free cash at the parent level, and approximately $2 billion in cash, cash equivalents, and U.S. Treasury securities on a consolidated basis. After a $90 million pay down this quarter, we have a net balance owing on our revolving line of credit of $490 million. As usual, our first priority with our free cash will be to support the regulatory capital needs of our subsidiaries, and to maintain liquidity.

 

Excluding the effect of the FHSC transaction, we expect our effective tax rate for the full year of 2009 to be 36% to 36.5%.

 

Effect of FHSC Transaction

 

During the second quarter of 2009, we recorded a non-cash net charge of $55.4 million related to the then pending FHSC divestiture, or $0.38 per diluted share. This charge included a gross write down of $72.4 million of goodwill, net of a $17.0 million reduction to our income tax provision in accordance with intra-period tax allocation requirements. Within the third quarter, the sale of FHSC was successfully completed. As expected, the additional charge related to the divestiture was $0.18 per diluted share, for a total of a $0.56 charge on a year-to-date basis. Subsequent to the closing of the transaction, the Company expects that the FHSC divestiture proceeds will be used for a combination of debt reduction and share repurchase.

 

Legal Proceedings

For this information, refer to Note G, Contingencies, to the condensed consolidated financial statements.

   ITEM 3: Quantitative and Qualitative Disclosures About Market Risk

These disclosures should be read in conjunction with the condensed consolidated financial statements, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and other information presented herein as well as in the Quantitative and Qualitative Disclosures About Market Risk section contained in our Annual Report on Form 10–K for the year ended December 31, 2008.

No material changes have occurred in our exposure to market risk since the date of our Annual Report on Form 10–K for the year ended December 31, 2008.

ITEM 4: Controls and Procedures

We have performed an evaluation as of the end of the period covered by this report of the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934), under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer. Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.

 

There have been no significant changes in our internal control over financial reporting (as defined in Rule 13a–15(f) promulgated under the Securities and Exchange Act of 1934) during the quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

 

ITEM 1: Legal Proceedings

For this information, refer to Note G, Contingencies, to the condensed consolidated financial statements.

ITEM 1A: Risk Factors

There have been no material changes with respect to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008.

ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds

The following table presents information about our purchases of our common shares during the quarter ended September 30, 2009 (in thousands, except average price paid per share information).

 

ITEM 3: Defaults Upon Senior Securities

Not Applicable.

ITEM 4: Submission of Matters to a Vote of Security Holders

Not Applicable.

ITEM 5: Other Information

Not Applicable.

ITEM 6: Exhibits

 

 

SIGNATURES

 

 

30

 

 

INDEX TO EXHIBITS

Reg. S-K: Item 601