Last10K.com

Coventry Health Care Inc (CVH) SEC Filing 10-K Annual report for the fiscal year ending Sunday, December 31, 2006

Coventry Health Care Inc

CIK: 1054833 Ticker: CVH

Exhibit 99.1

                                                                                                

 


News Release

6705 Rockledge Drive, Suite 900

Bethesda, MD 20817-1850

(301) 581-0600

 

Contact:

Shawn M. Guertin

Chief Financial Officer

(301) 581-5701

 

Drew Asher

Vice President, Investor Relations

(301) 581-5717

 

Coventry Health Care Reports Record Fourth Quarter Earnings of $0.97 per Diluted Share

 

Revises 2007 Diluted EPS Guidance Range to $3.85 to $3.95

 

Bethesda, Maryland (February 9, 2007) — Coventry Health Care, Inc. (NYSE: CVH) today reported operating results for the quarter ended December 31, 2006. Operating revenues totaled $1.94 billion for the quarter with net earnings of $156.1 million, or $0.97 per diluted share. For the year ended December 31, 2006, total revenues were $7.73 billion with net earnings of $560.0 million, or $3.47 per diluted share.

 

“I am pleased to report another strong quarter of financial results to complete 2006,” said Dale B. Wolf, chief executive officer of Coventry. “During the year, our health plans continued to perform at a high level, our Medicare business has expanded meaningfully and we successfully completed the integration of First Health. We have realigned our Company with a focus on positioning our well-diversified businesses for continued growth and new opportunities in 2007 and beyond.”

 

Additionally, on February 8th Coventry announced that it had entered into a definitive agreement to acquire Concentra’s workers’ compensation managed care services businesses for $387.5 million in an all-cash transaction. As this transaction is not expected to close for 90 to 180 days, the financial impact has been excluded from all 2007 guidance elements.

 

Fourth Quarter Highlights

GAAP diluted EPS growth of 26.0% over the prior year quarter

Revenues up 12.9% over the prior year quarter

Consolidated operating margin of 11.7%

Medicare Part D membership of 687,000

GAAP cash flows from operations of $315.9 million or 202% of net income, including the impact of stand-alone Medicare Part D as detailed on page 8.

 

Full Year 2006 Highlights

Revenues up 17.0% over the prior year

Consolidated operating margin of 10.9%

GAAP cash flows from operations of $1,066.5 million or 190% of net income, including the impact of stand-alone Medicare Part D as detailed on page 8.

Share repurchase of 4.6 million shares

 

Page 1 of 10

 

 

Fourth Quarter Operating Highlights

 

Health Plan Membership. As of December 31, 2006, Coventry had total health plan membership of 2.52 million members, an increase of 6,000 members from the prior quarter.

 

Health Plan Insured Commercial Trends. Commercial premium yields showed a favorable price-to-cost spread in the fourth quarter. Reported commercial yields rose to $262.72 PMPM (per member per month) in the quarter, an increase of 4.3% over the prior year quarter. Reported commercial medical expense was $203.10 PMPM in the quarter, an increase of 4.2% over the prior year quarter.

 

Health Plan Medical Loss Ratio (MLR). Health plan MLR was 78.3%, a 50 basis point improvement over the prior year quarter. Commercial MLR of 77.3% improved 10 basis points, Medicare MLR of 75.4% improved 350 basis points, and Medicaid MLR of 87.4% was consistent with the prior year quarter.

 

Selling, General & Administrative (SG&A) Expenses. Consolidated SG&A expenses were 18.3% of operating revenues for the quarter, an improvement of 100 basis points from the prior year quarter.

 

Stand-Alone Medicare Part D(1). Medicare Part D contributed GAAP earnings of $0.16 per diluted share for the fourth quarter. As of December 31, 2006, Coventry had Part D membership of 687,000 members. Total Part D revenue for the quarter was $165.6 million, including a reduction to revenue of ($48.3) million for CMS risk-sharing adjustments and ($8.6) million for revenue ceded to insurance company distribution partners. Premium yield, excluding the effect of CMS risk-sharing adjustments and ceded revenue, was $107.75 PMPM for the quarter.

 

Balance Sheet. Health plan net accounts receivable of $99.7 million represent 5.8 days of sales outstanding (DSO). Health plan reserves remain stable with days in claims payable (DCP) for the quarter of 55.0, down 1.0 days from the prior quarter and down 0.6 days from the prior year quarter.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)

Represents the Medicare Part D Prescription Drug Plan and excludes the health plan Medicare Advantage business.

 

Page 2 of 10

 

Consolidated Guidance Details

 

Q1 2007 Guidance

 

Total revenues of $2.10 billion to $2.30 billion

Earnings per share (EPS) on a diluted basis of $0.75 to $0.77

 

Includes a ($0.04) charge for debt refinancing

 

Includes seasonal impact of Medicare Part D

 

2007 Full Year Guidance

 

Medicare Private-Fee-For-Service membership of 90,000 to 100,000 by year-end

Risk revenues of $7.90 billion to $8.15 billion

Management services revenues of $860.0 million to $880.0 million

Consolidated revenues of $8.76 billion to $9.03 billion

Consolidated medical loss ratio (MLR%) of 79.6% to 80.0%

Consolidated selling, general, and administrative expenses (SG&A) of $1.42 billion to $1.44 billion

Depreciation and amortization expense of $118.0 million to $124.0 million

Investment income of $110.0 million to $120.0 million

Interest expense of $60.0 million to $63.0 million

 

Includes a charge for debt refinancing

Tax rate of 37.8% to 38.2%

Diluted share count of 157.0 million to 159.0 million shares

Earnings per share (EPS) on a diluted basis of $3.85 to $3.95

 

Mr. Wolf will host a conference call at 8:30 a.m. ET on Friday, February 9, 2007. To listen to the call, dial toll-free at (800) 289-0569 or, for international callers, (913) 981-5542. Callers will be asked to identify themselves and their affiliations. The conference call will also be broadcast from Coventry’s Investor Relations website at www.cvty.com. Coventry asks participants on both the call and webcast to review and be familiar with its filings with the Securities and Exchange Commission (SEC). A replay of the call will be available for one week at (888) 203-1112 or, for international callers, (719) 457-0820. The access code is 2409040.

 

This press release contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are defined as statements that are not historical facts and include those statements relating to future events or future financial performance. Actual performance may be significantly impacted by certain risks and uncertainties, including those described in Coventry’s Annual Report on Form 10-K for the year ended December 31, 2005 and Coventry’s Form 10-Q for the quarter ended September 30, 2006. Coventry undertakes no obligation to update or revise any forward-looking statements.

 

Coventry Health Care is a national managed health care company based in Bethesda, Maryland operating health plans, insurance companies, network rental, managed care and workers’ compensation services companies. Coventry provides a full range of risk and fee-based managed care products and services, including HMO, PPO, POS, Medicare Advantage, Medicare Prescription Drug Plans, Medicaid, Workers’ Compensation services and Network Rental to a broad cross section of individuals, employer and government-funded groups, government agencies, and other insurance carriers and administrators in all 50 states as well as the District of Columbia and Puerto Rico. More information is available on the Internet at www.cvty.com.

 

Page 3 of 10

 

COVENTRY HEALTH CARE, INC.

HEALTH PLAN MEMBERSHIP

(Amounts in thousands)

 

 

 

 

December 31,

 

September 30,

 

December 31,

 

 

2006

 

2006

 

2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Health Plan Membership By Market:

 

 

 

 

 

 

Delaware

 

148

 

145

 

119

Georgia

 

102

 

96

 

78

Illinois

 

103

 

103

 

93

Iowa

 

60

 

63

 

67

Kansas

 

227

 

222

 

218

Louisiana

 

55

 

55

 

64

Michigan

 

58

 

58

 

61

Nebraska

 

63

 

63

 

54

North Carolina

 

117

 

114

 

133

Pennsylvania

 

683

 

690

 

739

St. Louis

 

432

 

434

 

449

Utah

 

222

 

220

 

208

Virginia

 

177

 

178

 

181

West Virginia

 

77

 

77

 

82

Total Health Plans

 

2,524

 

2,518

 

2,546

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Membership By Product:

 

 

 

 

 

 

 

 

 

 

 

 

 

Fully-Insured:

 

 

 

 

 

 

Commercial

 

1,450

 

1,451

 

1,486

Medicare Advantage

 

80

 

79

 

75

Medicaid

 

373

 

373

 

393

Total Fully-Insured

 

1,903

 

1,903

 

1,954

 

 

 

 

 

 

 

Administrative Services Only

 

621

 

615

 

592

 

 

 

 

 

 

 

Total Health Plan Membership

 

2,524

 

2,518

 

2,546

 

Stand-Alone Medicare Part D Membership

 

 

687

 

 

687

 

 

-

 

Page 4 of 10

 

 

COVENTRY HEALTH CARE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except per share data)

 

 

 

Quarters Ended

 

Years Ended

 

December 31,

 

December 31,

 

2006

 

2005

 

2006

 

2005

 

 

(unaudited)

 

(unaudited)

 

(unaudited)

 

 

 

Operating revenues:

 

 

 

 

 

 

 

 

 

Managed care premiums

$ 1,723,890

 

$ 1,481,848

 

$ 6,857,301

 

$ 5,728,162

 

 

Management services

217,104

 

237,052

 

876,455

 

883,084

 

Total operating revenues

1,940,994

 

1,718,900

 

7,733,756

 

6,611,246

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Medical costs

1,328,668

 

1,166,289

 

5,439,964

 

4,550,871

 

 

Selling, general, administrative

355,356

 

331,013

 

1,339,522

 

1,182,381

 

 

Depreciation and amortization

29,556

 

25,734

 

113,267

 

86,176

 

Total operating expenses

1,713,580

 

1,523,036

 

6,892,753

 

5,819,428

 

 

 

 

 

 

 

 

 

 

 

Operating earnings

227,414

 

195,864

 

841,003

 

791,818

 

Operating earnings percentage of total revenues

11.7%

 

11.4%

 

10.9%

 

12.0%

 

 

 

 

 

 

 

 

 

 

 

Interest expense

13,125

 

12,745

 

52,446

 

58,414

 

Other income, net

33,139

 

18,360

 

107,791

 

66,021

 

 

 

 

 

 

 

 

 

 

 

Earnings before income taxes

247,428

 

201,479

 

896,348

 

799,425

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

91,334

 

75,051

 

336,303

 

297,786

 

Net earnings

$ 156,094

 

$ 126,428

 

$ 560,045

 

$ 501,639

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings per share, basic

$ 0.99

 

$ 0.79

 

$ 3.53

 

$ 3.18

 

Net earnings per share, diluted

$ 0.97

 

$ 0.77

 

$ 3.47

 

$ 3.10

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding, basic

158,129

 

160,803

 

158,601

 

157,965

 

Weighted average shares outstanding, diluted

160,513

 

164,628

 

161,434

 

161,716

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Page 5 of 10

 

 

COVENTRY HEALTH CARE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)

 

 

 

 

December 31,

 

September 30,

 

December 31,

 

 

2006

 

2006

 

2005

 

 

(unaudited)

 

(unaudited)

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

$

1,370,836

$

1,215,475

$

391,646

Short-term investments

 

292,392

 

192,105

 

545,615

Accounts receivable, net

 

209,180

 

201,251

 

228,028

Other receivables, net

 

164,829

 

161,459

 

76,462

Deferred income taxes

 

59,339

 

52,152

 

57,666

Other current assets

 

37,806

 

18,696

 

26,285

Total current assets

 

2,134,382

 

1,841,138

 

1,325,702

 

 

 

 

 

 

 

Long-term investments

 

1,130,572

 

1,107,668

 

1,125,632

Property and equipment, net

 

315,105

 

310,716

 

351,427

Goodwill

 

1,620,272

 

1,628,784

 

1,612,390

Other intangible assets, net

 

388,400

 

397,471

 

419,352

Other long-term assets

 

76,376

 

73,144

 

60,669

Total assets

$

5,665,107

$

5,358,921

$

4,895,172

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity:

 

 

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Medical liabilities

$

1,121,151

$

1,071,525

$

752,774

Accounts payable and accrued liabilities

 

460,489

 

342,890

 

442,785

Deferred revenue

 

60,349

 

83,610

 

64,668

Current portion of long-term debt

 

10,000

 

10,000

 

10,000

Total current liabilities

 

1,651,989

 

1,508,025

 

1,270,227

 

 

 

 

 

 

 

Long-term debt

 

750,500

 

750,500

 

760,500

Other long-term liabilities

 

309,616

 

324,888

 

309,742

Total liabilities

 

2,712,105

 

2,583,413

 

2,340,469

 

 

 

 

 

 

 

Stockholders’ equity

 

2,953,002

 

2,775,508

 

2,554,703

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

$

5,665,107

$

5,358,921

$

4,895,172

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Page 6 of 10

 

COVENTRY HEALTH CARE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)

(unaudited)

 

 

 

 

Quarter Ended

 

Year Ended

 

 

December 31, 2006

 

December 31, 2006

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

Net earnings

$

156,094 

$

560,045 

Adjustments to earnings:

 

 

 

 

Depreciation and amortization

 

29,556 

 

113,267 

Amortization of stock compensation

 

14,466 

 

55,197 

Changes in assets and liabilities:

 

 

 

 

Accounts receivable, net

 

(7,929)

 

21,164 

Medical liabilities

 

49,626 

 

368,377 

Accounts payable and accrued liabilities

 

128,589 

 

64,061 

Deferred revenue

 

(23,261)

 

(4,319)

Other operating activities

 

(31,195)

 

(111,321)

Net cash flows from operating activities

 

315,946 

 

1,066,471 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

Capital expenditures, net

 

(24,897)

 

(72,573)

(Payments) / proceeds on sales, maturities, and purchases of investments

 

(135,402)

 

255,013 

Payments for acquisitions, net of cash acquired

 

(522)

 

(35,392)

Net cash flows from investing activities

 

(160,821)

 

147,048 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

Proceeds from issuance of stock

 

822 

 

23,023 

Payments for repurchase of stock

 

(507)

 

(269,204)

Excess tax (provision) / benefit from stock compensation

 

(79)

 

21,852 

Repayment of long-term debt

 

-

 

(10,000)

Net cash flows from financing activities

 

236 

 

(234,329)

 

 

 

 

 

Net change in cash and cash equivalents for current period

 

155,361 

 

979,190 

Cash and cash equivalents at beginning of period

 

1,215,475 

 

391,646 

Cash and cash equivalents at end of period

$

1,370,836 

$

1,370,836 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and Investments:

 

 

 

 

Cash and cash equivalents

$

1,370,836 

$

1,370,836 

Short-term investments

 

292,392 

 

292,392 

Long-term investments

 

1,130,572 

 

1,130,572 

Total cash and investments

$

2,793,800 

$

2,793,800 

 

 

Page 7 of 10

 

 

 

 

COVENTRY HEALTH CARE, INC.

RECONCILIATION OF OPERATING CASH FLOWS

FOR THE THREE MONTHS ENDED DECEMBER 31, 2006

(Amounts in thousands, unaudited)

 

 

 

Stand-Alone Medicare Part D

All Other Operations

Consolidated

As Reported

GAAP net cash flows from operating activities

$ 116,584(1)

$ 199,362

$ 315,946

 

 

 

 

Net earnings

$ 26,129

$ 129,965

$ 156,094

 

 

 

 

GAAP operating cash flows as a percentage of net earnings

 

153%

202%

 

 

 

(1)

Stand-alone Medicare Part D adjusted operating cash flows include $26.6 million in reinsurance payments received for October through December, net of claims paid subject to reinsurance. Following the final settlement in 2007 related to the 2006 plan year, any remaining balances from reinsurance and other subsidy payments will be returned to CMS.

 

 

 

 

COVENTRY HEALTH CARE, INC.

RECONCILIATION OF OPERATING CASH FLOWS

FOR THE YEAR ENDED DECEMBER 31, 2006

(Amounts in thousands, unaudited)

 

 

 

Stand-Alone Medicare Part D

All Other Operations

Consolidated

As Reported

GAAP net cash flows from operating activities

$ 348,591(1)

$ 717,880

$ 1,066,471

 

 

 

 

Net earnings

$ 26,203

$ 533,842

$ 560,045

 

 

 

 

GAAP operating cash flows as a percentage of net earnings

 

134%

190%

 

 

 

(1)

Stand-alone Medicare Part D adjusted operating cash flows include $234.7 million in reinsurance payments received for January through December, net of claims paid subject to reinsurance. Following the final settlement in 2007 related to the 2006 plan year, any remaining balances from reinsurance and other subsidy payments will be returned to CMS.

 

 

 

 

Page 8 of 10

 

 

 

COVENTRY HEALTH CARE, INC.

SELECTED OPERATING STATISTICS

HEALTH PLAN & MEDICARE PART D

(Unaudited)

 

 

HEALTH PLANS

Total

2006

 

Q4 2006

 

Q3 2006

 

Q2 2006

 

Q1 2006

Total

2005

Total

2004

 

 

 

 

 

 

 

 

Revenue PMPM

 

 

 

 

 

 

 

Commercial

$ 259.52

$ 262.72

$ 261.05

$ 258.43

$ 255.96

$ 246.46

$ 226.59

Medicare

$ 857.28

$ 883.11

$ 855.05

$ 854.85

$ 836.00

$ 765.58

$ 695.96

Medicaid

$ 167.30

$ 169.80

$ 170.90

$ 165.53

$ 163.16

$ 157.52

$ 145.23

Management Fees

$   16.97

$   17.77

$   16.52

$   16.88

$   16.72

$   17.60

$   17.10

 

 

 

 

 

 

 

 

Medical PMPM

 

 

 

 

 

 

 

Commercial

$ 201.66

$ 203.10

$ 202.29

$ 199.43

$ 201.83

$ 193.37

$ 179.21

Medicare

$ 681.07

$ 665.88

$ 694.50

$ 679.77

$ 684.29

$ 614.55

$ 579.92

Medicaid

$ 143.18

$ 148.35

$ 145.48

$ 142.30

$ 136.81

$ 133.32

$ 126.88

 

 

 

 

 

 

 

 

MLR %

 

 

 

 

 

 

 

Commercial

77.7%

77.3%

77.5%

77.2%

78.9%

78.5%

79.1%

Medicare

79.4%

75.4%

81.2%

79.5%

81.9%

80.3%

83.3%

Medicaid

85.6%

87.4%

85.1%

86.0%

83.9%

84.6%

87.4%

Total

78.9%

78.3%

78.9%

78.6%

79.9%

79.5%

80.5%

 

 

 

 

 

 

 

 

SGA % of revenues

11.7%

13.0%

11.0%

11.5%

11.3%

11.4%

11.5%

SGA PMPM

$   24.11

$   27.13

$   22.81

$   23.64

$   22.88

$   22.22

$   20.81

 

 

 

 

 

 

 

 

Claims Statistics

 

 

 

 

 

 

 

Claims Inventory

 

141,018

125,601

138,158

148,441

137,413

149,263

Inventory Days on Hand

1.6

1.6

1.7

1.8

1.6

1.6

Total Medical Liabilities (000’s)

 

$ 719,426

$ 733,550

$ 709,437

$ 742,247

$ 700,066

$ 660,475

Days in Claims Payable

 

54.97

56.00

53.84

55.17

55.58

55.80

 

 

 

 

 

 

 

 

Member Growth

 

 

 

 

 

 

 

Same Store

(22,000)

6,000

(25,000)

(8,000)

5,000

37,000

64,000

Acquisition

-

-

-

-

-

-

62,000

 

 

 

 

 

 

 

 

 

 

MEDICARE PART D

 

 

 

 

 

 

 

 

 

 

 

 

 

Membership

 

687,000

687,000

663,000

529,000

 

Revenue PMPM (1)

$ 103.77

$ 107.75

$ 101.87

$ 104.09

$ 100.36

 

MLR %

84.5%

67.0%

76.7%

93.6%

98.0%

 

 

 

 

(1) Revenue PMPM excludes the impact of CMS risk-share premium adjustments and revenue ceded to insurance company distribution partners.

 

Page 9 of 10

 

COVENTRY HEALTH CARE, INC.

SELECTED OPERATING STATISTICS

FIRST HEALTH & CONSOLIDATED COVENTRY

(Unaudited)

 

 

 

Total

2006

Q4

2006

Q3

2006

Q2

2006

Q1

2006

Total

2005(2)

Total

2004

 

 

 

 

 

 

 

 

 

 

FIRST HEALTH

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Membership

 

 

 

 

 

 

 

 

National Accounts

 

 

 

 

 

 

n/a

 

On-going accounts

 

460,000

461,000

481,000

498,000

669,000

 

 

Run-out (1)

 

32,000

39,000

138,000

170,000

90,000

 

 

Total National Accounts

 

492,000

500,000

619,000

668,000

759,000

 

 

Mail Handlers

 

406,000

411,000

419,000

424,000

462,000

n/a

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues By Product Line (000s)

 

 

 

 

 

 

 

 

National Accounts

$ 113,990

$   23,976

$   27,308

$   29,898

$   32,808

$ 141,283

n/a

 

FEHBP

208,177

55,035

49,213

50,509

53,420

204,678

n/a

 

Network Rental

126,573

31,178

31,400

32,098

31,897

89,442

n/a

 

Group Health Subtotal

448,740

110,189

107,921

112,505

118,125

435,403

n/a

 

Medicaid / Public Sector

184,503

46,819

45,983

47,974

43,727

183,197

n/a

 

Workers’ Compensation

206,220

49,175

51,084

54,536

51,425

193,714

n/a

 

Specialty Business Subtotal

390,723

95,994

97,067

102,510

95,152

376,911

n/a

 

Total First Health Revenues

$ 839,463

$ 206,183

$ 204,988

$ 215,015

$ 213,277

$ 812,314

n/a

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

SGA % of revenues

64.6%

65.6%

64.9%

64.7%

63.2%

64.9%

n/a

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CONSOLIDATED COVENTRY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income % of revenues

10.9%

11.7%

11.7%

10.6%

9.4%

12.0%

9.4%

 

 

 

 

 

 

 

 

 

 

SGA % of revenues

17.3%

18.3%

16.9%

17.1%

16.9%

17.9%

11.5%

 

 

 

 

 

 

 

 

 

 

Total Debt (millions)

 

$    760.5

$    760.5

$    760.5

$    770.5

$    770.5

$    170.5

 

 

 

 

 

 

 

 

 

 

Total Capital

 

$ 3,713.5

$ 3,536.0

$ 3,350.4

$ 3,310.8

$ 3,325.2

$ 1,382.9

 

 

 

 

 

 

 

 

 

 

Debt to capital

 

20.5%

21.5%

22.7%

23.3%

23.2%

12.3%

 

 

(1)

Company is still providing services to terminated customers.

(2)

2005 includes First Health results of operations for the period from when the transaction closed on January 28, 2005.

 

Page 10 of 10

 

 


The following information was filed by Coventry Health Care Inc (CVH) on Friday, February 9, 2007 as an 8K 2.02 statement, which is an earnings press release pertaining to results of operations and financial condition. It may be helpful to assess the quality of management by comparing the information in the press release to the information in the accompanying 10-K Annual Report statement of earnings and operation as management may choose to highlight particular information in the press release.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

þANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006

OR

oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

COMMISSION FILE NUMBER 1-16477


COVENTRY HEALTH CARE, INC.

(Exact name of registrant as specified in its charter)

Delaware

 

52-2073000

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification Number)

6705 Rockledge Drive, Suite 900, Bethesda, Maryland 20817

(Address of principal executive offices) (Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 par value

Common Stock purchase rights

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ                  No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (check one). Large accelerated filer þ Accelerated filer o Non-accelerated filer o

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

The aggregate market value of the registrant’s voting Common Stock held by non-affiliates of the registrant as of June 30, 2006 (computed by reference to the closing sales price of such stock on the NYSE® stock market on such date) was $8,729,678,553.

 

As of January 31, 2007, there were 159,475,200 shares of the registrant’s voting Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the registrant’s Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the Commission pursuant to Regulation 14A subsequent to the filing of this Form 10-K Report are incorporated by reference in Items 10 through 14 of Part III hereof.

 

COVENTRY HEALTH CARE, INC.

FORM 10-K

TABLE OF CONTENTS

PART I.

 

 

Item 1:        Business

 

 

 

Item 1A:     Risk Factors

 

 

 

Item 1B:     Unresolved Staff Comments

 

 

 

Item 2:        Properties

 

 

 

Item 3:        Legal Proceedings

 

 

 

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

 

 

PART II.

 

 

 

Item 5:       Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

 

 

Item 6:       Selected Financial Data

 

 

 

Item 7:       Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

Item 7A:    Quantitative and Qualitative Disclosures About Market Risk

 

 

 

Item 8:       Financial Statements and Supplementary Data

 

 

 

Item 9:       Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

 

 

Item 9a:     Controls and Procedures

 

 

 

Item 9b:     Other Information

 

 

PART III.

 

 

 

Item 10:     Directors, Executive Officers and Corporate Governance

 

 

 

Item 11:   Executive Compensation

 

 

 

Item 12:    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

 

 

Item 13:    Certain Relationships and Related Transactions and Director Independence

 

 

 

Item 14:     Principal Accountant Fees and Services

 

 

PART IV.

 

 

 

Item 15:    Exhibits, Financial Statement Schedules

 

 

SIGNATURES

 

 

INDEX TO EXHIBITS

Ex-10.12    Summary of Non-Employee Directors’ Compensation.

Ex-10.14    Summary of Named Executive Officer Compensation.

Ex-10.28.3 Third Amendment to Coventry Health Care, Inc. Supplemental Executive Retirement Plan (now known as the
                              401(k) Restoration and Deferred Compensation Plan), effective as of December 1, 2006.

Ex-10.29    Coventry Share Plan, as amended and restated, effective as of January 1, 2006.

Ex-12        Computation of Ratio of Earnings to Fixed Charges.

Ex-14        Code of Business Conduct and Ethics initially adopted by the Board of Directors of Coventry on February 20,
                              2003, as amended on March 3, 2005 and November 1, 2006.

Ex-21        Subsidiaries of the Registrant

Ex-23        Consent of Ernst & Young LLP

Ex-31.1     Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act
                              of 2002.

Ex-31.2     Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to section 302 of the Sarbanes-Oxley Act
                              of 2002.

Ex-32       Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant to section 906 of the Sarbanes-Oxley Act
                              of 2002.

 

PART I

Cautionary Statement Regarding Forward-Looking Statements

This Form 10-K contains forward-looking statements which are subject to risks and uncertainties in accordance with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, typically include assumptions, estimates or descriptions of our future plans, strategies and expectations, and are generally identifiable by the use of the words “anticipate,” “will,” “believe,” “estimate,” “expect,” “intend,” “seek,” or other similar expressions. Examples of these include discussions regarding our operating and growth strategy, projections of revenue, income or loss and future operations. Unless this Form 10-K indicates otherwise or the context otherwise requires, the terms “we,” “our,” “our Company,” “the Company” or “us” as used in this Form 10-K refer to Coventry Health Care, Inc. and its subsidiaries as of December 31, 2006.

These forward-looking statements may be affected by a number of factors, including, but not limited to, the “Risk Factors” contained in Item 1A, “Risk Factors” in this Form 10-K. Actual operations and results may differ materially from those expressed in this Form 10-K. Among the factors that may materially affect our business are increases in medical costs, difficulties in increasing premiums due to competitive pressures, unanticipated revenue short falls in recently acquired companies, price restrictions under Medicaid and Medicare, problems in integrating or realizing efficiencies in acquired companies, issues related to product marketing and imposition of regulatory restrictions, costs, or penalties. Other factors that may materially affect the Company’s business include issues related to the inability in obtaining or maintaining favorable contracts with health care providers, credit risks on global capitation arrangements, financing costs and contingencies, the ability to increase membership and litigation risk.

Item 1: Business

General

We are a national managed health care company based in Bethesda, Maryland, operating health plans, insurance companies, network rental/managed care services companies, and workers’ compensation services companies. We provide a full range of risk and fee-based managed care products and services, including health maintenance organization (“HMO”), preferred provider organizations (“PPO”), point of service (“POS”), Medicare Advantage, Medicare Prescription Drug Plans, Medicaid, Workers’ Compensation and Network Rental to a broad cross section of individuals, employer and government-funded groups, government agencies and other insurance carriers and administrators in all 50 states, as well as the District of Columbia and Puerto Rico.

Coventry was incorporated under the laws of the State of Delaware on December 17, 1997 and is the successor to Coventry Corporation, which was incorporated on November 21, 1986. Our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports, and recent press releases can be found, within one week of being filed with or furnished to the Securities and Exchange Commission (“SEC”) and free of charge, on the Internet at www.coventryhealth.com.

Coventry has two operating segments: Health Plans and First Health. Our Health Plans segment serves 17 markets, primarily in the Mid-Atlantic, Midwest and Southeast United States. Our health plans are operated under the names Altius Health Plans, Carelink Health Plans, Coventry Health Care, Coventry Health and Life, Group Health Plan, HealthAmerica, HealthAssurance, HealthCare USA, OmniCare, PersonalCare, Southern Health and WellPath. Our health plans generally are located in small to mid-sized metropolitan areas.

Our Health Plans segment offers a broad range of managed care products to a broad cross-section of employers including federal, state, and local governments. In selected markets, we participate in Medicaid and Medicare Advantage. In addition, we participate in Medicare Prescription Drug programs in all 34 CMS established regions. Our products include traditional HMO, PPO and POS. We offer these products on an underwritten or “risk” basis where we receive a monthly premium in exchange for assuming underwriting risks including all medical and administrative costs, as well as on a self-funded basis where we perform administrative services only for a fee and the customer assumes the risk for medical costs. Within these products, we also offer consumer-directed benefit options including health reimbursement accounts (“HRA”) and health savings accounts (“HSA”). The Medicare Advantage and Medicaid products offered through our health plans are risk products.

 

3

Our First Health segment serves the group health, workers’ compensation and state public program markets and assists a broad range of payor clients through a portfolio of both integrated and stand-alone managed care and administrative products. The components of First Health’s offerings include:

 

A broad, national preferred provider organization of directly contracted, quality, cost-effective health care providers

 

Clinical programs, including case management, disease management and return to work programs

 

Administrative products, including group health claims administration and workers compensation business process outsourcing, including bill review, first report of injury and front end claim processing

 

Pharmacy benefit management

 

Fiscal agent services (generally for state entitlement programs)

 

Group health insurance products

Health Plan Business

Health Plan Products

Commercial Risk

Our health plans offer individuals and employer groups a full range of commercial risk products, including HMO, PPO and POS products. Our health plans design their products to meet the needs and objectives of a wide range of employers and members and to comply with the regulatory requirements in the markets in which they operate. Our health plans had 1.5 million commercial risk members as of December 31, 2006 that accounted for $4.5 billion of revenue in 2006.

Our health plan products vary with respect to product features, the level of benefits provided, the costs to be paid by employers and members, including deductibles and co-payments, and our members’ access to providers without referral or preauthorization requirements.

Health Maintenance Organizations

Our health plan HMO products provide comprehensive health care benefits to members, including ambulatory and inpatient physician services, hospitalization, pharmacy, mental health and ancillary diagnostic and therapeutic services. In general, a fixed monthly premium covers all HMO services although some benefit plans require co-payments or deductibles in addition to the basic premium. A primary care physician assumes overall responsibility for the care of a member, including preventive and routine medical care and referrals to specialists and consulting physicians. While an HMO member’s choice of providers is limited to those within the health plan’s HMO network, the HMO member is typically entitled to coverage of a broader range of health care services than is covered by typical reimbursement or indemnity policies. Furthermore, many of our health plan HMO products have added features to more easily allow “direct access” to providers.

Preferred Provider Organizations and Point of Service

Our health plan risk-based PPO and POS products also provide comprehensive managed health care benefits to members, but allow members to choose their health care providers at the time medical services are required and use providers that do not participate in our health plan managed care networks. If a member chooses a non-participating provider, deductibles, co-payments and other out-of-pocket costs to the member generally are higher than if the member chooses a participating provider. Our health plans also offer high deductible health plan products in conjunction with our consumer directed products. Premiums for our health plan PPO and POS products typically are lower than HMO premiums due to the increased out-of-pocket costs borne by the members.

Medicare Advantage

As of December 31, 2006, our health plans operated four Medicare Advantage (“MA”) HMOs in four states covering 65,187 members and operated four Medicare demonstration PPOs in six states covering 14,531 members. The Medicare Advantage line of business accounted for $814.6 million of revenue in 2006.

 

4

The Centers for Medicare & Medicaid Services (“CMS”) pays a county-specific fixed premium per member per month (“PMPM”) under our health plan Medicare contracts. In 2006, 25% of the payment was based on demographic factors of the individual member and 75% is based on individually determined health risk adjusters. In 2007, and beyond it will be 100% health risk based. Our health plans also receive a monthly premium from most of their Medicare members and/or their employer. However, beginning in 2006, each Medicare market in which the health plan segment operates had at least one plan for which members do not pay a premium.

Commencing January 1, 2007, the Company will offer Medicare Advantage Private Fee for Service (PFFS) plans in 43 states under the name Advantra Freedom. These plans are offered under a contract with CMS and provide enrollees with all benefits they receive under Original Medicare plus additional benefits such as preventive care and eyeglasses/hearing aid coverage and pharmacy benefits. Enrollees are not limited to network providers, but may utilize any provider willing to accept the plan’s terms and conditions. Providers generally receive the same reimbursement as under original Medicare. The Company’s products will be underwritten by its health insurance subsidiaries.

Medicare Part D

The Medicare Part D program, which provides eligible beneficiaries access to prescription drug coverage, took effect January 1, 2006. As part of the Medicare Part D program, eligible Medicare recipients are able to select a prescription drug plan through Medicare Part D. Medicare Part D replaced the transitional prescription drug discount program and replaced Medicaid prescription drug coverage for dual-eligible beneficiaries. The Medicare Part D prescription drug benefit is largely subsidized by the federal government and is additionally supported by risk-sharing with the federal government through risk corridors designed to limit the profits or losses of the drug plans and through reinsurance for catastrophic drug costs. The government subsidy is based on the national weighted average monthly bid by Medicare region by participating plans for this coverage, adjusted for member demographics and risk factor payments. The beneficiary will be responsible for the difference between the government subsidy and his or her plan’s bid, together with the amount of his or her plan’s supplemental premium. Additional subsidies are provided for dual-eligible beneficiaries and specified low-income beneficiaries.

Our new Medicare Part D business, which began in 2006, accounted for $669.9 million of revenue in 2006 and had 687,000 members as of December 31, 2006. The Medicare Part D plans are marketed under the brand names of Advantra Rx, First Health Premier and First Health Select. For 2007, these plans include options with first dollar coverage (no deductible) and options for coverage within the “doughnut hole” or the coverage gap in which no insurance coverage under the standard Part D program is available. Products are underwritten by Coventry Health and Life Insurance Company, First Health Life and Health Insurance Company and Cambridge Life Insurance Company. We have established partnerships with Medicare Supplement insurance carriers and brokerage channels nationwide to sell Medicare Part D prescription drug products to Medicare beneficiaries.

Medicaid

Certain of our health plans offer health care coverage to Medicaid recipients in seven states which, as of December 31, 2006, covered 373,000 members and accounted for $762.1 million of revenue in 2006. These health plans enter into a Medicaid Management Care contract with each of these individual states. Under a Medicaid contract, the participating state pays a monthly premium per member based on the age, sex, eligibility category and in some states, county or region of the Medicaid member enrolled. In some states, these premiums are adjusted according to the health risk associated with the individual member. The majority of the Medicaid members are in the Michigan, Missouri and Pennsylvania markets, representing 84.9% of the total Medicaid membership.         

Management Services

Our health plans offer management services and access to their provider networks to employers that self-insure their employee health benefits. The management services provided under these Administrative Services Only (“ASO”) arrangements typically include network management, claims processing, utilization management and quality assurance. Other features commonly provided to fully insured customers (such as value-added wellness benefits) are most commonly also extended to ASO customers. Under the ASO arrangements, our health plans receive a fixed fee for management services and access to their provider networks and they assume no underwriting risk. As of December 31, 2006, the health plans had approximately 621,000 non-risk health plan members.

Health plan management and other administrative services accounted for $124.6 million of revenue for the year ended December 31, 2006.

 

5

Health Plan Markets

The geographic markets in which our health plans operate are described as follows:

 

Delaware — commercial products in Delaware and Maryland; Medicaid products in the Baltimore metropolitan area.

 

Georgia — commercial products in the greater Atlanta, Savannah and Macon metropolitan areas.

 

Illinois — commercial products, primarily in the Western, Northern (exclusive of the Chicago Metropolitan area) and Central Illinois areas.

 

Iowa — commercial products to members primarily in the Des Moines metro area; Medicaid products in the Waterloo area; and Medicare Advantage products in five counties.

 

Kansas — commercial products in Kansas and portions of Western Missouri and Oklahoma; Medicare Advantage products in the Kansas City and Wichita metropolitan areas.

 

Louisiana — commercial products, primarily in the New Orleans, Baton Rouge and Shreveport metropolitan areas.

 

Michigan — Medicaid products in Wayne County, Michigan.

 

Missouri— commercial and Medicare Advantage products to members in the St. Louis metropolitan area, including portions of Southern Illinois; Medicaid products also in the St. Louis metropolitan area and Central and Western Missouri.

 

Nebraska — commercial products primarily in the Omaha metropolitan area with additional networks in Lincoln and rural Nebraska.

 

North Carolina — commercial products in the Durham (primarily Charlotte and Raleigh) and Charleston, South Carolina metropolitan areas.

 

Pennsylvania — commercial products primarily in Harrisburg, Lehigh Valley and the State College metropolitan areas comprising the Central Pennsylvania market; commercial products in the Philadelphia metropolitan area comprising the Eastern Pennsylvania market; commercial products in Pittsburgh, Erie and portions of Eastern Ohio comprising the Western Pennsylvania market; Medicaid products in the Harrisburg metropolitan area; and Medicare Advantage products in the Pittsburgh, Harrisburg and State College metropolitan areas.

 

Utah — commercial products primarily in the Ogden, Salt Lake City and Provo metropolitan areas; commercial products also in Wyoming and Idaho.

 

Virginia — commercial and Medicaid products primarily in the Richmond, Roanoke and Charlottesville metropolitan areas and the Shenandoah Valley.

 

West Virginia — commercial, Medicaid and Medicare Advantage products to a service area covering a majority of the state’s population.

 

6

Health Plan Membership

The following tables show the total number of health plan members as of December 31, 2006 and 2005 (in thousands) and the percentage change in membership between these dates.

 

 

 

 

December 31,

 

Percent

 

 

 

 

2006

 

2005

 

Change

Membership by market:

 

 

 

 

 

 

 

Delaware

 

148

 

119

 

24.4%

 

Georgia

 

102

 

78

 

30.8%

 

Illinois

 

103

 

93

 

10.8%

 

Iowa

 

60

 

67

 

(10.4%)

 

Kansas

 

227

 

218

 

4.1%

 

Louisiana

 

55

 

64

 

(14.1%)

 

Michigan

 

58

 

61

 

(4.9%)

 

Missouri

 

432

 

449

 

(3.8%)

 

Nebraska

 

63

 

54

 

16.7%

 

North Carolina

 

117

 

133

 

(12.0%)

 

Pennsylvania

 

683

 

739

 

(7.6%)

 

Utah

 

222

 

208

 

6.7%

 

Virginia

 

177

 

181

 

(2.2%)

 

West Virginia

 

77

 

82

 

(6.1%)

 

 

Total membership

 

2,524

 

2,546

 

(0.9%)

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

Percent

 

 

 

 

2006

 

2005

 

Change

Risk membership:

 

 

 

 

 

 

 

Commercial

 

1,450

 

1,486

 

(2.4%)

 

Medicare Advantage

 

80

 

75

 

6.7%

 

Medicaid

 

373

 

393

 

(5.1%)

 

 

Total risk membership

 

1,903

 

1,954

 

(2.6%)

Non-risk membership

 

621

 

592

 

4.9%

 

 

Total membership

 

2,524

 

2,546

 

(0.9%)

 

Health Plan Provider Networks

Our health plans maintain provider networks that furnish health care services through contractual arrangements with physicians, hospitals and other health care providers. All of our health plans currently offer an open panel delivery system. In an open panel structure, individual physicians or physician groups contract with the health plans to provide services to members but also maintain independent practices in which they provide services to individuals who are not members of our health plans.

Most of our health plan contracted primary care and specialist physicians are compensated under a discounted fee-for-service arrangement. The majority of our health plans contract with hospitals to provide for inpatient per diem or per case hospital rates. Outpatient services are contracted on a discounted fee-for-service or a per case basis. Our health plans pay ancillary providers on a fixed fee schedule or a capitation basis. Prescription drug benefits are provided through a formulary comprised of an extensive list of drugs. Drug prices are negotiated at discounted rates through a network of pharmacies in the markets in which our health plans operate.

Our health plans have capitation arrangements for certain ancillary health care services, such as mental health care, laboratory services and, in some cases, physician services. Under some capitated arrangements, physicians may also receive additional compensation from risk sharing and other incentive arrangements. Capitation arrangements limit our health plans’ exposure to the risk of increasing medical costs, but expose them to risk as to the adequacy of the financial and medical care resources of the provider organization. Our health plans are ultimately responsible for the coverage of their members pursuant to the customer agreements. To the extent that the respective provider organization faces financial difficulties or otherwise is unable to perform its obligations under the capitation arrangements, our health plans will be required to perform such obligations. Consequently, our health plans may have to incur costs in excess of the amounts they would otherwise have to pay under the original capitation arrangements. Medical costs associated with capitation arrangements made up approximately 6.1%, 6.5%, and 7.1% of our total medical costs for the years ended December 31, 2006, 2005 and 2004, respectively. Membership associated with global capitation arrangements was approximately 110,000, 116,000 and 127,000 as of December 31, 2006, 2005 and 2004, respectively. Based on our knowledge and experience, we do not consider the financial risk associated with our existing capitation arrangements to be material.

 

7

Health Plan Medical Management

Our health plans have established systems to monitor the availability, appropriateness and effectiveness of the patient care their network providers provide. Our health plans collect utilization data in each of our health plan markets that is used to analyze over-utilization or under-utilization of services and to assist our health plans in arranging for appropriate care for their members and improving patient outcomes in a cost efficient manner. Our corporate medical department monitors the medical management policies of our health plans and assists our health plans in implementing disease management programs, quality assurance programs and other medical management tools. In addition, our health plans have internal quality assurance review committees made up of practicing physicians and staff members whose responsibilities include periodic review of medical records, development and implementation of standards of care based on current medical literature and the collection of data relating to results of treatment.

Our health plans have developed a comprehensive disease management program that identifies those members having certain chronic diseases, such as asthma and diabetes. Our health plan case managers proactively work with members and their physicians to facilitate appropriate treatment, help to ensure compliance with recommended therapies and educate members on lifestyle modifications to manage the disease. We believe that our disease management program promotes the delivery of efficient care and helps to improve the quality of health care delivered.

Each of our health plans either employs or contracts with physicians as medical directors who monitor the quality and appropriateness of the medical services provided to our members. The medical directors supervise medical managers who review and approve, for coverage in accordance with the health benefit plan, requests by physicians to perform certain diagnostic and therapeutic procedures, using nationally recognized clinical guidelines developed based on nationwide benchmarks that maximize efficiency in health care delivery and InterQual, a nationally recognized evidence-based set of criteria developed through peer review medical literature. Medical managers also continually review the status of hospitalized patients and compare their medical progress with established clinical criteria, make hospital rounds to review patients’ medical progress and perform quality assurance and utilization functions.

Medical directors also monitor the utilization of diagnostic services and encourage the use of outpatient surgery and testing where appropriate. Data showing each physician’s utilization profile for diagnostic tests, specialty referrals and hospitalization are collected by each health plan and presented to the health plan’s physicians. The medical directors monitor these results in an attempt to ensure the use of cost-effective, medically appropriate services.

Our health plans also focus on the satisfaction of its members. They monitor appointment availability, member-waiting times, provider environments and overall member satisfaction. Our health plans continually conduct membership surveys of existing employer groups concerning the quality of services furnished and suggestions for improvement.

Health Plan Information Technology

We believe that integrated and reliable information technology systems are critical to our health plans’ success. We have implemented advanced information systems to improve the operating efficiency of our health plans, support medical management, underwriting and quality assurance decisions and effectively service our employer customers, members and providers. Each of our health plans operates on a single financial reporting system along with a common, fully integrated application which encompasses all aspects of our commercial, government and non-risk business, including enrollment, provider referrals, premium billing and claims processing. Our centralized data center processes approximately 26.0 million claims annually.

We have dedicated in-house teams providing infrastructure and application support services to our members. Our data warehouse collects information from all of our health plans and uses it in medical management to support our underwriting, product pricing, quality assurance, rates, marketing and contracting functions. We have dedicated in-house teams that convert acquired health plans to our information systems as soon as possible following the closing of the acquisition.

In 2006, approximately 72.9% of our claim transactions were received from providers in a HIPAA compliant electronic data interface format. In 2006, our claims system auto adjudicated 80.9% of all claims.

 

8

Health Plan Marketing

Our health plans market commercial HMO, POS and PPO products to individuals and employer group purchasers in their local markets. Employer groups are offered coverage on both a fully insured and self-funded basis, the latter occurring most commonly in the large group segment. Among small and medium size employers, our health plan commercial products are most commonly offered on an exclusive basis. In the large group segment, our health plan products may be made available to employees as one option among multiple carriers. In all size segments, employers generally pay a large part of their employees’ health care premiums, although we have witnessed a gradual trend toward a growing portion of that cost being assumed by employees. Typically our health plan employer group contracts are up for renewal annually.

To respond to market demand, our health plans have expanded the number of lower cost product options made available to employee group purchasers. These include Coventry FlexChoice products, a family of “consumer driven” products whereby the employee bears a substantially greater proportion of healthcare costs through mechanisms such as higher deductibles augmented by HRAs. In addition, our health plans offer HSAs which are tax-advantaged accounts for healthcare expenses. We continue to invest in an array of consumer-driven health plan alternatives.

Our health plans market their managed care products and services through their own direct sales staff and a network of several thousand independent brokers and agents. Our membership growth efforts are focused on both developing new business and retaining existing business. We compensate our direct sales staff through a combination of base salary and incentive arrangements. We compensate our independent brokers and agents on a commission basis.

Our products and services are most commonly marketed in a two-step process in which presentations are made first to employers to secure contracts to provide health benefits. In most instances, our health plan sales are made on a complete replacement basis. If they are co-existing in an employer account with another carrier, our health plan direct sales staff will then be involved in the solicitation of employees (subscribers) from the employee base during periodic open enrollments during which employees are permitted to change health care programs. In some markets, this second step of the marketing process incorporates workplace presentations, direct mail and mass media advertising to target prospective members.

Our health plan Medicaid products are marketed to Medicaid recipients by state Medicaid authorities. These contracts typically renew on an annual basis.

Our health plans commonly promote Medicare Advantage products through mass media and direct mail to both individuals and retirees of employer groups that provide benefits to retirees. Networks of independent brokers and agents are also used in the marketing of Medicare products. While Medicare enrollees are able to disenroll monthly, beginning in 2006, a “lock-in” period starting in May was introduced, in which specific criteria has to be met to disenroll.

Our health plans seek to enroll eligible Medicare members in plans covering both medical and pharmacy benefits. In 2006, we also began offering a stand alone prescription drug plan under the new CMS regulations. This product is marketed through our existing channels as well as through joint marketing arrangements with Medicare Supplement Health Insurers and third party payors and administrators (“TPAs”) and related broker distribution entities. Beginning in 2007, Medicare Private-Fee-For-Service (“PFFS”) products will be offered by our company. Products will be underwritten by Coventry Health and Life Insurance Company, First Health Life and Health Insurance Company and Cambridge Life Insurance Company. We have established partnerships with Medicare Supplement insurance carriers and brokerage channels nationwide to provide PFFS products to Medicare beneficiaries.

Our health plans maintain an active presence in the communities they serve through participation in health fairs, special children’s programs and other community activities, which we believe enhances our visibility and reputation in these communities.

Health Plan Significant Customers

Our health plan commercial business is diversified across a large customer base and there are no commercial groups that make up 10% or more of our managed care premiums. We received 21.6%, 11.8% and 10.9% of our managed care premiums for the years ended December 31, 2006, 2005 and 2004, respectively, from the federal Medicare program throughout our various health plan markets. We also received 11.1%, 13.2% and 11.7% of our managed care premiums for the years ended December 31, 2006, 2005 and 2004, respectively, from our state-sponsored Medicaid programs throughout our various health plan markets. In 2006, the State of Missouri accounted for almost half of our health plan Medicaid premiums.

 

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Health Plan Competition

The managed care industry is highly competitive; both nationally and in the individual markets we serve. Generally, in each market, we compete against local health plans and nationally focused health insurers and managed care plans. We compete for employer groups and members primarily on the basis of the price of the benefit plans offered, locations of the health care providers, reputation for quality care and service, financial stability, comprehensiveness of coverage, diversity of product offerings and access to care. We also compete with other managed care organizations and indemnity insurance carriers in obtaining and retaining favorable contracts for health care services and supplies.

First Health Business

Our First Health segment is a collection of health benefits services companies that serve the Group Health and Specialty sectors.

Group Health Sector Overview

The Group Health business offers its managed care and administrative products to commercial payors in three customer classifications: National Accounts, Federal Employee Health Benefits Program (“FEHB Program”) and Network Rental.

National Accounts

First Health serves businesses with locations in several states that self-insure the health care benefits of their employees subject to the Employee Retirement Income Security Act of 1974 (“ERISA”). A variety of stand-alone managed care services, as well as a portfolio of integrated health plan products, are generally offered to national, multi-site companies with 500 employees or more as well as to mid-size companies in regional and local markets.

Federal Employee Health Benefits Program

First Health has provided services to plans in the FEHB Program for nearly two decades. The FEHB Program is the largest employer-sponsored group health program in the United States. The FEHB Program sector is both a business-to-business and business-to-consumer sector where federal employees have the opportunity to choose a health benefits carrier from a number of offered plans each year. First Health provides a variety of managed care and administrative services and serves as the plan administrator to the Mail Handlers Benefit Plan (“MHBP”), First Health’s largest client. The MHBP offers health care benefits under the FEHB Program to federal employees and annuitants nationwide. First Health also provides a full range of managed care and administrative services to MHBP and, to a lesser degree, provides various managed care or administrative services to certain other FEHB Program Plans.

Network Rental

First Health offers its national PPO network and other managed care products to national, regional and local TPAs and insurance carriers. This business primarily operates on a business-to-business basis, focusing on delivering managed care and administrative solutions that increase client efficiency and improve their product offerings. Network services are supplemented with a variety of product offerings, including clinical management programs. A block of small group insured business underwritten by First Health Life and Health and supported by our provider network is included in the Group Health sector.

Specialty Sector Overview

The Specialty businesses offer network managed care and administrative services to Workers’ Compensation and Public/Medicaid customers.

 

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Workers’ Compensation

First Health offers administrative services to workers’ compensation TPAs, state funds and insurance carriers who underwrite or administer workers’ compensation insurance programs. Workers’ Compensation insurance covers the cost of medical care and lost wages for workers injured on the job. First Health offers managed care services, and clinical management programs as well as business process outsourcing services which include bill review, imaging, work flow management and first report of injury. In general, workers’ compensation carriers and self-funded entities have experienced significant challenges in recent years due to increases in medical costs. As a result, there is a demand by payors for products that target high cost and/or high volume services. First Health believes it has one of the largest and most cost effective national workers’ compensation network and bill review system that creates a value proposition for its customers. In addition, First Health has developed other products to help its clients contain costs such as a subset point-of-entry network (smaller network of providers that are accessed for initial treatment by injured workers) and a Medicare set-aside program (when a payor determines that they want to settle a workers’ compensation claim, a Medicare set-aside program must be submitted to CMS, under certain conditions, to ensure that Medicare’s rights as the secondary payor are protected). Furthermore, First Health’s business process outsourcing provides customers with work flow and medical records value-added solutions.

Medicaid/Public

Our Medicaid/Public entity, First Health Services, provides integrated automation, administration, payment and health care management services to state and local governments (“Public Sector”) related to their pharmacy and health benefits programs. First Health Services offers the following categories of programs:

 

Pharmacy benefit management

 

Health care management

 

Fiscal agent services

First Health Services has been able to utilize its Medicaid fiscal agent expertise, its base of experience in the public sector and its client relationships with over 27 state governments to provide new products and services as the public sector health programs (primarily Medicaid) move toward more efficient utilization of health care services.

Group Health Products

Provider Network

The national provider network incorporates both group health and workers’ compensation medical providers. The provider network is the core of our Group Health and Workers’ Compensation business, providing the foundation for all other Group Health products and services. We contract with hospitals, physicians and other health care providers that provide health care services at pre-negotiated rates to members and customers of various payors, including employee groups, workers’ compensation payors or other payors. Provider networks offer a means of managing health care costs by reducing the per-unit price of medical services accessed through the network while providing an increased number of patients to providers. Our provider network aggregates hospitals, physicians and other health care providers all across the country and allows First Health to offer services at pre-negotiated rates to a diverse group of payors, including group health and workers’ compensation insurance carriers, TPAs, HMOs, self-insured employers, union trusts and government employee plans.

Our provider network maximizes client savings through a combination of increased penetration to a broad network and discounted unit costs savings. The majority of the facility contracts feature fixed rate structures that ensure cost effectiveness while incentivizing providers to control utilization. The fixed rate structures include per diems based on the intensity of care and/or Diagnostic Related Group (“DRG”) based pricing for inpatient care. Hospital outpatient charges are typically controlled by fixed fee schedules. For facilities or procedures not covered by fixed pricing arrangements, charge master controls are generally negotiated to control attempts to increase charges by inflating the price list.

 

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Pharmacy Benefits Management

First Health offers a comprehensive pharmacy benefit management program, including:

 

A national, proprietary, point-of-sale, pharmacy network, consisting of more than 51,000 chain and independent pharmacies

 

Formulary management

 

Mail-order service through a third party vendor

 

Prospective drug utilization review

 

Online prescription claim adjudication

The single source combination of pharmacy benefits management and medical management is critical to managing and assessing the total medical cost. Pharmacy data sources are linked with other data sources to internally identify at-risk members for disease management.

Clinical Programs

First Health provides clinical programs including utilization review, case management, medication compliance and disease management through an internal staff consisting primarily of allied health professionals, registered nurses and physicians. This staff is supplemented by a nationwide network of consulting physicians with a full range of specialties. The in-house physician staff is a resource for the development of programs, as well as clinical policies and guidelines. The staff includes experienced, board-certified physicians in such specialties as internal medicine, psychology, psychiatry and family practice. The staff is crucial to the development and maintenance of evidence-based medical necessity guidelines and network quality assessment efforts.

First Health’s approach to clinical management is patient-centered, which means that it provides the level of support required to manage outcomes at an individual level. Its program focuses on proper management of illnesses and chronic conditions through early identification, intervention and education. Because First Health owns and operates the program, it is able to aggregate data to identify at-risk members at an early stage and to monitor individual claims data to identify high-risk patients. First Health connects these patients with network providers and sets appointments to facilitate compliance. First Health then works with the patients and their providers to identify and implement cost effective treatment alternatives. In all cases, the decision to proceed with these alternatives is made by the patient and the physician.

Medical Claims Administration and Health Plan Services

First Health provides comprehensive claims administration to group health clients who purchase its managed care services. First Health provides clients with an integrated package of health care benefits administration, including:

 

Managed care administration

 

Medical, dental and vision claims processing

 

Prescription drug plan administration

 

Flexible spending account administration

 

Health care reimbursement account administration

 

COBRA administration

 

Health savings account administration

 

Subrogation administration

 

Access to member services representatives 24-hours-a-day, 7-days-a-week

First Health’s proprietary claims administration system, the First Claim system, was internally developed, and has the flexibility to support business functions in an efficient, effective manner. Because First Health controls the system, it can offer maximum flexibility for clients who require a variety of benefit plan options or who wish to implement a customized benefit plan. Virtually all of First Health’s clients have benefit plans that are unique to them and their business.

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Stop-Loss Insurance

First Health’s stop-loss insurance capabilities enable it to serve as an integrated, single source for the managed care needs of its clients who are self-insured employers. Because its stop-loss rates are based on the savings and value generated through its various services, First Health is able to offer competitive rates and policies. Stop-loss policies are written through our wholly-owned insurance subsidiaries and can be written for specific and/or aggregate stop-loss insurance.

Workers’ Compensation Products

Bill Review

The First Health Bill Review system offers national and multi-regional workers’ compensation clients a single system to integrate and manage their workers’ compensation medical data. This means that clients can implement their workers’ compensation managed care strategies on a national basis, allowing them to capture data from multiple sources, analyze the information and use it to implement advanced managed care strategies.

First Health Bill Review provides its clients with an accurate and consistent application of state fee schedule pricing, including applicable rules, regulations and clinical guidelines. State fee schedules, which represent the maximum reimbursement for medical services provided to the injured worker, differ by state (and change as state laws and regulations are passed and/or amended). The system features full integration with our provider network and provides a seamless process for determining claim payment rates. As part of the bill adjudication process, First Health subjects bills to a sophisticated, proprietary process to detect duplicate bills and correct billing irregularities and inappropriate billing practices. First Health maintains and supports virtually all aspects of the system. Therefore, clients gain efficiencies when using its integrated services by decreasing the staff previously required to support bill processing systems. First Health has the capability to program and implement client-specific enhancements, which provides truly customized bill review systems for its clients.

The system supports a number of electronic data interchanges from front-end systems, including claim systems and bill entry systems. The system also supports electronic data interchange (“EDI”) output to populate back-end systems such as payment systems, claims systems, explanation of review production, state reporting and data warehousing.

In addition, its bill review system has a comprehensive reporting database that produces a standard set of client savings and management reports. Clients who lease the First Health Bill Review system have online access to their data and are able to create numerous reports at their desktops.

First Report of Injury

Early medical management intervention is important to achieving optimal outcomes in workers’ compensation cases. Prompt notification and initiation of medical management helps ensure that injured persons receive appropriate treatment that expedites their recovery and return to work.

The First Health First Report of Injury system is a quick and easy-to-use service that greatly simplifies the reporting process for workplace injuries, as well as non-occupational disability, property and general liability claims. The First Health First Report of Injury service promotes immediate intervention after such occurrences. The system can transmit a first report to a designated representative within hours of notification. In addition to expediting reporting, the system can serve as a gateway to medical management services and channeling work place injury patients to our provider network.

Medicaid/Public Products

Pharmacy Benefit Management

First Health Services’ pharmacy benefit management (“PBM”) program manages pharmacy benefit plans for Medicaid programs, state senior drug programs and state-funded specialty programs. This PBM program is one of the largest of its kind in the country and provides a full range of services, including:

 

Pharmacy point-of-sale eligibility verification and claims processing

 

Provider network development and management

 

Case management programs

 

Prospective and retrospective drug utilization reviews

 

Prescriber and provider profiling

 

Prescriber education, preferred drug list development and manufacturers’ rebate contracting and administration

 

Prior authorization of pharmaceutical use

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First IQ™, a proprietary database and decision support system for drug utilization management (e.g., retrospective drug utilization review and clinical intervention management)

PBM services are increasingly required by both public and private third-party payors as prescription drug expenses grow. First Health Services believes its role as an independent provider of PBM services gives it a distinct competitive advantage in the growing number of state government plans where clinical autonomy is often a requirement. The PBM business model is completely transparent so that the benefit of all rebates and network discounts is passed directly and totally to the client. Furthermore, First Health Services is a national leader in this area with substantial experience managing pharmacy plans for Medicaid and state pharmaceutical assistance programs. This clinical and management expertise provides a competitive advantage in the rapidly growing market of managed care organizations serving the Medicaid/Public customers on a non-risk, fee basis.

First Health Services also offers clinical management programs to assist physicians and network pharmacies in the appropriate management of patients using pharmaceuticals. This program provides physicians with reviews of treatment appropriateness and preferred drug guidelines which have been developed by nationally recognized clinicians and medical authorities. First Health Services’ clinical management program focuses on those patients who experience preventable therapeutic problems such as non-compliance, inappropriate therapy and adverse drug reactions. The program includes prior authorization initiatives, prospective and retrospective drug utilization reviews and educational intervention initiatives, known as concurrent drug utilization review and prescriber education.

In exchange for providing its PBM services, First Health Services receives a predetermined, contractual fee that is based upon services rendered or the number of transactions processed plus added fees for additional time and materials and for change orders outside of contract perimeters. First Health Services neither derives any revenue from drug manufacturers or the pharmacy network contracts, nor does it provide any mail order services. First Health Services contracts with pharmaceutical companies on behalf of the individual state programs unless they belong to a collective purchasing group. The rebate discount rate structure can vary by state. All rebates are retained by the individual state programs.

Through the acquisition of Provider Synergies, L.L.C. (effective January 1, 2006), we expanded and enhanced our offering of customized clinical pharmacy management services, including preferred drug list management and drug rebate contracting services, to state Medicaid programs across the country.

Health Care Management

First Health Services’ Health Care Management program provides external quality of care evaluation, utilization review and long-term care review services to Medicaid programs, state mental health agencies and other public sector health care programs desiring to improve quality of care, contain costs, ensure appropriate care and measure outcomes. The utilization review services cover a variety of medical, surgical and behavioral health programs, including acute and chronic inpatient and outpatient treatment of children, adult and geriatric populations, residential services and other alternative services. Under the long-term care review services, First Health Services provides level-of-care determinations as well as pre-admission screenings and annual resident reviews to determine the need for specialized services for mental illness, mental retardation or related conditions. The Health Care Management program also provides on-site quality reviews and inspection of care for community mental health centers, residential treatment centers and inpatient psychiatric programs. As state Medicaid programs and state departments of mental health spend increasing portions of public funds on treatment for Medicaid and other needy populations, the need for utilization review services increases. Some states are moving toward capitated contracts with private sector firms to help manage care. However, many states are opting to maintain fee-for-service programs but contract for utilization review services to ensure appropriate health care.

Fiscal Agent

First Health Services’ Fiscal Agent program administers state Medicaid health plans and other state-funded health care programs by providing clients with fiscal agent operations and systems maintenance and enhancement.

First Health Services’ customers include state Medicaid agencies, state departments of human services and departments of health serving Medicaid populations and other public assistance health benefit programs. Typically, fiscal agent systems are modified to meet a specific state’s program policy and administration requirements so that services are offered for all claim types. First Health Services has developed and operates a CMS certified information system for each client. These systems are utilized to process and adjudicate eligibility, health care claims and encounters, pay providers under a full range of reimbursement methods and generate reports for use in managing the program.

 

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First Health Marketing

Group Health Sector

We primarily market our services to national, multi-site direct accounts, including self-insured employers, government employee groups and multi-employer trusts with greater than 500 employees. In addition, we market our services to and through group health insurance carriers and TPAs.

In the case of insurance carriers, we typically enter into a master service agreement under which we agree to provide our cost management services to health care plans maintained by the carrier’s customers. Our services are offered not only to new insurance policyholders, but also to existing policyholders at the time group health policies are renewed.

For our National Accounts business, our target market generally consists of payors with 500 employees or more. In addition, we service mid-size, self-insured companies in local and regional markets with an integrated health plan offering, which may include stop-loss insurance coverage. Generally, marketing in this sector is done directly to payors and through relationships with select consultants and brokers.

For our Federal Employee Health Benefits business, we market directly to both health plan sponsors and federal employees to gain additional membership in the MHBP through direct mail and print. We expect to continue direct marketing as a means of increasing membership in the MHBP.

For our Network Rental business, we market on a business-to-business basis directly to TPAs and insurance carriers. In turn, our customers have primary responsibility for offering our services to their underlying clients, relieving us of significant marketing expense. We support these efforts through participation in the proposal process. The clients of our TPA and carrier customers typically are small in size and limited in geography.

Specialty Sector

For our Workers’ Compensation Services business, we solicit insurance carriers and TPAs, who in turn take responsibility for marketing our services to their prospects and clients. We also market directly to state funds, municipalities, self-insured payors and other distribution channels. For our Medicaid/Public business, we sell our government PBM, health care management and fiscal agent business lines through an internal sales team to state and local governments across the United States. While most contracts are ultimately awarded via request-for-proposals and a competitive bid process, pre-selling efforts are critical in targeting opportunities that best match our capabilities and service offerings. Through this pre-sell effort, we are also able to identify the particular needs of prospective clients and provide assistance in public and program policy development.

First Health Significant Customers

Our customer, the Mail Handlers Benefit Plan, represented 22.7% and 22.8% of our First Health revenues and 2.5% and 2.8% of Coventry’s consolidated revenues for the years ended December 31, 2006 and 2005, respectively. Our contract with the Mail Handlers Benefit Plan is up for renewal on December 31, 2007. No other customer represented 10% or more of our First Health business revenues for the years ended December 31, 2006 and 2005.

First Health Competition

Group Health Sector

We compete in a highly fragmented market with national, regional and local firms specializing in utilization review and PPO cost management services and with major insurance carriers and third party administrators that have implemented their own internal cost management services. In addition, other managed care programs, such as HMOs and group health insurers, compete for the enrollment of benefit plan participants. We are subject to intense competition in each market segment in which we compete. We distinguish ourselves on the basis of the quality and cost-effectiveness of our programs, our proprietary computer-based integrated information system, our emphasis on commitment to service with a high degree of physician involvement, our national provider network and its penetration into secondary and tertiary markets and our role as an integrated provider of PBM services.

 

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Specialty Sector

Workers’ compensation competition includes regional and national managed care companies and other service providers with an emphasis on PPO, clinical programs or bill review. We differentiate ourselves based on our national PPO coverage and the ability to provide an integrated product, coupled with technology that reduces administrative cost. We compete with a multitude of PPOs, technology companies that provide bill review services, clinical case management companies and rehabilitation companies for the business of these insurers. While experience differs with various clients, obtaining a workers’ compensation insurer as a new client typically requires extended discussions and a significant investment of time. Given these characteristics of the competitive landscape, client relationships are critical to the success of our workers’ compensation products.

The Medicaid/Public business serves state and local governmental agencies in three distinct focus areas-fiscal agent, pharmacy, and healthcare management services. Each of these lines of business has varying competitive factors that affect entry into the market as a new competitor. Fiscal agent services are provided to state Medicaid programs by four major competitors, including First Health. The market for pharmacy services to states that have elected to outsource pharmacy benefit management services is served by a select group of major national competitors including First Health. The market for healthcare management services is more fragmented with no distinguishable market leader. In addition to national competitors including First Health, regional peer review organizations/quality improvement organizations also hold contracts in their individual states or a local market.

Financial Information  

 

Required financial information related to our business segments is set forth in Note O of our consolidated financial statements.

Corporate Governance

Our Board of Directors has adopted a Code of Business Conduct and Ethics applicable to the members of our Board of Directors and our officers, including our Chief Executive Officer, Chief Financial Officer, Controller and our employees. In addition, the Board of Directors has adopted Corporate Governance Guidelines and committee charters for our Audit Committee, Compensation Committee and Nominating/Corporate Governance Committee. Our Code of Business Conduct and Ethics, Corporate Governance Guidelines and current committee charters can be accessed on our website at www.coventryhealth.com or may be requested by writing to the following address: Coventry Health Care, Inc., Attn: Corporate Secretary, 6705 Rockledge Drive, Suite 900, Bethesda, Maryland, 20817. Any amendments to our Code of Business Conduct and Ethics are posted and can be accessed on our website.

Government Regulation  

As a managed health care company, we are subject to extensive government regulation of our products and services. The laws and regulations affecting our industry generally give state and federal regulatory authorities broad discretion in their exercise of supervisory, regulatory and administrative powers. These laws and regulations are intended primarily for the benefit of the members of the health plans. Managed care laws and regulations vary significantly from jurisdiction to jurisdiction and changes are frequently considered and implemented.

State Regulation

The states served by our health plans provide the principal legal and regulatory framework for the commercial risk products offered by our insurance companies and HMO subsidiaries. One of our insurance company subsidiaries, Coventry Health and Life Insurance Company (“CH&L”), offers managed care products, primarily PPO and POS products, in conjunction with our HMO subsidiaries in states where HMOs are not permitted to offer these types of health care benefits. CH&L does not currently offer traditional health indemnity insurance. In addition, one of our subsidiaries, First Health Life & Health Insurance Company, offers a small group PPO product in certain states.

Our regulated subsidiaries are required by state law to file periodic reports and to meet certain minimum capital and deposit and/or reserve requirements and may be restricted from paying dividends to the parent or making other distributions or payments under certain circumstances. They also are required to provide their members with certain mandated benefits. Our HMO subsidiaries are required to have quality assurance and educational programs for their professionals and enrollees. Certain states’ laws further require that representatives of the HMOs’ members have a voice in policy making. Most states impose requirements regarding the prompt payment of claims and several states permit “any willing provider” to join our network. Compliance with “any willing provider” laws could increase our costs of assembling and administering provider networks.

 

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We also are subject to the insurance holding company regulations in the states in which our regulated subsidiaries operate. These laws and associated regulations generally require registration with the state department of insurance and the filing of reports describing capital structure, ownership, financial condition, certain inter-company transactions and business operations. Most state insurance holding company laws and regulations require prior regulatory approval or, in some states, prior notice, of acquisitions or similar transactions involving regulated companies, and of certain transactions between regulated companies and their parents. In connection with obtaining regulatory approvals of acquisitions, we may be required to agree to maintain capital of regulated subsidiaries at specified levels, to guarantee the solvency of such subsidiaries or to other conditions. Generally, our regulated subsidiaries are limited in their ability to pay dividends to their parent due to the requirements of state regulatory agencies that the subsidiaries maintain certain minimum capital balances.

Our First Health workers’ compensation business is also subject to state governmental regulation. Historically, governmental strategies to contain medical costs in the workers’ compensation field have been limited to legislation on a state-by-state basis. Many states have adopted guidelines for utilization management and have implemented fee schedules that list maximum reimbursement levels for health care procedures. In certain states that have not authorized the use of a fee schedule, we adjust bills to the usual and customary levels authorized by the payor.

Most states now impose risk-based or other net worth-based capital requirements on our regulated entities. These requirements assess the capital adequacy of the regulated subsidiary based upon the investment asset risks, insurance risks, interest rate risks and other risks associated with the subsidiary’s business. If a subsidiary’s capital level falls below certain required capital levels, it may be required to submit a capital corrective plan to regulatory authorities, and at certain levels may be subjected to regulatory orders, including regulatory control through rehabilitation or liquidation proceedings. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” for more information.

Federal Regulation

Privacy, Security and other HIPAA Requirements

The use, disclosure and secure handling of individually identifiable health information by our business is regulated at the federal level, including the privacy provisions of the Gramm-Leach-Bliley Act and privacy and security regulations pursuant to HIPAA. Further, our privacy and security practices are subject to various state laws and regulations. These state and federal requirements change frequently as a result of legislation, regulations and judicial or administrative interpretation. Varying requirements and enforcement approaches in the different states may adversely affect our ability to standardize our products and services across state lines. Further, state and local authorities are increasingly focused on the importance of protecting individuals from identity theft, with a significant number of states enacting laws requiring businesses to notify individuals of security breaches involving personal information. The U.S. Congress also is considering similar or additional measures.

HIPAA includes administrative requirements directed at simplifying electronic data interchange through standardizing transactions and establishing uniform health care provider, payer and employer identifiers. Assignment of a unique national identifier for providers must be implemented by May 2007. We are implementing the administrative changes, systems enhancements and training necessary to satisfy this requirement.

HIPAA also imposes obligations for health insurance issuers and health benefit plan sponsors. HIPAA requires guaranteed health care coverage for small employers having 2 to 50 employees and for individuals who meet certain eligibility requirements. HIPAA also requires guaranteed renewability of health coverage for most employers and individuals and contains nondiscrimination requirements. HIPAA limits exclusions based on pre-existing conditions for individuals covered under group policies to the extent the individuals had prior creditable coverage.

Failure to comply with any of the statutory and regulatory HIPAA requirements, state privacy and security requirements and other similar federal requirements could subject us to significant penalties.

 

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ERISA

The provision of services to certain employee health benefit plans is subject to the Employee Retirement Income Security Act of 1974 (“ERISA”). ERISA regulates certain aspects of the relationships between us and employers who maintain employee benefit plans subject to ERISA. Some of our administrative services and other activities may also be subject to regulation under ERISA. For instance, the U.S. Department of Labor regulations under ERISA (insured and self-insured) regulate the time allowed for health and disability plans to respond to claims and appeals, establish requirements for plan responses to appeals and expand required disclosures to participants and beneficiaries. In addition, some states require licensure or registration of companies providing third party claims administration services for benefit plans. We provide a variety of products and services to employee benefit plans that are covered by ERISA.

Medicare and Medicaid

Some of our health plans contract with CMS to provide services to Medicare beneficiaries pursuant to the Medicare program. Some of our health plans also contract with states to provide health benefits to Medicaid recipients. As a result, we are subject to extensive federal and state regulations. CMS may audit any health plan operating under a Medicare contract to determine the plan’s compliance with federal regulations and contractual obligations.

CMS and the appropriate state regulatory agency have the right to audit any health plan operating under a Medicaid managed care contract to determine the plan’s compliance with state and federal law. In some instances, states engage peer review organizations to perform quality assurance and utilization review oversight of Medicaid managed care plans. Our health plans are required to abide by the peer review organizations’ standards.

CMS rules require Medicaid managed care plans to have beneficiary protections and protect the rights of participants in the Medicaid program. Specifically, states must assure continuous access to care for beneficiaries with ongoing health care needs who transfer from one health plan to another. States and plans must identify enrollees with special health care needs and assess the quality and appropriateness of their care. These requirements have not had a material adverse effect on our business.

The federal anti-kickback statute imposes criminal and civil penalties for paying or receiving remuneration (which is deemed to include a kickback, bribe or rebate) in connection with any federal health care program, including the Medicare, Medicaid and FEHB Programs. The law and related regulations have been interpreted to prohibit the payment, solicitation, offering or receipt of any form of remuneration in return for the referral of federal health care program patients or any item or service that is reimbursed, in whole or in part, by any federal health care program. Similar anti-kickback provisions have been adopted by many states, which apply regardless of the source of reimbursement.

With respect to the federal anti-kickback statute, there exists a statutory exception and two safe harbors addressing certain risk-sharing arrangements. A safe harbor is a regulation that describes relationships and activities that are deemed not to violate the federal anti-kickback statute. However, failure to satisfy each criterion of an applicable safe harbor does not mean that the arrangement constitutes a violation of the law; rather the arrangement must be analyzed on the basis of its specific facts and circumstances. We believe that our risk agreements satisfy the requirements of these safe harbors. In addition, the Office of the Inspector General has adopted other safe harbor regulations that relate to managed care arrangements. We believe that the incentives offered by our health plans to Medicare and Medicaid beneficiaries and the discounts our plans receive from contracting health care providers satisfy the requirements of these safe harbor regulations. We believe that our arrangements do not violate the federal or similar state anti-kickback laws.

CMS has promulgated regulations that prohibit health plans with Medicare contracts from including any direct or indirect payment to physicians or other providers as an inducement to reduce or limit medically necessary services to a Medicare beneficiary. These regulations impose disclosure and other requirements relating to physician incentive plans such as bonuses or withholds that could result in a physician being at “substantial financial risk” as defined in Medicare regulations. Our ability to maintain compliance with such regulations depends, in part, on our receipt of timely and accurate information from our providers. Although we believe we are in compliance with all such Medicare regulations, we are subject to future audit and review.

 

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The federal False Claims Act prohibits knowingly submitting false claims to the federal government. Private individuals known as relators or whistleblowers may bring actions on the government’s behalf under the False Claims Act and share in any settlement or judgment. Violations of the federal False Claims Act may result in treble damages and civil penalties of up to $11,000 for each false claim. In some cases, whistleblowers, the federal government and some courts have taken the position that providers who allegedly have violated other statutes such as the federal anti-kickback statute have thereby submitted false claims under the False Claims Act. Under the Deficit Reduction Act of 2006 (“DEFRA”), every entity that receives at least $5 million annually in Medicaid payments must establish, by January 1, 2007, written policies for all employees, contractors or agents, providing detailed information about false claims, false statements and whistleblower protections under certain federal laws, including the federal False Claims Act, and similar state laws. The Company has established written policies which it believes are in compliance with this provision of DEFRA.

A number of states, including states in which we operate, have adopted their own false claims provisions as well as their own whistleblower provisions whereby a private party may file a civil lawsuit in state court. DEFRA creates an incentive for states to enact false claims laws that are comparable to the federal False Claims Act. From time to time, companies in the healthcare industry, including ours, may be subject to actions under the False Claims Act or similar state laws.

Federal Employees Health Benefits Program

Our health plans contract with the Office of Personnel Management (“OPM”) to provide managed health care services under the FEHB Program in their service area. These contracts with the OPM and applicable government regulations establish premium rating arrangements for this program. The OPM conducts periodic audits of its contractors to, among other things, verify that the premiums established under its contracts are in compliance with the community rating and other requirements under FEHB Program. The OPM may seek premium refunds or institute other sanctions against health plans that participate in the program if the health plan is found to be non-compliant with the program requirements.

Managed Care Legislative Proposals

Numerous proposals have been introduced in the U.S. Congress and various state legislatures relating to managed health care reform. The provisions of legislation that may be adopted at the state level can not be accurately and completely predicted at this time, and we therefore can not predict the effect of proposed legislation on our operations. On the federal level, it is possible that some form of managed health care reform may be enacted. At this time, it is unclear as to when any legislation might be enacted or the content of any new legislation, and we can not predict the effect on our operations of the proposed legislation or any other legislation that may be adopted.

Risk Management

In the normal course of business, we have been named as a defendant in various legal actions such as actions seeking payments for claims for medical services denied by the Company, medical malpractice actions, employment related claims and other various claims seeking monetary damages. The claims are in various stages of proceedings and some may ultimately be brought to trial. Incidents occurring through December 31, 2006 may result in the assertion of additional claims. We maintain general liability, professional liability and employment practices liability insurances in amounts that we believe are appropriate, with varying deductibles for which we maintain reserves. The professional liability and employment practices liability insurances are carried through our captive subsidiary.

Employees

At January 31, 2007, we employed approximately 10,250 persons, none of whom are covered by a collective bargaining agreement.

 

19

Acquisition Growth  

We began operations in 1987 with the acquisition of the American Service Companies entities, including Coventry Health and Life Insurance Company. We have grown substantially through acquisitions. The table below summarizes all of our significant acquisitions through December 31, 2006. See Note B to the consolidated financial statements for additional information on the most recent acquisitions.

Acquisition

Markets

Type of Business

Year Acquired

American Service Company entities

Multiple Markets

Multiple Products

1987

HealthAmerica Pennsylvania, Inc.

Pennsylvania

HMO

1988

Group Health Plan, Inc.

Missouri

HMO

1990

Southern Health Services, Inc.

Virginia

HMO

1994

HealthCare USA, Inc.

Multiple Markets

Medicaid

1995

Principal Health Care, Inc.

Multiple Markets

HMO

1998

Carelink Health Plans

West Virginia

HMO

1999

Kaiser Foundation Health Plan of North Carolina

North Carolina

HMO

1999

PrimeONE, Inc.

West Virginia

HMO

2000

Maxicare Louisiana, Inc.

Louisiana

HMO

2000

WellPath Community Health Plans

North Carolina

HMO

2000

Prudential Health Care Plan, Inc.

Missouri

Medicaid

2000

Blue Ridge Health Alliance, Inc.

Virginia

HMO

2001

Health Partners of the Midwest

Missouri

HMO

2001

Kaiser Foundation Health Plan of Kansas City, Inc.

Kansas

HMO

2001

NewAlliance Health Plan, Inc.

Pennsylvania

HMO

2002

Mid-America Health Partners, Inc.

Kansas

HMO

2002

PersonalCare Health Management, Inc.

Illinois

HMO

2003

Altius Health Plans, Inc.

Utah

HMO

2003

OmniCare Health Plan

Michigan

Medicaid

2004

First Health Group Corp.

Multiple Markets

Multiple Products

2005

Providers Synergies, L.L.C.

Multiple Markets

Rx Management Services

2006

Service Marks and Trademarks  

We have the following federally registered service marks:

 

Advantra

First Health with heart logo

OmniCare Plus

Altius Health Plans blue logo

First Health Services Corporation (2 registrations)

Omni Perks

Babylove Program

First IQ

PersonalCare What You Want in a Health Plan logo

Be Sure

First SX

POW

C Torch logo

GHP

POW-Providers on the Web

Carelink

GHP logo

POW Providers on the Web logo

CCN

HealthAmerica

Powered by People

CCN with shadow logo

HealthAmericaOne

Sensicare

CCN logo without shadow

HealthAssurance (2 registrations)

Senior Life Management

CompAmerica

HealthAssurance Flex

SouthCare

Compare

Heart logo

SouthCare Medical Alliance logo

Coventry (2 registrations)

It’s That Simple

Strong Starts

Coventry FlexChoice

Making Health Care as Simple as 1, 2, 3

The Answer To Your Health Care Needs

Coventry Healthy Choices Program

Mid America Health logo

True to Life

Coventry USA

Mid America Health Access

WellPath

Cross logo

Mid America Health Access +

WellPath 65

DirectorEase

Mid-America Health Network

With You When It Matters

First Claim

OmniCare

 

First Health (3 registrations)

OmniCare Health Plan

 

We have pending applications for federal registration of the following service marks: “CHCCARES,” “CHCCARE,” “CoventryOne,” “HealthCare USA,” “HealthAssurance FlexChoice,” “WellFirst Gold,” and “WellFirst+Gold.”

We also have the right in perpetuity to use the “HealthCare USA” mark in Missouri, Illinois, Kansas and Florida.

 

20

Executive Officers of Our Company  

The following table sets forth information with respect to our executive officers as of January 1, 2007:

Name

Age

Position

 

 

 

Dale B. Wolf

52

Chief Executive Officer and Director

Thomas P. McDonough

58

President

Harvey C. DeMovick, Jr

60

Executive Vice President, Customer Service Operations and Chief Information Officer

Shawn M. Guertin

43

Executive Vice President, Chief Financial Officer and Treasurer

Francis S. Soistman, Jr

50

Executive Vice President

Bernard J. Mansheim, M.D.

60

Senior Vice President and Chief Medical Officer

Harry “Skip” Creasey

52

Senior Vice President

Thomas C. Zielinski

55

Senior Vice President and General Counsel

Patrisha L. Davis

51

Vice President and Chief Human Resources Officer

John J. Ruhlmann

44

Senior Vice President and Corporate Controller

Dale B. Wolf was elected Chief Executive Officer of our Company effective January 2005. Prior to that he served as Executive Vice President, Chief Financial Officer and Treasurer of our Company from April 1998 to December 2004. He is a director and a member of the audit and compensation committees of HealthExtras, Inc., a provider of pharmacy benefit management services and supplemental benefits. Mr. Wolf is a Fellow of the Society of Actuaries.

Thomas P. McDonough was elected President of our Company effective January 2005. Prior to that he served as Executive Vice President of our Company from April 1998 to December 2004 and Chief Operating Officer from July 1998 to December 2004.

Harvey C. DeMovick, Jr. was elected Executive Vice President of our Company effective January 2005. Prior to that he served as Senior Vice President of our Company from April 1998 to December 2004. He has served as our Chief Information Officer since April 2001 and has been in charge of our Customer Service Operations since September 2001.

Shawn M. Guertin was elected Executive Vice President and Chief Financial Officer of our Company effective January 2005. Prior to that he served as Senior Vice President of our Company from February 2003 to December 2004. He has served as President of Coventry Health and Life Insurance Company since February 2002. From January 1998 to February 2003, he was Vice President of Finance of our Company. Mr. Guertin is a Fellow of the Society of Actuaries and a Member of the American Academy of Actuaries.

Francis S. Soistman, Jr. was elected Executive Vice President, effective January 2005. Mr. Soistman is in charge of Individual Consumer Markets and State and Federal Government Programs and, previously was in charge of Health Plan Operations. Prior to that he served as Senior Vice President of our Company from April 1998 to December 2004. He was named President and Chief Executive Officer of HealthAmerica Pennsylvania, Inc. and HealthAssurance Pennsylvania, Inc., our Pennsylvania subsidiaries, in May 1998 and July 2001, respectively, to January 2005.

Bernard J. Mansheim, M.D. was elected Executive Vice President of our Company effective August 2006. Prior to that he served as Senior Vice President of our Company from April 1998 to August 2006. He has served as our Chief Medical Officer since April 1998. Dr. Mansheim is Board Certified in Internal Medicine and Infectious Diseases and is a Fellow of the American College of Physicians.

Thomas C. Zielinski was elected Senior Vice President and General Counsel of our Company in August 2001. Prior to that time, Mr. Zielinski worked for 19 years in various capacities for the law firm of Cozen and O’Connor, P.C., including as a senior member, shareholder and Chair of the firm’s Commercial Litigation Department.

Harry “Skip” Creasey was elected Senior Vice President, National Network Management of our Company in March 2005. From February 2003 to the time he joined our company, Mr. Creasey served as Chairman and Chief Executive Officer of Kelson Physician Partners, Inc., a provider of pediatric management services. From August 2001 to February 2003, he was the President of InterPlan Group, a health care network company. From February 2000 to July 2001, he was the Chief Executive Officer of AviaHealth, Inc., a health care internet content provider.

Patrisha L. Davis was elected Vice President and Chief Human Resources Officer of our Company in March 2005, and has served in that position since November 2000. Ms. Davis has been a Human Resources executive with our Company since April 1998.

John J. Ruhlmann was elected Senior Vice President of our Company in November 2006. Prior to that time he was Vice President of our Company from November 1999 to November 2006. He has served as our Corporate Controller since November 1999.

 

 

21

Item 1A: Risk Factors

The risks described below are not the only ones that we face. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations.

Our business, financial condition or results of operations could be materially adversely affected by any of these risks. Further, the trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment.

Our results of operations may be adversely affected if we are unable to accurately estimate and control future health care costs.

Most of the premium revenue we receive is based upon rates set months before we deliver services. As a result, our results of operations largely depend on our ability to accurately estimate and control future health care costs. We base the premiums we charge, at least in part, on our estimate of expected health care costs over the applicable premium period. Factors that may cause health care costs to exceed our estimates include:

 

an increase in the cost of health care services and supplies, including pharmaceuticals;

 

higher than expected utilization of health care services;

 

periodic renegotiations of hospital, physician and other provider contracts;

 

the occurrence of epidemics and catastrophic events;

 

changes in the demographics of our members and medical trends affecting them;

 

general inflation or economic downturns;

 

new mandated benefits or other regulatory changes that increase our costs; and

 

other unforeseen occurrences.

In addition, medical liabilities in our financial statements include our estimated reserves for incurred but not reported and reported but not paid claims. The estimates for medical liabilities are made on an accrual basis. We believe that our reserves for medical liabilities are adequate, but we can not assure you of this. Any adjustments to our medical liabilities could adversely affect our results of operations.

Our results of operations will be adversely affected if we are unable to increase premiums to offset increases in our health care costs.

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

A reduction in the number of members in our health plans could adversely affect our results of operations.

A reduction in the number of members in our health plans could adversely affect our results of operations. Factors that could contribute to the loss of membership include:

 

competition in premium or plan benefits from other health care benefit companies;

 

reductions in the number of employers offering health care coverage;

 

reductions in work force by existing customers;

 

our increases in premiums or benefit changes;

 

our exit from a market or the termination of a health plan;

 

negative publicity and news coverage relating to our company or the managed health care industry generally; and

 

catastrophic events, including natural disasters and man-made catastrophes, and other unforeseen occurrences.

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Our growth strategy is dependent in part upon our ability to acquire additional managed care businesses and successfully integrate those businesses into our operations.

Part of our growth strategy is to grow through the acquisition of additional health plans and other managed care businesses. Historically, we have significantly increased our revenues through a number of acquisitions. We can not assure you that we will be able to continue to locate suitable acquisition candidates, successfully integrate the businesses we acquire and realize anticipated operational improvements and cost savings. The businesses we acquire also may not achieve our anticipated levels of profitability. Our future growth rate will be adversely affected if we are not able to successfully complete acquisitions.

Competition may limit our ability to attract new members or to increase or maintain our premium rates, which would adversely affect our results of operations.

We operate in a highly competitive environment that may affect our ability to attract new members and increase premium rates. We compete with other health plans for members. We believe the principal factors influencing the choice among health care options are:

 

price of benefits offered and cost and risk of alternatives such as self-insurance;

 

location and choice of health care providers;

 

quality of customer service;

 

comprehensiveness of coverage offered;

 

reputation for quality care;

 

financial stability of the plan; and

 

diversity of product offerings.

We compete with other managed care companies that may have broader geographical coverage, more established reputations in our markets, greater market share, larger contracting scale, lower costs and/or greater financial and other resources. We also may face increased rate competition from certain Blue Cross plan competitors that might be required by state regulation to reduce capital surpluses that may be deemed excessive.

Competition in the multi-site, national account business may limit our ability to grow revenues which could adversely affect our results of operations.

First Health competes in a highly competitive environment against other major national managed care companies in its national account customers to provide administrative, network access, and medical management services to large, multi-site, self-insured employers. Among these competitors are Aetna, United Healthcare and “Blue Card” (a joint venture of major Blue Cross plans), all of which have greater resources, brand identity and provider contracting scale compared to First Health or Coventry.

We depend on the services of non-exclusive independent agents and brokers to market our products to employers, and we can not assure you that they will continue to market our products in the future.

We depend on the services of independent agents and brokers to market our managed care products and services, particularly to small employer group members. We do not have long term contracts with independent agents and brokers, who typically are not dedicated exclusively to us and frequently market the health care products of our competitors. We face intense competition for the services and allegiance of independent agents and brokers, and we can not assure you that agents and brokers will continue to market our products in a fair and consistent manner.

Our failure to obtain cost-effective agreements with a sufficient number of providers may result in higher medical costs and a decrease in our membership.

Our future results largely depend on our ability to enter into cost-effective agreements with hospitals, physicians and other health care providers. The terms of those provider contracts will have a material effect on our medical costs and our ability to control these costs. In addition, our ability to contract successfully with a sufficiently large number of providers in a particular geographic market will impact the relative attractiveness of our managed care products in those markets, and our ability to contract at competitive rates with our PPO and workers’ compensation related providers will affect the attractiveness and profitability of our products in the national account, network rental and workers’ compensation businesses.

23

In some of our markets, there are large provider systems that have a major presence. Some of these large provider systems have operated their own health plans in the past or may choose to do so in the future. These provider systems could adversely affect our product offerings and results of operations if they refuse to contract with us, place us at a competitive disadvantage or use their market position to negotiate contracts that are less favorable to us. Provider agreements are subject to periodic renewal and renegotiations. We can not assure you that these large provider systems will continue to contract with us or that they will contract with us on terms that are favorable to us.

We may incur significant expenses in connection with implementing our new Medicare Advantage Private Fee-For-Service (PFFS) plan, which may have an adverse effect on our near-term operating results.

We received approval from CMS to offer PFFS plans. We have begun to incur expenses to upgrade and improve our infrastructure, technology, and systems to manage our PFFS product. We incurred significant expenses in 2006 as we prepared to provide these PFFS benefits as of January 1, 2007, and will in the future incur additional expenses. In particular, our expenses incurred in connection with the implementation of our PFFS benefits related to the following:

 

hiring and training of personnel to establish and manage systems, operations, regulatory relationships, and materials;

 

systems development and upgrade costs, including hardware, software and development resources;

 

marketing and sales;

 

enrolling new members;

 

developing and distributing member materials such as ID cards and member handbooks; and

 

handling sales inquiry and customer service calls.

Negative publicity regarding the managed health care industry generally or our Company in particular could adversely affect our results of operations or business.

Over the last several years, the managed health care industry has been subject to negative publicity. Negative publicity regarding the managed health care industry generally or our company in particular may result in increased regulation and legislative review of industry practices further increase our costs of doing business and adversely affect our results of operations by:

 

requiring us to change our products and services;

 

increasing the regulatory burdens under which we operate; or

 

adversely affecting our ability to market our products or services.

Negative publicity relating to our company or the managed care industry generally also may adversely affect our ability to attract and retain members.

A failure of our information technology systems could adversely affect our business.

We depend on our information technology systems for timely and accurate information. Failure to maintain effective and efficient information technology systems or disruptions in our information technology systems could cause disruptions in our business operations, loss of existing customers, difficulty in attracting new customers, disputes with customers and providers, regulatory problems, increases in administrative expenses and other adverse consequences.

24

We conduct business in a heavily regulated industry and changes in laws or regulations or alleged violations of regulations could adversely affect our business and results of operations.

Our business is heavily regulated by federal, state and local authorities. Legislation or other regulatory reform that increases the regulatory requirements imposed on us or that changes the way we currently do business may in the future adversely affect our business and results of operations. Legislative or regulatory changes that could significantly harm us and our subsidiaries include changes that:

 

impose increased liability for adverse consequences of medical decisions;

 

limit premium levels;

 

increase minimum capital, reserves and other financial viability requirements;

 

impose fines or other penalties for the failure to pay claims promptly;

 

impose fines or other penalties as a result of market conduct reviews;

 

prohibit or limit rental access to health care provider networks;

 

prohibit or limit provider financial incentives and provider risk-sharing arrangements;

 

require health plans to offer expanded or new benefits;

 

limit ability of health plans to manage care and utilization due to “any willing provider” and direct access laws that restrict or prohibit product features that encourage members to seek services from contracted providers or through referral by a primary care provider;

 

limit contractual terms with providers, including audit, payment and termination provisions;

 

implement mandatory third party review processes for coverage denials; and

 

impose additional health care information privacy or security requirements.

We also may be subject to governmental investigations or inquiries from time to time. For example in 2004, several companies in the insurance industry have received subpoenas for information from the New York Attorney General and the Connecticut Attorney General with respect to an industry wide investigation into certain insurance brokerage practices, including broker compensation arrangements, bid quoting practices and potential antitrust violations. Insurance regulators in several states, including states in which our subsidiaries are domiciled, have sent letters of inquiry concerning similar matters to the companies subject to their jurisdiction, including our subsidiaries. We have furnished the information requested and have received no further inquiry or comment from the insurance regulatory authorities. The existence of such investigations in our industry could negatively impact the market value of all companies in our industry including our stock price. Any similar governmental investigations of Coventry could have a material adverse effect on our financial condition, results of operations or business or result in significant liabilities to the Company, as well as adverse publicity.

In addition, we are required to obtain and maintain various regulatory approvals to market many of our products. Delays in obtaining or failure to obtain or maintain these approvals could adversely impact our results of operations. Federal, state and local authorities frequently consider changes to laws and regulations that could adversely affect our business. We can not predict the changes that government authorities will approve in the future or assure you that those changes will not have an adverse effect on our business or results of operations.

 

25

We face periodic reviews, audits and investigations under our contracts with federal and state government agencies, and these audits could have adverse findings that may negatively affect our business.

We contract with various federal and state governmental agencies to provide managed health care services. Pursuant to these contracts, we are subject to various governmental reviews, audits and investigations to verify our compliance with the contracts and applicable laws and regulations. Any adverse review, audit or investigation could result in:

 

refunding of amounts we have been paid pursuant to our government contracts;

 

 

imposition of fines, penalties and other sanctions on us;

 

loss of our right to participate in various federal programs;

 

damage to our reputation in various markets;

 

increased difficulty in selling our products and services; and

 

loss of one or more of our licenses to act as an insurer or HMO or to otherwise provide a service.

We may be adversely affected by changes in government funding for Medicare and Medicaid.

The federal government and many states from time to time consider altering the level of funding for government healthcare programs, including Medicare and Medicaid. The Deficit Reduction Act of 2006, signed into law on February 8, 2006, included Medicaid cuts of approximately $4.8 billion over 5 years. In addition, proposed regulatory changes would, if implemented, further reduce federal Medicaid funding. We cannot predict future Medicare or Medicaid funding levels or ensure that changes to Medicare or Medicaid funding will not have an adverse effect on our business or results of operations.

We are subject to litigation in the ordinary course of our business, including litigation based on new or evolving legal theories that could adversely affect our results of operations.

Due to the nature of our business, we are subject to a variety of legal actions relating to our business operations including claims relating to:

 

our denial of non-covered benefits;

 

vicarious liability for medical malpractice claims filed against our providers;

 

disputes with our providers alleging RICO and antitrust violations;

 

disputes with our providers over reimbursement and termination of provider contracts;

 

disputes related to our non-risk business, including actions alleging breach of fiduciary duties, claim administration errors and failure to disclose network rate discounts and other fee and rebate arrangements;

 

disputes over our co-payment calculations;

 

customer audits of our compliance with our plan obligations; and

 

disputes over payments for out-of-network benefits.

In addition, plaintiffs continue to bring new types of legal claims against managed care companies. Recent court decisions and legislative activity increase our exposure to these types of claims. In some cases, plaintiffs may seek class action status and substantial economic, non-economic or punitive damages. The loss of even one of these claims, if it resulted in a significant damage award, could have an adverse effect on our financial condition or results of operations. In the event a plaintiff was to obtain a significant damage award it may make reasonable settlements of claims more difficult to obtain. We can not determine with any certainty what new theories of recovery may evolve or what their impact may be on the managed care industry in general or on us in particular.

 

26

We have, and expect to maintain, liability insurance coverage for some of the potential legal liabilities we may incur. Currently, professional liability and employment practices liability insurance is covered through our captive subsidiary. Potential liabilities that we incur may not, however, be covered by insurance, our insurers may dispute coverage or may be unable to meet their obligations or the amount of our insurance coverage may be inadequate. We can not assure you that we will be able to obtain insurance coverage in the future, or that insurance will continue to be available on a cost effective basis, if at all.

Our stock price and trading volume may be volatile.

From time to time, the price and trading volume of our common stock, as well as the stock of other companies in the health care industry, may experience periods of significant volatility. Company-specific issues and developments generally in the health care industry (including the regulatory environment) and the capital markets may cause this volatility. Our stock price and trading volume may fluctuate in response to a number of events and factors, including:

 

variations in our operating results;

 

changes in the market’s expectations about our future operating results;

 

changes in financial estimates and recommendations by securities analysts concerning our company or the health care industry generally;

 

 

operating and stock price performance of other companies that investors may deem comparable;

 

news reports relating to trends in our markets;

 

changes in the laws and regulations affecting our business;

 

acquisitions and financings by us or others in our industry; and

 

sales of substantial amounts of our common stock by our directors and executive officers or principal stockholders, or the perception that such sales could occur.

Our indebtedness imposes restrictions on our business and operations.

The indentures for our senior notes and bank credit agreement impose restrictions on our business and operations. These restrictions limit our ability to, among other things:

 

incur additional debt;

 

pay dividends or make other restricted payments;

 

create or permit certain liens on our assets;

 

sell assets;

 

create or permit restrictions on the ability of certain of our restricted subsidiaries to pay dividends or make other distributions to us;

 

enter into transactions with affiliates;

 

enter into sale and leaseback transactions; and

 

consolidate or merge with or into other companies or sell all or substantially all of our assets.

 

27

Our ability to generate sufficient cash to service our indebtedness will depend on numerous factors beyond our control.

Our ability to service our indebtedness will depend on our ability to generate cash in the future. Our ability to generate the cash necessary to service our indebtedness is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We can not assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available in an amount sufficient to enable us to service our indebtedness or to fund other liquidity needs. In addition, we will be more vulnerable to economic downturns, adverse industry conditions and competitive pressures as a result of our significant indebtedness. We may need to refinance all or a portion of our indebtedness before maturity. We can not assure you that we will be able to refinance any of our indebtedness or that we will be able to refinance our indebtedness on commercially reasonable terms.

A substantial amount of our cash flow is generated by our regulated subsidiaries.

Our regulated subsidiaries conduct a substantial amount of our consolidated operations. Consequently, our cash flow and our ability to pay our debt and fund future acquisitions depends, in part, on the amount of cash that the parent company receives from our regulated subsidiaries. Our subsidiaries’ ability to make any payments to the parent company will depend on their earnings, business and tax considerations, legal and regulatory restrictions and economic conditions. Our regulated subsidiaries are subject to HMO and insurance regulations that require them to meet or exceed various capital standards and may restrict their ability to pay dividends or make cash transfers to the parent company. If our regulated subsidiaries are restricted from paying the parent company dividends or otherwise making cash transfers to the parent company, it could have material adverse effect on the parent company’s cash flow. For additional information regarding our regulated subsidiaries’ statutory capital requirements, see Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Statutory Capital Requirements.”

Our certificate of incorporation and bylaws and Delaware law could delay, discourage or prevent a change in control of our Company that our stockholders may consider favorable.

Provisions in our certificate of incorporation and bylaws and Delaware law may delay, discourage or prevent a merger, acquisition or change in control involving our company that our stockholders may consider favorable. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors and take other corporate actions. Among other things, these provisions:

 

provide for a classified board of directors with staggered three-year terms so that no more than one-third of our directors can be replaced at any annual meeting;

 

provide that directors may be removed without cause only by the affirmative vote of the holders of two-thirds of our outstanding shares;

 

provide that amendment or repeal of the provisions of our certificate of incorporation establishing our classified board of directors must be approved by the affirmative vote of the holders of three-fourths of our outstanding shares; and

 

establish advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at a meeting.

These provisions of our certificate of incorporation and bylaws and Delaware law may discourage transactions that otherwise could provide for the payment of a premium over prevailing market prices for our common stock and also could limit the price that investors are willing to pay in the future for shares of our common stock.

Changes in general economic conditions could adversely affect our business and results of operations.

Changes in economic conditions could adversely affect our business and results of operations. The state of the economy could adversely affect our employer group renewal prospects and our ability to collect or increase premiums. The state of the economy could also adversely affect the states’ budgets, which could result in the states attempting to reduce payments to Medicaid plans in those states in which we offer Medicaid plans, and increase taxes and assessments on our activities. Although we could attempt to mitigate or cover our exposure from such increased costs through, among other things, increases in premiums, there can be no assurance that we will be able to mitigate or cover all of such costs resulting from any budget cuts in states in which we operate. Although we have attempted to diversify our product offerings to address the changing needs of our membership, the effects of economic conditions could cause our existing membership to seek health coverage alternatives that we do not offer or could result in significant membership loss, lower average premium yields or decreased margins on continuing membership.

Our efforts to capitalize on Medicare business opportunities could prove to be unsuccessful.

Medicare programs represent a significant portion of our business, accounting for approximately 19.2% of our total revenue in 2006 and is expected to exceed 26.0% in 2007. In connection with the passage of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Drug Act”) and the Drug Act’s implementing regulations adopted in 2005, we have significantly expanded our Medicare health plans, restructured our Medicare program management team and operations to enhance our ability to pursue business opportunities presented by the Drug Act and the Medicare program generally.

Particular risks associated with our providing Medicare Part D prescription drug benefits under the Drug Act include potential uncollectability of receivables, inadequacy of underwriting assumptions, inability to receive and process information and increased pharmaceutical costs (as well as the underlying seasonality of this business).

 

28

In 2007, we expect that our Medicare programs will expand. Specifically, we will be introducing PFFS Medicare Advantage plans, expanding our Medicare Part D prescription drug benefits plans to all states, and enhancing our HMO/PPO product offerings. All of these growth activities require substantial administrative and operational capabilities which we are in the process of developing. If the transition and implementation of these key operational functions does not occur as scheduled, or we are unable to develop administrative capabilities to address the additional needs of our growing Medicare programs, it could have a material adverse effect on our Medicare business and operating results.

In addition, if the cost or complexity of the recent Medicare changes exceed our expectations or prevent effective program implementation, if the government alters or reduces funding of Medicare programs, if we fail to design and maintain programs that are attractive to Medicare participants or if we are not successful in winning contract renewals or new contracts under the Drug Act’s competitive bidding process, our current Medicare business and our ability to expand our Medicare operations could be materially and adversely affected, and we may not be able to realize any return on our investments in Medicare initiatives.

Item 1B: Unresolved Staff Comments

None.

Item 2: Properties

As of December 31, 2006, we leased approximately 60,000 square feet of space for our corporate office in Bethesda, Maryland. We also leased approximately 1,696,000 aggregate square feet for office space, subsidiary operations and customer service centers for the various markets where our health plans and other subsidiaries operate, of which approximately 7% is subleased. Our leases expire at various dates from 2007 through 2018. We also own eight buildings throughout the country with approximately 727,000 square feet, which is used for administrative services related to our health plan and other operations, of which less than one percent is subleased. We believe that our facilities are adequate for our operations.

Item 3: Legal Proceedings

See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Legal Proceedings” which is incorporated herein by reference.

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

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year 2006.

 

29

PART II

Item 5: Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Price Range of Common Stock  

Our common stock is traded on the New York Stock Exchange (“NYSE”) stock market under the ticker symbol “CVH.” The following table sets forth the quarterly range of the high and low sales prices of the common stock on the NYSE stock markets during the calendar period indicated. Such quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions:

 

 

2006

 

2005

 

 

High

Low

 

High

Low

First Quarter

 

$ 61.88

$ 53.70

 

$ 45.77

$ 34.21

Second Quarter

 

55.46

45.37

 

48.39

42.11

Third Quarter

 

57.66

50.29

 

58.07

44.33

Fourth Quarter

 

52.29

44.33

 

60.31

49.57

On January 31, 2007, we had approximately 629 stockholders of record, not including beneficial owners of shares held in nominee name. On January 31, 2007, our closing price was $51.55.

We have not paid any cash dividends on our common stock and expect for the foreseeable future to retain all of our earnings to finance the development of our business. Our ability to pay dividends is limited by certain covenants and restrictions contained in our debt obligations and by insurance regulations applicable to our subsidiaries. Subject to the terms of such insurance regulations and debt covenants, any future decision as to the payment of dividends will be at the discretion of our Board of Directors and will depend on our earnings, financial position, capital requirements and other relevant factors. See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”

In February 2006, our Board of Directors approved an increase to the share repurchase program in an amount equal to 5% of our outstanding common stock, thus increasing our repurchase authorization by 8.1 million shares. Stock repurchases may be made from time to time at prevailing prices on the open market, by block purchase or in private transactions. Under the share repurchase program, we purchased 4.6 million shares of our common stock in 2006 at an aggregate cost of $256.1 million. We did not repurchase any shares in 2005 under this program. As of December 31, 2006, the total remaining common shares we are authorized to repurchase under this program is 6.2 million.

Issuer Purchases of Equity Securities  

The following table shows our purchases of our common stock during the quarter ended December 31, 2006 (in thousands, except per share information).

 

 

Total Number of Shares Purchased (1)

Average Price Paid per Share

Total Number of Shares Purchased as Part of Publicly Announced Plans

Maximum Number of Shares That May Yet Be Purchased Under The Plan or Program

October 1-31, 2006

 

3

$ 50.60

-

6,169

November 1-30, 2006

 

-

$         -

-

6,169

December 1-31, 2006

 

7

$ 49.50

-

6,169

 

 

 

 

 

 

Totals

 

10

$ 50.23

-

6,169

(1)

 

Purchased in connection with the vesting of restricted stock awards to satisfy employees’ minimum statutory tax withholding obligations.

 

30

Item 6: Selected Financial Data

(in thousands, except per share and membership data)

 

December 31,

 

2006

2005

2004

2003

2002

Operations Statement Data (1)

 

 

 

 

 

Operating revenues

$ 7,733,756

$ 6,611,246

$ 5,311,969

$ 4,535,143

$ 3,576,905

Operating earnings

841,003

791,818

496,671

366,197

200,670

Earnings before income taxes

896,348

799,425

526,991

393,064

225,741

Net earnings

560,045

501,639

337,117

250,145

145,603

Basic earnings per share

3.53

3.18

2.55

1.89

1.09

Diluted earnings per share

3.47

3.10

2.48

1.83

1.05

Dividends declared per share

-

-

-

-

-

 

 

 

 

 

 

Balance Sheet Data (1)

 

 

 

 

 

Cash and investments

$ 2,793,800

$ 2,062,893

$ 1,727,737

$ 1,405,922

$ 1,119,120

Total assets

5,665,107

4,895,172

2,340,600

1,981,736

1,643,440

Total medical liabilities

1,121,151

752,774

660,475

597,190

558,599

Long-term liabilities

309,616

309,742

25,854

27,358

21,691

Debt

760,500

770,500

170,500

170,500

175,000

Stockholders’ equity

2,953,002

2,554,703

1,212,426

928,998

646,037

 

 

 

 

 

 

Operating Data (1)

 

 

 

 

 

Medical loss ratio

79.3%

79.4%

80.5%

81.2%

83.3%

Operating earnings ratio

10.9%

12.0%

9.4%

8.1%

5.6%

Administrative expense ratio

17.3%

17.9%

11.5%

12.0%

12.2%

Basic weighted average shares outstanding

158,601

157,965

132,188

132,170

133,203

Diluted weighted average shares outstanding

161,434

161,716

135,884

136,148

137,797

Health Plan Risk membership

1,903,000

1,954,000

1,949,000

1,899,000

1,640,000

Health Plan Non-risk membership

621,000

592,000

560,000

484,000

395,000

 

 

 

 

 

 

(1) Operations Statement Data include the results of operations of acquisitions since the date of acquisition. Balance Sheet Data reflect acquisitions as of December 31, of the year of acquisition. See the notes to consolidated financial statements for detail on our acquisitions.

 

31

Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the accompanying audited consolidated financial statements and notes thereto. The organization of our Management’s Discussion and Analysis of Financial Condition and Results of Operations is as follows.

 

Executive-Level Overview

 

Critical Accounting Policies

 

New Accounting Standards

 

Acquisitions

 

Membership

 

Results of Operations

 

Medicare Private Fee For Service

 

Liquidity and Capital Resources

 

Other Disclosures

 

Risk Factors

Executive-Level Overview

General Operations

We are a national managed health care company based in Bethesda, Maryland operating health plans, insurance companies, network rental/managed care services companies, and workers’ compensation services companies. We provide a full range of risk and fee-based managed care products and services, including health maintenance organization (“HMO”), preferred provider organization (“PPO”), point of service (“POS”), Medicare Advantage, Medicare Prescription Drug Plans, Medicaid, Workers’ Compensation and Network Rental to a broad cross section of individuals, employer and government-funded groups, government agencies, and other insurance carriers and administrators in all 50 states as well as the District of Columbia and Puerto Rico.

Summary of 2006 Performance

 

Health Plan membership decreased .9% over the prior year, excluding the new Medicare Part D business.

 

Medicare Part D revenues of $669.9 million and membership of 687,000.

 

Revenue increased 17% over the prior year.

 

Health Plan medical loss ratio of 78.9% improved 60 basis points over the prior year.

 

Selling, general and administrative expenses were 17.3% of operating revenues, a decrease of 60 basis points from the prior year.

 

Operating margin of 10.9% declined 110 basis points over the prior year.

 

Diluted earnings per share increased 11.9% over the prior year.

 

Cash flows from operations were $1,066 million (including $348.6 million related to the new Medicare Part D business), a 32.6% increase over the prior year.

 

Total cash and investments was $2.8 billion, a 35.4% increase over the prior year.

 

32

Operating Revenue and Products

We generate our operating revenues from premiums and fees from a broad range of managed care and management service products. Premiums for our risk products, for which we assume full underwriting risk, can vary. For example, premiums for our commercial PPO and commercial POS products are typically lower than our commercial HMO premiums due to medical underwriting and higher deductibles and co-payments that are typically required of the commercial PPO and commercial POS members. Premium rates for our government programs, Medicare and state-sponsored managed Medicaid, are largely established by governmental regulatory agencies in conjunction with competitive bidding processes. Medicare products, including Part D, have risk adjusted premium rates at the member level to help align expected cost and reimbursement. These government products are offered in selected markets where we believe we can achieve profitable growth based upon favorable reimbursement levels, provider costs and regulatory climates.

Revenue for our management services products (“non-risk”) is generally a fixed administrative fee, provided on a predetermined contractual basis or on a percentage-of-savings basis, for access to our health care provider networks and health care management services, for which we do not assume underwriting risk. The management services we provide typically include health care provider network management, clinical management, pharmacy benefit management (“PBM”), bill review, claims repricing, fiscal agent services (generally for state entitlement programs), claims processing, utilization review and quality assurance.

Operating Expenses

Our medical costs include medical claims paid under contractual relationships with a wide variety of providers and capitation arrangements. Medical costs also include an estimate of claims incurred but not reported.

We maintain provider networks that furnish health care services through contractual arrangements with physicians, hospitals and other health care providers. Prescription drug benefits are provided through a formulary comprised of an extensive list of drugs. Drug prices are negotiated at discounted rates through a national network of pharmacies.

We have capitation arrangements for certain ancillary heath care services, such as mental health care, and a small percentage of our membership is covered by global capitation arrangements. Under the typical arrangement, the provider receives a fixed percentage of premium to cover costs of all medical care or of the specified ancillary services provided to the globally capitated members. Under some capitated arrangements, physicians may also receive additional compensation from risk sharing and other incentive arrangements. Global capitation arrangements limit our exposure to the risk of increasing medical costs, but expose us to risk as to the adequacy of the financial and medical care resources of the provider organization. We are ultimately responsible for the coverage of our members pursuant to the customer agreements. To the extent that the respective provider organization faces financial difficulties or otherwise is unable to perform its obligations under the capitation arrangements, we will be required to perform such obligations. Consequently, we may have to incur costs in doing so in excess of the amounts we would otherwise have to pay under the original global or ancillary capitation through our contracted network arrangements.

We have established systems that monitor the availability, appropriateness and effectiveness of the patient care we provide. We collect utilization data in each of our markets that we use to analyze over-utilization or under-utilization of services and assist our health plans in arranging for appropriate care for their members and improving patient outcomes in a cost efficient manner. Medical directors also monitor the utilization of diagnostic services and encourage the use of outpatient surgery and testing where appropriate. Each health plan collects data showing each physician’s utilization profile for diagnostic tests, specialty referrals and hospitalization and presents such data to the health plan’s physicians. The medical directors monitor these results in an effort to ensure the use of medically, cost-effective appropriate services.

We operate regional service centers that perform claims processing, premium billing and collection, enrollment and customer service functions for our health plans. Our regional service centers enable us to take advantage of economies of scale, implement standardized management practices at each of our plans and capitalize on the benefits of our integrated information technology systems. We centralize the underwriting and product pricing functions for our health plans, which allows us to utilize our underwriting expertise and a disciplined pricing strategy at each of our health plans. First Health operating expenses consist primarily of salaries and related costs for personnel involved in the administrative services offered by the Company. To a lesser extent, the operating expenses include facility expenses and information processing costs needed to provide those administrative services.

Cash Flows

We generate cash through operations. As a profitable company in an industry that is not capital equipment intensive, we have not needed to use financing methods to fund operations. While we did incur debt (as described in Note I to our consolidated financial statements in this Form 10-K), the entire proceeds were used to finance an acquisition and were not used to fund operations. Our primary use of cash is to pay medical claims. Any excess cash has historically been used for acquisitions, to prepay indebtedness and for repurchases of our common stock.

Critical Accounting Policies  

We consider the accounting policies described below critical in preparing our consolidated financial statements. Critical accounting policies are ones that require difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The judgments and uncertainties affecting the application of these policies include significant estimates and assumptions made by us using information available at the time the estimates are made. Actual results could differ materially from those estimates.

 

33

Revenue Recognition

Managed care premiums are recorded as revenue in the month in which members are entitled to service. Premiums are based on both a per-subscriber contract rate and the number of subscribers in our records at the time of billing. Premium billings are generally sent to employers in the month preceding the month of coverage. Premium billings may be subsequently adjusted to reflect changes in membership as a result of retroactive terminations, additions, or other changes. Due to early timing of the premium billing, we are able to identify in the current month the retroactive adjustments for two subsequent months billings. Current period revenues are adjusted to reflect these retroactive adjustments.

Based on information received subsequent to generating premium billings, historical trends, bad debt write-offs and the collectibility of specific accounts, we estimate, on a monthly basis, the amount of bad debt and future membership retroactivity and adjust our revenue and allowances accordingly.

As of December 31, 2006, we maintained allowances for retroactive billing adjustments of approximately $20.1 million compared with approximately $20.6 million at December 31, 2005. We also maintained allowances for doubtful accounts of approximately $1.9 million and $3.6 million as of December 31, 2006 and 2005, respectively. The calculation for these allowances is based on a percentage of the gross accounts receivable with the allowance percentage increasing for the older receivables.

We also receive premium payments from the Centers for Medicare and Medicaid Services (“CMS”) on a monthly basis for our Medicare membership. Membership and category eligibility are periodically reconciled with CMS and can result in adjustments to revenue. Premiums collected in advance are recorded as deferred revenue.

We contract with the United States Office of Personnel Management (“OPM”) and with various federal employee organizations to provide health insurance benefits under the Federal Employees Health Benefits Program. These contracts are subject to government regulatory oversight by the Office of the Inspector General (“OIG”) of OPM who perform periodic audits of these benefit program activities to ensure that contractors meet their contractual obligations with OPM.  For our managed care contracts, the OIG conducts periodic audits to, among other things, verify that premiums established under its contracts are in compliance with community rating requirements under the FEHB Program.  The OPM may seek premium refunds or institute other sanctions against health plans that participate in the program.  For our experience-rated plans, the OIG focuses on the appropriateness of contract charges, the effectiveness of claims processing, financial and cost accounting systems, and the adequacy of internal controls to ensure proper contract charges and benefits payments.  The OIG may seek refunds of costs charged under these contracts or institute other sanctions against health plans.  These audits are generally a number of years in arrears.  We record reserves, on an estimated basis annually, for audit and other contract adjustments based on appropriate guidelines.  Any differences between actual results and estimates are recorded in the year the audits are finalized.

We enter into performance guarantees with employer groups where we pledge that we will meet certain standards. These standards vary widely and could involve customer service, member satisfaction, claims processing, claims accuracy, telephone on-hold time, etc. We also enter into financial guarantees which can take various forms including, among others, achieving an annual aggregate savings threshold, achieving a targeted level of savings per-member per-month or achieving overall network penetration in defined demographic markets. For each guarantee, we estimate and record performance based revenue after considering the relevant contractual terms and the data available for the performance based revenue calculation. Pro-rata performance based revenue is recognized on an interim basis pursuant to the rights and obligations of each party upon termination of the contracts.

Medical Claims Expense and Liabilities

Medical liabilities consist of actual claims reported but not paid and estimates of health care services incurred but not reported. Medical liabilities estimates are developed using actuarial principles and assumptions that consider, among other things, historical claims payment patterns, provider reimbursement changes, historical utilization trends, current levels of authorized inpatient days, other medical cost inflation factors, membership levels, benefit design changes, seasonality, demographic mix change and other relevant factors.

 

34

We employ a team of actuaries that have used a set of reserve models that are based on a consistent methodology. Although the calculation is consistent, we adjust our estimates of medical utilization and components of medical cost trends to amounts we estimate to be appropriate. The medical liabilities are an accumulation of the results from many individual models, each calculated at the statutory level and representing different markets and/or products. These reserve models do not calculate separate amounts for reported but not paid and incurred but not reported, but rather a single estimate of medical claims liabilities. These reserve models make use of both historical claim payment patterns as well as emerging medical cost trends to project our best estimate of claim liabilities. Within these models, historical data of paid claims is formatted into claim triangles which compare claim incurred dates to the claim payment dates. This information is analyzed to create “completion factors” that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the ultimate incurred claims.

Actuarial standards of practice generally require the actuarial developed medical claims estimates to cover obligations under an assumption of moderately adverse conditions. Adverse conditions are situations in which the actual claims are expected to be higher than the otherwise estimated value of such claims. In many situations, the claims paid amount experienced will be less than the estimate that satisfies the actuarial standards of practice. Medical claims liabilities are recorded at an amount we estimate to be appropriate. Adjustments of prior years estimates may result in additional medical costs or, as we have experienced during the last several years, a reduction in medical costs in the period an adjustment was made. Our reserve models have historically developed favorably suggesting that the accrued liabilities calculated from the models were more than adequate to cover our ultimate liability for unpaid claims. We believe that this favorable development is a result of good communications between our health plans and our actuarial staff regarding medical utilization, mix of provider rates and other components of medical cost trend.

The following table presents the components of the change in medical claims liabilities for the years ended December 31, 2006, 2005 and 2004, respectively (in thousands).

 

 

2006

 

2005

 

2004

Medical liabilities, beginning of period

$   752,774 

 

$  660,475 

 

$  597,190 

 

 

 

 

 

 

 

Acquisitions (1)

--

 

41,895 

 

--

 

 

 

 

 

 

 

Reported Medical Costs

 

 

 

 

 

 

Current year

5,570,872 

 

4,672,009 

 

4,257,942 

 

Prior year developments

(130,908)

 

(121,138)

 

(72,047)

Total reported medical costs

5,439,964 

 

4,550,871 

 

4,185,895 

 

 

 

 

 

 

 

Claim Payments

 

 

 

 

 

 

Payments for current year

4,852,359 

 

4,030,685 

 

3,691,092 

 

Payments for prior year

542,571 

 

469,782 

 

431,518 

Total claim payments

5,394,930 

 

4,500,467 

 

4,122,610 

 

 

 

 

 

 

 

Part D Related Subsidy Liabilities

323,343 

 

--

 

--

 

 

 

 

 

 

 

Medical liabilities, end of period

$ 1,121,151 

 

$ 752,774 

 

$ 660,475 

 

 

 

 

 

 

 

Supplemental Information:

 

 

 

 

 

 

 

 

 

 

 

 

 

Prior year development (2)

2.9%

 

2.9%

 

2.0%

 

Current year paid percent (3)

87.1%

 

86.3%

 

86.7%

 

 

 

 

 

 

 

(1) Acquisition balances represent medical liabilities of the acquired company as of the applicable acquisition date.

(2) Prior year reported medical costs in the current year as a percentage of prior year reported medical costs.

(3) Current year claim payments as a percentage of current year reported medical costs.

 

35

The negative amounts noted as “prior year” medical costs are favorable adjustments for claim estimates being settled for amounts less than originally anticipated. As noted above, these favorable restatements from original estimates occur due to changes in medical utilization, mix of provider rates and other components of medical cost trends. Medical claim liabilities are generally paid within several months of the member receiving service from the provider. Accordingly, the 2006 prior year medical costs relate almost entirely to claims incurred in calendar year 2005 and the increase in prior year medical cost was driven primarily by lower than anticipated medical cost increases, growth in the medical cost base and uncertainties at the prior year-end regarding our Louisiana operations and the effects of Hurricane Katrina.

The Medicare Part D related subsidy liabilities identified in the table above represent subsidy amounts received from CMS for reinsurance and for cost sharing related to low income individuals. These subsidies are recorded in medical liabilities and we do not recognize premium revenue or claims expense for these subsidies. Following the final settlement in 2007 related to the 2006 plan year, any remaining balances from these subsidy payments will be refunded to CMS.

For the more recent incurred months, the percentage of claims paid to claims incurred in those months is generally low. As a result, the completion factor methodology is less reliable for such months. For that reason, incurred claims for recent months are not projected solely from historical completion and payment patterns. Instead, they are projected by estimating the claims expense for those months based upon recent claims expense levels and health care trend levels, or “trend factors.” As these months mature over time, the two estimates (completion factor and trend) are blended with completion factors being used exclusively for older months.

Within the reserve setting methodologies for inpatient and non-inpatient services, we use certain assumptions. For inpatient services, authorized days are used for utilization factors, while cost trend assumptions are incorporated into per diem amounts. The per diem estimates reflect anticipated effects of changes in reimbursement structure and severity mix. For non-inpatient services, a composite trend assumption is applied which reflects anticipated changes in cost per service, provider contracts, utilization, and other factors.

Changes in the completion factors, trend factors and utilization factors can have a significant effect on the claim liability. The following example provides the estimated effect to our December 31, 2006 unpaid claims liability assuming hypothetical changes in the completion, trend, and inpatient day factors. While we believe the selection of factors and ranges provided are reasonable, certain factors and actual results may differ.

Completion Factor

 

Claims Trend Factor

 

Inpatient Day Factor

Increase (Decrease) in Completion Factor

 

(Decrease) Increase in Unpaid Claims Liabilities

 

(Decrease) Increase in Claims Trend Factor

 

(Decrease) Increase in Unpaid Claims Liabilities

 

(Decrease) Increase in Inpatient Day Factor

 

(Decrease) Increase in Unpaid Claims Liabilities

3.3 

%

$                  (21,471)

 

(5.0)

%

$                 (57,723)

 

(5.0)

%

$                (13,127)

2.0 

%

$                  (13,196)

 

(2.5)

%

$                 (28,861)

 

(2.5)

%

$                  (6,564)

1.0 

%

$                    (6,671)

 

(1.0)

%

$                 (11,545)

 

(1.0)

%

$                  (2,625)

(1.0)

%

$                      6,820 

 

1.0 

%

$                   11,545 

 

1.0 

%

$                    2,625 

(2.0)

%

$                    13,796 

 

2.5 

%

$                   28,861 

 

2.5 

%