Use these links to rapidly review the document
TABLE OF CONTENTS
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One) | ||
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the quarterly period ended September 30, 2013 | ||
OR | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the transition period from to |
Commission file number: 001-35149
UNIVERSAL AMERICAN CORP.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) | 27-4683816 (I.R.S. Employer Identification No.) |
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)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o | Accelerated filer ý | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No ý
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.
Class of Common Stock | Outstanding at November 1, 2013 | |
---|---|---|
Non-voting, par value $0.01 per share | 3,300,000 shares | |
Voting, par value $0.01 per share | 85,541,137 shares |
| Item | Description | Page | ||||||
---|---|---|---|---|---|---|---|---|---|
PART I | Financial Information | ||||||||
1 | Financial Statements: | ||||||||
Consolidated Balance Sheets | 3 | ||||||||
Consolidated Statements of Operations—Three Months | 4 | ||||||||
Consolidated Statements of Operations—Nine Months | 5 | ||||||||
Consolidated Statements of Comprehensive (Loss) Income | 6 | ||||||||
Consolidated Statements of Stockholders' Equity | 7 | ||||||||
Consolidated Statements of Cash Flows | 8 | ||||||||
Notes to Consolidated Financial Statements | 9 | ||||||||
2 | Management's Discussion and Analysis of Financial Condition and Results of Operations | 29 | |||||||
3 | Quantitative and Qualitative Disclosures About Market Risk | 48 | |||||||
4 | Controls and Procedures | 50 | |||||||
PART II | Other Information | ||||||||
1 | Legal Proceedings | 51 | |||||||
1A | Risk Factors | 51 | |||||||
2 | Unregistered Sales of Equity Securities and Use of Proceeds | 51 | |||||||
3 | Defaults Upon Senior Securities | 51 | |||||||
4 | Mine Safety Disclosures | 51 | |||||||
5 | Other Information | 51 | |||||||
6 | Exhibits | 51 | |||||||
Signatures | 53 |
1
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.
2
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
| September 30, 2013 | December 31, 2012 | |||||
---|---|---|---|---|---|---|---|
| Unaudited | | |||||
ASSETS | |||||||
Investments: | |||||||
Fixed maturities available for sale, at fair value (amortized cost: 2013, $982,993; 2012, $1,146,642) | $ | 1,005,754 | $ | 1,203,348 | |||
Short-term investments | — | 16,993 | |||||
Other invested assets | 20,519 | 14,451 | |||||
Total investments | 1,026,273 | 1,234,792 | |||||
Cash and cash equivalents | 94,014 | 59,779 | |||||
Accrued investment income | 8,580 | 9,264 | |||||
Deferred policy acquisition costs | 93,253 | 102,765 | |||||
Reinsurance recoverables—life | 523,244 | 539,770 | |||||
Reinsurance recoverables—health | 124,957 | 125,406 | |||||
Due and unpaid premiums | 6,409 | 33,710 | |||||
Present value of future profits and other amortizing intangible assets | 31,792 | 38,469 | |||||
Goodwill and other indefinite lived intangible assets | 150,474 | 242,942 | |||||
Income taxes receivable | 46,134 | 36,100 | |||||
Other assets | 120,986 | 108,302 | |||||
Total assets | $ | 2,226,116 | $ | 2,531,299 | |||
LIABILITIES AND STOCKHOLDERS' EQUITY | |||||||
LIABILITIES | |||||||
Reserves and other policy liabilities—life | $ | 534,366 | $ | 547,618 | |||
Reserves for future policy benefits—health | 445,234 | 449,597 | |||||
Policy and contract claims—health | 155,497 | 156,558 | |||||
Premiums received in advance | 8,576 | 11,405 | |||||
Series A mandatorily redeemable preferred shares | 40,000 | 40,000 | |||||
Loan payable | 121,283 | 131,984 | |||||
Amounts due to reinsurers | 7,918 | 8,920 | |||||
Deferred income taxes payable | 13,594 | 30,643 | |||||
Other liabilities | 131,636 | 142,077 | |||||
Total liabilities | 1,458,104 | 1,518,802 | |||||
STOCKHOLDERS' EQUITY | |||||||
Preferred stock (Authorized: 40 million shares) | — | — | |||||
Common stock—voting (Authorized: 400 million shares; issued and outstanding: 2013, 85.5 million shares; 2012, 85.0 million shares) | 855 | 850 | |||||
Common stock—non-voting (Authorized: 60 million shares; issued and outstanding: 3.3 million shares) | 33 | 33 | |||||
Additional paid-in capital | 757,695 | 827,298 | |||||
Accumulated other comprehensive income | 9,429 | 29,089 | |||||
Retained earnings | — | 155,227 | |||||
Total stockholders' equity | 768,012 | 1,012,497 | |||||
Total liabilities and stockholders' equity | $ | 2,226,116 | $ | 2,531,299 | |||
See Notes to unaudited Consolidated Financial Statements.
3
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amounts)
| For the three months ended September 30, | ||||||
---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||
| | (as adjusted) | |||||
Revenues: | |||||||
Net premium and policyholder fees earned | $ | 487,496 | $ | 499,232 | |||
Net investment income | 8,740 | 10,242 | |||||
Fee and other income | 23,298 | 35,299 | |||||
Net realized gains on investments | 624 | 4,668 | |||||
Total revenues | 520,158 | 549,441 | |||||
Benefits, claims and expenses: | |||||||
Claims and other benefits | 405,593 | 392,711 | |||||
Change in deferred policy acquisition costs | 3,471 | 1,039 | |||||
Amortization of intangible assets | 2,218 | 2,233 | |||||
Commissions | 9,309 | 10,698 | |||||
Reinsurance commissions and expense allowances | 1,888 | 1,509 | |||||
Interest expense | 1,647 | 1,688 | |||||
Other operating costs and expenses | 107,235 | 114,794 | |||||
Total benefits, claims and expenses | 531,361 | 524,672 | |||||
(Loss) income before equity in losses of unconsolidated subsidiaries | (11,203 | ) | 24,769 | ||||
Equity in losses of unconsolidated subsidiaries | (7,869 | ) | (3,882 | ) | |||
(Loss) income before income taxes | (19,072 | ) | 20,887 | ||||
(Benefit from) provision for income taxes | (6,371 | ) | 7,040 | ||||
Net (loss) income | $ | (12,701 | ) | $ | 13,847 | ||
(Loss) earnings per common share: | |||||||
Basic | $ | (0.15 | ) | $ | 0.16 | ||
Diluted | $ | (0.15 | ) | $ | 0.16 | ||
Weighted average shares outstanding: | |||||||
Basic weighted average shares outstanding | 87,402 | 87,267 | |||||
Effect of dilutive securities | — | 52 | |||||
Diluted weighted average shares outstanding | 87,402 | 87,319 | |||||
Cash dividends per common share | $ | 1.60 | $ | — | |||
See Notes to unaudited Consolidated Financial Statements.
4
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(in thousands, except per share amounts)
| For the nine months ended September 30, | ||||||
---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||
| | (as adjusted) | |||||
Revenues: | |||||||
Net premium and policyholder fees earned | $ | 1,493,015 | $ | 1,485,001 | |||
Net investment income | 28,136 | 32,033 | |||||
Fee and other income | 83,066 | 93,294 | |||||
Net realized gains on investments | 13,181 | 12,929 | |||||
Total revenues | 1,617,398 | 1,623,257 | |||||
Benefits, claims and expenses: | |||||||
Claims and other benefits | 1,241,751 | 1,202,343 | |||||
Change in deferred policy acquisition costs | 9,512 | 2,977 | |||||
Amortization of intangible assets | 6,677 | 5,880 | |||||
Commissions | 27,636 | 33,523 | |||||
Reinsurance commissions and expense allowances | 4,920 | 4,934 | |||||
Interest expense | 4,903 | 4,624 | |||||
Goodwill impairment charge | 91,742 | — | |||||
Other operating costs and expenses | 295,719 | 300,775 | |||||
Total benefits, claims and expenses | 1,682,860 | 1,555,056 | |||||
(Loss) income before equity in losses of unconsolidated subsidiaries | (65,462 | ) | 68,201 | ||||
Equity in losses of unconsolidated subsidiaries | (25,072 | ) | (5,987 | ) | |||
(Loss) income before income taxes | (90,534 | ) | 62,214 | ||||
Provision for income taxes | 25 | 24,181 | |||||
Net (loss) income | $ | (90,559 | ) | $ | 38,033 | ||
(Loss) earnings per common share: | |||||||
Basic | $ | (1.04 | ) | $ | 0.44 | ||
Diluted | $ | (1.04 | ) | $ | 0.44 | ||
Weighted average shares outstanding: | |||||||
Basic weighted average shares outstanding | 87,370 | 86,054 | |||||
Effect of dilutive securities | — | 337 | |||||
Diluted weighted average shares outstanding | 87,370 | 86,391 | |||||
Cash dividends per common share | $ | 1.60 | $ | — | |||
See Notes to unaudited Consolidated Financial Statements.
5
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(Unaudited)
(in thousands)
| For the three months ended September 30, | For the nine months ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012 | 2013 | 2012 | |||||||||
| | (as adjusted) | | (as adjusted) | |||||||||
Comprehensive (loss) income: | |||||||||||||
Net (loss) income | $ | (12,701 | ) | $ | 13,847 | $ | (90,559 | ) | $ | 38,033 | |||
Other comprehensive income (loss), net of income taxes: | |||||||||||||
Unrealized (loss) gain on investments | (127 | ) | 15,917 | (13,678 | ) | 31,625 | |||||||
Less: reclassification adjustment for gains included in net income | (406 | ) | (3,034 | ) | (8,568 | ) | (8,404 | ) | |||||
Change in net unrealized (loss) gain on securities available for sale | (533 | ) | 12,883 | (22,246 | ) | 23,221 | |||||||
Change in long-term claim reserve adjustment | 576 | (1,650 | ) | 2,586 | (4,047 | ) | |||||||
Total other comprehensive income (loss), net of income taxes | 43 | 11,233 | (19,660 | ) | 19,174 | ||||||||
Comprehensive (loss) income | $ | (12,658 | ) | $ | 25,080 | $ | (110,219 | ) | $ | 57,207 | |||
See Notes to unaudited Consolidated Financial Statements.
6
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Unaudited)
(in thousands)
| | Common Stock | | Accumulated Other Comprehensive Income | | | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Preferred Stock | Additional Paid-in Capital | Retained Earnings | | ||||||||||||||||||
| Voting | Non-Voting | Total | |||||||||||||||||||
2012 | ||||||||||||||||||||||
Balance at January 1, 2012, as adjusted | $ | — | $ | 782 | $ | 33 | $ | 738,029 | $ | 11,166 | $ | 190,353 | $ | 940,363 | ||||||||
Net income, as adjusted | — | — | — | — | — | 38,033 | 38,033 | |||||||||||||||
Other comprehensive income | — | — | — | — | 19,174 | — | 19,174 | |||||||||||||||
Net issuance of common stock | — | 5 | — | 10,006 | — | — | 10,011 | |||||||||||||||
Issuance of shares in connection with the acquisition of APS Healthcare | — | 63 | — | 74,451 | — | — | 74,514 | |||||||||||||||
Stock-based compensation | — | — | — | 3,617 | — | — | 3,617 | |||||||||||||||
Dividends to stockholders | — | — | — | — | — | 107 | 107 | |||||||||||||||
Balance at September 30, 2012, as adjusted | $ | — | $ | 850 | $ | 33 | $ | 826,103 | $ | 30,340 | $ | 228,493 | $ | 1,085,819 | ||||||||
2013 | ||||||||||||||||||||||
Balance at January 1, 2013 | $ | — | $ | 850 | $ | 33 | $ | 827,298 | $ | 29,089 | $ | 155,227 | $ | 1,012,497 | ||||||||
Net loss | — | — | — | — | — | (90,559 | ) | (90,559 | ) | |||||||||||||
Other comprehensive loss | — | — | — | — | (19,660 | ) | — | (19,660 | ) | |||||||||||||
Net issuance of common stock | — | 5 | — | 4,163 | — | — | 4,168 | |||||||||||||||
Stock-based compensation | — | — | — | 3,200 | — | — | 3,200 | |||||||||||||||
Dividends to stockholders | — | — | — | (76,966 | ) | — | (64,668 | ) | (141,634 | ) | ||||||||||||
Balance at September 30, 2013 | $ | — | $ | 855 | $ | 33 | $ | 757,695 | $ | 9,429 | $ | — | $ | 768,012 | ||||||||
See Notes to unaudited Consolidated Financial Statements.
7
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
| For the nine months ended September 30, | ||||||
---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||
| | (as adjusted) | |||||
Operating activities: | |||||||
Net (loss) income | $ | (90,559 | ) | $ | 38,033 | ||
Adjustments to reconcile net (loss) income to cash provided by operating activities, net of balances acquired: | |||||||
Deferred income taxes | (6,463 | ) | (3,229 | ) | |||
Net realized gains on investments | (13,181 | ) | (12,929 | ) | |||
Amortization of intangible assets | 6,677 | 5,880 | |||||
Amortization of debt issuance costs | 999 | 823 | |||||
Goodwill impairment charge | 91,742 | — | |||||
Net amortization of bond premium | 5,064 | 4,538 | |||||
Depreciation expense | 8,615 | 7,446 | |||||
Changes in operating assets and liabilities: | |||||||
Deferred policy acquisition costs | 9,512 | 2,977 | |||||
Reserves and other policy liabilities—life | (13,252 | ) | (12,205 | ) | |||
Reserves for future policy benefits—health | (386 | ) | (1,557 | ) | |||
Policy and contract claims—health | (1,061 | ) | (6,804 | ) | |||
Reinsurance balances | 15,973 | 18,765 | |||||
Due and unpaid/advance premium, net | 24,472 | 21,286 | |||||
Income taxes receivable | (10,034 | ) | 29,003 | ||||
Other, net | (21,901 | ) | 30,323 | ||||
Cash provided by operating activities | 6,217 | 122,350 | |||||
Investing activities: | |||||||
Proceeds from sale, maturity, call, paydown or redemption of fixed maturity investments | 487,537 | 444,637 | |||||
Cost of fixed maturity investments acquired | (315,949 | ) | (394,672 | ) | |||
Change in short-term investments | 16,993 | (26,993 | ) | ||||
Purchase of business, net of cash acquired | — | (137,747 | ) | ||||
Purchase of fixed assets | (4,448 | ) | (7,820 | ) | |||
Other investing activities | (4,471 | ) | 3,034 | ||||
Cash provided by (used for) investing activities | 179,662 | (119,561 | ) | ||||
Financing activities: | |||||||
Net proceeds from issuance of common and preferred stock, net of tax effect | 394 | 3,989 | |||||
Dividends paid to stockholders | (141,337 | ) | (13,549 | ) | |||
Principal payment on loan payable | (10,701 | ) | (14,448 | ) | |||
Proceeds from the issuance of loan payable | — | 150,000 | |||||
Payment of debt issue costs | — | (5,772 | ) | ||||
Cash (used for) provided by financing activities | (151,644 | ) | 120,220 | ||||
Net increase in cash and cash equivalents | 34,235 | 123,009 | |||||
Cash and cash equivalents at beginning of period | 59,779 | 63,539 | |||||
Cash and cash equivalents at end of period | $ | 94,014 | $ | 186,548 | |||
See Notes to unaudited Consolidated Financial Statements.
8
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 to sell Medicare Advantage products, life, accident and health insurance and annuities in all fifty states and the District of Columbia. We currently 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. 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.
In 2011, Universal American formed a new subsidiary, Collaborative Health Systems, LLC, also known as CHS, to work with physicians and other healthcare professionals to form Accountable Care Organizations, or ACOs, under the Medicare Shared Savings Program ("Shared Savings Program"). Nine of our ACOs were approved for participation in the program by the Centers for Medicare & Medicaid Services, known as CMS, effective April 1, 2012, an additional seven ACOs were approved effective July 1, 2012 and fifteen additional ACOs were approved effective January 1, 2013. Based on data provided by CMS, these thirty one ACOs currently include approximately 3,000 participating providers with approximately 327,000 assigned Medicare fee-for-service beneficiaries covering portions of thirteen 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 capital to CHS to support the operating activities of CHS and the ACOs.
On March 2, 2012, we completed our acquisition of APS Healthcare, Inc., known as APS Healthcare. APS Healthcare provides specialty health services focused on behavioral health benefits, disease and condition management, and quality review and improvement. All of these services are designed to reduce health-related costs and enhance the health and quality of life of the members served. APS Healthcare provides 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. For further discussion of this transaction, see Note 4—Business Combination and Goodwill.
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
9
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
2. BASIS OF PRESENTATION (Continued)
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 month periods ended September 30, 2013 and 2012 are not necessarily indicative of the results to be expected for the full year.
Unconsolidated Subsidiaries: In 2012, we entered into agreements with various healthcare providers to establish ACOs. These ACOs 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.
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.
10
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
2. BASIS OF PRESENTATION (Continued)
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 included in our Annual Report on Form 10-K for the year ended December 31, 2012.
Adjustments to Financial Statements: In connection with the restatement to correct the accounting related to our recording of certain policy reserves and deferred acquisition costs in our Traditional Insurance segment along with the related deferred income tax impact, the Company's prior annual financial statements, including the three and nine months ended September 30, 2012, have been adjusted to record adjustments in their proper period for items that are not considered material but were previously corrected out-of-period.
We evaluated these adjustments in connection with the preparation of our financial statements as of and for the year ended December 31, 2012 and determined that these changes should be reported as a correction of errors in the prior periods. See Note 2—Basis of Presentation included in our Annual Report on Form 10-K for the year ended December 31, 2012 for additional information regarding these adjustments.
The following table reflects the adjustments to the financial statement line items of our consolidated statements of operations for the three and nine months ended September 30, 2012:
| Three Months ended September 30, 2012 | Nine Months ended September 30, 2012 | |||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| As Reported | Other | As Adjusted | As Reported | Other | As Adjusted | |||||||||||||
| (in thousands, except per share amounts) | ||||||||||||||||||
Other operating costs and expenses | $ | 118,676 | $ | (3,882 | ) | $ | 114,794 | $ | 305,006 | $ | (4,231 | ) | $ | 300,775 | |||||
Total benefits, claims and expenses | 528,554 | (3,882 | ) | 524,672 | 1,559,287 | (4,231 | ) | 1,555,056 | |||||||||||
Income before equity in losses of unconsolidated subsidiaries | $ | 20,887 | $ | 3,882 | $ | 24,769 | $ | 63,970 | $ | 4,231 | $ | 68,201 | |||||||
Equity in losses of unconsolidated subsidiaries | — | (3,882 | ) | (3,882 | ) | — | (5,987 | ) | (5,987 | ) | |||||||||
Income before income taxes | 20,887 | — | 20,887 | 63,970 | (1,756 | ) | 62,214 | ||||||||||||
Provision for income taxes | 7,040 | — | 7,040 | 24,711 | (530 | ) | 24,181 | ||||||||||||
Net income | $ | 13,847 | $ | — | $ | 13,847 | $ | 39,259 | $ | (1,226 | ) | $ | 38,033 | ||||||
Earnings per common share: | |||||||||||||||||||
Basic | $ | 0.16 | $ | — | $ | 0.16 | $ | 0.46 | $ | (0.02 | ) | $ | 0.44 | ||||||
Diluted | $ | 0.16 | $ | — | $ | 0.16 | $ | 0.45 | $ | (0.01 | ) | $ | 0.44 | ||||||
Comprehensive income for the nine months ended September 30, 2012 as reported was $58.4 million and has been adjusted to $57.2 million. There were no adjustments to comprehensive income for the three months ended September 30, 2012.
11
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
2. BASIS OF PRESENTATION (Continued)
Retained earnings at January 1, 2012 decreased by $12.8 million, net of tax, with $10.9 million relating to the correction and $1.9 million relating to other adjustments. Retained earnings at September 30, 2012 decreased by $14.0 million, net of tax, with $10.9 million relating to the correction and $3.1 million related to other adjustments. For the nine months ended September 30, 2012, operating cash flows increased by $6.0 million, with a corresponding decrease in financing cash flows as a result of these adjustments.
3. RECENTLY ISSUED AND PENDING ACCOUNTING PRONOUNCEMENTS
Presentation of an Unrecognized Tax Benefit: In July 2013, the Financial Accounting Standards Board issued Accounting Standards Update 2013-11,Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, known as ASU 2013-11, which requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. This guidance does not require any new recurring disclosures. We plan to adopt this guidance on a prospective basis effective January 1, 2014.
Other Comprehensive Income: In February 2013, the Financial Accounting Standards Board issued Accounting Standards Update 2013-02,Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, known as ASU 2013-02, which requires an entity to provide additional disclosure about the amounts reclassified out of accumulated other comprehensive income. We adopted this guidance on a prospective basis effective January 1, 2013. There was no impact to our financial position or results of operations, as ASU 2013-02 only impacts financial statement disclosure.
4. BUSINESS COMBINATION AND GOODWILL
On March 2, 2012, we acquired 100% of the outstanding voting stock of APS Healthcare at a purchase price of $222.3 million, which is net of a working capital adjustment of $5.2 million. The consideration comprised $147.8 million in cash to retire APS Healthcare's outstanding indebtedness and other liabilities and approximately $74.5 million in Universal American common stock. The equity portion of the purchase price was funded through the issuance of 6,314,690 shares of Universal American common stock. The cash portion of the purchase price was funded with the proceeds of the $150 million term loan portion of a new Credit Facility.
We have recorded $5.0 million of acquisition accounting adjustments subsequent to the closing. The working capital adjustment was finalized in the third quarter of 2012, resulting in a $2.2 million decrease to the purchase price and the return of 189,771 shares of Universal American common stock. The remaining $2.8 million included an increase in deferred tax assets of $3.8 million, net of an increase in claims payable of $0.8 million and a decrease in other current assets of $0.2 million. These adjustments were offset to goodwill.
The allocation of the purchase price resulted in goodwill of $164.8 million and other intangible assets of $29.2 million. The goodwill recognized, assigned to the Corporate and Other segment, is attributable primarily to anticipated business growth and the assembled workforce of APS Healthcare. Approximately $5.5 million of the goodwill related to the acquisition of APS Healthcare is deductible
12
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
4. BUSINESS COMBINATION AND GOODWILL (Continued)
for tax purposes. The other intangible assets, which consist of customer relationships, technology, trade name and provider network, have weighted average useful lives ranging from 4 to 8 years.
We test goodwill for impairment annually based on information as of October 1 of the current year or more frequently if circumstances suggest that impairment may exist. During the quarter ended June 30, 2013, certain events occurred and circumstances changed which indicated that it was more likely than not that goodwill for APS Healthcare might be impaired.
These events and circumstances, occurring during the quarter ended June 30, 2013, included the following:
- •
- APS Healthcare failed to win certain new contracts that had previously been anticipated;
- •
- One contract that represents a significant portion of APS Healthcare's historical revenue was renewed, but at a lower rate than had previously been anticipated;
- •
- Certain of APS Healthcare's existing contracts were terminated, not renewed or we learned that they were likely to terminate in the next several months; and
- •
- Due to the general increase in interest rates during the second quarter, the discount rate used in the impairment analysis was increased by 50 basis points compared to the rate used in the prior impairment testing analysis.
Based on the foregoing, we performed an interim impairment review as of June 30, 2013, that included lowered expectations for future revenue growth and new business development and a higher discount rate. Based on the results of the step one impairment test, we determined that as of June 30, 2013 the carrying value of APS Healthcare exceeded its fair value. We then proceeded to the second step of the impairment test to estimate the implied fair value of the APS Healthcare goodwill. This implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, that is, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the estimated fair value was the purchase price paid. Based on the June 30, 2013 step two analysis, the carrying amount of the APS Healthcare goodwill exceeded its implied fair value, resulting in a pre-tax impairment charge of $91.7 million, which we allocated on a pro-rata basis between taxable and non-taxable goodwill.
We estimate the fair values of our reporting units using discounted cash flows, which include assumptions about a wide variety of internal and external factors. Significant assumptions used in the impairment analysis include financial projections of cash flow (including significant assumptions about operations and target capital requirements), long-term growth rates for determining terminal value, and discount rates. Forecasts and long-term growth rates used for our reporting units are consistent with, and use inputs from, our internal long-term business plan and strategy. During our forecasting process, we assess revenue trends, medical cost trends, operating cost levels and target capital levels. Significant factors affecting these trends include changes in membership, premium yield, medical cost trends, and the impact and expectations of regulatory environments.
Although we believe that the financial projections used are reasonable and appropriate at the time made, the use of different assumptions and estimates could materially impact the analysis and resulting
13
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
4. BUSINESS COMBINATION AND GOODWILL (Continued)
conclusions. In addition, due to the long-term nature of the forecasts there is significant uncertainty inherent in those projections. That uncertainty is increased by the impact of healthcare reforms as discussed in Item 1, "Business—Regulation" in our Annual Report on Form 10-K. For additional discussions regarding how the enactment or implementation of healthcare reforms and how other factors could affect our business and the related long-term forecasts, see Item 1A, "Risk Factors" in Part I of our Annual Report on Form 10-K and "Healthcare Reform" in Part 1, Item 2 of this Quarterly Report on Form 10-Q.
We use a range of discount rates that correspond to a market-based weighted average cost of capital. Discount rates are determined for each reporting unit based on the implied risk inherent in their forecasts. This risk is evaluated using comparisons to market information such as peer company weighted average costs of capital and peer company stock prices in the form of revenue and earnings multiples. The most significant estimates in the discount rate determinations include the risk-free rates and equity risk premium. Company-specific adjustments to discount rates are subjective and thus are difficult to measure with certainty.
Outcomes from the discounted cash flow analysis are compared to other market approach valuation methodologies for reasonableness.
The passage of time and the availability of additional information regarding areas of uncertainty in regards to the reporting units' operations could cause these assumptions used in our analysis to change materially in the future. If our assumptions differ from actual, the estimates underlying our goodwill impairment tests could be adversely affected. Decreases in business growth, decreases in earnings projections, increases in the weighted average cost of capital and increases in the amount of required capital for a reporting unit will all cause the reporting unit's fair value to decrease.
Changes in the carrying amounts of goodwill and intangible assets with indefinite lives (primarily trademarks and licenses) are shown below:
| | | Corporate & Other(2) | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Total, Net | Senior Managed Care—Medicare Advantage(1) | Gross | Accumulated write-offs | Net | |||||||||||
| (in thousands) | |||||||||||||||
Balance, January 1, 2013 | $ | 242,942 | $ | 77,459 | $ | 165,483 | $ | — | $ | 165,483 | ||||||
Acquisitions (dispositions) | — | — | — | — | — | |||||||||||
Impairments | (91,742 | ) | — | — | (91,742 | ) | (91,742 | ) | ||||||||
Adjustments | (726 | ) | — | (726 | ) | — | (726 | ) | ||||||||
Balance, September 30, 2013 | $ | 150,474 | $ | 77,459 | $ | 164,757 | $ | (91,742 | ) | $ | 73,015 | |||||
- (1)
- Represents both gross and net goodwill balances.
- (2)
- The goodwill in our Corporate & Other segment is associated with our APS Healthcare reporting unit.
The results of operations and financial condition of APS Healthcare have been included in our consolidated statements of operations and consolidated balance sheets from March 2, 2012, the date of
14
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
4. BUSINESS COMBINATION AND GOODWILL (Continued)
acquisition. In 2012, we recognized $3.7 million of acquisition related costs (primarily in the first quarter). These costs are included in the line item other operating costs and expenses in the consolidated statements of operations. We also incurred $5.8 million of costs in connection with the new credit facility. These costs have been deferred, are included in other assets in our consolidated balance sheets, and will be amortized over the life of the term loan. We have not recognized any acquisition-related costs in 2013.
The unaudited consolidated pro forma results of operations, assuming that operating results for APS Healthcare were included for the entire nine month period ended September 30, 2012, is as follows:
| Nine months ended | |||
---|---|---|---|---|
| September 30, 2012 | |||
| (in thousands) | |||
Total revenues | $ | 1,675,657 | ||
Income before income taxes | $ | 65,980 | ||
Net income | $ | 40,364 | ||
These amounts have been determined after applying our accounting policies and adjusting the results of APS Healthcare to reflect the changes in depreciation and amortization that would have been charged assuming the fair value adjustments to property, plant and equipment and intangible assets had been applied on January 1, 2012, and elimination of APS Healthcare's acquisition related costs, together with the related tax effects. These amounts also include adjustment of our results to reflect the cost of the new credit facility and additional stock based compensation that would have been charged assuming the acquisition took place on January 1, 2012, and elimination of our acquisition related costs, together with the related tax effects. The pro forma information presented above is for disclosure purposes only and is not necessarily indicative of the results of operations that would have occurred had we consummated the acquisition on the date assumed, nor is the pro forma information intended to be indicative of our future results of operations.
15
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
5. INVESTMENTS
The amortized cost and fair value of fixed maturity investments are as follows:
| September 30, 2013 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Classification | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Gross Unrealized OTTI(1) | Fair Value | |||||||||||
| (in thousands) | |||||||||||||||
U.S. Treasury securities and U.S. Government obligations | $ | 47,174 | $ | 151 | $ | (27 | ) | $ | — | $ | 47,298 | |||||
Government sponsored agencies | 10,926 | 323 | (172 | ) | — | 11,077 | ||||||||||
Other political subdivisions | 72,170 | 1,022 | (430 | ) | — | 72,762 | ||||||||||
Corporate debt securities | 434,589 | 18,254 | (2,710 | ) | — | 450,133 | ||||||||||
Foreign debt securities | 107,533 | 2,813 | (931 | ) | — | 109,415 | ||||||||||
Residential mortgage-backed securities | 190,988 | 5,552 | (2,783 | ) | — | 193,757 | ||||||||||
Commercial mortgage-backed securities | 76,417 | 3,095 | (22 | ) | (96 | ) | 79,394 | |||||||||
Other asset-backed securities | 43,196 | 850 | (30 | ) | (2,098 | ) | 41,918 | |||||||||
$ | 982,993 | $ | 32,060 | $ | (7,105 | ) | $ | (2,194 | ) | $ | 1,005,754 | |||||
| December 31, 2012 | |||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Classification | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Gross Unrealized OTTI(1) | Fair Value | |||||||||||
| (in thousands) | |||||||||||||||
U.S. Treasury securities and U.S. Government obligations | $ | 31,125 | $ | 192 | $ | (3 | ) | $ | — | $ | 31,314 | |||||
Government sponsored agencies | 16,893 | 764 | (2 | ) | — | 17,655 | ||||||||||
Other political subdivisions | 106,759 | 2,854 | (65 | ) | — | 109,548 | ||||||||||
Corporate debt securities | 498,497 | 35,186 | (423 | ) | — | 533,260 | ||||||||||
Foreign debt securities | 115,441 | 5,200 | (8 | ) | — | 120,633 | ||||||||||
Residential mortgage-backed securities | 241,647 | 12,157 | (139 | ) | — | 253,665 | ||||||||||
Commercial mortgage-backed securities | 74,142 | 4,841 | (474 | ) | — | 78,509 | ||||||||||
Other asset-backed securities | 62,138 | 1,805 | (548 | ) | (4,631 | ) | 58,764 | |||||||||
$ | 1,146,642 | $ | 62,999 | $ | (1,662 | ) | $ | (4,631 | ) | $ | 1,203,348 | |||||
- (1)
- Other-than-temporary impairments.
At September 30, 2013, gross unrealized losses on mortgage-backed and asset-backed securities totaled $5.0 million, including unrealized losses of $2.1 million on subprime residential mortgage loans, with the balance related to obligations of commercial and residential mortgage-backed securities. The fair value of certain subprime securities is depressed due to the deterioration of collectability of the underlying mortgages. The fair value of the other securities is depressed primarily due to changes in interest rates. We have evaluated these holdings, with input from our investment managers, and do not believe further other-than-temporary impairment to be warranted.
16
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
5. INVESTMENTS (Continued)
The amortized cost and fair value of fixed maturity investments at September 30, 2013 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| Amortized Cost | Fair Value | |||||
---|---|---|---|---|---|---|---|
| (in thousands) | ||||||
Due in 1 year or less | $ | 43,921 | $ | 44,364 | |||
Due after 1 year through 5 years | 295,415 | 307,190 | |||||
Due after 5 years through 10 years | 227,438 | 231,902 | |||||
Due after 10 years | 105,618 | 107,229 | |||||
Mortgage and asset-backed securities | 310,601 | 315,069 | |||||
$ | 982,993 | $ | 1,005,754 | ||||
The fair value and unrealized losses as of September 30, 2013 and December 31, 2012 for fixed maturities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are shown below:
| Less than 12 Months | 12 Months or Longer | Total | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value | Gross Unrealized Losses and OTTI | Fair Value | Gross Unrealized Losses and OTTI | Fair Value | Gross Unrealized Losses and OTTI | |||||||||||||
| (in thousands) | ||||||||||||||||||
September 30, 2013 | |||||||||||||||||||
U.S. Treasury securities and U.S. Government obligations | $ | 6,579 | $ | (27 | ) | $ | — | $ | — | $ | 6,579 | $ | (27 | ) | |||||
Government sponsored agencies | 2,433 | (172 | ) | — | — | 2,433 | (172 | ) | |||||||||||
Other political subdivisions | 21,021 | (430 | ) | — | — | 21,021 | (430 | ) | |||||||||||
Corporate debt securities | 95,215 | (2,710 | ) | — | — | 95,215 | (2,710 | ) | |||||||||||
Foreign debt securities | 33,846 | (930 | ) | 25 | (1 | ) | 33,871 | (931 | ) | ||||||||||
Residential mortgage-backed securities | 67,536 | (2,783 | ) | — | — | 67,536 | (2,783 | ) | |||||||||||
Commercial mortgage-backed securities | 5,052 | (11 | ) | 1,062 | (107 | ) | 6,114 | (118 | ) | ||||||||||
Other asset-backed securities | 3,570 | (29 | ) | 4,901 | (2,099 | ) | 8,471 | (2,128 | ) | ||||||||||
Total fixed maturities | $ | 235,252 | $ | (7,092 | ) | $ | 5,988 | $ | (2,207 | ) | $ | 241,240 | $ | (9,299 | ) | ||||
Total number of securities in an unrealized loss position | 130 | ||||||||||||||||||
17
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
5. INVESTMENTS (Continued)
| Less than 12 Months | 12 Months or Longer | Total | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value | Gross Unrealized Losses and OTTI | Fair Value | Gross Unrealized Losses and OTTI | Fair Value | Gross Unrealized Losses and OTTI | |||||||||||||
| (in thousands) | ||||||||||||||||||
December 31, 2012 | |||||||||||||||||||
U.S. Treasury securities and U.S. Government obligations | $ | 8,046 | $ | (3 | ) | $ | — | $ | — | $ | 8,046 | $ | (3 | ) | |||||
Government sponsored agencies | 2,612 | (2 | ) | — | — | 2,612 | (2 | ) | |||||||||||
Other political subdivisions | 12,688 | (65 | ) | — | — | 12,688 | (65 | ) | |||||||||||
Corporate debt securities | 27,374 | (189 | ) | 5,037 | (234 | ) | 32,411 | (423 | ) | ||||||||||
Foreign debt securities | 1,246 | (8 | ) | — | — | 1,246 | (8 | ) | |||||||||||
Residential mortgage-backed securities | 27,105 | (139 | ) | — | — | 27,105 | (139 | ) | |||||||||||
Commercial mortgage-backed securities | — | — | 1,005 | (474 | ) | 1,005 | (474 | ) | |||||||||||
Other asset-backed securities | — | — | 15,432 | (5,179 | ) | 15,432 | (5,179 | ) | |||||||||||
Total fixed maturities | $ | 79,071 | $ | (406 | ) | $ | 21,474 | $ | (5,887 | ) | $ | 100,545 | $ | (6,293 | ) | ||||
Total number of securities in an unrealized loss position | 71 | ||||||||||||||||||
The reduction in fair values at September 30, 2013 compared to December 31, 2012, and the resulting increase in the number of securities in an unrealized loss position, is due to an overall increase in interest rates as a result of the general improvement in the U.S. economic outlook, and the Federal Reserve's announcement regarding the eventual reduction in its quantitative easing program.
Interest Rate Swaps
We use interest rate swaps from time to time as part of our overall risk management strategy to efficiently reduce the duration, or sensitivity, of our fixed maturity investment portfolio market value to a rise in interest rates.
Our swaps are designated as held for managing asset-related risks that do not qualify for hedge treatment. Because the swaps do not meet the criteria for hedge accounting, gains or losses resulting from changes in fair value are recognized currently in earnings. Their fair value is based on the present value of expected net cash flows as determined by the contract rate and the LIBOR forward rate curve on the valuation date. As a component of managing overall interest rate risk, such gains and losses are most appropriately considered in the context of changes in the unrealized gains and losses on the fixed income portfolio. The swaps are recorded at fair value in other assets in our consolidated balance sheets.
We terminated all outstanding interest rate swaps as of June 30, 2013 and as of and during the three months ended September 30, 2013, we had no outstanding interest rate swaps. We recognized realized gains on interest rate swaps of $2.3 million for the three months ended September 30, 3012 and $9.9 million and $2.3 million, for the nine months ended September 30, 2013 and 2012, respectively. These gains are reflected in net realized gains on investments in the consolidated statements of operations.
18
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
5. INVESTMENTS (Continued)
Realized Gains and Losses
Gross realized gains and gross realized losses on investments included in net realized gains on investments in the consolidated statements of operations are as follows:
| For the three months ended September 30, | For the nine months ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012 | 2013 | 2012 | |||||||||
| (in thousands) | (in thousands) | |||||||||||
Realized Gains: | |||||||||||||
Fixed maturities | $ | 3,216 | $ | 2,822 | $ | 8,241 | $ | 12,300 | |||||
Interest rate swap | — | 2,340 | 9,927 | 2,340 | |||||||||
Other | 9 | — | 49 | 44 | |||||||||
3,225 | 5,162 | 18,217 | 14,684 | ||||||||||
Realized Losses: | |||||||||||||
Fixed maturities | (2,033 | ) | (355 | ) | (4,468 | ) | (1,616 | ) | |||||
Other | (568 | ) | (139 | ) | (568 | ) | (139 | ) | |||||
(2,601 | ) | (494 | ) | (5,036 | ) | (1,755 | ) | ||||||
Net realized gains on investments | $ | 624 | $ | 4,668 | $ | 13,181 | $ | 12,929 | |||||
6. 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 discussion, see Note 7—Fair Value Measurements included in our Annual Report on Form 10-K for the year ended December 31, 2012.
19
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. FAIR VALUE MEASUREMENTS (Continued)
The following table presents our recurring fair value measurements by ASC-820-10 hierarchy levels:
| Total | Level 1 | Level 2 | Level 3 | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September 30, 2013 | |||||||||||||
Assets: | |||||||||||||
Fixed maturities, available for sale | $ | 1,005,754 | $ | — | $ | 1,003,388 | $ | 2,366 | |||||
Equity securities | 13,323 | — | 13,323 | — | |||||||||
Total assets | $ | 1,019,077 | $ | — | $ | 1,016,711 | $ | 2,366 | |||||
December 31, 2012 | |||||||||||||
Assets: | |||||||||||||
Fixed maturities, available for sale | $ | 1,203,348 | $ | — | $ | 1,200,895 | $ | 2,453 | |||||
Equity securities | 7,608 | — | 7,608 | — | |||||||||
Interest rate swaps | 1,095 | — | 1,095 | — | |||||||||
Total assets | $ | 1,212,051 | $ | — | $ | 1,209,598 | $ | 2,453 | |||||
The following table provides a summary of changes in the recurring fair value measurement of our Level 3 financial instruments:
| Fixed Maturities | |||
---|---|---|---|---|
| (in thousands) | |||
Fair value as of December 31, 2012 | $ | 2,453 | ||
Paydowns | (38 | ) | ||
Unrealized gains included in AOCI(1)(2) | 30 | |||
Fair value as of March 31, 2013 | 2,445 | |||
Paydowns | (38 | ) | ||
Unrealized losses included in AOCI(1)(2) | (1 | ) | ||
Fair value as of June 30, 2013 | 2,406 | |||
Paydowns | (39 | ) | ||
Unrealized losses included in AOCI(1)(2) | (1 | ) | ||
Fair value as of September 30, 2013 | $ | 2,366 | ||
- (1)
- AOCI: Accumulated other comprehensive income.
- (2)
- Unrealized gains and losses represent changes in values of Level 3 financial instruments only for the periods in which the instruments are classified as Level 3.
Nonrecurring Fair Value Measurement—APS Healthcare Goodwill
During the quarter ended June 30, 2013, we determined that the carrying amount of the APS Healthcare goodwill exceeded its implied fair value of $73.0 million. As a result, we recorded an impairment charge to write off the excess amount. Because of the nature of the goodwill valuation process, we have classified this nonrecurring fair value measurement as Level 3. For further details see Note 4—Business Combination and Goodwill.
20
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
7. ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of accumulated other comprehensive income are as follows (in thousands):
| Net Unrealized Gains (Losses) on Investments Available for Sale | Gross Unrealized OTTI | Long-Term Claim Reserve Adjustment | Accumulated Other Comprehensive Income | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Three months ended September 30, 2013 | |||||||||||||
Balance as of July 1, 2013 | $ | 16,723 | $ | (1,512 | ) | $ | (5,825 | ) | $ | 9,386 | |||
Other comprehensive (loss) income before reclassifications | (213 | ) | 86 | 576 | 449 | ||||||||
Amounts reclassified from accumulated other comprehensive income | 406 | — | — | 406 | |||||||||
Net current-period other comprehensive income | (619 | ) | 86 | 576 | 43 | ||||||||
Balance as of September 30, 2013 | $ | 16,104 | $ | (1,426 | ) | $ | (5,249 | ) | $ | 9,429 | |||
Three months ended September 30, 2012 | |||||||||||||
Balance as of July 1, 2012 | $ | 27,955 | $ | (3,136 | ) | $ | (5,712 | ) | $ | 19,107 | |||
Other comprehensive income (loss) before reclassifications | 15,916 | 1 | (1,650 | ) | 14,267 | ||||||||
Amounts reclassified from accumulated other comprehensive income | 3,034 | — | — | 3,034 | |||||||||
Net current-period other comprehensive income | 12,882 | 1 | (1,650 | ) | 11,233 | ||||||||
Balance as of September 30, 2012 | $ | 40,837 | $ | (3,135 | ) | $ | (7,362 | ) | $ | 30,340 | |||
Nine months ended September 30, 2013 | |||||||||||||
Balance as of January 1, 2013 | $ | 39,934 | $ | (3,010 | ) | $ | (7,835 | ) | $ | 29,089 | |||
Other comprehensive (loss) income before reclassifications | (15,262 | ) | 1,584 | 2,586 | (11,092 | ) | |||||||
Amounts reclassified from accumulated other comprehensive income | 8,568 | — | — | 8,568 | |||||||||
Net current-period other comprehensive loss | (23,830 | ) | 1,584 | 2,586 | (19,660 | ) | |||||||
Balance as of September 30, 2013 | $ | 16,104 | $ | (1,426 | ) | $ | (5,249 | ) | $ | 9,429 | |||
Nine months ended September 30, 2012 | |||||||||||||
Balance as of January 1, 2012 | $ | 17,723 | $ | (3,242 | ) | $ | (3,315 | ) | $ | 11,166 | |||
Other comprehensive income (loss) before reclassifications | 31,518 | 107 | (4,047 | ) | 27,578 | ||||||||
Amounts reclassified from accumulated other comprehensive income | 8,404 | — | — | 8,404 | |||||||||
Net current-period other comprehensive income | 23,114 | 107 | (4,047 | ) | 19,174 | ||||||||
Balance as of September 30, 2012 | $ | 40,837 | $ | (3,135 | ) | $ | (7,362 | ) | $ | 30,340 | |||
Table amounts are presented net of tax at a rate of 35%.
21
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
8. 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, 2012.
Compensation expense, included in other operating costs and expenses, and the related tax benefit were as follows:
| Three Months Ended September 30, | ||||||
---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||
| (in thousands) | ||||||
Stock options | $ | 1,281 | $ | 1,291 | |||
Restricted stock awards | 1,026 | 849 | |||||
Total stock-based compensation expense | 2,307 | 2,140 | |||||
Tax benefit recognized(1) | 481 | 811 | |||||
Stock-based compensation expense, net of tax | $ | 1,826 | $ | 1,329 | |||
| Nine Months Ended September 30, | ||||||
---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||
| (in thousands) | ||||||
Stock options | $ | 3,200 | $ | 3,617 | |||
Restricted stock awards | 2,824 | 3,591 | |||||
Total stock-based compensation expense | 6,024 | 7,208 | |||||
Tax benefit recognized(1) | 964 | 1,706 | |||||
Stock-based compensation expense, net of tax | $ | 5,060 | $ | 5,502 | |||
- (1)
- Tax benefit recognized includes the estimated effect of non-deductible compensation costs.
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 ofCompensation—Stock Compensation Topic, ASC 718-10. We use the Black-Scholes valuation model to value stock options.
22
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
8. 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:
| For options granted in 2013 | |
---|---|---|
Weighted-average grant date fair value | $2.51 - $3.33 | |
Risk free interest rates | 0.50% - 1.11% | |
Dividend yields | 0.00% | |
Expected volatility | 39.29% - 41.72% | |
Expected lives of options (in years) | 3.75 |
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, 2013 is set forth below:
Options | Options (in thousands) | Weighted Average Exercise Price(1) | |||||
---|---|---|---|---|---|---|---|
Outstanding at January 1, 2013 | 5,224 | $ | 7.67 | ||||
Granted | 2,166 | 7.11 | |||||
Exercised | (73 | ) | 6.73 | ||||
Forfeited or expired | (1,441 | ) | 8.21 | ||||
Outstanding at September 30, 2013 | 5,876 | $ | 7.45 | ||||
- (1)
- Weighted average exercise price reflects a $1.60 per share reduction in the exercise price made in connection with the special dividend paid in August 2013. See "Special Cash Dividend" in Note 11—Other Disclosures.
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 less than $0.1 million during each of the nine month periods ended September 30, 2013 and 2012.
We received proceeds of approximately $0.6 million and $0.2 million from the exercise of stock options during the nine months ended September 30, 2013 and 2012, respectively.
As of September 30, 2013, the total compensation cost related to non-vested option awards not yet recognized was $12.4 million, which we expect to recognize over a weighted average period of 2.6 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, 2013 we paid a portion of the annual bonuses in the form of restricted stock, which vests under certain circumstances on the two year anniversary of the grant. 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.
23
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
8. STOCK-BASED COMPENSATION (Continued)
A summary of non-vested restricted stock award activity for the nine months ended September 30, 2013 is set forth below:
Non-Vested Restricted Stock | Shares (in thousands) | Weighted Average Grant-Date Fair Value | |||||
---|---|---|---|---|---|---|---|
Non-vested at January 1, 2013 | 1,029 | $ | 11.38 | ||||
Granted | 971 | 8.63 | |||||
Vested | (283 | ) | 11.52 | ||||
Forfeited | (335 | ) | 10.71 | ||||
Non-vested at September 30, 2013 | 1,382 | $ | 9.59 | ||||
The total fair value of shares of restricted stock vested during the nine months ended September 30, 2013 was $2.7 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 $0.4 million and $4.1 million of financing cash flows for these excess tax deductions for the nine months ended September 30, 2013 and 2012, respectively.
9. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
We are subject to a variety of legal proceedings, 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. While the outcome of these matters is currently not determinable, we do not currently expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
On September 17, 2013, APS Healthcare, Inc. received a subpoena from the Department of Health and Human Services, Office of Inspector General ("HHS-OIG"), requesting documents relating to APS Healthcare's former Medicaid contracts with the State of Missouri that were in existence from 2006 to 2010.
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 managing director of GTCR, and former senior management of APS Healthcare (Gregory Scott, Jerome Vaccaro and John McDonough). 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. In anticipation of our lawsuit, the day before our filing, GTCR filed an action in the Court of Chancery of the State of Delaware seeking declaratory relief regarding our claims against GTCR. On October 28, 2013, we
24
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
9. COMMITMENTS AND CONTINGENCIES (Continued)
removed GTCR's declaratory relief action to the United States District Court for the District of Delaware.
Government Regulations
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 recent healthcare reform legislation, CMS 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. According to CMS, we are a high-risk Medicare Advantage sponsor. As a result, CMS continues to audit 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.
10. BUSINESS SEGMENT INFORMATION
As of September 30, 2013, our business segments are based on product and consist of
- •
- Senior Managed Care—Medicare Advantage and,
- •
- Traditional Insurance.
The activities of our holding company, along with start-up and operating costs associated with our ACO business, the operations of APS Healthcare since its acquisition on March 2, 2012 and other ancillary operations are reported in our Corporate & Other segment.
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 for services provided by APS Healthcare to our Senior Managed Care—Medicare Advantage segment.
25
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
10. BUSINESS SEGMENT INFORMATION (Continued)
Financial data by segment, with a reconciliation of segment revenues and segment income (loss) before income taxes to total revenue and income from continuing operations before income taxes in accordance with U.S. GAAP is as follows:
| Three months ended September 30, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||||||||
| Revenues | Income(loss) before Income Taxes | Revenues | Income(loss) before Income Taxes | |||||||||
| (in thousands) | ||||||||||||
Senior Managed Care—Medicare Advantage | $ | 400,104 | $ | 3,158 | $ | 405,746 | $ | 24,538 | |||||
Traditional Insurance | 57,653 | 4,313 | 64,102 | 4,287 | |||||||||
Corporate & Other | 62,413 | (27,167 | ) | 77,682 | (12,606 | ) | |||||||
Intersegment revenues | (636 | ) | — | (2,757 | ) | — | |||||||
Adjustments to segment amounts: | |||||||||||||
Net realized gains on investments(1) | 624 | 624 | 4,668 | 4,668 | |||||||||
Total | $ | 520,158 | $ | (19,072 | ) | $ | 549,441 | $ | 20,887 | ||||
| Nine months ended September 30, | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||||||||
| Revenues | Income(loss) before Income Taxes | Revenues | Income(loss) before Income Taxes | |||||||||
| (in thousands) | ||||||||||||
Senior Managed Care—Medicare Advantage | $ | 1,225,041 | $ | 41,798 | $ | 1,229,133 | $ | 73,839 | |||||
Traditional Insurance | 177,914 | 11,716 | 200,867 | 14,095 | |||||||||
Corporate & Other | 209,773 | (157,229 | ) | 186,085 | (38,649 | ) | |||||||
Intersegment revenues | (8,511 | ) | — | (5,757 | ) | — | |||||||
Adjustments to segment amounts: | |||||||||||||
Net realized gains on investments(1) | 13,181 | 13,181 | 12,929 | 12,929 | |||||||||
Total | $ | 1,617,398 | $ | (90,534 | ) | $ | 1,623,257 | $ | 62,214 | ||||
- (1)
- We evaluate the results of operations of our segments based on income (loss) before realized gains and losses and income taxes. We believe that realized gains and losses are not indicative of overall operating trends.
11. OTHER DISCLOSURES
Income Taxes: Our effective tax rate was 33.4% for the third quarter of 2013 compared to 33.7% for the third quarter of 2012 and included non-recurring tax benefits of $0.5 million and $1.4 million, respectively. The variance in the effective tax rate compared with the 35% federal rate was driven by permanent items, primarily relating to non-deductible executive compensation and interest on the mandatorily redeemable preferred stock as well as foreign and state income taxes partially offset by the non-recurring tax benefits.
26
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
11. OTHER DISCLOSURES (Continued)
For the nine months ended September 30, 2013, our effective tax rate was less than 0.1% compared to 38.9% for the same period in 2012 and included non-recurring tax benefits of $0.8 million and $1.5 million, respectively. The variance in the effective tax rate compared with the 35% federal rate was driven by permanent items, relating to non-deductible goodwill impairment, executive compensation, APS Healthcare transaction costs and interest on the mandatorily redeemable preferred stock as well as foreign and state income taxes partially offset by the non-recurring tax benefits.
Special Cash 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. We also established a $2.2 million dividend payable liability to record amounts expected to be paid in the future to holders of our restricted stock as such shares vest. This liability is included in other liabilities in the consolidated balance sheets. In addition, pursuant to the terms of our 2011 Equity Award Plan, the exercise price on outstanding stock options was reduced by the amount of the dividend.
Earnings Per Common Share Computation: The calculation of the diluted loss per common share for the three and nine months ended September 30, 2013 presented in the consolidated statements of operations excludes 369,000 and 283,000, respectively, of 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.
Stock Repurchase Plan: On August 1, 2013, the Board of Directors of the Company authorized the repurchase of up to $40 million of its outstanding common stock. Purchases may occur from time to time in the open market, in privately negotiated transactions, or otherwise as market conditions permit. No repurchases have been made to date.
Acquisition of Total Care: On June 20, 2013, we entered into a definitive agreement to acquire the assets of the Total Care Medicaid managed care plan. Total Care is one of the oldest and largest Medicaid health plans in Upstate New York, currently serving approximately 35,000 members in Syracuse and surrounding areas. The transaction is subject to customary closing conditions, including approval from applicable New York regulators and is expected to close in the 4th quarter of 2013. The purchase price for the acquisition is approximately $3.5 million at closing and up to an additional $3.0 million of contingent consideration based on membership and quality improvements of the health plan.
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, 2013, 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 $136.7 million as of September 30, 2013.
27
UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
11. OTHER DISCLOSURES (Continued)
Restructuring Charges: A summary of our restructuring liability balance as of September 30, 2013 follows:
| Segment | January 1, Balance | Charge to Earnings | Cash Paid | Non-cash | September 30, Balance | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (in thousands) | |||||||||||||||||
2013 | ||||||||||||||||||
Workforce reduction | Corporate & Other | $ | 3,800 | $ | 1,867 | $ | (4,066 | ) | $ | (344 | ) | $ | 1,257 | |||||
Facility consolidation | Corporate & Other | 130 | — | — | (130 | ) | — | |||||||||||
Facility consolidation | Traditional | 334 | — | — | (84 | ) | 250 | |||||||||||
Total | $ | 4,264 | $ | 1,867 | $ | (4,066 | ) | $ | (558 | ) | $ | 1,507 | ||||||
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, 2012.
Principal and Interest Payments on Term Loan: 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.
During the three month and nine month periods ended September 30, 2012, we made principal payments totaling $3.6 million and $14.4 million, respectively, and interest payments totaling $0.8 million and $1.9 million, respectively.
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 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. We recognized losses of $7.9 million and $25.1 million from our ACO arrangements, for the three and nine months ended September 30, 2013, respectively, and losses of $3.9 million and $6.0 million for the three and nine months ended September 30, 2012. For additional information on the ACOs, see Note 1—Organization and Company Background and Note 2—Basis of Presentation.
12. SUBSEQUENT EVENTS
Credit Facility Amendment:
On November 4, 2013, the Company entered into an amendment to its 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 principal payments, totaling $17.8 million, due under the 2012 Credit Facility through December 31, 2014 and paid fees and expenses of approximately $0.5 million.
28
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, 2013 and our results of operations for the three and nine months ended September 30, 2013 and 2012. 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.
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, 2012. 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, 2012 filed on March 6, 2013 under Part II, Item 1A—Risk Factors.
Overview
Through our health insurance, and managed care subsidiaries, we primarily serve the growing Medicare population by providing Medicare Advantage insurance products. In addition, with the acquisition of APS Healthcare on March 2, 2012, we now provide a variety of healthcare services, including case management and care coordination, clinical quality and utilization review and behavioral health services to Medicaid agencies and other third parties. Approximately 29% of the over 65 year old population in the United States is currently enrolled in Medicare Advantage plans. In addition, we believe there is an opportunity to address the high cost of healthcare for the remaining Medicare population enrolled in traditional fee-for-service Medicare and have joined with primary-care provider groups, hospitals, integrated delivery systems, and a variety of other health care providers to form thirty-one Accountable Care Organizations, or ACOs, pursuant to the Medicare Shared Saving Program, or Shared Savings Program. All payers of healthcare costs, from the Federal and state governments to corporations and individuals, are incurring rising healthcare costs and we believe we can apply our capabilities and experience in controlling these costs while improving health outcomes.
Recent Developments
Medicare Accountable Care Organizations (Medicare Shared Savings Program)
In March 2010, President Obama signed into law The Patient Protection and Affordable Care Act and The Healthcare and Education Reconciliation Act of 2010, which we collectively refer to as the Affordable Care Act. The Affordable Care Act established ACOs as a tool to improve quality and lower costs through increased care coordination in the Medicare Fee-for-Service, or FFS, program, which covers approximately 71% of the Medicare recipients, approximately 36 million eligible Medicare beneficiaries. CMS established the Shared Savings Program to facilitate coordination and cooperation among providers to improve the quality of care for FFS beneficiaries and reduce unnecessary costs. Eligible providers, hospitals, and suppliers may participate in the Shared Savings Program by creating or participating in an ACO.
The Shared Savings Program is designed to improve beneficiary outcomes and increase value of care by (1) promoting accountability for the care of Medicare FFS beneficiaries; (2) requiring
29
coordinated care for all services provided under Medicare FFS; and (3) encouraging investment in infrastructure and redesigned care processes. The Shared Savings Program will reward ACOs that lower their health care costs while meeting performance standards on quality of care and putting patients first. Under the final Shared Savings Program rules, Medicare will continue to pay individual providers and suppliers for specific items and services as it currently does under the FFS payment methodologies. The Shared Savings Program rules require CMS to develop a benchmark for savings to be achieved by each ACO if the ACO is to receive shared savings or for ACOs that have elected to accept responsibility for losses. An ACO that meets the program's quality performance standards will be eligible to receive a share of the savings to the extent its assigned beneficiary medical expenditures are below its own medical expenditure benchmark provided by CMS.
We have partnered with primary-care provider groups and a variety of other health care providers to form thirty-one ACOs which have been approved by CMS for participation in the Shared Savings Program. Based on data provided by CMS, these thirty-one ACOs currently include approximately 3,000 participating providers with approximately 327,000 assigned Medicare fee-for-service beneficiaries covering portions of thirteen 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, improved health and lower healthcare costs for their Medicare fee-for-service beneficiaries.
The Medicare Shared Savings Program is relatively new and therefore has limited historical experience. This impacts our ability to accurately accumulate and interpret the data available for calculating the ACOs' shared savings. Therefore, we do not anticipate recognizing revenue for the year ending December 31, 2013. We expect that any revenue for the initial program periods ending December 31, 2013 will be reported in 2014. Based on the ACO operating agreements, we bear all costs of the ACO operations until revenue is recognized. At that point, we share in 100% of the revenue up to our costs incurred. Any remaining profit is generally shared equally with our ACO provider partners.
Healthcare Reform
In March 2010, President Obama signed into law the Affordable Care Act, legislating broad-based changes to the U.S. health care system. Certain provisions of the health reform legislation have already taken effect, and others become effective at various dates over the next several years. Due to the complexity of the health reform legislation, including yet to be promulgated implementing regulations, lack of interpretive guidance, and gradual implementation, the impact of the health reform legislation remains difficult to predict and quantify. In addition, we believe that any impact from the health reform legislation could potentially be mitigated by certain actions we may take in the future including modifying future Medicare Advantage bids to compensate for such changes. For example, the anticipation of additional revenues from STAR bonuses or reduced CMS reimbursement rates are factored into the anticipated level of benefits included in our Medicare Advantage bids for the upcoming year.
The provisions of these new laws include the following key points, which are discussed further below:
- •
- reduced Medicare Advantage reimbursement rates, beginning in 2012;
- •
- implementation of a quality bonus for Star Ratings beginning in 2012;
- •
- stipulated minimum medical loss ratios, beginning in 2014;
- •
- non-deductible health insurance industry fee, beginning in 2014;
30
- •
- coding intensity adjustments, with mandatory minimums beginning in 2015;
- •
- limitation on the federal tax deductibility of compensation earned by individuals, beginning in 2013; and
- •
- accountable care organizations, beginning in 2012.
Reduced Medicare Advantage reimbursement rates—Beginning in 2012, the Medicare Advantage "benchmark" rates began the transition to target Medicare fee-for-service cost benchmarks of 95%, 100%, 107.5% or 115% of the calculated Medicare fee-for-service costs. The transition period is 2, 4 or 6 years depending upon the applicable county in which services are provided. The counties are divided into quartiles based on each county's fee-for-service Medicare costs. We estimate that approximately 46% of our current membership resides in counties where the Medicare Advantage benchmark rate will equal 95% of the calculated Medicare fee-for-service costs, with approximately 93% of these members having a 6-year transition period. Under the new law, the premiums for such members commenced the transition to 95% of Medicare fee-for-service costs beginning in 2012. This followed the freezing of Medicare Advantage reimbursement rates in 2011 based on our 2010 levels.
Medicare Advantage payment benchmarks have been cut over the last several years, with additional funding reductions to be phased in as noted above. In April 2013, CMS released its "Final Notice for Methodological Changes for Calendar Year (CY) 2014 for Medicare Advantage (MA) Capitation Rates, and Part C and Part D Payment Policies and 2014 Call Letter" (the "Final Notice") regarding 2014 Medicare Advantage benchmark rates and payment policies. The Final Notice includes significant reductions to 2014 Medicare Advantage payments, including the benchmark reductions described above. These reductions and the Health Reform legislation insurance industry fee described below result in revenue reductions and incremental assessments totaling approximately 4.7% for 2014, against a typical industry forward medical cost trend outlook of 3% and limit the ability of plans to reduce benefits. As a result of these factors, we elected not to rebid our Medicare Advantage rural private fee-for-service contract covering approximately 12,000 beneficiaries. In addition, these factors will likely affect our plan benefit designs, market participation, growth prospects and earnings potential for our Medicare Advantage plans in the future.
Implementation of quality bonus for Star Ratings—Beginning in 2012, Medicare Advantage plans with an overall "Star Rating" of three or more stars (out of five) based on 2011 performance are eligible for a "quality bonus" in their basic premium rates. Plans receiving Star bonus payments are required to use the additional dollars to provide "extra benefits" for the plans' enrollees, to comply with required minimum loss ratios, resulting in a competitive advantage for those plans rather than a direct financial impact. The Affordable Care Act limits these quality bonuses to the plans that achieve 4 or more stars as their overall rating, but CMS is using demonstration authority to expand the quality bonus to 3 star plans for a three year period through 2014. In addition, beginning in 2012, Medicare Advantage star ratings affect the rebate percentage available for plans to provide additional member benefits (plans with quality ratings of 3.5 stars or above will have their rebate percentage increased from a base rate of 50% to 65% or 70%). In all cases, this rebate percentage is lower than the pre-Affordable Care Act rebate percentage of 75%. Our Medicare Advantage plans for 2013 are rated from 2.5 to 3.5 stars out
31
of 5. For 2014, we significantly improved our Star ratings with approximately 75% of our core membership now in plans rated 4 stars. A summary of these ratings is presented below:
Contract | Plan Name | Location | Members (000's) | 2014 Star Rating | Change | |||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
H4506 | Texan Plus HMO | Southeast Texas | 49.6 | 4.0 | 0.5 | |||||||||
H2816 | Today's Options Network PFFS | Northeast | 27.1 | 4.0 | 1.0 | |||||||||
H2775 | Today's Options PPO | Northeast | 13.2 | 3.5 | 0.5 | |||||||||
H3333 | Today's Options PFFS | Northeast (rural) | 2.0 | 3.5 | — | |||||||||
H3706 | Generations Healthcare HMO | Oklahoma City | 6.0 | 3.0 | — | |||||||||
H5656 | Texan Plus HMO | North Texas (Dallas) | 4.6 | 3.0 | — | |||||||||
H5378 | Today's Options PPO | Midwest, Southeast (non-core) | 3.4 | 3.0 | 0.5 | |||||||||
H6169 | Today's Options Network PFFS | Midwest, Southeast (non-core) | 15.7 | 3.0 | 0.5 | |||||||||
121.6 | (1) | |||||||||||||
- (1)
- Excludes approximately 12,000 rural members whose plans were not renewed in 2014.
Notwithstanding continued efforts to improve or maintain our Star Ratings and other quality measures, there can be no assurances that we will be successful in doing so. Accordingly, our plans may not be eligible for full level quality bonuses or increased rebates, which could adversely affect the benefits such plans can offer, reduce membership, and reduce profit margins.
In addition, CMS has indicated that plans with a Star Rating of less than 3.0 for three consecutive years may be subject to termination. While we do not currently have any plans with a rating below 3.0, our inability to maintain Star Ratings of 3.0 or better for a sustained period of time could ultimately result in plan termination by CMS which could have a material adverse impact on our business, cash flows and results of operations. Also, the CMS Star Ratings/Quality scores may be used by CMS to pay bonuses to Medicare Advantage plans that enable those plans to offer improved benefits and/or better pricing. Furthermore, lower quality scores compared to our competitors may result in us losing potential new business in new markets or dissuading potential members from choosing our plan in markets in which we compete. Lower quality scores compared to our competitors could have a material adverse effect on our rate of growth.
Stipulated minimum MLRs—Beginning in 2014, the new healthcare reform legislation will stipulate a minimum medical loss ratio, or MLR, of 85% for Medicare Advantage plans. Financial and other penalties may result from failing to achieve the minimum MLR ratio. Our reported Medicare Advantage MLR was 80.6% for the year ended December 31, 2012 and was 85.5% for the nine months ended September 30, 2013. Although the methodology for defining medical costs and for calculating MLRs was recently defined by CMS, it remains subject to interpretation and we are continuing to evaluate its impact. Complying with such minimum ratio by increasing our medical expenditures or refunding any shortfalls to the federal government could have a material adverse effect on our operating margins, results of operations, and our statutory required capital.
Non-deductible health insurance industry fee—Beginning in 2014, the new healthcare reform legislation will impose an annual aggregate health insurance industry fee of $8.0 billion (with increasing annual amounts thereafter) on health insurance premiums, including Medicare Advantage premiums, that is not deductible for income tax purposes. As a result, our effective income tax rate will increase in 2014. Our share of the new fee will be based on our pro rata percentage of premiums written during the preceding calendar year compared to the industry as a whole, calculated annually. We expect this fee to result in a significant payment by us which will reduce the profitability of our Medicare Advantage business and could have a material adverse effect on our results of operations. Pursuant to the guidance issued by the FASB in July 2011, for reporting in accordance with U.S generally accepted accounting principles (GAAP), the health insurance industry fee will be accrued over the year in which
32
it is payable. This fee will first be expensed and paid in 2014. For statutory reporting purposes, the National Association of Insurance Commissioners (NAIC) is continuing discussions regarding the accounting for the health insurance industry fee and may require surplus reductions or segregation in the year preceding payment, beginning in 2014, which is contradictory to GAAP. Accordingly, in 2014, we may be required to reduce statutory surplus for both the 2014 and 2015 fees.
Coding intensity adjustments—Under the new healthcare reform legislation, the coding intensity adjustment instituted in 2010 became permanent, resulting in mandated minimum reductions in risk scores of 4.91% in 2014 increasing each year to 5.91% in 2018. These coding adjustments may adversely affect the level of payments from CMS to our Medicare Advantage plans.
Limitation on the federal tax deductibility of compensation earned by individuals—Beginning in 2013, with respect to services performed during 2010 and afterward, for health insurance companies, the federal tax deductibility of compensation will be limited under Section 162(m)(6) of the Code to $500,000 per individual and will not contain an exception for "performance-based compensation." This limitation has increased our effective tax rate by approximately 200 basis points for the year ended December 31, 2012 and 330 basis points for the nine months ended September 30, 2013.
Accountable Care Organizations—The Affordable Care Act established Accountable Care Organizations, or ACOs, as a tool to improve quality and lower costs through increased care coordination in the Medicare fee-for-service program. CMS established the Medicare Shared Savings Program, or MSSP, to facilitate coordination and cooperation among providers to improve the quality of care for Medicare fee-for-service beneficiaries and reduce unnecessary costs. To date, we have partnered with numerous groups of healthcare providers to form thirty-one ACOs that have been approved to participate in the MSSP. ACOs are entities that contract with CMS to serve the Medicare fee-for-service population with the goal of better care for individuals, improved health for populations and lower costs. ACOs share savings with CMS to the extent that the actual costs of serving assigned beneficiaries are below certain trended benchmarks of such beneficiaries and certain quality performance measures are achieved. We provide a variety of services to the ACOs, including care coordination, analytics and reporting, technology and other administrative services to enable these physicians and their associated healthcare providers to deliver better quality care, improved health and lower healthcare costs for their Medicare fee-for-service patients. As of September 30, 2013, we have incurred inception-to-date expenses of approximately $50 million, pre-tax, related to our ACO business, including our equity in the losses of our unconsolidated ACOs and have received no revenues to date. We expect to incur significant costs during the remainder of 2013 and beyond. Under the MSSP, CMS will not make any payments to ACO's for the first measurement year ending December 31, 2013 until the second half of 2014, which will negatively impact our cash flows. In order to receive revenues from CMS under the MSSP, the ACO must meet certain minimum savings rates (i.e. save the federal government money) and meet certain quality measures. More specifically, an ACO's medical expenses for its assigned beneficiaries during a relevant measurement year must be below the benchmark established by CMS for such ACO. On the quality side, the MSSP requires ACOs to meet thirty-three quality measures, which CMS may vary from time to time. Notwithstanding our efforts, our ACOs may be unable to meet the required savings rates or may not satisfy the quality measures, which may result in our receiving no revenues and losing our substantial investment. In addition, as the MSSP is a new program, it presents challenges and risks associated with the timeliness and accuracy of data and interpretation of complex rules, which may impact the timing and amount of revenue we can recognize and could have a material adverse effect on our ability to recoup any of our investment in this new business. Further, there can be no assurance that we will maintain positive relations with each our thirty-one ACO partners which may result in certain of the ACOs terminating our relationship which will result in a potential loss of our investment.
In addition, CMS, the US Office of Inspector General, the Internal Revenue Service, the Federal Trade Commission, the US Department of Justice, and various states have adopted or are considering adopting new legislation, rules, regulations and guidance relating to formation and operation of ACOs. Such laws may, among other things, require ACOs to become subject to financial regulation such as
33
maintaining deposits of assets with the states in which they operate, the filing of periodic reports with the insurance department and/or department of health, or holding certain licenses or certifications in the jurisdictions in which the ACOs operate. Failure to comply with legal or regulatory restrictions may result in CMS terminating an ACO's agreement with CMS and/or subjecting an ACO to loss of the right to engage in some or all business in a state, payments, fines or penalties, or may implicate federal and state fraud and abuse laws relating to anti-trust, physician fee-sharing arrangements, anti-kickback prohibitions or prohibited referrals, any of which may adversely affect our operations and/or profitability.
Membership
The following table presents our membership in our Medicare Advantage segment:
| September 30, 2013 | December 31, 2012(1) | |||||
---|---|---|---|---|---|---|---|
| (in thousands) | ||||||
Membership | |||||||
Southwest HMO | 61.1 | 56.6 | |||||
Northeast Network | 39.7 | 36.0 | |||||
Southeast Network | 5.7 | 5.8 | |||||
Core Markets | 106.5 | 98.4 | |||||
All Other Network | 13.0 | 16.5 | |||||
Rural(2) | 14.0 | 16.1 | |||||
Total Membership | 133.5 | 131.0 | |||||
- (1)
- Restated to exclude 3,300 members in areas subject to 2013 Service Area Reductions.
- (2)
- Includes approximately 12,000 rural members whose plans were not renewed for 2014.
Goodwill Impairment Charge
We test goodwill for impairment annually based on information as of October 1 of the current year or more frequently if circumstances suggest that impairment may exist. During the quarter ended June 30, 2013 certain events occurred and circumstances changed which indicated that it was more likely than not that goodwill for APS Healthcare might be impaired.
These events and circumstances, occurring during the quarter ended June 30, 2013, included the following:
- •
- APS Healthcare failed to win certain new contracts that had previously been anticipated;
- •
- One contract that represents a significant portion of APS Healthcare's historical revenue was renewed, but at a lower rate than had previously been anticipated;
- •
- Certain of APS Healthcare's existing contracts were terminated, not renewed or we learned that they were likely to terminate in the next several months; and
- •
- Due to the general increase in interest rates during the second quarter, the discount rate used in the impairment analysis was increased by 50 basis points compared to the rate used in the prior impairment testing analysis.
34
Based on the foregoing, we performed an interim impairment review as of June 30, 2013, that included lowered expectations for future revenue growth and new business development and a higher discount rate. As a result of the step one impairment test, we determined that as of June 30, 2013 the carrying value of APS Healthcare exceeded its fair value. We then proceeded to the second step of the impairment test to estimate the implied fair value of the APS Healthcare goodwill. This implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination, that is, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the estimated fair value was the purchase price paid. Based on the June 30, 2013 step two analysis, the carrying amount of the APS Healthcare goodwill exceeded its implied fair value, resulting in a pre-tax impairment charge of $91.7 million, which we allocated on a pro-rata basis between taxable and non-taxable goodwill.
We estimate the fair values of our reporting units using discounted cash flows, which include assumptions about a wide variety of internal and external factors. Significant assumptions used in the impairment analysis include financial projections of cash flow (including significant assumptions about future revenue, operating margins and target capital requirements), long- term growth rates for determining terminal value, and discount rates. Forecasts and long-term growth rates used for our reporting units are consistent with, and use inputs from, our internal long-term business plan and strategy. During our forecasting process, we assess revenue trends, medical cost trends, operating cost levels and target capital levels. Significant factors affecting these trends include changes in membership, premium yield, medical cost trends, and the impact and expectations of regulatory environments.
Although we believe that the financial projections used are reasonable and appropriate at the time made, the use of different assumptions and estimates could materially impact the analysis and resulting conclusions. In addition, due to the long-term nature of the forecasts there is significant uncertainty inherent in those projections. That uncertainty is increased by the impact of healthcare reforms as discussed in Item 1, "Business—Regulation" in our Annual Report on Form 10-K. For additional discussions regarding how the enactment or implementation of healthcare reforms and how other factors could affect our business and the related long-term forecasts, see Item 1A, "Risk Factors" in Part I of our Annual Report on Form 10-K and "Healthcare Reform" in Part 1, Item 2 of this Quarterly Report on Form 10-Q.
We use a range of discount rates that correspond to a market-based weighted average cost of capital. Discount rates are determined for each reporting unit based on the implied risk inherent in their forecasts. This risk is evaluated using comparisons to market information such as peer company weighted average costs of capital and peer company stock prices in the form of revenue and earnings multiples. The most significant estimates in the discount rate determinations include the risk-free rates and equity risk premium. Company-specific adjustments to discount rates are subjective and thus are difficult to measure with certainty.
Outcomes from the discounted cash flow analysis are compared to other market approach valuation methodologies for reasonableness.
The passage of time and the availability of additional information regarding areas of uncertainty in regards to the reporting units' operations could cause these assumptions used in our analysis to change materially in the future. If our assumptions differ from actual, the estimates underlying our goodwill impairment tests could be adversely affected.
Future events that could have a negative impact on the levels of excess fair value over carrying value of our reporting units include, but are not limited to:
- •
- decreases in business growth;
- •
- decreases in earnings projections;
35
- •
- increases in the weighted average cost of capital; and
- •
- increases in the amount of required capital for a reporting unit.
Negative changes in one or more of these factors, among others, could result in additional impairment charges.
Results of Operations—Consolidated Overview
The following table reflects income (loss) before taxes from each of our segments and contains reconciliations to reported net income:
| Three months ended September 30, | Nine months ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012(1) | 2013 | 2012(1) | |||||||||
| (in thousands, except per share amounts) | ||||||||||||
Senior Managed Care—Medicare Advantage(2) | $ | 3,158 | $ | 24,538 | $ | 41,798 | $ | 73,839 | |||||
Traditional Insurance(2) | 4,313 | 4,287 | 11,716 | 14,095 | |||||||||
Corporate & Other(2) | (27,167 | ) | (12,606 | ) | (157,229 | ) | (38,649 | ) | |||||
Net realized gains on investments(2) | 624 | 4,668 | 13,181 | 12,929 | |||||||||
(Loss) income before income taxes(2) | (19,072 | ) | 20,887 | (90,534 | ) | 62,214 | |||||||
(Benefit from) provision for income taxes | (6,371 | ) | 7,040 | 25 | 24,181 | ||||||||
Net (loss) income | $ | (12,701 | ) | $ | 13,847 | $ | (90,559 | ) | $ | 38,033 | |||
(Loss) earnings per common share (diluted): | |||||||||||||
Net (loss) income | $ | (0.15 | ) | $ | 0.16 | $ | (1.04 | ) | $ | 0.44 | |||
- (1)
- In connection with the restatement to correct the accounting related to our recording of certain policy reserves and deferred acquisition costs in our Traditional Insurance segment along with the related deferred income tax impact, the Company's prior annual financial statements, including the three and nine months ended September 30, 2012, have been adjusted to record adjustments in their proper period for items that are not considered material but were previously corrected out-of-period.
- (2)
- We evaluate the results of operations of our segments based on income before realized gains (losses) and income taxes. We believe that realized gains and losses are not indicative of overall operating trends. This differs from U.S. GAAP, which includes the effect of realized gains (losses) and income taxes in the determination of net income. The schedule above reconciles our segment income (loss) before income taxes to net (loss) income in accordance with U.S. GAAP.
Three months endedSeptember 30, 2013 and 2012
Net loss for the three months ended September 30, 2013 was $12.7 million, or $(0.15) per diluted share, compared to net income of $13.8 million or $0.16 per diluted share for the three months ended September 30, 2012. Net (loss) income includes realized investment gains, net of taxes, of $0.4 million, or less than $0.01 per diluted share, and $3.0 million, or $0.03 per diluted share, for the three month periods ended September 30, 2013 and 2012, respectively.
Our effective tax rate was 33.4% for the third quarter of 2013 compared to 33.7% for the third quarter of 2012 and included non-recurring tax benefits of $0.5 million and $1.4 million, respectively. The variance in the effective tax rate compared with the 35% federal rate was driven by permanent items, primarily relating to non-deductible executive compensation and interest on the mandatorily redeemable preferred stock as well as foreign and state income taxes partially offset by the non-recurring tax benefits.
36
Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $3.2 million for the three months ended September 30, 2013, a decrease of $21.4 million compared to the three months ended September 30, 2012. The decrease in earnings was driven primarily by an increase in the medical expense ratio to 84.6% in the quarter ended September 30, 2013 from 79.2% in the quarter ended September 30, 2012, partially offset by improved expense efficiency as a result of our continued expense reduction initiatives. The third quarter of 2013 included favorable prior period items of $3.5 million compared to favorable prior period items of $16.9 million in the third quarter of 2012.
Our Traditional Insurance segment generated income before income taxes of $4.3 million for the three months ended September 30, 2013, which was in line with income for the three months ended September 30, 2012. The decrease in overall business inforce and resulting premium was more than offset by a decrease in benefits expense during the current year.
The loss before income taxes from our Corporate & Other segment increased by $14.6 million for the third quarter of 2013 compared to the third quarter of 2012 primarily due to an increase in total ACO costs, an increase in business development costs and lower profitability of our APS business.
Nine months ended September 30, 2013 and 2012
Net loss for the nine months ended September 30, 2013 was $90.6 million, or $(1.04) per diluted share, compared to net income of $38.0 million or $0.44 per diluted share for the nine months ended September 30, 2012. The year-to-date 2013 net loss includes a goodwill impairment charge, net of taxes, of $90.6 million, or $1.04 per diluted share. Net (loss) income also includes realized investment gains, net of taxes, of $8.6 million, or $0.10 per diluted share, and $8.4 million, or $0.10 per diluted share, for the nine month periods ended September 30, 2013 and 2012, respectively.
For the nine months ended September 30, 2013, our effective tax rate was less than 0.1% compared to 38.9% for the same period in 2012 and included non-recurring tax benefits of $0.8 million and $1.5 million, respectively. The variance in the effective tax rate compared with the 35% federal rate was driven by permanent items, relating to non-deductible goodwill impairment, executive compensation, APS Healthcare transaction costs and interest on the mandatorily redeemable preferred stock as well as foreign and state income taxes partially offset by the non-recurring tax benefits.
Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $41.8 million for the nine months ended September 30, 2013, a decrease of $32.0 million compared to the nine months ended September 30, 2012. The decrease in earnings was driven primarily by an increase in the medical expense ratio to 84.3% for first nine months of 2013 from 81.4% in the first nine months of 2012, partially offset by improved expense efficiency as a result of our continued expense reduction initiatives. The first nine months of 2013 included favorable prior period items of $21.4 million compared to favorable prior period items of $23.5 million in the first nine months of 2012.
Our Traditional Insurance segment generated income before income taxes of $11.7 million for the nine months ended September 30, 2013, compared to $14.1 million for the nine months ended September 30, 2012. The $2.4 million decrease in income was primarily due to a decrease in investment income and an increase in the change in deferred acquisition cost, partially offset by lower levels of commissions and general expense, primarily related to the decline in overall business in force.
The loss before income taxes from our Corporate & Other segment increased by $118.6 million for the third quarter of 2013 compared to the same period of 2012. This was due primarily to a goodwill impairment charge of $91.7 million taken in the second quarter of 2013, as well as an increase in total ACO costs, an increase in business development costs, and lower profitability of our APS business.
37
Segment Results—Senior Managed Care—Medicare Advantage
| Three months ended September 30, | Nine months ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012(1) | 2013 | 2012(1) | |||||||||
| (in thousands) | (in thousands) | |||||||||||
Net premiums | $ | 395,916 | $ | 400,006 | $ | 1,210,548 | $ | 1,211,398 | |||||
Net investment income | 4,142 | 5,685 | 14,360 | 17,595 | |||||||||
Fee and other income | 46 | 55 | 133 | 140 | |||||||||
Total revenue | 400,104 | 405,746 | 1,225,041 | 1,229,133 | |||||||||
Medical expenses | 334,870 | 316,757 | 1,019,968 | 986,007 | |||||||||
Amortization of intangible assets | 754 | 782 | 2,263 | 2,346 | |||||||||
Commissions and general expenses | 61,322 | 63,669 | 161,012 | 166,941 | |||||||||
Total benefits, claims and other deductions | 396,946 | 381,208 | 1,183,243 | 1,155,294 | |||||||||
Segment income before income taxes | $ | 3,158 | $ | 24,538 | $ | 41,798 | $ | 73,839 | |||||
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 34 states. Our HMOs offer coverage to Medicare beneficiaries primarily in Southeastern Texas, the area surrounding Dallas/Ft. Worth, 16 counties in Oklahoma and 3 counties in Indiana.
Three months ended September 30, 2013 and 2012
Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $3.2 million for the three months ended September 30, 2013, a decrease of $21.4 million compared to the three months ended September 30, 2012. The decrease in earnings was driven primarily by an increase in the medical expense ratio to 84.6% in the quarter ended September 30, 2013 from 79.2% in the quarter ended September 30, 2012, partially offset by improved expense efficiency as a result of our continued expense reduction initiatives. The third quarter of 2013 included favorable prior period items of $3.5 million compared to favorable prior period items of $16.9 million in the third quarter of 2012.
Net Premiums. Net premiums decreased by $4.1 million compared to the three months ended September 30, 2012, primarily due to lower member months in 2013, partially offset by a higher premium yield per member. During the third quarter of 2013, net premiums included $6.3 million of net favorable items related to prior periods compared to $12.8 million during the same period in 2012.
Net investment income. Net investment income decreased $1.5 million due to lower investment balances as a result of the payment of dividends to the parent in the second and third quarters of 2013 and due to the continuing maturity of higher yielding assets with the proceeds being reinvested in lower yielding securities in this low interest rate environment.
Medical expenses. Medical expenses increased by $18.1 million compared to the third quarter of 2012. During the third quarter of 2013, medical expenses included $2.8 million of net unfavorable items related to prior periods compared to $4.1 million of net favorable items during the same period in 2012. During the quarter ended September 30, 2013, sequestration and an increase in inpatient and emergent care utilization in our non-HMO lines of business increased our medical expense ratio compared to the same period in 2012. The medical expense ratio increased to 84.6% for the third quarter of 2013 from 79.2% for the same period in 2012. Excluding the prior period items discussed above for net premiums and medical expenses, the medical expense ratio for the third quarter of 2013 was 85.2%.
38
Commissions and general expenses. Commissions and general expenses for the three months ended September 30, 2013 decreased $2.3 million compared to the three months ended September 30, 2012, primarily as the result of the decreased level of membership and the continued execution of our expense reduction plan. The ratio of commissions and general expenses to net premiums improved to 15.5% in the third quarter of 2013 from 15.9% in the third quarter of 2012.
Nine months ended September 30, 2013 and 2012
Our Senior Managed Care—Medicare Advantage segment generated income before income taxes of $41.8 million for the nine months ended September 30, 2013, a decrease of $32.0 million compared to the nine months ended September 30, 2012. The decrease in earnings was driven primarily by deterioration in the medical expense ratio to 84.3% for first nine months of 2013 from 81.4% in the first nine months of 2012, partially offset by improved expense efficiency as a result of our continued expense reduction initiatives. The first nine months of 2013 included favorable prior period items of $21.4 million compared to favorable prior period items of $23.5 million in the first nine months of 2012.
Net Premiums. Net premiums decreased by $0.9 million compared to the nine months ended September 30, 2012, primarily due to lower member months in 2013 partially offset by a higher premium yield per member. In the first nine months of 2013, net premiums included $33.9 million of favorable prior period items compared to $31.6 million of favorable prior period adjustments in the first nine months of 2012.
Net investment income. Net investment income decreased $3.2 million due to lower investment balances as a result of the payment of dividends to the parent in the second and the beginning of the third quarters of 2013 and due to the continuing maturity of higher yielding assets with the proceeds being reinvested in lower yielding securities in this low interest rate environment.
Medical expenses. Medical expenses increased by $34.0 million compared to the first nine months of 2012. During the first nine months of 2013, medical expenses included $12.5 million of net unfavorable items related to prior periods compared to $8.1 million of net unfavorable items related to prior periods in the first nine months of 2012. In addition, the second and third quarter 2013 effects of sequestration and an increase in inpatient and emergent care utilization in our non-HMO lines of business unfavorably impacted medical expenses for the first nine months. The medical expense ratio deteriorated to 84.3% for the first nine months of 2013 from 81.4% for the same period in 2012. Excluding the prior period items discussed above for net medical premiums and medical expense, the medical expense ratio for the nine months of 2013 was 85.6%
Commissions and general expenses. Commissions and general expenses for the nine months ended September 30, 2013 decreased $5.9 million compared to the nine months ended September 30, 2012, primarily as the result of the decreased level of membership and the continued execution of our expense reduction plan. The ratio of commissions and general expenses to net premiums improved to 13.3% in the first nine months of 2013 from 13.8% in the first nine months of 2012.
39
Segment Results—Traditional Insurance
| Three months ended September 30, | Nine months ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012(1) | 2013 | 2012(1) | |||||||||
| (in thousands) | (in thousands) | |||||||||||
Net premiums | $ | 52,842 | $ | 59,160 | $ | 163,343 | $ | 184,942 | |||||
Net investment income | 4,419 | 4,472 | 13,376 | 14,266 | |||||||||
Fee and other income | 392 | 470 | 1,195 | 1,659 | |||||||||
Total revenue | 57,653 | 64,102 | 177,914 | 200,867 | |||||||||
Policyholder benefits | 37,001 | 45,840 | 121,051 | 142,915 | |||||||||
Change in deferred policy acquisition costs | 3,470 | 1,040 | 9,511 | 2,978 | |||||||||
Commissions and general expenses, net of allowances | 12,869 | 12,935 | 35,636 | 40,879 | |||||||||
Total benefits, claims and other deductions | 53,340 | 59,815 | 166,198 | 186,772 | |||||||||
Segment income before income taxes | $ | 4,313 | $ | 4,287 | $ | 11,716 | $ | 14,095 | |||||
Three months ended September 30, 2013 and 2012
Our Traditional Insurance segment generated income before income taxes of $4.3 million for the three months ended September 30, 2013, which was in line with income for the three months ended September 30, 2012. The decrease in overall business inforce and resulting premium was more than offset by a decrease in benefits expense during the current year.
Net Premiums. Net premium declined by $6.3 million or 10.7% from the third quarter of 2012. This is primarily the result of the continued effect of lapsation on our in force business and the decision to cease marketing and selling Traditional insurance products after June 1, 2012. The following table details premium for the segment by major lines of business:
| Three months ended September 30, | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||||||||||||||
| Gross | Ceded | Net | Gross | Ceded | Net | |||||||||||||
| (in thousands) | ||||||||||||||||||
Senior market | $ | 48,284 | $ | (10,060 | ) | $ | 38,224 | $ | 55,409 | $ | (11,845 | ) | $ | 43,564 | |||||
Specialty health | 12,736 | (1,654 | ) | 11,082 | 13,373 | (1,739 | ) | 11,634 | |||||||||||
Life insurance and annuity | 11,909 | (8,373 | ) | 3,536 | 13,092 | (9,130 | ) | 3,962 | |||||||||||
Total premium | $ | 72,929 | $ | (20,087 | ) | $ | 52,842 | $ | 81,874 | $ | (22,714 | ) | $ | 59,160 | |||||
Policyholder benefits. Policyholder benefits declined by $8.8 million, or 19.3%, compared to the third quarter of 2012. This decline was principally due to the overall decline of insurance in-force in the senior market and specialty health lines of business. For the three months ended September 30, 2013, the senior market policyholder benefit ratio improved to 64.0%, compared with 69.8% for the same period last year, due to favorable prior period development and a lower average claim trend in the Medicare supplement line of business. Specialty health's benefit ratio decreased to 92.8%, compared with 113.9% for the same period last year, due to a lower incidence of long-term claims during the third quarter of 2013 and the impact of favorable prior period items.
Change in deferred acquisition costs. The net change in deferred acquisition costs increased by $2.4 million due to a lower level of acquisition costs incurred and deferred in 2013 as a result of the decision to cease marketing and selling Traditional insurance products after June 1, 2012.
40
Commissions and general expenses, net of allowances. Total commissions and general expenses, net of allowances, are in line with the third quarter of 2012.
Nine months ended September 30, 2013 and 2012
Our Traditional Insurance segment generated income before income taxes of $11.7 million for the nine months ended September 30, 2013, compared to $14.1 million for the nine months ended September 30, 2012. The $2.4 million decrease in income was primarily due to a decrease in investment income and an increase in the change in deferred acquisition cost, partially offset by lower levels of commissions and general expense, primarily related to the decline in overall business in force.
Net Premiums. Net premium declined by $21.6 million or 11.7% from the nine months ending September 30, 2012. This is primarily the result of the continued effect of lapsation on our in force business and the decision to cease marketing and selling Traditional insurance products after June 1, 2012. The following table details premium for the segment by major lines of business:
| Nine months ended September 30, | ||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012 | |||||||||||||||||
| Gross | Ceded | Net | Gross | Ceded | Net | |||||||||||||
| (in thousands) | ||||||||||||||||||
Senior market | $ | 151,546 | $ | (32,259 | ) | $ | 119,287 | $ | 174,211 | $ | (37,980 | ) | $ | 136,231 | |||||
Specialty health | 38,164 | (5,017 | ) | 33,147 | 41,454 | (5,265 | ) | 36,189 | |||||||||||
Life insurance and annuity | 36,618 | (25,709 | ) | 10,909 | 40,741 | (28,219 | ) | 12,522 | |||||||||||
Total premium | $ | 226,328 | $ | (62,985 | ) | $ | 163,343 | $ | 256,406 | $ | (71,464 | ) | $ | 184,942 | |||||
Net investment income. Net investment income decreased by $0.9 million, primarily due to the maturity of higher yielding assets with the proceeds being reinvested in lower yielding securities in this low interest rate environment, as well as a lower invested asset base on the declining blocks of business.
Policyholder benefits. Policyholder benefits declined by $21.9 million, or 15.3%, compared to the nine months ending September 30, 2012. This decline was principally due to the overall decline of insurance in-force in the senior market and specialty health lines of business along with an improvement in policyholder benefit ratios. For the nine months ended September 30, 2013, the senior market policyholder benefit ratio improved to 68.7%, compared with 72.7% for the same period last year, due to favorable prior period development and a lower average claim trend in the Medicare supplement line of business. Specialty health's benefit ratio decreased to 96.9%, compared with 102.3% for the same period last year, due to a lower incidence of long-term claims during and the impact of favorable prior period items.
Change in deferred acquisition costs. The net change in deferred acquisition costs increased by $6.5 million due to a lower level of acquisition costs incurred and deferred in 2013 as a result of the decision to cease marketing and selling Traditional insurance products after June 1, 2012.
Commissions and general expenses, net of allowances. Total commissions and general expenses, net of allowances, decreased by $5.2 million compared to the nine months ending September 30, 2012. This decrease in expenses is attributed primarily to lower commissions and other acquisition costs as a result of the decline in new business issued in 2013, discussed above, as well as the decline in the business in force.
41
Segment Results—Corporate & Other
| Three months ended September 30, | Nine months ended September 30, | |||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2013 | 2012(1) | 2013 | 2012(1) | |||||||||
| (in thousands) | (in thousands) | |||||||||||
Net premiums | $ | 38,738 | $ | 40,067 | $ | 119,125 | $ | 88,661 | |||||
Net investment income | 180 | 86 | 400 | 172 | |||||||||
Fee and other income | 23,495 | 37,529 | 90,248 | 97,252 | |||||||||
Total revenue | 62,413 | 77,682 | 209,773 | 186,085 | |||||||||
Claims and other benefits | 33,721 | 30,114 | 100,732 | 73,421 | |||||||||
Amortization of intangible assets | 1,358 | 1,358 | 4,073 | 3,168 | |||||||||
Interest expense | 1,648 | 1,689 | 4,909 | 4,624 | |||||||||
Goodwill impairment charge | — | — | 91,742 | — | |||||||||
Commissions and general expenses | 44,984 | 53,245 | 140,474 | 137,535 | |||||||||
Total benefits, claims and other deductions | 81,711 | 86,406 | 341,930 | 218,748 | |||||||||
Equity in losses of unconsolidated subsidiaries | (7,869 | ) | (3,882 | ) | (25,072 | ) | (5,986 | ) | |||||
Segment loss before income taxes | $ | (27,167 | ) | $ | (12,606 | ) | $ | (157,229 | ) | $ | (38,649 | ) | |
Three months ended September 30, 2013 and 2012
The loss before income taxes from our Corporate & Other segment increased by $14.6 million for the third quarter of 2013 compared to the third quarter of 2012 primarily due to an increase in total ACO costs, an increase in business development costs and lower profitability of our APS business.
Net premiums. Net premiums decreased by $1.3 million compared with the quarter ended September 30, 2012 due primarily to decreased revenues from the APS Puerto Rico business as the result of a rate reduction that was effective July 1, 2013.
Fee and other income. Fee and other income declined by $14.0 million compared with the quarter ended September 30, 2012, due primarily to lower levels of fee for service business at APS Healthcare.
Claims and other benefits. Claims and other benefits increased by $3.6 million compared with the quarter ended September 30, 2012, primarily related to higher utilization levels in our APS Puerto Rico business.
Commissions and general expenses. Total commissions and general expenses decreased by $8.3 million compared to the three months ending September 30, 2012. This was driven by a $12.0 million decline at APS Healthcare primarily related to lower levels of fee for service business, net of the write off of $1.2 million of unamortized software for terminated programs. This was partially offset by a $3.5 million increase in general corporate expenses, compared with 2012, primarily related to business development activities and increased legal costs.
Equity in losses of unconsolidated subsidiaries. This line represents our share of losses on our unconsolidated ACO subsidiaries. Including the ACO operating expenses reported in commissions and general expenses above, total ACO costs were $10.2 million in the quarter ended September 30, 2013 compared with $6.0 million in the same period of 2012 and represent the start-up and operating costs of our ACO business. The increase of $4.2 million is driven by increased operating costs, as there are now thirty-one ACO entities in operation in 2013 compared to sixteen at September 30, 2012. As discussed above, we do not anticipate recognizing ACO revenue for the year ending December 31, 2013. We expect that any revenue for the initial program periods ending December 31, 2013 will be reported in 2014. Based on the ACO operating agreements, we bear all costs of the ACO operations
42
until revenue is recognized. At that point, we share in 100% of the revenue up to our costs incurred. Any remaining profit is generally shared equally with our ACO provider partners.
Nine months ended September 30, 2013 and 2012
The loss before income taxes from our Corporate & Other segment increased by $118.6 million for the third quarter of 2013 compared to the same period of 2012. This was due primarily to a goodwill impairment charge of $91.7 million taken in the second quarter of 2013, as well as an increase in total ACO costs, an increase in business development costs, and lower profitability of our APS business.
Net premiums. Net premiums increased by $30.5 million compared with the nine months ended September 30, 2012 due primarily to 2013 including a full nine months of APS Healthcare results compared with seven months in 2012. APS Healthcare was acquired on March 2, 2012.
Fee and other income. Fee and other income decreased by $7.0 million compared with the nine months ended September 30, 2012, due to lower levels of fee for service business at APS Healthcare.
Claims and other benefits. Claims and other benefits increased by $27.3 million compared with the nine months ended September 30, 2012, primarily related to 2013 including a full nine months of APS Healthcare results compared with seven months in 2012 as well as higher utilization levels in our APS Puerto Rico business.
Amortization of intangible assets. This represents the amortization of APS Healthcare intangible assets. The increase is due to 2013 including a full nine months of APS Healthcare results compared with seven months in 2012
Goodwill impairment charge. The goodwill impairment charge of $91.7 million relates to the impairment of APS Healthcare goodwill during the second quarter of 2013, as discussed above. For additional information, see Note 4—Business Combination and Goodwill.
Commissions and general expenses. Total commissions and general expenses increased by $2.9 million compared to the nine months ending September 30, 2012. This was driven by a $3.0 million increase at APS Healthcare primarily related to 2013 including a full nine months of APS Healthcare results compared with seven months in 2012, net of expense reduction initiatives and lower levels of business. In addition, operating expenses of our CHS subsidiary declined by $6.0 million, as more ACO development costs were incurred in 2012 as compared to 2013 (see further discussion below). General corporate expenses increased $5.9 million compared with 2012, primarily related to business development activities.
Equity in losses of unconsolidated subsidiaries. This line represents our share of losses on our unconsolidated ACO subsidiaries. Including the ACO operating expenses of our CHS subsidiary reported in commissions and general expenses above, total ACO costs were $28.4 million for the nine months ended September 30, 2013 compared with $15.3 million for the same period of 2012 and represent the start-up and operating costs of our ACO business. The increase of $13.1 million is driven by increased operating costs, as there are now thirty-one ACO entities in operation in 2013 compared to sixteen at September 30, 2012. As discussed above, we do not anticipate recognizing ACO revenue for the year ending December 31, 2013. We expect that any revenue for the initial program periods ending December 31, 2013 will be reported in 2014. Based on the ACO operating agreements, we bear all costs of the ACO operations until revenue is recognized. At that point, we share in 100% of the revenue up to our costs incurred. Any remaining profit is generally shared equally with our ACO provider partners.
43
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 insurance, HMO 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 sources and uses of liquidity are derived primarily from the following:
- •
- dividends from and capital contributions to our Insurance and HMO subsidiaries—During 2013, our Insurance and HMO subsidiaries paid $58.9 million of ordinary dividends and $141.5 million of extraordinary dividends to our parent company.
- •
- the cash flows of our other subsidiaries, including our management service organization and APS Healthcare—Net cash flows from our management service organization and APS Healthcare available to our parent company amounted to approximately $4.8 million during the first nine months of 2013.
- •
- the funding of our ACO business and other growth initiatives—Through the nine months ended September 30, 2013, we incurred expenses of approximately $28.4 million, pre-tax, related to our ACO business, including our equity in the losses of our unconsolidated ACOs and have received no revenues to date.
- •
- 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. On August 1, 2013, the Board of Directors of the Company 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, with the balance to be paid in the future to holders of our restricted stock as such shares vest. Payment of any future dividends would be dependent upon an evaluation of excess capital, as discussed below.
- •
- 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 first nine months of 2013. 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 first nine months of 2013, we made principal payments of $10.7 million, interest payments of $2.5 million and other fee payments totaling $0.4 million. There is a bullet payment of $75 million due in 2017.
- •
- payment of certain corporate overhead costs and public company expenses—Payments of certain corporate overhead costs and public company expenses amounted to $22.0 million for the nine months ended September 30, 2013.
As of September 30, 2013, we had approximately $89 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;
44
- •
- 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.
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, 2012, each 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, 2013, we held cash and cash equivalents totaling $94 million and fixed maturity securities that could readily be converted to cash with carrying values of $1.1 billion at our insurance and HMO subsidiaries. We believe that this level of liquidity is sufficient to meet our obligations and pay expenses.
Capital contributions to and dividends from our Insurance and HMO subsidiaries are made through their respective holding companies. We did not make any capital contributions to our insurance and HMO subsidiaries during the first nine months of 2013. During the second quarter, we evaluated capital levels at our insurance and HMO subsidiaries. In addition to ordinary dividends based on prior year earnings, we also requested extraordinary dividends at certain subsidiaries to reduce excess capital. As a result, our insurance and HMO subsidiaries paid $200.4 million of dividends to their holding companies, with $148.9 million paid in June and the balance of $51.5 million paid in July. These are summarized in the following table:
Subsidiary | Ordinary | Extraordinary | Total | |||||||
---|---|---|---|---|---|---|---|---|---|---|
| (in millions) | |||||||||
Pyramid Life | $ | 18.4 | $ | 90.0 | $ | 108.4 | ||||
SelectCare of Texas | 15.5 | 35.8 | 51.3 | |||||||
American Progressive | 14.3 | — | 14.3 | |||||||
Union Bankers | 1.9 | 11.3 | 13.2 | |||||||
Constitution Life | 4.4 | 4.4 | 8.8 | |||||||
SelectCare Health Plans | 4.4 | — | 4.4 | |||||||
$ | 58.9 | $ | 141.5 | $ | 200.4 | |||||
45
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 exceed scheduled uses of cash and result in amounts available to dividend to our parent company. 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.
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, 2013, approximately 99% of our fixed maturity investments had investment grade ratings from S&P or Moody's.
At September 30, 2013, cash and cash equivalents represent approximately 8% of our total cash and invested assets, approximately 24% 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 3.2% at September 30, 2013 and 3.3% at December 31, 2012.
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, the Company entered into an amendment to its 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 principal payments, totaling $17.8 million, due under the 2012 Credit Facility through December 31, 2014 and paid fees and expenses of approximately $0.5 million.
The Company's obligations under the Credit Agreement are secured by a first priority security interest in 100% of the capital stock of the Company's material subsidiaries and are also guaranteed by certain of our subsidiaries.
46
The 2012 Credit Facility bears interest at rates equal to, at the Company's election, LIBOR or the base rate, plus an applicable margin that varies based on the Company's 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, 2013, the interest rate on the term loan portion of the 2012 Credit Facility was 2.50%, based on a spread of 225 basis points above LIBOR. On November 1, 2013 our spread increased to 250 basis points above LIBOR.
The Company is required to pay a commitment fee on unused availability under the Revolving Facility that varies based on the Company's 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, 2012, filed by Universal American on March 6, 2013.
Critical Accounting Policies
There have been no changes to our critical accounting policies during the current quarter ended September 30, 2013. 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, 2012.
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:
| Nine months ended September 30, 2013 | |||
---|---|---|---|---|
| (in thousands) | |||
Balance at beginning of period | $ | 156,558 | ||
Less reinsurance recoverable | (4,811 | ) | ||
Net balance at beginning of period | 151,747 | |||
Incurred related to: | ||||
Current Year | 1,234,019 | |||
Prior Year Development | (672 | ) | ||
Total Incurred | 1,233,347 | |||
Paid related to: | ||||
Current Year | 1,085,121 | |||
Prior Year | 151,800 | |||
Total paid | 1,236,921 | |||
Net balance at end of period | 148,173 | |||
Plus reinsurance recoverable | 7,324 | |||
Balance at end of period | $ | 155,497 | ||
The liability for policy and contract claims—health at September 30, 2013 decreased by $1.1 million from December 31, 2012. The decrease in the liability was primarily attributable to the decrease in IBNR for our Medicare Supplement business.
The medical cost amount, noted as "prior year development" in the table above, represents (favorable) or unfavorable adjustments as a result of prior year claim estimates being settled or currently expected to be settled, for amounts that are different than originally anticipated. This prior
47
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, 2013, claim reserves settled, or are currently expected to be settled, for $0.7 million less than estimated at December 31, 2012. Prior period development represents less than 0.1% of the incurred claims recorded in 2012.
Sensitivity Analysis
The following table illustrates the sensitivity of our accident and health IBNR payable at September 30, 2013 to identified reasonably possible changes to the estimated weighted average completion factors and health care cost trend rates. However, it is possible that the actual completion factors and health care cost trend rates will develop differently from our historical patterns and therefore could be outside of the ranges illustrated below.
Completion Factor(1): | Claims Trend Factor(2): | ||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|
(Decrease) Increase in Factor | Increase (Decrease) in Net Health IBNR | (Decrease) Increase in Factor | (Decrease) Increase in Net Health IBNR | ||||||||
($ in thousands) | |||||||||||
-3 | % | $ | 480 | -3 | % | $ | (6,975 | ) | |||
-2 | % | 320 | -2 | % | (4,650 | ) | |||||
-1 | % | 160 | -1 | % | (2,325 | ) | |||||
1 | % | (160 | ) | 1 | % | 2,325 | |||||
2 | % | (319 | ) | 2 | % | 4,650 | |||||
3 | % | (479 | ) | 3 | % | 6,975 |
- (1)
- Reflects estimated potential changes in medical and other expenses payable, caused by changes in completion factors for incurred months prior to the most recent three months.
- (2)
- Reflects estimated potential changes in medical and other expenses payable, caused by changes in annualized claims trend used for the estimation of per member per month incurred claims for the most recent three months.
Effects of Recently Issued and Pending Accounting Pronouncements
A summary of 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.
48
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, 2013, and with all other variables held constant. The following table summarizes the impact of the assumed changes in market interest rates at September 30, 2013. 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.
| Effect of Change in Market Interest Rates on Fair Value of Fixed Income Portfolio as of September 30, 2013 | ||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|
September 30, 2013 | 200 Basis Point Decrease | 100 Basis Point Decrease | 100 Basis Point Increase | 200 Basis Point Increase | |||||||||
Fair Value of Fixed Income Portfolio | |||||||||||||
(in millions) | |||||||||||||
$1,005.8 | $ | 62.9 | $ | 36.1 | $ | (40.6 | ) | $ | (82.0 | ) |
Debt
We pay interest on our term loan based on rates equal to, at the Company's election, LIBOR or the base rate, plus an applicable margin that varies based on the Company's 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. 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 nine months ended September 30, 2013, and with all other variables held constant. The following table summarizes the impact of changes in LIBOR.
| | | Effect of Change in LIBOR on Pre-tax Income for the nine months ended Septebmer 30, 2013 | ||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Weighted Average Interest Rate | Weighted Average Balance Outstanding | |||||||||||||||||
Description of Floating Rate Debt | 200 Basis Point Decrease(1) | 100 Basis Point Decrease(1) | 100 Basis Point Increase | 200 Basis Point Increase | |||||||||||||||
| | (in millions) | |||||||||||||||||
Loan payable | 2.42 | % | $ | 128.3 | $ | 0.2 | $ | 0.2 | $ | (1.0 | ) | $ | (1.9 | ) |
- (1)
- The LIBOR rate during the nine months ended September 30, 2013 on our Loan payable was approximately 26 basis points. For the purposes of this illustration, we have set a LIBOR, or base rate, floor of 0%.
49
As noted above, we have floating rate debt outstanding of $121 million as of September 30, 2013, which is exposed to rising interest rates. In addition, we held approximately $94 million of cash and cash equivalents as of September 30, 2013. Our exposure to rising interest costs on our debt would be partially mitigated by the increase in net investment income on our cash and short-term investments.
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.
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, 2013. 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, 2013, 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, 2013 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
50
For information relating to litigation affecting us, see Note 9—Commitments and Contingencies in Part I—Item 1 of this report, which is incorporated into this Part II—Item 1—Legal Proceedings by reference.
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, 2012, filed with the SEC on March 6, 2013, as modified by the changes to those risk factors included in other reports we filed with the SEC subsequent to March 6, 2013:
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.
None.
Each exhibit identified below is filed as a part of this report.
10.18 | First Amendment to Credit Agreement, dated as of March 2, 2012, by and among Universal American Corp., each lender from time to time party thereto, Bank of America, N.A., as Administrative Agent, Swing Line Lender and an L/C Issuer and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Fifth Third Bank, Sun Trust Bank and U.S. Bank National Association as Joint Lead Arrangers, Joint Book Managers and Co-Syndication Agents. | ||
31.1 | Certification of Chief Executive Officer, as required by Rule 13a- 14(a) of the Securities Exchange Act of 1934. | ||
31.2 | Certification of Chief Financial Officer, as required by Rule 13a- 14(a) of the Securities Exchange Act of 1934. | ||
32.1 | Certification of the Chief Executive Officer and Chief Financial Officer, as required by Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
101.INS—XBRL | Instance Document. | ||
101.SCH—XBRL | Taxonomy Extension Schema Document. | ||
101.CAL—XBRL | Taxonomy Extension Calculation Linkbase Document. |
51
101.LAB—XBRL | Taxonomy Extension Label Linkbase Document. | ||
101.PRE—XBRL | Taxonomy Extension Presentation Linkbase Document. | ||
101.DEF—XBRL | Taxonomy Extension Definition Linkbase Document. |
52
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.
UNIVERSAL AMERICAN CORP. | ||
November 7, 2013 | /s/ RICHARD A. BARASCH Richard A. Barasch Chief Executive Officer | |
November 7, 2013 | /s/ ROBERT A. WAEGELEIN Robert A. Waegelein President and Chief Financial Officer (Principal Accounting Officer) |
53