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TABLE OF CONTENTS

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-Q

(Mark One)    

ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

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: 001-35149



UNIVERSAL AMERICAN CORP.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)
  27-4683816
(I.R.S. Employer
Identification No.)

Six International Drive, Suite 190, Rye Brook, New York 10573
(Address of principal executive offices and zip code)

(914) 934-5200
(Registrant's telephone number, including area code)



        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 ý    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 ý    No o

        Indicate by checkmark 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. (Check one):

Large accelerated filer o   Accelerated filer o   Non-accelerated filer ý
(Do not check if a
smaller reporting company)
  Smaller reporting company o

        Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No ý

        Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.

Class of Common Stock   Outstanding at October 24, 2011
Non-voting, par value $0.01 per share   3,300,000 shares
Voting, par value $0.01 per share   78,175,354 shares



TABLE OF CONTENTS

 
  Item   Description   Page  

PART I

       

Financial Information

       

    1  

Financial Statements:

       

       

Consolidated Balance Sheets

    3  

       

Consolidated Statements of Operations—Three Months

    4  

       

Consolidated Statements of Operations—Nine Months

    5  

       

Consolidated Statements of Stockholders' Equity and Comprehensive Income (loss)

    6  

       

Consolidated Statements of Cash Flows

    7  

       

Notes to Consolidated Financial Statements

    8  

    2  

Management's Discussion and Analysis of Financial Condition and Results of Operations

    34  

    3  

Quantitative and Qualitative Disclosures About Market Risk

    47  

    4  

Controls and Procedures

    47  

PART II

       

Other Information

       

    1  

Legal Proceedings

    48  

    1A  

Risk Factors

    48  

    2  

Unregistered Sales of Equity Securities and Use of Proceeds

    81  

    3  

Defaults Upon Senior Securities

    81  

    4  

(Removed & Reserved)

    82  

    5  

Other Information

    82  

    6  

Exhibits

    82  

       

Signatures

    83  

1


Table of Contents

        As used in this quarterly report on Form 10-Q, except as otherwise indicated, references to the "Company," "UAM," "we," "our," and "us" are to (i) Universal American Corp., a Delaware corporation (formerly known as Universal American Spin Corp., "New Universal American") and its subsidiaries following the closing of the sale of our Part D business on April 29, 2011 (the "Part D Transaction") and (ii) Universal American Corp., a New York corporation (now known as Caremark Ulysses Holding Corp., "Old Universal American") and its subsidiaries prior to the closing of the Part D Transaction on April 29, 2011.

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

        This report, including, without limitation, the information set forth or incorporated by reference under Part II, Item 1A "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" and oral statements made from time to time by our executive officers contains "forward-looking" statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, known as the PSLRA. Statements in this report that are not historical facts are hereby identified as forward- looking statements and are intended to be covered by the safe harbor provisions of the PSLRA. They can be identified by the use of the words "believe," "expect," "predict," "project," "potential," "estimate," "anticipate," "should," "intend," "may," "will" and similar expressions or variations of such words, or by discussion of future financial results and events, strategy or risks and uncertainties, trends and conditions in the Company's business and competitive strengths, all of which involve risks and uncertainties.

        Where, in any forward-looking statement, we or our management expresses an expectation or belief as to future results or actions, there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. Our actual results may differ materially from our expectations, plans or projections. We warn you that forward-looking statements are only predictions and estimates, which are inherently subject to risks, trends and uncertainties, many of which are beyond our ability to control or predict with accuracy and some of which we might not even anticipate. We give no assurance that we will achieve our expectations and we do not assume responsibility for the accuracy and completeness of the forward-looking statements. Future events and actual results, financial and otherwise, may differ materially from the results discussed in the forward-looking statements as a result of many factors, including the risk factors described or incorporated by reference in Part II, Item 1A of this report. We caution readers not to place undue reliance on these forward-looking statements that speak only as of the date made.

        We undertake no obligation, other than as may be required under the federal securities laws, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Although we believe that the expectations reflected in these forward-looking statements are reasonable at the time made, any or all of the forward-looking statements contained in this report and in any other public statements that are made may prove to be incorrect. This may occur as a result of inaccurate assumptions as a consequence of known or unknown risks and uncertainties. All of the forward- looking statements are qualified in their entirety by reference to the factors discussed or incorporated by reference under the caption "Risk Factors" under Part II, Item 1A of this report. We caution that these risk factors may not be exhaustive. We operate in a continually changing business environment that is highly complicated, regulated and competitive and new risk factors emerge from time to time. We cannot predict these new risk factors, nor can we assess the impact, if any, of the new risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied by any forward-looking statement. In light of these risks, uncertainties and assumptions, the forward-looking statements discussed in this report might not occur. You should carefully read this report and the documents that we incorporate by reference in this report in its entirety. It contains information that you should consider in making any investment decision in any of our securities.

2


Table of Contents

PART I

ITEM 1—FINANCIAL STATEMENTS (Unaudited)

        


UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except number of shares)

 
  September 30,
2011
  December 31,
2010
 

ASSETS

             

Investments:

             
 

Fixed maturities available for sale, at fair value (amortized cost: 2011, $1,203,915; 2010, $1,388,604)

 
$

1,223,576
 
$

1,398,498
 
 

Other invested assets

    1,511     1,409  
           
 

Total investments

    1,225,087     1,399,907  

Cash and cash equivalents

    219,390     23,224  

Accrued investment income

    11,206     12,455  

Deferred policy acquisition costs

    142,517     144,750  

Reinsurance recoverables—life

    392,067     590,253  

Reinsurance recoverables—health

    107,669     127,614  

Due and unpaid premiums

    17,967     52,617  

Present value of future profits and other amortizing intangible assets

    34,112     37,434  

Goodwill and other indefinite lived intangible assets

    77,459     77,459  

Income taxes receivable

    17,235      

Advances to agents

    24,018     36,717  

Other assets

    110,555     141,738  

Assets of discontinued operations

        1,011,842  
           
 

Total assets

  $ 2,379,282   $ 3,656,010  
           

LIABILITIES AND STOCKHOLDERS' EQUITY

             

LIABILITIES

             

Reserves and other policy liabilities—life

  $ 392,782   $ 582,248  

Reserves for future policy benefits—health

    389,664     407,312  

Policy and contract claims—health

    193,800     306,390  

Premiums received in advance

    164,009     16,410  

Series A mandatorily redeemable preferred shares

    40,000      

Amounts due to reinsurers

    11,166     6,710  

Income taxes payable

        48,983  

Deferred income taxes payable

    32,704     24,396  

Other liabilities

    149,198     181,813  

Liabilities of discontinued operations

        579,054  
           
 

Total liabilities

    1,373,323     2,153,316  
           

Commitments and contingencies (Note 11)

             

STOCKHOLDERS' EQUITY

             

Preferred stock (Authorized: 2011, 40 million shares; 2010, 3 million shares):

             
 

Series A preferred stock (Authorized: 2011, 0 shares; 2010, 300,000 shares, issued and outstanding: 2010, 42,105 shares, liquidation value: 2010, $86,105)

        42  

Common stock—voting (Authorized: 2011, 400 million shares; 2010, 200 million shares, issued and outstanding: 2011, 78.2 million shares; 2010, 78.6 million shares)

    782     786  

Common stock—non-voting (Authorized: 2011, 60 million shares; 2010, 30 million shares, issued and outstanding: 2011, 3.3 million shares)

    33      

Additional paid-in capital

    737,092     801,155  

Accumulated other comprehensive income (loss)

    12,783     (2,469 )

Retained earnings

    255,269     734,598  

Less: Treasury stock (2010, 2.9 million shares)

        (31,418 )
           
 

Total stockholders' equity

    1,005,959     1,502,694  
           
   

Total liabilities and stockholders' equity

  $ 2,379,282   $ 3,656,010  
           

See Notes to unaudited Consolidated Financial Statements.

3


Table of Contents


UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three Months Ended September 30, 2011 and 2010

(Unaudited)

(in thousands, per share amounts in dollars)

 
  2011   2010  
 

Net premium and policyholder fees earned

  $ 565,531   $ 865,179  
 

Net investment income

    11,524     9,903  
 

Fee and other income

    4,450     1,450  
 

Realized gain:

             
   

Total other-than-temporary impairment losses on securities

        (1,495 )
   

Portion of loss recognized in other comprehensive income

        969  
           
     

Net other-than-temporary impairment losses on securities recognized in earnings

        (526 )
     

Realized gain, excluding other-than-temporary impairment losses on securities

    408     7,611  
           
 

Net realized gains on investments

    408     7,085  
           
     

Total revenues

    581,913     883,617  
           

Benefits, claims and expenses:

             
 

Claims and other benefits

    456,274     723,822  
 

Change in deferred acquisition costs

    87     412  
 

Amortization of present value of future profits

    1,020     1,788  
 

Commissions

    13,335     30,107  
 

Reinsurance commissions and expense allowances

    3,366     (4,232 )
 

Interest expense

    842      
 

Other operating costs and expenses

    86,574     90,512  
           
     

Total benefits, claims and expenses

    561,498     842,409  
           

Income from continuing operations before income taxes

    20,415     41,208  
 

Provision for income taxes

    6,311     7,495  
           

Income from continuing operations

    14,104     33,713  
           

Discontinued operations:

             

Income from discontinued operations, net of income taxes

        27,031  

Expenses of transactions, net of income taxes

         
           

Income from discontinued operations

        27,031  
           

Net income

  $ 14,104   $ 60,744  
           

Earnings per common share:

             

Basic:

             
 

Continuing operations

  $ 0.18   $ 0.43  
 

Discontinued operations

        0.35  
           
 

Net income

  $ 0.18   $ 0.78  
           

Diluted:

             
 

Continuing operations

  $ 0.17   $ 0.43  
 

Discontinued operations

        0.34  
           
 

Net income

  $ 0.17   $ 0.77  
           

Weighted average shares outstanding:

             

Weighted average common shares outstanding

    80,478     76,594  
     

Less weighted average treasury shares

        (2,769 )
           

Basic weighted shares outstanding

    80,478     73,825  

Weighted average common equivalent of preferred shares outstanding

        4,211  
     

Effect of dilutive securities

    274     777  
           

Diluted weighted shares outstanding

    80,752     78,813  
           

Cash dividends per common share

  $   $ 2.00  
           

See Notes to unaudited Consolidated Financial Statements.

4


Table of Contents


UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Nine Months Ended September 30, 2011 and 2010

(Unaudited)

(in thousands, per share amounts in dollars)

 
  2011   2010  
 

Net premium and policyholder fees earned

  $ 1,704,797   $ 2,582,324  
 

Net investment income

    36,504     30,083  
 

Fee and other income

    9,937     7,101  
 

Realized gain:

             
   

Total other-than-temporary impairment losses on securities

        (1,915 )
   

Portion of loss recognized in other comprehensive income

        1,100  
           
     

Net other-than-temporary impairment losses on securities recognized in earnings

        (815 )
     

Realized gain, excluding other-than-temporary impairment losses on securities

    2,404     7,721  
           
 

Net realized gain on investments

    2,404     6,906  
           
     

Total revenues

    1,753,642     2,626,414  
           

Benefits, claims and expenses:

             
 

Claims and other benefits

    1,405,151     2,135,207  
 

Change in deferred acquisition costs

    2,233     3,527  
 

Amortization of present value of future profits

    3,322     5,465  
 

Commissions

    46,829     92,546  
 

Reinsurance commissions and expense allowances

    1,721     (13,768 )
 

Interest expense

    1,423      
 

Other operating costs and expenses

    265,907     273,987  
           
   

Total benefits, claims and expenses

    1,726,586     2,496,964  
           

Income from continuing operations before income taxes

    27,056     129,450  
 

Provision for income taxes

    8,199     35,551  
           

Income from continuing operations

    18,857     93,899  
           

Discontinued operations:

             

Loss from discontinued operations, net of income taxes

    (31,348 )   (10,745 )

Expenses of transactions, net of income taxes

    (10,524 )    
           

Loss from discontinued operations

    (41,872 )   (10,745 )
           

Net (loss) income

  $ (23,015 ) $ 83,154  
           

(Loss) earnings per common share:

             
 

Basic:

             
   

Continuing operations

  $ 0.24   $ 1.21  
   

Discontinued operations

    (0.51 )   (0.14 )
           
 

Net (loss) income

  $ (0.27 ) $ 1.07  
           
 

Diluted:

             
   

Continuing operations

  $ 0.23   $ 1.20  
   

Discontinued operations

    (0.52 )   (0.14 )
           
 

Net (loss) income

  $ (0.29 ) $ 1.06  
           

Weighted average shares outstanding:

             

Weighted average common shares outstanding

    79,366     79,316  
     

Less weighted average treasury shares

    (1,389 )   (5,558 )
           

Basic weighted shares outstanding

    77,977     73,758  

Weighted average common equivalent of preferred shares outstanding

    1,835     4,211  
     

Effect of dilutive securities

    642     521  
           

Diluted weighted shares outstanding

    80,454     78,490  
           

Cash dividends per common share

  $   $ 2.00  
           

See Notes to unaudited Consolidated Financial Statements.

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Table of Contents


UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

AND COMPREHENSIVE INCOME (LOSS)

For the Nine Months Ended September 30, 2011 and 2010

(Unaudited)

(in thousands)

 
   
  Common Stock    
  Accumulated
Other
Comprehensive
(Loss) Income
   
   
   
 
 
  Preferred
Stock
Series A
  Additional
Paid-in
Capital
  Retained
Earnings
  Treasury
Stock
   
 
 
  Voting   Non-Voting   Total  

2010

                                                 

Balance at January 1, 2010

  $ 42   $ 879   $   $ 880,709   $ (7,915 ) $ 709,695   $ (133,946 ) $ 1,449,464  

Net income

                        83,154         83,154  

Other comprehensive income

                    16,495             16,495  
                                                 

Comprehensive income

                                              99,649  
                                                 

Issuance of common stock

        6         3,773                 3,779  

Stock-based compensation

                4,394                 4,394  

Retire treasury stock

        (100 )       (98,959 )           99,059      

Treasury shares purchased, at cost

                            (4,182 )   (4,182 )

Treasury shares reissued

                4,911             9,445     14,356  

Dividends to stockholders

                        (159,503 )       (159,503 )
                                   

Balance at September 30, 2010

  $ 42   $ 785   $   $ 794,828   $ 8,580   $ 633,346   $ (29,624 ) $ 1,407,957  
                                   

2011

                                                 

January 1, 2011

  $ 42   $ 786   $   $ 801,155   $ (2,469 ) $ 734,598   $ (31,418 ) $ 1,502,694  

Net loss

                        (23,015 )       (23,015 )

Other comprehensive income

                    15,252             15,252  
                                                 

Comprehensive loss

                                              (7,763 )
                                                 

Changes in connection with the Part D Transaction:

                                                 
 

Separation from Old Universal American

                        (440,492 )       (440,492 )
 

Conversion of Series A preferred stock

    (42 )   9     33                      
 

Settlement of equity awards to employees and directors

        15         (25,032 )       (9,685 )       (34,702 )
 

Treasury shares retired

        (34 )       (35,429 )       (7,023 )   42,486      

Other activity:

                                                 
 

Net issuance of common stock

        6         4,494                 4,500  
 

Stock-based compensation

                2,535                 2,535  
 

Acquisition of noncontrolling interest of subsidiary

                      (10,555 )                     (10,555 )
 

Treasury shares purchased, at cost

                            (10,821 )   (10,821 )
 

Treasury shares reissued

                (76 )           (247 )   (323 )
 

Dividends to stockholders

                        886         886  
                                   

Balance at September 30, 2011

  $   $ 782   $ 33   $ 737,092   $ 12,783   $ 255,269   $   $ 1,005,959  
                                   

See Notes to unaudited Consolidated Financial Statements.

6


Table of Contents


UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2011 and 2010

(Unaudited)

(in thousands)

 
  Nine Months Ended
September 30,
 
 
  2011   2010  
 
  (in thousands)
 

Operating activities:

             
 

Net (loss) income

  $ (23,015 ) $ 83,154  
 

Loss from discontinued operations

    41,872     10,745  
 

Adjustments to reconcile net (loss) income to cash (used for) provided by operating activities:

             
   

Deferred income taxes

    104     25,742  
   

Realized gains on investments

    (2,404 )   (6,906 )
   

Amortization of intangible assets

    3,322     5,465  
   

Net amortization of bond premium

    5,708     3,872  
   

Depreciation expense

    8,353     8,299  
   

Changes in operating assets and liabilities:

             
     

Deferred policy acquisition costs

    2,233     3,527  
     

Reserves and other policy liabilities—life

    (189,466 )   (40,249 )
     

Reserves for future policy benefits—health

    (17,648 )   (7,440 )
     

Policy and contract claims—health

    (112,590 )   71,260  
     

Reinsurance balances

    222,587     51,682  
     

Due and unpaid/advance premium, net

    182,249     32,109  
     

Income taxes payable/receivable

    (80,688 )   (6,574 )
     

Other, net

    5,358     54,562  
           
 

Cash provided by operating activities from continuing operations

    45,975     289,248  
 

Cash used for operating activities from discontinued operations

    (176,400 )   (154,799 )
           
 

Cash (used for) provided by operating activities

    (130,425 )   134,449  
           

Investing activities:

             
   

Proceeds from sale, maturity, call, paydown or redemption of fixed maturity investments

    826,716     717,423  
   

Cost of fixed maturity investments acquired

    (645,333 )   (1,045,617 )
   

Proceeds from the sale of CHCS, net of cash sold

        6,492  
   

Cash received at closing of Part D Transaction

    15,516      
   

Purchase of fixed assets

    (5,779 )   (8,437 )
   

Other investing activities

    (2,787 )   3,038  
           
 

Cash provided by (used for) investing activities from continuing operations

    188,333     (327,101 )
 

Cash used for investing activities from discontinued operations

    (87,863 )    
           
 

Cash provided by (used for) investing activities

    100,470     (327,101 )
           

Financing activities:

             
   

Net proceeds from issuance of common and preferred stock, net of tax effect

    4,500     5,389  
   

Cost of treasury stock purchases

    (11,069 )   (4,182 )
   

Dividends paid to stockholders

    (910 )   (155,988 )
   

Settlement of equity awards to employees and directors

    (33,545 )    
   

Issuance of mandatorily redeemable preferred stock

    40,000      
   

Payment of debt issue costs

    (1,103 )    
   

Contributions to discontinued operations

    (36,015 )   (83,152 )
           
 

Cash used for financing activities from continuing operations

    (38,142 )   (237,933 )
 

Cash provided by financing activities from discontinued operations

    224,956     105,415  
           
 

Cash provided by (used for) financing activities

    186,814     (132,518 )
           

Net increase (decrease) in cash and cash equivalents

    156,859     (325,170 )

Less: net decrease in cash and cash equivalents from discontinued operations

    39,307     49,384  
           

Net increase (decrease) in cash and cash equivalents from continuing operations

    196,166     (275,786 )

Cash and cash equivalents of continuing operations at beginning of period

    23,224     322,494  
           

Cash and cash equivalents of continuing operations at end of period

  $ 219,390   $ 46,708  
           

See Notes to unaudited Consolidated Financial Statements.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND COMPANY BACKGROUND

        Except as otherwise indicated, references to the "Company," "UAM," "we," "our," and "us" are to (i) Universal American Corp., a Delaware corporation (formerly known as Universal American Spin Corp., "New Universal American") and its subsidiaries following the closing of the sale of our Part D business on April 29, 2011 (the "Part D Transaction") and (ii) Universal American Corp., a New York corporation (now known as Caremark Ulysses Holding Corp., "Old Universal American") and its subsidiaries prior to the closing of the Part D Transaction on April 29, 2011.

        New Universal American is a specialty health and life insurance holding company with an emphasis on providing a broad array of health insurance and managed care products and services to the growing senior population. Collectively, our insurance company subsidiaries are licensed to sell life, accident and health insurance and annuities in all fifty states and the District of Columbia. We currently sell Medicare Coordinated Care Plans, which we call HMOs, Medicare coordinated care products built around contracted networks of providers, which we call PPOs, Medicare Advantage private fee-for-service Plans, known as PFFS Plans, Medicare supplement, fixed benefit accident and sickness insurance and senior life insurance. We distribute these products through career and independent general agency systems and on a direct to consumer basis.

        New Universal American, a Delaware corporation, was formed on December 22, 2010 as a wholly-owned subsidiary of Universal American Corp., a New York corporation, ("Old Universal American"). On December 30, 2010, Old Universal American entered into (i) an Agreement and Plan of Merger (the "Merger Agreement") with CVS Caremark Corporation ("CVS Caremark") and Ulysses Merger Sub, L.L.C., an indirect wholly-owned subsidiary of CVS Caremark ("Merger Sub"), to provide for the purchase of Old Universal American's Medicare Part D Business, by CVS Caremark through the merger of Merger Sub with and into Old Universal American, with Old Universal American continuing as the surviving corporation and a wholly-owned subsidiary of CVS Caremark and (ii) a Separation Agreement (the "Separation Agreement") with New Universal American, to provide for the separation of Old Universal American's Medicare Part D Business from its remaining businesses, which include the Medicare Advantage and Traditional Insurance businesses. We refer to the sale of the Medicare Part D Business to CVS Caremark and related transactions as the "Part D Transaction." Prior to the closing of the Part D Transaction, New Universal American conducted no business activities.

        On April 29, 2011, the parties consummated the Part D Transaction and shareholders of Old Universal American received $14.00 in cash and one share of New Universal American common stock for each share owned. At the closing of the Part D Transaction, Old Universal American (i) separated all of its businesses other than its Medicare Part D Business and transferred those businesses to New Universal American, (ii) became a wholly-owned subsidiary of CVS Caremark, (iii) changed its name to Caremark Ulysses Holding Corp. (iv) de-registered its shares under the Securities Exchange Act of 1934 and (v) de-listed its shares on the New York Stock Exchange. The net assets transferred to CVS Caremark at the closing of the Part D Transaction amounted to $440.5 million and were recorded as an adjustment to retained earnings, as shown in the Consolidated statements of stockholders' equity and comprehensive income (loss).

        In addition, at the closing of the Part D Transaction, New Universal American changed its name to Universal American Corp. and its shares began trading on the New York Stock Exchange under the ticker symbol "UAM" on May 2, 2011. Subsequent to the closing of the Part D Transaction, New Universal American owns and operates the Medicare Advantage and Traditional Insurance businesses

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

1. ORGANIZATION AND COMPANY BACKGROUND (Continued)


and assets that previously comprised Old Universal American's Senior Managed Care-Medicare Advantage and Traditional Insurance segments and certain portions of the Corporate & Other segment.

        The Part D Transaction was accounted for as a reverse spin-off and historical financial statements of Old Universal American will be used as the basis for New Universal American's historical financial statements for purposes of New Universal American's ongoing SEC filings with the Medicare Part D Business of Old Universal American reclassified to discontinued operations.

2. BASIS OF PRESENTATION

        We have prepared the accompanying Consolidated Financial Statements in conformity with U.S. generally accepted accounting principles, or U.S. GAAP, for interim reporting in accordance with Article 10 of the Securities and Exchange Commission's Regulation S-X. Accordingly, they do not include all of the disclosures normally required by U.S. GAAP or those normally made in an annual report on Form 10-K. For the insurance and HMO subsidiaries, U.S. GAAP differs from statutory accounting practices prescribed or permitted by regulatory authorities. We have eliminated all material intercompany transactions and balances. The interim financial information in this report is unaudited, but in the opinion of management, includes all adjustments, including normal, recurring adjustments necessary to present fairly the financial position and results of operations for the periods reported. For further information regarding Old Universal American, please see the Quarterly Report on Form 10-Q for the quarter ended March 31, 2011 filed by Old Universal American on April 28, 2011 as well as the Annual Report on Form 10-K for the year ended December 31, 2010 filed on March 1, 2011. The results of operations for the three and nine months ended September 30, 2011 and 2010 are not necessarily indicative of the results to be expected for the full year.

        Use of Estimates:    The preparation of our financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported by us in our Consolidated Financial Statements and the accompanying Notes. Critical accounting policies require significant subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. These estimates are based on information available at the time the estimates are made, as well as anticipated future events. Actual results could differ materially from these estimates. We periodically evaluate our estimates, and as additional information becomes available or actual amounts become determinable, we may revise the recorded estimates and reflect the revisions in operating results. In our judgment, the accounts involving estimates and assumptions that are most critical to the preparation of our financial statements are policy related liabilities and expense recognition, deferred policy acquisition costs, goodwill and other intangible assets, investment valuation, revenue recognition—Medicare Advantage products, and income taxes. There have been no changes in our critical accounting policies during the current quarter.

        Significant Accounting Policies:    For a description of existing significant accounting policies, see Note 2—Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements included in our annual report on Form 10-K for the year ended December 31, 2010.

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(Unaudited)

2. BASIS OF PRESENTATION (Continued)

        Reclassifications:    In accordance with the provisions of Accounting Standards Codification (ASC) 360-10-45, Property, Plant & Equipment—Overall—Other Presentation Matters—Impairment or Disposal of Long-Lived Assets, effective with the closing of the Part D Transaction on April 29 2011, the results of operations and cash flows related to our Medicare Part D business and related corporate items are reported as discontinued operations for all periods presented. In addition, the related assets and liabilities have been segregated from the assets and liabilities related to our continuing operations and presented separately in our consolidated balance sheet as of December 31, 2010. Unless otherwise noted, all disclosures in the notes accompanying our consolidated financial statements reflect only continuing operations.

3. RECENTLY ISSUED AND PENDING ACCOUNTING PRONOUNCEMENTS

        Intangibles—Goodwill and Other:    In September 2011, ASU 2011-08, Intangibles—Goodwill and Other, Testing Goodwill for Impairment was issued by the FASB. Its objective is to simplify how entities test goodwill for impairment. The changes permit an entity to first assess qualitative factors to determine whether it is more likely than not (more than 50%) that the fair value of a reporting unit is less than its carrying amount. Such qualitative factors may include the following: macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; and other relevant entity-specific events. If an entity elects to perform a qualitative assessment and determines that an impairment is more likely than not, the entity is then required to perform the existing two-step quantitative impairment test, otherwise no further analysis is required. An entity also may elect not to perform the qualitative assessment and, instead, go directly to the two-step quantitative impairment test. These changes are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. Since these changes are only procedural in nature, adoption of this ASU will not have any impact on our consolidated financial position or results of operations.

        Other Expenses, Fees Paid to the Federal Government by Health Insurers:    In July 2011, ASU 2011-06, Other Expenses, Fees Paid to the Federal Government by Health Insurers was issued by the FASB to address questions about how health insurers should recognize and classify in their income statements fees mandated by the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act (the Acts). The Acts impose an annual fee on health insurers for each calendar year beginning on or after January 1, 2014. A health insurer's portion of the annual fee is payable no later than September 30 of the applicable calendar year and is not tax deductible. The annual fee for the health insurance industry will be allocated to individual health insurers based on the ratio of the amount of an entity's net premiums written during the preceding calendar year to the amount of health insurance for any U.S. health risk that is written during the preceding calendar year. The ASU provides that the liability for the fee should be estimated and recorded in full once the entity provides qualifying health insurance in the corresponding period with a corresponding deferred cost that is to be amortized to expense on a straight-line basis over the applicable calendar year. The ASU also notes that the fee would not meet the definition of an acquisition cost under ASC 944. The amendments are effective for calendar years beginning after December 31, 2013, when the fee initially becomes effective. Management has not yet determined the impact of adoption of this new guidance on our consolidated financial position or results of operations.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

3. RECENTLY ISSUED AND PENDING ACCOUNTING PRONOUNCEMENTS (Continued)

        Other Comprehensive Income:    In June 2011, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2011-05, Comprehensive Income, which provides amended disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the statement of changes in equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes are effective January 1, 2012. Early application is permitted. There will be no substantive impact to our financial position or results of operations, as the amendments relate only to changes in financial statement presentation.

        Fair Value Disclosures:    In May 2011, the FASB issued amended guidance and disclosure requirements for fair value measurements. These changes will be effective for interim and annual periods beginning after December 15, 2011. Early application is not permitted. We do not expect this update to have a material impact on our financial position or results of operations.

        Deferred Acquisition Costs:    On September 29, 2010, ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts was ratified by the FASB. The ASU amends FASB ASC Topic 944, Financial Services—Insurance. This guidance changes the accounting for costs associated with acquiring or renewing insurance contracts in response to diversity in practice in the capitalization of those costs. Under the new guidance, deferrable costs will be limited to incremental direct costs of a successful contract acquisition incurred with independent third parties and the portion of the total employee compensation and payroll- related fringe benefits related to time spent performing specified acquisition activities (e.g., underwriting, policy issuance and processing) for successful acquisition efforts. Companies will have a choice between prospective and retrospective adoption; the election must be made at the reporting entity level. The new guidance will be effective for fiscal years beginning after December 15, 2011. Management has not yet determined the impact of adoption of this new guidance on our consolidated financial position or results of operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. INVESTMENTS

        The amortized cost and fair value of fixed maturity investments are as follows:

 
  September 30, 2011(1)  
Classification
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Gross
Unrealized
OTTI(2)
  Fair Value  
 
  (in thousands)
 

U.S. Treasury securities and U.S. Government obligations

  $ 36,254   $ 1,001   $   $   $ 37,255  

Government sponsored agencies

    17,182     1,718             18,900  

Other political subdivisions

    105,830     2,260     (146 )       107,944  

Corporate debt securities

    532,556     15,685     (6,488 )       541,753  

Foreign debt securities

    81,939     846     (3,065 )       79,720  

Residential mortgage-backed securities

    264,790     12,995     (106 )       277,679  

Commercial mortgage-backed securities

    84,285     782     (928 )       84,139  

Other asset-backed securities

    81,079     2,471     (2,757 )   (4,607 )   76,186  
                       

  $ 1,203,915   $ 37,758   $ (13,490 ) $ (4,607 ) $ 1,223,576  
                       

 

 
  December 31, 2010  
Classification
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Gross
Unrealized
OTTI(2)
  Fair Value  
 
  (in thousands)
 

U.S. Treasury securities and U.S. Government obligations

  $ 75,543   $ 247   $ (598 ) $   $ 75,192  

Government sponsored agencies

    81,097     1,954     (88 )       82,963  

Other political subdivisions

    154,348     350     (3,514 )       151,184  

Corporate debt securities

    585,629     13,883     (4,252 )       595,260  

Foreign debt securities

    104,554     888     (808 )       104,634  

Residential mortgage-backed securities

    197,033     8,468     (1,364 )       204,137  

Commercial mortgage-backed securities

    91,674     151     (2,102 )       89,723  

Other asset-backed securities

    98,726     2,965     (2,896 )   (3,390 )   95,405  
                       

  $ 1,388,604   $ 28,906   $ (15,622 ) $ (3,390 ) $ 1,398,498  
                       

(1)
In connection with the Part D Transaction, on April 29, 2011, $64 million of fixed maturity investments were transferred to CVS Caremark.

(2)
Other-than-temporary impairments.

        At September 30, 2011, gross unrealized losses on mortgage-backed and asset-backed securities totaled $8.4 million, consisting primarily of unrealized losses of $7.2 million on subprime residential mortgage loans, as discussed below, and $0.9 million related to obligations of commercial mortgage-backed securities. The fair value of a majority of the subprime securities is depressed due to the expected deterioration of collectability of the underlying mortgages. The fair value of the other securities is depressed primarily due to changes in interest rates. We have evaluated these holdings,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. INVESTMENTS (Continued)


with input from our investment managers, and do not believe further other-than-temporarily impairment to be warranted.

        The amortized cost and fair value of fixed maturity investments at September 30, 2011 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 
  Amortized
Cost
  Fair
Value
 
 
  (in thousands)
 

Due in 1 year or less

  $ 65,286   $ 66,277  

Due after 1 year through 5 years

    336,897     343,797  

Due after 5 years through 10 years

    276,521     283,822  

Due after 10 years

    95,057     91,676  

Mortgage and asset-backed securities

    430,154     438,004  
           

  $ 1,203,915   $ 1,223,576  
           

        The fair value and unrealized loss as of September 30, 2011 and December 31, 2010 for fixed maturities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are shown below:

 
  Less than 12 Months   12 Months or Longer   Total  
September 30, 2011
  Fair
Value
  Gross
Unrealized
Losses and
OTTI
  Fair
Value
  Gross
Unrealized
Losses and
OTTI
  Fair
Value
  Gross
Unrealized
Losses and
OTTI
 
 
  (in thousands)
 

U.S. Treasury securities and U.S. Government obligations

  $   $   $   $   $   $  

Government sponsored agencies

                         

Other political subdivisions

    12,503     (146 )           12,503     (146 )

Corporate debt securities

    184,404     (6,488 )           184,404     (6,488 )

Foreign debt securities

    57,370     (3,065 )           57,370     (3,065 )

Residential mortgage-backed securities

    3,664     (21 )   667     (85 )   4,331     (106 )

Commercial mortgage-backed securities

    23,005     (201 )   1,978     (727 )   24,983     (928 )

Other asset-backed securities

    19,065     (97 )   14,090     (7,267 )   33,155     (7,364 )
                           

Total fixed maturities

  $ 300,011   $ (10,018 ) $ 16,735   $ (8,079 ) $ 316,746   $ (18,097 )
                           

Total number of securities in an unrealized loss position

                                  108  
                                     

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(Unaudited)

4. INVESTMENTS (Continued)

 

 
  Less than 12 Months   12 Months or Longer   Total  
December 31, 2010
  Fair
Value
  Gross
Unrealized
Losses and
OTTI
  Fair
Value
  Gross
Unrealized
Losses and
OTTI
  Fair
Value
  Gross
Unrealized
Losses and
OTTI
 
 
  (in thousands)
 

U.S. Treasury securities and U.S. Government obligations

  $ 39,345   $ (598 ) $   $   $ 39,345   $ (598 )

Government sponsored agencies

    48,057     (88 )           48,057     (88 )

Other political subdivisions

    139,968     (3,514 )           139,968     (3,514 )

Corporate debt securities

    260,968     (4,162 )   1,014     (90 )   261,982     (4,252 )

Foreign debt securities

    68,776     (808 )           68,776     (808 )

Residential mortgage-backed securities

    61,774     (1,280 )   813     (84 )   62,587     (1,364 )

Commercial mortgage-backed securities

    65,375     (1,011 )   1,813     (1,091 )   67,188     (2,102 )

Other asset-backed securities

    29,657     (496 )   15,561     (5,790 )   45,218     (6,286 )
                           

Total fixed maturities

  $ 713,920   $ (11,957 ) $ 19,201   $ (7,055 ) $ 733,121   $ (19,012 )
                           

Total number of securities in an unrealized loss position

                                  236  
                                     

Subprime Residential Mortgage Loans

        We hold securities with exposure to subprime residential mortgages, or mortgage loans to borrowers with weak credit profiles. The significant decline in U.S. housing prices and relaxed underwriting standards by some subprime loan originators have led to higher delinquency and loss rates, resulting in a significant reduction in the market valuation of these securities sector wide.

        As of September 30, 2011, we held subprime securities with par values of $22.0 million, an amortized cost of $21.5 million and a fair value of $14.3 million representing approximately 1.0% of our cash and invested assets, with collateral comprised substantially of first lien mortgages in senior or senior mezzanine level tranches, with an average Standard & Poor's, or equivalent, rating of BB+.

        The following table presents our exposure to subprime residential mortgages by vintage year.

Vintage Year
  Amortized
Cost
  Fair
Value
  Gross
Unrealized
Losses & OTTI
 
 
  (in thousands)
 

2003

  $ 172   $ 66   $ (106 )

2004

    183     101     (82 )

2005

    14,175     11,702     (2,473 )

2006

    7,000     2,418     (4,582 )
               

Totals

  $ 21,530   $ 14,287   $ (7,243 )
               

        We continuously review our subprime holdings stressing multiple variables, such as cash flows, prepayment speeds, default rates and loss severity, and comparing current base case loss expectations to

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. INVESTMENTS (Continued)


the loss required to incur a principal loss, or breakpoint. We expect loss rates in the subprime mortgage sector to continue to increase in the near term but at a decreasing rate. Those securities with a greater variance between the breakpoint and base case can withstand this further deterioration. Based on the analysis of the remaining subprime holdings at September 30, 2011, we do not believe these holdings are other-than-temporarily impaired.

        Gross realized gains and gross realized losses included in the Consolidated Statements of Operations are as follows:

 
  For the three months
ended September 30,
  For the nine months
ended September 30,
 
 
  2011   2010   2011   2010  
 
  (in thousands)
 

Realized gains:

                         
 

Fixed maturities

  $ 1,116   $ 19,185   $ 6,705   $ 20,126  
 

Other

        87     2     109  
                   

    1,116     19,272     6,707     20,235  
                   

Realized losses:

                         
 

Fixed maturities, excluding OTTI

    (708 )   (11,636 )   (4,303 )   (12,448 )
 

OTTI on fixed maturities

        (526 )       (815 )
 

Other

        (25 )       (66 )
                   

    (708 )   (12,187 )   (4,303 )   (13,329 )
                   

Net realized gains

  $ 408   $ 7,085   $ 2,404   $ 6,906  
                   

5. FAIR VALUE MEASUREMENTS

        We carry fixed maturity investments and equity securities at fair value in our Consolidated Financial Statements. These fair value disclosures consist of information regarding the valuation of these financial instruments followed by the fair value measurement disclosure requirements of Fair Value Measurements and Disclosures Topic, ASC 820-10.

    Fair Value Disclosures

        The following section applies the ASC 820-10 fair value hierarchy and disclosure requirements to our financial instruments that we carry at fair value. ASC 820-10 establishes a fair value hierarchy that prioritizes the inputs in the valuation techniques used to measure fair value into three broad Levels, numbered 1, 2, and 3.

            Level 1 observable inputs reflect quoted prices for identical assets or liabilities in active markets that we have the ability to access at the measurement date. We currently have no Level 1 securities.

            Level 2 observable inputs, other than quoted prices included in Level 1, reflect the asset or liability or prices for similar assets and liabilities. Most debt securities and some preferred stocks are model priced by vendors using observable inputs and we classify them within Level 2.

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(Unaudited)

5. FAIR VALUE MEASUREMENTS (Continued)

            Level 3 valuations are derived from techniques in which one or more of the significant inputs, such as assumptions about risk, are unobservable. Generally, Level 3 securities are less liquid securities such as highly structured or lower quality asset-backed securities, known as ABS, and private placement equity securities. Because Level 3 fair values, by their nature, contain unobservable market inputs, as there is no observable market for these assets and liabilities, we must use considerable judgment to determine the Level 3 fair values. Level 3 fair values represent our best estimate of an amount that we could realize in a current market exchange absent actual market exchanges.

        The following table presents our assets that are carried at fair value by hierarchy levels, as of September 30, 2011 (in thousands):

 
  Total   Level 1   Level 2   Level 3  

Assets:

                         

Fixed maturities, available for sale

  $ 1,223,576   $   $ 1,220,916   $ 2,660  
                   

        In many situations, inputs used to measure the fair value of an asset or liability position may fall into different levels of the fair value hierarchy. In these situations, we will determine the level in which the fair value falls based upon the lowest level input that is significant to the determination of the fair value.

    Determination of fair values

        The valuation methodologies used to determine the fair values of assets and liabilities under the "exit price" notion of ASC 820-10 reflect market participant objectives and are based on the application of the fair value hierarchy that prioritizes observable market inputs over unobservable inputs. We determine the fair value of our financial assets and liabilities based upon quoted market prices where available. The following is a discussion of the methodologies used to determine fair values for the financial instruments listed in the above table.

    Valuation of Fixed Maturities

        We determine the fair value of the majority of our fixed maturities using third party pricing service market prices. The following are examples of typical inputs used by third party pricing services:

    reported trades,

    benchmark yields,

    issuer spreads,

    bids,

    offers, and

    estimated cash flows and prepayment speeds.

        Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available

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(Unaudited)

5. FAIR VALUE MEASUREMENTS (Continued)


market observable information as outlined above. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price where the pricing services develop future cash flow expectations based upon collateral performance, discounted at an estimated market rate. The pricing for mortgage-backed and asset-backed securities reflects estimates of the rate of future prepayments of principal over the remaining life of the securities. The pricing services derive these estimates based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral.

        We have analyzed the third party pricing services' valuation methodologies and related inputs, and have also evaluated the various types of securities in our investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Based on the results of this evaluation and investment class analysis, we classified each price into Level 1, 2, or 3. We classified most prices provided by third party pricing services into Level 2 because the inputs used in pricing the securities are market observable.

        Due to a general lack of transparency in the process that brokers use to develop prices, we have classified most valuations that are based on broker's prices as Level 3. We may classify some valuations as Level 2 if we can corroborate the price. We have also classified internal model priced securities, primarily consisting of private placement asset-backed securities, as Level 3 because this model pricing includes significant non-observable inputs. We have classified private placement equity securities as Level 3 due to the lack of observable inputs.

        The following table provides a summary of changes in the fair value of our Level 3 financial instruments:

 
  Fixed
Maturities
 
 
  (in thousands)
 

Fair value as of January 1, 2011

  $ 7,238  

Sales

    (765 )

Transfer Out(1)

    (3,727 )

Realized Gain/Loss

    1  

Unrealized losses included in AOCI(2)(3)

    (11 )
       

Fair value as of March 31, 2011

    2,736  

Sales

    (32 )

Unrealized losses included in AOCI(2)(3)

    (5 )
       

Fair value as of June 30, 2011

    2,699  

Sales

    (33 )

Unrealized losses included in AOCI(2)(3)

    (6 )
       

Fair value as of September 30, 2011

  $ 2,660  
       

(1)
Transfer of four securities from Level 3 to Level 2 due to observable inputs.

(2)
AOCI: Accumulated other comprehensive income.

(3)
Unrealized gains/losses represent losses from changes in values of Level 3 financial instruments only for the periods in which the instruments are classified as Level 3.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

6. MANDATORILY REDEEMABLE PREFERRED SHARES

        On April 29, 2011, in conjunction with the consummation of the Part D Transaction, New Universal American issued an aggregate of $40 million of Series A Mandatorily Redeemable Preferred Stock (the "Series A Preferred Stock"), representing 1,600,000 shares with a par value of $0.01 per share and a liquidation preference of $25.00 per share. The Series A Preferred Stock pays cash dividends at the rate of 8.5% per annum and is mandatorily redeemable on the six year anniversary of the issue date. The proceeds from the sale of the Series A Preferred Stock were used to pay a portion of the existing indebtedness and transaction expenses of Old Universal American at the closing of the Part D Transaction. New Universal American did not retain any proceeds from the sale of the Series A Preferred Stock. Certain officers and directors of New Universal American collectively purchased an aggregate of $10 million of the Series A Preferred Stock.

        In accordance with ASC 480, Distinguishing Liabilities from Equity, because the issuance of the Series A Preferred Shares imposes an obligation on us requiring the transfer of assets, specifically, cash, at the redemption date, the Series A Preferred Shares will be treated as a liability on the consolidated balance sheets, with the related dividends reported as interest expense on the income statement. At September 30, 2011, we had accrued $0.7 million of such dividends, recorded in other liabilities in the consolidated balance sheets.

        Issue costs of approximately $1.1 million were capitalized and will be amortized over the six year term of the Series A Preferred Shares.

7. EARNINGS PER COMMON SHARE COMPUTATION

        Prior to the closing of the Part D Transaction, we had preferred stock outstanding representing 4.2 million common stock equivalents, which were converted to common stock in connection with the Part D Transaction, as discussed in Note 8—Stockholders' Equity. We are required to calculate basic earnings per common share using the two-class method. This method requires that we allocate net income between net income attributable to participating preferred stock and net income attributable to common stock, based on the dividend and earnings participation provisions of the preferred stock. Basic earnings per share excludes the dilutive effects of stock options outstanding during the periods and is equal to net income attributable to common stock divided by the weighted average number of common shares outstanding for the periods.

        For the periods ended September 30, 2011 and 2010, we allocated earnings between common and participating preferred stock as follows:

 
  Three months ended
September 30,
  Nine months ended
September 30,
 
 
  2011   2010   2011   2010  
 
  (in thousands)
  (in thousands)
 

Net income (loss) attributable to common stock

  $ 14,104   $ 57,465   $ (21,207 ) $ 78,664  

Undistributed income (loss) allocated to participating preferred stock

        3,279     (1,808 )   4,490  
                   

Net income (loss)

  $ 14,104   $ 60,744   $ (23,015 ) $ 83,154  
                   

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. EARNINGS PER COMMON SHARE COMPUTATION (Continued)

        ASC 260-10-45, Earnings Per Share—Overall—Other Presentation Matters, requires that an entity reporting discontinued operations shall use income from continuing operations as the control number in determining whether potential common stock equivalents are dilutive or antidilutive. Since all periods presented in the consolidated statements of operations include net income from continuing operations, common stock equivalents are included in computing diluted earnings per share as reported in the consolidated statements of operations.

8. STOCKHOLDERS' EQUITY

    Preferred Stock

        We currently have authorized for issuance 40 million shares of preferred stock of which 1.6 million shares of Series A Preferred Stock are issued and outstanding at September 30, 2011 (See Note 6—Mandatorily Redeemable Preferred Shares).

        At December 31, 2010 we had 42,105 shares of Series A preferred stock outstanding, convertible under specified circumstances to shares of common stock in the ratio of 100 shares of common stock for each share of Series A preferred stock. Pursuant to the terms of the Merger Agreement, at the closing of the Part D Transaction, the Series A preferred stock was cancelled and 3.3 million shares of non-voting common stock and 910,500 shares of voting common stock of New Universal American were issued.

    Common Stock—Voting

        We currently have authorized for issuance 400 million shares of voting common stock, par value $0.01 per share, of which 78,175,354 shares were issued and outstanding at September 30, 2011. The following table shows changes in the number of shares of voting common stock issued:

 
  September 30,
2011
  December 31,
2010
 

Common stock issued, beginning of year

    78,625,212     87,942,663  

Issuance of common stock

    576,919      

Conversion of Series A preferred stock

    910,500      

Exercise of stock options

    1,543,278     638,061  

Retired shares

    (3,480,555 )   (10,005,305 )

Stock purchase pursuant to agents' stock purchase and deferred compensation plans

        49,793  
           

Common stock issued, end of period

    78,175,354     78,625,212  
           

    Common Stock—Non Voting

        We currently have authorized for issuance 60 million shares of non-voting common stock, par value $0.01 per share. Pursuant to the terms of the Merger Agreement, at the closing of the Part D Transaction we issued 3.3 million shares of non-voting common stock, which remains outstanding at September 30, 2011.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

8. STOCKHOLDERS' EQUITY (Continued)

    Treasury Stock

        Changes in treasury stock were as follows (in thousands, except shares and per share amounts):

 
  September 30, 2011   December 31, 2010  
 
  Shares   Amount   Weighted
Average
Cost Per
Share
  Shares   Amount   Weighted
Average
Cost Per
Share
 

Treasury stock, beginning of year

    2,945,848   $ 31,418   $ 10.67     13,538,081   $ 133,946   $ 9.90  

Shares repurchased

    509,759     10,821     21.23     391,531     5,937     15.16  

Shares distributed in the form of employee bonuses

                (983,764 )   (9,406 )   9.56  

Treasury shares, reissued

    24,653     247     10.02              

Retirement of treasury stock

    (3,480,260 )   (42,486 )   12.21     (10,000,000 )   (99,059 )   9.91  
                               

Treasury stock, end of period

      $   $     2,945,848   $ 31,418   $ 10.67  
                               

        In connection with the closing of the Part D Transaction, on April 29, 2011 we retired all remaining treasury stock.

9. OTHER COMPREHENSIVE INCOME (LOSS)

        The components of accumulated other comprehensive income (loss) are as follows:

 
  September 30,
2011
  December 31,
2010
 
 
  (in thousands)
 

Continuing Operations:

             
 

Net unrealized gains on investments

  $ 24,273   $ 13,284  
 

Gross unrealized OTTI

    (4,607 )   (3,390 )
 

Deferred tax

    (6,883 )   (3,463 )
           
   

Accumulated other comprehensive income-continuing operations

    12,783     6,431  
           

Discontinued Operations:

             
 

Fair value of cash flow swap

        (13,693 )
 

Deferred tax

        4,793  
           
   

Accumulated other comprehensive loss-discontinued operations

        (8,900 )
           
     

Total accumulated other comprehensive income (loss)

  $ 12,783   $ (2,469 )
           

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

9. OTHER COMPREHENSIVE INCOME (LOSS) (Continued)

        The components of other comprehensive income and the related tax effects for each component are as follows:

 
  Three months ended September 30,  
 
  2011   2010  
 
  Before Tax
Amount
  Tax
Expense
  Net of Tax
Amount
  Before Tax
Amount
  Tax
Expense
  Net of Tax
Amount
 
 
  (in thousands)
 

From continuing operations:

                                     

Net unrealized gain arising during the period

  $ 1,316   $ 461   $ 855   $ 13,843   $ 4,845   $ 8,998  

Reclassification adjustment for gains included in net income

    408     143     265     7,085     2,480     4,605  
                           

Net unrealized gain

    908     318     590     6,758     2,365     4,393  
                           

From discontinued operations:

                                     

Cash flow hedge

                2,876     1,007     1,869  
                           
 

Total other comprehensive income

  $ 908   $ 318   $ 590   $ 9,634   $ 3,372   $ 6,262  
                           

 

 
  Nine months ended September 30,  
 
  2011   2010  
 
  Before Tax
Amount
  Tax
Expense
  Net of Tax
Amount
  Before Tax
Amount
  Tax
Expense
  Net of Tax
Amount
 
 
  (in thousands)
 

From continuing operations:

                                     

Net unrealized gain arising during the period

  $ 12,175   $ 4,261   $ 7,914   $ 31,284   $ 10,949   $ 20,335  

Reclassification adjustment for gains included in net income

    2,404     842     1,562     6,906     2,417     4,489  
                           

Net unrealized gain

    9,771     3,419     6,352     24,378     8,532     15,846  
                           

From discontinued operations:

                                     

Cash flow hedge

    13,693     4,793     8,900     999     350     649  
                           
 

Total other comprehensive income

  $ 23,464   $ 8,212   $ 15,252   $ 25,377   $ 8,882   $ 16,495  
                           

10. STOCK-BASED COMPENSATION

        In connection with the closing of the Part D Transaction, we established the Universal American Corp. 2011 Omnibus Equity Award Plan (the "2011 Plan") to replace the 1998 Incentive Compensation Plan (the "1998 ICP") established by Old Universal American. The 2011 Plan provides for the granting of various types of equity awards, including stock options, stock appreciation rights, restricted stock, restricted stock units, and other stock-based awards and/or performance compensation awards. The 2011 Plan is administered by the Compensation Committee of the Board of Directors. The aggregate number of shares of common stock available for awards under the 2011 Plan is 8,000,000. On May 2,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. STOCK-BASED COMPENSATION (Continued)


2011, we granted an aggregate of 2.7 million stock options with an exercise price of $9.33. The stock options have a five year term and vest 25% per year beginning on the one-year anniversary of the grant date.

        Our stock-based compensation expense prior to the closing of the Part D Transaction on April 29, 2011 was driven by stock awards issued by Old Universal American under the 1998 ICP. New Universal American's stock-based compensation expense relates to the equity awards granted under the 2011 Plan as well as restricted stock and performance share awards made by Old Universal American, which, carried over to New Universal American and vest at future dates. The stock-based compensation recorded in other operating costs and expenses included in continuing operations relates only to employees and directors that remained with the Company following the Part D Transaction. Stock-based compensation expense related to employees of the previously-owned Part D segment that was sold to CVS Caremark is reflected in discontinued operations for all periods presented.

        The compensation expense for our continuing operations that has been included in other operating costs and expenses for these plans and the related tax benefit were as follows:

 
  Three Months
Ended
September 30,
 
 
  2011   2010  
 
  (in thousands)
 

Stock options

  $ 643   $ 1,285  

Restricted stock awards

    1,480     1,654  
           
 

Total stock-based compensation expense

    2,123     2,939  

Tax benefit recognized

    743     1,043  
           
 

Stock-based compensation expense, net of tax

  $ 1,380   $ 1,896  
           

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. STOCK-BASED COMPENSATION (Continued)

 

 
  Nine Months Ended
September 30,
 
 
  2011   2010  
 
  (in thousands)
 

Stock-based compensation expense by type:

             
 

Part D Transaction—stock options

  $ 5,851   $  
 

Part D Transaction—restricted stock awards

    2,795      
           
   

Part D Transaction—subtotal

    8,646      
 

Stock options(1)

    2,570     1,994  
 

Restricted stock awards

    3,878     5,054  
           
   

Total stock-based compensation expense

    15,094     7,048  
 

Tax benefit recognized

    5,283     2,168  
           
   

Stock-based compensation expense, net of tax

  $ 9,811   $ 4,880  
           

(1)
Stock-based compensation expense—stock options for the nine month periods ended September 30, 2010 reflects a $2.0 million reduction related to the true-up of our forfeiture rate estimate for options that had non-vested terminations.

        The table above reflects $8.6 million of expense in April 2011 related to the accelerated vesting of unvested stock options and restricted stock held by certain officers in connection with the Part D Transaction, which was treated as though it constituted a change in control for purposes of our outstanding stock option awards and restricted stock awards. All stock options were valued as of the close of business on April 28, 2011, immediately prior to the closing of the Part D Transaction and were settled 50% in cash and 50% in shares of New Universal American stock. The restricted stock awards were settled on the same terms as the consideration paid in the Part D Transaction; $14.00 in cash and one share of New Universal American stock.

    Stock Option Awards

        We recognize compensation cost for share-based payments to employees and non-employee directors based on the grant date fair value of the award, which we amortize over the grantees' service period in accordance with the provisions of Compensation—Stock Compensation Topic, ASC 718-10. We use the Black-Scholes valuation model to value employee stock options.

        We estimated the fair value for these options at the date of grant using a Black-Scholes option pricing model with the following range of assumptions:

 
  For options granted in:
 
  2011   2010

Weighted-average grant date fair value

  $ 4.14   $5.43

Risk free interest rates

    1.49 % 1.08% - 2.26%

Dividend yields

    0.0 % 0.0%

Expected volatility

    58.36 % 48.96% - 55.79%

Expected lives of options (in years)

    3.75   3.3 - 3.8

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. STOCK-BASED COMPENSATION (Continued)

        We did not capitalize any cost of stock-based compensation for our employees or non-employee directors. Future expense may vary based upon factors such as the number of awards granted by us and the then-current fair value of such awards.

        A summary of option activity for the nine months ended September 30, 2011 is set forth below:

Options
  Options
(in thousands)
  Weighted
Average
Exercise
Price
 

Outstanding, January 1, 2011

    5,564   $ 12.97  
 

Exercised

    (660 )   12.04  
 

Forfeited or expired

    (76 )   12.78  
           

Outstanding just prior to Part D transaction

    4,828     13.10  
 

Settled in connection with Part D Transaction

    (4,828 )   13.10  
 

Granted following Part D Transaction

    2,680     9.33  
 

Forfeited or expired following Part D Transaction

    (13 )   9.33  
           

Outstanding, September 30, 2011

    2,667   $ 9.33  
           

        The total intrinsic value of options (the amount by which the market price of the stock on the date of exercise exceeded the exercise price of the option) exercised during the first nine months of 2011 was $6.2 million and the total intrinsic value of options exercised during the first nine months of 2010 was $3.8 million. The intrinsic value of options settled in connection with the Part D Transaction was $44.9 million, which does not include 390,000 options awarded to employees of the Part D segment, which were settled by CVS Caremark. As of September 30, 2011, the total compensation cost related to non-vested awards not yet recognized was $9.5 million, which we expect to recognize over a weighted average period of 1.9 years.

        We received proceeds of $8.0 million from the exercise of stock options during the first nine months of 2011 and proceeds of $3.2 million from the exercise of stock options during the first nine months of 2010. ASC 718-10 also requires us to report the benefits of tax deductions in excess of recognized compensation cost as a financing cash flow. We recognized $2.6 million of financing cash flows for these excess tax deductions for the nine months ended September 30, 2011 and $1.6 million for the nine months ended September 30, 2010.

    Employee and Director Restricted Stock Awards

        257,000 shares of Restricted Stock, issued prior to the Part D Transaction, vested in connection with the closing of the Part D Transaction. 83,000 shares of restricted stock awarded to employees of the Part D segment prior to the Part D Transaction were settled by CVS Caremark. The remaining 302,000 shares of Restricted Stock were exchanged for the right to receive the same merger consideration paid to Old Universal American shareholders in the Part D Transaction ($14.00 in cash and one share of New Universal American common stock), subject to the same vesting conditions. These restricted stock grants vest ratably over four years from the grant date. We value restricted stock awards at an amount equal to the market price of our common stock on the date of grant. We

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. STOCK-BASED COMPENSATION (Continued)

recognize compensation expense for restricted stock awards on a straight line basis over the vesting period.

        A summary of the status of our non-vested restricted stock awards is set forth below:

Non-Vested Restricted Stock
  Shares
(in thousands)
  Weighted
Average
Grant-Date
Fair Value
 

Non-vested at beginning of period

    897   $ 13.41  
 

Vested

    (235 )   12.87  
 

Forfeited

    (20 )   12.93  
           

Outstanding just prior to Part D Transaction

    642     13.62  
 

Settled in connection with Part D Transaction

    (340 )   13.92  
 

Vested following Part D Transaction

    (25 )   13.94  
 

Forfeited following Part D Transaction

    (4 )   12.39  
           

Non-vested at end of period

    273   $ 13.25  
           

        The total fair value of shares of restricted stock vested during the nine months ended September 30, 2011 was $4.9 million and the total fair value of shares of restricted stock vested during the nine months ended September 30, 2010 was $2.5 million.

    Performance Shares

        In 2009 and 2010, the Board of Directors awarded performance shares to certain of our officers. The actual number of shares that potentially could be earned at the conclusion of the three year vesting period varied from 0% to 150% of the target award, based on our total shareholder return relative to a group of peer companies that were selected prior to the award. Compensation expense is recognized on a straight line basis over the vesting period. Prior to vesting, previously recognized compensation expense may be reversed in the event a grantee resigns, however, once the vesting date is reached, previously recognized expense may not be changed, even if the actual award varies from the target.

        In connection with the closing of the Part D Transaction, each performance share was exchanged for the right to receive the same merger consideration paid to Old Universal American shareholders in the Part D Transaction ($14.00 in cash and one share of New Universal American common stock) on the one year anniversary of the closing date. At the closing of the Part D Transaction, our Compensation Committee determined that performance shares granted in 2009 and 2010 were earned at 150% and 100% of target, respectively, thus fixing the number of shares distributable upon completion of the remaining vesting period. This treatment resulted in revaluation of the awards and the recognition period for remaining unrecognized expense was adjusted to match the new vesting period.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. STOCK-BASED COMPENSATION (Continued)

        A summary of the status of our non-vested performance share awards is set forth below:

 
  Nine Months Ended
September 30, 2011
 
Non-Vested Performance Shares
  Shares
(in thousands)
  Weighted
Average
Grant-Date
Fair Value
 

Non-vested at beginning of period

    761   $ 13.86  
 

Granted

    171     11.65  
 

Forfeited

    (2 )   15.66  
           

Outstanding just prior to Part D Transaction

    930     13.45  
 

Settled in connection with Part D Transaction

    (140 )   13.49  
 

Forfeited following Part D Transaction

    (60 )   13.31  
           

Non-vested at end of period

    730   $ 13.45  
           

        The performance shares settled in connection with the Part D Transaction represent shares awarded to employees of the Part D segment, which were settled by CVS Caremark.

11. COMMITMENTS AND CONTINGENCIES

    Legal Proceedings

        We are subject to a variety of legal proceedings, claims, and litigation arising in the ordinary course of business, including claims for medical, disability, life insurance and other benefits. In some cases, plaintiffs seek punitive damages. While the outcome of these matters is currently not determinable, we do not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

    Government Regulations

        In July 2009 and March 2010, we received subpoenas from the Department of Health and Human Services, Office of Inspector General, known as HHS-OIG, requesting documents related to marketing, sales and enrollment practices for our Today's Health Medicare HMO Plans which were offered in the State of Wisconsin. We subsequently learned that the HHS-OIG's investigation was initiated as a result of a False Claims Act complaint filed by two former sales agents. In September 2011, we settled this matter and paid $4.8 million to HHS-OIG and entered into a five-year Corporate Integrity Agreement with HHS-OIG. The Corporate Integrity Agreement provides that we shall, among other things, keep in place and continue our current compliance program, including a corporate compliance officer and compliance officers for our Medicare Advantage business, a corporate compliance committee, a compliance committee of our Board of Directors, a code of conduct, comprehensive compliance policies, training and monitoring, a compliance hotline, an open door policy and a disciplinary process for compliance violations. The Corporate Integrity Agreement also requires us to engage an independent third party to review our compliance with our obligations under the Corporate Integrity Agreement and submit various reports to HHS-OIG.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

11. COMMITMENTS AND CONTINGENCIES (Continued)

        Laws and regulations governing Medicare and other state and federal healthcare and insurance programs are complex and subject to significant interpretation. As part of the recent healthcare reform legislation, CMS has been exercising increased oversight and regulatory authority over our Medicare businesses. Compliance with such laws and regulations is subject to CMS audit, other governmental review and investigation and significant interpretation. There can be no assurance that we will be found to be in compliance with all such laws and regulations in connection with these audits, reviews and investigations. Failure to be in compliance can subject us to significant regulatory action including significant fines, penalties or operating restrictions on our business, including, without limitation, suspension of our ability to market to and enroll new members in our Medicare plans and exclusion from Medicare and other state and federal healthcare programs. On November 19, 2010, CMS notified us that we were suspended from marketing to and enrolling new members in our Medicare Advantage plans, effective December 5, 2010. According to CMS, the suspension related primarily to agent oversight and market conduct issues and was to remain in effect until CMS was satisfied that we had corrected the issues and they were not likely to recur. On August 5, 2011 CMS notified us that the sanctions had been lifted, allowing us to begin enrolling new members with an effective date of September 1, 2011.

12. BUSINESS SEGMENT INFORMATION

        As of September 30, 2011, our business segments are based on product and consist of

    Senior Managed Care—Medicare Advantage, and

    Traditional Insurance.

        Our remaining segment, Corporate & Other, includes the activities of our holding company, along with the operations formerly reported in the Senior Administrative Services segment.

        We closed the Part D Transaction on April 29, 2011 (See Note 1—Organization and Company Background). The sale eliminated all of the business operations of our Medicare Part D segment and certain debt service expenses of our Corporate & Other segment. Beginning with our June 30, 2011 quarterly report on Form 10-Q, their current and historical results are reported as discontinued operations (See Note 14—Discontinued Operations).

        We report intersegment revenues and expenses on a gross basis in each of the operating segments but eliminate them in the consolidated results. These intersegment revenues and expenses affect the amounts reported on the individual financial statement line items, but we eliminate them in consolidation and they do not change income before taxes. The most significant items eliminated are intersegment revenue and expense relating to commissions earned by agency subsidiaries in our Corporate & Other segment from insurance subsidiaries in our Traditional segment.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

12. BUSINESS SEGMENT INFORMATION (Continued)

        Financial data by segment, with a reconciliation of segment revenues and segment income (loss) before income taxes to total revenue and income from continuing operations before income taxes in accordance with U.S. generally accepted accounting principles is as follows:

 
  Three months ended September 30,  
 
  2011   2010  
 
  Revenues   Income(Loss)
Before
Income Taxes
  Revenues   Income(Loss)
Before
Income Taxes
 
 
  (in thousands)
 

Senior Managed Care—Medicare Advantage

  $ 507,562   $ 21,408   $ 800,558   $ 36,884  

Traditional Insurance

    69,876     6,682     75,278     3,511  

Corporate & Other

    5,166     (8,083 )   696     (6,272 )

Intersegment revenues

    (1,099 )            

Adjustments to segment amounts:

                         
 

Net realized gains(1)

    408     408     7,085     7,085  
                   

Total

  $ 581,913   $ 20,415   $ 883,617   $ 41,208  
                   

 

 
  Nine months ended September 30,  
 
  2011   2010  
 
  Revenues   Income(Loss)
Before
Income Taxes
  Revenues   Income(Loss)
Before
Income Taxes
 
 
  (in thousands)
 

Senior Managed Care—Medicare Advantage

  $ 1,529,629   $ 48,161   $ 2,381,948   $ 136,109  

Traditional Insurance

    213,208     8,581     232,936     1,669  

Corporate & Other

    10,333     (32,090 )   10,582     (15,234 )

Intersegment revenues

    (1,932 )       (5,958 )    

Adjustments to segment amounts:

                         
 

Net realized gains(1)

    2,404     2,404     6,906     6,906  
                   

Total

  $ 1,753,642   $ 27,056   $ 2,626,414   $ 129,450  
                   

(1)
We evaluate the results of operations of our segments based on income before realized gains and losses and income taxes. We believe that realized gains and losses are not indicative of overall operating trends.

13. OTHER DISCLOSURES

        Income Taxes:    Our effective tax rate on income from continuing operations was 30.9% for the third quarter of 2011, compared to 18.2% for the third quarter of 2010. The periods include $2.2 million and $7.8 million, respectively, of non-recurring tax benefits. The 2011 benefit includes $2.1 million related to the sale of our previously-owned administrative services company, CHCS with the balance related to state income tax refunds. The 2010 benefit primarily relates to the impact of tax law changes on our insurance companies.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

13. OTHER DISCLOSURES (Continued)

        For the nine months ended September 30, 2011, our effective tax rate on income from continuing operations was 30.3%, compared with 27.5% for the same period of 2010. The periods include $3.0 million and $11.6 million, respectively, of non-recurring tax benefits. The 2011 benefit includes $2.1 million related to the sale of our previously-owned administrative services company, CHCS with the balance related to state income tax refunds. The 2010 benefit was primarily related to the impact of tax law changes on our insurance companies as well as benefits that were recognized upon the completion of examinations by the Internal Revenue Service and were primarily attributable to pre-acquisition tax returns of MemberHealth, Inc..

        Reinsurance:    In connection with the Part D Transaction, our previously owned insurance subsidiary, Pennsylvania Life Insurance Company, known as Pennsylvania Life, was sold to CVS Caremark. Pennsylvania Life included a Medicare Part D business as well as portions of our traditional business. At the closing of the Part D Transaction such traditional business was reinsured by one of our subsidiaries in order to retain that business at New Universal American. Under this reinsurance agreement, the assumed policy liabilities are recorded net of the portion ceded to third party reinsurers by Pennsylvania Life, resulting in offsetting decreases to gross policy liabilities and reinsurance recoverable of approximately $206 million, from the prior year end.

        We evaluate the financial condition of our reinsurers and monitor concentrations of credit risk to minimize our exposure to significant losses from reinsurer insolvencies. We are obligated to pay claims in the event that a reinsurer to whom we have ceded an insured claim fails to meet its obligations under the reinsurance agreement. We are also obligated to pay claims on the traditional business of Pennsylvania Life in the event that any of the third party reinsurers to whom Pennsylvania Life has ceded an insured claim fails to meet their obligations under the reinsurance agreement. We had approximately $500 million of amounts recoverable from reinsurers as reported on our consolidated balance sheet as of September 30, 2011. In addition, Pennsylvania Life had approximately $190 million of amounts recoverable from reinsurers that are netted in the policy liabilities assumed from Pennsylvania Life in our consolidated balance sheet.

        As of September 30, 2011, all of our primary reinsurers, as well as the primary third party reinsurers of Pennsylvania Life's traditional business, were rated "A-" (Excellent) or better by A.M. Best with the exception of one reinsurer. For that reinsurer, which is not rated, a trust containing assets at 106% of reserves is maintained. The reserves amounted to approximately $165 million as of September 30, 2011. We do not know of any instances where any of our reinsurers, or any of the primary third party reinsurers of Pennsylvania Life's traditional business, has been unable to pay any policy claims on any reinsured business.

        Acquisition of noncontrolling interest in subsidiary:    In July 2011, we acquired the noncontrolling membership interests held by one of our physician groups in our subsidiary, SelectCare of Texas, LLC. ASC 810, Consolidation, requires that changes in a parent's ownership interest while the parent retains its controlling interest in its subsidiary shall be accounted for as an equity transaction. As a result of this transaction, the noncontrolling interest was eliminated and the $10.5 million excess of the consideration over the carrying value of the noncontrolling interest was recorded as a reduction to additional paid-in capital.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

13. OTHER DISCLOSURES (Continued)

        Special Dividend:    On July 28, 2010, our Board of Directors approved the payment of a special cash dividend of $2.00 per share to each holder of the Company's outstanding common stock and Series A Preferred Stock. This special cash dividend was paid on August 19, 2010 to the stockholders of record as of the close of business on August 5, 2010. The cumulative dividend payment was $156.0 million. In addition, pursuant to the terms of our 1998 Incentive Compensation Plan, we established a dividend payable liability to hold amounts expected to be paid in the future to holders of our restricted stock and performance shares as such shares vest. This liability is approximately $2.0 million at September 30, 2011.

        Sale of CHCS:    On April 26, 2010, we entered into an agreement to sell the outstanding common stock of CHCS, our administrative services company, to Patni Americas, Inc, a wholly-owned subsidiary of Patni Computer Systems Limited (NYSE: PTI), for $6.0 million in cash, subject to an adjustment for any net working capital remaining at CHCS on the closing date. The transaction closed on June 9, 2010, with an effective date of April 1, 2010. The operations of CHCS are included in consolidated results up to the effective date of the sale. The total consideration was approximately $7.5 million. Our carrying value of the assets disposed of in connection with the sale of CHCS was approximately $7.2 million, including $4.4 million of goodwill. We recognized an immaterial loss on the disposition after consideration of transaction costs of approximately $0.3 million.

14. DISCONTINUED OPERATIONS

        As discussed in Note 1—Organization and Company Background, we sold our Medicare Part D business to CVS Caremark on April 29, 2011.

        In accordance with ASC 360, effective with the closing of Part D Transaction on April 29, 2011, the results of operations and cash flows related to our Medicare Part D business and related corporate items are reported as discontinued operations for all periods presented. In addition, the related assets and liabilities have been segregated from the assets and liabilities related to our continuing operations and presented separately in our consolidated balance sheet as of December 31, 2010. In addition, because the Part D Transaction is considered a "reverse spin-off" for accounting purposes, for financial statement presentation, there is no gain or loss on the separation of the disposed net assets and liabilities. Rather, the carrying amounts of the net assets and liabilities of our former Medicare Part D segment and related corporate accounts are removed at their historical cost with an offsetting reduction to stockholders' equity. As of April 29, 2011, we incurred a $440.5 million reduction in stockholders' equity from the separation, representing the net assets transferred to CVS Caremark upon the closing of the Part D Transaction.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

14. DISCONTINUED OPERATIONS (Continued)

        Summarized financial information for our discontinued operations, including expenses of the transaction for the periods ended September 30, is presented below:

 
  Three months ended
September 30,
  Nine months ended
September 30,
 
 
  2011   2010   2011   2010  
 
  (in thousands)
 

Net premium and policyholder fees earned

  $   $ 457,571   $ 815,370   $ 1,682,466  

Net realized loss on investments

        (1,610 )   (11,925 )   (1,610 )

Other income

        698     18,535     2,374  
                   
   

Total revenues

        456,659     821,980     1,683,230  
                   

Benefits, claims and expenses:

                         
 

Claims and other benefits

        358,564     807,161     1,536,360  
 

Amortization of present value of future profits

        4,011     5,348     12,035  
 

Expenses of transactions

            16,191      
 

Other operating costs and expenses

        51,291     72,299     150,587  
                   
   

Total benefits, claims and expenses

        413,866     900,999     1,698,982  
                   

Income (loss) from discontinued operations before income taxes

        42,793     (79,019 )   (15,752 )

Provision for (benefit from) income taxes(1)

        15,762     (37,147 )   (5,007 )
                   

Income (loss) from discontinued operations

  $   $ 27,031   $ (41,872 ) $ (10,745 )
                   

(1)
Income taxes for the nine-month period ended September 30, 2011 include non-recurring tax benefits of $9.5 million, related to state tax refunds and the true-up of deferred taxes related to the business sold in the Part D Transaction.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

14. DISCONTINUED OPERATIONS (Continued)

        Total assets and liabilities of discontinued operations are as follows:

 
  December 31, 2010  
 
  (in thousands)
 

Assets

       

Cash and cash equivalents

  $ 42,220  

Present value of future profits and other amortizing intangible assets

    106,807  

Goodwill and other indefinite lived intangible assets

    448,215  

CMS contract deposit receivables

    196,584  

Other Part D receivables

    214,183  

Other assets

    3,833  
       
 

Total assets

  $ 1,011,842  
       

Liabilities

       

Policy and contract claims—health

  $ 68,149  

Loan payable

    232,872  

Other long-term debt

    110,000  

Deferred income tax payable

    37,398  

Other Part D liabilities

    107,031  

Other liabilities

    23,604  
       
 

Total liabilities

  $ 579,054  
       

        As reflected above, the following are notable corporate items that were retained by Old Universal American and thus reported in discontinued operations in the historical balance sheets. For additional detail on these items, see the notes to consolidated financial statements in Universal American Corp's. Annual Report on Form 10-K for the year ended December 31, 2010.

        Loan Payable and Other Long-Term Debt—Our term loan and outstanding principal balance on trust preferred securities as well as the related deferred debt costs were assumed, paid off or retained by Old Universal American. The outstanding principal balances on the borrowings were $203.3 million and $110.0 million, respectively, as of April 29, 2011. The balance of deferred costs was $4.3 million at April 29, 2011.

        Interest Rate Swaps—In 2007, we entered into two separate interest rate swap agreements intended to swap the floating rate on our term loan to a fixed rate. The combined fair value of these swaps was a $14.0 million liability at December 31, 2010, partially offset by $4.8 million of deferred tax assets. In connection with the closing of the Part D Transaction on April 29, 2011, we settled the swaps on April 28, 2011 and recognized a realized loss of $11.7 million in discontinued operations.

        Continuing Cash Flows—In connection with the Part D Transaction, CVS Caremark and New Universal American entered into a Transition Services Agreement or TSA, under which New Universal American will continue to provide certain services to CVS Caremark, based on historical cost, for up to one year following the closing of the Part D Transaction, or a lesser period, with timing determined on a service-by-service basis. The cost of such services provided under the TSA, from the closing of the

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

14. DISCONTINUED OPERATIONS (Continued)


Part D Transaction through September 30, 2011, amounted to $6.2 million and was recorded in other operating costs and expenses in the consolidated statements of operations. Related revenues of $6.2 million were recorded in fees and other income.

        Prior to the Part D Transaction, our Medicare Part D segment provided Prescription Benefit Management, or PBM, services to our Medicare Advantage segment in connection with the Medicare Part D aspects of Medicare Advantage products. In connection with the Part D Transaction, we entered into an agreement with CVS Caremark to provide these services pursuant to a PBM services agreement with a term commencing October 15, 2011 and continuing through December 31, 2016, subject to earlier termination under certain specified circumstances. Prior to the Part D Transaction, amounts for these services were recorded as expense by our Medicare Advantage segment and Revenue by our Part D Segment and eliminated in consolidation. The cost of such services was $1.4 million and $1.9 million in the Quarters ended September 30, 2011 and 2010, respectively and $4.1 million and $5.7 million in the nine months ended September 30, 2011 and September 30, 2010, respectively, and was recorded in other operating costs and expenses in the consolidated statements of operations.

        Prior to the Part D Transaction, the net retained traditional business of Pennsylvania Life was assumed, on a 100% quota share coinsurance basis, by one of our retained subsidiaries through an Indemnity Reinsurance Agreement, essentially excluding this business from the Part D Transaction. We will continue to perform the administration of this business.

        We do not believe our ongoing relationship with CVS Caremark is significant and therefore it does not impact our conclusion on discontinued operations treatment for this business.

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ITEM 2—MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

        The following discussion and analysis presents a review of our financial condition as of September 30, 2011 and our results of operations for the three and nine months ended September 30, 2011 and 2010. As used in this report, except as otherwise indicated, references to the "Company," "UAM," "we," "our," and "us" are to (i) Universal American Corp., a Delaware corporation (formerly known as Universal American Spin Corp., "New Universal American") and its subsidiaries following the closing of the Part D Transaction on April 29, 2011 and (ii) Universal American Corp, a New York corporation (now known as Caremark Ulysses Holding Corp., "Old Universal American") and its subsidiaries prior to the closing of the Part D Transaction on April 29, 2011.

        You should read the following analysis of our consolidated results of operations and financial condition in conjunction with the Consolidated Financial Statements and related consolidated Footnotes included elsewhere in this quarterly report on Form 10-Q as well as the Consolidated Financial Statements and related consolidated Footnotes and the Management's Discussion and Analysis of Financial Condition and Results of Operations included in our annual report on Form 10-K for the year ended December 31, 2010 filed on March 1, 2011. For further information regarding New Universal American, please see Amendment No. 1 to the Registration Statement on Form S-4 (File No. 333-172691) of New Universal American filed on March 31, 2011. You should also read the following analysis in conjunction with the Risk Factors set forth or incorporated by reference in Part II, Item 1A in this report.

Part D Sale Transaction

        We closed the sale of our Medicare Part D business to CVS Caremark on April 29, 2011 (The Part D Transaction) and shareholders of Old Universal American received $14.00 per share in cash and one share of New Universal American common stock for each share owned. New Universal American now owns the businesses and assets that previously comprised Old Universal American's Senior Managed Care—Medicare Advantage, Traditional Insurance and Corporate & Other segments. For a further discussion of the Part D Transaction, please see Note 1—Organization and Company Background and Note 14—Discontinued Operations.

Membership

        The following table presents our membership in our Medicare Advantage segment as of September 30, 2011 and 2010.

 
  As of
September 30,
 
 
  2011   2010  
 
  (in thousands)
 

Non-network PFFS (Rural)

    30     198  

Network PFFS

    53      
           
 

Total PFFS

    83     198  

Network-based (HMO and PPO)

    81     94  
           
 

Total Membership

    164     292  
           

        Medicare Advantage membership decreased 128,000 compared to September 30, 2010. This decline was expected, as we were required to terminate approximately 60,000 members as a result of the network requirements of the Medicare Improvements for Patients and Providers Act of 2008, known as MIPPA. Further, due to lapsation and the limited ability to add new members during the 2011 Annual Election Period as a result of CMS sanctions, membership declined by an additional 68,000 members.

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Healthcare Reform

        In March 2010, President Obama signed into law The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the "Affordable Care Act") which enacts significant changes to various aspects of the U.S. health insurance industry. There are many important provisions of the legislation that will require additional guidance and clarification in the form of regulations and interpretations in order to fully understand the impact of the legislation on our overall business, which we expect to occur over the next several years. Certain aspects of the Affordable Care Act are currently being challenged in the judicial system. In addition, Congress may withhold the funding necessary to implement the new reforms or attempt to replace the legislation with amended provisions or repeal it altogether.

        Certain significant provisions of the Affordable Care Act that will impact our business include, among others, reduced Medicare Advantage reimbursement rates, implementation of quality bonus for Star Ratings, stipulated minimum medical loss ratios, shortened annual enrollment period, non-deductible federal premium taxes assessed to health insurers, coding intensity adjustments with mandatory minimums and a limitation on the federal tax deductibility of compensation earned by individuals. Due to the complexity of the health reform legislation, including yet to be promulgated implementing regulations, lack of interpretive guidance, gradual implementation and the fact that the Affordable Care Act has been challenged in the judicial system, the impact of the health reform legislation is difficult to predict and not yet fully known. In addition, financing for the reforms contained in the Affordable Care Act will come, in part, from additional taxes and fees on our business as well as reductions in payments to us, which could negatively impact our business and results of operations. The Health Care Reform Legislation is discussed more fully under Risk Factors set forth or incorporated by reference in Part II, Item 1A in this report.

Results of Operations—Consolidated Overview

        The following table reflects income (loss) before taxes from each of our segments and contains reconciliations to reported net income:

 
  Three months ended
September 30,
  Nine months ended
September 30,
 
 
  2011   2010   2011   2010  
 
  (in thousands, except per share amounts)
 

Senior Managed Care—Medicare Advantage(1)

  $ 21,408   $ 36,884   $ 48,161   $ 136,109  

Traditional Insurance(1)

    6,682     3,511     8,581     1,669  

Corporate & Other(1)

    (8,083 )   (6,272 )   (32,090 )   (15,234 )

Net realized gains on investments(1)

    408     7,085     2,404     6,906  
                   

Income before provision for income taxes(1)

    20,415     41,208     27,056     129,450  
 

Provision for income taxes

    6,311     7,495     8,199     35,551  
                   

Income from continuing operations

    14,104     33,713     18,857     93,899  

Income (loss) from discontinued operations(2)

        27,031     (41,872 )   (10,745 )
                   
 

Net income (loss)

  $ 14,104   $ 60,744   ($ 23,015 ) $ 83,154  
                   

Per share data (diluted):

                         
 

Income from continuing operations

  $ 0.17   $ 0.43   $ 0.23   $ 1.20  
 

Income (loss) from discontinued operations(2)

        0.34     (0.52 )   (0.14 )
                   
   

Net income (loss)

  $ 0.17   $ 0.77   $ (0.29 ) $ 1.06  
                   

(1)
We evaluate the results of operations of our segments based on income before realized gains (losses) and income taxes. We believe that realized gains and losses are not indicative of overall operating trends. This differs from U.S. GAAP, which includes the effect of realized gains (losses)

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    and income taxes in the determination of net income. The schedule above reconciles our segment income before income taxes to net income in accordance with U.S. GAAP.

(2)
Includes after-tax transaction costs of $10.5 million or $0.13 per diluted share, respectively, for the nine months ended September 30, 2011 (See Note 14—Discontinued Operations).

    Three months ended September 30, 2011 and 2010

        Income from continuing operations for the three months ended September 30, 2011 was $14.1 million, or $0.17 per diluted share, compared to $33.7 million, or $0.43 per diluted share for the three months ended September 30, 2010. Income from continuing operations for the quarter includes realized investment gains, net of taxes, of $0.3 million, or less than $0.01 per diluted share compared to $4.6 million, or $0.06 per diluted share, for the same period in 2010. Our effective tax rate from continuing operations was 30.9% for the third quarter of 2011 compared with 18.2% for the third quarter of 2010. The effective rate for the three months ended September 30, 2011 includes $2.2 million of non-recurring tax benefits recognized during the third quarter of 2011 compared to $7.8 million recognized in the third quarter of 2010. The 2011 benefit includes $2.1 million related to the sale of our previously-owned administrative services company, CHCS, with the balance related to state income tax refunds. The 2010 benefit primarily relates to the impact of tax law changes on our insurance companies. The higher effective rate in the quarter ended September 30, 2011 was also driven by revenue-based state taxes on lines of business where revenues were relatively constant year-over-year while pre-tax income was lower in 2011. Excluding the non-recurring tax benefits and the revenue-based state taxes, our effective tax rate was 38.5% and 35.5% for the three months ended September 30, 2011 and 2010, respectively.

        Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $21.4 million for the three months ended September 30, 2011, a decrease of $15.5 million compared to the three months ended September 30, 2010. The decrease in earnings was driven by a 41% decrease in member months for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 caused by the anticipated decline in membership and decreased expense efficiency as expense levels declined more slowly than revenues. The third quarter of 2011 included favorable prior period items of $20.7 million, compared to favorable prior period items of $3.9 million in the third quarter of 2010.

        Our Traditional Insurance segment generated income before income taxes of $6.7 million for the three months ended September 30, 2011; an increase of $3.2 million compared to the three months ended September 30, 2010. The increase in earnings is driven by increased net investment income, primarily due to a change in the mix of assets caused by the investing of our cash and cash equivalents into higher yielding fixed maturity securities, as well as a decrease in general expenses.

        The loss before income taxes from our Corporate & Other segment increased by $1.8 million for the third quarter of 2011 compared to the third quarter of 2010. This was due primarily to increases of $2.0 million in operating expenses and $0.8 million in interest expense, offset by a decrease of $0.8 million in stock-based compensation expenses.

    Nine months ended September 30, 2011 and 2010

        Income from continuing operations for the nine months ended September 30, 2011 was $18.9 million, or $0.23 per diluted share, compared to $93.9 million, or $1.20 per diluted share for the nine months ended September 30, 2010. Income from continuing operations for the first nine months of 2011 includes realized investment gains, net of taxes, of $1.6 million, or $0.02 per diluted share compared to $4.5 million, or $0.06 per diluted share, for the same period in 2010. Our effective tax rate from continuing operations was 30.3% for the first nine months of 2011, and 27.5% for the first nine months of 2010. The periods include $3.0 million and $11.6 million, respectively, of non-recurring

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tax benefits. The 2011 benefit includes $2.1 million related to the sale of our previously-owned administrative services company, CHCS, with the balance related to state income tax refunds. The 2010 benefit was primarily related to the impact of tax law changes on our insurance companies as well as benefits that were recognized upon the completion of examinations by the Internal Revenue Service and were primarily attributable to pre-acquisition tax returns of MemberHealth, Inc. The higher effective rate in the period ended September 30, 2011 was also driven by revenue-based state taxes on lines of business where revenues were relatively constant year-over-year while pre-tax income was lower in 2011. Excluding the non-recurring tax benefits and the revenue-based state taxes, our effective tax rate was 34.4% and 34.9% for the nine months ended September 30, 2011 and 2010, respectively.

        Our Senior Managed Care—Medicare Advantage segment generated income before taxes of $48.2 million for the nine months ended September 30, 2011, a decrease of $87.9 million compared to the nine months ended September 30, 2010. The decrease in earnings was driven principally by lower members in all products resulting in an anticipated 40% decrease in member months for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010 and decreased expense efficiency. The first nine months of 2011 included favorable prior period adjustments of $16.3 million compared to favorable prior period items of $34.0 million in the first nine months of 2010.

        Our Traditional Insurance segment generated income before income taxes of $8.6 million for the nine months ended September 30, 2011; an increase of $6.9 million compared to the nine months ended September 30, 2010. The increase in earnings is driven by increased net investment income, primarily due to a change in the mix of assets caused by the investing of our cash and cash equivalents into higher yielding fixed maturity securities, as well as a decrease in general expenses.

        The loss before taxes from our Corporate & Other segment increased by $16.9 million for the nine months ended September 30, 2011 compared to the same period of 2010. This was due primarily to increases of $8.0 million in stock-based compensation expenses, $6.1 million in operating expenses, $1.2 million related to the loss of earnings from our TPA which was sold in the third quarter of 2010 and $1.4 million in interest expense.

Segment Results—Senior Managed Care—Medicare Advantage

 
  Three months ended
September 30,
  Nine months ended
September 30,
 
 
  2011   2010   2011   2010  
 
  (in thousands)
  (in thousands)
 

Net premiums

  $ 501,124   $ 793,967   $ 1,507,922   $ 2,361,607  

Net investment and other income

    6,438     6,591     21,707     20,341  
                   
 

Total revenue

    507,562     800,558     1,529,629     2,381,948  
                   

Medical expenses

    408,808     672,606     1,253,089     1,967,976  

Amortization of intangible assets

    918     1,016     2,995     3,256  

Commissions and general expenses

    76,428     90,052     225,384     274,607  
                   
 

Total benefits, claims and other deductions

    486,154     763,674     1,481,468     2,245,839  
                   

Segment income before income taxes

  $ 21,408   $ 36,884   $ 48,161   $ 136,109  
                   

        Our Senior Managed Care—Medicare Advantage segment includes the operations of our Medicare coordinated care Plans including PPOs and HMOs as well as our network-based PFFS and rural PFFS business, which provides coverage to Medicare beneficiaries in 37 states. Our HMOs offer coverage to Medicare beneficiaries primarily in Southeastern Texas, the area surrounding Dallas/Ft. Worth, 15 counties in Oklahoma and 4 counties in Wisconsin.

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    Three months ended September 30, 2011 and 2010

        Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $21.4 million for the three months ended September 30, 2011, a decrease of $15.5 million compared to the three months ended September 30, 2010. The decrease in earnings was driven by a 41% decrease in member months for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 caused by the anticipated decline in membership and decreased expense efficiency as expense levels declined more slowly than revenues. The third quarter of 2011 included favorable prior period items of $20.7 million compared to favorable prior period items of $3.9 million in the third quarter of 2010.

        Membership.    Membership in our Medicare Advantage plans declined by 128,000 members from September 30, 2010 to September 30, 2011. As a result of the network requirements of MIPPA, we were required to terminate approximately 60,000 members as of January 1, 2011. Further, due to lapsation and the limited ability to add new members during the 2011 Annual Election Period as a result of the CMS sanctions, membership declined by an additional 68,000 members, resulting in membership of approximately 164,000 as of September 30, 2011.

        Net Premiums.    Net premiums for the Senior Managed Care—Medicare Advantage segment decreased by $292.8 million compared to the three months ended September 30, 2011, primarily due to the decline in membership that resulted in lower member months. During the third quarters of 2011 and 2010, CMS performed its annual final risk adjusted premium reconciliation for the prior year plan year that resulted in an additional $8.6 million in risk adjusted premium received in 2011 for the 2010 plan year and $10.4 million in revenue received in 2010 for the 2009 plan year. In addition during the third quarter of 2011, we received $7.1 million in revenue from CMS for prior periods principally related to the correction by CMS of the premium related to End-Stage Renal Disease, known as ESRD, members, compared with $7.0 million received in the same period in 2010, primarily related to 2009 member reconciliations.

        Medical expenses.    Medical expenses decreased by $263.8 million compared to the third quarter of 2010, as a result of the decrease in member months. The medical expense ratio improved to 81.6% for the third quarter of 2011 from 84.7% for the same period in 2010. Excluding the prior period items discussed above, the medical expense ratio was 84.9% for the third quarter of 2011.

        Commissions and general expenses.    Commissions and general expenses for the three months ended September 30, 2011 decreased $13.6 million compared to the three months ended September 30, 2010, primarily as the result of the decreased level of membership. The ratio of commissions and general expenses to net premiums increased to 15.3% in the third quarter of 2011 compared to 11.3% in third quarter of 2010, primarily as a result of reduced scale from lower membership and expenses incurred to address the issues raised by the CMS sanctions.

    Nine months ended September 30, 2011 and 2010

        Our Senior Managed Care—Medicare Advantage segment generated income before taxes of $48.2 million for the nine months ended September 30, 2011, a decrease of $87.9 million compared to the nine months ended September 30, 2010. The decrease in earnings was driven principally by lower members in all products resulting in an anticipated 40% decrease in member months for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010 and decreased expense efficiency. The first nine months of 2011 included favorable prior period adjustments of $16.3 million compared to favorable prior period items of $34.0 million in the first nine months of 2010.

        Net Premiums.    Net premiums for the Senior Managed Care—Medicare Advantage segment decreased by $853.7 million compared to the nine months ended September 30, 2010, primarily due to

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the lower member months in all plans. During the nine months ended September 30, 2011 and 2010, we received $11.7 million and $23.8 million, respectively, of premiums related to the prior plan year. These amounts were received as a result of our ongoing chart review process and CMS' final risk adjusted premium reconciliation for the prior plan year. In addition during the third quarter of 2011, we received $6.2 million in revenue from CMS for prior years principally related to the correction by CMS of the premium related to ESRD members, compared with $7.0 million received in the same period in 2010, primarily related to 2009 member reconciliations.

        Medical Expenses.    Medical expenses decreased by $714.9 million compared to the nine months ended September 30, 2010, consistent with the lower level of net premium. The medical expense ratio decreased to 83.1% for the nine months ended September 30, 2011 from 83.3% for the same period in 2010. Adjusting for the prior period items discussed above, the benefit ratio for the first nine months of 2011 was 83.9%.

        Commissions and general expenses.    Commissions and general expenses for the nine months ended September 30, 2011 decreased by $49.2 million compared to the nine months ended September 30, 2010 primarily as a result of the decreased level of membership. The ratio of commissions and general expenses to premiums increased to 14.9% for the nine months ended September 30, 2011 from 11.6% in 2010 as a result of reduced scale from lower membership and expenses incurred to address the issues raised by the CMS sanctions.

Segment Results—Traditional Insurance

 
  Three months ended
September 30,
  Nine months ended
September 30,
 
 
  2011   2010   2011   2010  
 
  (in thousands)
  (in thousands)
 

Net premiums

  $ 64,305   $ 71,148   $ 196,673   $ 220,669  

Net investment income

    5,349     3,676     16,082     10,953  

Other income

    222     454     453     1,314  
                   
 

Total revenue

    69,876     75,278     213,208     232,936  

Policyholder benefits

    47,460     51,192     152,065     167,223  

Change in deferred acquisition costs

    87     412     2,233     3,527  

Amortization of intangible assets

    22     704     327     2,003  

Commissions and general expenses, net of allowances

    15,625     19,459     50,002     58,514  
                   
 

Total benefits, claims and other deductions

    63,194     71,767     204,627     231,267  
                   

Segment income before income taxes

  $ 6,682   $ 3,511   $ 8,581   $ 1,669  
                   

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    Three months ended September 30, 2011 and 2010

        Our Traditional Insurance segment generated income before income taxes of $6.7 million for the three months ended September 30, 2011; an increase of $3.2 million compared to the three months ended September 30, 2010. The increase in earnings is driven by increased net investment income, primarily due to a change in the mix of assets caused by the investing of our cash and cash equivalents into fixed maturity securities, as well as a decrease in general expenses.

        The following tables detail premium for the segment by major lines of business:

Premium

 
  Three months ended September 30,  
 
  2011   2010  
 
  Gross   Ceded   Net   Gross   Ceded   Net  
 
  (in thousands)
 

Senior market

  $ 62,530   $ (15,740 ) $ 46,790   $ 70,416   $ (16,972 ) $ 53,444  

Specialty health

    14,944     (1,730 )   13,214     16,404     (2,530 )   13,874  

Life insurance and annuity

    14,333     (10,032 )   4,301     17,979     (14,149 )   3,830  
                           
 

Total premium

  $ 91,807   $ (27,502 ) $ 64,305   $ 104,799   $ (33,651 ) $ 71,148  
                           

        Net Premiums.    Net premium declined by $6.8 million or 9.6% from the third quarter of 2010. This is primarily the result of the continued effect of lapsation on our Medicare supplement and specialty health in-force business, offset partially by the increase in our retained senior life block of business.

        In conjunction with the sale of our Part D business, the traditional business of Pennsylvania Life was reinsured by one of our subsidiaries in order to retain that business at New Universal American. Under the reinsurance agreement, the net premium of Pennsylvania Life is recorded as gross premium on New Universal American, resulting in a decrease in both direct and ceded premium as compared to prior periods.

        Policyholder benefits.    Policyholder benefits declined by $3.7 million, or 7.3%, compared to the third quarter of 2010. This decline was principally due to the overall decline of insurance in-force in the senior market and specialty health lines of business offset by an increase in the overall average claim trend on Medicare supplement. For the three months ended September 30, 2011, the Medicare supplement policyholder benefit ratio increased slightly to 70.7%, compared with 70.2% for the same period last year. Specialty health's benefit ratio increased to 94.1%, compared with 85.3% for the same period last year. This was due to an increase in the severity of claims primarily on the long-term care block.

        Commissions and general expenses, net of allowances.    The following table details the components of commission and general expenses, net of allowances:

 
  Three months ended
September 30,
 
 
  2011   2010  
 
  (in thousands)
 

Direct commissions

  $ 5,567   $ 11,765  

Other operating costs

    6,728     12,466  

Reinsurance commissions and allowances

    3,330     (4,772 )
           

Commissions and general expenses, net of allowances

  $ 15,625   $ 19,459  
           

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        Total commissions and general expenses, net of allowances, decreased by $3.8 million compared to the third quarter of 2010. As a result of the reinsurance agreement with our former insurance company subsidiary, Pennsylvania Life Insurance Company, amounts which were reported as direct commissions and other operating costs in Pennsylvania Life Insurance Company are now reported as reinsurance commissions and allowances. Direct commission expense decreased $6.2 million compared to the same period in the prior year. This decrease was partially offset by a corresponding change in reinsurance commissions and allowances due to the new reinsurance agreement noted above. The remaining decrease in commissions is due to the decline in the amount of business in force. Other operating costs decreased $5.7 million for the quarter ended September 30, 2011, compared to the third quarter of 2010. This decrease was primarily offset by a corresponding change in reinsurance allowances, as discussed above.

        Our Traditional Insurance segment generated income before income taxes of $8.6 million for the nine months ended September 30, 2011; an increase of $6.9 million compared to the nine months ended September 30, 2010. The increase in earnings is driven by increased net investment income, primarily due to a change in the mix of assets caused by the investing of our cash and cash equivalents into fixed maturity securities, as well as a decrease in general expenses.

        The following tables detail premium for the segment by major lines of business:

Premium

 
  Nine months ended September 30,  
 
  2011   2010  
 
  Gross   Ceded   Net   Gross   Ceded   Net  
 
  (in thousands)
 

Senior market

  $ 191,434   $ (46,978 ) $ 144,456   $ 222,577   $ (54,359 ) $ 168,218  

Specialty health

    46,029     (6,105 )   39,924     50,256     (7,732 )   42,524  

Life insurance and annuity

    47,496     (35,203 )   12,293     53,187     (43,260 )   9,927  
                           
 

Total premium

  $ 284,959   $ (88,286 ) $ 196,673   $ 326,020   $ (105,351 ) $ 220,669  
                           

        Net Premiums.    Net premium declined by $24.0 million, or 10.9%. This is primarily the result of the continued effect of lapsation on our Medicare supplement and specialty health in-force business, offset partially by the increase in our retained senior life block of business. Additionally, 2011 includes a premium refund adjustment of $2.1 million. This adjustment related to the cumulative experience of certain Medicare supplement plans triggering refunds under the respective states' minimum lifetime loss ratio requirements.

        In conjunction with the sale of our Part D business, the traditional business of Pennsylvania Life was reinsured by one of our subsidiaries in order to retain that business at New Universal American. Under the reinsurance agreement, the net premium of Pennsylvania Life is recorded as gross premium on New Universal American, resulting in a decrease in both direct and ceded premium as compared to prior periods.

        Policyholder Benefits.    Policyholder benefits declined by $15.2 million, or 9.1%, compared to the nine months ended September 30, 2010. This decline was principally due to the overall decline of insurance in-force in the senior market and specialty health lines of business partially offset by an increase in average claim trend on Medicare supplement from the same period in the prior year. For the nine months ended September 30, 2011, the policyholder benefit ratio for senior market health was 74.9% compared with 73.2%. The policyholder benefit ratio for specialty health increased to 95.3%

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compared with 91.0% for the same period last year, due to an increase in the severity of claims primarily on the long-term care block.

        Commissions and general expenses, net of allowances.    The following table details the components of commission and general expenses, net of allowances:

 
  Nine months ended
September 30,
 
 
  2011   2010  
 
  (in thousands)
 

Direct commissions

  $ 21,774   $ 35,084  

Other operating costs

    28,263     38,725  

Reinsurance commissions and allowances

    (35 )   (15,295 )
           

Commissions and general expenses, net of allowances

  $ 50,002   $ 58,514  
           

        Total commissions and general expenses, net of allowances, decreased by $8.5 million compared to the nine months ended September 30, 2010. As a result of the reinsurance agreement with our former insurance company subsidiary, Pennsylvania Life Insurance Company, entered into in connection with the Part D Transaction, amounts which were reported as direct commissions and other operating costs in Pennsylvania Life Insurance Company are now reported as reinsurance commissions and allowances. Direct commission expense decreased $13.3 million compared to the same period in the prior year. This decrease was partially offset by a corresponding change in reinsurance commissions and allowances due to the new reinsurance agreement noted above. The remaining decrease in commissions is due to the decline in the amount of business in force. Other operating costs decreased $10.5 million for the nine months ended September 30, 2011, compared to the nine months ended September 30, 2010. This decrease was primarily offset by a corresponding change in reinsurance allowances, as discussed above.

Segment Results—Corporate & Other

        The following table presents the primary components comprising the loss before taxes for the segment:

 
  Three months
ended
September 30,
  Nine months
ended
September 30,
 
 
  2011   2010   2011   2010  
 
  (in thousands)
  (in thousands)
 

Interest expense

  $ 850   $   $ 1,435   $  

Amortization of capitalized loan origination fees

    46         77      

Stock-based compensation expense

    2,123     2,939     15,094     7,048  

Other parent company expenses, net revenues

    5,143     3,145     15,223     9,076  

Net (gain) loss—Senior Administrative Services

    (79 )   188     261     (890 )
                   
 

Segment loss before income taxes

  $ 8,083   $ 6,272   $ 32,090   $ 15,234  
                   

        The sale of CHCS during the second quarter of 2010 (See Note 13—Other Disclosures) eliminated substantially all of the business operations of our former Senior Administrative Services segment. As a result, beginning with the June 30, 2010 quarterly report on Form 10-Q, we began to report current and historical results of the former Senior Administrative Services and Corporate segments in one segment called Corporate & Other.

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        The loss before income taxes from our Corporate & Other segment increased by $1.8 million for the third quarter of 2011 compared to the third quarter of 2010. This was due primarily to increases of $2.0 million in operating expenses and $0.8 million in interest expense, offset by a decrease of $0.8 million in stock-based compensation expenses.

        Operating expenses were $2.0 million higher in 2011 compared to the same period in 2010 due to Corporate & Other segment absorption of $2.4 million of expenses that would have been allocated to the Medicare Part D segment prior to the closing of the Part D Transaction.

        Interest expense represents costs associated with the dividend on the Mandatorily Redeemable Preferred Stock, which was issued on April 29, 2011.

        Stock-based compensation expense declined as a result of the accelerated vesting triggered by the April 2011 Part D Transaction. This resulted in fewer unvested awards to be amortized after the close of the Part D Transaction.

        The loss before taxes from our Corporate & Other segment increased by $16.9 million for the nine months ended September 30, 2011 compared to the same period of 2010. This was due primarily to increases of $8.0 million in stock- based compensation expenses, $6.1 million in operating expenses, $1.2 million related to the loss of earnings from our TPA which was sold in the third quarter of 2010 and $1.4 million in interest expense.

        The increase in stock-based compensation expense was driven by $8.6 million related to the accelerated vesting of equity awards in 2011 in connection with the Part D Transaction and the one-time $2.0 million favorable variance in 2010 related to the true up of stock option forfeiture rates. This was partially offset by a decrease in regular quarterly expense amortization in 2011 compared to the same period in 2010 as the accelerated vesting triggered by the Part D Transaction resulted in fewer unvested awards to be amortized after the close of the Part D Transaction.

        Operating expenses were $6.1 million higher in 2011 compared to the same period in 2010 due to Corporate & Other segment absorption of $4.5 million of expenses that would have been allocated to the Medicare Part D segment prior to the closing of the Part D Transaction. In addition, costs for legal and outside services were higher in 2011 compared to the same period in 2010.

        Interest expense represents costs associated with the dividend on the Mandatorily Redeemable Preferred Stock, which was issued on April 29, 2011.

Liquidity and Capital Resources

        Sources and Uses of Liquidity to the Parent Company, Universal American Corp.    We require cash at our parent company to support the growth of our insurance and HMO subsidiaries, fund potential growth through acquisitions of other companies or blocks of business, and pay the operating expenses necessary to function as a holding company, as applicable insurance department regulations require us to bear our own expenses.

        The parent company's sources and uses of liquidity are derived primarily from the following:

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        Insurance and HMO subsidiaries—Surplus Note, Dividends and Capital Contributions.    We require cash at our insurance and HMO subsidiaries to meet our policy-related obligations and to pay operating expenses, including the cost of administration of the policies, and to maintain adequate capital levels. Excess capital can be used by the insurance and HMO subsidiaries to make dividend payments to their respective holding companies, subject to certain restrictions, and from there to our parent company.

        Our insurance subsidiaries are required to maintain minimum amounts of statutory capital and surplus as required by regulatory authorities and each currently exceeds its respective minimum requirement at levels we believe are sufficient to support their current levels of operation. Our HMO subsidiaries are also required by regulatory authorities to maintain minimum amounts of capital and surplus and each currently is at or exceeds this minimum requirement.

        At September 30, 2011, we held cash and cash equivalents totaling $219 million and fixed maturity securities that could readily be converted to cash with carrying values of $1,224 million at our insurance companies and HMO subsidiaries. We believe that this level of liquidity is sufficient to meet our obligations and pay expenses.

        In 2007, our wholly-owned subsidiary, The Pyramid Life Insurance Company issued $60.0 million of surplus notes payable to our parent company, which bear interest at an average fixed rate of 7.5%. The Notes are repayable beginning March 29, 2009 provided that capital and surplus are sufficient to maintain risk-based capital levels of 450% or greater in the immediate prior year end. At December 31, 2010, Pyramid's risk-based capital ratio was below 450%, and therefore no payments of principal or interest have been made or accrued to date. We anticipate that Pyramid's risk-based capital ratio at December 31, 2011 will exceed 450%, and that repayment of this surplus note, including interest, will commence in 2012.

        Capital contributions to and dividends from our Insurance and HMO subsidiaries are made through their respective holding companies. We did not make any capital contributions to our insurance subsidiaries during the first nine months of 2011. In March 2011, our wholly-owned subsidiary, Constitution Life Insurance Company, declared and accrued a dividend of $11.7 million, which was paid in April 2011. In May 2011, our wholly-owned subsidiary, American Progressive Life and Health Insurance Company of New York, declared and paid a dividend of $13.3 million. We made capital contributions of $360,000 in March 2011 and $2.8 million in May 2011 to our HMO subsidiary, Today's Options of Oklahoma, Inc. In July 2011, our HMO subsidiary, SelectCare of Texas, LLC, declared a dividend of $24 million, which was paid in August 2011.

        Management service organization cash flows.    The primary sources of liquidity for these subsidiaries are fees collected from clients for performing administrative, marketing and management services. The primary uses of liquidity are the payments for salaries and expenses associated with providing these services. We believe the sources of cash for these subsidiaries will exceed scheduled uses of cash and result in amounts available to dividend to our parent holding company.

        Mandatorily Redeemable Preferred Shares.    As part of the closing of the Part D Transaction, the company issued $40 million of Mandatorily Redeemable Preferred Shares which pay a dividend quarterly at a rate of 8.5% per annum (See Note 6—Mandatorily Redeemable Preferred Shares). The proceeds from the sale were used to pay fees and expenses in connection with the Part D Transaction and a portion of the existing indebtedness of the Company at the closing of the Part D Transaction.

Investments

        We invest primarily in fixed maturity securities of the U.S. Government and its agencies, U.S. state and local governments, mortgage-backed securities and corporate fixed maturity securities with investment grade ratings of BBB- or higher by S&P or Baa3 or higher by Moody's Investor Service. As

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of September 30, 2011, approximately 99% of our fixed maturity investments had investment grade ratings from S&P or Moody's.

        Cash equivalents represent approximately 18% of our portfolio at September 30, 2011 and 10% at December 31, 2010. In the aggregate, approximately 41% of our cash and invested assets are in securities backed by the U.S. government or its agencies, as compared with 26% at December 31, 2010. These increases were primarily driven by the early receipt of approximately $148 million of October CMS premium on September 30, 2011. The aggregate credit quality of our total investment portfolio was AA- at September 30, 2011 and December 31, 2010.

        The net yields on our cash and invested assets increased to 3.3% for the nine months ended September 30, 2011, from 2.3% for the nine months ended September 30, 2010. The overall increase in yield is primarily due to a change in the mix of assets caused by the investing of our cash and cash equivalents into higher yielding fixed maturity securities.

        For additional information on Liquidity and Capital Resources, please refer to our annual report on Form 10-K for the year ended December 31, 2010, filed by Old Universal American on March 1, 2011.

        There have been no changes in our critical accounting policies during the current quarter. For a description of significant accounting policies, see Note 3—Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements included in our annual report on Form 10-K for the year ended December 31, 2010.

        The following table presents the components of the change in our liability for policy and contract claims—health for the nine months ended September 30, 2011:

 
  September 30, 2011  
 
  (in thousands)
 

Balance at beginning of period

  $ 306,390  
 

Less reinsurance recoverable

    (13,677 )
       

Net balance at beginning of year

    292,713  
       

Incurred related to:

       
 

Current Year

    1,405,718  
 

Prior Year Development

    (1,757 )
       

Total Incurred

    1,403,961  
       

Paid related to:

       
 

Current Year

    1,208,644  
 

Prior Year

    299,757  
       

Total paid

    1,508,401  
       

Net balance at end of year

    188,273  
 

Plus reinsurance recoverable

    5,527  
       

Balance at end of period

  $ 193,800  
       

        The liability for policy and contract claims—health decreased by $112.6 million at September 30, 2011 from December 31, 2010. This decrease was primarily attributable to lower reserves for our

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Medicare Advantage business. The lower reserves are due to the decline in membership, as well as significantly lower amounts of pending claims.

        The medical cost amount, noted as "prior year development" in the table above, represents (favorable) or unfavorable adjustments as a result of prior year claim estimates being settled or currently expected to be settled, for amounts that are different than originally anticipated. This prior year development occurs due to differences between the actual medical utilization and other components of medical cost trends, and actual claim processing and payment patterns compared to the assumptions for claims trend and completion factors used to estimate our claim liabilities.

        During the nine months ended September 30, 2011, claim reserves settled, or are currently expected to be settled, for $1.8 million less than estimated at December 31, 2010. Prior period development represents less than 0.1% of the incurred claims recorded in 2010.

Sensitivity Analysis

        The following table illustrates the sensitivity of our accident and health IBNR payable at September 30, 2011 to identified reasonably possible changes to the estimated weighted average completion factors and health care cost trend rates. However, it is possible that the actual completion factors and health care cost trend rates will develop differently from our historical patterns and therefore could be outside of the ranges illustrated below.

Completion Factor(1):   Claims Trend Factor(2):  
(Decrease)
Increase
in Factor
  Increase
(Decrease) in
Net Health
IBNR
  (Decrease)
Increase
in Factor
  (Decrease)
Increase in
Net Health
IBNR
 
($ in thousands)
 
  -3 % $ 619     -3 % $ (8,810 )
  -2 %   413     -2 %   (5,874 )
  -1 %   206     -1 %   (2,937 )
                              1 %   (206 )   1 %   2,937  
                              2 %   (412 )   2 %   5,874  
                              3 %   (619 )   3 %   8,810  

(1)
Reflects estimated potential changes in medical and other expenses payable, caused by changes in completion factors for incurred months prior to the most recent three months.

(2)
Reflects estimated potential changes in medical and other expenses payable, caused by changes in annualized claims trend used for the estimation of per member per month incurred claims for the most recent three months.

Effects of Recently Issued and Pending Accounting Pronouncements

        A summary of other recent and pending accounting pronouncements is provided in Note 3—Recently Issued and Pending Accounting Pronouncements.

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ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        In general, market risk to which we are subject relates to changes in interest rates that affect the market prices of our fixed income securities.

Investment Interest Rate Sensitivity

        Our profitability could be affected if we were required to liquidate fixed income securities during periods of rising and/or volatile interest rates. We attempt to mitigate our exposure to adverse interest rate movements through a combination of active portfolio management and by staggering the maturities of our fixed income investments to assure sufficient liquidity to meet our obligations and to address reinvestment risk considerations. Our investment policy is to balance our portfolio duration to achieve investment returns consistent with the preservation of capital and to meet payment obligations of policy benefits and claims.

        Some classes of mortgage-backed securities are subject to significant prepayment risk. In periods of declining interest rates, individuals may refinance higher rate mortgages to take advantage of the lower rates then available. We monitor and adjust our investment portfolio mix to mitigate this risk.

        We regularly conduct various analyses to gauge the financial impact of changes in interest rate on our financial condition. The ranges selected in these analyses reflect our assessment as being reasonably possible over the succeeding twelve-month period. The magnitude of changes modeled in the accompanying analyses should not be construed as a prediction of future economic events, but rather, be treated as a simple illustration of the potential impact of such events on our financial results.

        The sensitivity analysis of interest rate risk assumes an instantaneous shift in a parallel fashion across the yield curve, with scenarios of interest rates increasing and decreasing 100 and 200 basis points from their levels as of September 30, 2011, and with all other variables held constant. The following table summarizes the impact of the assumed changes in market interest rates.

 
  Effect of Change in Market Interest Rates on Fair Value
of Fixed Income Portfolio as of September 30, 2011
 
September 30, 2011  
  200 Basis
Point Decrease
  100 Basis
Point Decrease
  100 Basis
Point Increase
  200 Basis
Point Increase
 
Fair Value of
Fixed Income Portfolio
 
(in millions)
 
  $ 1,223.6   $ 96.8   $ 49.1   $ (50.1 ) $ (101.2 )

ITEM 4—CONTROLS AND PROCEDURES

        We maintain disclosure controls and procedures that are designed to ensure that we record, process, summarize and report the information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 within the time periods specified in the SEC's rules and forms, and that we accumulate this information and communicate it to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

        Our disclosure controls and procedures and our internal controls over financial reporting may not prevent or detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system must reflect the fact that there are resource constraints, and we must consider the benefits of controls relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to

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error or fraud will not occur or that we have detected all control issues and instances of fraud, if any, within Universal American. These inherent limitations include the realities that judgments in decision making can be faulty and that breakdowns can occur because of simple error or mistake. The individual acts of some persons or collusion of two or more people can also circumvent controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

        We carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2011. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2011, at a reasonable assurance level, to timely alert management to material information required to be included in our periodic filings with the Securities and Exchange Commission.

        There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II

ITEM 1—LEGAL PROCEEDINGS

        For information relating to litigation affecting us, see Note 11—Commitments and Contingencies in Part I—Item 1 of this report, which is incorporated into this Part II—Item 1—Legal Proceedings by reference.

ITEM 1A—RISK FACTORS

        Investors in our securities should carefully consider the risks described below and other information included in this report. This report contains both historical and forward-looking statements. We are making the forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. We intend the forward-looking statements in this report or made by us elsewhere to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with and relying upon these safe harbor provisions. We have based these forward-looking statements on our current expectations and projections about future events, trends and uncertainties. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including, among other things, the information discussed below. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely affect our business. In making these statements, except as required by applicable securities laws, we are not undertaking to address or update each factor in future filings or communications regarding our business or results. Our business is highly complicated, regulated and competitive with many different factors affecting results. If any of the following risks or uncertainties develops into actual events, this could significantly and adversely affect our business, prospects, financial

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condition and operating results. In that case, the trading price of our common stock could decline materially and investors in our securities could lose all or part of their investment.

Risks Relating to the Part D Transaction

The historical consolidated financial information of Old Universal American is not necessarily representative of our future financial position, future results of operations or future cash flows nor do they reflect what our financial position, results of operations or cash flows would have been as a stand-alone company during the periods presented.

        We are the "accounting successor" to Old Universal American for financial reporting purposes in accordance with ASC No. 505-60. Following the consummation of the Part D Transaction, we report the historical consolidated results of operations of the Medicare Part D Business in discontinued operations in accordance with the provisions of ASC No. 205-20-45. Because the historical consolidated financial information of Old Universal American include the results of the Medicare Part D Business, it is not representative of our future financial position, future results of operations or future cash flows nor does it reflect what our financial position, results of operations or cash flows would have been as a stand-alone company during the periods presented.

Our stock price may be volatile and could drop precipitously and unexpectedly.

        Our common stock is traded on the NYSE. The prices of publicly traded stocks often fluctuate. The price of our common stock may rise or fall dramatically without any change in our business performance. Specific issues and developments related to our company or those generally in the health care and insurance industries, the regulatory environment, the capital markets and the general economy may cause this volatility. The principal events and factors that may cause our stock price and trading volume to fluctuate are:

Future sales of our common stock may depress the market price of our common stock.

        Certain significant shareholders collectively own approximately 55% of our outstanding common stock, which are not subject to lock-up or transfer restrictions. If any of these significant shareholders sells or distributes substantial amounts of our common stock, or if it is perceived that such sales or distributions could occur, the market price of our common stock could decline.

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Our reduced scale and focus on our current business, which no longer includes the Medicare Part D Business, may limit investor interest in our common stock.

        The Part D Transaction closed on April 29, 2011 and some shareholders, including institutional investors or certain significant shareholders, who hold our common stock may decide that they do not want to maintain an investment in our company because of our smaller size, because we are less diversified or because we no longer own or operate the Medicare Part D Business. If these shareholders decide to sell all or some of their shares, or the market perceives that those sales could occur, the market price of our common stock may decline. Because we are a smaller company that is more narrowly focused than Old Universal American and have a lower market capitalization than Old Universal American, our stock may not be followed as closely by market analysts or the investment community as Old Universal American stock had been in the past. In addition, institutional investors may be less likely to invest in our company in the future as a result of these factors. If there is only a limited following by market analysts or the investment community, or limited demand for our common stock by institutional investors, the amount of market activity in our common stock may be reduced, making it more difficult to sell our common stock.

Your percentage ownership in our company may be diluted in the future.

        As with any publicly traded company, your percentage ownership in our company may be diluted in the future because of equity awards that we have granted and expect to grant to our directors, officers, employees and others. In addition, we may from time to time issue additional equity, including in connection with merger and acquisition transactions.

We may be subject to assumed liabilities or indemnification obligations in connection with the Part D Transaction that are greater than anticipated.

        Under the terms of the separation agreement relating to the Part D Transaction, we have agreed to indemnify Old Universal American and CVS Caremark for certain liabilities, including those related to the separation. If such liabilities or indemnification obligations are larger than anticipated, our financial condition could be materially and adversely affected.

The separation agreement relating to the Part D Transaction contains a covenant limiting our ability to incur debt, which may limit our ability to operate our business going forward.

        The separation agreement relating to the Part D Transaction contains certain covenants, including a covenant restricting our ability to incur debt. Under the terms of the separation agreement, until April 30, 2013 (two years following the consummation of the Part D Transaction), we will not be permitted to incur debt that would cause, on a pro forma basis, the ratio of our consolidated funded indebtedness to consolidated adjusted EBITDA (as defined in Old Universal American's credit agreement) to be more than 3 to 1. While Old Universal American has historically operated at leverage ratios below 3 to 1, we operate as a new company and may require more capital to meet our business needs. Accordingly, this restriction could affect our ability to operate our business and may limit our ability to react to market conditions or take advantage of potential business opportunities as they arise. For example, this restriction could adversely affect our ability to finance our operations, make strategic acquisitions, finance investments or alliances, restructure its organization or finance its capital needs. The restriction could also limit the ability of a third party to acquire our company.

Failure to comply with covenants in any debt instrument we may enter into could materially and adversely affect us.

        Subject to compliance with the separation agreement relating to the Part D Transaction, we may enter into a new credit facility or other debt instrument in the future in connection with the incurrence

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of debt to fund our operations, make acquisitions or for other purposes. We expect that any credit facility or debt instrument that we enter into will contain customary restrictions, covenants, events of default and other terms, including financial covenants. These restrictions and covenants may limit our ability to, among other things:

        In addition, to borrow funds under any credit agreement or debt instrument, we anticipate that we will be required to meet specified financial covenants, including a consolidated leverage ratio. If we fail to maintain the financial covenants and are not able to obtain relief from any covenant violation, then an event of default could occur and the lenders could cease lending to us and accelerate the payments of our debt. Any such action by the lenders could materially and adversely affect us. The interests of our lenders may be different from ours and we may be unable to obtain our lenders' consent when and if needed, to engage in certain actions or obtain relief from any covenant violation. In addition, we may not be able to incur debt on terms acceptable to us. If we do not comply with the restrictions and covenants in any debt instrument we may enter into, our results of operations, financial condition and ability to pay dividends will be harmed.

Our business strategy is evolving and may involve pursuing strategic transactions in the future.

        We are a new company, and our business strategy will continue to evolve. Our business strategy may involve pursuing strategic transactions, including potential acquisitions of, or investments in, related or unrelated businesses and assets or divestitures of existing businesses or assets. In addition, we may pursue a merger or consolidation with a third party that results in a change in control, a sale or transfer of all or a portion of our assets or a purchase by a third party of our securities that may result in a minority or control investment by such third party.

        We may finance future acquisitions through available cash, equity issuances or through the incurrence of additional indebtedness, subject to existing limitations set forth in the separation agreement relating to the Part D Transaction. Future acquisitions or investments, and the incurrence of additional indebtedness, could subject us to a number of risks, including, but not limited to:

        In addition, any strategic transaction that we may pursue may not result in anticipated benefits to us and may result in unforeseen costs that, in each case, may adversely impact our financial condition and results of operations.

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Certain provisions in our amended and restated certificate of incorporation and by-laws, the provisions of Delaware law and the terms of the separation agreement relating to the Part D Transaction may make it more difficult for a third party to acquire our company.

        Provisions contained in our certificate of incorporation and by-laws could make it more difficult for a third party to acquire our company, even if doing so might be beneficial to our stockholders. These provisions include:

        We also have not elected to opt out of the application of the Delaware "anti-takeover" provisions of Section 203 of the DGCL. As a result, subject to certain exceptions as provided in Section 203 of the DGCL, we will be prohibited from engaging in any business combination, as defined in the DGCL, with an interested stockholder for a period of three years from the date on which the stockholder first becomes an interested stockholder.

        In addition, the separation agreement relating to the Part D Transaction provides that we may not consolidate with or merge into any other entity or convey, transfer or lease all or any substantial portion of its properties and assets to any entity, unless, in each case, the other party to such transaction expressly assumes all of our liabilities, including the due and punctual performance and observance of the split-off agreements relating to the Part D Transaction.

        These provisions could have the effect of delaying, deferring or preventing a change in control of our company, discourage others from making offers for our shares of common stock, lower the market price of our common stock or impede the ability of our stockholders to change our management, even if such changes would be beneficial to our stockholders.

Risks Relating to Our Business

The CMS sanction that suspended us from marketing to and enrolling new members in our Medicare Advantage plans has had and may continue to have a material adverse effect on the Medicare Advantage business, financial condition and results of operations.

        On November 19, 2010, CMS notified us that we were suspended from marketing to and enrolling new members in our Medicare Advantage plans, effective December 5, 2010. According to CMS, the suspension related primarily to agent oversight and market conduct issues and was to remain in effect until CMS was satisfied that we had corrected the issues and they were not likely to recur. As a result of the suspension, we were unable to enroll new members in our Medicare Advantage plans during a significant portion of the annual enrollment period for the 2011 plan year and, as a result, our Medicare Advantage membership decreased significantly during that time period which will have a negative impact on our financial results for 2011 and beyond. While we were notified on August 5, 2011 that CMS had lifted the sanction, CMS indicated that it still considers Universal American a high-risk sponsor and will be closely monitoring and overseeing our activities in all operational areas and we will continue to be subject to targeted monitoring and heightened surveillance and oversight. In addition, as a government contractor, we earn substantially all of our revenue from our Medicare businesses in which CMS is not only our largest customer but also our regulator. If we are unable to maintain a constructive working relationship with CMS, our business could suffer materially. Further, there can be no assurance that despite any corrective measures taken on our part, that we will not incur additional penalties, fines or other operating restrictions, which could include termination of our

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right to participate in the Medicare program, which could have a further material adverse effect on our business, financial condition and results of operations.

Recently enacted health care legislation and subsequent rules promulgated by CMS could have a material adverse effect on our opportunities for growth and our financial results.

        In March 2010, President Obama signed into law The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the Affordable Care Act) legislating broad-based changes to the U.S. health care system. Provisions of the health reform legislation become effective at various dates over the next several years. The Department of Health and Human Services, the National Association of Insurance Commissioners, the Department of Labor and the Treasury Department have yet to issue necessary enabling regulations and guidance with respect to the health reform legislation. Due to the complexity of the health reform legislation, including yet to be promulgated implementing regulations, lack of interpretive guidance, gradual implementation and the fact that the Affordable Care Act has been successfully challenged in the judicial system, the impact of the health reform legislation is difficult to predict and not yet fully known. However, we will need to dedicate significant resources and expense to complying with these new rules and there is a possibility that this new legislation could have a material adverse effect on our business, financial position and results of operations.

        The provisions of these new laws include the following key points, which are discussed further below:

        Reduced Medicare Advantage reimbursement rates—Beginning in 2012, the Medicare Advantage "benchmark" rates transition to target Medicare fee-for-service cost benchmarks of 95%, 100%, 107.5% or 115% of the calculated Medicare fee-for-service costs. The transition period will be 2, 4 or 6 years depending upon the applicable county in which services are provided. The counties are divided into quartiles based on each county's fee-for-service Medicare costs. We estimate that approximately 42% of our current membership resides in counties where the Medicare Advantage benchmark rate will equal 95% of the calculated Medicare fee-for-service costs, with approximately 90% of these members having a 6-year transition period. Under the new law, the premiums for such members will be transitioned to 95% of Medicare fee-for-service costs beginning in 2012. This follows the freezing of Medicare Advantage reimbursement rates in 2011 based on our 2010 levels. To address these rate freezes/reductions, we may have to reduce benefits, charge or increase member premiums, reduce profit margin expectations, or implement some combination of these actions. Such actions could adversely impact our membership growth, revenue expectations, and our operating margins.

        Implementation of quality bonus for Star Ratings—Beginning in 2012, Medicare Advantage plans with an overall "Star Rating" of three or more stars (out of five) will be eligible for a "quality bonus" in their basic premium rates. The Affordable Care Act limited these quality bonuses to the few plans that achieved 4 or more stars as their overall rating, but CMS is using demonstration authority to expand

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the quality bonus to 3 star plans for a three year period through 2014. In addition, also beginning in 2012, Medicare Advantage star ratings will affect the rebate percentage available for plans to provide additional member benefits (plans with quality ratings of 3.5 stars or above will have their rebate percentage increased from a base rate of 50% to 65% or 70%). In all cases, this rebate percentage is lower than the pre-Affordable Care Act rebate percentage of 75%. Our Medicare Advantage plans are currently rated 2.5-3 out of 5 stars, on average. Notwithstanding efforts to improve our star ratings and other quality measures prior to 2012, there can be no assurances that we will be successful in doing so. Accordingly, our plans may not be eligible for full level quality bonuses or increased rebates, which could adversely affect the benefits such plans can offer, reduce membership, and reduce profit margins. In addition, CMS has indicated that plans with a Star Rating of less than 3.0 for three consecutive years may be subject to termination.

        Stipulated Minimum MLRs—Beginning in 2014, the new healthcare reform legislation will stipulate a minimum medical loss ratio, or MLR, of 85%. Financial and other penalties may result from failing to achieve the minimum MLR ratio. For the year ended December 31, 2010, our reported Medicare Advantage MLR was 83.6%. The methodology for defining medical costs and for calculating MLRs has not yet been defined. Complying with such minimum ratio by increasing our medical expenditures or refunding any shortfalls to the federal government could have a material adverse affect on our operating margins, results of operations, and our statutory required capital.

        Shortened annual enrollment period—Medicare beneficiaries generally have a limited annual enrollment period during which they can choose to participate in a Medicare Advantage plan rather than receive benefits under the traditional fee-for-service Medicare program. After the annual enrollment period, most Medicare beneficiaries are not permitted to change their Medicare benefits.

        Beginning with the 2011 enrollment season, the new laws shorten the time in which we can sell our Medicare Advantage. Also, beginning in 2011, the new laws mandate that persons enrolled in Medicare Advantage may withdraw their enrollment at any time during the first 45 days of the year only to enroll in traditional Medicare fee-for-service, not another Medicare Advantage plan. Prior law allowed a member to withdraw enrollment during this period to enroll in another Medicare Advantage plan. There can be no assurance that these changes will not restrict our member growth, limit our ability to enter new service areas, limit the viability of our sales force, or otherwise adversely affect our ability to market to or enroll new members in our established service areas.

        Non-deductible federal premium taxes—Beginning in 2014, the new healthcare reform legislation will impose an annual aggregate non-deductible tax of $8.0 billion (increasing incrementally to $14.3 billion by 2018) on health insurance premiums, including Medicare Advantage premiums. Our share of the new tax will be based on our pro rata percentage of premiums compared to the industry as a whole, calculated annually. Although there is time to take into account this new tax in adjusting our business model and in designing future years' plan bids, there can be no assurance that such tax will not result in reduced member benefits, reduced profits, or both which could have a material adverse effect on our results of operations.

        Coding intensity adjustments—Under the new healthcare reform legislation, the coding intensity adjustment instituted in 2010 became permanent, resulting in mandated minimum reductions in risk scores of 4.71% in 2014 increasing to 5.7% for 2019 and beyond. These coding adjustments may adversely affect the level of payments from CMS to our Medicare Advantage plans.

        Limitation on the federal tax deductibility of compensation earned by individuals—Beginning in 2013, with respect to services performed during 2010 and afterward, for health insurance companies, the federal tax deductibility of compensation will be limited under Section 162(m)(6) of the Code to $500,000 per individual and will not contain an exception for "performance-based compensation." This limitation increased our effective tax rate, beginning in the second quarter of 2010.

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        Most of the provisions of the Affordable Care Act are not scheduled to go into effect immediately and may be delayed for several years, including as a result of judicial action challenging the legality of the Affordable Care Act. Financing for the reforms contained in the Affordable Care Act will come, in part, from additional taxes and fees on our business as well as reductions in payments to us, which could negatively impact our business and results of operations. In addition, during this time, the new healthcare reform legislation may be subject to further adjustments. Because of the unsettled nature of these reforms and numerous steps required to implement and monitor them, we cannot predict what additional health insurance reforms will be implemented at the federal or state level, the effect that any future legislation or regulation will have on our business or how CMS will review our future bid submissions and ultimately, the overall impact of the new healthcare reform legislation on our business.

If we fail to effectively design and price our products properly and competitively, if the premiums we charge are insufficient to cover the cost of health care services delivered to our members, or if our estimates of benefit expenses are inadequate, our profitability may be materially adversely affected.

        We use a substantial portion of our revenues to pay the costs of health care services delivered to our members. These costs include claims payments, capitation payments to providers, and various other costs incurred to provide health insurance coverage to our members. These costs also include estimates of future payments to hospitals and others for medical care provided to our members. Our premiums for our Medicare business are fixed for one-year periods. Accordingly, costs we incur in excess of our benefit cost projections generally are not recovered in the contract year through higher premiums. We estimate the costs of our future benefit claims and other expenses using actuarial methods and assumptions based upon claim payment patterns, medical inflation, historical developments, including claim inventory levels and claim receipt patterns, and other relevant factors. We continually review estimates of future payments relating to benefit claims costs for services incurred in the current and prior periods and make necessary adjustments to our reserves. However, these estimates involve extensive judgment, and have considerable inherent variability that is sensitive to payment patterns and medical cost trends. The profitability of our risk-based products depends in large part on our ability to predict, price for and effectively manage medical costs. Failure to adequately price our products or estimate medical costs may result in a material adverse effect on our business, cash flows and results of operations.

Reductions in funding for Medicare programs could materially reduce our profitability.

        We generate a significant majority of our total revenue from the operation of our Medicare Advantage health maintenance organization (which is referred to herein as an HMO), private fee-for-service (which is referred to herein as PFFS), and preferred provider organization plans (which is referred to herein as a PPO or PPOs). As a result, our revenue and profitability are dependent, in part, on government funding levels for these programs. The rates paid to Medicare Advantage health plans like ours are established by contract, although the rates differ depending on a combination of factors, such as upper payment limits established by CMS, a member's health profile and status, age, gender, county or region, benefit mix, member eligibility categories and the plan's risk scores. Future Medicare rate levels and overall funding for Medicare, may be affected by continuing government efforts to contain prescription drug costs and other medical expenses, and other federal budgetary constraints, including as a result of the deliberations of the "Super Committee" appointed by Congress in 2011 to consider overall deficit reduction. The government is currently examining Medicare Advantage health plans like ours in comparison to Medicare fee-for-service payments, and this examination could result in a reduction in payments to Medicare Advantage health plans like ours. Changes in the Medicare program or Medicare funding may affect our ability to operate under the Medicare program or lead to reductions in the amount of reimbursement, elimination of coverage for some benefits or reductions in the number of persons enrolled in or eligible for Medicare or increases in member premium.

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Failure to reduce our operating costs could have a material adverse effect on our financial position, results of operations and cash flows.

        The level of our operating costs affects our profitability. As a result of MIPPA and the CMS sanction, our Medicare Advantage membership decreased significantly as of January 1, 2011. In addition, after consummation of the Part D Transaction, we are a much smaller company. If we are unable to reduce our operating expenses to better match the smaller size of our company, it could have a material adverse effect on our financial condition, results of operations and cash flows.

Competition in the insurance and healthcare industries is intense, and if we do not design and price our products properly and competitively, our membership and profitability could decline.

        We operate in a highly competitive industry. Some of our competitors are more established in the insurance and, health care industries, with larger market share, more established reputations and brands and greater financial resources than we have in some markets. In addition, other companies may enter our markets in the future. Medicare Advantage plans are generally bid upon or renewed annually. We compete for members in our Medicare Advantage plans on the basis of the following and other factors:

        In addition to the challenge of controlling health care costs, we face intense competitive pressure to contain premium prices. Factors such as business consolidations, strategic alliances, legislative reform and marketing practices create pressure to contain premium rate increases, despite being faced with increasing medical costs. Premium increases, introduction of new product designs, our relationship with our providers in various markets, and our possible exit from or entrance into additional markets, among other issues, could also affect our membership levels.

        We compete based on innovation and service, as well as on price and benefit offering. We may not be able to develop innovative products and services which are attractive to clients. Moreover, although we need to continue to expend significant resources to develop or acquire new products and services in the future, we may not be able to do so. We cannot be sure that we will continue to remain competitive, nor can we be sure that we will be able to market our products and services to clients successfully at current levels of profitability.

        Consolidation within the industries in which we operate, as well as the acquisition of any of our competitors by larger companies, may lead to increased competition. Strategic combinations involving our competitors could have an adverse effect on our business or results of operations.

        If we do not compete effectively in our markets, if we set rates too high in highly competitive markets to maintain or increase our market share, if we set rates too low to maintain or increase our profitability, if membership does not increase as we expect, if membership declines, if we fail are unable to innovate and deliver products and services that demonstrate value to our customers or if we lose members with favorable medical cost experience while retaining or increasing members with unfavorable medical cost experience, our business and results of operations could be materially adversely affected.

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Our results of operations will be adversely affected if our insurance premium rates are not adequate.

        Our results of operations depend on our ability to charge and collect premiums sufficient to cover our health care costs, expenses of distribution and operations and provide a reasonable margin. Although we attempt to base the premiums we charge on our estimate of future health care costs, we may not be able to control the premiums we charge as a result of competition, government regulations and other factors. Our results of operations could be adversely affected if we are unable to set premium rates at appropriate levels or adjust premium rates in the event our health care costs increase.

        We set the premium rates on our insurance policies based on facts and circumstances known at the time we issue the policies and on assumptions about numerous variables, such as:

        In setting premium rates, we consider historical claims information, industry statistics and other factors. We cannot be assured that the data and assumptions used at the time of establishing premium rates will prove to be correct and that premiums will be sufficient to cover benefits and expenses plus a reasonable margin.

        For certain of our traditional products, we can periodically file for rate increases, if our actual claims experience proves to be less favorable than we assumed. If we are unable to raise our premium rates, our net income may decrease. We generally cannot raise our premiums in any state unless we first obtain the approval of the insurance regulator in that state. We review the adequacy of our accident and health premium rates regularly and file rate increases on our products when we believe permitted premium rates are too low. When determining whether to approve or disapprove our rate increase filings, the various state insurance departments take into consideration:

        If the regulators do not believe these factors warrant a rate increase, it is possible that we will not be able to obtain approval for premium rate increases from currently pending requests or requests filed in the future. If we are unable to raise our premium rates because we fail to obtain approval for rate increases in one or more states, our net income may decrease. If we are successful in obtaining regulatory approval to raise premium rates, the increased premium rates may reduce the volume of our new sales and cause existing policyholders to let their policies lapse. This would reduce our premium income in future periods. Increased lapse rates also could require us to expense all or a portion of the deferred policy costs relating to lapsed policies in the period in which those policies lapse, reducing our net income in that period.

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The competitive bidding process for our Medicare Advantage plans may adversely affect our profitability.

        Payments for the local Medicare Advantage health plans and regional Medicare Advantage PPO programs are based on a competitive bidding process that may decrease the amount of premiums paid to us or cause us to increase the benefits we offer to our members. We are required to submit Medicare Advantage bids annually, approximately six months in advance of the corresponding benefit year. We endeavor to use the best available member eligibility, claims and risk score data at the time of developing the bids. Furthermore, we make actuarial assumptions about the utilization of benefits in our plans. However, these assumptions are subject to significant judgment and we cannot be assured that the data and assumptions used at the time of bid development will prove to be correct and that premiums will be sufficient to cover member benefits plus a reasonable margin. If our bid assumptions are too low and member claims are higher than anticipated, we could be required to expend significant unanticipated amounts which could have a material adverse effect on our business, profitability and results of operations.

Because our Medicare Advantage premiums, which generate most of our Medicare Advantage revenues, are fixed by contract, we are unable to increase our Medicare Advantage premiums during the contract term if our corresponding medical benefits expense exceeds our estimates which can adversely affect our results of operations.

        Most of our Medicare Advantage revenues are generated by premiums consisting of fixed monthly payments per member. We use a significant portion of our revenues to pay the costs of health care services delivered to our members. The principal costs consist of claims payments, capitation payments and other costs incurred to provide health insurance coverage to our members. Generally, premiums in the health care business are fixed on an annual basis by contract, and we are obligated during the contract period to provide or arrange of the provision of healthcare services as established by the Federal government.

        We are unable to increase the premiums we receive under these contracts during the then-current term. If our medical expenses exceed our estimates, except in very limited circumstances or as a result of risk score adjustments for member acuity, we generally cannot recover costs we incur in excess of our medical cost projections in the contract year through higher premiums. As a result, our profitability depends, to a significant degree, on our ability to adequately predict and effectively manage our medical expenses related to the provision of healthcare services. Accordingly, the failure to adequately predict and control medical expenses and to make reasonable estimates and maintain adequate accruals for incurred but not reported claims, known as IBNR, may have a material adverse effect on our financial condition, results of operations, or cash flows. If our estimates of reserves are inaccurate, our ability to take timely corrective actions or to otherwise establish appropriate premium pricing could be adversely affected. Failure to adequately price our products or to estimate sufficient medical claim reserves may result in a material adverse effect on our financial position, results of operations and cash flows. In addition, to the extent that CMS or Congress takes action to reduce the levels of payments to Medicare Advantage providers, our revenues would be adversely affected.

        We estimate the costs of our future medical claims and other expenses using actuarial methods and assumptions based upon claim payment patterns, cost trends, product mix, seasonality, medical inflation, historical developments, such as claim inventory levels and claim receipt patterns, and other relevant factors. We continually review estimates of future payments relating to medical claims costs for services incurred in the current and prior periods and make necessary adjustments to our reserves. However, historically, our medical expenses as a percentage of premium revenue have fluctuated. The principal factors that may cause medical expenses to exceed our estimates are:

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Because of the relatively high average age of the Medicare population, medical expenses for our Medicare Advantage plans may be particularly difficult to control. We may not be able to continue to manage these expenses effectively in the future. If our medical expenses increase, our profits could be reduced or we may not remain profitable.

We hold reserves for expected claims, which are estimated, and these estimates involve an extensive degree of judgment; if actual claims exceed reserve estimates, our results could be materially adversely affected.

        Our benefits incurred expense reflects estimates of IBNR. We, together with our internal and external consulting actuaries, estimate our claim liabilities using actuarial methods based on historical data adjusted for payment patterns, cost trends, product mix, seasonality, utilization of healthcare services and other relevant factors. Actual conditions, however, could differ from those assumed in the estimation process, and those differences could be material. Due to the uncertainties associated with the factors used in these assumptions, the actual amount of benefit expense that we incur may be materially more or less than the amount of IBNR originally estimated, and materially different amounts could be reported in our financial statements for a particular period under different conditions or using different assumptions. We make adjustments, if necessary, to benefits incurred expense when the criteria used to determine IBNR change and when we ultimately determine act