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

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FORM 10-Q

Commission file number: 001-35149

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

44 South Broadway, Suite 1200, White Plains, New York 10601
(Address of principal executive offices and zip code)

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

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        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):

        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.

   

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        As used in this quarterly report on Form 10-Q, except as otherwise indicated, references to the "Company," "we," "our," and "us" are to Universal American Corp., a Delaware corporation and its subsidiaries.

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 other risks and uncertainties set forth in this report 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.

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PART I

ITEM 1—FINANCIAL STATEMENTS

        

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

   

See Notes to unaudited Consolidated Financial Statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share amounts)

   

See Notes to unaudited Consolidated Financial Statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share amounts)

   

See Notes to unaudited Consolidated Financial Statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

(in thousands)

   

See Notes to unaudited Consolidated Financial Statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(Unaudited)

(in thousands)

   

See Notes to unaudited Consolidated Financial Statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

   

See Notes to unaudited Consolidated Financial Statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND COMPANY BACKGROUND

        Except as otherwise indicated, references to the "Company," "Universal American," "we," "our," and "us" are to Universal American Corp., a Delaware corporation, and its subsidiaries.

        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 people covered by Medicare and Medicaid. Collectively, our health plans and insurance company subsidiaries are licensed in all fifty states and in the District of Columbia and authorized to sell Medicare Advantage products, life, accident and health insurance and annuities and to provide comprehensive medical services through Medicaid.

        Through our Medicare Advantage subsidiaries, we sell Medicare Coordinated Care Plan products, which we call HMOs, Medicare Coordinated Care products built around contracted networks of providers, which we call PPOs and Medicare Advantage private fee-for-service products, known as PFFS Plans. On August 29, 2014, we completed our sale of Today's Options of Oklahoma, Inc., known as TOOK, to Momentum Health, LLC. TOOK operates an HMO Medicare Advantage plan in Oklahoma with approximately 5,800 members. For further discussion of this transaction, see Note 10—Other Disclosures.

        Our APS Healthcare subsidiaries provide specialty health services focused on behavioral health benefits, disease and condition management, and quality review and improvement services to government agencies, such as state Medicaid programs, commercial health plans, employers and unions. These services are provided on either an at-risk basis or an administrative services only basis. Behavioral health benefits are administered through APS Healthcare's provider network that consists of health care providers and facilities with which APS Healthcare directly or indirectly contracts to provide the necessary treatment. APS Healthcare operates in the United States and Puerto Rico.

        Through our subsidiary, Collaborative Health Systems, LLC, also known as CHS, we formed Accountable Care Organizations, or ACOs, under the Medicare Shared Savings Program ("Shared Savings Program") with physicians and other healthcare professionals. As of September 30, 2014 we had thirty ACOs previously approved for participation in the program by the Centers for Medicare & Medicaid Services, known as CMS. In June 2014, we ceased our participation in three ACOs based on a variety of factors, including the level of engagement by the physicians in the ACO and the likelihood of those ACOs achieving shared savings. We may further reduce our participation in ACOs as we continue to evaluate their performance. In addition, earlier in 2014 we merged two ACOs to take advantage of operating synergies. Based on data provided by CMS, these thirty ACOs currently include approximately 4,500 participating providers with approximately 340,000 assigned Medicare fee-for-service beneficiaries covering portions of twelve states, both within and outside our current Medicare Advantage footprint, including southeast Texas and upstate New York. CHS provides these ACOs with care coordination, analytics and reporting, technology and other administrative capabilities to enable participating providers to deliver better care and lower healthcare costs for their Medicare fee-for-service beneficiaries. The Company provides funding to CHS to support the operating activities of CHS and the ACOs. On December 1, 2013, we completed our acquisition of the assets of the Total Care Medicaid managed care plan, known as Total Care. Total Care is a Medicaid health plan in Upstate New York, currently serving approximately 40,600 members in Syracuse and surrounding areas. For further discussion of this transaction, see Note 10—Other Disclosures.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

1. ORGANIZATION AND COMPANY BACKGROUND (Continued)

        We discontinued marketing and selling Traditional insurance products, consisting of Medicare supplement products, fixed benefit accident and sickness insurance and senior life insurance after June 1, 2012. However, we continue to manage the block as the policies remain in force over the renewal period.

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 our 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. The results of operations for the three and nine months ended September 30, 2014 and 2013 are not necessarily indicative of the results to be expected for the full year.

        Unconsolidated Subsidiaries:    The ACOs we established with various healthcare providers were generally formed as Limited Liability Companies. We own a majority interest in our ACOs but do not consolidate them because we share the power to direct the activities of the ACOs that most significantly impact their performance. Our share of the income of an ACO is generally 50% and our share of losses of an ACO is generally 100%. In the event of losses, we will share in 100% of subsequent profits until our losses are recovered. Any remaining profits are generally shared at 50%.

        The ACOs are considered variable interest entities, known as VIEs, under U.S. GAAP as these entities do not have sufficient equity to finance their own operations without additional financial support. We assess our contractual, ownership or other interests in a VIE to determine if our interest participates in the variability the VIE was designed to absorb and pass onto variable interest holders. We perform an ongoing qualitative assessment of our variable interests in VIEs to determine whether we have a controlling financial interest and would therefore be considered the primary beneficiary of the VIE. The power to direct the activities of the ACOs that most significantly impact their performance is shared between us and the healthcare providers that we have joined with to establish the ACOs pursuant to the structure of the Management Committee of each of the ACOs. Accordingly, we have determined that we are not the primary beneficiary of the ACOs, and therefore we cannot consolidate them. We account for our participation in the ACOs using the equity method. Gains and losses from our participation in the ACOs are reported as equity in earnings (losses) of unconsolidated subsidiaries in the consolidated statements of operations. Our net investment in the ACOs is reported in other assets in the consolidated balance sheets.

        During September 2014, we received notice that the ACOs we formed in partnership with primary care physicians generated $57 million in total program savings for CMS, as part of the Medicare

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. BASIS OF PRESENTATION (Continued)

Shared Savings Program for program years 2012 and 2013. Of our 30 ACOs with start dates in 2012 and 2013, the results showed that:

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3 ACOs, serving more than 56,000 Medicare beneficiaries and including our largest ACO in Houston, qualified for savings;



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11 ACOs, serving more than 120,000 Medicare beneficiaries, generated savings but fell below their Minimum Savings Rate required to share savings with CMS;



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8 ACOs were within 2 percent of their benchmark;



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8 ACOs were 2 percent or more above their benchmark; and



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All ACOs met CMS's quality reporting standards.

        The 3 ACOs qualifying for savings will receive payments of $20.4 million, part to be paid to physicians and part to defray a portion of the costs that we have incurred. Our share of these savings, including expense recovery, amounted to $13.4 million, which is reflected in equity in earnings (losses) of unconsolidated subsidiaries in our consolidated statements of operations. We received these payments in October 2014.

        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 our 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, and income taxes. There have been no changes in our critical accounting policies during the current quarter.

        Reclassifications:    Beginning in 2014, in connection with the reporting of minimum medical loss ratios under the Affordable Care Act, we are reporting the costs of quality improvement initiatives in claims and other benefits in the consolidated statements of operations. Historically, these costs were reported in other operating costs and expenses. To maintain consistency with the new reporting classification, for the three and nine months ended September 30, 2013 we have reclassified quality improvement initiative costs of $7.0 million and $19.9 million, respectively, from other operating costs and expenses to claims and other benefits in our consolidated statements of operations.

        Significant Accounting Policies:    For a description of existing significant accounting policies, see Note 3—Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. BASIS OF PRESENTATION (Continued)

included in our Annual Report on Form 10-K for the year ended December 31, 2013 and Note 3—Recently Issued and Pending Accounting Pronouncements.

3. RECENTLY ISSUED AND PENDING ACCOUNTING PRONOUNCEMENTS

        Revenue from Contracts with Customers:    In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers, to clarify the principles for revenue recognition. Insurance contracts are excluded from the scope of the guidance, however, our non-insurance contract revenues, including fee income, will be subject to the new guidance.

        The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The following steps are to be applied to achieve this core principle: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, the entity satisfies a performance obligation

        ASU 2014-09 provides companies with two implementation methods. Companies can choose to apply the standard retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application. This guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early application is not permitted. We do not expect adoption of this guidance to have a material impact on our financial position, results of operations or cash flows in future periods.

        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 (the "ACA fee") 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 direct 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.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

3. RECENTLY ISSUED AND PENDING ACCOUNTING PRONOUNCEMENTS (Continued)

        In January 2014, we had estimated that the fee to be paid in 2014, based on 2013 direct written premiums, would be approximately $21.7 million. As required under generally accepted accounting principles, we accrued this amount in other liabilities in our consolidated balance sheets in January 2014, with an offsetting deferred cost asset recorded in other assets. The asset is being amortized ratably over 2014 and is reported on a separate line in our consolidated statements of operations. In the second quarter, we received further data indicating the fee would be approximately $23.4 million and adjusted our accrual accordingly. In the third quarter of 2014, we made a payment of $23.4 million, representing our share of the ACA fee (including $0.3 million related to TOOK, for which we were reimbursed by the acquirer). For the three and nine month periods ended September 30, 2014, we amortized $5.8 million and $17.5 million, respectively, and as of September 30, 2014, we have an asset of $5.6 million representing the prepaid balance of the ACA Fee, which will be amortized in the fourth quarter of 2014.

4. INVESTMENTS

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

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. INVESTMENTS (Continued)

 

        At September 30, 2014, gross unrealized losses on mortgage-backed and asset- backed securities totaled $2.8 million, consisting primarily of unrealized losses of $1.5 million on residential mortgage-backed securities and $1.1 million related to one subprime residential mortgage-backed security. The fair value of the subprime security is depressed due to the deterioration of collectability of the underlying mortgages. The fair values of the other securities are depressed primarily due to changes in interest rates. We have evaluated these holdings, with input from our investment managers, and do not believe further other-than-temporary impairment to be warranted.

        The amortized cost and fair value of fixed maturity investments at September 30, 2014 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.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. INVESTMENTS (Continued)

        The fair value and unrealized loss as of September 30, 2014 and 2013 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:

 

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. INVESTMENTS (Continued)

        The decrease in gross unrealized losses at September 30, 2014 compared to December 31, 2013, and the resulting decrease in the number of securities in an unrealized loss position, is due to an overall flattening of the yield curve during 2014, resulting in a decline in interest-related unrealized losses.

Interest Rate Swaps

        We terminated all outstanding interest rate swaps during 2013 and had no outstanding interest rate swaps at September 30, 2014.

Realized Gains and Losses

        Gross realized gains and losses included in the consolidated statements of operations are as follows:

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 Accounting Standards Codification 820-10, Fair Value Measurements and Disclosures Topic, known as ASC 820-10. 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. For further

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

5. FAIR VALUE MEASUREMENTS (Continued)

discussion, see Note 7—Fair Value Measurements included in our Annual Report on Form 10-K for the year ended December 31, 2013.

        The following table presents our recurring fair value measurements by ASC-820-10 hierarchy levels (in thousands):

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

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

6. ACCUMULATED OTHER COMPREHENSIVE INCOME

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

        Table amounts are presented net of tax at a rate of 35%.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. STOCK-BASED COMPENSATION

        In April 2011, we established the Universal American Corp. 2011 Omnibus Equity Award Plan (the "2011 Equity Plan"). The 2011 Equity Plan is the sole active plan for providing equity compensation to eligible employees, directors and other third parties. We issue shares upon the exercise of options granted under the plan. Detailed information for activity in our stock-based incentive plan can be found in Note 19—Stock-Based Compensation in our Annual Report on Form 10-K for the year ended December 31, 2013.

        Compensation expense, included in other operating costs and expenses, and the related tax benefit were as follows:

 

Stock Option Awards

        We recognize compensation cost for share-based payments to employees, directors and other third parties 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 stock options.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. STOCK-BASED COMPENSATION (Continued)

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

        We did not capitalize any cost of stock-based compensation. 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, 2014 is set forth below:

        The total intrinsic value of stock options (the amount by which the market price of the stock on the date of exercise exceeded the exercise price of the option) exercised was $0.2 million and less than $0.1 million for the nine month periods ended September 30, 2014 and 2013, respectively.

        We received proceeds of $1.5 million and $0.6 million from the exercise of stock options for the nine month periods ended September 30, 2014 and 2013, respectively.

        As of September 30, 2014, the total compensation cost related to non-vested option awards not yet recognized was $8.1 million, which we expect to recognize over a weighted average period of 2.3 years.

Restricted Stock Awards

        In accordance with our 2011 Equity Plan, we may grant restricted stock to employees, directors and other third parties. These awards generally vest ratably over a four-year period; however during the nine months ended September 30, 2014 and 2013 we paid a portion of the annual bonuses in the form of restricted stock. The 2014 award and 2013 award vest under certain circumstances on the one-year and two-year anniversary of the grant, respectively. We generally value restricted stock awards at an amount equal to the market price of our common stock on the date of grant. We recognize compensation expense for restricted stock awards on a straight line basis over the vesting period.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. STOCK-BASED COMPENSATION (Continued)

        A summary of non-vested restricted stock award activity for the nine months ended September 30, 2014 is set forth below:

        The total fair value of shares of restricted stock vested during the three months ended September 30, 2014 was $2.6 million.

Tax Benefits of Stock-Based Compensation

        ASC 718-10 requires us to report the benefits of tax deductions in excess of recognized compensation cost of equity awards as a financing cash flow. We recognized ($0.7) million and $0.4 million of financing cash flows for these excess tax deductions for the nine months ended September 30, 2014 and 2013, respectively.

8. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

        In addition to the matters discussed below, we are also subject to a variety of legal proceedings, arbitrations, investigations, audits, claims and litigation, including claims under the False Claims Act and claims for benefits under insurance policies and claims by members, providers, customers, employees, regulators and other third parties. In some cases, plaintiffs seek punitive damages. It is not possible to accurately predict the outcome or estimate the resulting penalty, fine or other remedy that may result from any current or future legal proceeding, investigation, audit, claim or litigation. Nevertheless, the range of outcomes and losses could be significant and could have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

        On October 22, 2013, we filed a lawsuit in the United States District Court for the District of Delaware against funds affiliated with the private equity firm GTCR ("GTCR"), David Katz, a former managing director of GTCR, and former senior management of APS Healthcare (Gregory Scott, Jerome Vaccaro and John McDonough, all such defendants, collectively, the "Defendants"). The lawsuit, which alleges securities fraud, multiple material breaches of contract and common law fraud, seeks substantial damages, including punitive damages. The lawsuit arises out of our acquisition of APS Healthcare from GTCR in March 2012. The Defendants filed a motion to dismiss the complaint. In a decision issued on July 24, 2014, the court denied the motion with respect to the breach of contract

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

8. COMMITMENTS AND CONTINGENCIES (Continued)

claim. The court granted the motion with respect to the securities fraud claims and portions of the common law fraud claims on the ground that they did not provide enough detail about each Defendant's specific role in the alleged fraud. On September 22, 2014, the Company filed an Amended Complaint to provide additional details regarding each Defendant's role in the alleged fraud.

Government Regulations, Investigations

        Laws and regulations governing Medicare, Medicaid and other state and federal healthcare and insurance programs are complex and subject to significant interpretation. As part of the 2010 healthcare reform legislation, CMS, State regulatory agencies and other regulatory agencies have been exercising increased oversight and regulatory authority over our Medicare and other businesses. Compliance with such laws and regulations is subject to CMS audit, other governmental review and investigation and significant and complex interpretation. CMS audits our Medicare Advantage plans with regularity to ensure we are in compliance with applicable laws, rules, regulations and CMS instructions. There can be no assurance that we will be found to be in compliance with all such laws, rules and regulations in connection with these audits, reviews and investigations, and at times we have been found to be out of compliance. Failure to be in compliance can subject us to significant regulatory action including significant fines, penalties, cancellation of contracts with governmental agencies or operating restrictions on our business, including, without limitation, suspension of our ability to market to and enroll new members in our Medicare plans, termination of our contracts with CMS, exclusion from Medicare and other state and federal healthcare programs and inability to expand into new markets or add new products within existing markets.

        Certain of our businesses provide products and services to various government agencies. As a government contractor, we are subject to the terms of the contracts we have with those agencies and applicable laws governing government contracts. We may also be subject to false claim act litigation (also known as qui tam litigation) brought by individuals who seek to sue on behalf of the government, alleging that the government contractor submitted false claims to the government. Innovative Resources Group, LLC ("IRG"), a subsidiary of APS Healthcare, is the subject of an investigation by the Department of Health and Human Services, Office of Inspector General relating to its Medicaid contracts with the State of Missouri that were in existence from 2006 to 2010 and is also the subject of an investigation by the Tennessee Attorney General's office related to IRG's operation of a disease management, health management and wellness program for Tennessee state employees that was in existence in 2011 and 2012. In September 2014, IRG settled a false claim act litigation involving its Medicaid contract with the State of Nevada that terminated in 2010. It is possible that IRG, other APS Healthcare subsidiaries or other Universal American companies could be party to additional false claims act investigations and litigation in the future and that the existing or future litigation or investigations could have a material adverse effect on our business and results of operations.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

9. BUSINESS SEGMENT INFORMATION

        As of September 30, 2014, our business segments are based on product and consist of

•

Senior Managed Care—Medicare Advantage and,



•

Traditional Insurance.

        Our remaining segment, Corporate & Other, reflects the activities of our holding company, along with start-up and operating costs associated with our ACO business, the operations of APS Healthcare, the operations of Total Care, acquired on December 1, 2013, and other ancillary 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 and in 2013 for services provided by APS Healthcare to our Senior Managed Care—Medicare Advantage segment.

        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. GAAP is as follows:

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

9. BUSINESS SEGMENT INFORMATION (Continued)

 

10. OTHER DISCLOSURES

        Income Taxes:    For interim financial reporting, except in circumstances as described in the following paragraph we estimate our annual effective tax rate based on projected taxable income for the full year and record a quarterly tax provision based on that estimated annual effective tax rate.

        In situations where uncertainty surrounding possible future events or transactions precludes our ability to make a reliable estimate of pre-tax income for the full year, projected pre-tax income for the full year is close to break-even, or permanent differences are significant when compared to projected pre-tax income, our estimated annual effective tax rate may become volatile and could distort the income tax provision for an interim period. When this happens, we calculate our interim income tax provision using actual year-to-date financial results.

        As the year progresses, we refine our estimate of full year pre-tax income as new information becomes available, including actual year-to- date financial results. This continual estimation process could result in a change to our estimated annual effective tax rate, or cause us to change between use of an estimated annual effective tax rate and actual year-to-date financial results in calculating our year-to-date income tax provision. When this occurs, we adjust the income tax provision during the quarter in which the change occurs so that the year-to-date income tax provision reflects the current estimates and methodology used. In both cases, the tax effect of realized gains and losses as well as non-recurring tax items are reported in the interim period in which they occur. Significant judgment is required in determining our annual estimated effective tax rate and in evaluating our tax positions.

        For the three and nine months ended September 30, 2014, we determined our current year income tax provision using actual year-to-date financial results for our domestic and foreign tax jurisdictions, as compared to the estimated annual effective tax rate method utilized in 2013.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. OTHER DISCLOSURES (Continued)

        Our effective tax rate was 176.8% for the third quarter of 2014 compared to 33.4% for the third quarter of 2013. The variance in the effective tax rate compared with the 35% federal rate was driven primarily by permanent items. For the quarter ended September 30, 2014, the tax effect of permanent items exceeded the tax effect of our loss from operations, resulting in income tax expense. Permanent items include those items that were mandated as non-deductible under the Affordable Care Act (ACA fee of $5.8 million in 2014 and non-deductible executive compensation,) as well as interest on the mandatorily redeemable preferred stock and non-deductible goodwill disposed of in connection with our sale of TOOK. We include state and foreign income taxes in our tax expense that also contributed to the variance in the effective tax rate.

        Our effective tax rate was (103.4%) for the nine months ended September 30, 2014 compared to less than 1.0% for same period of 2013. The variance in the effective tax rate compared with the 35% federal rate was driven primarily by permanent items. For the nine months ended September 30, 2014, the tax effect of permanent items exceeded the tax effect of our loss from operations, resulting in income tax expense. Permanent items include those items that were mandated as non-deductible under the Affordable Care Act (ACA fee of $17.5 million in 2014 and non-deductible executive compensation) as well as interest on the mandatorily redeemable preferred stock and non-deductible goodwill disposed of in connection with our sale of TOOK. We include state and foreign income taxes in our tax expense that also contributed to the variance in the effective tax rate.

        Sale of Today's Options of Oklahoma:    On August 29, 2014, we completed the sale of TOOK to Momentum Health, LLC. TOOK operates an HMO Medicare Advantage plan in Oklahoma with approximately 5,800 members, representing approximately $63 million of annualized revenue. The estimated purchase price at closing was $16.0 million consisting of a base amount of $9.4 million, plus $6.6 million of adjustments primarily related to statutory capital and surplus levels. We anticipate that the purchase price will be finalized during the fourth quarter of 2014. We received $15.2 million of the estimated purchase price in cash at closing. The balance of $0.8 million is recorded as a receivable in other assets on the consolidated balance sheet and is expected to be settled in cash during the fourth quarter. At the date of sale, our carrying value of TOOK included $3.8 million of goodwill and $1.5 million of amortizing intangible assets that were disposed of in connection with the transaction. The transaction resulted in a pre-tax realized loss of $1.6 million, or $2.5 million, after taxes.

        Acquisition of Total Care:    On December 1, 2013, we completed our acquisition of the assets of the Total Care Medicaid managed care plan, known as Total Care. The purchase price for the acquisition was $6.2 million in cash, of which $3.3 million was paid at closing. An estimated $2.9 million of contingent consideration will be paid in the future based on membership and quality improvements of the health plan. At closing, the excess of the purchase price over the tangible assets acquired, totaling $5.8 million was allocated to amortizing intangible assets, including customer relationships, provider networks and trade names, with estimated lives of 8 years. The balance of $0.1 million was allocated to goodwill.

        During the first quarter of 2014, we made acquisition accounting adjustments to reflect a $0.1 million increase in our estimated fair value of the provider networks with a corresponding

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. OTHER DISCLOSURES (Continued)

adjustment to eliminate goodwill. There have been no other adjustments to the fair value estimates made as of the acquisition date.

        Reinsurance:    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 Insurance Company, the company that we sold to CVS Caremark in 2011, 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 are not aware of any instances where any of our reinsurers have been unable to pay any policy claims on any reinsured business.

        As of September 30, 2014, all of our primary reinsurers, as well as the primary first 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 was established at the inception of the reinsurance agreement. The trust agreement requires that on an ongoing basis the trust assets be maintained at a minimum level of 100% of reserves. The reserves amounted to approximately $127.0 million as of September 30, 2014.

        Restructuring Charges:    A summary of our restructuring liability balance as of September 30, 2014 follows:

        For further discussion of our restructuring initiatives, see Note 22—Other Operational Disclosures—Restructuring Charges in our Annual Report on Form 10-K for the year ended December 31, 2013.

        Principal and Interest Payments on Term Loan:    During the nine months ended September 30, 2014, we were not required to make any principal payments as all scheduled 2014 principal payments, totaling $14.3 million, were prepaid on November 4, 2013, in connection with the amendment of our credit facility. During the three and nine month periods ended September 30, 2014, we made interest payments totaling $0.5 million and $1.9 million, respectively.

        During the three and nine month periods ended September 30, 2013, we made principal payments totaling $3.6 million and $10.7 million, respectively, and interest payments totaling $1.2 million and $2.5 million, respectively.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. OTHER DISCLOSURES (Continued)

        Unconsolidated Subsidiaries:    We account for our participation in the ACOs using the equity method. Gains and losses from our participation in the ACOs are reported as equity in losses of unconsolidated subsidiaries in the consolidated statements of operations. Our net investment in the ACOs is reported in other assets in the consolidated balance sheets. We recognized equity in earnings (losses) of our unconsolidated ACOs of $5.2 million and ($10.4) million for the three and nine months ended September 30, 2014, respectively, and losses of $7.9 million and $25.1 million for the three and nine months ended September 30, 2013, respectively. 2014 includes our share of revenue related to program years 2012 and 2013, which amounted to $13.4 million, net of 100% of program year 2014 operating expenses. We did not recognize any shared savings revenue in 2013. For additional information on the ACOs, see Note 1—Organization and Company Background and Note 2—Basis of Presentation.

        Special Dividend:    On August 1, 2013, the Board of Directors approved the payment of a special cash dividend of $1.60 per share, payable on August 19, 2013 to shareholders of record as of August 12, 2013. The total dividend payment was $142.1 million of which $139.9 million was paid on August 19, 2013. This dividend is a liquidating dividend and was recorded as a reduction of additional paid-in capital.

        Stock Repurchase Plan:    On August 1, 2013, our Board of Directors authorized the repurchase of up to $40 million of our outstanding common stock. Purchases may occur from time to time in the open market, in privately negotiated transactions, or otherwise as market conditions permit. On May 13, 2014 we repurchased and retired six million shares of our common stock directly from funds associated with Capital Z Partners Management, LLC at a price of $6.03 per share for total consideration of $36.2 million. We used cash on hand to fund the repurchase of these shares.

        Earnings Per Common Share Computation:    The calculation of the diluted loss per common share presented in the consolidated statements of operations excludes common stock equivalents from stock options and unvested restricted stock that are potentially dilutive because to include them would be antidilutive when reporting a net loss. Total shares excluded were 0.8 million and 0.5 million, respectively, for the three and nine months ended September 30, 2014 and 0.4 million and 0.3 million, respectively, for the three and nine months ended September 30, 2013.

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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, 2014 and our results of operations for the three month and nine month periods ended September 30, 2014 and 2013. As used in this quarterly report, except as otherwise indicated, references to the "Company," "Universal American," "we," "our," and "us" are to Universal American Corp., a Delaware corporation and its subsidiaries.

        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, 2013. The following discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause our actual results to differ materially from management's expectations. Factors that could cause such differences include those set forth or incorporated by reference in our Annual Report on Form 10-K for the year ended December 31, 2013 filed on March 13, 2014 under Part II, Item 1A—Risk Factors.

Overview

        Universal American, through our health insurance and managed care subsidiaries, primarily serves the growing Medicare population by providing Medicare Advantage products. Approximately 30% of the Medicare population in the United States is currently enrolled in Medicare Advantage plans; a type of Medicare health plan offered by private companies that contract with the federal government to provide enrollees with health insurance. Our current focus is to grow our Medicare Advantage business in our core markets, which largely consists of our health plans offered in the Southwest and Upstate New York markets. In addition, we believe there is an opportunity to address the high cost of health care for the remaining 70% of the Medicare population enrolled in traditional fee- for-service Medicare and have joined primarily with primary-care and multi-specialty provider groups to operate thirty Accountable Care Organizations, or ACOs, pursuant to the Medicare Shared Savings Program, or Shared Savings Program. We also provide Medicaid services to Medicaid agencies through APS Healthcare and recently acquired the Total Care Medicaid health plan serving approximately 40,600 members in Upstate New York.

Recent Developments

        ACO Revenue—During September 2014, we received notice that the ACOs we formed in partnership with primary care physicians generated $57 million in total program savings for the Centers for Medicare & Medicaid Services, known as CMS, as part of the Medicare Shared Savings Program for program years 2012 and 2013. Of our 30 ACOs with start dates in 2012 and 2013, the results showed that:

•

3 ACOs, serving more than 56,000 Medicare beneficiaries and including our largest ACO in Houston, qualified for savings;



•

11 ACOs, serving more than 120,000 Medicare beneficiaries, generated savings but fell below their Minimum Savings Rate required to share savings with CMS;



•

8 ACOs were within 2 percent of their benchmark;

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•

8 ACOs were 2 percent or more above their benchmark; and



•

All ACOs met CMS's quality reporting standards.

        The 3 ACOs qualifying for savings will receive payments of $20.4 million, part to be paid to physicians and part to defray a portion of the costs that we have incurred. Our share of these savings, including expense recovery, amounted to $13.4 million, which is reflected in equity in earnings (losses) of unconsolidated subsidiaries in our consolidated statements of operations. We received these payments in October 2014.

        Sale of Today's Options of Oklahoma—On August 29, 2014, we completed the sale of Today's Options of Oklahoma, known as TOOK, to Momentum Health, LLC. TOOK operates an HMO Medicare Advantage plan in Oklahoma with approximately 5,800 members, representing approximately $63 million of annualized revenue. The estimated purchase price at closing was $16.0 million resulting in a pre-tax realized loss of $1.6 million, or $2.5 million, after taxes. The after-tax loss reflects the non-deductible goodwill disposed of in connection with the sale. For further discussion of this transaction, see Note 10—Other Disclosures.

        Stock repurchase—On March 28, 2014, we entered into a definitive agreement to repurchase six million shares of our voting common stock directly from funds associated with Capital Z Partners Management, LLC at a price of $6.03 per share. This transaction closed in May 2014. We used cash on hand to fund the repurchase of these shares.

        Non-deductible health insurance industry fee ("ACA Fee")—Beginning in 2014, the new healthcare reform legislation imposes an annual aggregate health insurance industry fee of $8.0 billion (with increasing annual amounts thereafter) on certain health insurance premiums, including Medicare Advantage premiums. 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. As a result, our effective income tax rate will be adversely affected in 2014 and future years. Our share of the new fee is based on our pro rata percentage of eligible or included premiums written during the preceding calendar year compared to the industry as a whole, calculated annually. This fee will affect the profitability of our Medicare Advantage business and could have a material adverse effect on our results of operations.

        In January 2014, we had estimated that the fee to be paid in 2014, based on 2013 direct written premiums, would be approximately $21.7 million. As required under generally accepted accounting principles, we accrued this amount in other liabilities in our consolidated balance sheets in January 2014, with an offsetting deferred cost asset recorded in other assets. The asset is being amortized ratably over 2014 and is reported on a separate line in our consolidated statements of operations. In the second quarter, we received further data indicating the fee would be approximately $23.4 and adjusted our accrual accordingly. In the third quarter of 2014, we made a payment in the amount of $23.4 million, representing our share of the ACA fee (including $0.3 million related to TOOK, for which we were reimbursed by the acquirer). For the three and nine month periods ended September 30, 2014, we amortized $5.8 million and $17.5 million, respectively, and as of September 30, 2014, we have an asset of $5.6 million representing the prepaid balance of the ACA Fee, which will be amortized in the fourth quarter of 2014. In accordance with promulgated statutory accounting principles, the fee was reported as an expense on January 1, 2014, rather than amortized to expense over the year. The statutory expense was adjusted in the second quarter of 2014 to reflect the increased estimate. The ACA fee will be factored in when calculating the stipulated minimum medical loss ratio.

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Membership

        The following table presents our membership in Medicare Advantage products:

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:

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Three months ended September 30, 2014 and 2013

        Net loss for the three months ended September 30, 2014 was $2.1 million, or ($0.03) per diluted share, compared to net loss of $12.7 million, or ($0.15) per diluted share, for the three months ended September 30, 2013. These amounts include realized losses, net of taxes, of $2.0 million, or ($0.02) per diluted share, and realized gains of $0.4 million, or less than $0.01 per diluted share for the third quarter of 2014 and 2013, respectively. 2014 realized losses include a realized loss on our sale of TOOK, which was $2.5 million, after taxes. The after-tax loss reflects the non-deductible goodwill disposed of in connection with the sale.

        For the three months ended September 30, 2014, we determined our current year income tax provision using actual year-to-date financial results for our domestic and foreign tax jurisdictions, as compared to the estimated annual effective tax rate method utilized in 2013. Our effective tax rate was 176.8% for the third quarter of 2014 compared to 33.4% for the third quarter of 2013. The variance in the effective tax rate compared with the 35% federal rate was driven primarily by permanent items. For the quarter ended September 30, 2014, the tax effect of permanent items exceeded the tax effect of our loss from operations, resulting in income tax expense. Permanent items include those items that were mandated as non-deductible under the Affordable Care Act (ACA fee of $5.8 million in 2014 and non-deductible executive compensation) as well as interest on the mandatorily redeemable preferred stock and non-deductible goodwill disposed of in connection with our sale of TOOK. We include state and foreign income taxes in our tax expense that also contributed to the variance in the effective tax rate.

        Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $5.3 million for the quarter ended September 30, 2014, an increase of $2.1 million compared to the quarter ended September 30, 2013. The increase in earnings was driven by an improved medical benefit ratio in 2014 and a $13.1 million reduction in commissions and general expenses, partially offset by lower membership levels in 2014, as well as $5.8 million of expense related to the new ACA fee. The quarter ended September 30, 2014 includes $3.7 million of net favorable prior period items compared to $3.5 million of net favorable prior period items for the quarter ended September 30, 2013.

        Our Traditional Insurance segment generated a loss before taxes of $0.1 million for the quarter ended September 30, 2014, a decrease of $4.4 million compared to 2013. The decrease in earnings is primarily driven by the continued reduction of business in-force, an increase in losses on our Specialty Health lines, and a higher amount of amortization of deferred acquisition costs.

        The loss before income taxes from our Corporate & Other segment decreased by $25.6 million for the three months ended September 30, 2014 compared to the same period in 2013. This was due to a $13.3 million improvement in our ACO results, as our unconsolidated ACO subsidiaries recognized revenue related to program years 2012 and 2013, improved profitability of our APS Healthcare business in 2014, corporate expense reduction initiatives and higher net investment income, partially offset by higher legal costs related to APS Healthcare matters.

Nine months ended September 30, 2014 and 2013

        Net loss for the nine months ended September 30, 2014 was $16.9 million, or ($0.20) per diluted share, compared to net loss of $90.6 million, or ($1.04) per diluted share, for the nine months ended September 30, 2013. These amounts include realized losses, net of taxes, of $1.1 million, or $(0.01) per diluted share, and realized gains of $8.6 million, or $0.10 per diluted share for the nine months ended September 30, 2014 and 2013, respectively. 2014 realized losses include a realized loss on our sale of TOOK, which was $2.5 million, after taxes. The after-tax loss reflects the non-deductible goodwill disposed of in connection with the sale.

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        For the nine months ended September 30, 2014, we determined our current year income tax provision using actual year-to-date financial results for our domestic and foreign tax jurisdictions, as compared to the estimated annual effective tax rate method utilized in 2013. Our effective tax rate was (103.4%) for the nine months ended September 30, 2014 compared to less than 1.0% for same period of 2013. The variance in the effective tax rate compared with the 35% federal rate was driven primarily by permanent items. For the nine months ended September 30, 2014, the tax effect of permanent items exceeded the tax effect of our loss from operations, resulting in income tax expense. Permanent items include those items that were mandated as non-deductible under the Affordable Care Act (ACA fee of $17.5 million in 2014 and non-deductible executive compensation) as well as interest on the mandatorily redeemable preferred stock and non-deductible goodwill disposed of in connection with our sale of TOOK. We include state and foreign income taxes in our tax expense that also contributed to the variance in the effective tax rate.

        Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $42.9 million for the nine months ended September 30, 2014, an increase of $1.1 million compared to the nine months ended September 30, 2013. The increase in earnings was driven by an improved medical benefit ratio in 2014 and a $24.3 million reduction in commissions and general expenses, partially offset by lower membership levels in 2014, as well as $17.3 million of expense related to the new ACA fee. For the nine months ended September 30, 2014, there were $28.2 million of net favorable prior year items compared to $21.4 million for the nine months ended September 30, 2013.

        Our Traditional Insurance segment generated income before taxes of $3.3 million for the nine months ended September 30, 2014, a decrease of $8.4 million compared to 2013. The decrease in earnings is driven primarily by the reduction of business in-force and an increase in losses on our Specialty Health lines.

        The loss before income taxes from our Corporate & Other segment decreased by $102.1 million for the nine months ended September 30, 2014 compared to the same period in 2013. This was due primarily to a goodwill impairment charge of $91.7 million taken in the second quarter of 2013 related to APS Healthcare. The remaining decrease was driven by improvement in our ACO results, as our unconsolidated ACO subsidiaries recognized revenue related to program years 2012 and 2013, higher profitability of our APS Healthcare business in 2014, corporate expense reduction initiatives and higher net investment income, partially offset by higher legal costs related to APS Healthcare matters.

Segment Results—Senior Managed Care—Medicare Advantage

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        Our Senior Managed Care—Medicare Advantage segment includes the operations of our Medicare coordinated care HMO, PPO, network-based PFFS and non-network (Rural) PFFS Plans (collectively, the "Plans"), which provides coverage to Medicare beneficiaries in 24 states. Our HMOs offer coverage to Medicare beneficiaries primarily in Southeastern Texas and the area surrounding Dallas/Ft. Worth. We have not re-bid the contracts containing our non-network (Rural) PFFS plans for 2015.

Three months ended September 30, 2014 and 2013

        Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $5.3 million for the quarter ended September 30, 2014, an increase of $2.1 million compared to the quarter ended September 30, 2013. The increase in earnings was driven by an improved medical benefit ratio in 2014 and a $13.1 million reduction in commissions and general expenses, partially offset by lower membership levels in 2014, as well as $5.8 million of expense related to the new ACA fee. The quarter ended September 30, 2014 includes $3.7 million of net favorable prior period items compared to $3.5 million of net favorable prior period items for the quarter ended September 30, 2013.

        Net premiums.    Net premiums for the Senior Managed Care—Medicare Advantage segment decreased by $55.9 million compared to the quarter ended September 30, 2013 primarily due to lower membership levels and lower premium yield per member resulting from a change in the mix of our membership, as well as a decrease in the impact of favorable prior period items. In 2014, net premiums included $1.4 million of favorable prior period items compared to $6.3 million of favorable prior period items in the quarter ended September 30, 2013. In 2014, CMS accelerated notification of the 2013 final HCC payment to the second quarter, which was thus reported in our financial statements in the quarter ended June 30, 2014, compared to 2013 in which the 2012 final HCC payment was reported during the quarter ended September 30, 2013.

        Net investment income.    Net investment income decreased $0.5 primarily due to lower invested asset levels resulting from the payment of dividends to the parent in 2013.

        Fee and other income.    Fee and other income increased $0.6 million for the quarter ended September 30, 2014 due to transition services fees earned as part of the divestment of TOOK. The transition was substantially completed as of September 30, 2014.

        Medical expenses.    Our medical expenses, decreased by $50.3 million for the quarter ended September 30, 2014 compared to the quarter ended September 30, 2013. The decrease was driven by lower membership and lower claims cost per member (as a result of exiting non-core markets that incurred higher claims cost per member), resulting in a medical benefit ratio of 85.7% in 2014 compared with 86.3% in 2013. During 2014, medical expenses included $2.3 million of net favorable items related to prior periods, compared to $2.8 million of net unfavorable items related to prior periods in the quarter ended September 30, 2013. Quality improvement initiative costs of $6.1 million and $7.0 million for the quarters ended September 30, 2014 and 2013, respectively, are included in medical expenses in connection with the reporting of minimum medical loss ratios under the Affordable Care Act. In 2013, these costs were reported in commissions and general expenses. The following table provides a breakdown of medical expenses and the related medical benefit ratios:

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        Adjusting for the prior year items discussed above, for the quarter ended September 30, 2014, our medical benefit ratio, excluding quality improvement initiative costs, was 84.9%.

        ACA fee.    The ACA fee for the three months ended September 30, 2014 amounted to $5.8 million, or 1.7% of net premiums. The ACA fee is included in the calculation of minimum medical loss ratios under the Affordable Care Act.

        Commissions and general expenses.    Commissions and general expenses decreased by $13.1 million for the quarter ended September 30, 2014 compared to the quarter ended September 30, 2013, primarily due to cost reduction initiatives and lower membership. Our administrative expense ratio was 12.3% for the quarter ended September 30, 2014 compared to 13.9% for the same period in 2013. Commissions and general expenses for the quarter ended September 30, 2013 were adjusted to exclude $7.0 million of quality initiative expenses, which have been reclassified to medical expenses to be consistent with 2014 classification, as discussed above.

Nine months ended September 30, 2014 and 2013

        Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $42.9 million for the nine months ended September 30, 2014, an increase of $1.1 million compared to the nine months ended September 30, 2013. The increase in earnings was driven by an improved medical benefit ratio in 2014 and a $24.3 million reduction in commissions and general expenses, partially offset by lower membership levels in 2014, as well as $17.3 million of expense related to the new ACA fee. For the nine months ended September 30, 2014, there were $28.2 million of net favorable prior year items compared to $21.4 million for the nine months ended September 30, 2013.

        Net premiums.    Net premiums for the Senior Managed Care—Medicare Advantage segment decreased by $156.2 million compared to the nine months ended September 30, 2013 primarily due to lower membership levels and lower premium yield per member, resulting from a change in the mix of our membership, as well as lower prior period items. In 2014, net premiums included $14.6 million of favorable prior period items compared to $33.9 million of favorable prior period items in the nine months ended September 30, 2013.

        Net investment income.    Net investment income decreased $2.9 primarily due to lower invested asset levels resulting from the payment of dividends to the parent in 2013.

        Fee and other income.    Fee and other income increased $0.7 million for the quarter ended September 30, 2014 primarily due to transition services fees earned as part of the divestment of TOOK. The transition was substantially completed as of September 30, 2014.

        Medical expenses.    Our medical expenses, decreased by $152.4 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013. The decrease was driven by lower membership and lower claims cost per member (as a result of exiting non-core markets that incurred higher claims cost per member) as well as favorable prior period items, resulting in a medical benefit ratio of 84.2% in 2014 compared with 85.9% in 2013. During 2014, medical expenses included $13.6 million of net favorable items related to prior periods, compared to $12.5 million of net unfavorable items related to prior periods in the nine months ended September 30, 2013. Quality improvement initiative costs of $21.7 million and $19.9 million for the nine months ended September 30, 2014 and 2013, respectively, are included in medical expenses in connection with the reporting of minimum medical loss ratios under the Affordable Care Act. These costs were previously

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reported in commissions and general expenses. The following table provides a breakdown of medical expenses and the related medical benefit ratios:

        Adjusting for the prior year items discussed above, for the nine months ended September 30, 2014, our medical benefit ratio, excluding quality improvement initiative costs, was 84.6%.

        ACA fee.    The ACA fee for the nine months ended September 30, 2014 amounted to $17.3 million, or 1.6% of net premiums. The ACA fee is included in the calculation of minimum medical loss ratios under the Affordable Care Act.

        Commissions and general expenses.    Commissions and general expenses decreased by $24.3 million for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013, primarily due to cost reduction initiatives and lower membership. Our administrative expense ratio was 11.3% for the nine months ended September 30, 2014 compared with 11.8% for the same period in 2013. Commissions and general expenses for the nine months ended September 30, 2013 were adjusted to exclude $19.9 million of quality initiative expenses, which have been reclassified to medical expenses to be consistent with 2014 classification, as discussed above.

Segment Results—Traditional Insurance

        Our Traditional Insurance segment consists of three major lines of business. Senior Market includes Medicare supplement, senior dental and hospital indemnity products. Specialty Health includes disability, specified disease, hospital, surgical and long-term care products. Life Insurance includes senior life products. We discontinued marketing and selling Traditional insurance products after June 1, 2012.

Three months ended September 30, 2014 and 2013

        Our Traditional Insurance segment generated a loss before taxes of $0.1 million for the quarter ended September 30, 2014, a decrease of $4.4 million compared to 2013. The decrease in earnings is

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primarily driven by the continued reduction of business in-force, an increase in losses on our Specialty Health lines, and a higher amount of amortization of deferred acquisition costs.

        Net premiums.    Net premium declined by $7.2 million, or 13.6%. This is primarily the result of the continued effect of lapsation across all lines of business. The following table details premium for the segment by major lines of business:

        Net investment income.    Net investment income decreased by $0.4 million, primarily due to a lower invested asset base due to the payment of dividends to the parent in 2013 and the declining blocks of business.

        Policyholder benefits.    Policyholder benefits incurred declined by $2.5 million, or 6.8%, compared to 2013. 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 higher benefit ratios in these lines. The policyholder benefit ratio for senior market health was 65.9% in 2014 compared with 64.0% in 2013, and for specialty health was 112.7% in 2014, compared with 92.8% in 2013. The increase in losses on specialty health was driven by an increase in the incidence rate and severity of disability income benefits.

        Change in deferred acquisition costs.    The change in deferred acquisition costs increased $1.4 million compared to 2013, driven by higher amortization.

        Commissions and general expenses, net of allowances.    Commissions and general expenses, net of allowances, decreased by $2.2 million from 2013. This decrease is primarily attributed to lower commissions and costs required to run a smaller book of business in-force.

Nine months ended September 30, 2014 and 2013

        Our Traditional Insurance segment generated income before taxes of $3.3 million for the nine months ended September 30, 2014, a decrease of $8.4 million compared to 2013. The decrease in earnings is driven primarily by the reduction of business in-force and an increase in losses on our Specialty Health lines.

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        Net premiums.    Net premium declined by $20.9 million, or 12.8%. This is primarily the result of the continued effect of lapsation across all lines of business. The following table details premium for the segment by major lines of business:

        Net investment income.    Net investment income decreased by $1.2 million, primarily due to a lower invested asset base due to the payment of dividends to the parent in 2013 and the declining blocks of business.

        Policyholder benefits.    Policyholder benefits incurred declined by $12.4 million, or 10.2%, compared to 2013. 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 higher benefit ratios in these lines. For 2014, the policyholder benefit ratio for senior market health was 68.9% compared with 68.7% in 2013, and for specialty health was 104.7% in 2014, compared with 96.9% in 2013. The increase in losses on specialty health was driven by an increase in the incidence rate and severity of disability income benefits.

        Commissions and general expenses, net of allowances.    Commissions and general expenses, net of allowances, decreased by $1.1 million from 2013. This decrease is primarily attributed to lower costs required to run a smaller book of business in-force.

Segment Results—Corporate & Other

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        Corporate & Other reflects the activities of our holding company, along with the operations of our ACO business, APS Healthcare, Total Care, acquired on December 1, 2013, and other ancillary operations. The operations of our ACO business include expenses for development and oversight of our ACOs incurred by our wholly-owned subsidiary, CHS, which are included in general expenses as well as our share of the program results of our ACO partnerships which are included in equity in earnings (losses) of unconsolidated subsidiaries.

Three months ended September 30, 2014 and 2013

        The loss before income taxes from our Corporate & Other segment decreased by $25.6 million for the three months ended September 30, 2014 compared to the same period in 2013. This was due to a $13.3 million improvement in our ACO results, as our unconsolidated ACO subsidiaries recognized revenue related to program years 2012 and 2013, improved profitability of our APS Healthcare business in 2014, corporate expense reduction initiatives and higher net investment income, partially offset by higher legal costs related to APS Healthcare matters. The following table details the loss before income taxes for our corporate segment:

        Net premiums.    Net premiums increased by $48.8 million for the three months ended September 30, 2014 compared to the same period in 2013 primarily due to the Total Care revenue included in 2014 as well as a $1.7 million increase in APS Healthcare premium, primarily on our Puerto Rico risk business. The following table details net premiums for our corporate segment:

        Net investment income.    Net investment income for the quarter ended September 30, 2014 included $2.7 million related to a distribution received on a cost-method investment.

        Fee and other income.    Fee and other income increased by $0.9 million for the three months ended September 30, 2014 compared to the same period in 2013 primarily due to an increase in fee for

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service business at APS Healthcare. The following table details fee and other income in our corporate segment:

        Claims and other benefits.    Claims and other benefits increased by $44.0 million for the three months ended September 30, 2014 compared to the same period in 2013, primarily related to the Total Care benefits included in 2014 as well as a $0.4 million increase in APS Healthcare claims, primarily on our Puerto Rico risk business. The following table details claims and other benefits for our corporate segment:

        Amortization of intangible assets.    This represents the amortization of APS Healthcare and Total Care intangible assets. The decrease is primarily due to the prior year impairment of APS Healthcare intangible assets, resulting in a lower asset balance being amortized in 2014.

        Interest expense.    This represents interest related to the credit facility entered into in connection with our acquisition of APS Healthcare on March 2, 2012 and dividends on the Mandatorily Redeemable Preferred Shares, which were issued on April 29, 2011.

        Commissions and general expenses.    Total commissions and general expenses decreased by $3.4 million for the three months ended September 30, 2014 compared to the same period in 2013. This was driven by a decrease of $7.3 million at APS Healthcare related to expense reduction initiatives and lower levels of business. This was partially offset by $3.3 million of 2014 Total Care operating expenses and an $0.8 million increase in general corporate expenses (primarily legal costs related to APS Healthcare matters partially offset by expense reduction initiatives). The following table details commissions and general expenses for our corporate segment:

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        Equity in income of unconsolidated subsidiaries.    This line represents our share of income in our unconsolidated ACO subsidiaries. Including operating expenses of our ACO subsidiary reported in commissions and general expenses above, we recognized pre-tax income on our ACOs of $3.2 million for the three months ended September 30, 2014 compared with a loss of $10.2 million for the three months ended September 30, 2013. 2014 includes our share of revenue related to program years 2012 and 2013, which amounted to $13.4 million, net of 100% of program year 2014 operating expenses. Operating expenses of our ACO business were $10.2 million in both 2014 and 2013. We did not recognize any shared savings revenue in 2013.

        Based on the ACO operating agreements, calculated at the individual ACO level, we bear all costs of the ACO operations until revenue is recognized. At that point, we have the right to receive 100% of the shared savings revenue up to our costs incurred. Any remaining profit is generally shared equally with our ACO provider partners.

Nine months ended September 30, 2014 and 2013

        The loss before income taxes from our Corporate & Other segment decreased by $102.1 million for the nine months ended September 30, 2014 compared to the same period in 2013. This was due primarily to a goodwill impairment charge of $91.7 million taken in the second quarter of 2013 related to APS Healthcare. The remaining decrease was driven by improvement in our ACO results, as our unconsolidated ACO subsidiaries recognized revenue related to program years 2012 and 2013, higher profitability of our APS Healthcare business in 2014, corporate expense reduction initiatives and higher net investment income, partially offset by higher legal costs related to APS Healthcare matters. The following table details the loss before income taxes for our corporate segment:

        Net premiums.    Net premiums increased by $127.5 million for the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to the Total Care revenue included in 2014 partially offset by a $4.7 million decrease in APS Healthcare premiums, due to a smaller block of risk business. The following table details net premiums for our corporate segment:

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        Net investment income.    Net investment income for the nine months ended September 30, 2014 included $2.7 million related to a distribution received on a cost-method investment.

        Fee and other income.    Fee and other income decreased by $21.2 million for the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to the planned reduction in fee for service business at APS Healthcare. The following table details fee and other income in our corporate segment:

        Claims and other benefits.    Claims and other benefits increased by $119.3 million for the nine months ended September 30, 2014 compared to the same period in 2013, primarily related to the Total Care benefits included in 2014. The following table details claims and other benefits for our corporate segment:

        Amortization of intangible assets.    This represents the amortization of APS Healthcare and Total Care intangible assets. The decrease is primarily due to prior year impairment of APS Healthcare intangible assets, resulting in a lower asset balance being amortized.

        Interest expense.    This represents interest related to the credit facility entered into in connection with our acquisition of APS Healthcare on March 2, 2012 and dividends on the Mandatorily Redeemable Preferred Shares, which were issued on April 29, 2011.

        Commissions and general expenses.    Total commissions and general expenses decreased by $3.8 million for the nine months ended September 30, 2014 compared to the same period in 2013. This was driven by a $28.8 million decrease at APS Healthcare primarily related to expense reduction initiatives and lower levels of business, offset by $10.4 million in Total Care expenses included in 2014, an $8.5 million increase in general corporate expense (primarily legal costs related to APS Healthcare matters partially offset by expense reduction initiatives) and a $6.2 million increase in ACO subsidiary

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operating expenses. The following table details commissions and general expenses for our corporate segment:

        Equity in losses of unconsolidated subsidiaries.    This line represents our share of losses on our unconsolidated ACO subsidiaries. Including operating expenses of our ACO subsidiary reported in commissions and general expenses above, total ACO costs were $19.9 million for the nine months ended September 30, 2014 compared with $28.4 million for the nine months ended September 30, 2013. 2014 includes 100% of program year 2014 operating expenses of $33.3 million, net of our share of revenue related to program years 2012 and 2013, which amounted to $13.4 million. We did not recognize any shared savings revenue in 2013.

        Based on the ACO operating agreements, calculated at the individual ACO level, we bear all costs of the ACO operations until revenue is recognized. At that point, we have the right to receive 100% of the shared savings revenue up to our costs incurred. Any remaining profit is generally shared equally with our ACO provider partners.

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 operations and growth of our HMO, insurance and other subsidiaries, fund new business opportunities through acquisitions or otherwise 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 ongoing sources and uses of liquidity are derived primarily from the following:

•

dividends from and capital contributions to our Insurance and HMO subsidiaries—Based on current estimates, we expect the aggregate amount of dividends that may be paid to our parent company in 2014 without prior approval by state regulatory authorities is $53.1 million. During the nine months ended September 30, 2014, our subsidiaries paid $38.2 million in dividends to their holding companies. An additional $2.9 million was paid in October 2014. We expect the remaining $12.0 million to be paid during the fourth quarter.



•

loans from and interest payments to our Insurance subsidiaries to support investments in our ACO business—During 2013, our Insurance subsidiaries loaned $22 million to our parent company. During the first nine months of 2014, the parent company paid interest totaling $0.6 million to our Insurance subsidiaries.



•

the cash flows of our other subsidiaries, including our management service organization—Net cash flows available to our parent company amounted to approximately $10.7 million, during the nine months ended September 30, 2014.

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•

the cash flows of our ACO business and other growth initiatives—For the nine months ended September 30, 2014, we incurred losses of approximately $19.9 million, pre-tax, related to our ACO business. This includes 100% of program year 2014 operating expenses, net of our share of revenue related to program years 2012 and 2013, which amounted to $13.4 million. We received these revenue payments in October 2014.



•

payment of dividends to holders of our mandatorily redeemable preferred shares—Dividends to holders of our mandatorily redeemable preferred shares amount to $3.4 million per year and we have paid $2.6 million during the nine months ended September 30, 2014. The $40 million face value of those shares cannot be redeemed prior to 2017, unless there is a change of control of the Company.



•

payment of debt principal, interest and fees required under our 2012 Credit Facility—During the nine months ended September 30, 2014, we made interest payments totaling $1.9 million and other fee payments totaling $0.4 million. We were not required to make any principal payments as all scheduled 2014 principal payments, totaling $14.3 million, were prepaid in 2013, in connection with the amendment of our credit facility on November 4, 2013. There is a bullet payment of $74.9 million due in 2017.



•

payment of certain corporate overhead costs and public company expenses, net of revenues which amounted to $24.7 million for the nine months ended September 30, 2014.

        In addition, the parent company from time-to-time engages in corporate finance activities that generate the following sources and uses of liquidity:

•

payment of dividends to shareholders—We do not currently pay a regular dividend to our shareholders, however, we have paid special dividends in the past, most recently in August 2013. Payment of any future dividends would be dependent upon an evaluation of excess capital, as discussed below.



•

repurchase of our common stock under our stock repurchase plan—On August 1, 2013, our Board of Directors authorized the repurchase of up to $40 million of our outstanding common stock. Purchases may occur from time to time in the open market, in privately negotiated transactions, or otherwise as market conditions permit. On May 13, 2014 we repurchased and retired six million shares of our common stock directly from funds associated with Capital Z Partners Management, LLC at a price of $6.03 per share. We used cash on hand to fund the repurchase of these shares.



•

proceeds from the sale of subsidiaries—During the quarter ended September 30, 2014, we completed the sale of TOOK for $16.0 million, generating cash proceeds of $15.2 million during the quarter plus a receivable of $0.8 million, which is expected to be settled in cash during the fourth quarter. As of September 30, 2014, we had approximately $90 million of cash and investments in our parent company and unregulated subsidiaries.

        We continually evaluate the potential use of any excess capital, which may include the following:

•

reinvestment in existing businesses;



•

acquisitions, investments or other strategic transactions;



•

return to shareholders through share repurchase, dividend or other means;



•

paydown of debt; or



•

other appropriate uses.

        Any such use is dependent upon a variety of factors and there can be no assurance that any one or more of these uses will occur.

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Sources and Uses of Liquidity of Our Subsidiaries

        Insurance and HMO subsidiaries.    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. The primary sources of liquidity are premiums received from CMS and policyholders and investment income generated by our invested assets.

        Our insurance and HMO 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. Additionally, the National Association of Insurance Commissioners, known as the NAIC, imposes regulatory risk-based capital, known as RBC, requirements on insurance companies. The level of RBC is calculated and reported annually. A number of remedial actions could be enforced if a company's total adjusted capital is less than 200% of authorized control level RBC. However, we generally consider target surplus to be 350% of authorized control level RBC. At December 31, 2013, all of our insurance subsidiaries had total adjusted capital in excess of our target of 350% of authorized control level RBC. 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.

        At September 30, 2014, we held cash and invested assets of approximately $887 million at our insurance and HMO subsidiaries that could readily be converted to cash. We believe that this level of liquidity is sufficient to meet our obligations and pay expenses.

        We did not make any capital contributions to our insurance and HMO subsidiaries during the first nine months of 2014. Based on statutory capital and surplus levels at December 31, 2013, the aggregate amount of dividends that may be paid to our parent company during 2014 without prior approval by state regulatory authorities was $53.1 million. During the nine months ended September 30, 2014, our insurance and HMO subsidiaries paid $38.2 million to their holding companies. An additional $2.9 million was paid in October 2014. We expect the remaining $12.0 million to be paid during the fourth quarter.

        Management service organizations.    The primary sources of liquidity for these subsidiaries are fees collected from affiliates 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 company.

        APS Healthcare.    The primary sources of liquidity for APS Healthcare are fees from its customers, including health plans, state agencies and related organizations for performing a range of healthcare 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 APS Healthcare will not cover scheduled uses of cash and therefore APS Healthcare will continue to need to borrow funds from our parent company, to the extent such funding continues to be made available. APS Healthcare's Puerto Rico subsidiary is required to maintain minimum statutory equity as required by contract with the Commonwealth of Puerto Rico and currently exceeds its minimum requirement at levels we believe are sufficient to support its current level of operations.

        Total Care.    We require cash at Total Care to pay claims and other benefits for our member, to pay operating expenses, to maintain adequate capital levels. The primary sources of liquidity are premiums received from the New York Department of Health and policyholders. Total Care is required to maintain a contingent reserve equal to a percentage of premium that grades from 7.25% for 2013, ultimately to 12.5%. At December 31, 2013, Total Care had net worth in excess of the contingent reserve requirements.

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        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 of September 30, 2014, approximately 99% of our investment portfolio had investment grade ratings from S&P or Moody's.

        At September 30, 2014, cash and cash equivalents represent approximately 11% of our total cash and invested assets, approximately 25% of cash and invested assets were held in securities backed by the U.S. government or its agencies and the average credit quality of our total investment portfolio was AA-.

        The average book yield of our total investment portfolio was 3.3% at September 30, 2014 and December 31, 2013.

        2012 Credit Facility.    In connection with the acquisition of APS Healthcare, on March 2, 2012, we entered into a new credit facility (the "2012 Credit Facility") consisting of a five-year $150 million senior secured term loan and a $75 million senior secured revolving credit facility.

        The 2012 Credit Facility contains customary representations and warranties as well as customary affirmative and negative covenants. Negative covenants include, among others, limitations on the incurrence of indebtedness, limitations on the incurrence of liens and limitations on acquisition, dispositions, investments and restricted payments. In addition, the 2012 Credit Facility contains certain financial covenants relating to minimum risk-based capital, consolidated leverage ratio, and consolidated debt service ratio. The 2012 Credit Facility also contains customary events of default. Upon the occurrence and during the continuance of an event of default, the Lenders may declare the outstanding advances and all other obligations under the 2012 Credit Facility immediately due and payable.

        On November 4, 2013, we entered into an amendment to our 2012 Credit Facility. The amendment, which is effective beginning with the quarter ending September 30, 2013, suspends certain financial covenants, including the consolidated leverage and debt service ratios, replacing them with total debt to capitalization and minimum liquidity ratios. These new financial covenants will remain in effect through December 31, 2014. Effective January 1, 2015, the original financial covenants will be reinstated. In connection with the amendment, we prepaid all scheduled 2013 and 2014 principal payments, including the final 2013 payment due December 31, 2013 of $3.6 million and all 2014 scheduled payments totaling $14.3 million. We also paid fees and expenses of approximately $0.5 million in 2013. We are required to ratably apply any future prepayments through the remaining scheduled repayments.

        As of September 30, 2014, we were in compliance with all financial covenants, as amended.

        Our obligations under the Credit Agreement are secured by a first priority security interest in 100% of the capital stock of our material subsidiaries and are also guaranteed by certain of our subsidiaries.

        The 2012 Credit Facility bears interest at rates equal to, at our election, LIBOR or the base rate, plus an applicable margin that varies based on our consolidated leverage ratio from 1.75% to 2.50%, in the case of LIBOR loans, and from 0.75% to 1.50% in the case of base rate loans. Effective September 30, 2014, the interest rate on the term loan portion of the 2012 Credit Facility was 2.70% based on a spread of 2.50% above LIBOR.

        We are required to pay a commitment fee on unused availability under the Revolving Facility that varies based on our consolidated leverage ratio, from 0.40% to 0.50% per year. As of the date of this report, we had not drawn on the Revolving Facility.

        For additional information on Liquidity and Capital Resources, please refer to our Annual Report on Form 10-K for the year ended December 31, 2013, filed by Universal American on March 13, 2014.

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Critical Accounting Policies

        There have been no changes to our critical accounting policies during the current quarter ended September 30, 2014. For a description of our significant accounting policies, see Note 3—Summary of Significant Accounting Policies included in our Annual Report on Form 10-K for the year ended December 31, 2013.

Policy and Contract Claims—Accident and Health Policies

        The following table presents the components of the change in our liability for policy and contract claims—health:

        The liability for policy and contract claims—health at September 30, 2014 decreased by $19.9 million from December 31, 2013. The decrease in the liability was primarily attributable to the decrease in IBNR for our Medicare Advantage business due to lower membership levels.

        The prior year development incurred 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, 2014, claim reserves settled, or are currently expected to be settled, for $4.5 million less than estimated at December 31, 2013. Prior period development represents less than 0.3% of the incurred claims recorded in 2013.

Sensitivity Analysis

        The following table illustrates the sensitivity of our accident and health IBNR payable at September 30, 2014 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

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factors and health care cost trend rates will develop differently from our historical patterns and therefore could be outside of the ranges illustrated below.

Effects of Recently Issued and Pending Accounting Pronouncements

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

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, the use of interest rate swaps 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, 2014, and with all other variables held constant. The

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following table summarizes the impact of the assumed changes in market interest rates at September 30, 2014. Due to the current low interest rate environment, when estimating the effect of market interest rate decreases on fair value we have set an interest rate floor of 0% and have not allowed interest rates to go negative.

Debt

        We pay interest on our term loan based on LIBOR over one, two, three or nine month interest periods. Due to the variable interest rate, we would be subject to higher interest costs if short-term interest rates rise. We regularly conduct various analyses to gauge the financial impact of changes in interest rates 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 scenarios involving increases or decreases in LIBOR of 100 and 200 basis points from their levels as of and for the three months ended September 30, 2014, and with all other variables held constant. The following table summarizes the impact of changes in LIBOR. Due to the current low interest rate environment, when estimating the effect of LIBOR decreases on pre-tax income, we have set an interest rate floor of 0% and have not allowed LIBOR to go negative.

        We have floating rate debt outstanding of $103.4 million as of September 30, 2014, which is exposed to rising interest rates. In addition, we had approximately $100.4 million of cash and cash equivalents as of September 30, 2014. Our exposure to rising interest costs on our debt would be partially mitigated by the increase in net investment income on our cash and cash equivalents.

        The magnitude of changes reflected in the above analysis regarding interest rates should not be construed as a prediction of future economic events, but rather as an illustration of the potential impact of such events on our financial results.

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ITEM 4—CONTROLS AND PROCEDURES

Disclosure 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.

Inherent Limitations on Effectiveness of Controls

        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 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.

Evaluation of Effectiveness of Controls

        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, 2014. 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, 2014, 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.

Changes in Internal Control over Financial Reporting

        There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II

ITEM 1—LEGAL PROCEEDINGS

        For information relating to litigation affecting us, see Note 8—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

        There have been no material changes to the risk factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the SEC on March 13, 2014.

ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

        None.

ITEM 3—DEFAULTS UPON SENIOR SECURITIES

        None.

ITEM 4—MINE SAFETY DISCLOSURES

        None.

ITEM 5—OTHER INFORMATION

        None.

ITEM 6—EXHIBITS

        Each exhibit identified below is filed as a part of this report.

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SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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