Caremark Ulysses Holding 10Q 2008 Q3 Quarterly report

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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, 2008
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: 0-11321

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


New York		11-2580136
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

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

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

Indicate by checkmark 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 is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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 companyo

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

As of October 31, 2008, 67,697,482 shares of the registrant's common stock were issued and outstanding.

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TABLE OF CONTENTS

	Item	Description

PART I		Financial Information
	1	Financial Statements (unaudited):
		Consolidated Balance Sheets	4
		Consolidated Statements of Operations—Three Months	5
		Consolidated Statements of Operations—Nine Months	6
		Consolidated Statements of Stockholders' Equity and Comprehensive Income	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	44
	3	Quantitative and Qualitative Disclosures About Market Risk	83
	4	Controls and Procedures	84
PART II		Other Information
	1	Legal Proceedings	86
	1A	Risk Factors	86
	2	Unregistered Sales of Equity Securities and Use of Proceeds	88
	3	Defaults Upon Senior Securities	88
	4	Submission of Matters to a Vote of Security Holders	88
	5	Other Information	88
	6	Exhibits	89
		Signatures	93

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As used in this quarterly report on Form 10-Q, "Universal American," "we," "our," and "us" refer to Universal American Corp. and its subsidiaries, except where the context otherwise requires or as otherwise indicated.

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

Portions of the information in this quarterly report on Form 10-Q, such as those set forth under "Risk Factors" and "Management's Discussion and Analysis of Financial Condition and Results of Operations", and oral statements made from time to time by our representatives may constitute "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. We intend these forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 21E of the Exchange Act and the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements are statements relating to:

•: Projections of revenue, earnings and other financial items,
•: Our future economic performance,
•: Plans and objectives for future operations and
•: The identification of acquisition candidates and the completion of transactions with them.

You may identify forward-looking statements by the use of words such as the following, or indicating or implying the following:

•: "prospects,"
•: "outlook,"
•: "believes,"
•: "estimates,"
•: "intends,"
•: "may,"
•: "will,"
•: "should,"
•: "anticipates,"
•: "expects,"
•: "plans,"
•: the negative or other variation of these or similar words, or
•: discussion of trends and conditions, strategy or risks and uncertainties.

Forward-looking statements 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. Although we believe that the expectations reflected in any forward-looking statements are based upon reasonable assumptions at the time made, we can give no assurance that we will achieve our expectations. Future events and actual results, financial and otherwise, may differ materially from the results discussed in the forward-looking statements. Readers should not place undue reliance on these forward-looking statements.

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Important factors may cause actual results to differ materially from forward-looking statements. We have included factors that may cause results to differ from forward-looking statements in this report in Part I Item 2 "Management's Discussion and Analysis of Financial Condition and Results of Operations", the current report on Form 8-K filed on August 8, 2008, as supplemented by the risk factors set forth in Part II, Item 1A "Risk Factors" below, and Part I, Item 1 "Business", Part I, Item 1A "Risk Factors" and Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our annual report on Form 10-K for the year ended December 31, 2007, as well as other reports that we file with the Securities and Exchange Commission. We assume no obligation to update or supplement any forward-looking statements that may become untrue because of subsequent events, whether as a result of new information, future events or otherwise.

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PART I

ITEM 1—FINANCIAL STATEMENTS (Unaudited)

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except number of shares)

			September 30, 2008			December 31, 2007

			(Unaudited)
ASSETS
Investments:
	Fixed maturities available for sale, at fair value (amortized cost: 2008, $1,088,882; 2007, $1,125,381)		$	1,046,761		$	1,124,849
	Policy loans			21,888			21,560
	Other invested assets			1,582			1,526

		Total investments		1,070,231			1,147,935
Cash and cash equivalents				546,959			667,685
Accrued investment income				11,999			13,364
Deferred policy acquisition costs				240,855			245,511
Amounts due from reinsurers				229,008			286,426
Due and unpaid premiums				165,317			100,351
Present value of future profits and other amortizing intangible assets				198,767			213,518
Goodwill and other indefinite lived intangible assets				538,046			606,972
Income taxes receivable				28,723			31,145
CMS contract deposit receivables				589,660			394,225
Other Part D receivables				159,487			181,696
Advances to agents				63,896			61,076
Other assets				142,255			139,859

		Total assets	$	3,985,203		$	4,089,763

LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Policyholder account balances			$	406,043		$	434,859
Reserves for future policy benefits				623,759			616,450
Policy and contract claims—life				10,378			12,213
Policy and contract claims—health				783,843			737,189
Advance premiums				7,815			25,232
Loan payable				321,500			349,125
Other long term debt				110,000			110,000
Amounts due to reinsurers				39,791			67,239
Deferred income tax liability				6,299			28,687
Other Part D liabilities				220,462			157,048
Other liabilities				174,502			200,655

		Total liabilities		2,704,392			2,738,697

Commitments and contingencies (Note 14)
STOCKHOLDERS' EQUITY
Preferred stock (Authorized: 3 million shares):
		Series A (Designated: 300,000 shares, issued and outstanding: 2008, 42,105 shares, liquidation value $84,210; 2007, 47,105 shares, liquidation value $94,210)		42			47
		Series B (Designated: 300,000 shares, issued and outstanding: 2008, 132,895 shares, liquidation value $265,790; 2007, 127,895 shares, liquidation value $255,790)		133			128
Common stock—voting (Authorized: 200 million shares, issued and outstanding: 2008, 73.3 million shares; 2007, 75.0 million shares)				733			750
Common stock—non voting (Authorized: 30 million shares)				—			—
Additional paid-in capital				865,027			890,882
Accumulated other comprehensive loss				(23,703	)		(66	)
Retained earnings				494,763			463,583
Less: treasury stock (2008, 4.9 million shares; 2007, 0.3 million shares)				(56,184	)		(4,258	)

		Total stockholders' equity		1,280,811			1,351,066

		Total liabilities and stockholders' equity	$	3,985,203		$	4,089,763

See notes to unaudited consolidated financial statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three Months Ended September 30, 2008 and 2007

(Unaudited)

(In thousands, per share amounts in dollars)

			2008			2007

Revenues:
	Direct premium and policyholder fees earned		$	1,160,165		$	870,781
	Reinsurance premiums assumed			12,055			8,296
	Reinsurance premiums ceded			(92,050	)		(174,866	)

		Net premiums and policyholder fees earned		1,080,170			704,211
	Net investment income			19,770			28,383
	Fee and other income			10,200			6,088
	Net realized losses on investments			(12,141	)		(519	)

		Total revenues		1,097,999			738,163

Benefits, Claims and Expenses:
	Claims and other benefits			855,738			569,416
	Change in reserves for future policy benefits			(452	)		1,808
	Interest credited to policyholders			3,572			4,265
	Change in deferred acquisition costs			1,595			1,763
	Amortization of intangible assets			5,913			2,382
	Commissions			34,849			42,928
	Reinsurance commission and expense allowances			(15,778	)		(18,116	)
	Interest expense			5,698			4,869
	Early extinguishment of debt			—			913
	Other operating costs and expenses			150,172			97,803

		Total benefits, claims and other deductions		1,041,307			708,031

Income before equity in earnings of unconsolidated subsidiary				56,692			30,132
Equity in earnings of unconsolidated subsidiary				20,448			12,788

Income before income taxes				77,140			42,920
Provision for income taxes				28,328			15,775

Net income			$	48,812		$	27,145

Earnings per common share:
		Basic (Note 2)	$	0.57		$	0.40

		Diluted	$	0.56		$	0.40

Weighted average shares outstanding:
	Weighted average common shares outstanding			73,340			61,717
		Less weighted average treasury shares		(4,693	)		(578	)

	Basic weighted shares outstanding (Note 2)			68,647			61,139
	Weighted average common equivalent of preferred shares outstanding			17,500			6,223
		Effect of dilutive securities		339			1,293

	Diluted weighted shares outstanding			86,486			68,655

See notes to unaudited consolidated financial statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Nine Months Ended September 30, 2008 and 2007

(Unaudited)

(In thousands, per share amounts in dollars)

			2008			2007

Revenues:
	Direct premium and policyholder fees earned		$	4,009,700		$	2,524,652
	Reinsurance premiums assumed			35,888			24,942
	Reinsurance premiums ceded			(522,843	)		(587,202	)

		Net premiums and policyholder fees earned		3,522,745			1,962,392
	Net investment income			63,527			77,362
	Fee and other income			32,986			19,217
	Net realized (losses) gains on investments			(54,434	)		1,122

		Total revenues		3,564,824			2,060,093

Benefits, Claims and Expenses:
	Claims and other benefits			3,014,419			1,622,082
	Change in reserves for future policy benefits			3,179			5,594
	Interest credited to policyholders			11,094			13,292
	Change in deferred acquisition costs			12,394			13,922
	Amortization of intangible assets			17,738			6,364
	Commissions			110,862			121,718
	Reinsurance commission and expense allowances			(50,404	)		(54,739	)
	Interest expense			17,794			13,232
	Early extinguishment of debt			—			913
	Other operating costs and expenses			429,141			272,465

		Total benefits, claims and other deductions		3,566,217			2,014,843

(Loss) income before equity in earnings of unconsolidated subsidiary				(1,393	)		45,250
Equity in earnings of unconsolidated subsidiary				51,781			39,111

Income before income taxes				50,388			84,361
Provision for income taxes				19,208			30,581

Net income			$	31,180		$	53,780

Earnings per common share:
		Basic (Note 2)	$	0.35		$	0.85

		Diluted	$	0.35		$	0.84

Weighted average shares outstanding:
	Weighted average common shares outstanding			73,658			60,616
		Less weighted average treasury shares		(2,821	)		(621	)

	Basic weighted shares outstanding (Note 2)			70,837			59,995
	Weighted average common equivalent of preferred shares outstanding			17,500			2,939
		Effect of dilutive securities		470			1,313

	Diluted weighted shares outstanding			88,807			64,247

See notes to unaudited consolidated financial statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME

For the Nine Months Ended September 30, 2008 and 2007

(Unaudited)

(In thousands)

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

*2007*
Balance, January 1, 2007	$	—		$	—	$	599		$	252,542		$	1,883		$	379,511	$	(10,626	)	$	623,909
Net income		—			—		—			—			—			53,780		—			53,780
Other comprehensive loss		—			—		—			—			(14,375	)		—		—			(14,375	)

Comprehensive income																					39,405

Issuance of common stock		47			128		5			339,066			—			—		—			339,246
Equity transactions related to the acquisition of MemberHealth		—			—		142			283,358			—			—		—			283,500
Stock-based compensation		—			—		—			3,356			—			—		—			3,356
Treasury shares reissued		—			—		—			609			—			—		2,010			2,619

Balance, September 30, 2007	$	47		$	128	$	746		$	878,931		$	(12,492	)	$	433,291	$	(8,616	)	$	1,292,035

*2008*
Balance, January 1, 2008	$	47		$	128	$	750		$	890,882		$	(66	)	$	463,583	$	(4,258	)	$	1,351,066
Net income		—			—		—			—			—			31,180		—			31,180
Other comprehensive loss		—			—		—			—			(23,637	)		—		—			(23,637	)

Comprehensive income																					7,543

Preferred stock conversion		(5	)		5		—			—			—			—		—			—
Issuance of common stock		—			—		3			2,036			—			—		—			2,039
Equity transactions related to the acquisition of MemberHealth		—			—		(20	)		(34,521	)		—			—		—			(34,541	)
Stock-based compensation		—			—		—			6,783			—			—		—			6,783
Treasury shares purchased, at cost		—			—		—			—			—			—		(53,400	)		(53,400	)
Treasury shares reissued		—			—		—			(153	)		—			—		1,474			1,321

Balance, September 30, 2008	$	42		$	133	$	733		$	865,027		$	(23,703	)	$	494,763	$	(56,184	)	$	1,280,811

See notes to unaudited consolidated financial statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2008 and 2007

(Unaudited)

(In thousands)

			2008			2007

Cash flows from operating activities:
Net income			$	31,180		$	53,780
Adjustments to reconcile net income to net cash provided by operating activities, net of balances acquired:
Equity in earnings of unconsolidated subsidiary				(51,781	)		(39,111	)
Distribution from unconsolidated subsidiary				40,500			40,500
Deferred income taxes				(4,833	)		(173	)
Realized losses (gains) on investments				54,434			(1,122	)
Amortization of intangible assets				17,738			6,364
Net amortization of bond premium				1,575			1,132
Changes in operating assets and liabilities:
	Deferred policy acquisition costs			12,394			13,922
	Reserves for future policy benefits			7,309			13,328
	Policy and contract claims payable			44,819			255,648
	Reinsurance balances			28,277			(16,305	)
	Due and unpaid advance premium, net			(82,079	)		(10,723	)
	Income taxes payable/receivable			2,234			18,601
	Other Part D receivables			22,209			1,366
	Other Part D liabilities			63,414			15,897
	Other, net			(14,101	)		(1,949	)

		Cash provided by operating activities		173,289			351,155

Cash flows from investing activities:
Proceeds from sale or redemption of fixed maturity investments				195,101			225,844
Cost of fixed maturity investments purchased				(214,391	)		(295,686	)
Proceeds from sale of subsidiary, net of cash sold				—			5,102
Purchase of business and return of purchase price, net of cash acquired				40,990			(301,325	)
Purchase of fixed assets				(15,836	)		(7,417	)
Other investing activities				564			938

Cash provided by (used in) investing activities—continuing operations				6,428			(372,544	)
Cash used in investing activities—discontinued operations				—			(19,836	)

		Cash provided by (used in) investing activities		6,428			(392,380	)

Cash flows from financing activities:
Net proceeds from issuance of common stock, net of tax effect				3,758			339,246
Cost of treasury stock purchases				(53,400	)		—
Receipts from CMS contract deposits				2,375,977			571,210
Withdrawals from CMS contract deposits				(2,571,412	)		(683,491	)
Deposits and interest credited to policyholder account balances				12,262			14,745
Surrenders and other withdrawals from policyholder account balances				(40,003	)		(52,622	)
Issuance of new debt				—			444,105
Principal repayment on loan payable and other long term debt				(27,625	)		(140,563	)

		Cash (used in) provided by financing activities		(300,443	)		492,630

Net (decrease) increase in cash and cash equivalents				(120,726	)		451,405
Cash and cash equivalents at beginning of period				667,685			542,130

Cash and cash equivalents at end of period			$	546,959		$	993,535

See notes to unaudited consolidated financial statements.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND COMPANY BACKGROUND

Universal American Corp., which we refer to as "we," the "Company," or "Universal American", is a specialty health and life insurance holding company with an emphasis on providing a broad array of health insurance and managed care products and services to the growing senior population. Universal American was incorporated in the State of New York in 1981. Collectively, our insurance company subsidiaries are licensed to sell life and accident and health insurance and annuities in all fifty states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. We currently sell Medicare Advantage private fee-for-service plans, known as PFFS plans, Medicare coordinated care plans, which we call HMOs, Medicare Part D prescription drug benefit plans, known as PDPs, Medicare supplement and select, fixed benefit accident and sickness disability insurance and senior life insurance. We distribute these products through an independent general agency system and a career agency system.

In 2006, we began offering PDPs pursuant to Medicare Part D under the Prescription Pathway^SM brand through our Pennsylvania Life Insurance Company, American Progressive Life & Health Insurance Company of New York and Marquette National Life Insurance Company subsidiaries, in connection with a strategic alliance with Caremark Rx, Inc., known as Caremark, formerly PharmaCare Management Services, Inc., a third party pharmacy benefits manager, or PBM, and a wholly-owned subsidiary of CVS Caremark Corp. In February 2008, we announced that the parties are terminating this strategic alliance effective December 31, 2008. Upon termination of the strategic alliance, Caremark and Universal American will each assume responsibility for the drug benefit of specified Prescription Pathway^SM plan members to achieve an approximately equal distribution of the value of business that has been generated by the strategic alliance. We will continue to operate PDPs derived from this business under the name PrescribaRx^SM.

We currently operate Medicare Advantage PFFS plans through American Progressive, The Pyramid Life Insurance Company and Marquette as well as Medicare Advantage HMOs in Houston and Beaumont, Texas through SelectCare of Texas, L.L.C., in North Texas through SelectCare Health Plans, Inc., and in Oklahoma through SelectCare of Oklahoma, Inc. and GlobalHealth, Inc. All of these companies are our subsidiaries. In addition, beginning in 2007, we expanded into new health plan markets in Wisconsin.

CHCS Services, Inc., our administrative services company, provides administrative services for both affiliated and unaffiliated insurance companies for senior market insurance and non-insurance programs.

On September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held PBM and sponsor of Community CCRx^SM, a national Medicare Part D prescription drug benefit plan. Effective on the date of the acquisition, we transferred all of the PDP business of MemberHealth, Inc. except New York business into Pennsylvania Life and we transferred the New York PDP business into American Progressive. In connection with this acquisition, we reconstituted MemberHealth, Inc. into a limited liability company and named it MemberHealth, L.L.C. See Note 4—Business Combinations.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

accordance with Article 10 of the Securities and Exchange Commission's Regulation S-X, and consolidate the accounts of Universal American and its subsidiaries:

•: American Exchange Life Insurance Company,
•: American Pioneer Life Insurance Company,
•: American Progressive,
•: Constitution Life Insurance Company,
•: Marquette,
•: Pennsylvania Life,
•: Pyramid Life,
•: Union Bankers Insurance Company,
•: Heritage Health Systems, Inc.,
•: MemberHealth, and
•: CHCS.

During 2005, we entered into a strategic alliance with Caremark and created Part D Management Services, L.L.C., known as PDMS. PDMS is 50% owned by Universal American and 50% owned by Caremark. We do not control PDMS and therefore PDMS is not consolidated in our financial statements. We account for our investment in PDMS on the equity basis and include it in other assets. PDMS principally performs marketing and risk management services on behalf of our Prescription Pathway^SM PDP, for which it receives fees and other remuneration from our PDPs and Caremark.

For the insurance subsidiaries, U.S. GAAP differs from statutory accounting practices prescribed or permitted by regulatory authorities. We have eliminated all material intercompany transactions and balances between Universal American and its subsidiaries. We have also eliminated all material intercompany transactions and balances between our subsidiaries.

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 nine months ended September 30, 2008 and 2007 are not necessarily indicative of the results to be expected for the full year. You should read the accompanying consolidated financial statements and notes in conjunction with our annual report on Form 10-K for the year ended December 31, 2007.

Earnings Per Common Share: We calculate earnings per common share using the two-class method. This method requires that we allocate net income between net income attributable to participating preferred stock and net income attributable to common stock, based on the dividend and earnings participation provisions of the preferred stock. Basic earnings per share excludes the dilutive effects of stock options outstanding during the periods and is equal to net income attributable to common stock divided by the weighted average number of common shares outstanding for the periods.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

At September 30, 2008 and 2007, we allocated earnings between common and participating preferred stock as follows:

	Three months ended September 30,				Nine months ended September 30,

	2008		2007		2008		2007
	(In thousands)
Net income attributable to common stock	$	38,896	$	24,637	$	25,003	$	51,268
Undistributed income allocated to participating preferred stock		9,916		2,508		6,177		2,512

Net income	$	48,812	$	27,145	$	31,180	$	53,780

Income Taxes: We establish valuation allowances based upon an analysis of projected taxable income and our ability to implement prudent and feasible tax planning strategies. We carried valuation allowances on deferred tax assets of $3.1 million at both September 30, 2008 and December 31, 2007. At September 30, 2008, we assessed the amount of the deferred tax asset that was more likely than not to be realized under SFAS No. 109,Accounting for Income Taxes, and concluded that we can record tax benefits related to our realized losses relating to our investments for financial statement purposes.

Reserve Development: The PFFS medical loss ratio decreased to 81.6% for the third quarter of 2008 from 85.7% for the third quarter of 2007 primarily due to $20.8 million favorable development of 2007 claim experience. The PFFS medical loss ratio decreased to 85.7% for the first nine months of 2008 from 86.0% for the first nine months of 2007 primarily due to $32.9 million favorable development of 2007 claim experience partially offset by higher medical cost levels. The per share impact of this favorable development was $0.15 per diluted share for the quarter ended September 30, 2008 and $0.24 per diluted share for the nine months ended September 30, 2008.

Recognition of Prior Plan Year Settlements under Medicare Part D and Private Fee-For-Service Plans: The Medicare Part D prescription drug benefit program sponsored by the federal government commenced in 2006. This business is detail-oriented and relatively complex. The amount due from CMS is impacted by membership, prescription drug events, known as PDEs, for those members (including the covered plan paid amounts), deductibles, catastrophic reinsurance and the risk corridor adjustment. An extended period of time after the close of the annual coverage period (December 31^st) is required for the government to reconcile each member's PDEs and provide back to each plan the information the plans need to finalize the accounting for this coverage. The federal government has a stated time schedule for providing information back to the plans for, among other items, revenue adjustments based on risk scores, member eligibility by plan to reconcile the plan to plan reimbursements and the calculation of the final settlement with the federal government for low-income cost subsidies, reinsurance and risk corridor payments.

Reconciliation and related settlement of CMS's prospective subsidies, including reinsurance payments and low-income cost subsidies, as well as the risk corridor is made after the end of each plan year. In August 2008, we received Medicare Part D risk score adjustment settlement data from CMS for the 2007 plan year. Furthermore, in October 2008, we received Medicare Part D reconciliation settlement data from CMS for the 2007 Plan year. The net impact of these final 2007 settlements for our Prescription Pathways and Community CCRx plans combined, which were recorded in the third

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2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

quarter, was a reduction of revenues of $4.7 million ($0.04 per diluted share for the three months ended September 30, 2008 and $0.03 per diluted share for the nine months ended September 30, 2008) and a reduction of claims expense of $2.4 million ($0.02 per diluted share for both the three and nine month periods ended September 30, 2008 and $0.01 per diluted share for the nine months then ended). The effect of these adjustments related to the portion of the 2007 plan year prior to our acquisition of MemberHealth was recorded as an adjustment to goodwill as part of our final purchase GAAP accounting. These adjustments increased goodwill by $7.9 million, (See Note 4—Business Combinations).

The reconciliation and settlement process with CMS for the Part D coverage within Medicare Advantage PFFS plans is similar to Medicare Part D plans with the two exceptions: (1) PFFS plans are ineligible for aggregate risk corridor payments; and (2) prospective monthly catastrophic reinsurance payments to PFFS plans are based on CMS estimated average reinsurance payments to other Medicare Advantage—Prescription Drug (MA-PD) plans for their Part D coverage. In October 2008, we received notification from CMS of an adjustment to our catastrophic reinsurance reimbursement for the Part D coverage within our PFFS plans for the 2007 Plan year. The impact of this adjustment, which was recorded in the third quarter, was a reduction of revenues of $4.5 million ($0.03 per diluted share for both the three and nine month periods ended September 30, 2008).

In addition, during August 2008 we received 2007 plan year risk score adjustment settlement data from CMS for our Medicare Advantage HMO plans. The impact of this adjustment, which was recorded in the third quarter, was an increase net income before taxes of $4.1 million ($0.03 per diluted share for both the three and nine month periods ended September 30, 2008).

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. As of September 30, 2008, all of our primary reinsurers were rated "A" or better by A.M. Best, except for PharmaCare Re, which is unrated. We have secured a letter of credit from PharmaCare Re that we believe will adequately support the risks ceded. We do not know of any instances where any of our reinsurers have been unable to pay any policy claims on any reinsured business.

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 of assets and liabilities and disclosures of assets and liabilities reported by us at the date of the financial statements and the revenues and expenses reported during the reporting period. As additional information becomes available or actual amounts become determinable, we may revise the recorded estimates and reflect the revisions in operating results. Actual results could differ from those estimates. In our business judgment, the accounts involving estimates and assumptions that are most critical to the preparation of our financial statements are future policy benefits and claim liabilities, deferred policy acquisition costs, goodwill, present value of future profits and other intangibles, the valuation of investments and income taxes. There have been no changes in our critical accounting policies during the current year.

Supplemental Cash Flow Information: Cash and cash equivalents include cash on deposit, money market funds, and short term investments that had an original maturity of three months or less from

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the time of purchase. At September 30, 2008, cash equivalents included $361.0 million of agency discount notes, $140.7 million of government money market funds and $63.6 million of A1/P1 rated commercial paper. Supplemental cash flow information for interest and income taxes paid for continuing and discontinued operations is as follows:

			Nine months ended September 30,

			2008			2007
			(In thousands)
Supplemental cash flow information from continuing operations:
	Cash paid for interest		$	17,027		$	12,493

	Cash paid for income taxes		$	34,310		$	8,409

	Non-cash financing activities:
		(Return) issuance of common stock in connection with MemberHealth acquisition (See Note 4—Business Combinations.)	$	(34,541	)	$	283,500

Supplemental cash flow information from discontinued operations:
	Cash paid for income taxes		$	—		$	28,200

Cash flows from investing activities—discontinued operations for the nine months ended September 30, 2007 represents net cash outflows related to the December 2006 sale of our subsidiary, PennCorp Life Canada. The net outflow includes U.S. income taxes paid of $28.2 million, partially offset by approximately $8.4 million of additional proceeds received equal to the balance of net earnings generated by PennCorp Life Canada during the period from January 1, 2006 through the closing date, December 1, 2006.

Significant Accounting Policies: For a description of significant accounting policies, see Note 2—Summary of Significant Accounting Policies in the notes to the consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2007.

Reclassifications: We have made reclassifications to prior years' financial statements to conform to the current period presentation, in connection with our resegmentation at December 31, 2007. These reclassifications had no effect on net income or earnings per share as previously stated.

3. RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS

Business Combination: On December 4, 2007, the Financial Accounting Standards board, or FASB, issued Statement of Financial Accounting Standards No. 141(R), Business Combinations, known as SFAS 141(R) and SFAS No. 160,Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51, known as SFAS 160. These standards will significantly change the financial accounting and reporting of business combination transactions and noncontrolling or minority interests in business entities. SFAS 141(R) is required to be adopted

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concurrently with SFAS 160 and is effective for business combination transactions for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited. Companies will not be required to adjust assets and liabilities that arose from business combinations with acquisition dates prior to the SFAS 141R effective date, with specified exceptions for acquired deferred tax assets and acquired income tax positions. We expect to adopt SFAS 141(R) and SFAS 160 on January 1, 2009, and have not yet determined whether or to what extent they will affect our results of operations and financial condition.

Fair Value Measurements: On January 1, 2008, we adopted SFAS No. 157, "Fair Value Measurements," issued in September 2006. For financial statement elements currently required to be measured at fair value, SFAS 157 redefines fair value, establishes a framework for measuring fair value under U.S. GAAP and enhances disclosures about fair value measurements. The new definition of fair value focuses on the price, called an exit price that would be received to sell the asset or paid to transfer the liability regardless of whether an observable liquid market price existed. An exit price valuation will include margins for risk even if they are not observable. As we obtain release from risk, the margins for risk will also be released through net realized capital gains or losses in net income. SFAS 157 provides guidance on how to measure fair value, when required, under existing accounting standards. SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, which we call Levels 1, 2, and 3.

We applied the provisions of SFAS 157 prospectively to financial assets and financial liabilities that we are required to measure at fair value under existing U.S. GAAP. We determined that there was no effect to our opening retained earnings or current period statement of operations from the implementation of SFAS 157. See Note 7 for additional information regarding SFAS 157.

In February 2008, the FASB issued FSP FAS No. 157-2, "Effective Date of FASB Statement No. 157" which delays the effective date of SFAS 157 to fiscal years beginning after November 15, 2008 for specified nonfinancial assets and nonfinancial liabilities. FSP FAS 157-2 applies to the following nonfinancial assets and liabilities, as well as other nonfinancial assets and liabilities:

•: Nonfinancial assets and nonfinancial liabilities initially measured at fair value in a business combination that are not subsequently remeasured at fair value; and
•: Reporting units measured at fair value in the goodwill impairment test as described in SFAS No. 142, "Goodwill and Other Intangible Assets", and nonfinancial assets and nonfinancial liabilities measured at fair value in the SFAS 142 goodwill impairment test, if applicable.

As a result of the issuance of FSP FAS 157-2, we did not apply the provisions of SFAS 157 to the nonfinancial assets and nonfinancial liabilities within the scope of FSP FAS 157-2.

In October 2008, the FASB issued FSP FAS No. 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active". This FSP clarifies the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in the determination of the fair value of a financial asset when the market for that asset is not active. The key considerations illustrated in the FSP FAS 157-3 example include the use of an entity's own assumptions about future cash flows and appropriately risk-adjusted discount rates, appropriate risk adjustments for nonperformance and liquidity risks, and the reliance that an entity should place on quotes that do not

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reflect the results of market transactions. FSP FAS 157-3 was preceded by a press release that was jointly issued by the Office of the Chief Accountant of the SEC and the FASB staff on September 30, 2008 which provided immediate clarification on fair value accounting based on the measurement guidance of SFAS 157. FSP FAS 157-3 was effective upon issuance. FSP FAS 157-3 did not have an impact on our consolidated financial statements.

4. BUSINESS COMBINATIONS

Acquisitions

MemberHealth

On September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held PBM and sponsor of Community CCRx, a national Medicare Part D prescription drug benefit plan. Prior to the acquisition, MemberHealth, Inc. was a leading national Medicare Part D sponsor, offering Medicare prescription drug plans in 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands.

We paid the original purchase price of $630 million, apportioned 55% in cash and 45% in our common stock valued at $20 per share. We paid transaction costs of approximately $12 million in cash. In addition to the purchase price, the transaction contemplated an additional three year earn-out tied to target earnings from the MemberHealth business. The maximum aggregate amount potentially payable under the performance-based earn-out was $150 million, payable in cash and our common stock.

Subsequent to December 31, 2007, we determined that expected operating income for 2008 from the MemberHealth business, which we acquired in September 2007, would be less than previously forecast. The reason for the decline in expected income was that premium payments to MemberHealth would be lower than anticipated based upon the bids submitted by MemberHealth in June 2007 for its 2008 Part D plans, and later accepted by CMS. The premium payments were lower primarily as a result of incorrect information concerning the risk scores in the MemberHealth bids. In accounting for the issue relating to the 2008 bids, we recorded an acquisition liability of $39.2 million for the below-market contract that we will amortize into income over the contract period, January 1, 2008 to December 31, 2008. We amortized $9.8 million of this acquisition liability in the quarter ended September 30, 2008, and $29.5 million for the nine months ended September 30, 2008. We reflected this amortization in direct premium and policyholder fees earned in the consolidated statements of operations.

We also discovered after December 31, 2007 that MemberHealth incorrectly calculated its expected risk corridor receivable in its first quarter 2007 financial statements, resulting in an overstatement of pre-tax income for the first quarter of 2007 of approximately $26 million. In our financial statements for the year ended December 31, 2007 included in our filed annual report on Form 10-K, we adjusted the pro forma financial information to reflect the impact of this error, through an adjustment to purchase GAAP accounting, which reduced receivables and increased goodwill by $23 million, the after-tax amount of the misstatement.

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4. BUSINESS COMBINATIONS (Continued)

In connection with these issues, in March 2008, we concluded a settlement agreement and amendment of the merger agreement under which the sellers of MemberHealth delivered approximately $98 million of value, consisting of $47 million in cash, forgiveness of $16 million of our payment obligations under the original merger agreement and 2,027,071 shares of our common stock, valued at $35 million. We have retired these shares. As a result of this settlement, in the first quarter of 2008, we reduced goodwill by the amount of the cash and common shared received, $82 million in total, and we adjusted liabilities in relation to the $16 million forgiveness.

During the quarter ended September 30, 2008, we performed the final purchase accounting for the MemberHealth acquisition, adjusting the purchase price allocation to reflect the final values. The adjustments posted increased goodwill by $7.9 million, primarily as a result of two significant items, the final 2007 CMS risk score adjustment and the 2007 final CMS prescription drug event reconciliation, as discussed below.

During the third quarter of 2008, we received the final risk score adjustments for 2007 members in our Part D plans. The risk score reflects the relative health of the member and impacts the level of reimbursement from CMS, with a higher reimbursement for members with higher risk scores. The total adjustment for our 2007 membership reduced CMS expected payments by $5.2 million. The estimated risk corridor impact was approximately $3.6 million, resulting in a net reduction of receivables of $1.6 million. We allocated this amount to pre-acquisition and post acquisition periods to capture the portion of the adjustment impacting the opening purchase GAAP balance sheet. Based on our analysis, we determined that $1.2 million of the reduction related to periods preceding the acquisition and $0.4 million related to periods subsequent to the acquisition. We recorded the $1.2 million portion as an increase in goodwill and reported the $0.4 million portion as a reduction to third quarter revenues.

The final plan year reconciliation cannot be completed until CMS finalizes the membership eligibility data, the prescription drug event data, the plan to plan membership reconciliation and the risk score adjustments. CMS finalized the risk score adjustment in July 2008, the prescription drug event data submission deadline was July 31, 2008, CMS completed the Phase III or final plan to plan membership reconciliation in September 2008 and we received the final reconciliation for the 2007 Plan year in October 2008. After the receipt of this finalized information, we reconciled the amount due to CMS. We performed the reconciliation for the pre-acquisition and post-acquisition periods to capture the portion of the adjustment impacting the opening purchase GAAP balance sheet. Based on the reconciliation, we determined that the CMS receivable as of the date of acquisition was overstated by approximately $10.3 million, and that the receivable relating to post-acquisition activity was understated by approximately $2.0 million. We recorded the pre-acquisition amount, net of deferred taxes of $3.6 million, as an adjustment to goodwill and we reported the post-acquisition amount as a reduction of third quarter claims expense.

After giving effect to the settlement and the final allocation adjustments discussed above, the excess of the purchase price over the fair value of net tangible assets acquired, adjusted for deferred

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4. BUSINESS COMBINATIONS (Continued)

income taxes, was approximately $610.2 million, which we allocated to identifiable intangible assets and goodwill as follows:

Description	Amount (In thousands)			Amortization Basis

Membership base acquired	$	135,426	10	Straight line over the estimated life of the membership base
Trademarks/trade names		20,433	9	Straight line over the estimated life of the trademarks/trade names
Licenses		3,500	15	Straight line over the estimated life of the licenses
Goodwill		450,881	—	Non amortizing

Total excess of purchase price over tangible book value	$	610,240

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4. BUSINESS COMBINATIONS (Continued)

The following condensed balance sheet sets forth the amounts assigned to assets and liabilities for MemberHealth on the date of acquisition, as adjusted to reflect the settlement and the final purchase price allocation discussed above:

		September 21, 2007

		(In thousands)
*Assets*
Cash and cash equivalents		$	74,215
Amortizing intangible assets:
	Membership base		135,426
	Trademarks/trade names		20,433
	Licenses		3,500
Goodwill			450,881
Due and unpaid premium			135,218
CMS deposit contract receivable			91,347
Other Part D receivables			92,120
Deferred taxes			14,220
Other			28,424

	Total Assets	$	1,045,784

*Liabilities*
Policy related liabilities		$	297,437
Due to reinsurers			72,243
Other			115,161

	Total Liabilities		484,841
Equity			560,943

	Total Liabilities and Equity	$	1,045,784

We have not reflected operating results generated by MemberHealth prior to September 21, 2007, the date of acquisition, in our consolidated financial statements. The unaudited consolidated pro forma results of operations, assuming that we purchased MemberHealth on January 1, 2007 are as follows:

		Three months ended September 30, 2007		Nine months ended September 30, 2007

		(In thousands)
Total revenue		$	1,078,812	$	3,292,816
Income before taxes		$	87,184	$	121,909
Net income		$	55,111	$	77,717
Income per common share:
	Basic	$	0.63	$	0.92
	Diluted	$	0.62	$	0.91

The pro forma information presented above includes an adjustment to reflect the impact of the risk corridor calculation error correction previously disclosed in Note 23 in the notes to consolidated

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4. BUSINESS COMBINATIONS (Continued)

financial statements contained in our annual report on Form 10-K for the year ended December 31, 2007.

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 if the acquisition had been consummated on the date assumed, nor is the pro forma information intended to be indicative of our future results of operations.

Harmony Health

On March 1, 2007, the Company acquired Harmony Health, Inc. ("Harmony"), a provider-owned company that operates GlobalHealth, a Medicare Advantage and commercial managed care plan in Oklahoma City, Oklahoma for $18.2 million in cash, including direct costs of acquisition of $0.2 million. Harmony was a majority-owned subsidiary of the Oklahoma City Clinic. Under the terms of the agreement, the Oklahoma City Clinic has entered into a long-term agreement with Universal American to provide healthcare services to GlobalHealth members. In addition, Oklahoma City Clinic has retained the risk for commercial business under a global capitation arrangement.

The tangible book value at the date of acquisition was $3.8 million. The excess of purchase price over the tangible book value, adjusted for deferred income taxes, was $17.1 million, which we allocated to identifiable intangible assets and goodwill as follows:

Description	Amount (In thousands)			Amortization Basis

Membership base acquired	$	6,072	10	Straight line over the estimated life of the membership base
Non-compete agreement		1,018	7	Straight line over the length of the agreement
Goodwill		9,962	—	Non amortizing

Total excess of purchase price over tangible book value	$	17,052

Sale of Subsidiary

On January 19, 2007, we completed the sale of Peninsular Life Insurance Company, an inactive subsidiary, for approximately $7.9 million, resulting in a pre-tax gain of $2.0 million, which we reflected in net realized gains. We received the entire amount in cash: $7.7 million in 2007, and $0.2 million on January 23, 2008.

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(Unaudited)

5. INTANGIBLE ASSETS

The following table shows our acquired intangible assets that continue to be subject to amortization and accumulated amortization expense:

					September 30, 2008				December 31, 2007

			Weighted Average Life (Years)		Value Assigned		Accumulated Amortization		Value Assigned		Accumulated Amortization
					(In thousands)
Traditional Insurance:
	Policies in force—Health			9	$	18,473	$	12,814	$	18,473	$	12,252
	Distribution channel			30		26,684		5,200		22,055		3,492
	Policies in force—Life/Annuity			7		4,127		2,380		4,127		2,241
Medicare Part D:
	Membership base			10		135,426		13,881		138,000		3,795
	Trademarks/trade names			9		20,433		2,327		18,000		550
	Licenses			15		3,500		239		5,000		92
Senior Managed Care—Medicare Advantage:
	Membership base			7		23,988		9,224		23,988		7,542
	Provider contracts			10		15,539		5,060		15,539		3,853
	Non-compete			7		1,425		274		1,425		121
Senior Administrative Services:
	Administrative service contracts			6		7,671		7,602		7,671		7,526
	Hospital network contracts			10		1,797		1,295		1,797		1,093

		Total		17	$	259,063	$	60,296	$	256,075	$	42,557

The following table shows the changes in the amortizing intangible assets:

		Three months ended September 30,						Nine months ended September 30,

		2008			2007			2008			2007
		(In thousands)
Balance, beginning of period		$	204,680		$	57,845		$	213,518		$	54,738
	Additions and adjustments		—			161,000			2,987			168,089
	Amortization		(5,913	)		(2,382	)		(17,738	)		(6,364	)

Balance, end of period		$	198,767		$	216,463		$	198,767		$	216,463

Amortization, net of interest increased in 2008 over 2007 as a result of amortization of intangible assets recognized in connection with the September 2007 acquisition of MemberHealth.

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5. INTANGIBLE ASSETS (Continued)

Estimated future net amortization expense (in thousands) is as follows:


2008 remainder of year	$	6,309
2009		23,632
2010		23,184
2011		21,334
2012		21,171
2013		21,040
Thereafter		82,097

	$	198,767

Changes in the carrying amounts of goodwill and intangible assets with indefinite lives are shown below:

		December 31, 2007		Additions		Adjustments			September 30, 2008

		(In thousands)
Traditional Insurance:
	Goodwill	$	3,893	$	1,646	$	—		$	5,539
	Other		4,867		—		—			4,867

Subtotal—Traditional Insurance			8,760		1,646		—			10,406
Medicare Part D—Goodwill			520,764		—		(69,883	)		450,881
Senior Managed Care—Medicare Advantage:
	Goodwill		67,928		—		(689	)		67,239
	Other		5,163		—		—			5,163

Subtotal—Senior Managed Care—Medicare Advantage			73,091		—		(689	)		72,402
Senior Administrative Services—Goodwill			4,357		—		—			4,357

Total		$	606,972	$	1,646	$	(70,572	)	$	538,046

Other non-amortizing intangible assets consist primarily of trademarks and licenses. The addition of goodwill for Traditional Insurance was a result of an acquisition, the decrease in goodwill in Senior Managed Care—Medicare Advantage was the result of the settlement of pre-acquisition adjustments in connection with the Harmony Health acquisition and the decrease in goodwill for Medicare Part D was the result of $12.0 million in post-closing adjustments on MemberHealth and the $81.9 million MemberHealth purchase price adjustment in 2008. For a full discussion of the MemberHealth purchase price adjustment see Note 4—Business Combinations.

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(Unaudited)

6. INVESTMENTS

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

	September 30, 2008

Classification	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
U.S. Treasury securities and obligations of U.S. Government	$	34,561	$	631	$	—		$	35,192
Government sponsored agencies		99,496		2,048		(87	)		101,457
Other political subdivisions		9,993		39		(169	)		9,863
Corporate debt securities		437,060		2,197		(29,290	)		409,967
Foreign debt securities		32,925		216		(1,321	)		31,820
Mortgage-backed and asset-backed securities		474,847		4,206		(20,591	)		458,462

	$	1,088,882	$	9,337	$	(51,458	)	$	1,046,761

	December 31, 2007

Classification	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(In thousands)
U.S. Treasury securities and obligations of U.S. government	$	34,510	$	378	$	(2	)	$	34,886
Government sponsored agencies		95,975		2,750		—			98,725
Other political subdivisions		5,558		34		(57	)		5,535
Corporate debt securities		431,002		7,772		(6,633	)		432,141
Foreign debt securities		29,363		472		(194	)		29,641
Mortgage-backed and asset-backed securities		528,973		4,494		(9,546	)		523,921

	$	1,125,381	$	15,900	$	(16,432	)	$	1,124,849

At September 30, 2008, gross unrealized losses of $20,591million on mortgage-backed and asset-backed securities reflect unrealized losses of $8,757 on subprime residential mortgage loans, as discussed below, and $11,834 related to obligations of commercial mortgage-backed securities and other asset-backed securities. The value of a majority of these securities is depressed due to the deterioration of value in the mortgage-backed securities market and related businesses. Corporate debt securities have gross unrealized losses of $29,290 at September 30, 2008. These unrealized losses relate to corporate securities across all sectors, and reflect the general depressed market conditions that existed at September 30, 2008. Management and the Investment Committee have evaluated these holdings, with input from our investment managers, and do not believe them to be other-than-temporarily impaired.

The amortized cost and fair value of fixed maturity investments at September 30, 2008 by contractual maturity are shown below. Expected maturities will differ from contractual maturities

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6. INVESTMENTS (Continued)

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	$	70,766	$	70,653
Due after 1 year through 5 years		388,125		378,413
Due after 5 years through 10 years		96,367		91,404
Due after 10 years		58,777		47,828
Mortgage and asset-backed securities		474,847		458,463

	$	1,088,882	$	1,046,761

Subprime Residential Mortgage Loans

We hold securities with exposure to subprime residential mortgages. Subprime mortgage lending is the origination of residential mortgage loans to customers with weak credit profiles. The slowing U.S. housing market, greater use of mortgage products with low introductory interest rates, generally referred to as "teaser rates," and relaxed underwriting standards for some originators of subprime loans have led to higher delinquency and loss rates, especially with regard to securities issued in 2006 and 2007 that are collateralized by interests in mortgages originated in 2006 and 2007. These factors have caused a significant reduction in market liquidity and repricing of risk, which has led to a decrease in the market valuation of these securities sector wide.

As of September 30, 2008, we held subprime securities with par values of $141.0 million, an amortized cost of $56.4 million and a market value of $49.0 million representing approximately 3.0% of our cash and invested assets, with collateral comprised substantially of first lien mortgages. The majority of these securities are in senior or senior-mezzanine level tranches, which have preferential liquidation characteristics, and have an average rating of A+ by Standard & Poors, a division of the McGraw Hill Companies, Inc., known as S&P, or equivalent.

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

Vintage Year	Amortized Cost		Fair Value		Unrealized Gain (Loss)

	(In thousands)
2003	$	6,510	$	5,215	$	(1,295	)
2004		3,496		3,052		(444	)
2005		25,460		18,676		(6,784	)
2006		15,355		16,226		871
2007		5,592		5,881		289

Totals	$	56,413	$	49,050	$	(7,363	)

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6. INVESTMENTS (Continued)

We continuously review our subprime holdings stressing multiple variables, such as cash flows, prepayment speeds, default rates and loss severity, and comparing current base case loss expectations to the loss required to incur a principal loss, or breakpoint. This breakpoint currently exceeds the base case loss expectation for all but one holding to varying degrees. We expect delinquency and loss rates in the subprime mortgage sector to continue to increase in the near term but at a decreasing rate. Those securities with a greater variance between the breakpoint and base case can withstand this further deterioration. However, holdings where the base case is closer to the breakpoint, principally holdings from the 2006 and 2007 vintage years, are more likely to incur a principal loss. We utilize third party pricing services to provide or estimate market prices. The major inputs used by third party pricing services include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and estimated cash flows and prepayment speeds. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price, as has recently been the case with many of our subprime holdings.

The following table summarizes, on a pre-tax basis, our other-than-temporary impairments recorded since the subprime deterioration began last year:

			2008 Quarter Ended

	2007		March 31		June 30		September 30		2008		Cumulative
	(In thousands)
Subprime	$	40,997	$	29,800	$	11,771	$	2,329	$	43,900	$	84,897
Other structured		—		—		1,384		2,432		3,816		3,816
Corporate		—		—		—		7,177		7,177		7,177

	$	40,997	$	29,800	$	13,155	$	11,938	$	54,893	$	95,890

At December 31, 2007, we recognized an other-than-temporary impairment on fourteen 2006 and 2007 vintage year subprime holdings. As of September 30, 2008, we recognized an additional other-than-temporary impairment on the same fourteen securities impaired at December 31, 2007 plus four additional subprime holdings that were initially impaired during the first quarter of 2008. In addition, during 2008, we have recognized an other-than-temporary impairment on four other structured securities and two corporate securities. The corporate other-than-temporary impairment includes $6.1 million on Lehman Brothers holdings.

7. FAIR VALUE MEASUREMENTS

We carry fixed maturity investments, equity securities and interest rate swaps 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 SFAS 157.

We applied the provisions of SFAS 157 prospectively to financial instruments that we record at fair value. Our adoption of SFAS 157 did not have an impact on opening retained earnings.

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7. FAIR VALUE MEASUREMENTS (Continued)

Fair Value Disclosures

The following section applies the SFAS 157 fair value hierarchy and disclosure requirements to our financial instruments that we carry at fair value. SFAS 157 establishes a fair value hierarchy that prioritizes the inputs in the valuation techniques used to measure fair value into three broad Levels, numbered 1, 2, and 3.

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

Level 2 observable inputs, other than quoted prices included in Level 1, for the asset or liability or prices for similar assets and liabilities. Most debt securities and some preferred stocks are model priced by vendors using observable inputs and are classified within Level 2. Derivative instruments that are priced using models with observable market inputs, such as interest rate swap contracts, also fall into Level 2 category.

Level 3 valuations are derived from techniques in which one or more of the significant inputs, such as assumptions about risk, are unobservable. Generally, Level 3 securities are less liquid securities such as highly structured and/or lower quality asset-backed securities, known as ABS, and private placement equity securities. Because Level 3 fair values, by their nature, contain unobservable market inputs, as there is no observable market for these assets and liabilities, we must use considerable judgment to determine the SFAS 157 Level 3 fair values. Level 3 fair values represent our best estimate of an amount that could be realized in a current market exchange absent actual market exchanges.

The following table presents our assets and liabilities that are carried at fair value by SFAS 157 hierarchy levels, as of September 30, 2008 (in thousands):

		Total		Level 1		Level 2		Level 3

Assets:
Fixed maturities, available-for-sale		$	1,046,761	$	—	$	1,041,992	$	4,769
Equity securities			490		—		—		490

	Total assets	$	1,047,251	$	—	$	1,041,992	$	5,259

Liabilities:
Interest rate swaps		$	2,724	$	—	$	2,724	$	—

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

Determination of fair values

The valuation methodologies used to determine the fair values of assets and liabilities under the "exit price" notion of SFAS 157 reflect market participant objectives and are based on the application of the fair value hierarchy that prioritizes observable market inputs over unobservable inputs. We determine the fair value of our financial assets and liabilities based upon quoted market prices where

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7. FAIR VALUE MEASUREMENTS (Continued)

available. Fair values of our interest rate swap liabilities reflect adjustments for counterparty credit quality, our credit standing, liquidity and, where appropriate, risk margins on unobservable parameters. The following is a discussion of the methodologies used to determine fair values for the financial instruments listed in the above table.

Valuation of Fixed Maturity and Equity Securities

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

•: reported trades,
•: benchmark yields,
•: issuer spreads,
•: bids,
•: offers, and
•: estimated cash flows and prepayment speeds.

Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price where the pricing services develop future cash flow expectations based upon collateral performance, discounted at an estimated market rate. The pricing for mortgage-backed and asset-backed securities reflects estimates of the rate of future prepayments of principal over the remaining life of the securities. The pricing services derive these estimates based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral.

We have analyzed the third party pricing services' valuation methodologies and related inputs, and have also evaluated the various types of securities in our investment portfolio to determine an appropriate SFAS 157 fair value hierarchy level based upon trading activity and the observability of market inputs. Based on the results of this evaluation and investment class analysis, we classified each price into Level 1, 2, or 3. We classified most prices provided by third party pricing services into Level 2 because the inputs used in pricing the securities are market observable.

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

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7. FAIR VALUE MEASUREMENTS (Continued)

The following table presents the fair value of the significant asset sectors within the SFAS 157 Level 3 securities as of September 30, 2008:

	Fair Value

	(In thousands)
Mortgage and asset-backed securities	$	2,947	56.0	%
Corporate		1,822	34.7	%
Equity securities		490	9.3	%

Total Level 3 securities	$	5,259	100	%

Mortgage and asset-backed securities represent private-placement collateralized debt obligations that are thinly traded and priced using an internal model or modeled by independent brokers.

Interest rate swaps

We report interest rate swaps in other assets and other liabilities on our consolidated balance sheets at fair value. Their fair value is based on the present value of cash flows as determined by the LIBOR forward rate curve and credit spreads, including our own credit.

We have classified interest rate swaps as Level 2. We have determined their valuations using pricing models with inputs that are observable in the market or can be derived principally from or corroborated by observable market data.

Level 3 Rollforward

We classify the fair values of financial instruments within Level 3 if there are no observable markets for the instruments or, in the absence of active markets, the majority of the inputs used to determine the fair value of the instruments are based on assumptions about market participant assumptions. Rollforward tables for each quarter from January 1, 2008 to September 30, 2008 for the

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7. FAIR VALUE MEASUREMENTS (Continued)

Level 3 financial instruments for which we have used significant unobservable inputs in the fair value measurement on a recurring basis are presented below:

	Fixed Maturities			Equity Securities		Total

	(thousands)
Fair value as of January 1, 2008	$	7,757		$	490	$	8,247
Net purchases and sales		(379	)		—		(379	)
Unrealized losses included in AOCI(1),(2)		(289	)		—		(289	)

Fair value as of March 31, 2008		7,089			490		7,579
Net purchases and sales		(20	)		—		(20	)
Net transfers out		(2,372	)		—		(2,372	)
Unrealized losses included in AOCI(1),(2)		(121	)		—		(121	)

Fair value as of June 30, 2008		4,576			490		5,066
Net purchases and sales		(40	)		—		(40	)
Net transfers in		168			—		168
Unrealized losses included in AOCI(1),(2)		65			—		65

Fair value as of September 30, 2008	$	4,769		$	490	$	5,259

(1): AOCI: Accumulated other comprehensive income
(2): Unrealized losses represent losses from changes in values of Level 3 financial instruments only for the periods in which the instruments are classified as Level 3.

8. STOCKHOLDERS' EQUITY

Preferred Stock

We have 3.0 million authorized shares of preferred stock, of which we have designated 300,000 shares as Series A preferred stock and 300,000 shares as Series B preferred stock. The holders of both Series A preferred stock and Series B preferred stock possess specified rights whereby they may, in specified circumstances, convert the shares directly or indirectly into shares of common stock. In addition, we have the right to convert the shares of our Series B preferred stock to common stock, in the ratio of 100 share of common stock for each share of Series B preferred stock, from and after the first anniversary of the issuance of the shares of Series B preferred stock. We have issued notices to the holders of our Series B preferred stock informing them that we intend to convert the shares, and if not rescinded the conversion will become effective on November 24, 2008. As of November 5, 2008, there were 132,895 shares of Series B preferred stock outstanding, and these shares will be converted into 13,289,500 shares of our common stock. For a description of our Series A preferred stock and Series B preferred stock, see Note 6—Stockholders' Equity in the notes to consolidated financial statements contained in our annual report on Form 10-K for the year ended December 31, 2007.

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8. STOCKHOLDERS' EQUITY (Continued)

At September 30, 2008, there were 42,105 shares of Series A preferred stock outstanding and 132,895 shares of Series B preferred stock outstanding. At December 31, 2007, there were 47,105 shares of Series A preferred stock outstanding and 127,895 shares of Series B preferred stock outstanding, all of which were issued in connection with raising cash to fund the MemberHealth acquisition and to provide us with capital to support our organic growth.

On April 23, 2008, upon the request of Welsh, Carson, Anderson & Stowe X, L.P., which we call "WCAS X," and pursuant to the securities purchase agreement dated May 7, 2007 between us, WCAS X and other parties, a copy of which was included as Exhibit 10.1 to our current report on Form 8-K, dated May 11, 2007, we issued to WCAS X 5,000 shares of our Series B participating convertible preferred stock, par value $1.00 per share, in exchange for a like number of shares of our Series A participating convertible preferred stock. The shares of Series A preferred stock exchanged by WCAS X had been issued and sold to WCAS X in connection with the previously announced private placement of Series A preferred stock and Series B preferred stock to WCAS X and other investors that closed on May 15, 2007.

Common Stock—Voting

We currently have authorized for issuance 200 million shares of voting common stock, par value $0.01 per share. Changes in the number of shares of common stock issued were as follows:

Nine months ended September 30,

Common stock outstanding, beginning of period	74,952,177		59,890,500
Return of stock issued and stock issued in connection with MemberHealth acquisition (See Note 4—Business Combinations)	(2,027,071	)	14,175,000
Stock options exercised	372,237		528,930
Agent stock award	—		2,543
Stock purchases pursuant to agents' stock purchase and deferred compensation plans	47,657		22,243

Common stock outstanding, end of period	73,345,000		74,619,216

Common Stock—Non Voting

We currently have authorized for issuance 30 million shares of non-voting common stock, par value $0.01 per share. None of this class of stock is, or has been, issued.

Treasury Stock

We have approved share repurchase plans with an estimated aggregate 3.8 million shares of our common stock available for repurchase. In February 2008, our board of directors approved the repurchase of up to $50 million of our common shares during an 18-month period beginning on February 18, 2008. In June 2008, Universal American Corp. announced that our Board of Directors has approved the repurchase of up to an additional $50 million of the Company's common shares. Through September 30, 2008, we have repurchased 4.7 million shares of our common stock for an aggregate amount of $53.4 million, under these programs. We are not obligated to repurchase any specific number of shares under the programs or to make repurchases at any specific time or price.

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8. STOCKHOLDERS' EQUITY (Continued)

Changes in treasury stock were as follows:

	For the nine months ended September 30,

	2008								2007
	Shares			Amount			Weighted Average Cost Per Share		Shares			Amount			Weighted Average Cost Per Share
	(In thousands)								(In thousands)
Treasury stock beginning of year		285,545		$	4,258		$	14.91		712,868		$	10,626		$	14.91
Shares repurchased		4,715,885			53,400			11.32		—			—			—
Shares distributed in the form of employee bonuses		(119,312	)		(1,474	)		12.36		(134,823	)		(2,010	)		14.91

Treasury stock, end of period		4,882,118		$	56,184		$	11.51		578,045		$	8,616		$	14.91

Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss are as follows:

		September 30, 2008			December 31, 2007

		(In thousands)
Net unrealized losses on investments		$	(42,121	)	$	(532	)
Deferred acquisition cost adjustment			7,963			224
Foreign currency translation gains			416			485
Fair value of cash flow swap on debt			(2,724	)		(279	)
Deferred tax			12,763			36

	Total accumulated other comprehensive loss	$	(23,703	)	$	(66	)

9. STOCK-BASED COMPENSATION

We have various stock-based incentive plans for our employees, non-employee directors and agents. We issue new shares upon the exercise of options granted under these stock-based incentive plans. Detailed information for activity in our stock-based incentive plans can be found in Note 7—Stock-Based Compensation to the financial statements in our annual report on Form 10-K for the year ended December 31, 2007.

Stock Option Awards

Beginning January 1, 2006, we adopted FASB Statement of Financial Accounting Standards No. 123-Revised, "Share-Based Payment," known as FAS 123-R, using the modified prospective method, and began recognizing compensation cost for share-based payments to employees and non-employee directors based on the grant date fair value of the award, which we amortize over the grantees' service period. We elected to use the Black-Scholes valuation model to value employee stock options, as we had done for our previous pro forma stock compensation disclosures. The adoption of

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9. STOCK-BASED COMPENSATION (Continued)

FAS 123-R did not have a material effect on our method of computing compensation costs for options as compared to that used to prepare the pro forma disclosures in prior periods.

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

	For options granted in:

	2008	Prior years
Risk free interest rates	1.97% – 2.86%	4.01% – 5.16%
Dividend yields	0.0%	0.0%
Expected volatility	35.60% – 43.57%	35.39% – 42.53%
Expected lives of options (in years)	3.5 – 5.0	3.0 – 6.0

The weighted-average grant-date fair value was $2.82 for options granted during the first nine months of 2008 and was $7.26 for options granted during the first nine months of 2007.

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

A summary of option activity for the nine months ended September 30, 2008 and September 30, 2007 is set forth below:

			Weighted Average Exercise Price			Aggregate Intrinsic Value (In thousands)

Outstanding, January 1, 2007	4,325		$	7.73	4.0
Granted	1,332			19.13
Exercised	(529	)		10.66
Forfeited or expired	(119	)		16.11

Outstanding, September 30, 2007	5,009		$	10.25	3.5	$	62,938

Exercisable, September 30, 2007	3,714		$	7.37	3.2	$	57,331

Outstanding, January 1, 2008	5,676		$	12.71	4.0
Granted	1,172			13.94
Exercised	(372	)		3.73
Forfeited or expired	(43	)		17.14

Outstanding, September 30, 2008	6,433		$	13.42	3.6	$	17,306

Exercisable, September 30, 2008	3,710		$	9.33	2.7	$	17,118

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9. STOCK-BASED COMPENSATION (Continued)

The total intrinsic value of options exercised during the first nine months of 2008 was $3.5 million and the total intrinsic value of options exercised during the first nine months of 2007 was $5.2 million.

As of September 30, 2008, the total compensation cost related to non-vested awards not yet recognized was $14.3 million, which we expect to recognize over a weighted average period of 1.4 years.

We received cash of $1.4 million from the exercise of stock options during the first nine months of 2008 and cash of $5.6 million from the exercise of stock options during first nine months of 2007. FAS 123-R also requires us to report the benefits of tax deductions in excess of recognized compensation cost as a financing cash flow, rather than as an operating cash flow as required under the prior statement. We recognized $1.7 million of financing cash flows for these excess tax deductions for the nine months ended September 30, 2008 and $1.2 million for the nine months ended September 30, 2007.

Employee Stock Awards

In accordance with our 1998 Incentive Compensation Plan, we may grant restricted stock to our officers and non-officer employees. We have issued restricted stock grants which vest ratably over three and four year periods, and some restricted stock grants have contained portions that vest immediately. We value restricted stock awards at an amount equal to the market price of our common stock on the date of grant and generally issue restricted stock out of treasury shares. We recognize compensation expense for restricted stock awards on a straight line basis over the vesting period. A summary of the status of our non-vested restricted stock awards is set forth below:

	Nine months ended September 30,

	2008					2007
Non-vested Restricted Stock	Shares (In thousands)			Weighted Average Grant-Date Fair Value		Shares (In thousands)			Weighted Average Grant-Date Fair Value
Non-vested at beginning of period		518		$	21.06		148		$	13.60
Granted		119			11.04		135			19.43
Vested		(81	)		16.03		(58	)		12.12
Forfeited		—			—		—			—

Non-vested at end of period		556		$	19.65		225		$	17.46

The total fair value of shares of restricted stock vested during the nine months ended September 30, 2008 was $1.0 million and the total fair value of shares of restricted stock vested during the nine months ended September 30, 2007 was $1.1 million.

10. STATUTORY FINANCIAL DATA

Regulatory authorities require our insurance subsidiaries to maintain minimum amounts of statutory capital and surplus. However, our insurance subsidiaries need substantially more than these minimum amounts to meet statutory and administrative requirements of adequate capital and surplus to support the current level of their operations. Each of the insurance subsidiaries' statutory capital and

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10. STATUTORY FINANCIAL DATA (Continued)

surplus exceeds its respective minimum statutory requirement at levels we believe are sufficient to support their current levels of operation. Additionally, the National Association of Insurance Commissioners, known as NAIC, imposes regulatory risk-based capital or RBC requirements on life insurance enterprises. At September 30, 2008, all of our insurance subsidiaries maintained ratios of total adjusted capital to RBC in excess of the "authorized control level." The combined statutory capital and surplus, including asset valuation reserve, of our insurance subsidiaries totaled $473.0 million at September 30, 2008 and $486.1 million at December 31, 2007. For the nine months ended September 30, 2008, the insurance subsidiaries generated a combined statutory net loss of $2.8 million. For the nine months ended September 30, 2007, the insurance subsidiaries generated combined statutory net income of $69.6 million.

Regulatory authorities also require our health plan subsidiaries to maintain minimum amounts of capital and surplus, and these subsidiaries are also subject to RBC requirements. At September 30, 2008, the statutory capital and surplus of each of our health plan affiliates exceeds its minimum requirement and its RBC is in excess of the "authorized control level." The combined statutory capital and surplus for our health plan affiliates was $83.4 million at September 30, 2008 and $64.3 million at December 31, 2007. Combined statutory net income for our health plan affiliates was $22.4 million for the nine months ended September 30, 2008 and $10.1 million for the nine months ended September 30, 2007.

11. LOAN PAYABLE

2007 Credit Facility

In connection with the MemberHealth transaction, we refinanced our amended credit facility and revolving credit facility with a new credit facility consisting of a $350 million term loan and a $150 million revolver. For a description of the MemberHealth transaction, see Note 4—Business Combinations above. We used a portion of the proceeds from the refinancing to repay in full the amounts outstanding on our previous credit facilities. Interest under the new credit facility is currently based on LIBOR plus a spread of 62.5 basis points. In addition, we currently pay a commitment fee on the unutilized revolving loan facility at an annualized rate of 10 basis points. In accordance with the credit agreement for the new credit facility, the spread and fee are determined based on our consolidated leverage ratio. Effective September 30, 2008, the interest rate on the term loan portion of the new credit facility was 3.42%. We had not drawn on the revolving loan facility as of the date of this report. As a result of the value received pursuant to the settlement agreement discussed in Note 4, on April 23, we prepaid $25 million of principal under the new facility, under an approved waiver.

Under the terms of the new credit facility, we must make principal repayments quarterly at the rate of $3.5 million per year over a five-year period with a final payment of $308.4 million due upon

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11. LOAN PAYABLE (Continued)

maturity in September, 2012. The following table shows the schedule of principal payments remaining on the new credit facility as of September 30, 2008:

	2007 Credit Facility

	(In thousands)
2008 (remainder of the year)	$	875
2009		3,500
2010		3,500
2011		3,500
2012		310,125

	$	321,500

Short Term Facility

On January 18, 2007, we requested and received, from the administrative agent for the lenders under our old credit facility, an additional short-term revolving credit facility of $50.0 million. On March 13, 2007, we drew down all $50.0 million of the new short-term revolving credit facility. This new short-term revolving credit facility had a maturity date of September 30, 2007 and bore interest at a spread of 75 basis points over the three month LIBOR rate. The initial rate was 6.1%. On July 18, 2007, we fully repaid the $50.0 million balance on this revolving credit facility, including accrued interest of $0.3 million.

Principal and Interest Payments

We made regularly scheduled principal payments of $2.6 million plus the $25.0 million prepayment discussed above during the nine months ended September 30, 2008 and regularly scheduled principal payments of $2.6 million during the nine months ended September 30, 2007, in connection with our credit facilities. During 2007, we repaid the $87.9 million balance outstanding on our old credit facility in connection with the refinancing described above.

We paid interest of $10.7 million during the nine months ended September 30, 2008 and $6.2 million during the nine months ended September 30, 2007, in connection with our credit facilities.

12. OTHER LONG TERM DEBT

We have formed separate statutory business trusts, each of which exists for the exclusive purpose of issuing trust preferred securities representing undivided beneficial interests in the assets of the trust, investing the gross proceeds of the trust preferred securities in junior subordinated deferrable interest debentures issued by us and engaging in only those activities necessary or incidental to the issuance and payment of these securities. In accordance with the adoption of FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities," we do not consolidate the trusts. In March, 2007 we issued $50 million of trust preferred securities at a fixed interest rate of 7.7%. As of September 30, 2008, the trusts have a combined outstanding balance of $110.0 million in thirty year trust preferred securities.

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12. OTHER LONG TERM DEBT (Continued)

We paid $6.3 million in interest in connection with the junior subordinated debentures issued in connection with the trust preferred securities during the nine months ended September 30, 2008, and $6.3 million during the nine months ended September 30, 2007.

13. DERIVATIVE INSTRUMENTS—CASH FLOW HEDGE

On December 4, 2007, we entered into two separate interest rate swap agreements, one with Citibank, and one with Calyon Corporate and Investment Bank to hedge the variability of cash flows to be paid under the new credit facility described in Note 11—Loan Payable above. In entering into the swap with Citibank, we agreed to swap our floating rate interest payment based on the floating three-month LIBOR base rate on a notional amount of $125 million in exchange for a fixed interest rate payment based on a 4.14% locked-in fixed rate. In entering into the swap with Calyon, we agreed to swap our floating rate interest payment based on the floating three-month LIBOR base rate on a notional amount of $125 million in exchange for a fixed interest rate payment based on a 4.13% locked-in fixed rate. The objective of the hedges is to eliminate the variability of cash flows in the interest payments on the a combined $250 million amount of the variable rate term loan portion of our new credit facility, which is due to changes in the LIBOR base rate, through September 2012. We expect changes in the cash flows of the interest rate swap to exactly offset the changes in cash flows from interest rate payments attributable to fluctuations in the LIBOR base rate on the $250 million portion of the variable rate term loan portion of our new credit facility. The combined fair value of these swaps was $2.7 million liability at September 30, 2008. We have reflected this fair value in other liabilities. Based on the fact that, at inception, the critical terms of the hedging instrument and the hedged forecasted transaction were the same, we have concluded that we expect changes in cash flows attributable to the risk being hedged to be completely offset by the hedging derivative, and have designated these swaps as cash flow hedges. As a result, we reflected the unrealized loss on these hedges in accumulated other comprehensive loss. We will perform subsequent assessments of hedge effectiveness by verifying and documenting whether the critical terms of the hedging instrument and the forecasted transaction have changed during the period, rather than by quantifying the relevant changes in cash flows.

Effective September 4, 2003, we entered into a swap agreement whereby we pay a fixed rate of 6.7% on a $15.0 million notional amount relating to the December 2002 trust preferred securities issuance, in exchange for a floating rate of LIBOR plus 400 basis points, capped at 12.5%. This swap contract expired in December 2007. Effective April 29, 2004, we entered into a second swap agreement whereby we pay a fixed rate of 6.98% on a $20.0 million notional amount relating to the October 2003 trust preferred securities issuance, in exchange for a floating rate of LIBOR plus 395 basis points, capped at 12.45%. This swap contract expired in October 2008. The fair value of this swap was $0 at September 30, 2008 and $0.3 million at December 31, 2007 and is reflected in other assets. During the nine months ended September 30, 2008, we reported a net $0.3 million in realized gains relating to the increase in the fair value of the cash flow swap agreement. During the nine months ended September 30, 2007, we reported a realized loss of $0.6 million relating to the reduction in the fair value of the cash flow swap agreement.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

14. COMMITMENTS AND CONTINGENCIES

Derivative Litigation

Plaintiff Arthur Tsutsui filed a derivative action on December 30, 2005, index no. 05-22523, in the Supreme Court for New York State, Westchester County. The defendants in the Tsutsui Action were our officers Richard A. Barasch, Robert A. Waegelein and Gary W. Bryant, as well as all of the directors sitting on our board of directors as of the time the complaint was filed. The Tsutsui action alleged that the same alleged misstatements that were the subject of a prior action, and that had been dismissed after the commencement of the Tsutsui action, constituted a breach of fiduciary duty by the officer defendants and the directors that caused us to sustain damages. The Tsutsui action also sought recovery of any proceeds derived by the officer defendants from the sale of our stock that was in breach of their fiduciary duties. On August 17, 2006, the Court issued an order staying the case until such time, among others, as the prior action was fully and finally resolved or settled.

Despite the dismissal of the prior action with prejudice, the plaintiff in the Tsutsui action declined to dismiss the complaint in that case. Accordingly, the defendants filed a motion to dismiss the complaint for failure to state a claim, as well as on other grounds. The Court has granted this motion. The plaintiff has filed, but has not yet perfected, a notice of appeal; the deadline for perfecting this notice of appeal, which is necessary to permit the appeal to proceed, is December 26, 2008.

Class Action Litigation Relating to Merger Proposal

On July 25, 2007, plaintiffs filed a purported class action entitledElizabeth A. Conolly, Thomas McCormack, Shelly Z. Zhang, Green Meadows Partners, James Stellato and Rocco Sorrentino vs. Universal American Financial Corporation, Richard A. Barasch, Lee Equity Partners LLC, Perry Capital LLC, Union Square Partners Management LLC, Welsh, Carson, Anderson & Stowe, Barry Averill, Bradley E. Cooper, Mark M. Harmeling, Bertram Harnett, Linda H. Lamel, Eric W. Leathers, Patrick J. McLaughlin, Robert A. Spass, and Robert F. Wright, index no. 07-13422, in the Supreme Court for New York State, Westchester County. The complaint alleged that

•: the defendants who are our directors breached fiduciary duties they owed to our shareholders in connection with our entering into the merger agreement to acquire MemberHealth and concurrent agreements with equity investors for these equity investors to acquire our securities, and the defendants who are equity investors purportedly aided and abetted that breach; and
•: the defendants who are our directors breached their duty of candor to our shareholders by failing to disclose material information concerning these transactions.

The plaintiffs sought, among other things, an injunction against the consummation of the transactions and damages in an amount to be determined.

On May 6, 2008, the parties entered into a stipulation of settlement dated as of May 1, 2008, pursuant to which they have agreed to settle this action. The settlement stipulation provides for the amendment of our by-laws to require specified procedures in the event of related party transactions described in the amendment, and to require that we maintain a committee that includes at least one independent member of our board of directors to oversee the process of preparing bids for the MemberHealth Part D plans. The stipulation also provides for the payment of the plaintiffs' legal fees in an amount not to exceed $800,000. Our directors and officers insurance carrier has provisionally

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

14. COMMITMENTS AND CONTINGENCIES (Continued)

agreed to pay 75% of this amount. The payment of the plaintiffs' legal fees and other terms of the settlement were subject to the approval of the Court, which it granted in an order dated October 8, 2008. However, the Court reserved granting the portion of the motion awarding plaintiffs' legal fees, which it plans to take up in a hearing on December 5, 2008. Shareholders who are members of the class proposed to be certified in the settlement have received notice describing the full terms of the settlement.

Other Litigation

We have litigation in the ordinary course of our business asserting claims for medical, disability and life insurance benefits and other matters. In some cases, plaintiffs seek punitive damages. We believe that after liability insurance recoveries, none of these actions will have a material adverse effect on our results of operations or financial condition.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

15. OTHER COMPREHENSIVE LOSS

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

		Three months ended September 30,

		2008									2007
		Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount			Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
		(In thousands)
Net unrealized losses arising during the year (net of SFAS 115 reserve adjustment for deferred acquisition costs)		$	(35,865	)	$	(12,552	)	$	(23,313	)	$	(9,249	)	$	(3,238	)	$	(6,011	)
Reclassification adjustment for losses included in net income			12,141			4,249			7,892			519			182			337

Net unrealized losses			(23,724	)		(8,303	)		(15,421	)		(8,730	)		(3,056	)		(5,674	)
Cash flow hedge			(2,271	)		(795	)		(1,476	)		—			—			—
Foreign currency translation adjustment			(39	)		(14	)		(25	)		116			41			75

	Other comprehensive loss	$	(26,034	)	$	(9,112	)	$	(16,922	)	$	(8,614	)	$	(3,015	)	$	(5,599	)

		Nine months ended September 30,

		2008									2007
		Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount			Before Tax Amount			Tax Expense (Benefit)			Net of Tax Amount
		(In thousands)
Net unrealized losses arising during the year (net of SFAS 115 reserve adjustment for deferred acquisition costs)		$	(88,284	)	$	(30,899	)	$	(57,385	)	$	(21,241	)	$	(7,434	)	$	(13,807	)
Reclassification adjustment for losses (gains) included in net income			54,434			19,052			35,382			(1,122	)		(393	)		(729	)

Net unrealized losses			(33,850	)		(11,847	)		(22,003	)		(22,363	)		(7,827	)		(14,536	)
Cash flow hedge			(2,445	)		(856	)		(1,589	)		—			—			—
Foreign currency translation adjustment			(69	)		(24	)		(45	)		247			86			161

	Other comprehensive loss	$	(36,364	)	$	(12,727	)	$	(23,637	)	$	(22,116	)	$	(7,741	)	$	(14,375	)

16. UNCONSOLIDATED SUBSIDIARY

During 2005, we entered into a strategic alliance with Caremark and created PDMS, which is 50% owned by us and 50% owned by Caremark. PDMS principally performs marketing and risk management services on behalf of our Prescription Pathway^SM PDPs and Caremark, for which it receives fees and other remuneration from our Prescription Pathway^SM PDPs and Caremark. We do not control PDMS and therefore we have not consolidated PDMS in our financial statements. We account for our investment in PDMS on an equity basis and reflect it in other assets. Our investment in PDMS was

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

16. UNCONSOLIDATED SUBSIDIARY (Continued)

$12.9 million at September 30, 2008 and $1.6 million at December 31, 2007. We reflect our share in the income or loss of PDMS in equity in earnings of unconsolidated subsidiary. Our share in the net income of PDMS was $20.4 million and $12.8 million for the three months ended September 30, 2008 and 2007, respectively. Our share in the net income of PDMS was $51.8 million and $39.1 million for the nine months ended September 30, 2008 and 2007, respectively. PDMS made distributions to its owners aggregating $81.0 million during the nine months ended September 30, 2008. Our share of those distributions was $40.5 million.

The condensed financial information for 100% of PDMS is as follows:

		September 30, 2008		December 31, 2007

		Unaudited (In thousands)
Assets
Cash and investments		$	685	$	701
Other			26,041		6,071

	Total assets	$	26,726	$	6,772

Liabilities and Equity
Accrued expenses and other		$	922	$	3,530
Equity			25,804		3,242

	Total liabilities and equity	$	26,726	$	6,772

		Three months ended September 30,				Nine months ended September 30,

		2008		2007		2008		2007
		(Unaudited)
Total revenue		$	41,458	$	26,944	$	105,901	$	81,211
Total expenses			562		1,368		2,339		2,989

	Net income	$	40,896	$	25,576	$	103,562	$	78,222

17. BUSINESS SEGMENT INFORMATION

Our business segments are based on product and consist of

•: Senior Managed Care—Medicare Advantage,
•: Medicare Part D,
•: Traditional Insurance, and
•: Senior Administrative Services.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

17. BUSINESS SEGMENT INFORMATION (Continued)

We also report the activities of our holding company in a separate segment. We have made reclassifications to conform prior year amounts to the current year presentation. A description of these segments follows:

Senior Managed Care—Medicare Advantage—The Senior Managed Care—Medicare Advantage segment contains the operations of our initiatives in managed care for seniors.

•: We operate various HMOs, such as SelectCare of Texas, that offer coverage to Medicare beneficiaries under contracts with CMS in Southeastern Texas, North Texas, Oklahoma and Wisconsin. Our career and independent agents sell the HMOs' products, as do our employee representatives on a direct basis.
•: In connection with the HMOs, we operate separate Management Service Organizations, known as MSOs that manage that business and affiliated Independent Physician Associations or IPAs. We participate in the net results derived from these affiliated IPAs.
•: Our career and independent agents also sell our Medicare Advantage PFFS plans, which also operate under a contract with CMS. We currently market PFFS products in 3,100 counties throughout 47 states.
•: In addition, in late 2007, we began efforts to cultivate provider relationships to establish Medicare Advantage preferred provider organizations, known as PPOs. In December 2007, we advised CMS of our intent to market PPO products and as of September 30, 2008, we have received approval from CMS to launch PPO plans in 9 states, across 15 markets. Marketing for these PPO plans began on October 1, 2008.

Medicare Part D—This segment consists of

•: Our Medicare Part D plans, consisting of our Prescription Pathway^SM business and the equity in the income of PDMS, which began offering prescription drug benefit coverage for seniors and other Medicare beneficiaries on January 1, 2006, and, since the acquisition of MemberHealth on September 21, 2007, the Community CCRx business, and
•: Our participation, on a 33.3% basis, in an unaffiliated plan with Arkansas Blue Cross and Blue Shield and PharmaCare Re. The contract for this participation terminated as of January 1, 2008. Under the termination provisions of the contract, we received $0.8 million, an amount equal to two years of the estimated future profits generated by the block of business, which was recorded in the first quarter 2008.

The growth in our Medicare Part D business has resulted in an increase in the level of seasonality in our reported results during a given calendar year. This is due to the uneven nature of the standard benefit design under Medicare Part D. As a result, this business generally sees higher claims experience in the first two quarters of the year while beneficiaries are in the deductible and initial coverage phases of the benefit design. As the beneficiary reaches the coverage gap and catastrophic phases of the benefit design, the plan experiences lower claims liability which is generally in the last two quarters of the year, resulting in a pattern of increasing reported net income attributable to the Part D business.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

17. BUSINESS SEGMENT INFORMATION (Continued)

Traditional Insurance—This segment consists of

•: our Medicare supplement business,
•: our traditional and universal life insurance and fixed annuities business distributed through our career agency sales force and through our network of independent general agencies,
•: specialty health insurance products, primarily fixed benefit accident and sickness disability insurance sold to the middle income self-employed market in the United States, and
��: products that we no longer sell such as long term care and major medical insurance.

Senior Administrative Services—Our senior administrative services subsidiary acts as a third party administrator and service provider of senior market insurance products and geriatric care management for both affiliated and unaffiliated insurance companies. This business provides the following services:

•: policy underwriting and issuance,
•: telephone and face-to-face assessments,
•: policyholder services,
•: agent licensing,
•: commission payments,
•: claims adjudication,
•: case management,
•: care assessment,
•: referral to health care facilities and
•: administration of our Prescription Pathway^SM Part D prescription drug plans, which commenced on January 1, 2006.

Corporate—This segment reflects the activities of our parent holding company, such as debt service, senior executive compensation, and compliance with requirements resulting from our status as a public company.

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 services performed by the Senior Administrative Services segment for our other segments and interest on notes payable or receivable between the Corporate segment and the operating segments.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

17. 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 net income in accordance with generally accepted accounting principles is as follows:

		Three months ended September 30,

		2008						2007
		Revenue			Income (Loss) Before Income Taxes			Revenue			Income (Loss) Before Income Taxes
		(In thousands)
Senior Managed Care—Medicare Advantage		$	615,544		$	44,077		$	529,694		$	16,476
Medicare Part D			397,952			49,196			87,999			23,595
Traditional Insurance			111,175			3,099			126,642			5,052
Senior Administrative Services			20,823			5,034			27,289			6,388
Corporate			560			(12,125	)		1,057			(8,072	)
Intersegment revenues			(15,466	)		—			(21,211	)		—
Adjustments to segment amounts:
	Net realized losses(1)		(12,141	)		(12,141	)		(519	)		(519	)
	Equity in earnings of unconsolidated subsidiary(2)		(20,448	)		—			(12,788	)		—

Total		$	1,097,999		$	77,140		$	738,163		$	42,920

		Nine months ended September 30,

		2008						2007
		Revenue			Income (Loss) Before Income Taxes			Revenue			Income (Loss) Before Income Taxes
		(In thousands)
Senior Managed Care—Medicare Advantage		$	1,805,412		$	77,813		$	1,405,885		$	42,816
Medicare Part D			1,498,128			30,210			280,260			37,782
Traditional Insurance			346,751			6,268			390,808			8,395
Senior Administrative Services			65,537			17,442			79,149			17,715
Corporate			2,664			(26,911	)		2,965			(23,469	)
Intersegment revenues			(47,453	)		—			(60,985	)		—
Adjustments to segment amounts:
	Net realized (losses) gains(1)		(54,434	)		(54,434	)		1,122			1,122
	Equity in earnings of unconsolidated subsidiary(2)		(51,781	)		—			(39,111	)		—

Total		$	3,564,824		$	50,388		$	2,060,093		$	84,361

(1): We evaluate the results of operations of our segments based on income before realized gains and losses and income taxes. We believe that realized gains and losses are not indicative of overall operating trends.
(2): We report the equity in the earnings of unconsolidated subsidiary as revenue for our Medicare Part D segment for purposes of analyzing the ratio of net pharmacy benefits incurred because the amount is incorporated in the calculation of the risk corridor adjustment. For consolidated reporting, we included this amount as a separate line following income from continuing operations.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

17. BUSINESS SEGMENT INFORMATION (Continued)

Identifiable assets by segment are as follows:

	September 30, 2008			December 31, 2007

	(In thousands)
Traditional Insurance	$	1,452,487		$	1,475,299
Medicare Part D		1,221,008			1,313,538
Senior Managed Care—Medicare Advantage		1,102,775			1,050,336
Senior Administrative Services		21,847			30,903
Corporate		1,641,713			1,753,467
Intersegment assets(1)		(1,454,627	)		(1,533,780	)

Total Assets	$	3,985,203		$	4,089,763

(1): Intersegment assets reflect the elimination of the parent holding company's investment in its subsidiaries as well as the elimination of other intercompany balances.

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

Introduction

The following discussion and analysis presents a review of our Company as of September 30, 2008 and our results of operations for the three and nine months ended September 30, 2008 and 2007. 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, 2007. You should also read the following analysis in conjunction with the Risk Factors contained in the current report on Form 8-K that we filed with the Securities and Exchange Commission on August 8, 2008, as supplemented by the risk factors set forth in Part II, Item 1A "Risk Factors" below.

Overview

As a result of the MemberHealth acquisition and Medicare Advantage expansion discussed in the notes to our financial statements set forth above, we have modified the way we manage and report our business compared to that reported in the prior year. Our Senior Managed Care—Medicare Advantage segment remains unchanged and we continue to provide separate information on the results of our PFFS and HMO businesses contained in this segment. In addition, we are now including separate information regarding development of our preferred provider organization, or PPO, within this segment. We have split Part D from our Senior Market Health segment and formed a new segment to include both our Prescription Pathway^SM product and our Community CCRx^SM product. We have combined the remaining former Senior Market Health segment, primarily Medicare supplement, with the former Specialty Health and Life & Annuity segments to form a new combined segment, Traditional Insurance. The Senior Administrative Services segment remains unchanged and we continue to report the corporate activities of our holding company in a separate segment. We have made reclassifications to conform prior year amounts to the current year presentation. We began to use this segment reporting structure with our annual report on Form 10-K for the year ended December 31, 2007. See "Note 17—Business Segment Information" in our consolidated financial statements included in this quarterly report on Form 10-Q for a description of our segments.

We report inter-segment revenues and expenses on a gross basis in each of the operating segments but eliminate them in the consolidated results. These inter-segment 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 significant items eliminated are

•: inter-segment revenue and expense relating to services performed by the Senior Administrative Services segment for our other segments,
•: inter-segment revenue and expense relating to PBM services performed by the Part D segment for other segments, and
•: interest on notes payable or receivable between the Corporate segment and the other operating segments.

Critical Accounting Policies

We have prepared our consolidated financial statements in accordance with U.S. generally accepted accounting principles, known as U.S. GAAP. The preparation of our financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts of

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assets and liabilities and disclosures of assets and liabilities reported by us at the date of the financial statements and the revenues and expenses reported during the reporting period. As additional information becomes available or actual amounts become determinable, we may revise the recorded estimates and reflect them in operating results. Actual results could differ from those estimates. The accounts that, in our judgment, are most critical to the preparation of our financial statements are:

•: future policy benefits and claim liabilities,
•: deferred policy acquisition costs,
•: goodwill,
•: present value of future profits and other intangible assets,
•: the valuation of specified investments, and
•: deferred income taxes.

There have been no changes in our critical accounting policies during the current quarter.

Policy Related Liabilities

We calculate and maintain reserves for the estimated future payment of claims to our policyholders using actuarial assumptions that are consistent with actuarial assumptions we use in the pricing of our products. For our accident and health insurance business, we establish an active life reserve for expected future policy benefits, plus a liability for due and unpaid claims and incurred but not reported claims. Our net income depends upon the extent to which our actual claims experience is consistent with the assumptions we used in setting our reserves and pricing our policies. If our assumptions with respect to future claims are incorrect, and our reserves are insufficient to cover our actual losses and expenses, we would need to increase our liabilities, resulting in reduced net income and shareholders' equity.

A summary of our liabilities by category is presented in the following table:

Liability Type

		September 30, 2008					December 31, 2007

		Amount		% of Total Policy Liabilities			Amount		% of Total Policy Liabilities
		($ in thousands)
Policyholder account balances		$	406,043		22	%	$	434,859		24	%
Future policy benefit reserves:
	Traditional life insurance		209,680		11	%		202,258		11	%
	Accident and health		414,079		23	%		414,192		23	%

Total future policy benefit reserves			623,759		34	%		616,450		34	%

Policy and contract claims—accident and health:
	Due and unpaid claims		510,944		28	%		435,073		24	%
	Incurred but not reported claims ("IBNR")		272,899		15	%		302,116		17	%

Total accident and health claim liabilities			783,843		43	%		737,189		41	%
Policy and contract claims—life			10,378		1	%		12,213		1	%

Total policy liabilities		$	1,824,023		100	%	$	1,800,711		100	%

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Policyholder Account Balances

Policyholder account balances represent the balance that accrues to the benefit of the policyholder, otherwise known as the account value, as of the financial statement date. Account values increase to reflect additional deposits received and interest credited based on the account value. Account values decline to reflect surrenders and other withdrawals, including withdrawals relating to the cost of insurance and expense charges. We review the interest crediting rates periodically and adjust them with certain minimum levels below which the crediting rate cannot fall as deemed necessary.

Future Policy Benefit Reserves—Traditional Life Insurance Policies

The liability for future policy benefits represents the present value of estimated future benefits to be paid to or on behalf of policyholders, less the future value of net premiums. We calculate this amount based on actuarially recognized methods using morbidity and mortality tables, which we modify to reflect our actual experience when appropriate.

Future Policy Benefit Reserves—Accident and Health Policies

For our fixed benefit accident and sickness and our long term care products, we establish a reserve for future policy benefits at the time we issue each policy based on the present value of future benefit payments less the present value of future premiums. We have ceased issuing new long term care policies, although our current policies are renewable annually at the discretion of the policyholder, as evidenced by the policyholder continuing to make premium payments. In establishing these reserves, we must evaluate assumptions about mortality, morbidity, lapse rates and the rate at which new claims are submitted to us. We estimate the future policy benefits reserve for these products using the above assumptions and actuarial principles. For long-duration insurance contracts, we use these original assumptions throughout the life of the policy and generally do not subsequently modify them.

A portion of our reserves for long-term care products also reflect our estimates relating to members currently receiving benefits. We estimate these reserves primarily using recovery and mortality rates, as described above.

Policy and Contract Claims—Accident and Health Policies

The policy and contract claims liability for our accident and health policies reflect a liability for unpaid claims, such as claims in the course of settlement, as well as a liability for incurred but not yet

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reported claims, known as IBNR. Our accident & health claims liability by major product grouping is as follows:

Accident & Health Claims Liability

		Direct and Assumed										Net of Reserves Ceded to Reinsurers

		September 30, 2008		% of Total Policy Liabilities			December 31, 2007		% of Total Policy Liabilities			September 30, 2008		December 31, 2007
		($ In thousands)
Due & unpaid claims:
	Medicare Part D	$	426,930		23	%	$	352,688		20	%	$	410,610	$	336,218
	Medicare Advantage—HMO		74,403		4	%		59,058		3	%		70,779		53,563
	Other—specialty		9,611		1	%		23,327		1	%		8,803		9,106

Total due & unpaid claims			510,944		28	%		435,073		24	%		490,192		398,887
IBNR:
	Medicare supplement		46,314		2	%		46,834		3	%		33,088		33,653
	Medicare Advantage—PFFS		217,247		12	%		246,048		13	%		215,976		240,832
	Other—specialty		9,338		1	%		9,234		1	%		7,424		7,240

Total IBNR			272,899		15	%		302,116		17	%		256,488		281,725

Total accident and health claim liabilities		$	783,843		43	%	$	737,189		41	%	$	746,680	$	680,612

The following factors can affect these reserves and liabilities:

•: economic and social conditions,
•: inflation,
•: hospital and pharmaceutical costs,
•: changes in doctrines of legal liability,
•: premium rate increases,
•: extra contractual damage awards, and
•: other factors affecting health care and insurance generally.

Therefore, we establish the reserves and liabilities based on extensive estimates, assumptions and prior years' statistics. When we acquire other insurance companies or blocks of insurance, our assessment of the adequacy of acquired policy liabilities is subject to similar estimates and assumptions. Establishing reserves involves inherent uncertainties, and it is possible that actual claims could materially exceed our reserves and have a material adverse effect on our results of operations and financial condition.

We develop our estimate for IBNR using actuarial methodologies and assumptions, primarily based upon historical claim payment and claim receipt patterns, as well as historical medical cost trends. Depending on the period for which we are estimating incurred claims, we apply a different method in determining our estimate. For periods prior to the most recent three months, the key assumption used in estimating our IBNR is that the completion factor pattern, adjusted for known changes in claim inventory levels and claim payment processes, remains consistent over a specified rolling period. This period, ranging from 3 to 12 months, is dependent on the type of business valued. Completion factors

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result from the calculation of the percentage of claims incurred during a given period that have historically been adjudicated as of the reporting period. For the most recent three months, we estimate the incurred claims primarily from a trend analysis based upon per member per month, known as PMPM, claims trends developed from our historical experience in the preceding months, adjusted for known changes in estimates of recent hospital and drug utilization data, provider contracting changes, changes in benefit levels, product mix, and seasonality.

We use the completion factor method for the months of incurred claims prior to the most recent three months because the historical percentage of claims processed for those months is at a level sufficient to produce a consistently reliable result. Conversely, for the most recent three months of incurred claims, the volume of claims processed historically is not at a level sufficient to produce a reliable result, which therefore requires that we examine historical trend patterns as the primary method of evaluation. Due to the limited historical claims experience for PFFS, estimates for the most recent three months of incurred claims are based largely on our pricing assumptions for the product. The amounts above reflect the estimated potential medical and other expenses payable based upon assumptions used in determining the loss ratio for the pricing of our PFFS products.

Medical cost trends potentially are more volatile than other segments of the economy. The principal intrinsic drivers of medical cost trends are:

•: changes in the utilization of hospital facilities, physician services, prescription drugs, and new medical technologies, and
•: the inflationary effect on the cost per unit of each of these expense components.

Other external factors may impact medical cost trends, such as:

•: government-mandated benefits,
•: other regulatory changes,
•: increases in medical services,
•: an aging population,
•: natural disasters and other catastrophes, and
•: epidemics.

Factors internal to our company may also affect our ability to accurately predict estimates of historical completion factors or medical cost trends, such as:

•: claims processing cycle times,
•: changes in medical management practices, and
•: changes in provider contracts.

We consider all of these factors in estimating IBNR and in estimating the PMPM claims trend for purposes of determining the reserve for the most recent three months. Additionally, we continually prepare and review follow-up studies to assess the reasonableness of the estimates generated by our process and methods over time. We also consider the results of these studies in determining the reserve for the most recent three months. Each of these factors requires significant judgment by management.

Our historical assumptions have not varied significantly during the nine months ended September 30, 2008 from the actual amounts experienced to the extent that the variance resulted in a material adverse impact on reserves and net income, other than $32.9 million favorable development of 2007 claims experience on our PFFS business during the nine months ended September 30, 2008, which we discuss in connection with Segment Results—Senior Managed Care—Medicare Advantage, later in

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this section. We have included a summary of the activity in our accident & health policy and contract claim liability in Note 9—Accident & Health Policy and Contract Claim Liabilities in the notes to the consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2007.

Sensitivity Analysis

The following table illustrates the sensitivity of our accident and health IBNR payable at September 30, 2008 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 Accident & Health IBNR			(Decrease) Increase in Factor			(Decrease) Increase in Net Accident & Health IBNR
($ in thousands)
(3)%	$	2,144			(3	)%	$	(11,513	)
(2)%	$	1,429			(2	)%	$	(7,675	)
(1)%	$	714			(1	)%	$	(3,838	)
1%	$	(714	)		1	%	$	3,850
2%	$	(1,427	)		2	%	$	7,699
3%	$	(2,130	)		3	%	$	11,549

(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.

Policy and Contract Claims—Life Policies

The liability for unpaid claims, including IBNR, reflects estimates of amounts to fully settle known reported claims as well as claims related to insured events that we estimate have been incurred, but have not yet been reported to us.

Deferred Policy Acquisition Costs

We defer the following costs of acquiring new business:

•: non-level commissions,
•: agency production costs,
•: policy underwriting costs,
•: policy issue costs,
•: associated issuance costs, and
•: other costs that vary with, and are primarily related to, the production of new and renewal business.

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We refer to these costs as deferred acquisition costs or DAC. For interest-sensitive life and annuity products, we amortize these costs in relation to the present value of expected gross profits on the policies arising principally from investment, mortality and expense margins in accordance with FAS No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." The determination of expected gross profits for interest-sensitive products is an inherently uncertain process that relies on assumptions regarding:

•: projected interest rates,
•: the persistency of the policies issued,
•: anticipated benefits,
•: anticipated commissions,
•: anticipated expenses, and
•: other factors regarding these products.

It is possible that the actual profits from the business may vary materially from the assumptions used in the determination and amortization of DAC.

For other life and health products, we amortize DAC in proportion to premium revenue using the same assumptions used in estimating the liabilities for future policy benefits in accordance with FAS No. 60, "Accounting and Reporting by Insurance Enterprises." Under FAS No. 60, when a policy lapses, we must amortize the remaining balance of DAC relating to that policy as of the date of the lapse. During 2007, we experienced an increase in the amount of lapses on our Medicare supplement business, resulting in an increased level of DAC amortization. During 2008, we have seen improved persistency on this business, requiring less amortization of DAC.

We write off deferred policy acquisition costs to the extent that we determine that the present value of future policy premiums and investment income or the net present value of expected gross profits would not be adequate to recover the unamortized costs.

Amortization of Present Value of Future Profits and Other Intangibles

Business combinations accounted for as a purchase result in the allocation of the purchase consideration to the fair values of the assets and liabilities acquired, including the present value of future profits, establishing such fair values as the new accounting basis. The present value of future profits is based on an estimate of the cash flows of the in force business acquired, discounted to reflect the present value of those cash flows. The discount rate we select depends upon the general market conditions at the time of the acquisition and the inherent risk in the transaction. We allocate purchase consideration in excess of the fair value of net assets acquired, including the present value of future profits and other identified intangibles, for a specific acquisition, to goodwill. We perform the allocation of purchase price in the period in which we consummate the purchase. Adjustments, if any, in subsequent periods relate to resolution of pre-acquisition contingencies, tax matters and refinements made to estimates of fair value in connection with the preliminary allocation.

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Set forth below are our annual amortization policies for each of the main categories of amortizing intangible assets:

Description		Amortization Basis

Insurance policies acquired	7-9	The pattern of projected future cash flows for the policies acquired over the estimated weighted average life of the policies acquired.
Distribution channel acquired	30	Straight line over the estimated life of the asset.
Membership base acquired	7-10	Straight line over the estimated weighed average life of the membership base.
Trademarks/trade names	9	Straight line over the estimated weighted average life of the trademarks/trade names.
Licenses	15	Straight line over the estimated weighed average life of the licenses.
Provider contracts	10	Straight line over the estimated weighted average life of the contracts
Non-compete	7	Straight line over the length of the agreement.
Administrative service contracts	6	The pattern of projected future cash flows for the customer contracts acquired over the estimated weighted average life of the contracts
Hospital network contracts	10	The pattern of projected future cash flows for the hospital network contracts acquired over the estimated weighted average life of the contracts

At least annually, we review the unamortized balances of present value of future profits, goodwill and other identified intangibles to determine whether events or circumstances indicate the carrying value of these assets is not recoverable, in which case we would recognize an impairment charge. We believe that no impairment of the present value of future profits, goodwill or other identified intangibles existed as of September 30, 2008.

Investment valuation

The fair value for the majority of our fixed maturity and equity securities is determined by third party pricing service market prices. Third party pricing services typically use the following principal inputs:

•: reported trades,
•: benchmark yields,
•: issuer spreads,
•: bids,
•: offers, and
•: estimated cash flows and prepayments speeds.

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identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price where the pricing services develop future cash flow expectations based upon collateral performance, discounted at an estimated market rate. The pricing for mortgage-backed and asset-backed securities reflects estimates of the rate of future prepayments of principal over the remaining life of the securities. The pricing services derive these estimates based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates. See Part I, Item 3, Quantitative and Qualitative Disclosures About Market Risk, for a discussion regarding the interest rate sensitivity of our investment portfolio.

The following table presents the fair value of fixed maturity and equity securities that we carried at fair value by SFAS 157 hierarchy levels, as of September 30, 2008 (in thousands):

	Fair Value

Level 1	$	—	—
Level 2		1,041,992	99.5	%
Level 3		5,259	0.5	%

	$	1,047,251	100.0	%

The fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between knowledgeable, unrelated willing parties using inputs, including assumptions and estimates, a market participant would utilize. As such, the estimated fair value of a financial instrument may differ significantly from the amount that could be realized if the security was sold immediately.

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

The following table presents the fair value of the asset sectors within the SFAS 157 Level 3 securities as of September 30, 2008 (in thousands):

	Fair Value

Mortgage and asset-backed securities	$	2,947	56.0	%
Corporate		1,822	34.7	%
Equity securities		490	9.3	%

Total Level 3 securities	$	5,259	100	%

Mortgage and asset-backed securities represents private-placement collateralized debt obligations that are thinly traded and priced using an internal model or by independent brokers.

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Impairment

We regularly evaluate the amortized cost of our investments compared to the fair value of those investments. We generally recognize impairments of securities when we consider a decline in fair value below the amortized cost basis to be other-than-temporary. The evaluation includes the intent and ability to hold the security to recovery, and is considered on an individual security basis. We recognize impairment losses when we determine declines in fair values based on quoted prices to be other-than-temporary.

The evaluation of impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether we should recognize declines in the fair value of investments in current period earnings. The principal risks and uncertainties are

•: changes in general economic conditions,
•: the issuer's financial condition or near term recovery prospects,
•: the effects of changes in interest rates or credit spreads, and
•: the recovery period.

Our accounting policy requires that we assess a decline in the value of a security below its cost or amortized cost basis to determine if the decline is other-than-temporary. If we deem the security to be other-than-temporarily impaired, we record a charge in net realized capital losses equal to the difference between the fair value and cost or amortized cost basis of the security. The fair value of the other-than-temporarily impaired investment becomes its new cost basis. We have a security monitoring process overseen by our Investment Committee, consisting of investment and accounting professionals that identify securities that, due to specified characteristics, as described below, we subject to an enhanced analysis on a quarterly basis.

We review our fixed maturity securities at least quarterly to determine if an other-than-temporary impairment is present based on quantitative and qualitative factors. The primary factors we consider in evaluating whether a decline in value is other-than-temporary are:

•: the length of time and the extent to which the fair value has been or is expected to be less than cost or amortized cost,
•: the financial condition, credit rating and near-term prospects of the issuer,
•: whether the debtor is current on contractually obligated interest and principal payments and
•: our intent and ability to retain the investment for a period of time sufficient to allow for recovery.

Each quarter, during this analysis, we assert our intent and ability to retain until recovery those securities we judge to be temporarily impaired. Once identified, we restrict trading on these securities unless approved by members of the Investment Committee. The Investment Committee will only authorize the sale of these securities based on criteria that relate to events that could not have been foreseen. Examples of the criteria are the deterioration in the issuer's creditworthiness, a change in regulatory requirements or a major business combination or major disposition.

Subprime Residential Mortgage Loans

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2006 and 2007 that are collateralized by interests in mortgages originated in those years; the year of issuance is known as the vintage year. These factors have caused a significant reduction in market liquidity and repricing of risk, which has led to a decrease in the market valuation of these securities sector wide.

As of September 30, 2008, we held subprime securities with par values of $141 million, an amortized cost of $56 million and a market value of $49 million representing approximately 3.0% of our cash and invested assets, with collateral comprised substantially of first lien mortgages. The majority of these securities are in senior or senior-mezzanine level tranches, which have preferential liquidation characteristics, and have an average rating of A+ by Standard & Poors, a division of the McGraw Hill Companies, Inc., known as S&P, or equivalent. The following table presents our exposure to subprime residential mortgages by vintage year.

Vintage Year	Amortized Cost		Fair Value		Unrealized Gain (Loss)

	(In thousands)
2003	$	6,510	$	5,215	$	(1,295	)
2004		3,496		3,052		(444	)
2005		25,4601		18,676		(6,784	)
2006		15,355		16,226		871
2007		5,592		5,881		289

Totals	$	56,413	$	49,050	$	(7,363	)

We continuously review our subprime holdings stressing multiple variables, such as cash flows, prepayment speeds, default rates and loss severity, and comparing current base case loss expectations to the loss required to incur a principal loss, or breakpoint. This breakpoint currently exceeds the base case loss expectation for all but one holding to varying degrees. We expect delinquency and loss rates in the subprime mortgage sector to continue to increase in the near term but at a decreasing rate. Those securities with a greater variance between the breakpoint and base case can withstand this further deterioration. However, holdings where the base case is closer to the breakpoint, principally holdings from the 2006 and 2007 vintage years, are more likely to incur a principal loss. We utilize third party pricing services to provide or estimate market prices. Third party pricing services typically use the following principal inputs:

•: reported trades,
•: benchmark yields,
•: issuer spreads,
•: bids,
•: offers, and
•: estimated cash flows and prepayments speeds.

If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price, as has recently been the case with many of our subprime holdings.

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The following table summarizes our other-than-temporary impairments recorded since the subprime deterioration began last year:

			2008 Quarter Ended

	2007		March 31		June 30		September 30		2008		Cumulative
	(In thousands)
Subprime	$	40,997	$	29,800	$	11,771	$	2,329	$	43,900	$	84,897
Other structured		—		—		1,384		2,432		3,816		3,816
Corporate		—		—		—		7,177		7,177		7,177

	$	40,997	$	29,800	$	13,155	$	11,938	$	54,893	$	95,890

At December 31, 2007, we recognized an other-than-temporary impairment on fourteen 2006 and 2007 vintage year subprime holdings. As of September 30, 2008, we recognized an additional other-than-temporary impairment on the same fourteen securities impaired at December 31, 2007 plus four additional subprime holdings. In addition, during 2008, we have recognized an other-than-temporary impairment on four other structured securities and two corporate securities. The corporate other-than-temporary impairment includes $6.1 million on Lehman Brothers holdings.

We continue to review the estimated fair values indicated by pricing provided by the third party pricing services however, we cannot give assurance that there will be no further impairments on these securities, until the market as a whole stabilizes. However, we believe that we will recover principal and interest greater than the market prices currently indicate on the subprime and other structured securities.

Income Taxes

We use the liability method to account for deferred income taxes. Under the liability method, we recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted tax rates that we expect to apply to taxable income in the years in which we expect to recover or settle those temporary differences. We recognize in income the effect on deferred tax assets and liabilities of a change in tax rates in the period that includes the enactment date of a change in tax rates.

We establish valuation allowances on our deferred tax assets for amounts that we determine will not be recoverable based upon our analysis of projected taxable income and our ability to implement prudent and feasible tax planning strategies. We recognize increases in these valuation allowances as deferred tax expense. We reflect portions of the valuation allowances subsequently determined to be no longer necessary as deferred tax benefits. To the extent that we established valuation allowances in conjunction with acquisitions, we first apply changes in those allowances to increasing or decreasing the goodwill, but not below zero, or other intangibles related to the acquisition and then apply those changes as an increase or decrease in income tax expense.

We carried valuation allowances on deferred tax assets of $3.1 million at September 30, 2008 and December 31, 2007 primarily related to the tax benefits associated with a New York state net operating loss carryforward. At September 30, 2008, we recorded our deferred tax assets based on the amount that was more likely than not to be realized under SFAS No. 109,Accounting for Income Taxes.

Significant Transactions and Initiatives

Medicare Advantage

We entered the Medicare Advantage business in 2004 with the acquisition of Heritage Health Systems, Inc. which operates Medicare Advantage coordinated care plans in Texas, Oklahoma and

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Wisconsin. We have continued to increase our marketing of Medicare Advantage plans for Medicare HMOs and PFFS.

As of September 30, 2008, our HMO enrollment has increased to approximately 54,700 members from 46,000 members at December 31, 2007. We elected not to renew our Medicare Advantage HMO contract in Florida for 2008, and, as of January 1, 2008, we had no HMO membership in Florida.

Through our insurance subsidiaries American Progressive, Pyramid Life and Marquette we currently offer our PFFS products in 47 states in 2008, up from 35 states at December 31, 2007. As of September 30, 2008, our enrollment in PFFS plans has decreased to approximately 188,000 members, compared with 190,000 members at December 31, 2007.

In late 2007, we began efforts to cultivate provider relationships to establish Medicare Advantage preferred provider organizations, known as PPOs. In December 2007, we advised CMS of our intent to market PPO products and as September 30, 2008, we have received approval from CMS to launch PPO plans in 9 states, across 15 markets. Marketing for these PPO plans began on October 1, 2008.

Medicare Part D

Effective January 1, 2006, private insurers were permitted to sponsor insured stand-alone PDPs pursuant to Part D, which was established by the Medicare Modernization Act. The federal government pays a portion of the premium for this insurance, and the individuals who enroll pay the balance, if any. The federal government will also provide additional subsidies in the form of premium support and coverage of the cost-sharing elements of the plan to specified low income Medicare beneficiaries. For the 2008 plan year, we offered, through our insurance subsidiaries, our Community CCRx^SM and Prescription Pathway^SM prescription drug plans in all 34 regions designated by CMS in which we bid. In addition, since we had a national plan bid below the benchmark in 29 and 30 regions, for Community CCRx^SM and Prescription Pathway^SM, respectively, we received auto assignment of "dual eligible" and "low income subsidy" beneficiaries who are dually eligible for Medicare and Medicaid in the regions where our bids were below the benchmark.

Through our strategic alliance with Caremark, we retain 50% of the Medicare Part D business of our Prescription Pathway^SM PDPs. PharmaCare Re reinsures the remainder on a 50% quota share basis. Additionally, as part of the strategic alliance, we created PDMS, which is 50% owned by us and 50% owned by Caremark. PDMS principally performs marketing and risk management services on behalf of our Prescription Pathway^SM PDPs. In February 2008, we announced that the parties are terminating this strategic alliance effective December 31, 2008. Upon termination of the strategic alliance, Caremark and Universal American will each assume responsibility for the drug benefit of specified Prescription Pathway^SM plan members to achieve an approximately equal distribution of the value of business that has been generated by the strategic alliance. We will continue to operate PDPs derived from this business under the name PrescribaRx^SM.

We participate, on a 33.3% basis, in an unaffiliated plan with Arkansas Blue Cross and Blue Shield and PharmaCare Re. The contract for this participation terminated as of January 1, 2008. Under the termination provisions of the contract, we received $0.8 million, an amount equal to two years of the estimated future profits generated by the block of business, which we recorded in the first quarter 2008.

MemberHealth

On September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held pharmacy benefits manager, or PBM, and sponsor of Community CCRx^SM, a national Medicare Part D plan with 1.2 million members. Prior to the acquisition, MemberHealth was a leading national Medicare Part D sponsor, offering Medicare prescription drug plans in 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. MemberHealth, Inc. had more than 60,000

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pharmacies in its pharmacy network and covered 98 of the top 100 medications taken by Medicare beneficiaries.

We paid the initial purchase price of $630 million, 55% in cash and 45% in our common stock valued at $20 per share. We paid transaction costs of approximately $12 million in cash. In addition to the purchase price, the transaction includes an additional three year earn-out tied to target earnings from the MemberHealth business. The maximum aggregate amount potentially payable under the performance-based earn-out is $150 million, payable in cash and our common stock.

Subsequent to December 31, 2007, we determined that expected operating income for 2008 from the MemberHealth business, which we acquired in September 2007, will be less than previously forecast. The reason for the decline in expected income is that premium payments to MemberHealth will be lower than anticipated based upon the bids submitted to, and later accepted by CMS from MemberHealth in June 2007 for its 2008 Part D plans. The premium payments are lower primarily as a result of incorrect information concerning the risk scores in the MemberHealth bids. In accounting for the issue relating to the 2008 bids, we recorded an acquisition liability of $39.2 million for the below-market contract that we are amortizing into income over the contract period, January 1, 2008 to December 31, 2008. We amortized $9.8 million of this acquisition liability in the quarter ended September 30, 2008, and $29.5 million for the nine months ended September 30, 2008. We reflected this amortization in direct premium and policyholder fees earned in the consolidated statements of operations.

We also discovered after December 31, 2007 that MemberHealth incorrectly calculated its expected risk corridor receivable in its first quarter 2007 financial statements, resulting in an overstatement of pre-tax income for the first quarter of 2007 of approximately $26 million. In our financial statements for the year ended December 31, 2007 included in our filed Annual report on Form 10-K, we adjusted the pro forma financial information to reflect the impact of this error, through an adjustment to purchase GAAP accounting, which reduced receivables and increased goodwill by $23 million, the after-tax amount of the misstatement.

In connection with these issues, in March 2008, we concluded a settlement agreement under which the sellers of MemberHealth delivered approximately $98 million of value, consisting of $47 million in cash, 2,027,071 shares of our common stock and $16 million in future amounts due to the sellers, which have been forgiven. We have retired the shares.

During the third quarter of 2008, we received the final risk score adjustments for 2007 members in our Part D plans. The risk score reflects the relative health of the member and impacts the level of reimbursement from CMS, with a higher reimbursement for members with higher risk scores. The total adjustment for our 2007 membership reduced CMS expected payments by $5.2 million. The estimated risk corridor impact, which reduced the receivable from CMS, was approximately $3.6 million, resulting in a net reduction of receivables of $1.6 million. We allocated this amount to pre-acquisition and post acquisition periods to capture the portion of the adjustment impacting the opening purchase GAAP balance sheet. Based on our analysis, we determined that $1.2 million of the reduction related to periods preceding the acquisition and $0.4 million related to periods subsequent to the acquisition. We recorded the $1.2 million portion as an increase in goodwill and reported the $0.4 million portion as a reduction to third quarter revenues.

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After giving effect to the settlement and the final allocation adjustments discussed above, the excess of the purchase price over the fair value of net tangible assets acquired, adjusted for deferred income taxes, was approximately $610.2 million.

We expect the MemberHealth transaction to create significant strategic benefits, including the opportunity for us to build upon MemberHealth's successful pharmacy-centric business model through its ongoing alliance with the National Community Pharmacists Association, known as the NCPA, and to introduce additional value-oriented health products and services into the market.

To fund the cash required to close the transaction and to provide us with capital to support our organic growth, investment funds operated by Lee Equity Partners, LLC, Perry Capital, LLC, Union Square Partners Management, LLC, the successor to Capital Z Management, LLC, and Welsh, Carson, Anderson & Stowe X, L.P., acquired shares of our Series A and Series B preferred stock valued at $20 per equivalent share of our common stock. The preferred stock is convertible into shares of our common stock. We have the right to convert the shares of our Series B preferred stock to common stock, in the ratio of 100 share of common stock for each share of Series B preferred stock, from and after the first anniversary of the issuance of the shares of Series B preferred stock. We have issued notices to the holders of our Series B preferred stock informing them that we intend to convert the shares, and if not rescinded the conversion will become effective on November 24, 2008. As of November 5, 2008, there were 132,895 shares of Series B preferred stock outstanding, and these shares will be converted into 13,289,500 shares of our common stock. The preferred stock does not bear a dividend. See Note 8—Stockholders' Equity to the consolidated financial statements included elsewhere in this quarterly report on Form 10-Q, for additional information regarding the preferred stock. These funds invested a total of approximately $350 million, of which they funded $100 million in the second quarter of 2007, and the remainder effective September 21, 2007. We did not register the preferred stock under the Securities Act of 1933, as amended, and it may not be subsequently offered or sold by investors in the United States absent registration or an applicable exemption from the registration requirement.

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Results of Operations—Consolidated Overview

The following table reflects income before taxes from each of our segments and contains a reconciliation to reported net income:

		Three months ended September 30,						Nine Months ended September 30,

		2008			2007			2008			2007
		(In thousands)
Senior Managed Care—Medicare Advantage(1)		$	44,077		$	16,476		$	77,813		$	42,816
Medicare Part D(1)			49,196			23,595			30,210			37,782
Traditional Insurance(1)			3,099			5,052			6,268			8,395
Senior Administrative Services(1)			5,034			6,388			17,442			17,715
Corporate(1)			(12,125	)		(8,072	)		(26,911	)		(23,469	)
Net realized gains (losses) on investments			(12,141	)		(519	)		(54,434	)		1,122

Income before provision for income taxes(1)			77,140			42,920			50,388			84,361
	Provision for income taxes		28,328			15,775			19,208			30,581

Net income		$	48,812		$	27,145		$	31,180		$	53,780

Earnings per common share (diluted)		$	0.56		$	0.40		$	0.35		$	0.84

(1): We evaluate the results of operations of our segments based on income before realized gains 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) in the determination of net income. The schedule above reconciles our segment income before income taxes to net income in accordance with U.S. GAAP.

Three months ended September 30, 2008 and 2007

Net income for the three months ended September 30, 2008 was $48.8 million, or $0.56 per diluted share, compared to net income of $27.1 million, or $0.40 per diluted share for the three months ended September 30, 2007. We acquired MemberHealth on September 21, 2007 and our results for the three months ended September 30, 2008 reflect income of $42.0 million on MemberHealth's business, which is an increase of $36.0 million over the prior year quarter. The net income for the third quarter of 2008 includes realized investment losses of $12.1 million, relating primarily to the recognition of other-than-temporary impairments on investments, and income taxes of $28.3 million. Net income for the third quarter of 2007 includes realized investment losses, of $0.5 million, and income taxes of $15.8 million. Our effective tax rate was 36.7% for the third quarter of 2008, and 36.7% for the third quarter of 2007.

During the third quarter of 2008, our PFFS, HMO and Part D plans each had performed various reconciliations with CMS for 2007 Plan year activity. During the three months ended September 30, 2008, CMS provided an updated 2007 risk score revenue adjustment for our PFFS, HMO and Part D plans. In addition, CMS performed a PDE reconciliation with our HMO and Part D plans. Finally, CMS performed a true up of federal reinsurance related to the 2007 Part D payment reconciliation for

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PFFS. In the aggregate, the CMS 2007 reconciliations resulted in a net decrease to pre-tax income of $1.8 million for the period, as shown below (in millions):


2007 risk score revenue adjustment:
	Medicare Advantage—PFFS	0.7
	Medicare Advantage—HMO	4.1
	Part D	(1.2	)
2007 PDE reconciliation:
	Medicare Advantage—HMO	0.2
	Part D	(1.1	)
2007 Part D federal reinsurance true up:
	Medicare Advantage—PFFS	(4.5	)

		(1.8	)

Our Senior Managed Care—Medicare Advantage segment generated segment income before taxes of $44.1 million in the three months ended September 30, 2008, an increase of $27.6 million compared to the three months ended September 30, 2007, primarily due to $16.3 million of net positive 2007 developments in our PFFS business, a $4.1 million favorable variance related to the 2007 risk score adjustment recognized during the quarter as well as favorable 2008 PFFS and HMO results, partially offset by $3.5 million of start-up costs associated with the establishment of our PPO networks.

Our Medicare Part D income increased by $25.6 million, compared to the third quarter of 2007. We acquired MemberHealth on September 21, 2007 and our results for the three months ended September 30, 2008 reflect income of $42.0 million on MemberHealth's business, which is an increase of $36.0 million over the prior year quarter. This is due to the prior year quarter only reflecting the results of MemberHealth subsequent to the acquisition on September 21, 2007. This increase was partially offset by an $18.1 million decline in the earnings generated by the Prescription Pathway^SM business compared with the third quarter of 2007, primarily as a result of increases in prescription drug costs and changes in the calculation of the government risk corridor that changes the seasonality of reported amounts

Our Traditional Insurance segment income before taxes decreased by $2.0 million, compared to the third quarter of 2007, due primarily to decreased earnings on the specialty health and life insurance and annuity businesses, as compared to the third quarter of 2007, partially offset by slightly increased earnings on the Medicare supplement business. The declines were primarily due to lower investment income. The overall loss ratio for the segment was 76.8% for the quarter ended September 30, 2008, compared with 75.5% for the same period last year. Individual loss ratios for the quarter ended September 30, 2008 were 76.9% for Medicare supplement, compared with 73.3% for the same period last year. The increase was due to higher skilled nursing facility claims; 87.4% for specialty health, compared with 91.1% for the same period last year and 63.4% for life and annuity, compared with 67.4% for the same period last year.

Segment income before taxes for our Senior Administrative Services segment declined by $1.4 million, or 21%, to $5.0 million for the third quarter of 2008, as compared to the same period of 2007. This decrease is primarily the result of reduced levels of unaffiliated service fee revenues.

The loss from our Corporate segment increased by $4.1 million, or 50%, for the third quarter of 2008 compared to the third quarter of 2007. This was due primarily to increases in other parent company expenses, net of revenues, interest costs, and the cost of stock based compensation.

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Nine months ended September 30, 2008 and 2007

Net income for the nine months ended September 30, 2008 was $31.2 million, or $0.35 per diluted share, compared to net income of $53.8 million, or $0.84 per diluted share for the nine months ended September 30, 2007. The net income for the first nine months of 2008 includes realized investment losses of $54.4 million, relating primarily to the recognition of other-than-temporary impairment of investments, and income taxes of $19.2 million. Net income for the first nine months of 2007 includes realized investment gains, of $1.1 million, relating primarily to the gain on the sale of Peninsular, and income taxes of $30.6 million. Our effective tax rate was 38.1% for the first nine months of 2008, and 36.2% for the first nine months of 2007. Excluding realized losses, the effective tax rate for the first nine months of 2008 was 36.5%, compared to 36.3% for the same period in 2007.

Our Senior Managed Care—Medicare Advantage segment generated segment income before taxes of $77.8 million in the nine months ended September 30, 2008, an increase of $35.0 million compared to the same period in 2007, primarily due to growth in PFFS member months, $28.4 million of net positive 2007 developments in our PFFS business, a $4.1 million favorable variance related to the 2007 risk score adjustment recognized during the year as well as favorable 2008 PFFS and HMO results, partially offset by $6.3 million of start-up costs associated with the establishment of our PPO networks.

Our Medicare Part D income decreased by $7.6 million, compared to the first nine months of 2007. We acquired MemberHealth on September 21, 2007 and our results for the nine months ended September 30, 2008 reflect income of $13.8 million on MemberHealth's business, which is an increase of $7.9 million over the prior year period. In addition, the year to date earnings on Prescription Pathway^SM business decreased by $15.4 million compared with the first nine months of 2007, primarily as a result of increases in prescription drug costs and changes in the calculation of the government risk corridor that changes the seasonality of reported amounts.

Our Traditional Insurance segment income before taxes decreased by $2.1 million, compared to the first nine months of 2007, due to lower earnings on specialty health and life insurance and annuity businesses, partially offset by increased earnings on Medicare supplement business. The declines were primarily due to lower investment income. The overall loss ratio for the segment was 77.2% for the nine months ended September 30, 2008, compared with 75.6% for the same period last year. Individual loss ratios for the nine months ended September 30, 2008 were 76.6% for Medicare supplement, compared with 74.4% for the same period last year, due to higher skilled nursing facility claims; 89.4% for specialty health, compared with 88.8% for the same period last year and 64.8% for life and annuity, compared with 65.6% for the same period last year.

Segment income before taxes for our Senior Administrative Services segment decreased by $0.3 million, or 2%, to $17.4 million for the first nine months of 2008, as compared to the same period of 2007. This decrease is primarily the result of reduced levels of unaffiliated service fee revenues.

The loss from our Corporate segment increased by $3.4 million, or 15%, for the first nine months of 2008 compared to the first nine months of 2007. The increase was due primarily to an increase in interest costs, and the cost of stock based compensation, partially offset by lower other parent-company expenses, net of revenues.

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Segment Results—Senior Managed Care—Medicare Advantage

		Three months ended September 30,				Nine months ended September 30,

		2008		2007		2008		2007
		(In thousands)
Net premiums		$	610,734	$	522,276	$	1,791,862	$	1,389,224
Net investment and other income			4,810		7,418		13,550		16,661

	Total revenue		615,544		529,694		1,805,412		1,405,885

Medical expenses			488,136		438,603		1,493,222		1,163,604
Amortization of intangible assets			1,014		992		3,042		2,852
Commissions and general expenses			82,317		73,623		231,335		196,613

	Total benefits, claims and other deductions		571,467		513,218		1,727,599		1,363,069

Segment income before taxes		$	44,077	$	16,476	$	77,813	$	42,816

Our Senior Managed Care—Medicare Advantage segment includes the operations of our private fee-for-service business, known as PFFS, and our coordinated care plans, which we refer to as HMO's, which offer coverage to Medicare beneficiaries in southeastern Texas, north Texas, Oklahoma and Wisconsin. These businesses provide managed care for seniors under a contract with CMS. Our career and independent agents currently sell PFFS through American Progressive, Pyramid Life and Marquette in approximately 3,100 counties across 47 states. Our HMO products are sold by our career and independent agents and directly by employee representatives. In addition, beginning in 2008, this segment includes start up costs associated with the establishment of affiliated PPO organizations.

Three months ended September 30, 2008 and 2007

Nine months ended September 30, 2008 and 2007

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PFFS

		Three months ended September 30,				Nine months ended September 30,

		2008		2007		2008		2007
		(In thousands)
Net premiums		$	436,913	$	394,596	$	1,302,779	$	1,016,071
Net investment and other income			2,713		5,339		8,407		11,005

	Total revenue		439,626		399,935		1,311,186		1,027,076

Medical expenses			356,582		338,094		1,116,223		873,925
Commissions and general expenses			53,552		52,186		152,325		133,073

	Total benefits, claims and other deductions		410,134		390,280		1,268,548		1,006,998

Income before taxes		$	29,492	$	9,655	$	42,638	$	20,078

Membership. For a discussion of the accounting for Medicare Advantage policies, including PFFS, see Note 2 of the notes to the consolidated financial statements in our annual report on Form 10-K There are timing differences between the addition of members to our administrative system and the approval, or accretion, of the member by CMS before we are paid for the member by CMS. We analyze the membership in our administrative system and the enrollment provided by CMS. Due to the significant growth of the business and limited historical experience, we recognize these timing delays and that CMS may not approve the Medicare Beneficiary for enrollment in our plans. Although we are unable to precisely quantify the impact of any potential member change from that used in our consolidated financial results, we do not believe that any change from the amounts reported as of September 30, 2008 is likely to be material.

Three months ended September 30, 2008 and 2007

Revenues. Net premiums for the PFFS business increased by $42.3 million compared to the three months ended September 30, 2007, primarily due to an increase in the amount of premium earned per member partially offset by a reduction of revenues related to a slight decline in the number of member months and $4.5 million revenue decline due to a CMS true up of federal reinsurance related to final 2007 Part D payment reconciliation. The member months for the three months ended September 30, 2008 decreased to approximately 560,000 from approximately 580,000 for the three months ended September 30, 2007. Net investment and other income decreased by $2.6 million, due primarily to lower yields of invested assets as a result of a decline in short term interest rates.

Benefits, Claims and Expenses. Medical expenses increased by $18.5 million compared to the third quarter of 2007, primarily due to the increase in the amount of benefits incurred per member, partially offset by $20.8 million of positive 2007 reserve development. The PFFS medical loss ratio decreased to 81.6% for the third quarter of 2008 from 85.7% for the third quarter of 2007 primarily as a result of the positive development mentioned above. Backing out the impact of 2007 positive development, the medical loss ratio for the third quarter of 2008 was 87.5%. Commissions and general expenses increased by $1.4 million compared to the third quarter of 2007 as the result of an increase in general expenses and the write-off of uncollectible agents balances.

Nine months ended September 30, 2008 and 2007

Revenues. Net premiums for the PFFS business increased by $286.7 million compared to the nine months ended September 30, 2007, primarily due to growth in member months partially offset by a $4.5 million revenue decline due to a CMS true up of federal reinsurance related to final 2007 Part D payment reconciliation. Membership decreased to approximately 188,000 as of September 30, 2008 from

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approximately 190,000 as of September 30, 2007. However, the member months for the nine months ended September 30, 2008 increased to approximately 1,686,000 from approximately 1,460,000 for the nine months ended September 30, 2007 as a result of the timing of the effective date of membership for each period. Net investment and other income decreased by $2.6 million, due primarily to lower yields of invested assets as a result of a decline in short term interest rates.

Benefits, Claims and Expenses. Medical expenses increased by $242.3 million compared to the nine months ended September 30, 2007, primarily due to growth in member months. Year to date 2008 results include $32.9 million of positive prior period reserve development. The PFFS medical loss ratio decreased to 85.7% for the nine months ended September 30, 2008 from 86.0% for the nine months ended September 30, 2007. Backing out the the impact of 2007 positive development, the medical loss ratio for the first nine months of 2008 was 87.1%. Commissions and general expenses increased by $19.3 million compared to the nine months ended September 30, 2007, due primarily to the growth in business.

HMOs

		Three months ended September 30,				Nine months ended September 30,

		2008		2007		2008		2007
		(In thousands)
Net premiums		$	173,821	$	127,680	$	489,083	$	373,153
Net investment and other income			2,097		2,079		5,143		5,656

	Total revenue		175,918		129,759		494,226		378,809

Medical expenses			131,554		100,509		377,000		289,679
Amortization of intangible assets			1,014		992		3,042		2,852
Commissions and general expenses			25,230		21,437		72,693		63,540

	Total benefits, claims and other deductions		157,798		122,938		452,735		356,071

Income before taxes		$	18,120	$	6,821	$	41,491	$	22,738

Three months ended September 30, 2008 and 2007

Revenues. Net premiums for our HMOs increased by $46.1 million, or 36%, compared to the third quarter of 2007, primarily due to growth in membership combined with higher member risk scores, an increase in Part D corridor revenue and additional 2007 risk score revenue received during the quarter. Medicare membership increased to approximately 54,700 members at September 30, 2008 from approximately 47,400 at September 30, 2007.

Benefits, Claims and Expenses. Medical expenses increased by $31.0 million, or 31%, compared to the third quarter of 2007 driven primarily by growth in membership combined with higher claims costs associated with higher member risk scores. The member benefit ratio for the HMOs decreased to 75.7% for the third quarter of 2008, from 78.7% for the third quarter of 2007, due to improved revenue yields and a $4.1 million 2007 risk score adjustment recognized during the quarter. Commissions and general expenses, while increasing by $3.8 million compared to 2007, decreased as a percent of net premiums by 2.3% from 16.8% in the third quarter of 2007 to 14.5% in the third quarter of 2008.

Nine months ended September 30, 2008 and 2007

Revenues. Net premiums for our HMOs increased by $115.9 million, or 31%, compared to the first nine months of 2007. Approximately $104.4 million of the increase was due to the growth in

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Medicare membership along with higher member risk scores and additional 2007 risk score revenue received during the year . Medicare membership increased to approximately 54,700 members at September 30, 2008 from approximately 47,400 at September 30, 2007. Revenue from the commercial business in Oklahoma increased $11.5 million due to growth in membership and because the nine months ended September 30, 2007 included seven months of commercial operations whereas the nine months ended September 30, 2008 included a full nine months of operations.

Benefits, Claims and Expenses. Medical expenses increased by $87.3 million, or 30%, compared to the first nine months of 2007. Growth in Medicare membership added approximately $74.9 million and growth in commercial business added $10.0 million. The remaining $2.4 million was due to an increase in member risk scores offset by a decrease in utilization of member benefits. The member benefit ratio for the HMOs decreased to 77.1% for the first nine months of 2008, from 77.6% for the first nine months of 2007, as a result of a $4.1 million 2007 risk score adjustment recorded during the year and a decrease in utilization of member benefits. Commissions and general expenses, while increasing $9.2 million compared to 2007, decreased as a percent of net premiums by 2.1% from 17.0% in the first nine months of 2007 to 14.9% in the first nine months of 2008. The nine months ended September 30, 2007 also included start-up costs associated with the acquisition of members in new markets.

PPOs

		Three months ended September 30,					Nine months ended September 30,

		2008			2007		2008			2007
		(In thousands)
Net premiums		$	—		$	—	$	—		$	—
Net investment and other income			—			—		—			—

	Total revenue		—			—		—			—

Medical expenses			—			—		—			—
Amortization of intangible assets			—			—		—			—
Commissions and general expenses			3,535			—		6,316			—

	Total benefits, claims and other deductions		3,535			—		6,316			—

Loss before taxes		$	(3,535	)	$	—	$	(6,316	)	$	—

Three months ended September 30, 2008 and 2007

Expenses. Commissions and general expenses increased by $3.5 million compared to the third quarter of 2007 due to the costs of establishing the Local PPO networks.

Nine months ended September 30, 2008 and 2007

Expenses. Commissions and general expenses increased by $6.3 million compared to the nine months ended September 30, 2007 due to the costs of establishing the Local PPO networks.

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Segment Results—Medicare Part D

		Three months ended September 30,						Nine months ended September 30,

		2008			2007			2008			2007
		(In thousands)
Direct and assumed premium		$	516,453		$	178,283		$	1,570,611		$	450,025
Risk corridor adjustment/government reinsurance			(91,784	)		(62,917	)		91,140			(12,533	)

Direct and assumed premium after risk corridor adjustment			424,669			115,366			1,661,751			437,492
Ceded premiums			(51,869	)		(41,558	)		(231,283	)		(200,088	)

	Net premiums		372,800			73,808			1,430,468			237,404
Other Part D income—PDMS			20,448			12,788			51,781			39,111

Total Part D revenue			393,248			86,596			1,482,249			276,515
Net investment and other income			4,704			1,403			15,879			3,745

	Total revenue		397,952			87,999			1,498,128			280,260

Pharmacy benefits			292,887			50,969			1,292,481			210,140
Amortization of intangibles			4,012			403			12,011			403
Commissions and general expenses			51,857			13,032			163,426			31,935

	Total benefits, claims and other deductions		348,756			64,404			1,467,918			242,478

Segment income before taxes		$	49,196		$	23,595		$	30,210		$	37,782

On January 1, 2006, we began providing prescription drug benefits in accordance with Medicare Part D as a stand-alone benefit to Medicare eligible beneficiaries under our Prescription Pathway^SM PDPs. We reinsure 50% of the business of our Prescription Pathway^SM PDPs to PharmaCare Re.

Our participation, on a 33.3% basis, in an unaffiliated plan with Arkansas Blue Cross and Blue Shield and PharmaCare Re terminated as of January 1, 2008. Under the termination provisions of the contract, we received $0.8 million, an amount equal to two years of the estimated future profits generated by the block of business, which was recorded in the first quarter of 2008.

For a discussion of the accounting for Part D see Notes 2 and 15 of the notes to the consolidated financial statements in our annual report on Form 10-K. Our revenues and claims expense are based on earned premium and incurred pharmacy benefits for the reported enrolled membership. The membership information is subject to reconciliation and refinement with CMS with respect to the allocation among all plans participating in the Part D program and is an on-going process. As a result of the on-going reconciliation process, it is likely that the membership data upon which we based our results will change, with a corresponding change in the financial results for the segment. We are unable to precisely quantify the impact of any potential change until the membership data for specific time periods is fully reconciled with CMS, however, based upon our past experience, we do not believe that the effect of any change from the amounts reported as of September 30, 2008 is likely to be material.

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Other Part D income—PDMS represents our equity in the earnings of PDMS. We report this as revenue for segment reporting purposes in analyzing the ratio of net pharmacy benefits incurred because the amount is incorporated in the calculation of the risk corridor adjustment. For consolidated reporting, we reflect this amount as a separate line following income from continuing operations. See the reconciliation of segment revenues in Note 17 of the notes to the consolidated financial statements in this quarterly report on Form 10-Q.

Three months ended September 30, 2008 and 2007

Our Medicare Part D income increased by $25.6 million, compared to the third quarter of 2007. We acquired MemberHealth on September 21, 2007 and our results for the three months ended September 30, 2008 reflect income of $42.0 million on MemberHealth's business, which is an increase of $36.0 million over the prior year quarter. This is due to the prior year quarter only including the results of MemberHealth subsequent to the acquisition on September 21, 2007. This increase was partially offset by a decline in the earnings generated by the Prescription Pathway^SM business compared with the third quarter of 2007, primarily as a result of increases in prescription drug costs and changes in the calculation of the government risk corridor that changes the seasonality of reported amounts

Membership. At September 30, 2008, our total membership for Medicare Part D was 1,836,000 members compared to 1,638,000 members at September 30, 2007, an increase of 198,000 members or 12% over September 30, 2007. The increase is principally attributable to growth from open enrollment, and dual eligible members auto assigned to our plans in 2008. For Medicare Part D,^. we based our membership on enrollment information provided by CMS which indicated that, as of September 30, 2008, approximately 1,836,000 members were enrolled for which we were paid by CMS. At September 30, 2008, our Part D membership reflects approximately 1,309,000 members enrolled in our Community CCRx^SM PDP and 527,000 members enrolled in our Prescription Pathway^SM business, which we participate in on a 50% basis. Prior to January 1, 2008, we participated, on a 33.3% basis, in Arkansas BCBS which had approximately 24,000 members at September 30, 2007.

Revenues. Direct and assumed premium after risk corridor adjustment increased by $309.3 million, or 268%, compared to the third quarter of 2007. This growth resulted primarily from the acquisition of MemberHealth which generated $329.0 million of direct and assumed premium in the third quarter of 2008, which was an increase of $298.0 million over the same period of 2007. The MemberHealth premium includes $9.8 million of amortization of the below market contract liability recorded in connection with the MemberHealth acquisition. The change in the government risk corridor adjustment decreased revenue by an additional $28.9 million compared to the third quarter of 2007. The government risk corridor adjustment from MemberHealth for the third quarter of 2008 was a decrease in revenues of $50.1 million, compared with a decrease of $5.4 million for the same period of 2007. The government risk corridor adjustment from our Prescription Pathway^SM business decreased revenue $41.7 million for the three months ended September 30, 2008 compared to a decrease of $57.5 million for the same period in 2007. The 2008 amount reflects a $3.5 million risk corridor adjustment to reduce revenue related to the final 2007 CMS PDE reconciliation as well as a $0.9 million mid year revenue adjustment related to the 2007 plan year for Prescription Pathway^SM business.

Other Part D income—PDMS increased by $7.7 million compared to the third quarter of 2007 as a result of growth in business at Prescription Pathway^SM and increased revenue rates. Net investment and other income increased by $3.3 million principally as a result of the inclusion of revenue earned by MemberHealth for third party services, partially offset by lower rates of return on investments.

Benefits, Claims and Expenses. Pharmacy benefits increased by $241.9 million compared to the third quarter of 2007. The MemberHealth business generated $242.9 million of benefits in the quarter, which was an increase of $221.8 million over the prior year quarter. 2008 benefits reflect a $2.0 million

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reduction related to the final 2007 CMS PDE reconciliation for MemberHealth. Pharmacy benefits for our Prescription Pathway^SM business increased by $20.1 million or 67.6% over the third quarter of 2007. The ratio of incurred prescription drug benefits to net premium in 2008 for Prescription Pathway^SM was 73.2% compared to 53.3% for 2007 primarily as a result of the impact in 2008 of the negative 2007 revenue adjustments discussed above as well as increased benefits. Amortization of intangibles increased $3.6 million as the result of amortization of intangible assets recorded in connection with the acquisition of MemberHealth. Commissions and general expenses increased by $38.8 million compared to the third quarter of 2007. MemberHealth added $41.0 million during the quarter, which was an increase of $37.4 million over the prior year quarter. The balance of the increase of $1.4 million relates to the growth in our Prescription Pathway^SM business.

Nine months ended September 30, 2008 and 2007

Membership. At September 30, 2008, our total membership for Medicare Part D was 1,836,000 members compared to 1,638,000 members at September 30, 2007, an increase of 198,000 members or 12% over September 30, 2007. The increase is principally attributable to growth from open enrollment, and dual eligible members auto assigned to our plans in 2008. For Medicare Part D, we based our membership on enrollment information provided by CMS which indicated that, as of September 30, 2008, approximately 1,836,000 members were enrolled. for which we were paid by CMS. At September 30, 2008, our Part D membership reflects approximately 1,309,000 members enrolled in our Community CCRx^SM PDP and 527,000 members enrolled in our Prescription Pathway^SM business, which we participate in on a 50% basis. Prior to January 1, 2008, we participated, on a 33.3% basis, in Arkansas BCBS which had approximately 24,000 members at September 30, 2007.

Revenues. Direct and assumed premium after risk corridor adjustment increased by $1,224.3 million, or 280%, compared to the first nine months of 2007. This growth resulted primarily from the acquisition of MemberHealth which generated $1,223.7 million of direct and assumed premium for the nine months ended September 30, 2008. The MemberHealth premium includes $29.5 million of amortization of the below market contract liability recorded in connection with the MemberHealth acquisition. The change in the government risk corridor adjustment increased revenue by an additional $103.7 million compared to the nine months ended September 30, 2007. The government risk corridor adjustment from MemberHealth for the nine months ended September 30, 2008 was an increase in revenues of $74.7 million, which was an increase of $80.1 million over the prior year as we acquired MemberHealth on September 21, 2007. The government risk corridor adjustment from our Prescription Pathway^SM business increased revenue $16.5 million for the nine months ended September 30, 2008 compared to a decrease of $7.1 million for the same period in 2007. 2008 revenues reflect a $3.9 million reduction related to the final 2007 CMS PDE reconciliation for Prescription Pathway^SM business.

Other Part D income—PDMS increased by $12.7 million compared to the first nine months of 2007 as a result of growth in business at Prescription Pathway^SM and increased revenue rates. Net investment and other income increased by $12.1 million principally as a result of the inclusion of revenue earned by MemberHealth for third party services, partially offset by lower rates of return on investments.

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Benefits, Claims and Expenses. Pharmacy benefits increased by $1,082.3 million compared to the first nine months of 2007. The MemberHealth business generated $1,069.0 million of benefits for the nine months ended September 30, 2008, which was an increase of $1,047.8 million over the prior year period due to the acquisition of MemberHealth on September 21, 2007. 2008 benefits reflect a $2.0 million reduction related to the final 2007 CMS PDE reconciliation for MemberHealth. Pharmacy benefits for our Prescription Pathway^SM business increased by $34.5 million or 18% over the first nine months of 2007. The ratio of incurred prescription drug benefits to net premium for Prescription Pathway^SM was 82.5% compared to 76.9% for 2007 primarily as a result of the impact in 2008 of the negative 2007 revenue adjustments discussed above as well as increased benefits. Amortization of intangibles increased $11.6 million as the result of amortization of intangible assets recorded in connection with the acquisition of MemberHealth. Commissions and general expenses increased by $131.5 million, compared to the first nine months of 2007. MemberHealth added $132.4 million during 2008 which was an increase of $128.9 over the prior year. The balance of the increase of $2.6 million relates to the growth in our Prescription Pathway^SM business.

Segment Results—Traditional Insurance

			Three months ended September 30,						Nine months ended September 30,

			2008			2007			2008			2007
			(In thousands)
Premiums:
	Direct and assumed		$	130,197		$	231,320		$	575,939		$	692,528
	Ceded			(33,562	)		(123,196	)		(275,516	)		(356,584	)

		Net premiums		96,635			108,124			300,423			335,944
Net investment income				14,232			18,351			45,421			53,714
Other income				308			167			907			1,150

		Total revenue		111,175			126,642			346,751			390,808
Policyholder benefits				74,262			81,651			231,903			254,111
Interest credited to policyholders				3,572			4,265			11,094			13,292
Change in deferred acquisition costs				1,595			1,562			12,394			13,549
Amortization of intangible assets				796			876			2,411			2,778
Commissions and general expenses, net of allowances				27,851			33,236			82,681			98,683

		Total benefits, claims and other deductions		108,076			121,590			340,483			382,413

Segment income before taxes			$	3,099		$	5,052		$	6,268		$	8,395

Three months ended September 30, 2008 and 2007

Our Traditional Insurance segment income before taxes decreased by $2.0 million compared to the third quarter of 2007, due primarily to decreased earnings on the specialty health and life insurance and annuity businesses, partially offset by slightly increased earnings on the Medicare supplement business. The declines were primarily due to lower investment income. The overall loss ratio for the segment was 76.8% for the quarter ended September 30, 2008, compared with 75.5% for the same period last year, due to higher skilled nursing facility claims. Individual loss ratios for the quarter ended September 30, 2008 were 76.9% for Medicare supplement, compared with 73.3% for the same period last year; 87.4% for specialty health, compared with 91.1% for the same period last year and 63.4% for life and annuity, compared with 67.4% for the same period last year.

Revenues. Net premium declined by $11.5 million, or 11%, primarily caused by the continued effect of lapsation of our Medicare supplement in force products. Gross premium for Specialty health

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declined in the third quarter of 2008 compared to the same period of 2007 as the result of the termination of a reinsurance arrangement with PharmaCare Re. Below is a summary of premium for the segment by major lines of business:

Premium

		Three months ended September 30,

		2008							2007
		Gross		Ceded			Net		Gross		Ceded			Net
		(In thousands)
Medicare supplement		$	91,007	$	(24,116	)	$	66,891	$	104,492	$	(28,734	)	$	75,758
Specialty health			19,740		(3,199	)		16,541		107,451		(89,286	)		18,165
Life insurance and annuity			19,450		(6,247	)		13,203		19,377		(5,176	)		14,201

	Total premium	$	130,197	$	(33,562	)	$	96,635	$	231,320	$	(123,196	)	$	108,124

Net investment income decreased by $4.1 million as a result of lower invested assets caused by less business in force as well as lower interest rates.

Benefits, Claims and Expenses. Policyholder benefits incurred declined by $7.4 million, or 9%, compared to the third quarter of 2007. This decline was principally caused by a net reduction in Medicare supplement benefits of $4.1 million as a result of a decline in the business partially offset by an increase in the loss ratio to 76.9% for the third quarter of 2008 from 73.3% for the same period last year, driven by an increase in skilled nursing facility claims.

Change in deferred acquisition costs was flat with the third quarter of 2007.

Commissions and general expenses, net of allowances, decreased by $5.4 million, or 16%, compared to the third quarter of 2007. The following table details the components of commission and general expenses, net of allowances:

	Three months ended September 30,

	2008			2007
	(In thousands)
Commissions	$	15,313		$	21,708
Other operating costs		20,030			21,480
Reinsurance allowances		(7,492	)		(9,952	)

Commissions and general expenses, net of allowances	$	27,851		$	33,236

The lower level of commissions is associated with the continued aging of our in force renewal premium and less new business production that has higher commission rates. Other operating costs declined $1.5 million for the quarter ended September 30, 2008, compared to the third quarter of 2007. Allowances received from reinsurers decreased $2.5 million for the third quarter of 2008 from the third quarter of 2007, primarily due to the reduction in new business ceded and the effects of normal lower commission allowances on our aging base of ceded renewal business and the termination of a reinsurance arrangement with PharmaCare Re.

Nine months ended September 30, 2008 and 2007

Our Traditional Insurance segment income before taxes decreased by $2.1 million compared to the first nine months of 2007, due to lower earnings on specialty health and life insurance and annuity businesses, partially offset by increased earnings on Medicare supplement business. The declines were primarily due to lower investment income. The overall loss ratio for the segment was 77.2% for the

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nine months ended September 30, 2008, compared with 75.6% for the same period last year. Individual loss ratios for the nine months ended September 30, 2008 were 76.6% for Medicare supplement, compared with 74.4% for the same period last year, due to higher skilled nursing facility claims; 89.4% for specialty health, compared with 88.8% for the same period last year and 64.8% for life and annuity, compared with 65.6% for the same period last year.

Revenues. Net premium declined by $35.5 million or 11% and was primarily caused by the continued effect of lapsation of our Medicare supplement in force products. Below is a summary of premium for the segment by major lines of business:

		Nine months ended September 30,

		2008							2007
		Gross		Ceded			Net		Gross		Ceded			Net
		(In thousands)
Medicare supplement		$	285,016	$	(76,460	)	$	208,556	$	326,790	$	(90,352	)	$	236,438
Specialty health			232,611		(181,433	)		51,178		307,211		(251,322	)		55,889
Life insurance and annuity			58,312		(17,623	)		40,689		58,527		(14,910	)		43,617

	Total premium	$	575,939	$	(275,516	)	$	300,423	$	692,528	$	(356,584	)	$	335,944

Net investment income decreased by $8.3 million as a result of less invested assets caused by less business in force as well as lower interest rates.

Benefits, Claims and Expenses. Policyholder benefits incurred declined by $22.2 million, or 9%, compared to the first nine months of 2007. This decline was principally caused by a net reduction in Medicare supplement benefits of $16.4 million as well as declines in the levels of Specialty Health and Life and Annuity benefits as a result of a decline in the business partially offset by an increase in the Medicare Supplement loss ratio to 76.6% for the first nine months of 2008 from 74.4% for the same period last year.

Change in deferred acquisition costs decreased $1.2 million compared to the first nine months of 2007, primarily as a result of a lower level of lapsation of our Medicare supplement in force business principally occurring during the first three months of each year.

Commissions and general expenses, net of reinsurance allowances, decreased by $16.0 million, or 16%, compared to the first nine months of 2007. The following table details the components of commission and other operating expenses, net of allowances:

	Nine months ended September 30,

	2008			2007
	(In thousands)
Commissions	$	48,045		$	65,863
Other operating costs		59,559			63,575
Reinsurance allowances		(24,923	)		(30,755	)

Commissions and general expenses, net of allowances	$	82,681		$	98,683

The lower level of commissions is associated with the continued aging of our in force renewal premium and less new business production, which has higher commission rates. Other operating costs were $4.0 million lower for the first nine months of 2008 compared to the first nine months of 2007 as a result of lower acquisition expenses due to less new business production and lower fixed costs. Reinsurance allowances received from reinsurers decreased $5.8 million for the first nine months of 2008 from the first nine months of 2007, primarily due to the non-renewal of the State of Connecticut agreement with PharmaCare Re on July 1, 2008 as well as a reduction in new business ceded and the

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effects of normal lower commission allowances on our aging base of ceded renewal business and the termination of a reinsurance arrangement with PharmaCare Re.

Segment Results—Senior Administrative Services

			Three months ended September 30,				Nine months ended September 30,

			2008		2007		2008		2007
			(In thousands)
Affiliated fee revenue
	Medicare supplement		$	4,541	$	5,698	$	14,919	$	17,925
	Part D			6,909		6,249		20,930		18,584
	PFFS			—		5,293		—		13,004
	Long term care			756		538		1,883		1,737
	Life insurance			1,340		561		3,081		1,511
	Other			1,571		2,313		5,170		6,392

		Total affiliated revenue		15,117		20,652		45,983		59,153

Unaffiliated fee revenue
	Medicare Advantage			2,721		2,813		9,935		7,879
	Medicare supplement			1,299		1,419		4,176		4,435
	Long term care			1,448		1,776		4,445		5,368
	Non-insurance products			198		272		676		1,079
	Part D			—		324		200		1,120
	Other			40		33		122		115

		Total unaffiliated revenue		5,706		6,637		19,554		19,996

		Total revenue		20,823		27,289		65,537		79,149

Amortization of present value of future profits				92		110		275		330
General expenses				15,697		20,791		47,820		61,104

		Total expenses		15,789		20,901		48,095		61,434

Segment income before taxes			$	5,034	$	6,388	$	17,442	$	17,715

Unaffiliated revenue reflects fees received to administer certain business of our insurance subsidiaries that is 100% reinsured to an unaffiliated reinsurer. These fees amounted to $0.6 million and $0.8 million for the three months ended September 30, 2008 and 2007, respectively and $1.8 million and $2.2 million for the nine months ended September 30, 2008 and 2007, respectively. In 2007 we performed administrative functions for the affiliated PFFS line that the affiliated entities perform directly in 2008. We eliminated these fees, together with the affiliated revenue, in consolidation.

Three months ended September 30, 2008 and 2007

Revenue declined by $6.4 million, or 24%, during the third quarter of 2008 compared to the third quarter of 2007. Affiliated service fee revenue decreased by $5.5 million primarily as a result of the loss of fee income associated with the administration of our PFFS business that is performed directly by the affiliated entities in 2008. Unaffiliated service fee revenue decreased by $0.9 million, due primarily to a decrease in services performed for unaffiliated Medicare Advantage, Part D and long term care

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business. General expenses for the segment decreased by $5.1 million, or 25%, primarily due to the decline of the affiliated PFFS business.

Nine months ended September 30, 2008 and 2007

Revenue declined by $13.6 million, or 17%, during the first nine months of 2008 compared to the first nine months of 2007. Affiliated service fee revenue decreased by $13.2 million primarily as a result of the loss of fee income associated with the administration of our PFFS business that our affiliated entities performed directly in 2008 and a decline in Medicare supplement revenues on a smaller book of business partially offset by an increase in Part D revenues on a growing block of business. Unaffiliated service fee revenue decreased by $0.4 million, due primarily to a decrease in services performed for unaffiliated Medicare Advantage, Part D and long term care business. General expenses for the segment decreased by $13.3 million, or 22%, primarily due to the decline of the affiliated PFFS business.

Segment Results—Corporate

The following table presents the primary components comprising the loss from the segment:

		Three months ended September 30,				Nine months ended September 30,

		2008		2007		2008		2007
		(In thousands)
Interest expense		$	5,699	$	4,869	$	17,794	$	13,232
Amortization of capitalized loan origination fees			262		327		786		895
Early extinguishment of debt			—		913		—		913
Stock-based compensation expense			1,541		1,038		4,778		3,145
Other parent company expenses, net of revenues			4,623		925		3,553		5,284

	Segment loss before taxes	$	12,125	$	8,072	$	26,911	$	23,469

Three months ended September 30, 2008 and 2007

The increase in interest cost of $0.8 million is due primarily to the increase in our debt outstanding, offset in part by a reduction in the interest rates charged on the debt, as compared to the third quarter of 2007. While our combined outstanding debt decreased by $43.5 million to $431.5 million at September 30, 2008 from $475.0 million at September 30, 2007, the balance at September 30, 2007 had increased significantly from $262.9 million at June 30, 2007, due primarily to the refinancing of our credit facility in connection with the acquisition of MemberHealth in September 2007. The weighted average interest rate on our loan payable was 4.6% for the third quarter of 2008 compared to 7.3% for the third quarter of 2007. The weighted average interest rate on our other long term debt was 7.3% for the third quarter of 2008 compared to 7.9% for the third quarter of 2007. See "Liquidity and Capital Resources" for additional information regarding our loan payable and other long term debt.

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The increase in stock-based compensation resulted primarily from option awards, in the second half of 2007 and the first half of 2008, to officers and other employees approved by the compensation committee.

The increase in other parent company expenses, net of revenues was primarily due to a decrease in net investment income, an increase in the costs of restricted stock awards, legal fees associated with the defense and settlement of a shareholder's lawsuit and other, individually insignificant, unfavorable expense variances.

Nine months ended September 30, 2008 and 2007

The loss from our Corporate segment increased by $3.4 million, or 15%, for the first nine months of 2008 compared to the first nine months of 2007. The improvement was due primarily to an increase in interest costs, and the cost of stock based compensation, partially offset by lower other parent-company expenses, net of revenues.

The increase in interest cost of $4.6 million is due primarily to the increase in the average balance of our debt outstanding, offset in part by a reduction in the interest rates charged on the debt, as compared to the first six months of 2007. While our combined outstanding debt decreased by $43.5 million to $431.5 million at September 30, 2008 from $475.0 million at September 30, 2007, the balance at September 30, 2007 had increased significantly from $262.9 million at June 30, 2007, due primarily to the refinancing of our credit facility in connection with the acquisition of MemberHealth in September 2007. The weighted average interest rate on our loan payable was 4.6% for the first nine months of 2008 compared to 7.3% for the first nine months of 2007. The weighted average interest rate on our other long term debt was 7.5% for the first nine months of 2008 compared to 7.8% for the first nine months of 2007. See "Liquidity and Capital Resources" for additional information regarding our loan payable and other long term debt.

The decrease in other parent company expenses, net of revenues was primarily due to the reversal of a 2007 bonus accrual that was $5.6 million in excess of the final amounts approved by the compensation committee and paid in 2008 and an increase of $0.3 million in net investment income, partially offset by an increase in the costs of restricted stock awards, legal fees associated with the defense and settlement of a shareholder's lawsuit and other, individually insignificant, unfavorable expense variances.

Liquidity and Capital Resources

We use our capital primarily to support the retained risks and growth of our insurance company subsidiaries and HMOs and to support our parent company as an insurance holding company. In addition, we use capital to fund our growth through acquisitions of other companies, blocks of insurance or administrative service business.

We require cash at our parent company to meet our obligations under our credit facility. We also require cash to pay the operating expenses necessary to function as a holding company, as applicable insurance department regulations require us to bear our own expenses, and to meet the costs of being a public company.

We believe that our current cash position, the expected cash flows of our administrative service company and our senior managed care company, our PBM business in MemberHealth and the surplus note interest and principal payments from our American Exchange subsidiary can support our current

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parent company obligations. However, there can be no assurance as to our actual future cash flows or to the continued availability of dividends from our insurance company subsidiaries.

To provide the cash and capital for our insurance company subsidiaries to support our growth and expansion initiatives in Medicare Advantage, we have used the proceeds from the sale of our Canadian operations and proceeds from the issuance of debt, equity and trust preferred securities. There can be no assurance as to our continued ability to access funds though the capital markets to support our growth and expansion initiatives.

2007 Credit Facility

In connection with the MemberHealth transaction, as described in Note 4—Business Combinations to our consolidated financial statements set forth above, we refinanced our credit facility with a new credit facility consisting of a $350 million term loan and a $150 million revolver. We used a portion of the proceeds from the refinancing to repay in full the amounts outstanding on the previous credit facility. Interest under the new credit facility is currently based on LIBOR plus a spread of 62.5 basis points. In addition, we currently pay a commitment fee on the unutilized revolving loan facility at an annualized rate of 10.0 basis points. In accordance with the credit agreement for the new credit facility, the spread and fee are determined based on our consolidated leverage ratio. Effective September 30, 2008, the interest rate on the term loan portion of the new credit facility was 3.42%. We had not drawn on the revolving loan facility as of the date of this report. As a result of the value to be received pursuant to the settlement agreement discussed in Significant Transactions and Initiatives, on April 23, 2008 we prepaid $25 million of principal under the new facility, under an approved waiver.

Our Heritage Health Systems and MemberHealth subsidiaries have guaranteed our obligations under the new credit facility. In addition, when a "rating condition" exists whereby we are either no longer rated by S&P or our rating falls below BBB-, this facility is secured by a pledge of substantially all of the equity interests of each of our Heritage Health Systems, American Exchange and MemberHealth subsidiaries. In March 2008, S&P reduced our rating to BB+, which constituted a rating condition that triggered this added security requirement.

Our new credit facility requires us and our subsidiaries to meet specified financial tests requiring that we maintain a minimum consolidated leverage ratio and a minimum risk based capital. Our new credit facility also contains covenants, which among other things, under specified conditions, limit

•: the incurrence of liens or additional indebtedness;
•: investments;
•: fundamental changes such as mergers, dissolution, consolidation, disposition of assets;
•: restricted payments such as dividends by us;
•: changing the nature of our business;
•: transactions with affiliates;
•: limitations on dividends by subsidiaries and other burdensome arrangements;
•: use of proceeds;
•: amendments of organization documents;
•: prepayments of other indebtedness;
•: restricted subsidiaries; and
•: other matters customarily restricted in such agreements.

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Our new credit facility contains customary events of default, such as, among other things,

•: payment defaults;
•: breach of covenants or representations and warranties;
•: cross-defaults to certain other indebtedness;
•: certain events of bankruptcy and insolvency;
•: judgment defaults; and
•: change of control.

We incurred additional loan origination fees of approximately $4.7 million, which we capitalized and are amortizing on a straight-line basis, which does not differ significantly from the effective yield basis, over the life of the new credit facility. The early extinguishment of our old credit facility triggered the immediate amortization of the related capitalized loan origination fees, resulting in a pre-tax expense of approximately $0.9 million during the third quarter of 2007.

Under the terms of the new credit facility, we must make principal repayments quarterly at the rate of $3.5 million per year over a five-year period and a final payment of $308.4 million due upon maturity in September, 2012. The following table shows the schedule of principal payments remaining on the new credit facility as of June 30, 2008, including the $25 million prepayment, discussed above.

	2007 Credit Facility

	(in thousands)
2008	$	875
2009		3,500
2010		3,500
2011		3,500
2012		310,125

	$	321,500

Interest Rate Swap

On December 4, 2007, we entered into two separate interest rate swap agreements, one with Citibank, N.A. and one with Calyon Corporate and Investment Bank to hedge the variability of cash flows for interest payments on a total notional amount of $250 million of our new credit facility. In entering the swap with Citibank, we agreed to swap our floating rate interest payment based on the floating LIBOR base rate on a notional amount of $125 million in exchange for a fixed interest rate payment based on a 4.14% locked in fixed rate. In entering the swap with Calyon, we agreed to swap our floating rate interest payment based on the floating LIBOR base rate on a notional amount of $125 million in exchange for a fixed interest rate payment based on a 4.13% locked in fixed rate.

Short Term Facility

On January 18, 2007, we requested and received from the administrative agent for the lenders under our old credit facility and revolving credit facility, an additional short-term revolving credit facility of $50.0 million. On March 13, 2007, we drew all $50.0 million of the new short-term revolving credit facility. This new short-term revolving credit facility had a maturity date of September 30, 2007 and bore interest at a spread of 75 basis points over the LIBOR rate. The initial rate was 6.1%. On July 18, 2007, we repaid the $50.0 million balance on this revolving credit facility, including accrued interest of $0.3 million.

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Principal and Interest Payments

We made regularly scheduled principal payments of $2.6 million during the nine months ended September 30, 2008. In addition, we made a $25 million prepayment on April 23, 2008 in connection with an approved waiver as discussed above. During the nine months ended September 30, 2007, we made regularly scheduled principal payments of $2.6 million and fully repaid the balance of $87.9 million on our old Credit Facility in connection with the refinancing described above.

We paid interest of $10.8 million during the nine months ended September 30, 2008 and $6.2 million during the nine months ended September 30, 2007 in connection with our credit facilities. Due to the variable interest rate on the new credit facility, the portion not covered by the interest rate swaps would be subject to higher interest costs to us if short term interest rates rise.

Other Long Term Debt

We have formed statutory business trusts, which exist for the exclusive purpose of issuing trust preferred securities representing undivided beneficial interests in the assets of the trust, investing the gross proceeds of the trust preferred securities in junior subordinated deferrable interest debentures of our parent holding company and engaging in only those activities necessary or incidental thereto. In accordance with the adoption of FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities," we do not consolidate the trusts.

In late March, 2007, we issued $50.0 million of trust preferred securities at a fixed interest rate of 7.7% pursuant to terms similar to our other trust preferred securities. On December 4, 2007, we exercised our option to redeem all $15.0 million of the trust preferred securities scheduled to mature December 2032.

Separate subsidiary trusts of our parent holding company have issued a combined $125.0 million in thirty year trust preferred securities, with $110 million currently outstanding as detailed in the following table:

Maturity Date	Amount Issued		Term	Spread Over LIBOR

	(In thousands)			(Basis points)
April 2033	$	10,000	Floating		400		6.8	%
May 2033		15,000	Floating		420		7.0	%
May 2033		15,000	Fixed/Floating		410	(1)	6.9	%
October 2033		20,000	Fixed/Floating		395	(2)	7.0	%
March 2037		50,000	Fixed/Floating		275	(3)	7.7	%

	$	110,000

(1): The rate on this issue was fixed at 7.4% for the first five years. On May 15, 2008 the rate converted to a floating rate equal to LIBOR plus 410 basis points.
(2): Effective April 29, 2004, we entered into a swap agreement whereby we will pay a fixed rate of 6.98% in exchange for a floating rate of LIBOR plus 395 basis points. The swap contract expires in October 2008.
(3): The rate on this issue is fixed at 7.7% for the first five years. On March 23, 2012, the rate will convert to a floating rate equal to LIBOR plus 275 basis points.

We paid $6.3 million in interest in connection with the junior subordinated debt during the nine months ended September 30, 2008 and $6.3 million during the nine months ended September 30, 2007.

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Sources of Liquidity to the Parent Company

We anticipate funding the obligations of our parent company and the capital required to grow our business from the following distinct and uncorrelated sources of cash flow within the organization:

•: the expected cash flows of our senior administrative services company;
•: the expected cash flows of our senior managed care company;
•: the expected cash flows of our MemberHealth subsidiary; and
•: surplus note principal and interest payments from American Exchange.

As of September 30, 2008, the parent company had readily available cash of $141 million. In addition, we have access to funds under existing credit facilities. We have $150.0 million available under the revolving portion of our new credit facility.

We also have the ability, from time to time, to access the capital markets for additional capital. In March 2007, we issued $50 million of trust preferred securities. In addition, in connection with the May 8, 2007 announcement of the signing of definitive agreements to acquire MemberHealth as described in Note 4—Business Combinations of the notes to the consolidated financial statements included in this quarterly report on Form 10-Q, we issued preferred stock for aggregate proceeds of $350 million, at $20 per common equivalent share, to four private equity investment fund groups. We also issued $100 million of preferred stock during the second quarter of 2007 and the balance in September 2007. There can be no assurance as to our actual future cash flows from the continued availability of dividends from our insurance company subsidiaries or from access to the capital markets to support our growth and expansion initiatives. In addition, we are reviewing other sources of liquidity that may be available to us at equivalent or lower interest rates.

Senior Administrative Services Company. Liquidity for our senior administrative services subsidiary is measured by its ability to pay operating expenses and pay dividends to our parent company. The primary source of liquidity is fees collected from clients. We believe that the sources of cash for our senior administrative services company exceed scheduled uses of cash and will result in amounts being available to pay dividends to our parent holding company.

Senior Managed Care Company. Liquidity for our managed care company is measured by its ability to pay operating expenses and pay dividends to our parent company. The primary source of liquidity is management fees for administration of our health plan affiliates and services provided to the IPA's. Dividend payments by our HMO affiliates to our Heritage subsidiary are subject to the approval of the insurance regulatory authorities of our HMO affiliates' respective states of domicile. Our SCOT subsidiary is not able to pay dividends during 2008 without prior approval.

MemberHealth. Liquidity for our MemberHealth subsidiary is measured by its ability to pay operating expenses and pay dividends to our parent company. The primary source of liquidity is fees collected from clients. We believe that the sources of cash for our MemberHealth subsidiary exceed scheduled uses of cash and results in amounts available to dividend to our parent holding company.

Insurance Subsidiaries—Surplus Note, Dividends and Capital Contributions. Cash generated by our insurance company subsidiaries will be made available to our holding company, principally through periodic payments of principal and interest on the surplus note owed to our holding company by our American Exchange subsidiary. As of September 30, 2008, the principal amount of the surplus note was $8.6 million. The note bears interest to our parent holding company at 25 basis points over the interest rate on the new credit facility. We anticipate that the surplus note will be primarily serviced by dividends from Pennsylvania Life, a wholly owned subsidiary of American Exchange and by distributions from PDMS, and by tax-sharing payments among the insurance companies that are wholly owned by American Exchange and are included in the consolidated federal income tax return filed by

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American Exchange. American Exchange made principal payments totaling $9.0 million during the nine months ended September 30, 2008 and $7.0 million during the nine months ended September 30, 2007. American Exchange paid interest on the surplus note of $0.5 million during the nine months ended September 30, 2008 and $1.6 million during the nine months ended September 30, 2007.

On June 29, 2007 and December 31, 2007, our Pyramid subsidiary issued two $30.0 million surplus notes payable to our parent holding company. The notes are repayable through annual principal payments beginning March 29, 2009, based on a schedule, provided that capital and surplus are sufficient to maintain risk based capital levels of 450% or greater. The surplus notes can be pre-paid, with prior approval by the State of Kansas to the extent that Pyramid's risk based capital levels exceed 450%. The notes bear interest to our parent holding company at fixed rates of 7.7% and 7.3%, respectively, for the term of the notes.

Dividend payments by our insurance companies to our parent holding company or to intermediate subsidiaries are limited by, or subject to the approval of the insurance regulatory authorities of each insurance company's state of domicile. These dividend requirements and approval processes vary significantly from state to state. Pennsylvania Life is able to pay ordinary dividends of up to $51.1 million to its direct parent American Exchange and American Exchange is able to pay ordinary dividends of up to $26.1 million to Universal American in 2008 without the prior approval from the insurance department for either of their respective states of domicile.

Our parent holding company made capital contributions to American Exchange amounting to $81.0 million during 2007. American Exchange made capital contributions of $44.0 million to American Progressive, $32.0 million to Pyramid and $5 million to Marquette during 2007. In December 2007, Pennsylvania Life declared and paid a dividend in the amount of $21.0 million to American Exchange. From these proceeds, American Exchange made an additional capital contribution of $20.0 million to Pyramid. American Exchange made a capital contribution of $7.0 million to Pyramid in the second quarter of 2008

Insurance Subsidiaries—Liquidity

Liquidity for our insurance company subsidiaries is measured by their ability to pay scheduled contractual benefits, pay operating expenses, fund investment commitments, and pay dividends to their parent company. The principal sources of cash for our insurance operations are

•: scheduled and unscheduled principal and interest payments on investments,
•: premium payments,
•: annuity deposits, and
•: the sale or maturity of investments.

Both the sources and uses of cash are reasonably predictable and we believe that these sources of cash for our insurance company subsidiaries exceed scheduled uses of cash.

Liquidity is also affected by unscheduled benefit payments such as

•: benefits under accident and health insurance policies,
•: death benefits and
•: interest-sensitive policy surrenders and withdrawals.

Our accident and health insurance policies generally provide for fixed-benefit amounts and, in the case of Medicare supplement policies, for supplemental co-payments in accordance with approved Medicare provider rates. Some of these benefits are subject to medical-cost inflation and we have the capability to file for premium rate increases to mitigate rising medical costs. Prescription drug benefits

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under Part D plans may vary in terms of coverage levels and out-of-pocket costs for beneficiary premiums, deductibles and co-insurance. However, all Part D plans must offer either "standard coverage" or its actuarial equivalent, with out-of-pocket threshold and deductible amounts that do not exceed those of standard coverage. These defined "standard" benefits represent the minimum level of benefits mandated by Congress. We also offer other PDPs containing benefits in excess of standard coverage limits for an additional beneficiary-paid premium. Our PDPs receive monthly payments from CMS which generally represent our bid amount for providing insurance coverage. Due to the nature of the benefit design, where the PDP is covering the initial deductibles, Part D benefit costs will exceed these monthly CMS payments resulting in negative cash flows in the early part of the year. As beneficiaries reach deductibles and we share benefit costs with the plan members, the resulting cash flows match more evenly and eventually turn positive, so that monthly plan receipts exceed the benefit costs in the latter part of the year. The Part D benefit costs are subject to risk corridor adjustment, which permits our PDPs and CMS to share the risk associated with the ultimate costs of the Part D benefit. However, the cash settlement for the risk corridor adjustment does not occur until well into the following year. Our Medicare Advantage policies provide benefits to Medicare enrollees as specified in our contracts with CMS, with premiums received from CMS and, depending on the individual product, from the enrollee. Our health insurance business is widely dispersed in the United States, which mitigates the risk of unexpected increases in claim payments due to epidemics and events of a catastrophic nature. These accident and health polices are not interest-sensitive and therefore are not subject to unexpected policyholder redemptions due to investment yield changes.

Some of our life insurance and annuity policies are interest-sensitive in nature. The amount of surrenders and withdrawals can vary as a result of a variety of factors such as

•: credited interest rates for similar products,
•: general economic conditions and
•: events in the industry that affect policyholders' confidence.

Although the contractual terms of substantially all of our in force life insurance policies and annuities give the holders the right to surrender the policies and annuities, we impose penalties for early surrenders. As of September 30, 2008 we held reserves that exceeded the underlying cash surrender values of our net retained in force life insurance and annuities by $34 million. Our insurance subsidiaries, in our view, have not experienced any material changes in surrender and withdrawal activity in recent years.

Changes in interest rates may affect the incidence of policy surrenders and withdrawals. In addition to the potential impact on liquidity, unanticipated surrenders and withdrawals in a changed interest rate environment could adversely affect earnings if we were required to sell investments at reduced values in order to meet liquidity demands. We manage our asset and liability portfolios in order to minimize the adverse earnings impact of changing market rates. We have segregated a portion of our investment portfolio in order to match liabilities that are sensitive to interest rate movements with fixed income securities containing similar characteristics to the related liabilities, most notably the expected duration and required interest spread. We believe that this asset/liability management process adequately covers the expected payment of benefits related to these liabilities.

At September 30, 2008, our insurance companies held cash and cash equivalents totaling $314 million and fixed maturity securities that we could readily convert to cash with carrying values and fair values of $1.0 billion.

Our domestic insurance subsidiaries must maintain minimum amounts of statutory capital and surplus as required by regulatory authorities. However, these subsidiaries need substantially more than the statutory minimum amounts to meet statutory and administrative requirements of adequate capital and surplus to support the current level of our insurance subsidiaries' operations. Each of our

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insurance subsidiaries' statutory capital and surplus exceeds its respective minimum statutory requirement at levels we believe are sufficient to support their current levels of operation. Additionally, the National Association of Insurance Commissioners, or the NAIC, imposes regulatory risk-based capital or RBC requirements on life insurance enterprises. At December 31, 2007, all of our insurance subsidiaries maintained ratios of total adjusted capital to RBC in excess of the "authorized control level." The combined statutory capital and surplus, including asset valuation reserve, of our U.S. insurance subsidiaries totaled $473.0 million at September 30, 2008 and $486.1 million at December 31, 2007. Our U.S. insurance subsidiaries generated statutory net loss of $2.8 million for the nine months ended September 30, 2008 and statutory net income of $69.6 million for the nine months ended September 30, 2007.

Our HMO subsidiaries are also required by regulatory authorities to maintain minimum amounts of capital and surplus and are also subject to RBC requirements. At September 30, 2008, the statutory capital and surplus of each of our HMO subsidiaries exceeded its minimum requirement and its RBC is in excess of the "authorized control level." The statutory capital and surplus for our HMO subsidiaries was $83.4 million at September 30, 2008 and $64.3 million at December 31, 2007. Statutory net income for our HMO subsidiaries was $22.4 million for the nine months ended September 30, 2008 and $10.1 million for the nine months ended September 30, 2007.

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. As of September 30, 2008, all of our primary reinsurers were rated "A" or better by A.M. Best, except for PharmaCare Re, which is unrated. We have secured a letter of credit from PharmaCare Re that we believe will adequately support the risks ceded. We do not know of any instances where any of our reinsurers have been unable to pay any policy claims on any reinsured business.

Investments

Our investment policy is to balance the portfolio duration to achieve investment returns consistent with the preservation of capital and maintenance of liquidity adequate to meet payment of policy benefits and claims. We invest in assets permitted under the insurance laws of the various states in which we operate. These laws generally prescribe the nature, quality of and limitations on various types of investments that may be made. We do not currently have investments in the following:

•: partnerships,
•: special purpose entities,
•: real estate,
•: commodity contracts, or
•: other derivative securities.

We currently engage the services of two investment advisors under the direction of the management of our insurance company subsidiaries and in accordance with guidelines adopted by the investment committees of their respective boards of directors. Conning Asset Management Company manages the portfolio of all of our subsidiaries, except for the portfolios of Pyramid Life, SelectCare of Texas, L.L.C. and some floating rate portfolios, which are managed by Hyperion Capital.

We invest primarily in fixed maturity securities of the U.S. Government and its agencies and in corporate fixed maturity securities with investment grade ratings of BBB- or higher by S&P or Baa3 or

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higher by Moody's Investor Service. As of September 30, 2008, approximately 98% of our fixed maturity investments had investment grade ratings from S&P or Moody's. As of September 30, 2008, we held $7.0 million par value of Lehman Brothers holdings that were non-income producing. These were the only non-income producing securities in our investment portfolio. As of September 30, 2008, we held securities with par values of approximately $141 million with exposure to subprime mortgages. The market value of these securities was $49 million at September 30, 2008, representing approximately 3% of our cash and invested assets. The collateral for these securities is substantially all first lien mortgages. These securities have an average S&P equivalent rating of A+. During the nine months ended September 30, 2008, we recognized other than temporary impairment totaling $43.9 million in the value of our securities with exposure to subprime mortgages. In addition, we have recognized an other than temporary impairment of $6.1 million on Lehman Brothers holdings and $3.5 million on other corporate bond and mortgage backed securities for a total year-to-date impairment of $11.0 million at September 30, 2008 in addition to the impairment on subprime holdings. We did not write down the value of any fixed maturity securities during the nine months ended September 30, 2007.

The net yields on our cash and invested assets decreased to 4.9% for the nine months ended September 30, 2008, from 5.4% for the nine months ended September 30, 2007. We held a portion of these securities to support the liabilities for policyholder account balances, which liabilities are subject to periodic adjustments to their credited interest rates. We determine the credited interest rates of the interest-sensitive policyholder account balances based upon factors such as portfolio rates of return and prevailing market rates and typically follow the pattern of yields on the assets supporting these liabilities.

We have recently adopted a more conservative approach to our investment portfolio, which focuses more on capital preservation than on generation of investment yield. As a result, as of September 30, 2008, approximately 34% of our portfolio is in cash equivalents, largely in government money funds, and, in the aggregate, around 58% of our portfolio are securities backed by the US government or its agencies.

Federal Income Taxation of the Company

We establish valuation allowances based upon an analysis of projected taxable income and its ability to implement prudent and feasible tax planning strategies. We carried valuation allowances on deferred tax assets of $3.1 million at both September 30, 2008 and December 31, 2007, primarily related to the tax benefits associated with a New York state net operating loss carryforward. At September 30, 2008, we assessed the amount of the deferred tax asset that was more likely than not to be realized under SFAS No. 109, Accounting for Income Taxes, and concluded that we can record tax benefits related to our realized losses relating to our investments for financial statement purposes. During the second quarter we released a deferred tax valuation allowance of $10.4 million that had been recorded in the first quarter of 2008 in connection with other-than-temporary impairments taken in that period.

Effects of Recently Issued and Pending Accounting Pronouncements

A summary of other recent and pending accounting pronouncements is provided in Note 3 of the consolidated financial statements in the quarterly report on Form 10-Q under the caption "Recent and Pending Accounting Pronouncements." We do not anticipate any material impact from the future adoption of the pending accounting pronouncements discussed in that note.

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ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

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. However, we attempt to mitigate our exposure to adverse interest rate movements through a combination of active portfolio management and by staggering the maturities of our fixed income investments to assure sufficient liquidity to meet our obligations and to address reinvestment risk considerations. Our investment policy is to attempt to balance our portfolio duration to achieve investment returns consistent with the preservation of capital and to meet payment obligations of policy benefits and claims.

Some classes of mortgage-backed securities are subject to significant prepayment risk due to the fact that 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, 2008, and with all other variables held constant. The following table summarizes the impact of the assumed changes in market interest rates.

	Effect of Change in Market Interest Rates on Market Value of Fixed Income Portfolio as of September 30, 2008

September 30, 2008
September 30, 2008	200 Basis Point Decrease	100 Basis Point Decrease	100 Basis Point Increase	200 Basis Point Increase
Market Value of Fixed Income Portfolio	200 Basis Point Decrease	100 Basis Point Decrease	100 Basis Point Increase	200 Basis Point Increase
	(in millions)
$1,046.8	$64.5	$34.1	$(34.1)	$(69.9)

Debt

We pay interest on our term loan and a portion of our trust preferred securities based on the London Inter Bank Offering Rate, known as LIBOR, over one, two, three or six month interest periods. Due to the variable interest rate, we would be subject to higher interest costs if short-term interest rates rise. We have attempted to mitigate our exposure to adverse interest rate movements by fixing the rate on $65.0 million of our trust preferred securities for a five year period through the contractual terms of the security at inception and an additional $35.0 million through the use of interest rate swaps. In December 2007, we exercised our option to redeem all $15.0 million of the trust preferred securities scheduled to mature December 2032, which was covered by an interest rate swap.

Also in December 2007, we entered into two separate interest rate swap agreements to mitigate our exposure to increasing interest rate movements by fixing the rate on a combined $250.0 million portion of our new credit facility.

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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, 2008, 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 September 30, 2008

				Weighted Average Balance Outstanding
Description of Floating Rate Debt	Weighted Average Interest Rate			Weighted Average Balance Outstanding		200 Basis Point Decrease		100 Basis Point Decrease		100 Basis Point Increase			200 Basis Point Increase
	(in millions)
Loan Payable		4.08	%	$	83.6	$	1.3	$	0.6	$	(0.6	)	$	(1.3	)
Other long term debt		7.40	%	$	40.0		0.6		0.3		(0.3	)		(0.6	)

Total						$	1.9	$	0.9	$	(0.9	)	$	(1.9	)

As noted above, we have fixed the interest rate on $320 million of our $432 million of total debt outstanding, leaving $112 million of the debt exposed to rising interest rates, as of September 30, 2008. We had approximately $547 million of cash and cash equivalents as of September 30, 2008. We anticipate that any increase or decrease in the interest cost of our debt as a result of an increase in interest rates will be mitigated by an increase or decrease in the net investment income from our cash and cash equivalents.

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

As a result of the value to be received pursuant to the settlement agreement discussed in Significant Transactions and Initiatives, we prepaid $25 million of principal under the new facility in April 2008 pursuant to a waiver. See Note 4—Business Combinations and Note 11—Loan Payable included in the Notes to consolidated financial statements in Part I, Item 1 of this quarterly report on Form 10-Q for additional information on this transaction.

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 and 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,

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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, 2008. 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, 2008, 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, 2008 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II

ITEM 1—LEGAL PROCEEDINGS

For information relating to litigation affecting us, please see Note 14—Commitments and Contingencies of the notes to the consolidated financial statements in Part I—Item 1 of this report, which is incorporated into this Part II—Item 1—Legal Proceedings by reference.

ITEM 1A—RISK FACTORS

In addition to the other information set forth in this report, you should consider carefully the risks and uncertainties described under the caption Item 8.01 of our current report on Form 8-K filed on August 8, 2008, as supplemented by the additional risk factors set forth below, and under the caption "Part I—Item 1A. Risk Factors" in our annual report on Form 10-K for the year ended December 31, 2007, all three of which are incorporated by reference into this Part II—Item 1A—Risk Factors. The occurrence of any of these risks and uncertainties could materially adversely affect our business, prospects, financial condition or results of operations. Additional risks and uncertainties of which we are not currently aware, or which we currently consider to be immaterial, could also materially adversely affect our business, prospects, financial condition or results of operations.

The following risk factors supplement the risk factors set forth in Item 8.01 of our current report on Form 8-K filed on August 8, 2008:

Our business and its growth are subject to risks related to difficulties in the financial markets and general economic conditions.

As has been widely reported, financial markets around the world have been experiencing extreme disruption in recent months, including, among other things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades and declining or indeterminate valuations of many investments and declines in real estate values. Governments have taken unprecedented actions intended to address these market conditions. While currently these conditions have not impaired our ability to access credit markets and finance our operations, largely because our financing has generally come from internal cash generation since September 2007, there can be no assurance that there will not be a further deterioration in financial markets and confidence in major economies or that any deterioration in markets or confidence will not impair our ability to access credit markets and finance our operations. These economic developments affect businesses such as ours in a number of ways, many of which we cannot predict. Among the potential effects could be further writedowns in the value of securities we hold, an inability or refusal by lenders under our credit agreement to fund a draw by us, and an inability to access credit markets should we require external financing in excess of or in addition to the current revolving commitment under our credit agreement. In addition, it is possible that economic conditions, and resulting budgetary concerns, could prompt the federal government to make changes in the Medicare program, which could adversely affect our results of operations. We are unable to predict the likely duration and severity of the current disruptions in financial markets and adverse economic conditions, or the effects on us of these disruptions and conditions.

We have debt outstanding that contains restrictive covenants, and we may be unable to access other sources of financing should we require additional external financing or obtain waivers of relevant covenants or, if they arise, defaults under the debt agreements.

We have available borrowing capacity under the revolving portion of our credit facility of $150 million. Our credit agreement significantly restricts our ability to borrow from other sources. Therefore, if we are required to fund the growth of our business, or to fund capital requirements at our insurance company and health plan subsidiaries, in excess of the aggregate of our cash, revolver borrowing capacity and other borrowing capacity permitted under the credit facility, we could be

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restricted in our ability to generate new premium or other revenue, to construct the preferred provider organizations that we are in the process of contracting, or to otherwise fund or expand our business. Moreover, if we determine to enter into a transaction or effect another corporate event that requires a waiver or consent under a debt agreement, or if we experience an event of default under a debt agreement, lenders could refuse to grant a required waiver or consent, or could charge a material amount for it. As a consequence, we could be unable to complete the desired transaction or other corporate event, or the required waiver or consent could cost more than it otherwise would, or we could experience a default under the relevant debt instrument, or our results of operations and financial condition could be adversely affected.

A significant portion of our assets are invested in fixed income securities and other securities that are subject to market fluctuations, which have recently been intensified by general economic conditions.

As we noted in our August 8, 2008 Form 8-K, a significant portion of our investment portfolio consists of fixed income securities and other investment securities. Our portfolio can be viewed on our web site,www.universalamerican.com, in the Investors section. Our reference to the web site in this quarterly report on Form 10-Q is not intended to incorporate the information contained in the web site into this report. The fair market value of these assets and the investment income from these assets generally fluctuate depending on general economic and market conditions, and these variations have been exacerbated by the recent economic conditions. The fair market value of our investments in fixed income securities generally increases or decreases in an inverse relationship with fluctuations in interest rates, while net investment income realized by us from future investments in fixed income securities will generally increase or decrease with interest rates; in addition, these values and prospective income have recently been adversely affected by general economic conditions. Moreover, actual net investment income or cash flows from investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, may differ from those anticipated at the time of investment or at various financial statement dates as a result of interest rate fluctuations, general economic conditions and other factors. Because significant amounts of our investment securities are classified as available for sale, we reflect changes in the market value of these securities in our balance sheet. Therefore, interest rate fluctuations and changes in the values of securities we hold could adversely affect our results of operations and financial condition. In addition, while the statutory accounting rules applicable to our insurance company subsidiaries do not currently require that we revalue investment securities as generally accepted accounting principles require, those statutory accounting rules could change, which could lead to requirements that we increase the capital of some of these subsidiaries, and as a result of any required capital increase, we could be required to deposit unrestricted cash held at our parent company or borrow.

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

Issuer Purchases of Equity Securities

Period		Average Price Paid Per Share

July 1, 2008 — July 31, 2008	—		—	—	4,766,591
August 1, 2008 — August 31, 2008	112,325	$	12.51	112,325	3,689,732
September 1, 2008 — September 30, 2008	156,605	$	12.31	156,605	3,828,407

Total	268,930			268,930

(1): In February 2008, our board of directors approved the repurchase of up to $50 million of our common stock during an 18-month period beginning February 18, 2008. In June 2008, we announced that our board of directors has approved the repurchase of up to an additional $50 million of our common stock. Through September 30, 2008, we have repurchased 4.7 million shares of our common stock for an aggregate amount of $53.3 million. We are not obligated to repurchase any specific number of shares under this program or to make repurchases at any specific time or price.

Recent Sales of Unregistered Securities

None.

ITEM 3—DEFAULTS UPON SENIOR SECURITIES

There were no defaults upon senior securities during the third quarter of 2008.

ITEM 4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

ITEM 5—OTHER INFORMATION

None.

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ITEM 6—EXHIBITS

All references below to our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K share the Securities and Exchange Commission File No. 0-11321. These reports and our other Securities and Exchange Commission filings are available on the Commission's EDGAR web site athttp://www.sec.gov/edgar/searchedgar/companysearch.html.


	2.1		Agreement and Plan of Merger and Reorganization dated as of May 7, 2007 among Universal American Financial Corp., MH Acquisition I Corp., MH Acquisition II LLC, MHRx LLC, MemberHealth, Inc. and the shareholder representative named therein (filed as Exhibit 2.1 to the Registrant's Current Report on Form 8-K filed May 11, 2007, and incorporated by reference herein).
	2.2		Settlement Agreement and Amendment to Merger Agreement, dated as of March 5, 2008 (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated March 10, 2008, and incorporated herein by reference).
	3.1		Restated Certificate of Incorporation of Universal American Financial Corp. (filed as Exhibit 3.1 to Amendment No. 2 to the Registrant's Registration Statement on Form S-3 filed on July 11, 2001, and incorporated by reference herein).
	3.2		Certificate of Amendment of the Certificate of Incorporation of Universal American Financial Corp. (filed as Exhibit 3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, filed August 9, 2004, and incorporated by reference herein).
	3.3		Amended and Restated By-Laws of Universal American Corp. (filed as Exhibit 3.3 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2008, filed on May 12, 2008, and incorporated by reference herein).
	3.4		Certificate of Amendment to the Certificate of Incorporation of Universal American Financial Corp. for the Series A Preferred Stock (filed as Exhibit 3.1 to the Registrant's Current Report on Form 8-K filed May 11, 2007, and incorporated by reference herein).
	3.5		Certificate of Amendment of the Certificate of Incorporation of Universal American Financial Corp. for the Registrant's Series B Preferred Stock (filed as Exhibit 3.2 to the Registrant's Current Report on Form 8-K filed May 11, 2007, and incorporated by reference herein).
	3.6		Certificate of Amendment to Certificate of Incorporation changing the name of Universal American Financial Corp. to Universal American Corp. (filed as Exhibit 99.1 to the Registrant's Current Report on Form 8-K filed December 3, 2007, and incorporated by reference herein).
	4.1		Form of Senior Indenture dated as of December 2004 between Universal American Financial Corp. and U.S. Bank National Association, as Trustee (filed as Exhibit 4.01 to Amendment No. 1 to the Registrant's Registration Statement on Form S-3 (File No. 333-120190) filed on December 10, 2004, and incorporated by reference herein).
	4.2		Form of Subordinated Indenture dated as of December 2004 between Universal American Financial Corp. and U.S. Bank National Association, as Trustee (filed as Exhibit 4.02 to Amendment No. 1 to the Registrant's Registration Statement on Form S-3 (File No. 333-120190) filed on December 10, 2004, and incorporated by reference herein).
	4.3		Guarantee Agreement, dated as of March 22, 2007, by Universal American Financial Corp., as Guarantor, and Wilmington Trust Company, as Trustee (filed as Exhibit 4.3 to the Registrant's Current Report on Form 8-K filed March 28, 2007, and incorporated by reference herein).

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	4.4		Indenture, dated as of March 22, 2007, between Universal American Financial Corp. and Wilmington Trust Company, as Trustee, relating to Fixed/Floating Rate Junior Subordinated Debentures Due 2037 (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed March 28, 2007, and incorporated by reference herein).
	4.5		Stockholders' Agreement, dated as of September 21, 2007, among Universal American Corp. and security holders listed on the signature pages thereto (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed September 25, 2007, and incorporated by reference herein).
	10.1		Employment Agreement dated July 30, 1999, between Registrant and Richard A. Barasch (filed as Exhibit D to the Registrant's Current Report on Form 8-K/A filed March 19, 2001 and incorporated by reference herein).
	10.2		Letter dated April 9, 2008, correcting clerical error in Employment Agreement dated July 30, 1999, between Registrant and Richard A. Barasch. (filed as Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2008, filed on May 12, 2008, and incorporated by reference herein).
	10.3		Employment Agreement dated July 30, 1999, between Registrant and Gary Bryant (filed as Exhibit E to the Registrant's Current Report on Form 8-K/A filed March 19, 2001 and incorporated by reference herein).
	10.4		Employment Agreement dated July 30, 1999, between Registrant and Robert Waegelein (filed as Exhibit E to the Registrant's Current Report on Form 8-K/A filed March 19, 2001 and incorporated by reference herein).
	10.5		Employment Letter dated September 17, 2002, between the Company and Jason Israel (filed as Exhibit 10.17 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005, filed March 16, 2006, and incorporated by reference herein).
	10.6		Employment Agreement dated March 9, 2004, by and among the Company, Heritage Health Systems, Inc. and Theodore M. Carpenter, Jr. (filed as Exhibit 10.18 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005, filed March 16, 2006, and incorporated by reference herein).
	10.7		1998 Incentive Compensation Plan (filed as Exhibit A to the Registrant's Definitive Proxy Statement on Form 14A filed April 29, 1998, and incorporated by reference herein).
	10.8		First Amendment to the Universal American Financial Corp. 1998 Incentive Compensation Plan (filed as Exhibit 10.1 to the Registrant's Registration Statement on Form S-3, Registration No. 333-120190, filed on November 3, 2004, and incorporated by reference herein).
	10.9		Agent Stock Plan for Agents of Pennsylvania Life and PennCorp Canada (filed as part of Amendment 1 to the Registrant's Registration Statement on Form S-2, dated July 13, 2000, and incorporated by reference herein).
	10.10		Agent Equity Plan for Regional Managers and Sub Managers of Pennsylvania Life and PennCorp Canada (filed as part of Amendment 1 to the Registrant's Registration Statement on Form S-2, dated July 13, 2000, and incorporated by reference herein).
	10.11		Agreement dated as of September 14, 2000, by and between ALICOMP, a division of ALICARE, Inc. and Universal American Financial Corp., as amended (filed as Exhibit 10.1 to Amendment No. 1 to the Registrant's Form 10-Q/A for the period ended September 30, 2003, filed December 23, 2003, and incorporated by reference herein).

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	10.12		Amended and Restated Credit Agreement dated as of May 28, 2004, among Universal American Financial Corp., various lending institutions and Bank of America, N.A., as the Administrative Agent, the Collateral Agent and the L/C Issuer (filed as Exhibit 10 to the Registrant's Current Report on Form 8-K filed June 1, 2004, and incorporated herein by reference).
	10.13		First Amendment to Amended and Restated Credit Agreement dated as of September 2, 2005 among Universal American Financial Corp., the Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.12 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005, filed March 16, 2006, and incorporated by reference herein).
	10.14		Waiver and Second Amendment to Amended and Restated Credit Agreement dated as of December 30, 2005 among Universal American Financial Corp., the Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.13 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005, filed March 16, 2006, and incorporated by reference herein).
	10.15		Waiver and Third Amendment to Amended and Restated Credit Agreement dated as of November 29, 2006, among Universal American Financial Corp., the Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed January 24, 2007, and incorporated by reference herein).
	10.16		Credit Agreement dated as of January 18, 2007, among Universal American Financial Corp., one or more Lending Institutions, and Bank of America, N.A., as the Administrative Agent and the L/C Issuer (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed January 24, 2007, and incorporated by reference herein).
	10.17		Addendum II for Item 1A to Agreement dated as of September 14, 2000, between ALICOMP, a division of ALICARE, Inc. and Universal American Financial Corp. (filed as Exhibit 10.13 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2004, filed March 16, 2005, and incorporated by reference herein).
	10.18		Quota Share Reinsurance Agreement, dated as of June 30, 2005, between Pennsylvania Life Insurance Company and PharmaCare Captive Re, Ltd. (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, filed November 9, 2007, and incorporated by reference herein).
	10.19		Fourth Amendment dated as of March 22, 2007, to Amended and Restated Credit Agreement dated as of May 28, 2004 among Universal American Financial Corp., the Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, filed May 10, 2007, and incorporated by reference herein).
	10.20		First Amendment dated as of March 22, 2007, to Credit Agreement dated as of January 18, 2007, among Universal American Financial Corp., the Banks party to the Credit Agreement, and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, filed May 10, 2007, and incorporated by reference herein).
	10.21		Stage 1 Securities Purchase Agreement dated as of May 7, 2007 among Universal American Financial Corp. and the several investors party thereto (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed May 11, 2007, and incorporated by reference herein).

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	10.22		Stage 2 Securities Purchase Agreement dated as of May 7, 2007 among Universal American Financial Corp. and the several investors party thereto. (filed as Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed May 11, 2007, and incorporated by reference herein).
	10.23		Fifth Amendment dated as of May 7, 2007to Amended and Restated Credit Agreement dated as of May 28, 2004, among Universal American Financial Corp., the Banks party to the Amended and Restated Credit Agreement, and Bank of America, N.A., as Administrative Agent (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed May 17, 2007, and incorporated by reference herein).
	10.24		Second Amendment dated as of May 7, 2007to Credit Agreement dated as of January 18, 2007, among Universal American Financial Corp., the Banks party to the Credit Agreement, and Bank of America, N.A., as Administrative Agent (filed as Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed May 17, 2007, and incorporated by reference herein).
	10.25		Fourth Amendment dated as of March 22, 2007, to Amended and Restated Credit Agreement dated as of May 28, 2004 among Universal American Financial Corp., the Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent. (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 filed May 10, 2007, and incorporated by reference herein).
	10.26		First Amendment dated as of March 22, 2007, to Credit Agreement dated as of January 18, 2007, among Universal American Financial Corp., one or more Lending Institutions, and Bank of America, N.A., as the Administrative Agent and L/C Issuer (filed as Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 filed May 10, 2007, and incorporated by reference herein).
	10.27		Credit Agreement dated as of September 18, 2007, among Universal American Financial Corp., each lender from time to time party thereto, and Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer (filed as Exhibit 10.26 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 filed November 9, 2007, and incorporated by reference herein).
	10.28		Settlement Agreement and Amendment to Merger Agreement, dated as of March 5, 2008 (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated March 10, 2008, and incorporated herein by reference).
	11.1*		Statement re Computation of per share Earnings (contained in the Consolidated Statements of Operations in this Report).
	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.

*: Filed or furnished herewith.

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SIGNATURES

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


		UNIVERSAL AMERICAN CORP.
November 10, 2008		/s/ RICHARD A. BARASCH Richard A. Barasch Chief Executive Officer
November 10, 2008		/s/ ROBERT A. WAEGELEIN Robert A. Waegelein Executive Vice President and Chief Financial Officer (Principal Accounting Officer)

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Caremark Ulysses Holding (UHCO) Inactive 10-Q2008 Q3 Quarterly report

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