Use these links to rapidly review the documentUNIVERSAL AMERICAN CORP. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS TABLE OF CONTENTS

Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



FORM 10-K

(Mark One)ý

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2008ORo

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period
from                                  to


Commission file Number: 0-11321



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

New York(State or other jurisdiction of
incorporation or organization)

11-2580136(I.R.S. Employer
Identification No.)


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

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

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

Title of Each Class

Name of Each Exchange On Which RegisteredCommon Stock, par value $.01 per share

New York Stock Exchange, Inc.


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

None



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

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

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

Indicate by check mark 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, a non-accelerated filer, or a smaller reporting
company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o

Accelerated filer ý

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company 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 ý

The aggregate market value of the registrant's voting and non-voting common stock held by non-affiliates of the registrant on
June 30, 2008, the last business day of the registrant's most recently completed second fiscal quarter, was approximately $277 million (based on the closing sales price of the
registrant's common stock on that date). As of March 6, 2009, 78,255,434 shares of the registrant's common stock were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive proxy statement in connection with its 2009 Annual Meeting of Stockholders (the "Proxy Statement"), scheduled to be held on
May 28, 2009, are incorporated by reference into Part III hereof. Except with respect to information specifically incorporated by reference in this Form 10-K, the
Proxy Statement is not deemed to be filed as part hereof.



---





Table of Contents

TABLE OF CONTENTS



Item

Description

PagePART 1

1

Business


41A

Risk Factors


341B

Unresolved Staff Comments


712

Properties


713

Legal Proceedings


714

Submission of Matters to a Vote of Security Holders


72PART II

5

Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities


736

Selected Financial Data


757

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


777A

Quantitative and Qualitative Disclosures about Market Risk


1268

Financial Statements and Supplementary Data


1279

Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure


1279A

Controls and Procedures


1289B

Other Information


129PART III

10

Directors and Executive Officers of the Registrant


13011

Executive Compensation


13012

Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters


13013

Certain Relationships and Related Transactions


13014

Principal Accountant Fees and Services


130PART IV

15

Exhibits and Financial Statement Schedules


131Signatures


135


2

---



Table of Contents

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

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

Portions of the information in this annual report on Form 10-K, such as those set forth under "Risk Factors" and
"Management's Discussion and Analysis of Financial Condition and Results of Operations", and oral statements made from time to time by our representatives may constitute "forward-looking statements"
within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and the Private Securities Litigation Reform Act of 1995, known as the PSLRA. We intend these
forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 21E of the Exchange Act and the PSLRA. These forward-looking
statements are statements relating to:



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



Forward-looking
statements are inherently subject to risks, trends and uncertainties, many of which are beyond our ability to control or predict with accuracy and some of which we might
not even anticipate. Although we believe that the expectations reflected in any forward-looking statements are based upon reasonable assumptions at the time made, we can give no assurance that we will
achieve our expectations. Future events and actual results, financial and otherwise, may differ materially from the results discussed in the forward-looking statements. We caution readers not to place
undue reliance on these forward-looking statements.

The
risks and uncertainties set forth in this report in Item 1 "Business," Item 1A "Risk Factors" and Item 7 "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and other risks and uncertainties set forth in this report, constitute important factors that may cause actual results to differ materially from forward-looking
statements. We assume no obligation to update or supplement any forward-looking statements that may become untrue because of subsequent events, whether as a result of new information, future events or
otherwise.

3

---





Table of Contents

PART I

ITEM 1BUSINESS

Through its family of companies, Universal American Corp., which we refer to collectively with our subsidiaries as "we," "us," the
"Company" or "Universal American," offers a broad array of health insurance and managed care products and services, primarily to the growing senior population. Our principal health insurance products
for the senior market are Medicare Advantage, insured stand-alone prescription drug benefit plans pursuant to Medicare Part D, and Medicare supplement. We also provide administrative services
for senior market insurance and non-insurance programs to both affiliated and unaffiliated insurance companies, and prescription benefit management, or PBM, services to seventeen state
pharmacy assistance programs, or SPAPs, and offer PBM services and drug discount card programs through a number of group contracts.

Collectively,
our insurance subsidiaries are licensed or otherwise authorized to sell health insurance, life insurance and annuities in all 50 states, the District of Columbia and Puerto
Rico, as well as some U.S. territories. Our managed care subsidiary operates Medicare Advantage coordinated care plans, known as health plans in Texas, Wisconsin and Oklahoma.

We
were incorporated under the laws of the State of New York on August 31, 1981. On December 3, 2007, our common shares began trading on the New York Stock Exchange or the
NYSE under the ticker symbol UAM. Previously our common shares were traded on the NASDAQ Stock Market under the ticker symbol UHCO. Our corporate headquarters are located at Six International Drive,
Rye Brook, New York 10573 and our telephone number is (914) 934-5200. We make available free of charge on our Internet website at http://www.universalamerican.comour annual reports on
Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable
after we electronically file this material with, or furnish it to, the Securities and Exchange Commission. The reference to our website is not intended to incorporate the information on our website
into this filing. You can read or copy materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. You can obtain information on the operation
of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements,
and other information regarding issuers that file electronically with the SEC. Copies of any materials we have filed electronically with the SEC may be accessed at the SEC's website: http://www.sec.gov.

Senior Market Opportunity

We believe that attractive growth opportunities exist in providing a range of products, particularly health insurance, to the growing
senior market. At present, approximately 45 million Americans are eligible for Medicare, the Federal program that offers basic hospital and medical insurance to people over 65 years old
and some disabled people under the age of 65. According to the U.S. Census Bureau, more than 2 million Americans turn 65 in the United States each year, and this number is expected to grow as
the so-called baby boomers begin to turn 65. In addition, many large employers that traditionally provided medical and prescription drug coverage to their retirees have begun to curtail
these benefits. Finally, the passage of the Medicare Prescription Drug, Improvement and Modernization Act of 2003, known as the MMA, increased the healthcare options available to Medicare
beneficiaries through the expansion of Medicare managed care plans through the Medicare Advantage program, and the authorization of a subsidized prescription drug insurance benefit pursuant to
Part D. While it is likely that there will be changes to these programs that may reduce their popularity or potential profitability, it does not change our basic view that there are significant
business opportunities in the provision of health insurance and other services to the senior population.

4

---



Table of Contents

Our Strategy

The principal components of our business strategy are to:



Our Operating Segments

We manage and report our business as follows:



Please
see "Note 22Business Segment Information" in our consolidated financial statements included in this Annual Report on Form 10-K for
information regarding each segment's revenue and income or loss before taxes for each of the last three fiscal years and total assets as of the end of each of the last two fiscal years.



During 2008, we operated Medicare Advantage HMO plans in 16 counties in Texas, primarily in Southeastern Texas and the surrounding
Dallas area, 16 counties in Oklahoma and 4 counties in Wisconsin. In addition, we offer Medicare Advantage PFFS plans in 47 states. In January 2009, we began offering PPO products in 50 counties in 9
states. As a result of the passage of the Medicare Improvements for Patients and Providers Act of 2008, known as MIPPA, in 2008, the PFFS product will no longer be available as of January 1,
2010, except in certain designated rural areas. We have begun to implement a strategy to develop network-based products in selected core markets to enable the migration of our PFFS membership to these
products.

5

---



Table of Contents

Membership and Annualized Premium in Force.The following table shows the total membership and annualized premium in force for our
Medicare Advantage
products:

Membership

Annualized PremiumsDecember 31,

December 31,Senior Managed Care

2008

2007

2006

2008

2007

2006(in thousands)PFFS plans


186.2


190.4


18.2

$
1,698,800

$
1,567,500

$
144,300HMO plans


54.3


46.0


35.4


652,200


499,500


367,100PPO plans

















Total


240.5


236.4


53.6

$
2,351,000

$
2,067,000

$
511,400


Medicare
AdvantageHMO plans:    Our HMO plans are offered under contracts with the Center for Medicare & Medicaid Services, known as CMS, and provide all
basic Medicare covered benefits with reduced member cost-sharing as well as additional supplemental benefits, including a defined prescription drug benefit. We built this coordinated care
product around contracted
networks of providers who, in connection with the health plan, coordinate an active medical management program. In addition to a monthly payment per member from CMS, the plan may collect a monthly
premium from its members for specified products.

We
operate plans offering the product TexanPlus® in 12 counties in Houston and southeastern Texas through SelectCare of Texas, which had approximately
42,100 members enrolled at December 31, 2008, representing approximately $500 million of annualized premium in force. We have expanded our Medicare Advantage HMO operations to
locations outside of Southeastern Texas including four counties in North Texas offering TexanFirst Health Plans® through SelectCare Health Plans; nine counties in Oklahoma City and six
counties in Tulsa offering Generations Healthcare through GlobalHealth; and, our counties in the Milwaukee, Wisconsin area offering Today's Health®. Effective January 1, 2008, we
terminated our HMO plans operating in Florida.

Medicare
AdvantagePFFS Plans:    Our PFFS plans are known as "Today's Options®." They are offered under contracts with the Centers for
Medicare & Medicaid Services, known as CMS and provide enhanced health care benefits compared to traditional Medicare, subject to cost sharing and other limitations. These plans have limited
provider network restrictions, which allow the members to have more flexibility in the delivery of their health care services than other Medicare Advantage plans with limited provider network
restrictions. Some of these products include a defined prescription drug benefit. In addition to a fixed monthly payment per member from CMS, individuals in these plans may be required to pay a
monthly premium in selected counties or for selected enhanced products. As of December 31, 2008, we offered PFFS plans in a total of 47 states, up from 35 states at December 31, 2007. We
will offer PFFS plans in a total of 47 states in 2009 as well. As a result of the passage of MIPPA in 2008, the PFFS product will no longer be available as of January 1, 2010, except in certain
designated rural areas. We have begun to implement a strategy to develop network-based products in selected core markets to enable the migration of our PFFS membership to these products.

Medicare
AdvantagePPO plans:    Our PPO plans are known as "Today's Options®PPO." They are offered under contracts with CMS and provide all basic
Medicare covered benefits with reduced member cost-sharing as well as additional supplemental benefits, including a defined prescription drug benefit. This coordinated care product is
built around contracted networks of providers who, in connection with the health plan, coordinate an active medical management program. In addition to a monthly payment per member from CMS, the plan
may collect a monthly premium from its members for specified products. Beginning October 1, 2008, we began offering PPO plans with a 2009 effective date in 15 markets in 9 states.

6

---



Table of Contents



In 2006, we began to offer a stand-alone prescription drug benefit pursuant to Part D known as Prescription
PathwaySM through a strategic relationship with CVS Caremark Corp., ("CVS"). As of January 1, 2009, we ended the strategic relationship with CVS and renamed our plan PrescribaRx.
On September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held pharmacy benefits manager, or PBM, and sponsor of Community CCRxSM,
a national Medicare Part D plan with 1.2 million members as of the date of acquisition. Prior to and after the acquisition, MemberHealth has been a leading national Medicare
Part D sponsor, offering Medicare prescription drug plans in 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. MemberHealth has more than 60,000 pharmacies in its
pharmacy network and covers 98 of the top 100 medications taken by Medicare beneficiaries.

Membership and Annualized Premium In Force.The following table shows the total membership and annualized premium in force for our
Medicare
Part D products:

Membership

Annualized PremiumsDecember 31,

December 31,Medicare Part D

2008

2007

2006

2008

2007

2006(in thousands)Prescriba RxSM (formerly Prescription PathwaySM) plans(1)


515.6


479.9


432.2

$
546,700

$
539,200

$
563,400CommunityCCRxSM plans(2)


1,276.4


1,164.0





1,434,700


1,439,300


Other plans(3)





25.0


23.7





9,000


9,900Total


1,792.0


1,668.9


455.9

$
1,981,400

$
1,987,500

$
573,300


---

Medicare Part D.Effective January 1, 2006, private insurers were permitted to sponsor insured stand-alone prescription drug
benefit
plans pursuant to Part D, known as Prescription Drug Plans or PDPs which was established by the Medicare Modernization Act, known as MMA. A portion of the premium for this insurance is paid by
the Federal government,, and the balance is paid by the individuals who enroll. The Federal government supports Part D through a combination of direct subsidies of premium for low income
beneficiaries, risk adjustors, federal reinsurance subsidy for claims in the catastrophic benefit phase and risk corridors. Further, the federal government will provide additional
cost-sharing subsidies to Medicare beneficiaries who also qualify for Medicaid, known as dual eligible beneficiaries or dual eligibles, and other low income subsidy, known as LIS,
beneficiaries. Our revenue from CMS and the PDP members are determined from the bids we submit annually to CMS. These revenues also reflect the health status of the members (risk adjustors or risk
scores) and the symmetrical risk sharing, or risk corridor provisions in our PDP contracts with CMS. We recognize premium revenue over the period of time we provide Part D benefit coverage to
our members.

CMS
automatically assigns dual eligible beneficiaries who do not enroll themselves in a PDP on a pro rata basis among the PDPs which submitted bids below the applicable regional
benchmarks for standard plans. Medicare beneficiaries who qualify for LIS can choose to enroll in the PDP of their choice. CMS automatically assigns those beneficiaries who qualify for this
subsidy but do not so enroll to one of the PDPs whose bids for the standard product were below the applicable regional benchmark.

7

---



Table of Contents

Our
PDP contracts with CMS are renewable for successive one-year terms unless CMS notifies us of its decision not to renew by May 1 of the current contract year, or we notify
CMS of our decision not to renew by the first Monday in June of the contract year.

For
the 2008 plan year, we offered, through our insurance subsidiaries, our Community CCRxSM and Prescription PathwaySM prescription drug plans in all 34
regions designated by CMS in which we bid. In addition, since we had bids below the benchmark in 29 and 30 regions, for Community CCRxSM and Prescription PathwaySM,
respectively.

Community CCRxSMPlans.These plans offer basic coverage with benefits
mandated by the
MMA, as well as plans providing enhanced coverage with varying degrees of out-of-pocket costs for premiums, deductibles and co-insurance. As of December 31,
2008, we had approximately 1.3 million members enrolled in our Community CCRxSM PDPs. We have a multi-year strategic alliance with the National Community Pharmacists
Association ("NCPA") which provides broad exclusive outreach and communications for our Community CCRxSM PDPs to NCPA's independent pharmacy membership. Our alliance with NCPA, and its
more than 25,000 independent pharmacy members, provides us with direct access to the largest community pharmacy network in the U.S. The NCPA member pharmacies make up over one-third of our
pharmacy network, which totals over 62,000 pharmacy locations and accounted for approximately 60% of the prescriptions filled under our Community CCRxSM PDPs in 2008.

Prescription PathwaySMPlans.In March 2005, we entered into a strategic
alliance with
a subsidiary of CVS to offer the prescription drug benefit. The essential elements of the strategic alliance were:



Prescriba RxSMPlans.We terminated this strategic alliance effective
December 31, 2008. Upon termination of the strategic alliance, CVS and Universal American each assumed responsibility for the drug benefit of specified Prescription PathwaySM plan
members to achieve an approximately equal distribution of the value of business that has been generated by the strategic alliance. We will continue to operate PDPs derived from this business under the
name PrescribaRxSM.



Our Traditional insurance segment reflects the results of our Medicare supplement, other senior health insurance, specialty health
insurance, life insurance and annuity products. We designed the products in this segment primarily for the senior market and market them through our Senior Solutions® career agency force
and our network of independent general agencies.

Medicare
supplement has historically been our primary Traditional Insurance segment product. Fixed benefit accident and sickness disability and other health insurance products sold to
the self-employed market, primarily by our career agents, are also part of this segment. We designed the life insurance products that we currently sell primarily for the senior market
including "final expense" life insurance. These are also part of the Traditional Insurance segment. We have reinsured the "final expense" life insurance 75% to 90% to unaffiliated reinsurers depending
on the product. This segment also reflects some products that we no longer sell, such as long term care and major medical insurance as well as previously produced or acquired term, universal life, and
whole life insurance products and single and flexible premium fixed annuities

During
the fourth quarter 2008, we agreed to reinsure substantially all of the net in force life and annuity business with Commonwealth Annuity and Life Insurance Company, a Goldman
Sachs

8

---



Table of Contents

Group, Inc.
subsidiary. The agreements, which are subject to regulatory approval, are expected to become effective no later than the second quarter of 2009.

Annualized Premium In Force.Total traditional health insurance product annualized premium in force on a gross basis before reinsurance
and the net
amount we retained after reinsurance, is as follows:

Gross

NetYear ended December 31,

Year ended December 31,Traditional Insurance In Force

2008

2007

2006

2008

2007

2006(In thousands)Medicare supplement and Other Senior Health

$
368,000

$
419,300

$
504,800

$
271,100

$
304,500

$
363,400Accident & Sickness and Other Health(1)


45,300


50,600


55,100


43,900


49,300


53,400Long Term Care


32,600


35,100


37,500


21,800


22,800


24,300Total

$
445,900

$
505,000

$
597,400

$
336,800

$
376,600

$
441,100Percentage retained











76
%

75
%

74
%


---

Medicare Supplement.Medicare supplement insurance reimburses the policyholder for specified expenses, such as deductibles and co-pays,
that are not covered by standard Medicare coverage. This coverage is designed for people who want the freedom to choose providers who participate in the standard Medicare program, as opposed to the
more restrictive networks that exist in many Medicare Advantage products. We believe that the market for Medicare supplement products will continue to be attractive, especially because many seniors
may lose similar coverage that had previously been offered to them as a retiree benefit by their former employers and as the federal government considers reforms to the Medicare Advantage program.

These
products are guaranteed renewable for the lifetime of the policyholder, which means that we cannot cancel the policy but we can seek to increase premium rates on existing and
future policies issued based upon our actual claims experience. We monitor the claims experience and, when necessary, apply for rate increases in the states in which we sell the products. These rate
increases are subject to state regulatory approval and loss-ratio requirements.

Fixed Benefit Accident and Sickness.Fixed benefit accident and health products provide three principal types of benefits:



Because
the benefits we provide are fixed in amount at the time of policy issuance and are not intended to provide full reimbursement for medical and hospital expenses, payment amounts are not
generally affected by inflation or the rising cost of health care services.

Connecticut State Employees.In 2005, the Company commenced a reinsurance arrangement with PharmaCare Re. Under the terms of the
agreement, the
Company provided an insured drug benefit for

9

---



Table of Contents

the
employees of the State of Connecticut. The agreement was renewable annually by the State of Connecticut with the risk reinsured to PharmaCare Re under a 100% quota share contract. Effective
July 1, 2008, the agreement was not renewed. During the period that the agreement was in force the Company received an underwriting fee ranging between 1% and 2% of premium with 1% being the
rate during 2008. Annualized premium for this program was approximately $346 million during 2008.

Long Term Care.As of the end of 2004, we ceased selling new long term care products. Previously, we had offered several long term care
plans
consisting of fully integrated plans and nursing home and home health care plans, which remain in force. These products typically are guaranteed renewable for the lifetime of the policyholder, which
means that we cannot cancel the policy but can seek to increase premium rates on existing policies based upon our actual claims experience, subject to state regulatory approval and
loss-ratio requirements. There are circumstances when regulatory authorities do not grant approval for adequate rate relief.

Life Insurance.We offer a line of low-face amount, simplified issue whole life products that we sell through our senior market
independent agency and our career agency systems. We also market a line of interest sensitive whole life products that are designed for efficient asset transfer to beneficiaries. These products also
offer acceleration of death benefit features that cover specified long term care expenses. As discussed above, we have agreed to reinsure substantially all of the net in force life and annuity
business with Commonwealth Annuity and Life Insurance Company, subject to regulatory approval.

New Business Production.The following table shows the total new sales, consisting of issued annualized premiums of our traditional
insurance
products produced by our independent and career agency systems on a gross basis before reinsurance:

Year ended December 31,Traditional Insurance Production

2008

2007

2006(In thousands)Medicare Supplement and Other Senior Health

$
13,619

$
16,707

$
37,958Accident & Sickness and Other Health


3,773


5,040


3,846Life Insurance


10,911


11,853


16,259Total

$
28,303

$
33,600

$
58,063


Annuities.As of September 30, 2006, we ceased selling annuity products. The annuity products sold prior to September 30,
2006 were
primarily focused on the senior and retirement markets. Our current credited rates on our annuity products range from 2.5% to 5.5%. Minimum guaranteed interest rates on our annuity products range from
1.5% to 5.5%. We have the right to change the crediting rates at any time, subject to the minimums, and generally adjust them quarterly.



We have built our administrative services capabilities through internal development and acquisition. Through our wholly-owned
subsidiary, CHCS Services, Inc., we provide outsourcing services to our affiliated insurance companies as well as unaffiliated companies that support insurance and non-insurance
products, primarily for the senior market. Our Senior Administrative Services segment generated revenues of $84.8 million for the year ended December 31, 2008, of which
$24.2 million was from nonaffiliates. Beginning January 1, 2009 specified services performed for affiliated Part D business representing $27.9 million of 2008 revenue, will
be performed directly by the affiliated entities.

We
perform a full range of administrative services for senior market insurance and managed care products, primarily Medicare supplement, Medicare Advantage, Part D, senior life
and long term care, for both affiliated and unaffiliated companies. Our proprietary network of registered nurses and social

10

---



Table of Contents

workers
provides personalized support and care for our senior programs nationwide. In addition, our proprietary network of discount providers is an integral part of our geriatric care management
services.



Our corporate segment reflects debt service, a portion of senior executive compensation and compliance with regulatory requirements
resulting from our status as a public company.

Marketing and Distribution

We distribute our Medicare Advantage and Part D products through our career agency systems, independent agents, direct sales and
telemarketing. Our Traditional Insurance products are distributed through our career agency systems and independent agents.



Our career agency system currently consists of 3,000 agents in 200 offices. Our career agents are required to sell only
the products that we offer or contract for them.

In
addition to selling our Medicare Advantage and PDP products, our career agency sales force distributes traditional insurance products offered by our companies such as Medicare
supplement, life insurance, disability, dental, cancer and hospital indemnity. They also sell life insurance, annuities and long term care insurance offered by unaffiliated carriers with whom we have
contracted on their behalf.



These marketing organizations and general agencies typically recruit and train their own agents, bearing all of the costs incurred in
connection with developing their organizations. We now sell our products through approximately 33,000 independent licensed agents in 47 states.



This has been one of our fastest growing channels. Working with our telemarketing partners, this channel has grown from 13% of our MA
enrollments in the 2008 selling season to more than 20% of our enrollments for the 2009 plan year.

11

---



Table of Contents



In 2008, one marketing organization produced 20% of our total annualized new sales and one marketing organization produced 13% of our
total agent produced annualized new sales both primarily PFFS plans. In 2007, one marketing organization produced 32% of our total annualized new sales, primarily PFFS plans. In 2006, one marketing
organization produced 23% of our total annualized new sales, primarily health plans, a second marketing organization produced 7% of our total annualized new sales, primarily PFFS plans and a third
marketing organization produced 5% of our total annualized new sales, primarily Medicare supplement. No other marketing organization or single agent produced more than 5% of our total annualized new
sales in 2008, 2007 or 2006.



We distribute our PrescribaRx,SM formerly known as Prescription Pathway,SM products through our career and
independent agents.

Additionally,
we place career agents and independent licensed sales agents and CMS-approved marketing materials in many of the independent pharmacies. We also have an
independent sales agent force for the Community CCRx PDPs through a strategic relationship with Community Care Outreach Services LLC, or CCOS, an insurance marketing operation with
approximately 35,000 independent licensed agents specializing in the sale of insurance and financial products to the senior market.

Geographical Distribution of Premium

Through our insurance subsidiaries, we are licensed to market our products in all 50 states, the District of Columbia, and Puerto Rico
and the U.S. Virgin Islands through a CMS waiver. Our managed care subsidiary operated Medicare Advantage coordinated care plans in Texas, Florida, Oklahoma and Wisconsin and PFFS plans in 47 states
during 2008. The following table shows the geographical distribution of the direct cash premium collected in thousands, as reported on a statutory basis to the regulatory authorities for the years
ended December 31, 2008 and 2007:

State/Region

2008(1)

% of
Premium

2007(1)

% of
PremiumTexas

$
850,377


17.8
%
$
610,676


19.2
%New York


422,418


8.8
%

284,868


9.0
%Indiana


235,394


4.9
%

151,490


4.8
%Pennsylvania


235,314


4.9
%

168,558


5.3
%North Carolina


222,161


4.7
%

175,694


5.5
%Florida


203,083


4.3
%

174,682


5.5
%Georgia


197,827


4.1
%

90,988


2.9
%Virginia


189,159


4.0
%

170,060


5.3
%Subtotal


2,555,733


53.5
%

1,827,016


57.5
%All other


2,221,355


46.5
%

1,355,289


42.5
%Total

$
4,777,088


100.0
%
$
3,182,305


100.0
%


---

12

---



Table of Contents

Total Business In Force

The following table sets forth our direct, acquired and assumed annualized premium in force, including only the portion of premiums on
interest-sensitive products that is applied to the cost of insurance and related membership counts:

Gross Annualized Premium In Force(1)December 31, 2008

December 31, 2007$

%

Members

$

%

Members(Dollars in millions, Members in thousands)Senior Managed CareMedicare AdvantagePrivate Fee-for-Service(2)

$
1,698.8


35.1
%

186.2

$
1,567.5


33.9
%

190.4HMO Plans(2)


652.2


13.4
%

54.3


499.5


10.8
%

46.0PPO Plans






%








%

Sub total


2,351.0


48.5
%

240.5


2,067.0


44.7
%

236.4Medicare Part DPrescriba RxSM (formerly Prescription PathwaySM) Plans(2)


546.7


11.3
%

515.6


539.2


11.7
%

479.9CommunityCCRxSM(2)


1,434.7


29.6
%

1,276.4


1,439.3


31.1
%

1,164.0Other Plans






%




9.0


0.2
%

25.0Sub total


1,981.4


40.9
%

1,792.0


1,987.5


43.0
%

1,668.9Traditional InsuranceMedicare Supplement and Other Senior Health


368.0


7.6
%

153.8


419.3


9.1
%

186.6Accident & Sickness and Other


45.3


0.9
%

138.0


50.6


1.1
%

152.0Long Term Care


32.6


0.7
%

18.1


35.1


0.7
%

19.3Sub total


445.9


9.2
%

309.9


505.0


10.9
%

357.9Life Insurance and Annuity


65.8


1.4
%

160.2


66.3


1.4
%

163.3Total

$
4,844.1


100.0
%

2,502.6

$
4,625.8


100.0
%

2,426.5


---

Account Values on Interest-Sensitive Products

The following table shows the account values and policy counts for our interest-sensitive products before reinsurance. For these
products, we earn income on the difference between investment income that we earn on our invested assets and interest credited to these account balances.

As of December 31,2008

2007

2006(In thousands)Annuities

$
237,752

$
274,049

$
321,075Interest-sensitive Life


158,948


160,810


164,114Total

$
396,700

$
434,859

$
485,189Policies


37.9


39.9


42.9


13

---



Table of Contents

Investments

Our investment policy is to attempt to balance our portfolio duration to achieve investment returns consistent with the preservation of
capital and maintenance of liquidity adequate to meet payment obligations of policy benefits and claims. We invest in assets permitted under the insurance laws of the various states in which we
operate. These laws generally prescribe the nature, quality of and limitations on various types of investments that we may make. We do not currently have investments in partnerships, special purpose
entities, real estate, commodity contracts or other derivative securities.

The
following table summarizes the composition of our investment portfolio by carrying value (which represents fair value):

December 31, 2008

December 31, 2007Carrying Value
(Fair Value)

Percent of
Total
Carrying Value

Carrying Value
(Fair Value)

Percent of
Total
Carrying Value(In thousands)Fixed Maturity Securities:U.S. Treasury securities and obligations of U.S. government

$
35,335


2.3
%
$
34,886


1.9
%Government sponsored agencies


95,029


6.1
%

98,724


5.4
%Other political subdivisions


9,885


0.6
%

5,536


0.3
%Investment grade corporates


404,164


25.8
%

415,046


22.9
%Non-investment grade corporates


16,119


1.0
%

17,095


0.9
%Foreign debt securities


30,890


2.0
%

29,641


1.6
%Mortgage-backed securities(1)


357,626


22.8
%

371,328


20.5
%Asset-backed securities


83,345


5.3
%

152,593


8.4
%Total fixed maturity securities


1,032,393


65.9
%

1,124,849


61.9
%Other Investments:Policy loans


22,274


1.4
%

21,560


1.2
%Other invested assets


1,649


0.1
%

1,526


0.1
%Total invested assets


1,056,316


67.4
%

1,147,935


63.2
%Cash and cash equivalents


511,032


32.6
%

667,685


36.8
%Total cash and invested assets

$
1,567,348


100.0
%
$
1,815,620


100.0
%


---

The
following table shows the distribution of the contractual maturities of our portfolio of fixed maturity securities by carrying value as of December 31, 2008. Expected
maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Available for Sale

Carrying Value

Percent of Total
Fixed Maturities(In thousands)Due in 1 year or less

$
73,228


7.1
%Due after 1 year through 5 years


391,922


38.0
%Due after 5 years through 10 years


95,333


9.2
%Due after 10 years


30,939


3.0
%Mortgage and asset-backed securities


440,971


42.7
%Total

$
1,032,393


100.0
%


14

---



Table of Contents

The
following table shows the distribution of the ratings assigned by Standard & Poor's, a division of The McGraw-Hill Companies, Inc. or equivalent, to the
securities in our portfolio of fixed maturity securities:

December 31, 2008

December 31, 2007Standard & Poor's Rating

Carrying Value
(Estimated
Fair Value)

% of
Total Fixed
Investment

Carrying Value
(Estimated
Fair Value)

% of
Total Fixed
Investment(In thousands)AAA

$
531,126


51.5
%
$
548,217


48.7
%AA


68,618


6.6
%

179,882


16.0
%A


337,525


32.7
%

293,420


26.0
%BBB


72,632


7.0
%

86,234


7.7
%BB


6,389


0.6
%

8,748


0.8
%B


3,113


0.3
%

4,430


0.4
%CCC


6,974


0.7
%

3,918


0.4
%D


6,016


0.6
%




Total

$
1,032,393


100.0
%
$
1,124,849


100.0
%


At
December 31, 2008 and 2007, approximately 98% of our fixed maturity investments were rated "investment grade." "Investment grade" securities are those rated "BBB-"
or higher by Standard & Poor's or "Baa3" or higher by Moody's Investors Service. We owned approximately $441.0 million of mortgage backed securities secured by residential mortgages and
asset-backed securities, as of December 31, 2008 compared to $523.9 million, as of December 31, 2007, representing approximately 42.7% of our fixed maturity portfolio as of
December 31, 2008 and 46.6% of our fixed maturity portfolio as of December 31, 2007. Some classes of mortgage backed securities are subject to significant prepayment risk, because in
periods of declining interest rates, mortgages may be repaid more rapidly than scheduled, as individuals refinance higher rate mortgages to take advantage of the lower rates. As a result, holders of
mortgage backed securities may receive higher prepayments on their investments, which they may not be able to reinvest at an interest rate comparable to the rate paid on such mortgage backed
securities.

As
of December 31, 2008, we held securities with par values of approximately $140.3 million with exposure to Subprime mortgages. The market value of these securities was
$38.3 million at December 31, 2008, representing approximately 2.4% of our cash and invested assets. The collateral for these securities is substantially all first lien mortgages. These
securities have an average S&P, or equivalent, rating of AA-.

Fixed
maturity securities with less than investment grade ratings had aggregate carrying values of $22.5 million as of December 31, 2008 and $17.1 million as of
December 31, 2007, amounting to 2.2% of total fixed maturity investments as of December 31, 2008 and 1.6% of total fixed maturity investments as of December 31, 2007. These
securities represented approximately 0.6% of total assets as of December 31, 2008 and 0.4% of total assets as of December 31, 2007. Our holdings of less than investment grade fixed
maturity securities are diversified and the largest investment in any one such security as of December 31, 2008 was $5.4 million, which was approximately 0.1% of total assets. During
2008, we recognized other-than-temporary impairments totaling $48.0 million on securities with exposure to subprime mortgages and $11.8 million on corporate and
other mortgage backed securities. During the fourth quarter of 2007, we recognized other-than-temporary impairments in the value of some of our securities with exposure to
subprime mortgage totaling $41.0 million. We did not write down the value of any fixed maturity securities during 2006.

15

---



Table of Contents

Investment Income

Investment income is an important part of our total revenues and profitability. We cannot predict the impact that changes in future
interest rates or impairments will have on our financial statements. The following table presents the investment results of our total invested asset portfolio:

Years ended December 31,2008

2007

2006(In thousands)Total cash and invested assets, end of period

$
1,567,348

$
1,815,620

$
1,677,973Net investment income

$
81,270

$
106,970

$
75,459Yield on average cash and investments


4.9
%

5.4
%

5.1
%Net realized investment (losses) gains before taxes, including other-than-temporary declines in market value

$
(59,681
)
$
(40,178
)
$
4,818


Reinsurance

In the normal course of business, we reinsure portions of policies that we underwrite. We enter into reinsurance arrangements with
unaffiliated reinsurance companies to limit our exposure on individual claims and to limit or eliminate risk on our non-core or under-performing blocks of business. Accordingly, we are
party to various reinsurance agreements on our life and accident and health insurance risks. Our senior market accident and health insurance products are generally reinsured under quota share
coinsurance treaties, while our life insurance risks are generally reinsured under either quota share coinsurance or yearly-renewable term treaties. Under quota share coinsurance treaties, we pay the
reinsurer an agreed upon percentage of all premiums and the reinsurer reimburses us that same percentage of any losses. In addition, the reinsurer pays us allowances to cover commissions, cost of
administering the policies and premium taxes. Under yearly-renewable term treaties, the reinsurer receives premiums at an agreed upon rate for its share of the risk on a yearly-renewable term basis.
We also use excess of loss reinsurance agreements for some policies whereby we limit our loss in excess of specified thresholds.

16

---



Table of Contents

The
table below details our gross annualized premium in force, the portion that we ceded to reinsurers and the net amount that we retained:

December 31, 2008

December 31, 2007Gross

Ceded

Net

Retained

Gross

Ceded

Net

Retained(In millions)Medicare AdvantageHMO

$
652.2

$
18.3

$
633.9


97
%
$
499.5

$
6.1

$
493.4


99
%PFFS


1,698.8


2.3


1,696.5


99
%

1,567.5


1.9


1,565.6


99
%PPO












%











%Sub total


2,351.0


20.6


2,330.4


99
%

2,067.0


8.0


2,059.0


99
%Medicare Part DPrescriba RxSM (formerly Prescription PathwaySM)


546.7


273.4


273.3


50
%

539.2


269.6


269.6


50
%Community CCRxSM


1,434.7





1,434.7


100
%

1,439.3





1,439.3


100
%Other Plans












%

9.0





9.0


100
%Sub total


1,981.4


273.4


1,708.0


86
%

1,987.5


269.6


1,717.9


86
%Traditional Insurance(1)Medicare Supplement and Other Senior Health


368.0


97.0


271.0


74
%

419.3


114.8


304.5


73
%Accident & Sickness and other


45.3


1.3


44.0


97
%

50.6


1.3


49.3


97
%Long Term Care


32.6


10.8


21.8


67
%

35.1


12.3


22.8


65
%Sub total


445.9


109.1


336.8


76
%

505.0


128.4


376.6


75
%Life Insurance and Annuity


65.8


23.6


42.2


64
%

66.3


20.9


45.4


68
%Total

$
4,844.1

$
426.7

$
4,417.4


91
%
$
2,558.8

$
418.9

$
2,139.9


84
%


---

We
have several quota share reinsurance agreements in place with General Re Life Corporation, Hannover Life Re of America and Swiss Re Life & Health America. A.M. Best
Company, Inc. has rated these reinsurers "A" or better. These agreements cover various insurance products, primarily Medicare supplement, long term care and senior life policies, written or
acquired by the Company and contain ceding percentages ranging between 15% and 100%. Effective January 1, 2004, our retention on all new Medicare supplement business was 100%. Therefore, we no
longer reinsures new Medicare supplement business.

During
2008, we ceded premiums of $449.8 million to PharmaCare Re, $58.4 million to General Re, $49.2 million to Hannover and $10.6 million to Swiss Re,
representing 8.6%, 1.1%, 1% and 0.2% respectively of our total direct and assumed premiums. During 2007, we ceded premiums of $580.3 million to PharmaCare Re, $67.8 million to General
Re, $58.8 million to Hannover and $12.2 million to Swiss Re, representing 15%, 2%, 2% and 0.3% respectively of our total direct and assumed premiums. During 2006, we ceded premiums of
$530.2 million to PharmaCare Re, $80.5 million to General Re, $74.1 million to Hannover and $12.4 million to Swiss Re, representing 28%, 4%, 4% and 1% respectively of our
total direct and assumed premiums.

Our
quota share coinsurance agreements are generally subject to cancellation on 90 days notice as to future business, but policies reinsured prior to any cancellation remain
reinsured as long as they remain
in force. There is no assurance that if any of our reinsurance agreements were canceled we would be able to obtain other reinsurance arrangements on satisfactory terms.

17

---



Table of Contents

We evaluate the financial condition of our reinsurers and monitor concentrations of credit risk to minimize our exposure to significant losses from reinsurer
insolvencies. We must pay claims in the event that a reinsurer to which we have ceded an insured claim fails to meet its obligations under the reinsurance agreement. As of December 31, 2008,
all of our primary reinsurers were rated "A" or better by A.M. Best, except for PharmaCare Re, which is unrated. We have secured a letter of credit from PharmaCare Re that we believe will
adequately support the risks ceded. As a result of the termination of the strategic alliance, we do not anticipate ceding any additional premium to PharmaCare Re and we anticipate that any risks ceded
will be settled upon CMS's final reconciliation of the 2008 plan year. We do not know of any instances where any of our reinsurers have been unable to pay any policy claims on any reinsured business.



We retain the responsibility for administration for most reinsured blocks of business, consisting principally of underwriting, issue,
policy maintenance, rate management and claims adjudication and payment. In addition to reimbursement for commissions and premium taxes on the reinsured business, we also receive allowances from the
reinsurers as compensation for our administration.



We reinsure our Medicare Advantage coordinated care and PFFS products on an excess of loss basis, which limits our per member risk to
amounts ranging from $100,000 to $250,000. Our retention on 2008 claims is $250,000.



Historically, we reinsured much of our senior market health insurance business to unaffiliated reinsurers under quota share coinsurance
agreements. In 2001, we began reducing the amount of premium that we ceded to reinsurers on new business, and we have retained all new Medicare supplement business written after January 1,
2004. Under the existing coinsurance agreements, which remain in effect for the life of each policy reinsured, we reinsure a portion of the premiums, claims and commissions on a pro rata basis and
receive additional expense allowances for policy issue and administration and premium taxes. The amounts reinsured under these agreements range from 25% to 100%. As older, reinsured business lapses
and we write new business that we do not reinsure, the overall percentage of business we retain will increase. As of December 31, 2008, the percentage of Medicare supplement business in force
retained by us increased to 74%, as compared to 73% at the end of 2007 and 72% at the end of 2006.



The PDPs sponsored by our subsidiaries other than our MemberHealth PDP business acquired in September 2007, are reinsured, on a 50%
coinsurance funds withheld share basis, to PharmaCare Re. During 2008, there was approximately $277.9 million of ceded premium as a result of this agreement, compared with $255.3 million
during 2007. The contract was terminated effective December 31, 2008. Pennsylvania Life also assumed, on a 33.3% quota share basis, risks of an unaffiliated prescription drug plan. The contract
for the 33.3% assumed business ended as of January 1, 2008.



We retain 100% of the fixed benefit accident & sickness disability and hospital business issued in our insurance specialty
health segment. We reinsure our long term care business on a 50% quota share basis, except for the acquired long term care business written in Pennsylvania Life Insurance Company, and Union Bankers
Insurance Company which is 100% retained. We have excess of loss reinsurance

18

---



Table of Contents

agreements
to reduce our liability on individual risks for home health care policies to $250,000. For other long term care policies issued in the U.S. we have reinsurance agreements which cover 90% of
the benefits on claims after two years and 100% of the benefits on claims after the third or fourth years depending upon the plan. We also have excess of loss reinsurance agreements with unaffiliated
reinsurance companies on most of our major medical insurance policies to reduce the liability on individual risks to $325,000 per year.



During the third quarter of 2005, the Company commenced a reinsurance arrangement with PharmaCare Re. Under the terms of the agreement,
the Company provides an insured drug benefit for the employees of the State of Connecticut. The agreement was renewable annually by the State of Connecticut with the risk reinsured to PharmaCare Re
under a 100% quota share contract. Effective July 1, 2008, the agreement was non-renewed. During the period that the agreement was in force the Company received an underwriting fee
ranging between 1% and 2% of premium with 1% being the rate during 2008. Annualized premium for this program was approximately $346 million during 2008. PharmaCare Re has provided a letter of
credit to support amounts recoverable from PharmaCare Re in an amount equal to the total unpaid claims and claim reserves for this business, but no less than $35 million. The amount of this
letter of credit was $35 million at December 31, 2008.



We reinsure our senior life insurance products currently being issued under 75% quota share coinsurance agreements. We reinsure our
whole life products currently being issued on a yearly renewable term basis for amounts in excess of $100,000. During the fourth quarter
2008, we agreed to reinsure substantially all of the net in force life and annuity business with Commonwealth Annuity and Life Insurance Company, a Goldman Sachs Group, Inc. subsidiary. The
agreements, which are subject to regulatory approval, are expected to become effective in the second quarter of 2009.

Provider Arrangements

Our network providers deliver health care services to members enrolled in our Medicare Advantage coordinated care plans through a
network of contracted providers, including physicians, and other clinical providers, hospitals, a variety of outpatient facilities and the full range of ancillary provider services. The major
ancillary services and facilities include:



19

---



Table of Contents



We
use a wide range of systems and processes to organize and deliver needed health care services to our members. The key steps in this process are:



We
employ health evaluation and assessment tools, quality improvement, care management and credentialing programs to ensure that we meet target goals relating to the provision of quality
patient care. The major medical management systems are:



Our
hospitalist programs use either the patient's primary care physician or a specially-trained physician to manage or arrange the member's medical care during hospital admissions and to
coordinate the member's discharge and post-discharge care. In addition, we utilize on-site case managers at high volume hospitals. Upon initial enrollment, a majority of all
members complete a health risk assessment, which along with other available clinical and risk information permits the stratification of membership into categories of health risk. Members in higher
risk categories receive enhanced clinical attention. We have integrated these various medical management systems through a care coordination information system to provide clinical and administrative
information to support the medical management process. Our chronic illness management programs target specific high risk medical conditions such as congestive heart failure, coronary artery disease,
diabetes, and other conditions and focus on addressing major gaps in care. Our special needs plans for institutionalized beneficiaries focus on the unique needs of this population. In our southeast
Texas market, we have implemented a quality compensation program that measures quality process indicators of care related to prevention and disease specific metrics. We plan to implement this program
in new markets in the future.

Our
health plans usually contract with hospitals based on Medicare's Severity Diagnosis-Related Group or MS-DRG methodology, which is an all-inclusive rate per
admission. We generally contract with outpatient facilities on Medicare's Ambulatory Payment Classification (APC) or Ambulatory Surgery Center (ASC) methodology as appropriate, or a percentage of
billed charges which approximates APC or ASC reimbursement. We generally contract with physicians, and contract with some other providers, on a capitation or fee-for-service
basis, utilizing Medicare's Resource Based

20

---



Table of Contents

Relative
Value Scale or RBRVS methodology. Under a capitation arrangement, a physician receives a monthly fixed fee for each member, regardless of the medical services the physician provides to the
member. Our provider contracts with network primary care physicians, specialists and ancillaries generally have terms of one year, with automatic renewal for successive one-year terms. We
may terminate these contracts for cause, based on provider conduct or other appropriate reasons, subject to laws giving providers due process rights. Either party generally may cancel the contracts
without cause upon 60 or 90 days prior written notice. Our contracts with hospitals generally have terms of one to two years, with automatic renewal for successive one-year terms.
We may terminate these contracts for cause, based on provider misconduct or other appropriate reasons. Either party generally may cancel our hospital contracts without cause upon 90 days prior
written notice.

Underwriting Procedures

For our Medicare advantage plans (HMO, PFFS, and PPO) and Medicare Part D plans, pursuant to applicable regulations, we are not
permitted to underwrite new enrollees. However, premiums received for these members are risk adjusted based on CMS adjustment policies reflecting the expected claim risk for each member.

For
our Traditional Insurance business, we base the premium we charge, in part, on assumptions about expected mortality and morbidity experience. We have adopted and follow detailed
uniform underwriting procedures designed to assess and quantify various insurance risks before issuing individual life insurance policies and health insurance policies to individuals. We generally
base these procedures on industry practices, reinsurer underwriting manuals and our prior underwriting experience. To implement these procedures, our insurance company subsidiaries employ an
experienced professional underwriting staff.

We
review applications for insurance on the basis of the answers that the customer provides to the application questions. Where appropriate to the type and amount of insurance applied
for and the applicant's age and medical history, we require additional information such as medical examinations, statements from doctors who have treated the applicant in the past and, where
indicated, special medical tests. If necessary, we use investigative services to supplement and substantiate information. For some coverages, we may verify information with the applicant by telephone.
After reviewing the information collected, we either issue the policy as applied for on a standard basis, issue the policy with an extra premium charge due to unfavorable factors, issue the policy
excluding benefits for specified conditions, either permanently or for a period of time, or reject the application. For some of our coverages, we have adopted simplified policy issue procedures in
which the applicant submits an application for coverage typically containing only a few health-related questions instead of a complete medical history. Under regulations promulgated by the NAIC and
adopted as a result of the Omnibus Budget Reconciliation Act of 1990, we are prohibited from using medical underwriting criteria for our Medicare supplement policies for specified
first-time purchasers and for specified disenrollees from Medicare Advantage plans. If a person applies for insurance within six months after becoming eligible by reason of age, or
disability in some circumstances, we may not reject the application due to medical conditions. For other prospective Medicare supplement policyholders, such as senior citizens who are purchasing our
products, the underwriting procedures are limited based upon standard industry practices and state insurance regulations.

In
New York and some other states, some of our products, such as Medicare supplement, are subject to guaranteed issue "community rating" laws that severely limit or prevent underwriting
of individual applications. See the "Regulation" section of this document.

21

---



Table of Contents

Reserves

In accordance with applicable insurance regulations, we establish, and carry as liabilities in our GAAP and statutory financial
statements, actuarially determined reserves.

We
calculate reserves together with premiums to be received on outstanding policies and contracts and interest at assumed rates on these amounts, which we believe to be sufficient to
satisfy policy and contract obligations. Reserves for life insurance policies are determined using actuarial factors based on mortality tables and interest rates prescribed by statute. Reserves for
accident and health insurance policies (excluding Medicare Advantage and Part D) use prescribed morbidity tables based on our historical experience. For Medicare Advantage and Part D
policies, claims reserves are estimated using standard actuarial development methodologies. Under such methods, we take into consideration the historical lag between incurral date of claim and payment
date of claim, membership changes, expected medical cost trend, changes in pending claims, amount of claims receipts, claims seasonality, changes in average risk profile, and benefit plan changes. We
also maintain reserves for unearned premiums, for premium deposits, for claims that have been reported and are in the process of being paid or contested and for our estimate of claims that have been
incurred but have not yet been reported.

We
calculate the reserves reflected in our consolidated financial statements in accordance with generally accepted accounting principles, known as GAAP. We determine these reserves based
on our best estimates of mortality and morbidity, persistency, expenses and investment income. We use the net level premium method for all non-interest-sensitive products and the
retrospective deposit method for interest-sensitive products. GAAP reserves differ from statutory reserves due to the use of different assumptions regarding mortality and morbidity, interest rates and
the introduction of lapse assumptions into the GAAP reserve calculation.

When
we acquire blocks of insurance policies or insurers owning blocks of policies, our assessment of the adequacy of the transferred policy liabilities is subject to risks and
uncertainties. With acquired and existing businesses, we may from time to time need to increase our claims reserves significantly in excess of those previously estimated. An inadequate estimate of
reserves could have a material adverse impact on our results of operations or financial condition.

Competition

The life and accident and health insurance and managed care industries in the U.S. are highly competitive. Approximately 2,000 life and
accident and health insurance companies and approximately 400 managed care organizations operate in the United States. We compete with numerous other insurance and managed care companies on a national
basis plus other regional
insurance companies and financial services companies, including health maintenance organizations, preferred provider organizations, and other health care-related institutions that provide
medical benefits based on contractual agreements. We may be at a disadvantage because many of these organizations may have



In
addition, it has become increasingly difficult for smaller and mid-size companies to compete effectively with these larger competitors for insurance product sales in part
as a result of heightened consumer and agent awareness of the ratings and financial size of companies.

22

---



Table of Contents

We
believe we can meet these competitive pressures by offering a high level of service and accessibility to our members and our field force and by developing specialized products and
marketing approaches. We also believe that our policies and premium rates, as well as the commissions paid to our sales agents, are generally competitive with those offered by other companies selling
similar types of products in the same jurisdictions. In addition, our insurance subsidiaries operate at lower policy acquisition and administrative expense levels than some other insurance companies,
allowing us to offer competitive rates while maintaining underwriting margins. In the case of our Medicare supplement business, low expense levels are necessary in order to meet state mandated loss
ratios and achieve the desired underwriting margins. Also, we believe the following factors provide us additional strength to compete effectively:



In
addition, we compete with other managed care organizations for government healthcare program contracts, renewals of those government contracts, members and providers. Many of our
competitors are large companies that have greater financial, technological and marketing resources than we do. In the Medicare managed care market, our primary competitors for contracts, members and
providers are either national and regional commercial managed care organizations that serve Medicare recipients or provider-sponsored organizations.

We
will be filing additional bids with CMS to offer Medicare Advantage PPO products for 2010. Medicare Advantage PPOs allow their members more flexibility to select physicians than other
Medicare Advantage plans, such as HMOs, which often require members to coordinate with a primary care physician. Regional Medicare PPO plans will compete with our own and our competitors' local
Medicare Advantage HMOs, and with our Medicare supplement business. In addition, several of our competitors have introduced highly competitive PFFS plans that compete with our Medicare Advantage and
Medicare supplement products.

The
increased competition from other Medicare supplement carriers, as well as from Medicare Advantage plans, has affected our production of Medicare supplement business and has caused
more of our in-force business to lapse than we had anticipated.

Ratings

Increased public and regulatory concerns regarding the financial stability of insurance companies have resulted in policyholders
placing greater emphasis upon company ratings and have created some measure of competitive advantage for insurance carriers with higher ratings. A.M. Best is considered to be a leading
insurance company rating agency. In evaluating a company's financial and operating performance, A.M. Best reviews the following criteria for an insurance company:



23

---



Table of Contents



A.M.
Best's ratings are based upon factors relevant to policyholders, agents, insurance brokers and intermediaries and are not directed to the protection of investors. Currently, A.M. Best
maintains ratings of "B++" on the following subsidiaries:



A.M.
Best maintains ratings of "B+" on Constitution Life Insurance Company, Union Bankers Insurance Company and SelectCare of Texas and a rating of "B" on GlobalHealth. These B++ and B+ ratings mean
that, in A.M. Best's opinion, these companies have a "good" ability to meet their ongoing obligations to policyholders and are in the "Secure" category of all companies rated by A.M.
Best. The B rating means that, in A.M. Best's opinion, the company has a "fair" ability to meet its ongoing obligations to policyholders and is in the "Vulnerable" category of all companies
rated by A.M. Best. A.M. Best does not rate our other insurance company subsidiaries.

Standard &
Poor's currently assigns its "BBB+" counterparty credit and financial strength ratings to our American Pioneer, American Progressive, Pennsylvania Life and Pyramid Life
subsidiaries. This rating means that in Standard & Poor's opinion, these companies have good financial security characteristics, but are more likely to be affected by adverse business
conditions than are insurers that are rated higher by Standard & Poor's. A plus (+) or minus (-) shows Standard & Poor's opinion of the relative standing of the insurer within a rating
category.

Moody's
Investors Service and Fitch Ratings do not currently rate our insurance company subsidiaries. Although a higher rating by A.M. Best, Standard & Poor's or another
insurance rating organization could have a favorable effect on our business, we believe that our competitive pricing, effective rate management, quality customer service and effective marketing have
enabled, and will continue to enable, our insurance company subsidiaries to compete effectively.

Regulation



Our insurance company subsidiaries and health plan affiliates are subject to the state and local laws, regulations and supervision of
the jurisdictions in which they are domiciled and licensed, as well as to Federal laws and supervision. Those laws and regulations provide safeguards for policyholders and members, and do not exist to
protect the interest of shareholders. Government agencies that oversee insurance and health care products and services generally have broad authority to issue regulations to interpret and enforce laws
and rules. Changes in applicable laws and regulations are continually being considered, and the interpretation of existing laws and rules also may change periodically, which could make it increasingly
difficult to control medical costs, among other things. Therefore, future regulatory revisions could affect our operations and financial results.

24

---



Table of Contents



Medicare is a Federal program that provides eligible persons age 65 and over and some eligible disabled persons a variety of hospital
and medical insurance benefits. Medicare beneficiaries have the option to enroll in a Medicare Advantage private fee-for-service or health plan in counties where these plans
are offered. Under Medicare Advantage, insurance companies and managed care organizations contract with CMS to provide benefits comparable to the traditional fee-for-service
Medicare program in exchange for a fixed monthly payment per member that varies based on the county in which a member resides as well as a member's demographics and acuity.

Under
Federal regulations and model regulations published by the National Association of Insurance Commissioners, known as the NAIC, which are adopted in substantially all states, there
are 14 standard Medicare supplement plans: Plans A through L and High Deductible Plans F and J. Plan A provides the least extensive coverage, while Plan J provides the most extensive coverage. Under
NAIC model regulations, Medicare supplement insurers must offer Plan A, but may offer any of the other plans at their option. The MMA prohibits the sale of the former H, I and J plans and authorizes
two additional plans after December 2005, known as Plans K and L.

The
MMA created a voluntary prescription drug benefit, called the "Part D" benefit, for Medicare beneficiaries. This program began on January 1, 2006, established a new
Medicare Advantage program
to replace the Medicare+Choice program, and enacted tax-advantaged health savings accounts, or HSA's, for non-Medicare eligible individuals and groups.

The
Part D drug benefit enables Medicare beneficiaries to obtain covered outpatient prescription drug benefits offered through a private drug plan. Depending on the plan, the
Part D drug benefit may be subject to cost sharing. Under the standard drug coverage, for 2008 the cost sharing is a $275 deductible, 25% coinsurance for annual drug costs reimbursed by
Medicare up to a maximum of $2,510 and no reimbursement for drug costs above $2,510, until the beneficiary has paid $4,050 of his or her own money. After that, the MMA provides catastrophic stop loss
coverage for annual incurred drug costs in excess of $5,726, subject to nominal cost-sharing. Plans are not required to mirror these limits; instead, Part D drug plans are required
to provide coverage that is at least actuarially equivalent to the standard drug coverage delineated in the MMA. CMS adjusts these numbers on an annual basis. The MMA provides subsidies and the
reduction or elimination of cost sharing for specified low-income beneficiaries, including "dual-eligible" individuals who receive benefits under both Medicare and Medicaid.

The
MMA also revised payment methodologies for Medicare Advantage organizations beginning in 2004, and in 2006 the MMA expanded the Medicare Advantage program to include new regional
plans that provide out-of-network benefits in addition to in-network benefits, as well as the traditional health and fee-for-service plans
established by county. The Secretary of Health and Human Services, or HHS, created 34 regions, each of which may include more than one state or portions of a particular state. The MMA created a new
competitive bidding process that began in 2006 for both the local health plans and the new regional plans for setting the payment to the Medicare Advantage plans and the beneficiary premium and
benefits. The bidding process does not limit the number of plans that may participate in the Medicare Advantage program.

The
Medicare Improvements for Patients and Providers Act of 2008, known as MIPPA, which amended the Medicare provisions of the Social Security Act revises requirements for Medicare
Advantage private fee-for-service plans, which we expect will have the effect of ending these plans in plan year 2011 in non-rural markets. We anticipated many of
MIPPA's provisions, and had undertaken initiatives to replace the private fee-for-service revenue that we thought might be lost to us, depending on the final text of the bill.
In particular, we have been working to establish preferred provider organization, or PPO, and health maintenance organization, or HMO, networks in strategic locations,

25

---



Table of Contents

some
of which we have established for the 2009 plan year and others of which we are continuing to establish for the 2010 plan year and beyond.

CMS
conducts periodic audits of plans qualified under its Medicare program and may perform other reviews more frequently to determine compliance with Federal regulations and contractual
obligations.
These audits and reviews may include review of the plans' administration and management, including management information and data collection systems, fiscal stability, utilization management and
physician incentive arrangements, health services delivery, quality assurance, marketing, enrollment and disenrollment activity, claims processing, and complaint systems.

CMS
regulations require submission of annual financial statements. In addition, CMS requires that disclosures be made to it and to Medicare beneficiaries concerning operations of a
health plan contracted under the Medicare program. CMS's rules require disclosure, upon request, to members of information concerning financial arrangements and incentive plans between a plan and
physicians in the plan's networks. These rules also require specified levels of stop loss coverage to protect contracted physicians against major losses relating to patient care, depending on the
amount of financial risk they assume.



Enforcement of health care fraud and abuse laws has become a top priority for the nation's law enforcement entities. The funding of
these law enforcement efforts has increased dramatically in the past few years and is expected to continue. The focus of these efforts has been directed at participants in Federal government health
care programs such as Medicare. We participate in these programs and have continued our stringent regulatory compliance efforts for these programs.



The use of individually identifiable data by our business is regulated at Federal and state levels. These laws and rules are subject to
administrative interpretation. Various state laws address the use and maintenance of individually identifiable health data. Many are derived from the privacy provisions in the Federal
Gramm-Leach-Bliley Act and the Health Insurance Portability and Accountability Act of 1996, known as HIPAA.



HIPAA
also calls for the adoption of standards for the exchange of electronic health information and privacy requirements that govern the handling, use and disclosure of protected
customer health information. We believe that we met the HIPAA Security Rule changes that became effective on April 21, 2005; however, HIPAA is far-reaching and complex and proper
interpretation and practice under the law continue to evolve. Consequently, our efforts to measure, monitor and adjust our business practices to comply with HIPAA are ongoing. We do not believe that
compliance with HIPAA will have a material adverse effect on our financial condition or results of operations.

Insurance
companies also are required to comply with Federal "Do Not Call" regulations. Insurance companies are required to develop their own "Do Not Call" lists and reference state and

26

---



Table of Contents

Federal
Do Not Call Registries, before making calls to market insurance products. Estimates suggest that approximately two thirds of the country's residential telephone numbers are on the Federal
registry, which could limit the marketing calls made and potentially could negatively impact sales.



A portion of the USA PATRIOT Act applying to insurance companies became effective in mid 2004. Insurance companies have to impose
processes and procedures to thoroughly verify their agents, applicants, insureds, claimants and premium payers in an effort to prevent money laundering. Our insurance companies have implemented
measures to comply with the Office of Federal Asset Control requirements, whereby the names of customers and potential customers must be reviewed against a listing of known terrorists and money
launderers. The identification verification requirement of the USA PATRIOT Act became final in late 2005. In May 2006, insurance companies were required to verify the identity of their applicants,
insureds, and beneficiaries. We continually upgrade our internal procedures, securing software and training of home office staff and producers to maintain compliance.



Each of our insurance company subsidiaries and our health plan affiliates is also subject to the regulations of and supervision by the
insurance department of each of the jurisdictions in which they are admitted and authorized to transact business. These regulations cover, among other things,



A
failure to comply with legal or regulatory restrictions may subject the insurance company subsidiary to a loss of a right to engage in some or all business in a state or states or an
obligation to pay fines or make restitution, which may affect our profitability.

American
Pioneer is a Florida domiciled insurance company. American Progressive is a New York domiciled insurance company. Pyramid Life is a Kansas domiciled insurance company.
Pennsylvania Life is a Pennsylvania domiciled insurance company. American Exchange, Constitution, Marquette and Union Bankers are Texas domiciled insurance companies. SelectCare of Texas and
SelectCare Health Plans, Inc. are licensed as health plans in Texas. SelectCare of Oklahoma, Inc. and GlobalHealth, Inc. are licensed health plans in Oklahoma. Collectively, our
insurance subsidiaries and managed care organizations are licensed to sell health insurance, life insurance and annuities in all 50 states, the District of Columbia and Puerto Rico and the U.S. Virgin
Islands. In addition, some of these

27

---



Table of Contents

subsidiaries
have CMS-approved plans to enroll members in our PDPs in 48 states plus the U.S. Virgin Islands and in our Medicare Advantage PFFS and HMO plans in 47 states, for 2009.

Most
jurisdictions mandate minimum benefit standards and loss ratios for accident and health insurance policies. We are generally required to maintain, with respect to our individual
long term care policies, minimum anticipated loss ratios over the entire period of coverage. With respect to our Medicare supplement policies, we are generally required to attain and maintain an
actual loss ratio, after three years, of not less than 65 percent of earned premium. We provide to the insurance departments of all states in which we conduct business annual calculations that
demonstrate compliance with required loss ratio standards for both long term care and Medicare supplement insurance. We prepare these calculations utilizing appropriate statutory assumptions. In the
event we fail to maintain minimum mandated loss ratios, our insurance company subsidiaries could be required to provide retrospective premium refunds or prospective premium rate reductions. We believe
that our insurance company subsidiaries currently comply with all applicable mandated minimum loss ratios. In addition, we actively review the loss ratio experience of our products and request
approval for rate increases from the respective insurance departments when we determine they are needed. We cannot guarantee that we will receive the rate increases we request.

Every
insurance company that is a member of an "insurance holding company system" generally is required to register with the insurance regulatory authority in its domicile state and file
periodic reports concerning its relationships with its insurance holding company and with its affiliates. Material transactions between registered insurance companies and members of the holding
company system are required to be "fair and reasonable" and in some cases are subject to administrative approval. The books, accounts and records of each party are required to be maintained so as to
clearly and accurately disclose the precise nature and details of any intercompany transactions.

Each
of our insurance company subsidiaries is required to file detailed reports with the insurance department of each jurisdiction in which it is licensed to conduct business and its
books and records are subject to examination by each licensing insurance department. In accordance with the insurance codes of their domiciliary states and the rules and practices of the NAIC, our
insurance company subsidiaries are examined periodically by examiners of each company's domiciliary state with elective participation by representatives of the other states in which they are licensed
to do business. During 2008, insurance departments completed regularly scheduled regulatory financial examinations and financial examination reports for American Pioneer, American Exchange,
Constitution, Marquette, Union Bankers, Pyramid, Pennsylvania Life (for the period ended December 31, 2005) and SelectCare
Health Plans, Inc. as of and for the period ended December 31, 2006. We have not been informed of any significant findings or adjustments to statutory surplus, in the aggregate,
resulting from these examinations. During 2008, a regularly scheduled examination of SelectCare Health Plans was completed as of and for the period ended December 31, 2007 with no significant
findings noted. During 2007, a regularly scheduled examination of SelectCare of Oklahoma was completed as of and for the period ended December 31 2006 with no significant findings noted. A
regularly scheduled examination of American Progressive for the three years ended December 31, 2006 was completed in 2008. There were no adjustments to statutory surplus.

In
2005, the Wisconsin Office of the Commissioner of Insurance, known as the Wisconsin OCI, initiated an investigation into the sales practices of Pennsylvania Life sales agents in the
state. On June 12, 2008, Pennsylvania Life entered into a stipulation and consent order with the Wisconsin OCI settling and concluding the investigation, which required, among other things, a
forfeiture of $925,000 and implementation of remediation program for affected policyholders.

Many
states require deposits of assets by insurance companies for the protection either of policyholders in those states or for all policyholders. These deposited assets remain part of
the total assets of the company. As of December 31, 2008, we had securities totaling $41.6 million on deposit

28

---



Table of Contents

with
various state treasurers or custodians. As of December 31, 2007, we had securities totaling $41.9 million on deposit. These deposits must consist of securities that comply with the
standards established by the particular state.

CHCS
Services Inc., our senior administrative services entity, is subject to regulation as a third party administrator in those states where it services policyholders. The primary
intention of the regulation is to ensure propriety in the premium collection, claims adjudication and other servicing requirements of insurance policies being administered. MemberHealth is also
subject to regulations as a PBM and/or third party administrator in states requiring PBMs to be licensed.



New York State insurance law provides that the declaration or payment of a dividend by American Progressive requires the approval of
the New York Superintendent of Insurance. American Progressive would be able to pay ordinary dividends of up to $8.5 million to its direct parent, American Exchange in 2009, with such approval.

Pennsylvania,
Kansas and Texas insurance laws provide that a life insurer may pay dividends or make distributions from accumulated earnings without the prior approval of the Insurance
Department, provided the dividends and distributions do not exceed the greater of



Accordingly,
Pennsylvania Life and Pyramid Life would be able to pay ordinary dividends of up to $20.8 million and $9.0 million, respectively, to their direct parent American Exchange
and American Exchange is able to pay ordinary dividends of up to $46.2 million to Universal American in 2009, without the prior approval from the insurance department for their respective
states of domicile.

Texas
insurance companies also are required to have positive "earned surplus" as defined by Texas regulations, which differs from statutory unassigned surplus, in order to pay dividends
without prior regulatory approval. Marquette, Constitution and Union Bankers had negative earned surplus at December 31, 2008 and would not be able to pay dividends in 2009 without regulatory
approval. SelectCare of Texas and SelectCare Health Plans are licensed health plans in Texas and would also not be able to pay dividends in 2009 without regulatory approval.

Florida
insurance law provides that a life insurer may pay a dividend or make a distribution without the prior written approval of the insurance department when specified conditions are
met. American Pioneer had negative unassigned surplus at December 31, 2008 and would not be able to pay dividends in 2009 without regulatory approval.



Risk-based capital requirements promulgated in each state take into account asset risks, interest rate risks, mortality and
morbidity risks and other relevant risks with respect to the insurer's business and specify varying degrees of regulatory action to occur to the extent that an insurer does not meet the specified
risk-based capital thresholds, with increasing degrees of regulatory scrutiny or intervention provided for companies in categories of lesser risk-based capital compliance. As
of December 31, 2008, all of our U.S. insurance company subsidiaries and managed care affiliates maintained ratios of total adjusted capital to risk-based capital in excess of the
authorized control level except for Marquette. Effective January 1, 2009, Marquette novated its PFFS business to its affiliate Pyramid Life. As a result of this novation, it is anticipated that
Marquette's ratio of total adjusted capital to risk-based capital will exceed the authorized control level. However, should our insurance company subsidiaries' and

29

---



Table of Contents

managed
care affiliates' risk-based capital position decline in the future, their ability to pay dividends, the need for capital contributions or the degree of regulatory supervision or
control to which they are subjected might be affected.

Effective
January 1, 2009 the NAIC has adopted SSAP No. 98,Treatment of Cash Flows When Quantifying Changes in Valuation and
Impairments.SSAP No. 98 effectively changes the impairment trigger from an undiscounted cash flow basis test to a discounted test. In addition, SSAP No. 98
changes the method of valuing the new cost basis of the impaired security from an undiscounted cash flow basis to a fair value basis. Had we adopted SSAP No. 98 on December 31, 2008, we
would have recognized an additional $69.3 million of realized losses, pre-tax, for other-than-temporary impairments of investments on a statutory basis,
however, the actual impairment recorded will depend upon conditions at the measurement date.



Solvency or guaranty laws of most jurisdictions in which our insurance company subsidiaries do business may require them to pay
assessments to fund policyholder losses or liabilities of unaffiliated insurance companies that become insolvent. These assessments may be deferred or forgiven under most solvency or guaranty laws if
they would threaten an insurer's financial strength and, in most instances, may be offset against future premium taxes. Our insurance company subsidiaries provide for known and expected insolvency
assessments based on information provided by the National Organization of Life & Health Guaranty Associations. Our insurance company subsidiaries
have not incurred any significant costs of this nature. The likelihood and amount of any future assessments is unknown and is beyond our control.



State regulators and attorneys general have initiated investigations into producer compensation and product pricing. While the initial
investigations have focused on commercial lines insurers and brokers, it remains to be seen whether the investigations will broaden and potentially change how we sell our products. We have responded
to inquiries regarding our sales practices, and we do not anticipate that our responses will require any change in our compensation practices or any other adverse result. Under the NAIC's Producer
Licensing Model Act, known as the PLMA, when a producer receives compensation from both a customer and an insurance company, the producer must receive the customer's documented acknowledgement that it
will receive compensation from the insurance company and must disclose the amount of this compensation to the customer. These disclosures, however, will not be necessary if the producer does not
receive a fee from the customer for the placement of insurance and discloses to the customer that it is acting on behalf of the insurance company and may provide services to the customer on behalf of
the insurance company.

Several
states, such as Arizona, Colorado, Connecticut, Georgia, Nevada, New Jersey, Oregon, Rhode Island and Texas have enacted producer compensation disclosure legislation or
regulations. Some other states, such as New York, are considering legislation or regulations dealing with producer commission disclosure. It is possible that some states will adopt laws that are
broader than the NAIC model acts..



In September 2003, the NAIC adopted the Senior Protection in Annuity Transaction Model Regulation. Several states are adopting this
model regulation or similar suitability regulations. The model regulation imposes additional obligations on insurance producers, their supervisors and insurance carriers relating to annuity sales to
customers age 65 and over. The producer bears the burden of demonstrating suitability of the recommended annuity with oversight responsibilities imposed on the

30

---



Table of Contents

producer's
supervisor and the insurer. We have developed and distributed guidelines to our sales forces to assist in complying with these regulations. The NAIC is in the process of revising this Model
Regulation to require producers to demonstrate annuity suitability for all customers. We stopped selling annuities as of September 30, 2006.

Outsourcing Arrangements

Mainframe ProcessingData Center Outsourcing.We outsource our mainframe processing to Alicomp, a division of Alicare,
 Inc. The
data center is located in Leonia, New Jersey. We run our core traditional insurance application software programs in Alicomp's data center facility to obtain the necessary mainframe computer capacity
and other computer support services without making the substantial capital and infrastructure investments that would be necessary for us to provide these services internally.

Our
current agreement with Alicomp obligates Alicomp to provide us with comprehensive data processing services and obligates us to use Alicomp's services for substantially all of our
traditional insurance mainframe data processing requirements. Alicomp bills us monthly for these services on an as-used basis in accordance with a predetermined pricing schedule for
specific services. Our agreement with Alicomp expires on December 31, 2009, and is terminable by us with or without cause. Our current agreement with Alicomp renews automatically for
consecutive one year terms unless either party has provided the other with six months prior written notice of nonrenewal. If we elect to terminate the contract, we would be subject to termination fees
of one month of current fees or one month of current fees should we terminate the contract in 2009. Alicomp also provides us with mainframe disaster recovery services. During 2008, we incurred
approximately $3.6 million of expenses under this contract.

Membership Administration.We outsource the administrative information technology platform necessary to support the PrescribaRx
portion of the
Part D business and the Today's Options PFFS businesses to The Trizetto Group. We have entered into an annual support and license agreement, a master hosting services agreement and a consulting
services agreement with Trizetto. These agreements collectively support the basic infrastructure surrounding the membership information of this portion of our Part D and Medicare Advantage
businesses. The initial term for each of the agreements is one year, with automatic renewal from year to year provided that written notice not to renew is given with at least six months prior notice.
During 2008, we incurred $17.2 million of expenses under the Trizetto contract.

We
outsource some administrative services for one of our HMOs, such as member services and billing and enrollment to an unaffiliated heath care services company, pursuant to an agreement
which expires in December 2010. Under this agreement, we pay a percentage of monthly revenues, based on a tiered scale, for the contracted services. During 2008, we incurred $10.1 million of
expenses under this contract.

Infocrossing
West, Inc. provides online and batch reporting and data extraction and other data processing services. We entered into this Agreement in April 2004 with the ability
by either party to terminate upon 90 days written notice. Under this agreement, we pay a volume based fee based on a tiered scale. During 2008, we incurred approximately $1.2 million of
expenses under this contract.

31

---





Table of Contents

Call Center Outsourcing.We outsource a portion of our call center operations to PRC L.L.C. PRC operates in multiple locations
and in 2008 handled
calls on the Prescription Pathway portion of our Medicare Part D and our Medicare Advantage and Medicare supplement business; in 2009, PRC is handling calls on the PrescribaRx portion of our
Medicare Part D and our Medicare Advantage and Medicare supplement business. PRC bills monthly on an "as used" basis. We have agreements with PRC that have an initial term of four years and
will expire in 2009, with automatic renewal provided prior written notice of nonrenewal has not been given. PRC declared bankruptcy in 2008 and emerged from bankruptcy protection later in the year.
There are no minimum payments required under the terms of this contract. During 2008 we incurred approximately $9.6 million of expenses under this contract.

We
also use Computer Sciences Corporation, known as CSC, to handle calls and provide other services for our operations on the Community CCRx portion of our Medicare Part D
business. For a description of this arrangement, see "Business Process Outsourcing" below.

Business Process Outsourcing.We have retained Patni Computer Systems, Inc. as a business outsource vendor to provide data
entry, member
application intake and processing, data validation, mailroom
imaging and scanning, paper-based and electronic claims adjudication and processing, and overflow labor support services for our operations. Patni also provides some information technology support and
programming. Patni bills us monthly on an as used basis. We signed a master services agreement with Patni in 2005 with an initial term of four years. We have executed additional statements of work to
cover specific limited assignments. The master services agreement renews automatically for annual periods unless written notice of nonrenewal has been provided in advance. There are no explicit
minimum payments required under the terms of this contract. In 2008, we incurred approximately $18.1 million of expenses under these agreements.

We
outsource claims adjudication services to SXC Health Solutions, Inc. on the Community CCRxSM portion of our Medicare Part D business. We have an agreement
with SXC that has an initial term of three years expiring on December 31, 2009. The agreement calls for minimum payments of $0.5 million per month. In 2008, we incurred
$12.4 million of expense. We gave notice to SXC in January 2009 that we were terminating the contract effective December 31, 2009. In 2009, SXC will only adjudicate claims incurred in
2008 or prior.

We
entered into an agreement with Medco Health Solutions, Inc. for the period January 1, 2009 through December 31, 2013 to provide pharmacy network management,
claims adjudication and administrative services and other prescription drug benefit services.

We
also outsource claims-related services to Envoy, L.L.C., an Emdeon Inc. business services company. The principal services Envoy provides us are:



We
signed a master services agreement with Envoy in 2006 which continues until all services under applicable statements of work or SOWs are terminated. Under this agreement, we pay a fee
based on the volume of services utilized under the applicable SOWs. There are no explicit minimum payments required under the terms of this contract. In 2008, we incurred $5.9 million of
expenses to Envoy under this agreement.

32

---



Table of Contents

In
2008, we also used CSC to primarily handle calls, provide administrative information technology platform services, data entry, data validation, mailroom imaging and scanning, and
overflow labor support services for our operations on the Community CCRx portion of our Medicare Part D business. CSC billed us monthly on a cost plus basis. The agreement with CSC expired on
December 31, 2008. For the work provided by CSC in 2008, For the work provided by CSC in 2008, we incurred approximately $46.9 million of expenses under this contract. We entered into
two separate agreements with CSC effective January 1, 2009. The first is an information technology services agreement under which CSC provides services related to our Community CCRx
Part D business. The second is a general services agreement, under which CSC performs front end processing, data capture, and member payment processing for the Community CCRx Part D
business.

Risk Score Management.We previously contracted with MedAssurant, Inc. to review claims and other data to use its clinical
algorithms to
identify Medicare Advantage HMO and PFFS members who may have CMS assigned risk scores that are not indicative of the members' actual clinical acuity. We use an outside risk scoring consultant to
organize the review of medical charts for these members and to collect data to be submitted to CMS, after review and validation by us, with a view to producing a more accurate risk score assignment by
CMS.

Our
agreement with MedAssurant had an initial term of three years and was to expire in 2010. There were no explicit minimum payments required under the terms of this contract. During
2008, we incurred approximately $3.9 million of expenses under this contract. During 2008, we and MedAssurant mutually agreed to terminate our contract prior to the expiration of the
three-year term.

We
have contracted with Outcomes Health Information Solutions, L.L.C. to review claims and other data to use its clinical algorithms to identify Medicare Advantage HMO and PFFS members
who may have CMS assigned risk scores that are not indicative of the members' actual clinical acuity. Outcomes organizes the review of medical charts for these members and collects data to be
submitted to CMS, after review and validation by the Company, which will result in a more accurate risk score assignment by CMS. We have executed additional statements of work to cover specific
limited assignments.

We
have an agreement with Outcomes that has an initial term of three years and will expire in 2011, but may be terminated upon 60 days notice. There are no explicit minimum
payments required under the terms of this contract and fees are based on one or more statements of work. During 2008, we incurred approximately $15.0 million of expenses under this contract.

Clinical Integration Outsourcing.We have retained WorldDoc, Inc. as a business outsource vendor as the platform for
integration of our case
management, focused chronic illness management, care coordination, and other programs relating to our clinical operations. WorldDoc also provides a 24 hour per day, seven day per week call
center for members who may make inquiries relating to various health care topics. The WorldDoc agreement has a three year term expiring in July 2009. Under this agreement, we pay a fee based on the
use of licensed software as well as on the volume of members. There are no explicit minimum payments required under the terms of this contract. In 2008, we incurred approximately $2.6 million
of expenses under the WorldDoc agreement.

Employees

As of February 28, 2009, we employed approximately 2,100 employees, none of whom is represented by a labor union in such
employment. We consider our relations with our employees to be good.

33

---



Table of Contents

ITEM 1ARisk Factors

This report contains both historical and forward-looking statements. We are making the forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend the forward-looking statements in this report or made
by us elsewhere to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for
purposes of complying with and relying upon these safe harbor provisions. We have based these forward-looking statements on our current expectations and projections about future events, trends and
uncertainties. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, including, among other things, the information
discussed below. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us or that we currently believe to be
immaterial also may adversely affect our business. In making these statements, we are not undertaking to address or update each factor in future filings or communications regarding our business or
results. Our business is highly complicated, regulated and competitive with many different factors affecting results. If any of the following risks or uncertainties develops into actual events, this
could significantly and adversely affect our business, prospects, financial condition and operating results. In that case, the trading price of our common stock could decline materially.

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

As has been widely reported, financial markets around the world have been experiencing extreme disruption, including, among other
things, extreme volatility in security prices, severely diminished liquidity and credit availability, rating downgrades and declining or indeterminate valuations of many investments and declines in
real estate values. Governments have taken unprecedented actions intended to address these market conditions. While currently these conditions have not impaired our ability to access credit markets
and finance our operations, largely because our financing has generally come from internal cash generation since September 2007, there can be no assurance that there will not be a further
deterioration in financial markets and confidence in major economies or that any deterioration in markets or confidence will not impair our ability to access credit markets and finance our operations.

These
economic developments affect businesses such as ours in a number of ways, many of which we cannot predict. Among the potential effects could be further writedowns in the value of
investments we hold, an inability or refusal by lenders under our credit agreement to fund a draw by us, and an inability to access credit markets should we require external financing in excess of or
in addition to the current revolving commitment under our credit agreement. In addition, it is possible that economic conditions, and resulting budgetary concerns, could prompt the federal government
to make changes in the Medicare program, which could adversely affect our results of operations. We are unable to predict
the likely duration and severity of the current disruptions in financial markets and adverse economic conditions, or the effects these disruptions and conditions could have on us.

We may suffer losses due to fraudulent activity, which could adversely affect our financial condition and results of operation.

Both traditional Medicare and the newer Medicare Advantage and Medicare Part D plans have in the past been subject to fraudulent
activity perpetrated by actual and purported beneficiaries and providers, as well as others. We have recently incurred losses as a result of a fraudulent scheme or a group of similar fraudulent
schemes. While we have undertaken efforts to prevent these schemes, there can be no assurance that we will not again become the target of fraud, or that we will detect fraud prior to incurring losses.
The need to expend effort and construct infrastructure to combat fraud

34

---



Table of Contents

requires
significant expenditures. These expenditures, and losses arising from any fraud that we suffer, could have a material adverse effect on our financial condition and results of operations.

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

We have available $150 million of borrowing capacity under the revolving portion of our credit facility. Our credit agreement
significantly restricts our ability to borrow from other sources. Therefore, if we are required to fund the growth of our business, or to fund capital requirements at our insurance company and health
plan subsidiaries, in excess of the aggregate of our cash, revolver borrowing capacity and other borrowing capacity permitted under the credit facility, we could be restricted in our ability to
generate new premium or other revenue, to construct the health maintenance organizations and preferred provider organizations that we are in the process of contracting, or to otherwise fund or expand
our business. Moreover, if we determine to enter into a transaction or affect another corporate event that requires a waiver or consent under a debt agreement, or if we experience an event of default
under a debt agreement, lenders could refuse to grant a required waiver or consent, could charge a material amount for it or could otherwise demand costly concessions. As a consequence, we could be
unable to complete the desired transaction or other corporate event, or the required waiver or consent could cost more than it otherwise would, or we could experience a default under the relevant debt
instrument, or our results of operations and financial condition could be adversely affected.

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

A significant portion of our investment portfolio consists of fixed income securities and other investment securities. Our portfolio
can be viewed on our web site,www.universalamerican.com, in the "Investors" section. Our reference to the web site in this annual report on
Form 10-K is not intended to, and does not, incorporate the information contained in the web site into this report.

The
fair market value of these assets and the investment income from these assets generally fluctuate depending on general economic and market conditions, and these variations have been
exacerbated by the ongoing adverse economic conditions. The fair market value of our investments in fixed income securities generally increases or decreases in an inverse relationship with
fluctuations in interest rates, while net investment income realized by us from future investments in fixed income securities will generally increase or decrease in a direct relationship with
fluctuations in interest rates; in addition, these values and prospective income have been adversely affected by general economic conditions. Moreover, actual net investment income or cash flows from
investments that carry prepayment risk, such as mortgage-backed and other asset-backed securities, may differ from those anticipated at the time of investment or at various financial statement dates
as a result of interest rate fluctuations, general economic conditions and other factors.

Because
our investment securities are classified as available for sale, we reflect changes in the market value of these securities in our consolidated balance sheet. Therefore, interest
rate fluctuations and changes in the values of securities we hold could adversely affect our results of operations and financial condition.

In
addition, while the statutory accounting principles permitted or prescribed by the insurance departments of the states of domicile of our insurance company subsidiaries did not
previously require that we revalue investment securities as is required by generally accepted accounting principles, those statutory accounting principles changed effective January 1, 2009,
which could lead to requirement that we increase the capital of some of these subsidiaries, and as a result of any required capital increase, we could be required to deposit unrestricted cash held at
our parent company or borrow.

35

---



Table of Contents

We may be unable to execute our plan to respond to the challenges resulting from the passage into law of the Medicare Improvements for Patients and Providers Act of 2008.

On July 15, 2008, the Medicare Improvements for Patients and Providers Act of 2008, known as MIPPA, which amended the Medicare
provisions of the Social Security Act, became law. Among many other things, MIPPA revises requirements for Medicare Advantage private fee-for-service plans, which we expect
will have the effect of ending these plans in plan year 2011 in non-rural markets.

We
anticipated many of MIPPA's provisions, and had undertaken initiatives to replace the private fee-for-service revenue that we thought might be lost to us,
depending on the final text of the bill. In particular, we have been working to establish preferred provider organization, or PPO, and health maintenance organization, or HMO, networks in strategic
locations, some of which we have established for the 2009 plan year and others of which we are continuing to establish for the 2010 plan year and beyond.

We
could experience difficulty in building these PPO and HMO networks, which must be approved by CMS. In addition, the cost of building PPO and HMO networks can be substantial.
Accordingly, if



then
we could experience a material adverse effect on our revenues, results of operations and financial condition.

In
addition, MIPPA places prohibitions and limitations on specified sales and marketing activities under Medicare Advantage plans and Medicare Prescription Drug Plans. For those
prohibitions and limitations that have become effective, we have adapted our processes and procedures to comply with those prohibitions and limitations. Some prohibitions and limitations, which are
not yet effective, are required to be interpreted through regulations established by CMS, and we are awaiting the promulgation of these regulations. The prohibitions and limitations, and the
regulations promulgated by CMS, could have the effect of making it more difficult to sell our products to potential members and beneficiaries, which could materially adversely affect our revenues,
results of operations and financial condition. In addition, if we are unable to comply fully with these prohibitions and limitations and their attendant regulations, we could be subject to
investigation or audit by regulators or to complaints by members and beneficiaries, and potential members and beneficiaries, which could lead to sanctions, such as financial penalties, an enrollment
freeze, and the requirement that we make changes in our operations, and these could materially adversely affect our results of operations and financial condition.

We are subject to extensive government regulation; compliance with laws and regulations is complex and expensive, and any violation of the laws and regulations applicable to
us could reduce our revenues and profitability and otherwise adversely affect our operating results.

There is substantial Federal and state governmental regulation of our business. Several laws and regulations adopted by the Federal
government, such as the Sarbanes-Oxley Act of 2002, the Gramm-Leach-Bliley Act, the Health Insurance Portability and Accountability Act, known as HIPAA, the MMA, the USA PATRIOT Act, the False Claims
Act, anti-kickback laws, MIPPA and "Do Not Call" regulations, have created administrative and compliance requirements for us. The requirements of these laws and regulations are continually
evolving, and the cost of compliance may have an adverse effect on our profitability. As laws and regulations evolve, the costs of compliance, which are already significant, will tend to increase. If
we fail to comply with existing or future applicable laws and regulations, we could suffer civil, criminal or administrative penalties. Different interpretations and enforcement

36

---



Table of Contents

policies
of these laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make significant changes to our operations. In addition,
we cannot predict the impact of future legislation and regulatory changes on our business or assure you that we will be able to obtain or maintain the regulatory approvals required to operate our
business.

Laws
in each of the states in which we operate our health plans, insurance companies and other businesses also regulate our sales practices, operations, the scope of benefits, rate
formulas, delivery systems, utilization review procedures, quality assurance, complaint systems, enrollment requirements, claim payments, marketing, and advertising. These state regulations generally
require, among other things, prior approval or notice of new products, premium rates, benefit changes and specified material transactions, such as dividend payments, purchases or sales of assets,
inter-company agreements, and the filing of various financial and operational reports.

We
are also subject to various governmental reviews, audits and investigations to verify our compliance with our contracts and applicable laws and regulations. State departments of
insurance audit our health plans and insurance companies for financial and contractual compliance. State departments of health audit our health plans for compliance with health services. State
attorneys general, CMS, the Office of the Inspector General of Health and Human Services, the Office of Personnel Management, the Department of Justice, the Department of Labor, the Government
Accountability Office, state departments of insurance and departments of health and Congressional committees also conduct audits and investigations of us. We have historically incurred, and expect to
continue to incur, significant costs to respond to governmental reviews, audits and investigations, and we expect these costs to increase over time as regulation increases and becomes more complex and
as regulatory agencies and Congressional committees become more sophisticated and thorough.

Any
adverse review, audit or investigation, or changes in regulations resulting from the conclusion of reviews, audits or investigations, could result in:



Any
of these events could make it more difficult for us to sell our products and services, reduce our revenues and profitability and otherwise adversely affect our operating results. For
more information on governmental regulation of our business, see the section captioned "Regulation" in Part I, Item 1 of this annual report on Form 10-K.

CMS
from time to time releases proposed or amended regulations that, if adopted, would, among other things, place tighter restrictions on marketing processes relative to the Medicare
Advantage program and Medicare prescription drug benefit program. Depending upon the final content of these regulations, if CMS proposes and adopts them, compliance with and enforcement of the
regulations could have a material adverse effect on our results of operations.

Changes in governmental regulation or legislative reform could increase our costs of doing business and adversely affect our profitability.

The Federal government and the states in which we operate extensively regulate our health plans, insurance companies and other
business. The laws and regulations governing our operations are

37

---



Table of Contents

generally
intended to benefit and protect policyholders, health plan members and providers rather than shareholders. From time to time, Congress has considered various forms of "Patients' Bill of
Rights" legislation, which, if adopted, could alter the treatment of coverage decisions under applicable federal employee benefits laws. There have also been legislative attempts at the state level to
limit the preemptive effect of Federal employee benefits laws on state laws. If adopted, these types of limitations could increase our liability exposure and could permit greater state regulation of
our operations. The government agencies administering these laws and regulations have broad latitude to enforce them. These laws and regulations, along with the terms of our government contracts,
regulate how we do business, what services we offer, and how we interact with our policyholders, members, providers and the public. Healthcare laws and regulations are subject to frequent change and
differing interpretations. Changes in the political climate or in existing laws or regulations, or their interpretations, or the enactment of new laws or the issuance of new regulations could
adversely affect our business by, among other things:



While
it is not possible to predict when and whether fundamental policy changes would occur, policy changes on the local, state and federal level could fundamentally change the dynamics
of our industry, such as policy changes mandating a much larger role of the government in the health care arena. Changes in public policy could materially affect our profitability, our ability to
retain or grow business, or our financial condition. State and federal governmental authorities are continually

38

---



Table of Contents

considering
changes to laws and regulations applicable to us and are currently considering regulations relating to:



All
of these proposals could apply to us and could result in new regulations that increase the cost of our operations. Healthcare organizations also may reduce or delay the purchase of
PBM services, and manufacturers may reduce administrative fees and rebates or reduce supplies of some products. Any of the foregoing legislative or regulatory changes could adversely affect our or our
service providers' ability to negotiate rebate and administrative fee arrangements with manufacturers and have a material adverse effect on our business and results of operations.

Both
Congress and state legislatures are expected to consider legislation to increase governmental regulation of managed care plans. Some of these initiatives would, among other things,
require that health plan members have greater access to drugs not included on a plan's formulary and give health plan members the right to sue their health plans for malpractice when they have been
denied care. The scope of the managed care reform proposals under consideration by Congress and state legislatures and enacted by states to date vary greatly, and we cannot predict the extent of
future legislation. However, these initiatives could limit our business practices and impair our ability to serve our clients and could have a material adverse effect on our business and results of
operations.

In
addition, CMS has adopted regulations that, and may in the future propose regulations that, if adopted, would, among other things, place tighter restrictions on marketing processes
relative to the Medicare Advantage program and prescription drug benefit program. Compliance with and enforcement of the existing and any proposed regulations could have a material adverse effect on
our results of operations.

We are required to comply with laws governing the transmission, security and privacy of health information that require significant compliance costs, and any failure to
comply with these laws could result in material criminal and civil penalties.

Regulations under HIPAA require us to comply with standards regarding the exchange of health information within our company and with
third parties, such as healthcare providers, business associates and our members. These regulations impose standards for common healthcare transactions, such as



HIPAA
also provides that to the extent that state laws impose stricter privacy standards than HIPAA privacy regulations, HIPAA does not preempt the state standards and laws.

39

---



Table of Contents

Given
the complexity of the HIPAA regulations, the possibility that the regulations may change, and the fact that the regulations are subject to changing and potentially conflicting
interpretation, our ability to comply with the HIPAA requirements is uncertain and the costs of compliance are significant. Furthermore, a state's ability to promulgate stricter laws, and uncertainty
regarding many aspects of state requirements, make compliance more difficult. To the extent that we submit electronic healthcare claims and payment transactions that do not comply with the electronic
data transmission standards established under HIPAA, payments to us may be delayed or denied. Additionally, the costs of complying with any changes to the HIPAA regulations may have a negative impact
on our operations. We could be subject to criminal penalties and civil sanctions for failing to comply with the HIPAA health information provisions, which could result in the incurrence of significant
monetary penalties. In addition, our failure to comply with state health information laws that may be more restrictive than the regulations issued under HIPAA could result in additional penalties.

Compliance
with HIPAA regulations requires significant systems enhancements, training and administrative effort. HIPAA could also expose us to additional liability for violations by our
business associates. A business associate is a person or entity, other than a member of the work force, who on behalf of an entity subject to HIPAA performs or assists in the performance of a function
or activity involving the use or disclosure of individually identifiable health information, or provides legal, accounting, consulting, data aggregation, management, administrative, accreditation or
financial services.

Legal and regulatory investigations and actions are increasingly common in the insurance and managed care business and may result in financial losses and harm our
reputation.

We face a significant risk of class action lawsuits and other litigation and regulatory investigations and actions in the ordinary
course of operating our businesses. Due to the nature of our businesses, we are subject to a variety of legal and regulatory actions relating to our business operations, such as the design, management
and offering of products and services. The following are examples of the types of potential litigation and regulatory investigations we face:



40

---



Table of Contents



Plaintiffs
in class action and other lawsuits against us may seek very large or indeterminate amounts, and punitive and treble damages, which may remain unknown for substantial periods
of time. We are also subject to various regulatory inquiries, such as information requests, formal and informal inquiries, subpoenas and books and record examinations, from state and Federal
regulators and other authorities. A substantial legal liability or a significant regulatory action against us could have an adverse effect on our business, financial condition and results of
operations.

We
cannot predict the outcome of actions we face with certainty, and we have incurred and are incurring expenses in the defense of our past and current matters. We also may be subject to
additional litigation in the future. Litigation could materially adversely affect our business or results of operations
because of the costs of defending these cases, the costs of settlement or judgments against us, or the changes in our operations that could result from litigation. The defense of any these actions may
be time-consuming and costly, and may distract our management's attention. In addition, we could suffer significant harm to our reputation, which could have an adverse effect on our
business, financial condition and results of operations. As a result, we may incur significant expenses and may be unable to effectively operate our business.

Potential
liabilities may not be covered by insurance or indemnity, insurers or indemnifying parties may dispute coverage or may be unable to meet their obligations or the amount of our
insurance or indemnification coverage may be inadequate. In addition, some types of damages, such as punitive damages or damage for willful acts, may not be covered by insurance. The cost of business
insurance coverage has increased, and may in the future increase, significantly. Insurance coverage for all or some forms of liability may become unavailable or prohibitively expensive in the future.
We cannot 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.

The
health care industry continues to receive significant negative publicity regarding the public's perception of it. This publicity and public perception have been accompanied by
increased litigation, in some cases resulting in



These
factors, as well as any negative publicity about us in particular, could adversely affect our ability to market our products or services and to attract and retain members, may
require us to change our products or services, may increase the regulatory burdens under which we operate and may require us to pay large judgments or fines. Any combination of these factors could
further increase our cost of doing business and adversely affect our financial position, results of operations and cash flows.

41

---



Table of Contents

After the termination of our strategic alliance for the Prescription PathwaySM product, we may not receive the intended benefit of the members allocated to us,
or we could have difficulty retaining the members allocated to us.

Effective January 1, 2009, we terminated our strategic alliance with CVS Caremark relating to the Prescription
PathwaySM product. In the agreement terminating the alliance, we agreed to allocate the Prescription Pathway members between us, for our PrescribaRxSM product, and
Silverscript Insurance Company, a Medicare Part D prescription drug benefit plan and wholly-owned subsidiary of CVS Caremark, such that each party receives an equal economic benefit based on
the members allocated to it. It is possible that we will not, in fact, receive an equal economic benefit, or that we could have difficulty retaining the members allocated to us. In either of these
events, we could experience a material adverse effect on our revenues or results of operations.

We may fail to realize the anticipated synergies, cost savings and growth opportunities we anticipate from any acquisition and other growth initiatives, which could result
in a material adverse effect on our financial position, results of operations and cash flows.

The success of any acquisition will depend, in part, on our ability to realize synergies, cost savings and growth opportunities that we
anticipate from integrating our preexisting businesses with those of the acquired business. Our success in realizing these synergies, cost savings and growth opportunities, and the timing of this
realization, depends on the successful integration of the businesses and operations. Even if we are able to integrate the businesses and operations successfully, there can be no assurance that this
integration will result in the realization of the full benefits of synergies, cost savings and growth opportunities that we would expect from this integration or that these benefits will be achieved
within the time frame we anticipate. For example, the elimination of duplicative costs may not be possible or may take longer than anticipated, the benefits from the acquisition may be offset by costs
incurred or delays in integrating the businesses and regulatory authorities could impose conditions on the combined company's business.

The
growth of our Medicare Advantage and Medicare Part D business is an important part of our business strategy. Any failure to achieve this growth may have a material adverse
effect on our financial position, results of operations or cash flows. In addition, the expansion of our Medicare Advantage and Medicare Part D business in relation to our other businesses may
intensify the regulatory and other risks to us inherent in the Medicare Advantage and Medicare Part D business, which we describe elsewhere in this document. These expansion efforts may result
in less diversification of our revenue stream.

There
can be no assurance that we will be able to successfully implement our operational and strategic initiatives that we intend to position us for future growth, or that the products
we design will be accepted or adopted in the time periods assumed. Investments in these initiatives may not recoup their costs or be profitable in the future. Failure to implement this strategy may
result in a material adverse effect on our financial position, results of operations and cash flows.

The completion of any acquisition could impact or cause disruptions in our businesses, which could have a material adverse effect on our results of operations and financial
condition.

Specifically:



42

---



Table of Contents



We will not be able to continue for an indefinite period all of the prescription drug plans that we currently operate.

Current rules promulgated by the Centers for Medicare and Medicaid Services, or CMS, will allow us to operate both PrescribaRx and
Community CCRxSM Part D plans, a total of six plans, for the 2009 plan year. CMS has required that we reduce the aggregate number of plans we offer to five in 2010, four in 2011
and three in 2012 and thereafter. We may be allowed to offer up to four plans in a given region depending upon whether benefits under one, some or all plans include coverage of the donut hole and
coverage of all generics and all preferred brands through the entire gap period. The restriction on the number of plans we may offer could adversely affect our results of operations.

Sales of our common stock and the ownership of common stock by the former shareholders of MemberHealth and by the equity investors, or by the former shareholders of
companies that we acquire in the future or the investors who finance any future acquisitions, may negatively affect the market price of our common stock.

The market price of our common stock could decline as a result of sales of an increased number of shares of our common stock in the
market after the completion of and any acquisition or upon the sale of shares by the equity investors who finance any acquisition, or the perception that these sales could occur. Sales of shares
issued as acquisition consideration or to finance an acquisition, or the possibility that these sales may occur, may also make it more difficult for us to obtain additional capital by selling equity
securities in the future at a time and at a price that we deem appropriate.

Following
the MemberHealth acquisition and the completion of the transactions contemplated by the securities purchase agreements entered into in connection with the acquisition, the
former shareholders of MemberHealth and the equity investors own a significant block of our voting shares and have the ability to appoint six of our thirteen directors. A similar situation could arise
following a future acquisition. This may negatively affect the market price of our common stock.

Any acquisition or disposition that we undertake may not be accretive and may cause dilution to our earnings per share, which may harm the market price of our common stock.

The combined businesses resulting from any acquisition, or remaining businesses resulting from any disposition, could encounter
unanticipated transaction and integration-related costs or other factors such as the failure to realize all of the benefits expected in the acquisition or disposition. These or other factors could
cause dilution to our earnings per share or decrease the expected accretive effect of the acquisition or disposition and cause a decrease in the price of our common stock.

Some of our directors and executive officers may have interests that are different from, or in addition to, the interests of our shareholders generally.

Some of our directors and executive officers may have significant equity ownership in us, employment, indemnification and severance
benefit arrangements, potential rights to other benefits on a change in control and rights to ongoing indemnification and insurance that result in their having interests that may differ from the
interests of our shareholders generally. The receipt of compensation

43

---



Table of Contents

or
other benefits by our directors or executive officers in connection with the any acquisition may make it more difficult for the combined company to retain their services after the acquisition, or
require the combined company to expend additional sums to continue to retain their services. In addition, consistent with our compensation philosophy of senior executives holding approximately 5% of
our aggregate equity ownership, some of our executives are likely to receive additional equity grants as a result of the increase in our outstanding shares due to the acquisition and the investment by
the equity investors.

We may be unable to continue to provide Medicare Advantage or Medicare Part D plans profitably.

Organizations that offer Medicare Advantage plans of the type we currently offer are required to offer a prescription drug benefit, as
defined by CMS, and Medicare Advantage enrollees are required to obtain their drug benefit from their Medicare Advantage plan. These combined managed care plans offering drug benefits are, under the
new law, called MA-PDs. Current enrollees may prefer a stand-alone drug benefit plan and may disenroll from the Medicare Advantage plan altogether in order to participate in another drug
benefit plan, which could reduce our profitability and membership enrollment.

Some
enrollees may have chosen our Medicare Advantage plan in the past rather than a competitor's Medicare Advantage plan because of the added drug benefit that we offer with our
Medicare Advantage plans. Medicare beneficiaries currently have the opportunity to obtain a drug benefit without joining a managed care plan. Additionally, Medicare beneficiaries who participate in a
Medicare Advantage plan and enroll in a stand-alone Prescription Drug Plan, known as a PDP, are automatically disenrolled from their Medicare Advantage plan. Accordingly, the existence of PDPs in the
regions in which we sell Medicare Advantage plans could result in our members intentionally disenrolling or automatically being disenrolled from our Medicare Advantage plans, which would reduce our
membership and could reduce our profitability.

Our
ability to operate our MA-PDs and PDPs profitably will depend on our ability to attract members, to continue to develop the necessary core systems and processes and to
manage our medical expenses related to these plans, and other factors. Because CMS's Medicare Part D prescription drug benefit program remains relatively new, there exists uncertainty as to the
ultimate market size, consumer demand, and related medical loss ratio. Accordingly, we are uncertain whether we will be able to continue to operate our MA-PDs or PDPs profitably or
competitively in the future, and our failure to do so could have a material adverse effect on our results of operations and financial condition. Even if we are able to operate our MA-PDs
or PDPs profitably and competitively in the future, our margins on these products may decline over time.

The
MMA provides for "risk corridors" that are expected to limit to some extent the losses MA-PDs or PDPs would incur if their costs turned out to be higher than those in the
per member per month bids for particular plans submitted to CMS in excess of specified ranges. For example, for 2008 and 2009 drug plans bear all gains and losses up to 5% of their expected costs, but
were reimbursed for 50% of the losses between 5% and 10%, and 80% of losses in excess of 10%. We anticipate that in 2010 and future years the thresholds will increase and the reimbursement percentages
will decrease or disappear. In addition, as the risk corridors are designed to be symmetrical, a plan whose actual costs fall below its expected costs would be required to reimburse CMS based on a
similar methodology as set forth above.

In
addition, there has in the past been, and may in the future be, a delay in obtaining reimbursement from CMS for reimbursable losses pursuant to the risk corridors. These delays result
in our being required to finance excess losses until we receive reimbursement, which produces a negative impact on our results of operations, cash flows and financial condition. Furthermore,
reconciliation payments for estimated upfront Federal reinsurance payments and payments for low income cost

44

---



Table of Contents

sharing
subsidies are made retroactively on an annual basis, which could expose plans to upfront costs in providing the benefit. Accordingly, it may be difficult to accurately predict or report the
operating results associated with our drug benefits. We anticipate settling with CMS on amounts related to the risk corridor adjustment and subsidies for a given plan year in the following year.

CMS's risk adjustment payment system and budget neutrality factors make our revenue and profitability difficult to predict and could result in material retroactive
adjustments to our results of operations.

All of the Medicare Advantage programs we offer are subject to Congressional appropriation. As a result, our profitability is
dependent, in large part, on continued funding for government healthcare programs at or above current levels. The reimbursement rates paid to health plans like ours by the Federal government are
established by contract, although the rates differ depending on a combination of factors such as a member's health status, age, gender, county or region, benefit mix, member eligibility categories,
and the plans' risk scores.

CMS
has implemented a risk adjustment model that apportions premiums paid to Medicare health plans according to health severity. A risk adjustment model pays more for enrollees with
predictably higher costs. CMS has completely phased in this payment methodology with a risk adjustment model that bases a portion of the total CMS reimbursement payments on various clinical and
demographic factors such as



Under
the risk adjustment methodology, all Medicare health plans must capture, collect and submit the necessary diagnosis code information from inpatient and ambulatory treatment
settings to CMS within prescribed deadlines. The CMS risk adjustment model uses this diagnosis data to calculate the risk adjusted premium payment to Medicare health plans. As a result of this
process, it is difficult to predict with certainty our future revenue or profitability. CMS may also change the manner in which it calculates risk adjusted premium payments in ways that are adverse to
us. In addition, our own risk scores for any period may result in favorable or unfavorable adjustments to the payments we receive from CMS and our Medicare premium revenue. Because diagnosis coding is
a manual process, there is the potential for human error in the recording of codings, and there can be no assurance that our contracting physicians and hospitals will be successful in improving the
accuracy of recording diagnosis code information and therefore our risk scores.

Coincident
with phase-in of the risk-adjustment methodology, CMS also adjusted payments to Medicare Advantage plans by a "budget neutrality" factor. CMS
implemented the budget neutrality factor to prevent overall health plan payments from being reduced during the transition to the risk-adjustment payment model. CMS first developed the
payment adjustments for budget neutrality in 2002 and began to use them with the 2003 payments. CMS began phasing out the budget neutrality adjustment in 2007 and will fully eliminate it by 2011. The
risk adjustment methodology and phase-out of the budget neutrality factor will reduce our plans' premiums unless our risk scores increase. We do not know if our risk scores will increase
in the future or, if they do, that the increases will be large enough to offset the elimination of this adjustment. As a result of the CMS payment methodology described previously, the amount and
timing of our CMS monthly premium payments per member may change materially, either favorably or unfavorably. In addition, the possibility exists that CMS may

45

---



Table of Contents

reduce
revenues in 2009 or thereafter for plans whose risk scores have increased significantly greater than the general Medicare average increase in risk scores. If our risk scores increase
significantly greater than the general Medicare average increase, and CMS introduces this approach, it could adversely affect our results of operations.

Our ability to market some of our Part D plans is substantially dependent on two of our strategic relationships with third parties.

Our ability to market some of our Part D plans is substantially dependent on our strategic alliance with the National Community
Pharmacists Association, known as the NCPA, which provides outreach and communications for our CCRx Part D plans to NCPA's independent pharmacy membership. NCPA member pharmacies make up over
one-third of MemberHealth's pharmacy network and, in 2008, accounted for a significant percentage of the prescriptions filled under our CCRx Part D plans. Additionally, we are
substantially dependent on our strategic relationship with Community Care Outreach Services LLC, or CCOS, an insurance marketing operation that provides our historical CCRx business its primary
"outsourced" sales force. If either of these strategic relationships are terminated, or do not provide us with the services and benefits we anticipate, our ability to market CCRx Part D plans
could be materially and adversely affected. Further, to the extent that CMS or other regulatory authorities determine that any provisions of our agreements with NCPA or CCOS conflict with any
applicable law, regulation or policy, we may not be able to realize fully the benefits we anticipate from the acquisition, and we could potentially incur regulatory liability.

There are significant risks associated with our participation in the Medicare Part D program, the occurrence of which could have a material adverse effect on our
results of operations.

Our actual results may differ from our assumptions regarding the Medicare Part D program. Our participation in the Medicare
Part D program involves the following risks, the occurrence of any or all of which could have a material adverse effect on our financial condition, results of operations and cash
flows:



46

---



Table of Contents



Any
contractual or regulatory non-compliance on our part could entail significant sanctions and monetary penalties, which in turn could negatively affect our results of
operations and the market price of our common stock.



47

---



Table of Contents



Our inability to collect receivables owed to us by other Medicare Part D PDPs may disrupt or adversely affect our PDPs.

From time to time, due to record-keeping discrepancies between CMS's systems and those of the PDPs, we incur Medicare Part D
prescription expenses on behalf of Medicare beneficiaries who are not members of our PDPs. Likewise, we receive notice of claims from other plans that they have paid claims on behalf of our members.
CMS established a plan-to-plan, known as P2P, reconciliation process to address this condition and provide a means of settlement between plans. Additionally, CMS also
established a state-to-plan, known as S2P, reconciliation process whereby health plans will settle with state Medicaid programs that pay claims on behalf of Medicare
beneficiaries. We record our estimated liabilities under P2P and S2P as of the end of each year. Ultimate resolution of the P2P and S2P reconciliation processes could result in adjustments, positive
or negative, to the amounts estimated and recoverable at year end.

Although
CMS has initiated a process for reconciling these errors in membership and drug costs, there can be no assurance that we will be fully reimbursed for these costs by CMS or
another PDP sponsor. Although we intend to actively pursue amounts due us in the CMS reconciliation process, we cannot assure you that we will receive reimbursements from any other plan. Any amounts
not collectible will be reported as additional claim costs and are subject to both reinsurance and the risk corridor adjustment.

Our liabilities related to the CMS policy regarding the special transition period for retroactive enrollment may result in an unknown amount of liability, which could
adversely affect our PDPs.

Under requirements of the Prescription Drug Benefit Manual on Coordination of Benefits. Part D plans must provide a special
transition period in each coverage year to accommodate specified claims incurred by or on behalf of beneficiaries whom CMS has retroactively enrolled in a Part D plan. Part D plans must
accommodate claims incurred by or on behalf of these beneficiaries during a no greater than seven-month retroactive eligibility period, which may extend into the previous coverage year.

Part D
plan sponsors may not use the annual March 31st coverage year deadline, which is the cut-off date for the submission of claims associated with
payment reconciliation, to deny requests for reimbursement of claims incurred during retroactive enrollment periods. CMS requires that
Part D plans are liable for claims received after March 31st even if retroactive enrollment is not an issue, subject to contractual provisions regarding timely claims filing for
network pharmacies. To ensure that third party payors have the opportunity to request reimbursement for claims incurred during a retroactive enrollment period on behalf of dual eligible beneficiaries,
CMS requires that Part D plan sponsors use the date of Medicaid notification to establish a new timely claims filing period. We could face an unknown amount of liability as a result of
complying with this special transition policy on retroactive enrollment, which could negatively affect our business.

Financial accounting for the Medicare Part D and Medicare Advantage benefits is complex.

The accounting and regulatory guidance regarding the proper method of accounting for Medicare Part D and Medicare Advantage,
particularly as it relates to the timing of revenue and expense recognition and, with respect to Part D, calculation of the risk corridor, taken together with the

48

---



Table of Contents

complexity
of the Medicare Part D and Medicare Advantage products and challenges in reconciling CMS Medicare Part D and Medicare Advantage membership data with our records, may lead to
variability in our reporting of quarter-to-quarter and year-to-year earnings and to uncertainty among investors and research analysts following us as to
the impacts of our Medicare PDPs on our full year results.

We rely on the accuracy of information provided by CMS regarding the eligibility of an individual to participate in our Medicare Advantage and Medicare Part D plans,
and any inaccuracies in those lists could cause CMS to recoup premium payments from us with respect to members who turn out not to be ours, or could cause us to pay benefits in respect of members who
turn out not to be ours, which could reduce our revenue and profitability.

Premium payments that we receive from CMS are based upon eligibility lists produced by Federal and local governments. From time to
time, CMS requires us to reimburse it for premiums that we received from CMS based on eligibility and dual-eligibility lists that CMS later discovers contained individuals who were not in
fact residing in our service areas or eligible for any government-sponsored program or were eligible for a different premium category or a different program. We may have already provided services to
these individuals and reimbursement of amounts paid on behalf of services provided to them may be unrecoverable. In addition to recoupment of premiums previously paid, we also face the risk that CMS
could fail to pay us for members for whom we are entitled to payment. Our profitability would be reduced as a result of this failure to receive payment from CMS if we had made related payments to
providers and were unable to recoup these payments from them.

The pharmacy benefit management component of our business, as well as our outsourced mail order pharmacy benefits, are subject to significant additional regulation.

The mail order pharmacy business is subject to extensive Federal, state and local regulation, such as the application of state laws
related to the operation of internet and mail-service pharmacies. In addition, our PBM operations are subject to a variety of Federal and state laws. Medicare Part D regulations,
such as anti-kickback rules and compliance requirements under Federal employee benefits laws, also govern the treatment of related entities. CMS has indicated that it will apply greater
scrutiny to arrangements between PDPs and related parties, especially to rebate retention arrangements. Federal and state legislative proposals regarding PBMs are frequently introduced, and
these proposals, if adopted, could affect a variety of industry practices, such as the receipt of rebates and administrative fees from pharmaceutical manufacturers.

In
addition, changes in existing Federal or state laws or regulations or in their interpretation by courts and agencies, or the adoption of new laws or regulations relating to patent
term extensions, purchase discount, administrative fee and rebate arrangements with pharmaceutical manufacturers, as well as proposed legislation requiring direct rebate negotiation and contracting
between CMS and pharmaceutical manufacturers, could reduce the discounts, rebates or other fees received by PBMs and could adversely impact our business, financial condition, liquidity and
operating results.

If we are unable to develop and maintain satisfactory relationships with the providers of care to our members, our profitability could be adversely affected and we may be
precluded from operating in some markets.

We contract with physicians, hospitals and other providers to deliver health care to our members. Our Medicare Advantage products
encourage or require our customers to use these contracted providers. In some circumstances, these providers may share medical cost risk with us or have financial incentives to deliver quality medical
services in a cost-effective manner. Our operations and profitability are significantly dependent upon our ability to enter into appropriate cost-effective contracts with
hospitals, physicians and other healthcare providers that have convenient locations for our members in our geographic markets.

49

---



Table of Contents

In the long term, our ability to contract successfully with a sufficiently large number of providers in a particular geographic market will affect the relative
attractiveness of our Medicare Advantage and managed care products in that market. Any difficulty in contracting with providers in a market could preclude us from renewing or from entering our
Medicare contracts in that market. We will be required to establish acceptable provider networks prior to entering new markets. We may be unable to maintain our relationships with our network
providers or enter into agreements with providers in new markets on a timely basis or under favorable terms. In any particular market, providers could refuse to contract with us, demand to contract
with us, demand higher payments, or take other actions that could result in higher health care costs for us, less desirable products for members, disruption of benefits to our members, or difficulty
meeting regulatory or accreditation requirements. In some markets, some providers, particularly hospitals, physician specialty groups, physician/hospital organizations or multi-specialty physician
groups, may have significant market positions and negotiating power. In addition, physician or practice management companies, which aggregate physician practices for administrative efficiency and
marketing leverage, may compete directly with us. In our southeastern Texas HMO market, one of our significant provider groups recently has formed a health plan. If this provider group refuses to
contract with us, uses its market position to negotiate favorable contracts or otherwise places us at a competitive disadvantage, our ability to market products or to be profitable in that market
could be adversely affected.

In
some situations, we have contracts with individual or groups of primary care physicians for a fixed, per-member-per-month fee under which
physicians are paid an amount to provide all required medical services to our members. This type of contract is referred to as a "capitation" contract. The inability of providers to properly manage
costs under these
capitation arrangements can result in the financial instability of these providers and the termination of their relationship with us. In addition, payment or other disputes between a primary care
provider and specialists with whom the primary care provider contracts can result in a disruption in the provision of services to our members or a reduction in the services available to our members.
The financial instability or failure of a primary care provider to pay other providers for services rendered could lead those other providers to demand payment from us even though we have made our
regular fixed payments to the primary provider. There can be no assurance that providers with whom we contract will properly manage the costs of services, maintain financial solvency or avoid disputes
with other providers. Any of these events could have an adverse effect on the provision of services to our members and our operations, resulting in loss of membership or higher healthcare costs or
other adverse effects.

Corporate practice of medicine and fee-splitting laws may govern our business operations, and violation of these laws could result in penalties and adversely
affect our arrangements with contractors and our profitability.

Several states have laws commonly known as "corporate practice of medicine" laws that prohibit a business corporation from practicing
medicine, employing physicians to practice medicine, or exercising control over medical treatment decisions by physicians. In these states, typically only medical professionals or a professional
corporation in which the shares are held by licensed physicians or other medical professionals may provide medical care to patients. Many states also have some form of fee-splitting law
prohibiting business arrangements that involve the splitting or sharing of medical professional fees earned by a physician or another medical professional for the delivery of healthcare services.

We
perform only non-medical administrative and business services for physicians and physician groups. We do not represent that we offer medical services, and we do not
exercise control over the practice of medical care by providers with whom we contract. We do, however, monitor medical services to ensure they are provided and reimbursed within the appropriate scope
of licensure. In

50

---



Table of Contents

addition,
we have developed close relationships with our network providers under which we review and monitor the coding of medical services provided by those providers, among other services we
provide.

Regulatory
authorities may assert that we are engaged in the corporate practice of medicine or that our contractual arrangements with providers constitute unlawful
fee-splitting. Moreover, we cannot predict whether changes will be made to existing laws or if new ones will be enacted, which could cause us to be out of compliance with these
requirements. If our arrangements are found to violate corporate practice of medicine or fee-splitting laws, our provider or independent physician association management contracts could be
found to be legally invalid and unenforceable,
which could adversely affect our operations and profitability, and we could be subject to civil or, in some cases, criminal, penalties.

We may not have adequate intellectual property rights in our brand names for our health plans, and we may be unable to adequately enforce these rights.

Our success depends, in part, upon our ability to market our health plans under the brand names that we own or license, such as Today's
Options®, PrescribaRxSM, Senior Solutions®, and Texan Plus® family of products, and our MemberHealth®, MHRx, and
CommunityCCRxSM family of products. We may not have taken enforcement action to prevent infringement of our marks and may not have secured registrations of the other brand names that we
use in our business. Unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Policing unauthorized use of our intellectual property is difficult, and we cannot
be certain that the steps we have taken will prevent misappropriation of our intellectual property rights. Other businesses may have prior rights in our brand names or in similar names, which could
cause market confusion or limit or prevent our ability to use these marks or prevent others from using similar marks. If we are unable to prevent others from using our brand names, or if others
prohibit us from using them, our revenues could be adversely affected. Even if we are able to protect our intellectual property rights in our brands, we could incur significant costs in doing so.

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

We operate in a highly competitive industry. Some of our competitors are more established in the insurance, health care and PBM
industries, with larger market share and greater financial resources than we have in some markets. In addition, other companies may enter our markets in the future. We believe that barriers to entry
in many markets are not substantial, so the addition of new competitors can occur relatively easily, and customers enjoy significant flexibility in moving between competitors. Contracts for the sale
of commercial products are generally bid upon or renewed annually. We compete for members in our health plans and PBM on the basis of the following and other factors:



In
addition to the challenge of controlling PBM and health care costs, we face intense competitive pressure to contain premium prices. Factors such as business consolidations, strategic
alliances, legislative reform and marketing practices create pressure to contain premium rate increases, despite being faced with increasing medical costs. Premium increases, introduction of new
product designs, our

51

---



Table of Contents

relationship
with our providers in various markets, and our possible exit from or entrance into additional markets, among other issues, could also affect our membership levels.

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

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

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

If the PBM and service providers that support our business do not continue to earn and retain purchase discounts and rebates from manufacturers at current levels, our gross
margins may decline.

We have direct and indirect contractual relationships with pharmaceutical manufacturers that provide us with purchase discounts on
drugs dispensed to our members. Manufacturer rebates often depend on our ability to meet contractual market share or other requirements. Pharmaceutical manufacturers have also increasingly made rebate
payments dependent upon our agreement to include a broad array of their products in our formularies.

Changes
in existing Federal or state laws or regulations or in their interpretation by courts and agencies or the adoption of new laws or regulations relating to patent term extensions,
purchase discount, administrative fee and rebate arrangements with pharmaceutical manufacturers, as well as some of the formulary and other services we provide to pharmaceutical manufacturers, could
also reduce the discounts or rebates we receive and adversely impact our business, financial condition, liquidity and operating results.

Changes in industry pricing benchmarks could adversely affect our financial performance.

Contracts in the prescription drug industry generally use published benchmarks to establish pricing for prescription drugs. The
principal benchmarks are average wholesale price, known as AWP, average selling price, known as ASP, wholesale acquisition cost, known as WAC, and average manufacturer price, known as AMP.

Recent
events have raised uncertainties as to whether payors, pharmacy providers, PBMs and others in the prescription drug industry will continue to utilize AWP as it has
previously been calculated, or whether they will adopt other pricing benchmarks for establishing prices within the industry. Specifically, in the proposed settlement in the case of New England Carpenters Health Benefits Fund,
et al. v. First DataBank, et al., a civil class action case brought against McKesson Corporation and First
DataBank, known as FDB, which is one of several companies that report data on prescription drug prices, FDB has agreed to reduce the reported AWP of specified drugs by 4% at a future time as
contemplated by the settlement. At this time, the proposed settlement has not received final court approval. We cannot precisely predict the long-term effect of the proposed settlement or
the timing of any impact it may have on our PBM business.

52

---



Table of Contents

Demands by our clients for enhanced service levels or possible loss or unfavorable modification of contracts with our clients could negatively affect our profitability.

As our clients face the continued rapid growth in prescription drug costs, they may demand additional services and enhanced service
levels to help mitigate the increase in spending. We operate in a very competitive PBM environment, and as a result, we may not be able to increase our fees to compensate for these increased services,
which could negatively affect our profitability.

Our results of operations could suffer if we lose our pharmacy network affiliations.

Our PBM operations are dependent to a significant extent on our ability to obtain discounts on prescription purchases from retail
pharmacies that can be utilized by our clients and participants. Our contracts with retail pharmacies, as well as our network vendor's contracts with retail pharmacies, which are
non-exclusive, are generally terminable by either party on short notice. If one or more of our top large volume network pharmacies elects to terminate its relationship with us or our
network vendor or if we are only able to continue our relationship on terms less favorable to us, access to retail pharmacies by our clients and health plan participants, and our business, results of
operations and financial condition could suffer. In addition, some large retail pharmacy chains either own or have strategic alliances with PBMs or could attempt to acquire or enter into these
kinds of relationships in the future. Ownership of, or alliances with, PBMs by retail pharmacy chains, particularly large pharmacy chains which control a significant amount of retail pharmacy
business, could have material adverse effects on our relationships with those retail pharmacy chains, particularly the discounts they are willing to make available, and on our business, results of
operations and financial condition.

Our PBM could be subject to claims under ERISA if it is found to be a fiduciary of health benefit plans governed by ERISA.

PBMs typically provide services to corporations and other sponsors of health benefit plans. These plans are subject to the
Employee Retirement Income Security Act of 1974, as amended, known as ERISA, which regulates health and medical plans and other employee pension benefit plans and employee welfare benefit plans. The
U.S. Department of Labor, which is the agency that enforces ERISA, could assert that the fiduciary obligations imposed by the statute apply to some or all of the services provided by a PBM. If a court
were to determine, in litigation brought by a private party or in a proceeding arising out of a position taken by the Department of Labor, that MemberHealth was a fiduciary in connection with services
it provides, MemberHealth could potentially be subject to claims for breaching fiduciary duties and/or entering into specified "prohibited transactions" under ERISA. In addition, claims also might be
made against our PBM under common law and state fiduciary obligation theories.

Our reliance upon third party administrators and other outsourcing arrangements may disrupt or adversely affect our operations.

We depend, and may in the future increase our dependence, on independent third parties for significant portions of our data center
operations, data network, voice communication services and pharmacy data processing and payment and other systems-related support, equipment, facilities and data. This dependence makes our operations
vulnerable to the third parties' failure to perform adequately under the contract, due to internal or external factors.

We
have outsourced portions of the operation of our data center, call centers and new business processing services to independent third parties and may from time to time obtain
additional services or facilities from other independent third parties. Dependence on third parties for these services and facilities may make our operations vulnerable to their failure to perform as
agreed. We also rely upon third parties for information relating to Medicare Part D membership and claims administration.

53

---



Table of Contents

Incorrect
information from these entities could generate inaccurate or incomplete membership and payment reports concerning our Medicare eligibility and enrollment, and claims information used by CMS
to determine plan benefit subsidies and risk corridor payments. This could cause us to incur additional expense to utilize additional resources to validate, reconcile and correct the information. We
have not been able to independently test and verify some of these third party systems and data. There can be no assurance that future third party data will not disrupt or adversely affect our plans'
relationships with our members or our results of operations. A change in service providers or a move of services from a third party to internal operations could result in a decline in service quality
and effectiveness, increased cost or less favorable contract terms which could adversely affect our operating
results. Some of our outsourced services are being performed offshore. CMS requires attestations from plans that utilize the services of offshore vendors as to the vendors' ability to perform
delegated functions. Prevailing economic conditions and other circumstances could prevent our offshore vendors' ability to adequately perform as agreed, which would impair our ability to provide the
requisite attestations to CMS and could have a material adverse effect on our results of operations and financial condition.

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

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

The MMA and MIPPA made changes to the Medicare program that will materially impact our operations and could reduce our profitability and increase competition for existing
and prospective members.

The MMA substantially changed the Medicare program and caused us to modify how we operate our business and MIPPA changed the Medicare
program as it existed under the MMA. Although many of these changes are designed to benefit Medicare Advantage plans generally, some provisions of the MMA and MIPPA may increase competition, create
challenges for us with respect to educating our existing and potential members about the changes, and create other risks and substantial and potentially adverse uncertainties.

Increased competition could adversely affect our enrollment and results of operations.

The MMA increased reimbursement rates for Medicare Advantage plans. Higher reimbursement rates may have induced the establishment of
new plans that participate in the Medicare program, creating new competition that may in the past have adversely affected, and could in the future adversely affect, our profitability and cause
increased lapsation in our Medicare Supplement in force as policyholders choose to enroll in a competitor's plan. These effects may be exacerbated if reimbursement rates for Medicare Advantage plans
decrease in the future, as CMS and other governmental authorities have indicated may occur.

54

---



Table of Contents

The
MMA mandated a new regional Medicare preferred provider organization, or Medicare Advantage PPO, program and private fee-for-service plans. Medicare Advantage
PPOs and private fee-for-service plans allow their members more flexibility to select physicians than the Medicare Advantage HMO plans, which are health plans that require
members to coordinate with a primary care physician. The regional Medicare Advantage PPO program and private fee-for-service plans compete with local Medicare Advantage HMO
programs and have affected, and may continue to affect, our Medicare Advantage business.

MIPPA
further modified the Medicare Advantage program by restricting the Medicare private fee-for-service plans to smaller markets, specifically those that do not
have two or more Medicare Advantage HMO plans. If we are unable to generate a sufficient number of new members in regions that still have Medicare private fee-for-service plans
or where we have established Medicare Advantage PPO or HMO plans, our revenues and results of operations could be adversely affected.

The competitive bidding process may adversely affect our profitability.

Payments for the local Medicare Advantage health plans and regional Medicare Advantage PPO programs are based on a competitive bidding
process that may decrease the amount of premiums paid to us or cause us to increase the benefits we offer. As in the Part D program, we are required to submit PDP bids annually. We endeavor to
use the best available member eligibility, claims and risk score data at the time of developing the bids. Furthermore, we make actuarial assumptions about the utilization of benefits in our plans. We
cannot be assured that the data and
assumptions used at the time of bid development will prove to be correct and that premiums will be sufficient to cover benefits plus a reasonable margin.

The limited annual enrollment process may adversely affect our growth and ability to market our products.

Medicare beneficiaries generally have a limited annual enrollment period during which they can choose to participate in a Medicare
Advantage plan or receive benefits under the traditional fee-for-service Medicare program. After the annual enrollment period, most Medicare beneficiaries will not be permitted
to change their Medicare benefits until the next enrollment period. This annual enrollment process and subsequent "lock-in" provisions of the MMA may adversely affect our growth as it will
limit our ability to enter new service areas and market to or enroll new members in our established service areas outside of the annual enrollment period.

The limited annual enrollment period may make it difficult to retain an adequate sales force.

As a result of the limited annual enrollment period and the subsequent "lock-in" provisions of the MMA, our internal and
external sales force may be limited in its ability to market some of our products year-round. Our agents rely substantially on sales commissions for their income. Given the limited annual
sales window, it may become more difficult to find agents to market and promote our products.

We may be responsible for the actions of our independent and career agents, and restrictions on our ability to market would adversely affect our revenue.

In litigation against our subsidiaries, our members sometimes claim that agents failed to comply with applicable laws, regulations and
rules, or acted improperly in other ways, and that we are responsible for the alleged failure. We could be liable for contractual and extra-contractual damages on these claims. We cannot assure you
that any future claim will not result in material liability in the future. Federal and state regulators increasingly scrutinize the marketing practices of insurers, such as Medicare Advantage and
private fee-for-service plans, MA-PDs and PDPs and their marketing agents,

55

---



Table of Contents

and
there is no guarantee that regulators will not scrutinize the practices of our Medicare Advantage plans, PDPs and our marketing agents, and will not expose us to liability.

We
rely on our marketing and sales efforts for a significant portion of our premium revenue growth. The Federal government and state governments in the states in which we currently
operate permit marketing but impose strict requirements and limitations as to the types of marketing activities that we may conduct. If our marketing efforts were to be prohibited or curtailed, our
ability to increase or sustain membership would be significantly harmed, which would adversely affect our revenue and results of operations.

Similarly,
Federal and state governments and regulatory agencies have recently placed an increased focus on the sales and marketing of private fee-for-service
plans. Concerns over the growing number of market conduct complaints regarding improprieties in agents' sales activities of private fee-for-service plans have spawned stricter
marketing standards by CMS relating to these plans and their agents. This heightened focus on market conduct and stricter standards in the marketing and sales of private
fee-for-service plans could require us to modify our systems, increase our costs and change our agent training requirements, which could result in a material adverse effect on
our results of operations and financial condition.

If our government contracts are not renewed or are terminated, our business could be substantially impaired.

We provide our Medicare benefits and other services through a limited number of contracts with Federal government agencies. These
contracts generally have terms of one or two years and are subject to non-renewal by the applicable agency. All of our
government contracts are terminable for cause if we breach a material provision of the contract or violate relevant laws or regulations. In addition, a government agency may suspend our right to add
new members if it finds deficiencies in our provider network or operations. If we are unable to renew, or to successfully re-bid or compete for any of our government contracts, or if any
of our contracts are terminated, our business could be substantially impaired. If any of those circumstances were to occur, we would likely pursue one or more alternatives, such as



If
we were unable to do so, we could be forced to cease conducting business. In this event, our revenues and profits would decrease materially.

We have debt outstanding that contains restrictive covenants, and we may be unable to service and repay our debt obligations if our subsidiaries cannot pay sufficient
dividends or make other cash payments to us.

As of December 31, 2008, we had $321 million of debt outstanding under the term portion of our credit agreement. We have
available borrowing capacity under the revolving portion of our credit facility of $150 million. As of December 31, 2008, we had $110 million of trust preferred securities
outstanding. Our credit agreement provides that upon the occurrence of specified events all of the capital stock of the guarantor subsidiaries under the credit agreement will be pledged to our bank
lenders; those events have occurred and we have pledged this stock. Because our principal outstanding indebtedness has been incurred by our parent company, our ability to make interest and principal
payments on our outstanding debt is dependent upon the ability of our subsidiaries to pay cash dividends or make other cash payments to our parent company. Our subsidiaries will be able to pay
dividends to our parent company only if they earn sufficient profits and, in the case of our insurance company and health plan subsidiaries, they satisfy the requirements of the state insurance laws
relating to dividend payments and the maintenance of required surplus.

56

---



Table of Contents

Our
debt service obligations will require us to use a portion of our operating cash flow to pay interest and principal on indebtedness before use for other corporate purposes, such as
funding future expansion of our business and ongoing capital expenditures. If our operating cash flow and capital resources are insufficient to service our debt obligations, we may be forced to sell
assets, seek additional equity or debt capital or restructure our debt. However, these measures might be unsuccessful or inadequate in permitting us to meet scheduled debt service obligations. We may
also incur additional indebtedness in the future. Our indebtedness could have additional adverse consequences, such as:



Capital constraints could restrict our ability to support our premium growth.

Our continued growth is dependent upon our ability to support premium revenue growth through the expansion of our markets and our
network of agents while at the same
time maintaining sufficient levels of capital and surplus to support that growth. Our new business growth typically results in reduced income caused by costs related to new market expansion and, on
some insurance products, net losses during the early years of a policy, called statutory surplus strain. The resulting reduction in capital and surplus can limit our ability to generate new business
due to statutory restrictions on premium to surplus ratios and other required statutory surplus parameters. In addition, some states, such as Florida and Texas, limit an insurer's ability to write
specified lines of business if gross or net premiums written would exceed a specified percentage of capital and surplus. Likewise, we are required to maintain adequate risk-based capital
ratios as prescribed by each state. Moreover, we need substantially more capital than the statutory minimums to support our level of premium growth and to finance acquisitions. If we cannot generate
sufficient capital and statutory surplus to maintain minimum statutory requirements and to support our growth, we could be restricted in our ability to generate new premium revenue.

If we are required to maintain higher statutory capital levels for our existing operations or if we are subject to additional capital reserve requirements as we pursue new
business opportunities, our ability to obtain funds from our subsidiaries may be restricted and our cash flows and liquidity may be adversely affected.

Because Universal American operates as a holding company, it is dependent upon dividends and administrative expense reimbursements from
its subsidiaries to fund its obligations, such as payment of principal and interest on its debt obligations. These subsidiaries generally are regulated by state departments of insurance. Our health
plan and insurance company subsidiaries are subject to laws and regulations that limit the amount of dividends and distributions they can pay for purposes other than to pay income taxes related to
their earnings. These laws and regulations also limit the amount of management fees our subsidiaries may pay to our management subsidiaries and their other affiliates without prior notification to, or
in some cases approval of, state regulators.

We
are also required by law to maintain specific prescribed minimum amounts of capital in these subsidiaries. The levels of capitalization required depend primarily upon the volume of
premium generated. A significant increase in premium volume will require additional capitalization from our

57

---



Table of Contents

parent
company. In most states, we are required to seek prior approval by these state regulatory authorities before we transfer money or pay dividends that exceed specified amounts from these
subsidiaries, or, in some states, any amount. The pre-approval and notice requirements vary from state to state, and the discretion of the state regulators, if any, in approving or
disapproving a dividend is not always clearly defined. Subsidiaries that declare non-extraordinary dividends must usually provide notice to the regulators in advance of the intended
distribution date. If the regulators were to deny or significantly restrict our subsidiaries' requests to pay dividends to us or to pay management and other fees to affiliates, the funds available to
us would be limited, which could impair our ability to implement our business and growth strategy and satisfy our debt obligations, or we could be required to incur additional indebtedness to fund
these strategies.

In
addition, one or more of these states could increase the statutory capital level from time to time. States have also adopted risk-based capital requirements based on
guidelines adopted by the National Association of Insurance Commissioners, which tend to be, although are not necessarily, higher than existing statutory capital requirements. Regardless of whether
the states in which we operate maintain or adopt risk-based capital requirements, the state departments of insurance can require our subsidiaries to maintain minimum levels of statutory
capital in excess of amounts required under the applicable state laws if they determine that maintaining additional statutory capital is in the best interests of our members. Any increases in these
requirements could materially increase our reserve requirements. In addition, as we continue to expand our plan offerings in new states or pursue new business opportunities, such as our recent
offerings of PDPs and expansion of private fee-for-service products and health plans in new markets, we may be required to maintain additional statutory capital reserves. In
either case, our available funds could be materially reduced, which could harm our ability to implement our business strategy.

In
the event that we are unable to provide sufficient capital to fund the debt obligations of Universal American, our operations or financial position may be adversely affected.

Downgrades in our debt ratings, should they occur, may adversely affect our business, financial condition and results of operations.

Increased public and regulatory concerns regarding the financial stability of insurance companies and health plans have resulted in
consumers placing greater emphasis upon financial strength ratings. Claims paying ability, financial strength, and debt ratings by recognized rating organizations are increasingly important factors in
establishing the competitive position of insurance companies and health plans. Ratings information is broadly disseminated and generally used throughout the industry. Our ability to expand and to
attract new business is affected by the financial strength ratings assigned to our subsidiaries by independent industry rating agencies, such as A.M. Best Company, Inc. Some distributors
such as financial institutions, unions, associations and affinity groups may not sell our products to these groups unless the rating of our subsidiary writing the business improves to at least an
"A-." The lack of higher A.M. Best ratings for our subsidiaries could adversely affect sales of our products.

Our
debt ratings affect both the cost and availability of future borrowings. Each of the rating agencies reviews its ratings periodically and there can be no assurance that current
ratings will be maintained in the future. Our ratings reflect each rating agency's opinion of our financial strength, operating performance, and ability to meet our debt obligations or obligations to
policyholders, but are not evaluations directed toward the protection of investors in our common stock and should not be relied upon as such. There is no assurance that the rating agencies will
maintain our current ratings in the future. Any future downgrade in our ratings may cause our policyholders and members to lapse, and may cause some of our agents to sell less of our products or to
cease selling our products altogether. Increased lapse rates would reduce our premium revenue and net income. Thus,

58

---



Table of Contents

downgrades
in our ratings, should they occur, may adversely affect our business, financial condition and results of operations.

If we fail to properly maintain the integrity of our data and information systems, our business could be materially adversely affected.

Our business depends significantly on efficient, effective and secure information systems and the integrity and timeliness of the data
we use to run our business. We have various information systems which support our operating segments. The information gathered and processed by our management information systems assists us in, among
other things, marketing and sales tracking, underwriting, billing, claims processing, medical management, medical care cost and utilization trending, financial and management accounting, reporting,
planning and analysis and e-commerce. These systems also support on-line customer service functions, provider and member administrative functions and support tracking and
extensive analyses of medical expenses and outcome data.

Our
information systems and applications require an ongoing commitment of significant resources to maintain, protect and enhance existing systems and develop new systems to keep pace
with continuing changes in information processing technology, evolving industry and regulatory standards and changing customer preferences. If the information we rely upon to run our businesses were
to be found to be inaccurate or unreliable, if we fail to properly maintain our information systems and data integrity, or if we fail to successfully update or expand processing capability or develop
new capabilities to meet our business needs in a timely manner, we could have operational disruptions, have problems in determining medical cost estimates and establishing appropriate pricing, have
customer and physician and other health care provider disputes, lose our ability to produce timely and accurate reports, have regulatory or other legal problems, have increases in operating and
administrative expenses, lose existing customers, have difficulty in attracting new customers or in implementing our growth strategies, sustain losses due to fraud or suffer other adverse
consequences.

To
the extent we fail to maintain effective information systems, we may need to contract for these services with third-party management companies, which may be on less favorable terms to
us and
significantly disrupt our operations and information flow. In addition, we have outsourced the operation of our data centers to independent third parties and may from time to time obtain additional
services or facilities from other independent third parties. Dependence on third parties for these services and facilities may make our operations vulnerable to their failure to perform as agreed.

Furthermore,
our business requires the secure transmission of confidential information over public networks. Because of the confidential health information we store and transmit,
security breaches could expose us to a risk of regulatory action, litigation, possible liability and loss. Our security measures may be inadequate to prevent security breaches, and our business
operations and profitability would be adversely affected by cancellation of contracts, loss of members and potential criminal and civil sanctions if they are not prevented.

There
can be no assurance that our process of improving existing systems, developing new systems to support our expanding operations, integrating new systems, protecting our proprietary
information, and improving service levels will not be delayed or that additional systems issues will not arise in the future. Failure to adequately protect and maintain the integrity of our
information systems and data may result in a material adverse effect on our financial positions, results of operations and cash flows.

Any failure by us to manage our growing operations or to successfully complete or integrate acquisitions, dispositions and other significant transactions could harm our
financial results, business and prospects.

As part of our business strategy, we frequently engage in discussions with third parties regarding possible investments, acquisitions,
dispositions, strategic alliances, joint ventures and outsourcing transactions and often enter into agreements relating to these transactions that are designed to enhance

59

---



Table of Contents

our
business objectives. In order to pursue this strategy successfully, we must identify suitable candidates for, and successfully complete, transactions as well as effectively integrate any acquired
companies into our operations and efficiently separate any businesses we sell. If we fail to identify and successfully complete transactions that further our strategic objectives, we may be required
to expend resources to develop products and technology internally, we may be unable to sustain our historical growth rates, we may be put at a competitive disadvantage or we may be adversely affected
by negative market perceptions, any of which may have a material adverse effect on our results of operations, financial position or cash flows.

Acquisition risk

The rapid growth in the size and complexity of our operations has placed, and will continue to place, significant demands on our
management, operations systems, accounting systems, internal control systems and financial resources. As part of our strategy, we have experienced, and expect to continue to experience, considerable
growth through acquisitions.

Acquisitions
involve numerous risks, some of which we have experienced in the past, such as:



In
addition, we generally are required to obtain regulatory approval from one or more governmental agencies when making acquisitions, which may require a public hearing, regardless of
whether we already operate a plan in the state in which the business to be acquired is located. We may be unable to comply with these regulatory requirements for an acquisition in a timely manner, or
at all. Moreover, some sellers may insist on selling assets that we may not want, such as commercial lines of business, or transferring their liabilities to us as part of the sale of their companies
or assets. Even if we identify suitable acquisition targets, we may be unable to complete acquisitions or obtain the necessary financing for acquisitions on terms favorable to us, or at all.

To
the extent we complete an acquisition, we may be unable to realize the anticipated benefits from it because of operational factors or difficulties in integrating the following or
other aspects of acquisitions with our existing businesses:



60

---



Table of Contents



For
all of the above reasons, we may not be able to implement our acquisition strategy successfully, which could materially adversely affect our growth plans and on our business,
financial condition and results of operations.

Furthermore,
in the event of an acquisition or investment, you should be aware that we may issue stock that would dilute stock ownership, incur debt that would restrict our cash flow,
assume liabilities, incur large and immediate write-offs, incur unanticipated costs, divert management's attention from our existing business, experience risks associated with entering
markets in which we have no or limited prior experience, or lose key employees from the acquired entities or our historical business.

Internal growth and expansion risk

Additionally, we are likely to incur additional costs if we develop new product offerings or enter new service areas or states where we
do not currently operate, which may limit our ability to expand to, or further expand in, those areas. Our rate of expansion into new geographic areas may also be limited
by:



Our
ability to manage our growth and compete effectively will depend, in part, on our success in addressing these demands and risks. Any failure by us to effectively manage our growth
could have a material adverse effect on our business, financial condition or results of operations.

Any failure to manage sales and administrative costs could impair profitability.

The level of our sales and administrative expenses affects our profitability. While we proactively attempt to manage these expenses
effectively, increases in the cost of sales and marketing, staff-related expenses, investment in new products, greater emphasis on small group and individual health insurance products, acquisitions
and implementation of regulatory requirements, among others, may occur from time to time.

61

---



Table of Contents

There
can be no assurance that we will be able to contain our sales expenses in line with our actual levels of production and our administrative expenses in line with our membership
base. This may result in a material adverse effect on our financial position, results of operations and cash flows.

Further deterioration in the mortgage-backed securities market or significant deterioration in the mortgage-backed securities we hold could adversely affect our results of
operations or financial condition.

As of December 31, 2008, we held securities with a par value of approximately $140 million with exposure to subprime
mortgages. We have recognized other-than-temporary impairment in the value of some of our securities with exposure to subprime mortgages, securities issued by financial
institutions and some of our other securities. As the economy in general, as well as the market for mortgage-backed securities with exposure to subprime mortgages and securities issued by financial
institutions, have deteriorated, these securities have become increasingly illiquid. In addition, as some financial institutions have become insolvent, their securities have become worthless or have
significantly lost value. If the mortgage-backed securities with exposure to subprime mortgages in our portfolio experience significant rates of default, if the market for these securities, securities
issued by financial institutions and other securities continues to experience lack of liquidity or otherwise deteriorates or this lack of liquidity worsens, we might need to continue to impair the
value of our securities, which could adversely effect our results of operations or financial condition.

Additionally,
mortgage-backed securities are subject to prepayment risks that vary with interest rates, among other things. During periods of declining interest rates, mortgage-backed
securities generally prepay faster as the underlying mortgages are prepaid or refinanced by borrowers in order to take advantage of lower rates. Mortgage-backed securities that have an amortized cost
greater than par
because we purchased them at a premium may incur a reduction in yield or a loss as a result of these prepayments.

In
addition, in connection with the other-than-temporary impairments that we have recognized for financial statement purposes, we believe we have available
opportunities to recover the tax assets generated by the other-than-temporary impairments. Circumstances may arise in the future that cause us to re-determine the
recoverability of those tax benefits, which could result in the loss of the tax benefits we expect to take.

The occurrence of natural or man-made disasters could adversely affect our financial condition and results of operation.

We are exposed to various risks arising out of natural disasters, such as



For
example, a natural or man-made disaster could lead to unexpected changes in persistency rates as policyholders and members who are affected by the disaster may be unable
to meet their contractual obligations, such as payment of premiums on our insurance policies. The continued threat of terrorism and ongoing military actions may cause significant volatility in global
financial markets, and a natural or man-made disaster could trigger an economic downturn in the areas directly or indirectly affected by the disaster. These consequences could, among other
things, result in a decline in business and increased claims from those areas. Disasters also could disrupt communications and financial services

62

---



Table of Contents

and
other aspects of public and private infrastructure, which could disrupt our normal business operations.

A
natural or man-made disaster also could disrupt the operations of our counterparties or result in increased prices for the products and services they provide to us. In
addition, a disaster could adversely affect the value of the assets in our investment portfolio if it affects companies' ability to pay principal or interest on their securities.

Our business may suffer if we are not able to hire and retain sufficient qualified personnel or if we lose our key personnel.

Our future success depends partly on the continued contribution of our senior management and other key employees. While we currently
have employment agreements with key executives, these do not guarantee that the services of these executives will continue to be available to us. The loss of the services of any of our senior
management, or other key employees, could harm our business. In addition, recruiting and retaining the personnel we require to effectively compete in our markets may be difficult. If we fail to hire
and retain qualified employees, we may not be able to maintain and expand our business.

If we fail to effectively execute our Medicare initiatives and our other operational and strategic initiatives, our business could be materially adversely affected.

Our future performance depends in large part upon our management team's ability to execute our strategy to position us for the future.
This strategy relies to a significant extent on opportunities created by the MMA. The MMA offers new opportunities in our HMO, PPO and private fee-for-service Medicare
Advantage products and other Medicare programs, as well as Medicare Part D plans. We have made substantial investments in our Medicare programs to enhance our ability to participate in these
programs. The growth in our
Medicare membership and revenues, as well as the timing of membership enrollment and the speed with which the individual members meet their deductibles and cost-sharing obligations,
impacts the pattern of our quarterly earnings. Moreover, we are continuing to expand our Medicare offerings with the establishment of our Medicare Advantage PPOs in selected markets.

Our
contracts with CMS, as well as applicable Medicare Part D regulations and federal and state laws, requires us to, among other obligations:



Any
contractual or regulatory non-compliance on our part could entail significant sanctions and monetary penalties.

We
cannot predict the length of the selling season for any year. If the selling season for any plan year is shorter than in prior years, there could be a material adverse effect on our
business and results of operations.

63

---





Table of Contents

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

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

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

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



64

---



Table of Contents



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

We derive a substantial portion of our Medicare Advantage HMO revenues and profits from Medicare Advantage HMO operations in Texas, and legislative actions, economic
conditions or other factors that adversely affect those operations could materially reduce our revenues and profits.

We derive a substantial portion of our Medicare Advantage HMO revenues and profits from Medicare Advantage HMO operations in Texas. If
we are unable to continue to operate in Texas, or if we must significantly curtail our current operations in any portion of Texas, our revenues will decrease materially. Our reliance on our operations
in Texas could cause our revenues and profitability to change suddenly and unexpectedly, depending on legislative actions, economic conditions and similar factors. In addition, our market share in
some areas of Texas may make it more difficult for us to expand our membership in those areas. Our inability to continue to operate in Texas, or a decrease in the revenues or profitability of our
Texas operations, would harm our overall operating results.

Our net income may decline if our insurance premium rates are not adequate.

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



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



65

---



Table of Contents



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

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

Our benefits incurred expense reflects estimates of IBNR. We, together with our internal and external consulting actuaries, estimate
our claim liabilities using actuarial methods based on historical data adjusted for payment patterns, cost trends, product mix, seasonality, utilization of healthcare services and other relevant
factors. Actual conditions, however, could differ from those assumed in the estimation process, and those differences could be material. Due to the uncertainties associated with the factors used in
these assumptions, the actual amount of benefit expense that we incur may be materially more or less than the amount of IBNR originally estimated, and materially different amounts could be reported in
our financial statements for a particular period under different conditions or using different assumptions. We make adjustments, if necessary, to benefits incurred expense when the criteria used to
determine IBNR change and when we ultimately determine actual claim costs. If our estimates of IBNR are inadequate in the future, our reported results of operations will be adversely affected.
Further, our inability to estimate IBNR accurately may also affect our ability to take timely corrective actions or otherwise establish appropriate premium pricing, further exacerbating the extent of
any adverse effect on our results.

Our reserves for future insurance policy benefits and claims may prove to be inadequate, requiring us to increase liabilities and resulting in reduced net income and
shareholders' equity.

We calculate and maintain reserves for the estimated future payment of claims to our insurance policyholders using the same actuarial
assumptions that we use to set our premiums. For our accident and health insurance business, we establish active life reserves for expected future policy benefits, plus a liability for due and unpaid
claims, claims in the course of settlement, and incurred but not reported claims. Many factors can affect these reserves and liabilities, such as economic and social conditions, inflation, hospital
and medical costs, changes in doctrines of legal liability and extra-contractual damage awards. Therefore, we necessarily base our reserves and liabilities on extensive estimates, assumptions and
prior years' statistics. When we acquire other insurance companies or blocks of insurance, our assessment of the adequacy of acquired policy liabilities is subject to similar estimates and
assumptions. Establishing reserves involves inherent uncertainties, and it is possible that actual claims could materially exceed our reserves and have a material adverse effect on our results of
operations and financial condition. Our net income depends significantly upon the extent to which our actual claims experience is consistent with the assumptions we used in setting our reserves and
pricing our policies. If our assumptions with respect to future claims are incorrect, and our reserves are insufficient to cover our actual losses and expenses, we would be required to increase our
liabilities resulting in reduced net income, statutory surplus and shareholders' equity.

66

---



Table of Contents

The availability of reinsurance on acceptable terms and the financial stability of our reinsurers could impact our ability to manage risk and increase the volume of
insurance that we sell.

We utilize reinsurance agreements with larger, financially sound and highly-rated reinsurers to mitigate insurance risks that we
underwrite. We enter into reinsurance arrangements with unaffiliated reinsurance companies to limit our exposure on individual claims and to limit or eliminate risk on our non-core or
under-performing blocks of business. Reinsurance arrangements leave us exposed to two risks: Credit risk and replacement risk. Credit risk exists because reinsurance does not relieve us of our direct
liability to our insureds for the portion of the risks ceded to reinsurers. We are exposed to the risk of a reinsurer's failure to pay in full and in a timely manner the claims we make against them in
accordance with the terms of our reinsurance agreements, which could expose our insurance company subsidiaries to liabilities in excess of their reserves and surplus and could expose them to
insolvency proceedings. The failure of a reinsurer to make timely claims payments to us, whether due to their inability or unwillingness to pay, could materially and adversely affect our results of
operations and financial condition and our ability to make payments to our policyholders. Replacement risk exists because a reinsurer may cancel its participation on new business issued on advance
notice. As a result, we would need to find reinsurance from another source to support our level of new business. The amount and cost of reinsurance available to us is subject, in large part, to
prevailing market conditions beyond our control. Because our current reinsurance agreements are non-cancelable for business in force,
non-renewal or cancellation of a reinsurance arrangement affects only new business and the reinsurer remains liable on business reinsured prior to non-renewal or cancellation.
In the event that current reinsurers cancel their participation on new business, we would seek to replace them, possibly at higher rates. If we are not able to reinsure our life insurance products on
acceptable terms, we would consider limiting the amount of this new business we issue. A failure to obtain reinsurance on acceptable terms would allow us to underwrite new business only to the extent
that we are willing and able to bear the exposure to the new business on our own.

We may experience future lapsation in our Medicare supplement business, requiring faster amortization of the deferred acquisition costs.

We have in the past experienced higher than expected lapsation in our Medicare supplement business. We believe competitive pressure
from other Medicare supplement companies and Medicare Advantage products, as well as the departure of some of our sales managers, and other factors, contributed to the level of lapsation. This excess
lapsation required us to accelerate the amortization of the deferred acquisition cost and present value of future profits assets associated with the business that lapsed. We cannot give assurances
that lapsation of our Medicare supplement business will not again increase, requiring faster amortization of the deferred costs.

We may experience higher than expected loss ratios in our Medicare supplement business, which could materially adversely affect our results of operations.

We may experience higher than expected loss ratios on our Medicare supplement business. We actively seek to obtain appropriate rate
action in an effort to reverse any upward trend in loss ratios; however, we can make no assurances that future rate increases will be obtained, or if obtained, will be sufficient. We also cannot give
assurance that our Medicare supplement loss ratio will not continue to increase beyond what we currently anticipate, and any increases could materially adversely affect our results of operations.

We may not be able to compete successfully if we cannot recruit and retain insurance agents, which could materially adversely affect our business and ability to compete.

We distribute our products principally through career agents and independent agents who we recruit and train to market and sell our
products. We also engage managing general agents from time

67

---



Table of Contents

to
time to recruit agents and develop networks of agents in various states. We compete with other insurance companies for productive agents, primarily on the basis of our financial position, support
services, compensation and product features. It can be difficult to successfully compete for productive agents with larger insurance companies that have higher financial strength ratings than we do.
Our business and ability to compete will suffer if we are unable to recruit and retain insurance agents or if we lose the services provided by our managing general agents.

We may be required to refund or reduce premiums if our premium rates are determined to be too high.

Insurance regulators require that we maintain minimum statutory loss ratios on some of the insurance products that we sell. We must
therefore pay out, on average, a specified minimum percentage of premiums as benefits to policyholders. State regulations also mandate the manner in which insurance companies may compute loss ratios
and the manner in which compliance is measured and enforced. If our insurance products are not in compliance with state mandated minimum loss ratios, state regulators may require us to refund or
reduce premiums.

We have stopped selling annuities and long term care insurance and the premiums that we charge for the long term care policies that remain in force may not be adequate to
cover the claims expenses that we incur.

We have concluded that the sale of long term care insurance and annuities does not fit within our strategic or financial goals.

We
began to curtail the sale of new long-term care business in 2003, and stopped all new sales at the end of 2004. As of December 31, 2008, approximately,
$33 million of annualized premium remains in force, of which we retain approximately $22 million. The overall block of business continues to generate losses; a portion of the losses we
have incurred relates to a specific block of
Florida home health care business that we stopped selling in 1999. There can be no assurance that current premiums we charge will be adequate to cover the claims expenses that we will incur in the
future. There is also no assurance that rate increases that we may seek will be approved by the applicable state regulators or, if approved, will be adequate to fully mitigate adverse loss experience.

We
stopped selling annuity products in 2006. As a result of not offering new products, our agents and policyholders might seek to move their deposits to insurance companies that are
active in this business, causing an increase in the lapsation of our in force annuity deposits. This could require us to amortize a higher than expected amount of deferred acquisition costs associated
with the terminated policies and might also require us to sell bonds that were purchased to provide an appropriate interest spread to these interest sensitive products, and would negatively impact our
operating results.

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. The principal factors that
could contribute to the loss of membership are:



68

---



Table of Contents



We have incurred and may in the future incur significant expenses in connection with the implementation and expansion of our new Medicare Advantage plans, which could
adversely affect our operating results.

For the 2008 selling season, we expanded the markets in which we offer our Medicare Advantage products. We expanded our private
fee-for-service plans from 35 to 47 states and our health plans to new markets in North Texas and Wisconsin. We expanded to 15 new markets for 2009. In addition, we are
conducting a major expansion of our Medicare Advantage business by building Medicare Advantage PPO networks. In connection with this expansion, we have incurred expenses to upgrade and improve our
infrastructure, technology, and systems to manage these products, and will in the future incur additional expenses. In particular, we incurred the following expenses in connection with the
implementation and expansion of our Medicare Advantage program:



There
can be no assurance that we will recoup these expenditures or that they will result in profitable operations, currently, or in the future.

Our stock price and trading volume may be volatile, which could result in a decrease in the price of our common stock.

From time to time, the price and trading volume of our common stock may experience periods of significant volatility. Company-specific
issues and developments generally in the health care and insurance industries, the regulatory environment, the capital markets and the general economy may cause this volatility. The principal events
and factors that we have identified that may cause our stock price and trading volume to fluctuate are:



69

---



Table of Contents



If we are unable to maintain effective internal controls over financial reporting, investors could lose confidence in the reliability of our financial statements, which
could result in a decrease in the price of our common stock.

Because of our status as a public company, we are required to test our financial, internal, and management control systems to meet
obligations imposed by the Sarbanes-Oxley Act of 2002. These control systems relate to our corporate governance, corporate control, internal audit, disclosure controls and procedures, and financial
reporting and accounting systems. Our disclosure controls and procedures and our internal control over financial reporting may not prevent or detect all errors and all fraud. A control system, no
matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within the Company have been detected. Among these
inherent limitations are the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. The individual acts of some persons or the
collusion of two or more people can circumvent controls. The design of any system of controls is based in part on assumptions about the likelihood of future events, and there can be no assurance that
any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks. Over time,
controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.

If
we conclude that we do not have effective internal controls over financial reporting or if our independent auditors are unable to conclude that our internal controls over financial
reporting are
effective, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock. Our assessment of our internal controls
over financial reporting may also uncover material weaknesses, significant deficiencies or other issues with these controls that could also result in adverse investor reaction. These results may also
subject us to adverse regulatory consequences.

State insurance laws and anti-takeover provisions in our organizational documents could make an acquisition of us more difficult and may prevent attempts by our
shareholders to replace or remove our current management.

Provisions of state insurance laws, the business corporation law of the State of New York, where we are incorporated, and our
certificate of incorporation and bylaws, as well as the percentage of our common stock owned by our management, directors and equity investors may delay or prevent an acquisition of us or a change in
our management or similar change in control transaction, such as transactions in which shareholders might otherwise receive a premium for their shares over then current prices or that shareholders may
otherwise deem to be in their best interests. In addition, these provisions may frustrate or prevent any attempts by our shareholders to replace or remove our current management by making it more
difficult for shareholders to replace members of our board of directors. Because our board of directors is responsible for appointing the members of our management team, these provisions could in turn
affect any attempt by our shareholders to replace current members of our management team.

70

---



Table of Contents

ITEM 1BUNRESOLVED STAFF COMMENTS

There are no unresolved comments from the Staff of the Securities and Exchange Commission regarding the registrant's periodic or
current reports under the Act.

ITEM 2PROPERTIES

Our executive offices are located in Rye Brook, New York. Marketing and professional staff for our U.S. insurance subsidiaries occupy
space in Lake Mary, Florida and Solon, Ohio. Our Administrative Services operations occupy office space in Pensacola and Weston, Florida. Our Medicare Advantage operations occupy office space in
Houston, Beaumont and Dallas, Texas, as well as Oklahoma City, Oklahoma and Milwaukee, Wisconsin. Our Part D operations occupy space in Solon, Ohio and Pensacola, Florida. We lease over 450,000
square feet of office space. Management considers its office facilities suitable and adequate for the current level of operations. In addition to the above, Pennsylvania Life is the named lessee on
over 40 properties occupied by career agents for use as field offices. Rent for these field offices is reimbursed by the agents. Additional information regarding our lease obligations is included in
Note 17Commitments and Contingencies in our consolidated financial statements included in this Annual Report on Form 10-K.

ITEM 3LEGAL PROCEEDINGS



Plaintiff Arthur Tsutsui filed a derivative action on December 30, 2005, in the Supreme Court for New York State, Westchester
County. The defendants inTsutsui v. Barasch, et al., index no. 05-22523, are our officers Richard A. Barasch, Robert A. Waegelein
and Gary W. Bryant, as well as all of the directors sitting on our board of directors as of the time the complaint was filed. The Tsutsui action alleges that the same alleged misstatements that were
the subject of earlier actions, which have now all been dismissed or voluntarily withdrawn, constituted a breach of fiduciary duty by the officer defendants and the directors that caused the Company
to sustain damages. The Tsutsui action also seeks recovery of any proceeds derived by the officer and director defendants from the sale of our stock that the plaintiff claims was in breach of their
fiduciary duties. The defendants filed a motion to dismiss the complaint for failure to state a claim, as well as on other grounds. The Court granted this motion, and the plaintiff has appealed the
dismissal.



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



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

71

---



Table of Contents

On
May 6, 2008, the parties entered into a stipulation of settlement dated as of May 1, 2008, pursuant to which they agreed to settle this action. The settlement
stipulation provides for the amendment of our by-laws to require specified procedures in the event of related party transactions described in the amendment, and to require that we maintain
a committee that has as a member at least one independent member of our board of directors to oversee the process of preparing bids to the federal Centers for Medicare & Medicaid Services by
the MemberHealth Part D plans. The stipulation also provides for the payment of the plaintiffs' legal fees in an amount not to exceed $800,000. The Court has approved the payment of the
plaintiffs' legal fees, which we paid in December 2008, and
other terms of the settlement. The parties have consummated the settlement, and this case has therefore concluded.



We have litigation in the ordinary course of our business, including claims for medical, disability and life insurance benefits, and in
some cases, seeking punitive damages. Management believes that after liability insurance recoveries, none of these actions will have a material adverse effect on the Company.

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

There were no matters submitted by us to a vote of stockholders, through the solicitation of proxies or otherwise, during the fourth
quarter of 2008.

72

---





Table of Contents

PART II

ITEM 5MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY  SECURITIES

Market Information

On December 3, 2007, our common shares began trading on the New York Stock Exchange, or the NYSE, under the ticker symbol "UAM."
Prior to December 3, 2007, our common stock traded in the over-the-counter market and was quoted on the NASDAQ Global Select tier of The NASDAQ Stock Market, or the
NASDAQ, under the symbol "UHCO". The following table sets forth the high and low sales prices for our common stock on the NYSE and NASDAQ National Market, as reported by the NYSE or NASDAQ for the
periods indicated.

Common StockPeriod

High

LowYear Ended December 31, 2007First Quarter

$
19.50

$
18.42Second Quarter


22.00


18.29Third Quarter


22.85


19.14Fourth Quarter


25.80


22.90Year Ended December 31, 2008First Quarter


25.59


10.35Second Quarter


12.61


9.11Third Quarter


13.69


8.71Fourth Quarter


12.19


6.79Year Ending December 31, 2009First Quarter (through March 6, 2009)


10.66


5.41


The
closing sale price of our common stock on March 6, 2009, as reported by NYSE, was $6.14 per share.

Stockholders

As of the close of business on March 6, 2009, there were approximately 1,000 holders of record of our common stock. There are no
outstanding shares of our nonvoting common stock. We estimate that there are approximately 3,500 beneficial owners of our common stock. In addition, there were 5 record and beneficial holders of our
Series A preferred stock. Each outstanding share of our preferred stock is convertible, directly or indirectly, into 100 shares of our common stock.

Dividends

We have never declared cash dividends on our common stock, and have no present intention to declare any cash dividends in the
foreseeable future. As discussed under "Item 7Management's Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources",
our credit facility limits our ability to pay dividends, and the debentures that we have issued simultaneously with our trust preferred securities also limit our ability to pay dividends if we fail to
make the required interest payments under the debentures.

73

---



Table of Contents

Issuer Purchases of Equity Securities

Period

Total Number
of Shares
Purchased

Average
Price Paid
Per Share

Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs

Approximate
dollar value of
shares that may
yet be purchased
under the Plans
or Programs
(In Thousands)October 1, 2008October 31, 2008


1,087,900

$
9.30


1,087,900

$
36,550November 1, 2008November 30, 2008


436,671


9.01


436,671


32,617December 1, 2008December 31, 2008


489,271


9.03


489,271


28,200Total


2,013,842





2,013,842


We
have approved share repurchase plans that have authorized us to repurchase up to $100 million of shares of our common stock. Through December 31, 2008, we have
repurchased 6.7 million shares of our common stock for an aggregate amount of $71.8 million, under these programs. Subsequent to year end, through March 3, 2009, we repurchased an
additional 1.7 million shares for $14.8 million. As of March 3, 2009, we have $13.4 million that remains available to repurchase additional shares under these plans. We are
not obligated to repurchase any specific number of shares under the programs or to make repurchases at any specific time or price.

Recent Sales of Unregistered Securities

None.

Securities Authorized for Issuance Under Equity Compensation Plans

The information regarding securities authorized for issuance under our equity compensation plans is disclosed in Item 12
"Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters."

74

---



Table of Contents

ITEM 6SELECTED FINANCIAL DATA

The table below provides selected financial data and other operating information as of and for the five fiscal years ended
December 31, 2008. We derived the selected financial data presented below for the five fiscal years ended December 31, 2008 from our audited financial statements. We have prepared the
following data, other than statutory data, in conformity with generally accepted accounting principles. You should read this selected financial data together with our consolidated financial statements
and the notes to those consolidated financial statements as well as the discussion under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations."

As of or for the Year Ended December 31,2008

2007(1)

2006

2005(2)

2004(2),(3)(in thousands, except per share data)Income Statement Data:Direct premium and policyholder fees

$
5,177,108

$
3,677,749

$
1,883,579

$
1,088,857

$
793,749Reinsurance premium assumed


47,818


39,937


32,187


32,108


35,682Reinsurance premium ceded


(624,472
)

(776,267
)

(718,624
)

(349,003
)

(243,590
)Net premium and other policyholder fees


4,600,454


2,941,419


1,197,142


771,962


585,841Net investment income


81,270


106,970


75,459


61,448


55,564Fee and other income


37,130


26,412


27,645


18,294


14,436Net realized (losses) gains on investments


(59,681
)

(40,178
)

4,818


5,044


5,616Total revenues


4,659,173


3,034,623


1,305,064


856,748


661,457Total benefits, claims and other deductions


4,580,682


2,958,661


1,257,495


786,385


583,999Income from continuing operations before equity in earnings of unconsolidated subsidiary


78,491


75,962


47,569


70,363


77,458Equity in earnings (loss) of unconsolidated subsidiary


72,813


56,664


46,187


(3,980
)

Income from continuing operations before taxes


151,304


132,626


93,756


66,383


77,458Provision for income taxes


56,212


48,554


32,610


22,626


25,639Income from continuing operations


95,092


84,072


61,146


43,757


51,819Discontinued Operations:Income from discontinued operations, net of taxes








9,788


10,119


12,052Gain on Sale of discontinued operations, net of taxes








48,372





Income from discontinued operations








58,160


10,119


12,052Net income

$
95,092

$
84,072

$
119,306

$
53,876

$
63,871Earnings per common share:Basic:Continuing operations

$
1.09

$
1.20

$
1.04

$
0.76

$
0.95Discontinued operations








0.99


0.18


0.22Net income

$
1.09

$
1.20

$
2.03

$
0.94

$
1.17Diluted:Continuing operations

$
1.08

$
1.18

$
1.02

$
0.74

$
0.92Discontinued operations








0.97


0.17


0.21Net income

$
1.08

$
1.18

$
1.99

$
0.91

$
1.13


---

75

---



Table of Contents

As of December 31,2008

2007(1)

2006

2005(2)

2004(2),(3)(in thousands, except per share data)Balance Sheet Data:Total cash and investments

$
1,567,348

$
1,815,620

$
1,677,973

$
1,272,343

$
1,187,775Total assets


3,870,712


4,089,256


2,585,042


2,224,344


2,011,016Policyholder related liabilities


1,760,915


1,798,886


1,300,398


1,202,922


1,141,439Outstanding bank debt


320,625


349,125


90,563


95,813


101,063Trust preferred securities


110,000


110,000


75,000


75,000


75,000Shareholders' equity


1,316,084


1,351,066


623,909


531,884


419,421Book value per share:Basic

$
15.58

$
14.66

$
10.54

$
9.13

$
7.60Data Reported to Regulators:Statutory capital and surplus

$
611,497

$
545,201

$
282,453

$
180,448

$
135,380Asset valuation reserve


590


5,220


4,445


3,182


2,423Adjusted capital and surplus

$
612,087

$
550,421

$
286,898

$
183,630

$
137,803


---

76

---





Table of Contents

ITEM 7MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

You should read the following analysis of our consolidated results of operations and financial condition in conjunction with the
consolidated financial statements and related consolidated footnotes included in this Annual Report on Form 10-K.

The
following discussion and analysis presents a review of the Company as of December 31, 2008 and its results of operations for the fiscal years ended December 31, 2008,
2007 and 2006.

Overview

As a result of the MemberHealth acquisition and Medicare Advantage expansion discussed in the notes to our financial statements set
forth above, we have modified the way we manage and report our business compared to that reported during 2006. Our Senior Managed CareMedicare Advantage segment remains unchanged and we
continue to provide separate information on the results of our PFFS and HMO businesses contained in this segment. In addition, we are now including separate information regarding development of our
preferred provider organization, or PPO, within this segment. We have split Part D from our Senior Market Health segment and formed a new segment to include both our Prescription
PathwaySM historical product and its successor, PrescribaRxSM, and our Community CCRxSM product. We have combined the remaining former Senior Market Health
segment, primarily Medicare supplement, with the former Specialty Health and Life & Annuity segments to form a new combined segment, Traditional Insurance. The Senior Administrative
Services segment remains unchanged and we continue to report the corporate activities of our holding company in a separate segment. We have made reclassifications to conform prior year amounts to the
current year presentation. We began to use this segment reporting structure with our annual report on Form 10-K for the year ended December 31, 2007. See
"Note 22Business Segment Information" in our consolidated financial statements included in this annual report on Form 10-K for a description of our segments.

We
report inter-segment revenues and expenses on a gross basis in each of the operating segments but eliminate them in the consolidated results. These inter-segment revenues and expenses
affect the amounts reported on the individual financial statement line items, but we eliminate them in consolidation and they do not change income before taxes. The significant items eliminated are



Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles, known as GAAP.
The preparation of our financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts of reported by us in our consolidated financial statements and
the accompanying notes. Critical accounting policies are ones that require significant subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that
are inherently uncertain. These estimates are based on information available at the time the estimates are made, as well as anticipated future events. Actual results could

77

---



Table of Contents

differ
materially from these estimates. We periodically evaluate our estimates, and as additional information becomes available or actual amounts become determinable, we may revise the recorded
estimates and reflect them in operating results. We believe that the following accounting policies are critical, as they involve the most significant judgments and estimates used in the preparation of
our consolidated financial statements:



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

The
following table presents a summary of our policy-related liabilities by category:

December 31,Liability Type

2008

% of
Total
Policy
Liabilities

2007

% of
Total
Policy
Liabilities($ in thousands)Policyholder account balances

$
396,700


23
%
$
434,859


24
%Future policy benefit reserves:Traditional life insurance


209,986


12
%

202,258


11
%Accident and health


415,026


23
%

414,192


23
%Total future policy benefit reserves


625,012


35
%

616,450


34
%Policy and contract claimsaccident and health


729,070


41
%

735,364


41
%Policy and contract claimsLife


10,133


1
%

12,213


1
%Total policy liabilities

$
1,760,915


100
%
$
1,798,886


100
%




Policyholder account balances represent the balance that accrues to the benefit of the policyholder, otherwise known as the account
value, as of the financial statement date. Account values increase to reflect additional deposits received and interest credited based on the account value. Account values decline to reflect
surrenders and other withdrawals, including withdrawals relating to the cost of

78

---



Table of Contents

insurance
and expense charges. We review the interest crediting rates periodically and adjust them with minimum levels below which the crediting rate cannot fall as we deem necessary.



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



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

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

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



The policy and contract claims liability for our accident and health policies include a liability for unpaid claims, including claims
in the course of settlement, as well as a liability for IBNR claims. Our IBNR, by major product grouping is as follows:

Carrying Value at December 31,Direct and Assumed

Net of Reserves Ceded
to ReinsurersAccident & Health Claims Liability

2008

% of
Total
Policy
Liabilities

2007

% of
Total
Policy
Liabilities

2008

2007($ In thousands)Medicare Part D

$
408,802


23
%
$
352,688


20
%
$
396,205

$
336,218Medicare AdvantagePFFS


197,942


11
%

246,048


13
%

197,075


240,832Medicare AdvantageHMO


59,366


3
%

57,233


3
%

56,367


53,563Medicare supplement


43,590


2
%

46,834


3
%

31,715


33,653Otherspecialty


19,370


2
%

32,561


2
%

16,787


16,346Total accident and health claim liabilities

$
729,070


41
%
$
735,364


41
%
$
698,149

$
680,612


79

---



Table of Contents

The
following factors can affect these reserves and liabilities:



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

We
develop our estimate for IBNR using actuarial methodologies and assumptions, primarily based upon historical claim payment and claim receipt patterns, as well as historical medical
cost trends. Depending on the period for which we are estimating incurred claims, we apply a different method in determining our estimate. For periods prior to the most recent three months, the key
assumption we use in estimating our IBNR is that the completion factor pattern, adjusted for known changes in claim inventory levels and claim payment processes, remains consistent over a specified
rolling period. This period, ranging from 3 to 12 months, is dependent on the type of business with respect to which we are estimating reserves or liabilities. Completion factors result from
the calculation of the percentage of claims incurred during a given period that have historically been adjudicated as of the reporting period. For the most recent three months, we estimate the
incurred claims primarily from a trend analysis based upon per member per month, known as PMPM, claims trends developed from our historical experience in the preceding months, adjusted for known
changes in estimates of recent hospital and drug utilization data, provider contracting changes, changes in benefit levels, product mix, and seasonality.

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

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



80

---



Table of Contents



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



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



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

The
following table presents the components of the change in our accident and health policy and contract claim liabilities for the years ended December 31, 2008, 2007 and 2006:

2008

2007

2006(In thousands)Balance at beginning of year

$
735,364

$
193,391

$
107,156Less reinsurance recoverables


(56,580
)

(54,615
)

(29,258
)Net balance at beginning of year


678,784


138,776


77,898Balances acquired





280,982


Incurred related to:Current year


3,846,808


1,881,554


857,898Prior years


(44,803
)

(1,485
)

(628
)Total incurred


3,802,005


1,880,069


857,270Paid related to:Current year


3,210,310


1,463,482


720,901Prior years


574,495


157,561


75,491Total paid


3,784,805


1,621,043


796,392Net balance at end of year


695,984


678,784


138,776Plus reinsurance recoverables


33,086


56,580


54,615Balance at end of year

$
729,070

$
735,364

$
193,391


The
negative medical cost amount, noted as "prior year development" in the table above, represents favorable adjustments as a result of prior year claim estimates being settled for
amounts less than originally anticipated. These favorable developments occur due to differences between the actual medical utilization and other components of medical cost trends, and actual claim
processing and

81

---



Table of Contents

payment
patterns compared to the assumptions for claims trend and completion factors used to estimate our claim liabilities.

The
claim reserve balances at December 31, 2007 ultimately settled during 2008 for $44.8 million less than originally estimated, representing 2.4% of the incurred claims
recorded in 2007. The majority of the favorable development of 2007 claim reserves resulted from our Senior Managed CareMedicare Advantage segment, including $35.2 million relating
to our PFFS business and $6.9 million relating to our HMO business. The actual claims trends were lower than the original estimate of trend factors as a result of:



Additionally,
our original estimate of the completion factors used to establish reserves at December 31, 2007, which were based upon historical patterns, were lower than the
actual pattern that emerged during 2008. The actual patterns reflect a shortening of the cycle time associated with provider claim submissions and changes in claim payment and recovery patterns
associated with continued enhancements made in our claims processing functions for our PFFS product.

We
have adjusted for the favorable historical trend and completion factor experience together with our knowledge of recent events that may impact current trends and completion factors
when establishing our reserves at December 31, 2008. However, based on our historical experience, it is reasonably likely that our actual trend and completion factors may vary from the factors
used in our December 31, 2008 estimates. Any future variances are expected to be within the ranges presented in our sensitivity analysis table.

During
the fourth quarter of 2008, we determined that a number of PFFS claims had been submitted to us by fictitious providers, as well as by some actual providers, seeking reimbursement
for services that were not rendered. We believe that these activities are part of a pattern that has targeted traditional Medicare, as well as several Medicare Advantage PFFS plans including ours. We
estimate that we paid approximately $18.9 million in benefits as a result of these false claims, mostly incurred in the fourth quarter of 2008, which reduced our fourth quarter profits by
approximately $0.14 per share. These false claims, which we reflected in claims and other benefits in the consolidated statements of operations, did not have any impact on our prior year claim reserve
development, as discussed above.

During
2007, the claim reserve balances at December 31, 2006 ultimately settled for $1.5 million less than originally estimated, representing 0.2% of the incurred claims
recorded in 2006. During 2006, the claim reserve balances at December 31, 2005 ultimately settled for $0.6 million more than originally estimated, representing 0.1% of the incurred
claims recorded in 2005.

In
2007, we acquired MemberHealth. The "balances acquired" line item in the table above represents the accident and health claim liabilities acquired in this transaction.



The following table illustrates the sensitivity of our accident and health IBNR payable at December 31, 2008 to identified
reasonably possible changes to the estimated weighted average completion factors and health care cost trend rates. However, it is possible that the actual completion

82

---



Table of Contents

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

Completion Factor(1):

Claims Trend Factor(2):(Decrease)
Increase
in Factor

Increase
(Decrease) in
Net Accident
& Health
IBNR

(Decrease)
Increase
in Factor

(Decrease)
Increase in
Net Accident
& Health
IBNR($ in thousands)(3
)%
$
2,115


(3
)%
$
(11,269
)(2
)%
$
1,409


(2
)%
$
(7,512
)(1
)%
$
704


(1
)%
$
(3,756
)1
%
$
(704
)

1
%
$
3,7692
%
$
(1,407
)

2
%
$
7,5373
%
$
(2,111
)

3
%
$
11,306


---



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



We defer the following costs of acquiring new business:



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



83

---



Table of Contents



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

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

We
have approximately $238 million of unamortized DAC as of December 31, 2008. Approximately $84 million relates to our Life and Annuity business which we have
entered into an agreement to reinsure. We anticipate that the closing will take place during the second quarter of 2009. Upon the closing of the reinsurance agreement, the Life & Annuity DAC
will be written off as part of the net gain or loss on the transaction.

We
test for the recoverability of DAC at least annually. To the extent that we determine that the present value of future policy premiums and investment income or the net present value
of expected gross profits would not be adequate to recover the unamortized costs, we would write off the excess deferred policy acquisition costs. Based on our review of DAC recoverability as
October 1, 2008, we determined the DAC was recoverable.

84

---



Table of Contents

Goodwill and other intangible assets

Valuation of acquired intangible assets

Business combinations accounted for as a purchase result in the allocation of the purchase consideration to the fair values of the
assets and liabilities acquired, including the present value of future profits, establishing these fair values as the new accounting basis of the acquired assets. The present value of future profits
is based on an estimate of the cash flows of the in force business acquired, discounted to reflect the present value of those cash flows. The discount rate we select depends upon the general market
conditions at the time of the acquisition and the inherent risk in the transaction. We allocate purchase consideration in excess of the fair value of net assets acquired, including the present value
of future profits and other identified intangibles, for a specific acquisition, to goodwill. We perform the allocation of purchase price in the period in which we consummate the purchase. Adjustments,
if any, in subsequent periods relate to resolution of pre-acquisition contingencies, tax matters and refinements made to estimates of fair
value in connection with the preliminary allocation for acquisitions that occurred prior to January 1, 2009.



We must estimate and make assumptions regarding the useful life we assign to our amortizing intangible assets. Set forth below are our
annual amortization policies for each of the main categories of amortizing intangible assets:

Description

Weighted
Average Life
At Acquisition

Amortization BasisInsurance policies acquired


79

The pattern of projected future cash flows for the policies acquired over the estimated weighted average life of the policies acquiredDistribution channel acquired


30

Straight line over the estimated life of the assetMembership base acquired


710

Straight line over the estimated weighed average life of the membership baseTrademarks/tradenames


9

Straight line over the estimated weighted average life of the trademarks/tradenamesLicenses


15

Straight line over the estimated weighed average life of the licensesProvider contracts


10

Straight line over the estimated weighted average life of the contractsNon-compete


7

Straight line over the length of the agreementAdministrative service contracts


6

The pattern of projected future cash flows for the customer contracts acquired over the estimated weighted average life of the contractsHospital network contracts


10

The pattern of projected future cash flows for the hospital network contracts acquired over the estimated weighted average life of the contracts


We
periodically review amortizing intangible assets whenever adverse events or changes in circumstances indicate the carrying value of the asset may not be recoverable.
In assessing recoverability, we must make assumptions regarding estimated future cash flows and other factors to
determine if an impairment loss may exist, and, if so, estimate fair value. If these estimates or their related assumptions change in the future, we may be required to record impairment losses for
these assets. There were no impairment losses relating to our amortizing intangible assets during 2008.

85

---



Table of Contents



SFAS No. 142,Goodwill and Other Intangible Assets, known as SFAS 142,
requires that goodwill balances be reviewed for impairment, at the reporting unit level, at least annually for impairment or more frequently if events occur or circumstances change that would indicate
that a triggering event, as defined in SFAS 142, has occurred. A reporting unit is defined as an operating segment or one level below an operating segment. Our reporting units are equivalent to
our operating segments. We had goodwill allocated to the following reporting units as follows (in thousands):

December 31,2008

2007Senior Managed CareMedicare Advantage(1)

$
77,459

$
77,958Medicare Part D(1)


448,215


520,764Traditional Insurance(2)





3,893Senior Administrative Services


4,357


4,357Total Goodwill

$
530,031

$
606,972


---

The
goodwill impairment test follows a two step process as defined in SFAS 142. In the first step, the fair value of a reporting unit is compared to its carrying value. If the
carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the
reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. This allocation is similar to a purchase price allocation performed in
purchase accounting. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss shall be recognized in an amount equal to that excess.

Our
strategy, long-range business plan, and annual planning process support our goodwill impairment tests. These tests are based primarily on an evaluation of future
discounted cash flows under several scenarios. Outcomes from the discounted cash flow analysis were compared to other market approach valuation methodologies for reasonableness. We used a range of
discount rates that correspond to a market-based weighted-average cost of capital. Key assumptions, including changes in membership, premium yields, medical cost trends and selected government
contract extensions, are consistent with those utilized in our long-range business plan and annual planning process. Other assumptions include levels of economic capital, future business
growth, earnings projections, assets under management for the Traditional reporting unit and the weighted average cost
of capital used for purposes of discounting. Decreases in the amount of economic capital allocated to a reporting unit, decreases in business growth, decreases in earnings projections and increases in
the weighted average cost of capital will all cause the reporting unit's fair value to decrease. If these assumptions differ from actual, the estimates underlying our goodwill impairment tests could
be adversely affected.

The
Company performed its annual goodwill assessment for the individual reporting units as of October 1, 2008. The conclusion reached as a result of the annual goodwill impairment
testing for 2008 was that the fair value of each reporting unit, for which goodwill had been allocated, was in excess of the respective reporting unit's carrying value (the first step of the goodwill
impairment test), except for the Traditional reporting unit. The Company concluded that the fair value of the Traditional reporting

86

---



Table of Contents

unit
had declined, due to decreasing sales outlooks and the lapsation of Medicare supplement policies. As a result of the step 2 analysis, the allocation of the fair value of the Traditional reporting
units to its respective assets and liabilities as of October 1, 2008 indicated an implied level of goodwill of $0. Therefore, the Company recorded an impairment charge of $3.9 million of
goodwill for the Traditional reporting unit.



The fair value for the majority of our fixed maturity and equity securities is determined by market prices supplied by third party
pricing services. Typical inputs used by third party pricing services include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows and
prepayment speeds. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices through recent
reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported
trades, the third party pricing services may use matrix or model processes to develop a security price where future cash flow expectations are developed based upon collateral performance and
discounted at an estimated market rate. Included in the pricing for mortgage-backed and asset-backed securities are estimates of the rate of future prepayments of principal over the remaining life of
the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the
underlying collateral. Actual prepayment experience may vary from these estimates. See Part I, Item 3, Quantitative and Qualitative Disclosures About Market Risk, for a discussion
regarding the interest rate sensitivity of our investment portfolio.

SFAS
No. 157,Fair Value Measurements, known as SFAS 157, requires all publicly-traded companies in the U.S. to classify
their assets based on the certainty with which fair values can be calculated into
three asset categories: Level 1, Level 2 and Level 3. Level 1 assets are the easiest to value accurately based on standard market-based prices and Level 3 are the
most difficult. We have analyzed the third party pricing services valuation methodologies and related inputs, and have also evaluated the various types of securities in our investment portfolio to
determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Based on the results of this evaluation and investment class analysis, we
classified most securities that had prices provided by third party pricing services into Level 2 because the inputs used in pricing the securities are market observable.

The
following table presents the fair value of fixed maturity and equity securities that are carried at fair value by SFAS 157 hierarchy levels, as of December 31, 2008 (in
thousands):

Fair
Value

% of Total
Fair ValueLevel 1

$



Level 2


1,028,449


99.6
%Level 3


4,434


0.4
%$
1,032,883


100.0
%


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

87

---



Table of Contents

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

The
following table presents the fair value of the asset sectors within the SFAS 157 Level 3 securities as of December 31, 2008 (in thousands):

Fair
Value

% of Total
Fair ValueMortgage and asset-backed securities

$
1,862


42.0
%Corporate debt securities


2,082


47.0
%Equity securities


490


11.0
%Total Level 3 securities

$
4,434


100.0
%


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



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

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



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

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



88

---



Table of Contents



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



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

As
of December 31, 2008, we held subprime securities with par values of $140.3 million, an amortized cost of $51.4 million and a market value of $38.3 million
representing approximately 2.4% of our cash and invested assets, with collateral comprised substantially of first lien mortgages. The majority of these securities are in senior or senior-mezzanine
level tranches, which have preferential liquidation characteristics, and have an average rating of AA- by Standard & Poors, a division of the McGraw Hill Companies, Inc.,
known as S&P, or an equivalent rating.

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

Vintage Year

Amortized
Cost

Fair
Value

Unrealized
Loss(In thousands)2003

$
6,243

$
3,991

$
(2,252
)2004


3,308


2,692


(616
)2005


24,928


16,764


(8,164
)2006


12,177


10,388


(1,789
)2007


4,706


4,486


(220
)Totals

$
51,362

$
38,321

$
(13,041
)


We
continuously review our subprime holdings stressing multiple variables, such as cash flows, prepayment speeds, default rates and loss severity, and comparing current base case loss
expectations to the loss required to incur a principal loss, or breakpoint. This breakpoint currently exceeds the base case loss expectation for 21 out of a total of 32 holdings to varying degrees. We
expect delinquency and loss rates in the subprime mortgage sector to continue to increase in the near term but at a decreasing rate. Those securities with a greater variance between the breakpoint and
base case can withstand this further deterioration. However, holdings where the base case is closer to the breakpoint, principally holdings from the 2006 and 2007 vintage years, are more likely to
incur a principal loss. We utilize third party pricing services to provide or estimate market prices. The major inputs used by third party

89

---



Table of Contents

pricing
services include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and estimated cash flows and prepayment speeds. If there are no recent reported
trades, the third party pricing services may use matrix or model processes to develop a security price, as has recently been the case with many of our subprime holdings.

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

2008 Quarter Ended2007

March 31

June 30

September 30

December 31

2008

Cumulative(In thousands)Subprime

$
40,997

$
29,800

$
11,771

$
2,329

$
4,064

$
47,964

$
88,961Other structured








1,384


2,432


829


4,645


4,645Corporate











7,177





7,177


7,177$
40,997

$
29,800

$
13,155

$
11,938

$
4,893

$
59,786

$
100,783


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

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



Medicare is a federal program that provides persons age 65 and over and some disabled persons under the age of 65 hospital and medical
insurance benefits. Hospitalization benefits are provided under Part A, without the payment of any premium, for up to 90 days per incident of illness plus a lifetime reserve aggregating
60 days. Eligible beneficiaries are required to pay an annually adjusted premium to the federal government to be eligible for physician care and other services under Part B.
Beneficiaries eligible for Part A and Part B coverage under traditional Medicare are still required to pay out-of-pocket deductibles and coinsurance. Prescription
drug benefits are provided under Part D. The Centers for Medicare and Medicaid Services, known as CMS, an agency of the United States Department of Health and Human Services, administers the
Medicare program. We contract with CMS under the Medicare Advantage program to provide a comprehensive array of health insurance benefits including wellness programs to Medicare eligible persons under
HMO, PPO, PFFS and stand-alone Part D plans in exchange for contractual payments received from CMS, usually a fixed payment per member per month.

We
routinely monitor the collectability of specific accounts, the aging of receivables, historical retroactivity trends, as well as prevailing and anticipated economic conditions, and
reflect any required adjustments in the current period's revenue.

Premiums
received pursuant to Medicare Advantage contracts with CMS for Medicare enrollees are recorded as revenue in the month in which members are entitled to receive service. Premiums
collected in advance are deferred. Accounts receivable from CMS and health plan members for

90

---



Table of Contents

coordinating
physician services and inpatient, outpatient and ancillary care are included in other assets and are recorded net of estimated bad debts. It is the Company's practice to accrue revenue in
addition
to the premiums received from CMS based upon changes to hierarchical condition categories (HCC) risk scores not then considered by CMS and based solely on the analysis of claims information and
confirmed chart data that is in the possession of the Company. Certain commissions are deferred and recognized in relation to the corresponding revenues for which they are earned, no longer than a
one-year period. Policies and contract claims include actual claims reported but not paid and estimates of health care services incurred but not reported. The estimated claims incurred but
not reported are based on historical data, current enrollment, health service utilization statistics and other related information. Although considerable variability is inherent in such estimates,
management believes that the liability is adequate. Changes in assumptions for medical costs caused by changes in actual experience could cause these estimates to change in the near term.



CMS uses monthly rates per person for each county to determine the fixed monthly payments per member to pay to health benefit plans,
including our HMO, PFFS and PPO plans. CMS has implemented a risk adjustment model which apportions premiums paid to all health plans according to health severity. The risk adjustment model uses
health status indicators, or risk scores, to improve the accuracy of payment. The CMS risk adjustment model pays more for members with predictably higher costs. Under this risk adjustment methodology,
diagnosis data from inpatient and ambulatory treatment settings are used to calculate the risk adjusted premium payment to us. All health benefit organizations must capture, collect, and submit the
necessary diagnosis code information to CMS within prescribed deadlines. Accordingly, we collect, capture, and submit the necessary and available diagnosis data to CMS within prescribed deadlines. We
estimate risk adjustment revenues based upon the diagnosis data submitted to CMS and ultimately accepted by CMS. The risk adjustment revenues are periodically reconciled by CMS and the settlement
could result in adjustments to premium revenue. The stand-alone PDP payment methodology is based on the risk adjustment model, however, we do not have access to diagnosis data with respect to our
stand-alone PDP members. We are reliant on CMS to capture and collect the necessary diagnosis information for these members. Changes in revenues from CMS for our Medicare products resulting from the
periodic changes in risk adjustment scores for our membership are recognized when the amounts become determinable and the collectability is reasonably assured. Our monthly premium payment from CMS
could change materially, either favorably or unfavorably, as a result of changes in the risk scores for the underlying membership of our plans.



We analyze the membership for our Medicare Part D, HMO, PFFS and PPO plans in our administrative system and reconcile to the
enrollment provided by CMS. Our revenues and claims expense are based on the enrollment information provided by CMS. There are timing differences between the addition of members to our administrative
system and the approval, or accretion, of the member by CMS before we are paid for that member by CMS. Additionally, the monthly payments from CMS include adjustments to reflect changes in membership
as a result of
retroactive terminations, additions or other changes. Current period revenues are adjusted to reflect retroactive changes in membership.



We provide prescription drug coverage in accordance with Medicare Part D as a stand-alone benefit to Medicare-eligible
beneficiaries, known as Part D benefits, through our PDPs under multiple contracts with from the CMS On January 1, 2006, we began providing Part D benefits under our Prescription
PathwaySM plans pursuant to a strategic alliance with CVS/Caremark. The Prescription

91

---



Table of Contents

PathwaySM
PDPs sponsored by subsidiaries of Universal American were reinsured, on a 50% coinsurance funds withheld basis, to PharmaCare Re, a subsidiary of CVS/Caremark. The strategic
alliance with CVS/Caremark was terminated as of December 31, 2008. In connection with termination, we divided the membership between Universal American and CVS/Caremark, transferring 236,000
members to CVS/Caremark.

The
remaining 280,000 will continue under our Prescriba RxSM PDP, our successor to Prescription PathwaySM, under which we will participate on a 100% basis in
the plan. In connection with our acquisition of MemberHealth on September 21, 2007, we began providing Part D benefits through Community CCRx PDP. Our Medicare contracts with CMS renew
annually.

In
general, prescription drug benefits under Part D PDPs may vary in terms of coverage levels and out-of-pocket costs for beneficiary premiums, deductibles
and co-insurance. However, all Part D PDPs must offer either "standard coverage" or its actuarial equivalent (with out-of-pocket threshold and deductible
amounts that do not exceed those of standard coverage). These defined "standard" benefits represent the minimum level of benefits mandated by Congress. We also offer other PDPs containing benefits in
excess of standard coverage limits for an additional beneficiary premium.

Our
PDPs receive monthly payments from CMS and members which generally represent our bid amount for providing insurance coverage. The payments from CMS reflect the health status of the
beneficiary and risk sharing provisions, as discussed below. We recognize premium revenue for providing this insurance coverage during each month in which members are entitled to benefits.



Our CMS payment is subject to risk sharing through the Medicare Part D risk corridor provisions. The risk corridor provisions
permit our PDPs and CMS to share the risk associated with the ultimate costs of the Part D benefit. The risk corridor provisions compare a plan's actual prescription drug costs, known as actual
allowable costs, to their targeted costs, as reflected in their bids ("target amount') and could result in positive or negative adjustments to the CMS payment, that are reported through premium
revenues. Variances exceeding, or below, thresholds may result in CMS making additional payments to us, or requiring us to refund to CMS a portion of the payments we received. Actual allowable costs
subject to risk sharing with CMS are limited to the costs that are, or would have been, incurred under the CMS defined "standard" benefit plan. We estimate and recognize an adjustment to premium
revenues related to the risk corridor payment, at the contract level, based upon prescription drug claims experience to date, net of manufacturer rebates and other Part D revenues, at the end
of each reporting period. Accordingly, this estimate does not consider future prescription drug claims experience. We record a receivable or payable in the consolidated balance sheets based on the
expected settlement. The estimate of the settlement associated with risk corridor provisions requires us to consider factors that may not be certain, including, among others, member eligibility
differences with CMS.

Our
CMS payments also include catastrophic reinsurance allowances and Federal subsidies (CMS contract deposits) for which we do not bear risk. These subsidies represent
reimbursements from CMS for claims we pay for which we assume little or no risk. A large percentage of claims paid above the out-of-pocket or catastrophic threshold for which
we are not at risk are reimbursed by CMS through the reinsurance subsidy for PDPs offering the standard coverage. Low-income cost subsidies represent reimbursements from CMS for all or a
portion of the deductible, the coinsurance and co-payment amounts above the out-of-pocket threshold for low-income beneficiaries. Monthly prospective
payments from CMS for reinsurance and low-income cost subsidies are based on assumptions submitted with our annual bid. A reconciliation and related settlement of CMS's prospective
subsidies against actual prescription drug costs we paid is made after the end of the year. We account for these subsidies as deposits in our consolidated balance sheets and as a financing activity

92

---



Table of Contents

in
our consolidated statements of cash flows. We do not recognize premium revenues or claims expense for these subsidies. Receipt and payment activity is accumulated at the contract level and recorded
in our consolidated balance sheets as a CMS contract deposit account asset or liability depending on the net contract balance at the end of the reporting period.

In
order to allow plans offering enhanced benefits the maximum flexibility in designing alternative prescription drug coverage, CMS provided a demonstration payment option in lieu of the
reinsurance subsidy for plans offering enhanced coverage, or coverage beyond CMS's defined standard benefits. The demonstration payment option is an arrangement in which CMS pays a capitation amount
to a
plan for assuming the government's portion of prescription drug costs in the catastrophic layer of coverage. The capitation amount represents a fixed monthly amount per member to provide prescription
drug coverage in the catastrophic layer. We chose the demonstration payment option for all of our enhanced benefit plans. This capitation amount, derived from our annual bid submissions, is recorded
as premium revenue. The variance between the capitation amount and actual drug costs in the catastrophic layer is subject to risk sharing as part of the risk corridor settlement.

Settlement
of the reinsurance and low-income cost subsidies as well as the risk corridor payment is based on a reconciliation made by CMS approximately 9 months after
the close of each calendar year. This reconciliation process requires us to submit claims data necessary for CMS to administer the program. In October 2008, we received the reconciliation settlement
data from CMS for the 2007 Plan year. These amounts were settled on a preliminary basis in the fourth quarter. However, the Company has requested a reopening of the 2007 Plan year. The Company does
not expect any reopening to have a material impact on the consolidated financial statements. In October 2007, we received the reconciliation settlement data from CMS for the 2006 Plan year. These
amounts were settled on a preliminary basis in the fourth quarter of 2007. However, CMS reopened the 2006 Plan year which resulted in the settlement of additional amounts for that Plan year in June
2008. The reopening did not have a material impact on the consolidated financial statements.

At
December 31, 2008, the remaining balance due from CMS for both plans for the 2008 Plan year was approximately $547 million, including approximately $529 million
for reinsurance and low-income cost subsidies and $18 million for the risk corridor. At December 31, 2008, the total due from CMS for both plans for the 2007 Plan year was
approximately $103 million, including approximately $86 million for reinsurance and low-income cost subsidies and $17 million for the risk corridor. The Company
received payment of $80 million for a reopening of the 2007 Plan year on January 2, 2009 and continues to work with CMS to settle the remaining amounts for the 2007 Plan year. At
December 31, 2007, the total due from CMS from both plans for the 2007 Plan year was approximately $451 million, including approximately $406 million for reinsurance and
low-income cost subsidies and $45 million for the risk corridor. At December 31, 2007, the remaining balance due to CMS from both plans for the 2006 Plan year was
approximately $23 million, including approximately $12 million for reinsurance and low-income cost subsidies and $11 million for the risk corridor.

During
2008 and 2007, we also paid Part D benefits for individuals who ultimately were determined to be members of other plans. At December 31, 2008 and 2007, in connection
with both the Prescription PathwaySM and Community CCRx plans, we have established a receivable totaling $17.4 million and $24.2 million, respectively, for these claims
which is included in other Part D receivables on the consolidated balance sheets. Membership information continues to be reconciled and refined by CMS with respect to the enrollment of members
among all plans participating in the Part D program. Additionally, we have established a liability totaling $6.2 million and $11.2 million, at December 31, 2008 and 2007,
respectively, included in policy and contract claims-health on the consolidated balance sheets, for our estimate of claims paid by state Medicaid programs on behalf of members of our PDPs. As these
membership differences are resolved, it is likely that the membership data upon which we based our results for prior plan years will change, with a corresponding change in the financial results for
the segment. We are unable to precisely quantify the impact of any potential

93

---



Table of Contents

change
until the membership data is fully reconciled with CMS; however, we do not believe that any change from the amounts reported as of December 31, 2008 or 2007 is likely to be material.



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

We
establish valuation allowances on our deferred tax assets for amounts that we determine will not be recoverable based upon our analysis of projected taxable income and our ability to
implement prudent and feasible tax planning strategies. We recognize increases in these valuation allowances as deferred tax expense. We reflect portions of the valuation allowances subsequently
determined to be no longer necessary as deferred tax benefits. To the extent that valuation allowances were established in conjunction with acquisitions, we first apply changes in those allowances to
increasing or decreasing the goodwill, but not below zero, or other intangibles related to the acquisition, for acquisitions occurring before January 1, 2009, and then apply those changes as an
increase or decrease in income tax expense.

We
carried valuation allowances on deferred tax assets of $4.4 million at December 31, 2008 and $3.1 million at December 31, 2007 primarily related to the tax
benefits associated with a New York state net operating loss carryforward. At December 31, 2008, we recorded our deferred tax assets based on the amount that was more likely than not to be
realized under SFAS No. 109,Accounting for Income Taxes.

Significant Transactions and Initiatives



Through HMO subsidiaries of Heritage Health Systems, Inc., we operate Medicare Advantage coordinated care plans in Texas,
Oklahoma and Wisconsin. We have continued to increase our marketing of Medicare Advantage plans for Medicare HMOs and PFFS. As of December 30, 2008, our HMO enrollment has increased to
approximately 54,300 members from 46,000 members at December 31, 2007. We elected not to renew our Medicare Advantage HMO contract in Florida for 2008, and, as of January 1, 2008, we had
no HMO membership in Florida.

Through
our insurance subsidiaries American Progressive, Pyramid Life and Marquette we offered our PFFS products in 47 states in 2008, up from 35 states at December 31, 2007. As
of December 31, 2008, our enrollment in PFFS plans has decreased to approximately 186,200 members, compared with 190,000 members at December 31, 2007.

In
late 2007, we began efforts to cultivate provider relationships to establish Medicare Advantage preferred provider organizations, known as PPOs. In December 2007, we advised CMS of
our intent to market PPO products and received approval from CMS to launch PPO plans in 9 states, across 15 markets. Marketing for these PPO plans began on October 1, 2008. We
continue to cultivate provider relationships across additional states and markets, with the anticipation of filing several more markets with CMS in first quarter 2009 for the 2010 benefit year.



Effective January 1, 2006, private insurers were permitted to sponsor insured stand-alone PDPs pursuant to Part D, which
was established by the Medicare Modernization Act. The federal government

94

---



Table of Contents

pays
a portion of the premium for this insurance, and the individuals who enroll pay the balance, if any. The federal government will also provide additional subsidies in the form of premium support,
coverage of the cost-sharing elements of the plan to specified low income Medicare beneficiaries and the federal reinsurance subsidy for claims in the catastrophic benefit phase. For the
2008 plan year, we offered, through our insurance subsidiaries, our Community CCRxSM and Prescription PathwaySM prescription drug plans in all 34 regions designated by CMS
in which we bid. In addition, since we had a national plan bid below the benchmark in 29 and 30 regions, for Community CCRxSM and Prescription PathwaySM, respectively, we
received auto assignment of "dual eligible" and "low income subsidy" beneficiaries who are dually eligible for Medicare and Medicaid in the regions where our bids were below the benchmark.

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

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



On September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held pharmacy benefits
manager, or PBM, and sponsor of Community CCRxSM, a national Medicare Part D plan with 1.2 million members. Prior to the acquisition, MemberHealth was a leading national
Medicare Part D sponsor, offering Medicare prescription drug plans in 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. MemberHealth, Inc. had more than
60,000 pharmacies in its pharmacy network and covered 98 of the top 100 medications taken by Medicare beneficiaries.

We
paid the original purchase price of $630 million, apportioned 55% in cash and 45% in our common stock valued at $20 per share. We paid transaction costs of approximately
$12 million in cash. In addition to the purchase price, the transaction contemplated an additional three year earn-out tied to target earnings from the MemberHealth business. The
maximum aggregate amount potentially payable under the performance-based earn-out was $150 million, payable in cash and our common stock. On December 31, 2008, the maximum
potential payable was amended so that there is no longer a stock portion of the earn-out payment; therefore, the maximum potential payout for any earn-out has been reduced from
$150 million to $82.5 million, representing the 55% cash portion only. Additionally, there was no earn-out earned for 2008, thus further reducing the maximum potential
earn-out from $82.5 million to $55 million for 2009 and 2010.

Subsequent
to December 31, 2007, we determined that expected operating income for 2008 from the MemberHealth business, which we acquired in September 2007, will be less than
previously forecast. The reason for the decline in expected income is that premium payments to MemberHealth will be lower than anticipated based upon the bids submitted to, and later accepted by CMS
from

95

---



Table of Contents

MemberHealth
in June 2007 for its 2008 Part D plans. The premium payments are lower primarily as a result of incorrect information concerning the risk scores in the MemberHealth bids. In
accounting for the issue relating to the 2008 bids, we recorded an acquisition liability of $39.2 million for the below-market contract that we are amortizing into income over the contract
period, January 1, 2008 to December 31, 2008. We reflected this amortization in direct premium and policyholder fees earned in the consolidated statements of operations. See
Note 3 of notes to consolidated financial statements for further discussion.

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

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

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

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

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

96

---



Table of Contents

deferred
taxes of $3.6 million, as an adjustment to goodwill and we reported the post-acquisition amount as a reduction of third quarter claims expense.

After
giving effect to the settlement and the final allocation adjustments discussed above, the excess of the purchase price over the fair value of net tangible assets acquired, adjusted
for deferred income taxes, was approximately $607.6 million.

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

To
fund the cash required to close the transaction and to provide us with capital to support our organic growth, investment funds operated by Lee Equity Partners, LLC, Perry
Capital, LLC, Union Square Partners Management, LLC, the successor to Capital Z Management, LLC, and Welsh, Carson, Anderson & Stowe X, L.P., acquired shares of our
Series A and Series B preferred stock valued at $20 per equivalent share of our common stock. These funds invested a total of approximately $350 million, of which they funded
$100 million in the second quarter of 2007, and the remainder effective September 21, 2007. The preferred stock is convertible into shares of our common stock and does not bear a
dividend. See Note 8Stockholders' Equity to the consolidated financial statements included elsewhere in this annual report on Form 10-K, for additional
information regarding the preferred stock. We did not register the preferred stock under the Securities Act of 1933, as amended, and it may not be subsequently offered or sold by investors in the
United States absent registration or an applicable exemption from the registration requirement.



Medicare supplement insurance reimburses the policyholder for deductibles, co-pays and other specified expenses that are
not covered by standard Medicare coverage. This coverage is designed for people who want the freedom to choose providers who participate in the standard Medicare program and limit their out of pocket
costs to the fixed annual premiums they pay, as opposed to the more restrictive networks that exist in Medicare Advantage HMO markets or the co-payments and deductibles that exist in PFFS
plans. We believe that the market for Medicare supplement products will continue to be attractive, especially because many seniors may lose similar coverage that had previously been offered to them as
a retiree benefit by their former employers.

In
the last two years, there has been increased competition from Medicare Advantage plans, including our own, which has affected our production and persistency of Medicare supplement
business. As a result, we continue to experience higher than expected lapsation in our Medicare supplement business. However, the rate of excess lapsation declined in 2008 compared to our experience
in 2007. This excess lapsation has accelerated the amortization of the deferred acquisition costs and present value of future profits assets associated with the lapsed business. We cannot give
assurances that lapsation of our Medicare supplement business will decline, and continued excess lapsation will require continued accelerated amortization of these assets.



On December 1, 2006, we completed the sale of our Canadian operations for approximately $131 million cash. The sale
resulted in an after-tax realized gain of approximately $48 million and generated approximately $96 million of after tax proceeds. As a result, we have reported our Canadian
operations as discontinued operations. See Note 23Discontinued Operations in our consolidated financial statements included in this annual report on Form 10-K
for a more detailed description of the sale.

97

---



Table of Contents

Results of OperationsConsolidated Overview

The following table reflects income (loss) from each of our segments and contains a reconciliation to reported net income:

For the year ended December 31,2008

2007

2006(In thousands)Senior Managed CareMedicare Advantage(1)

$
94,625

$
52,726

$
10,509Medicare Part D(1)


127,444


116,888


49,190Traditional Insurance(1)(2)


4,845


14,106


35,842Senior Administrative Services(1)


22,020


24,124


15,840Corporate(1)


(37,949
)

(35,040
)

(22,443
)Net realized (losses) gains on investments


(59,681
)

(40,178
)

4,818Income before provision for income taxes(1)


151,304


132,626


93,756Provision for income taxes


56,212


48,554


32,610Income from continuing operations


95,092


84,072


61,146Discontinued Operations:Income from discontinued operations, net of income taxes








9,788Gain on sale of discontinued operations, net of taxes








48,372Income from discontinued operations








58,160Net income

$
95,092

$
84,072

$
119,306Earnings per common share (diluted):Continuing operations

$
1.08

$
1.18

$
1.02Discontinued operations








0.97Net income

$
1.08

$
1.18

$
1.99


---



Net income for 2008 was $95.1 million, or $1.08 per diluted share, compared to $84.1million, or $1.18 per diluted share for
2007. Net income for 2008 reflects realized investment losses, net of tax, of $38.8 million, or $0.44 per diluted shares, relating primarily to the recognition of
other-than-temporary impairment of some of our securities with exposure to subprime mortgages, other structured securities and corporate securities . Income from continuing
operations for 2007 reflects realized investment losses, net of tax, of $26.1 million, or $0.37 per diluted shares, relating primarily to the recognition of
other-than-temporary impairment of some of our securities with exposure to subprime mortgages.

Our
Senior Managed CareMedicare Advantage segment generated segment income before taxes of $94.6 million in the year ended December 31, 2008, an increase of
$41.9 million compared to 2007, primarily due to growth in HMO and PFFS member months, $35.2 million of net positive 2007 development in our PFFS business, $6.9 million of net
positive 2007 development in our HMO business and improved PFFS and HMO medical loss ratios, partially offset by false claims of $18.9 million

98

---



Table of Contents

submitted
by fictitious providers in our PFFS business, lower investment income due to declining short term interest rates and $12.3 million of start-up costs mainly associated with
the establishment of our PPO networks.

Our
Medicare Part D income increased by $10.6 million, compared to the year ended December 31, 2007. We acquired MemberHealth on September 21, 2007 and our
results for the year ended December 31, 2008 reflect income of $89.4 million on MemberHealth's business, which is an increase of $26.1 million over the prior year period. This was
partially offset by a decrease in year to date earnings on Prescription PathwaySM business of $15.5 million compared with the prior year period, primarily as a result of increases
in prescription drug costs and the impact of the government risk corridor.

Our
Traditional Insurance segment income before taxes decreased by $9.3 million compared to 2007, due to $3.9 million impairment of goodwill and lower earnings on specialty
health and life insurance and annuity businesses, partially offset by increased earnings on Medicare supplement business. The
declines were primarily due to lower investment income. The overall loss ratio for the segment was 76.8% for 2008, compared with 75.3% for last year. Individual loss ratios for 2008 were 75.2% for
Medicare supplement, compared with 73.4% for last year, due to higher skilled nursing facility claims and aging of the business; 91.7% for specialty health, compared with 90.1% for last year and 65.8%
for life and annuity, compared with 67.1% for last year.

Segment
income before taxes for our Senior Administrative Services segment decreased by $2.1 million, or 9%, to $22.0 million for the year ended December 31, 2008,
as compared to 2007. This decrease is primarily the result of reduced levels of unaffiliated service fee revenues.

The
loss from our Corporate segment increased by $2.9 million, or 8%, for the year ended December 31, 2008 compared to the 2007. The increase was due primarily to an
increase in interest costs and the cost of stock based compensation, partially offset by lower other parent company expenses, net of revenues and the non-recurring early extinguishment of
debt costs incurred in 2007.



Net income for 2007 was $84.1 million, or $1.18 per diluted share, compared to $119.3 million, or $1.99 per diluted share
for 2006. Income from continuing operations increased by 37% compared to income from continuing operations of $61.1 million, or $1.02 per diluted share, for 2006. Income from continuing
operations for 2007 reflects realized investment losses, net of tax, of $26.1 million, or $0.37 per diluted shares, relating primarily to the recognition of
other-than-temporary impairment of some of our securities with exposure to subprime mortgages. Income from continuing operations for 2006 reflects realized investment gains,
net of tax, of $5.0 million, which reflects a benefit from a $1.9 million release of a tax valuation allowance relating to net capital loss carryforwards.

Results
for 2007 include MemberHealth from September 21, 2007, the date of its acquisition by us, which generated incremental revenues of $318.3 million and
pre-tax income of $63.3 million. In connection with the acquisition and related refinancing, we issued 31.7 million common equivalent shares of equity securities and incurred
a pre-tax expense of $0.6 million, after-tax, related to the immediate amortization of the remaining capitalized loan fees on the debt that we refinanced. In connection
with issues that arose in 2008 with respect to the MemberHealth transaction, in March 2008, we concluded a settlement agreement under which the sellers of MemberHealth delivered to us 2,027,071 shares
of our common stock.

Our
effective tax rate for continuing operations was 36.6% for 2007, and 34.8% for 2006, reflecting the release of the valuation allowance noted above.

Net
income for 2006 included income from discontinued operations, after taxes, including the gain on the sale of PennCorp Life, was $58.2 million or $0.97 per diluted share.

99

---



Table of Contents

Our
senior managed careMedicare Advantage segment generated segment income of $52.7 million in 2007, an increase of $42.2 million compared to 2006, resulting
primarily from growth in business due to our expansion of PFFS plan offerings from 500 counties in 15 states to 3,100 counties in 47 states.

Our
Medicare Part D income increased by $67.7 million, or 138%, compared to 2006. This reflects $63.3 million on MemberHealth's business since September 21,
2007, the date of acquisition, a period of the year that typically represents the highest operating results for prescription drug plans due to the seasonal nature of the benefits provided.

Our
traditional insurance segment income decreased by $21.7 million, or 61%, compared to 2006. Results for our Medicare supplement business declined by $9.7 million
compared to 2006 primarily as a result of a lower level of in force business as a result of the effect of higher levels of lapsation of our Medicare supplement in force business in 2007 and 2006 and
an increase in our Medicare supplement medical loss ratio. A significant portion of the lapsation was attributable to Medicare supplement policyholders who switched to our PFFS coverage. Our specialty
health insurance income decreased by $6.3 million, or 62%, compared to 2006, primarily as the result of increased medical costs and an increase in the amortization of deferred costs in 2007
compared to 2006, partially offset by higher net investment income. Income from our life insurance and annuity business declined by $4.1 million, compared to 2006, primarily as a result of
higher commissions and general expenses.

Segment
income for our senior administrative services segment increased by $8.3 million, or 52%, to $24.1 million for the year ended December 31, 2007, as compared
to 2006. This increase is primarily the result of the growth in business administered.

The
loss from our corporate segment increased by $12.6 million, or 56%, for the year ended December 31, 2007 compared to 2006. The increase was due primarily to the
increase in interest costs, the cost associated with the early extinguishment of debt and the cost of stock based compensation, offset by an increase in net investment income.

Segment ResultsSenior Managed CareMedicare Advantage

For the year ended December 31,Total Segment

2008

2007

2006(In thousands)Net premiums

$
2,404,067

$
1,920,309

$
444,663Net and other investment income


16,626


23,142


5,972Total revenue


2,420,693


1,943,451


450,635Medical expenses


2,001,163


1,611,824


332,248Amortization of intangible assets


4,056


3,844


3,479Commissions and general expenses


320,849


275,057


104,399Total benefits, claims and other deductions


2,326,068


1,890,725


440,126Segment income before taxes

$
94,625

$
52,726

$
10,509


Our
Senior Managed CareMedicare Advantage segment reflects the operations of our PFFS business and our HMOs, which offer coverage to Medicare beneficiaries in southeastern
Texas, north Texas, Oklahoma and Wisconsin. These businesses provide managed care for seniors under a contract with CMS. Our career and independent agents sold PFFS through American Progressive,
Pyramid Life and Marquette in approximately 3,100 counties across 47 states. Our HMO products are sold by our career and independent agents and directly by employee representatives. Beginning in 2008,
this segment also reflects start up costs associated with the establishment of affiliated PPO organizations.

100

---



Table of Contents



Our Senior Managed CareMedicare Advantage segment generated segment income before taxes of $94.6 million in the
year ended December 31, 2008, an increase of $41.9 million compared to 2007, primarily due to growth in HMO and PFFS member months, $35.2 million of net positive 2007 development
in our PFFS business, $6.9 million of net positive 2007 development in our HMO business and improved PFFS and HMO medical loss ratios, partially offset by false claims of $18.9 million
submitted by fictitious providers in our PFFS business, lower investment income due to declining short term interest rates and $12.3 million of start-up costs mainly associated with
the establishment of our PPO networks.



Our Senior Managed CareMedicare Advantage segment generated segment income of $52.7 million in 2007, an increase of
$42.2 million compared to 2006, primarily due to growth in business due to our expansion of PFFS plan offerings from 500 counties in 15 states in 2006 to 3,100 counties in 47 states in
2007.

For the year ended December 31,PFFS

2008

2007

2006(In thousands)Net premiums

$
1,740,948

$
1,412,842

$
111,278Net and other investment income


10,093


15,419


988Total revenue


1,751,041


1,428,261


112,266Medical expenses


1,495,209


1,217,884


87,843Commissions and general expenses


205,014


187,515


34,765Total benefits, claims and other deductions


1,700,223


1,405,399


122,608Income before taxes

$
50,818

$
22,862

$
(10,342
)


Membership.For a discussion of the accounting for PFFS and other Medicare Advantage policies, see Note 2 of the notes to the
consolidated
financial statements in our annual report on Form 10-K. There are timing differences between the addition of members to our administrative system and the approval, or accretion, of
the member by CMS before CMS pays us for the member. We analyze the membership in our administrative system and the enrollment provided by CMS. We recognize these timing delays and that CMS may not
approve the Medicare beneficiary for enrollment in our plans. Although we are unable to precisely quantify the impact of any potential member change from that used in our consolidated financial
results, we do not believe that any change from the amounts reported as of December 31, 2008 is likely to be material.



Revenues.Net premiums for the PFFS business increased by $328.1 million compared to 2007, primarily due to growth in member
months and higher
revenue per member. Membership decreased to approximately 186,200 as of December 31, 2008 from approximately 190,000 as of December 31, 2007. However, the member months for the year
ended December 31, 2008 increased to approximately 2,242,000 from approximately 2,041,000 for the year ended December 31, 2007 as a result of the timing of the effective date of
membership for each period. Net investment and other income decreased by $5.3 million, due primarily to lower yields of invested assets as a result of a decline in short term interest rates and
lower invested asset levels.

101

---



Table of Contents

Benefits, Claims and Expenses.Medical expenses increased by $277.3 million compared to 2007, primarily due to growth in member
months and
false claims of $18.9 million submitted by fictitious providers. 2008 results also include $35.2 million of positive prior period reserve development. The PFFS medical loss ratio
decreased to 85.9% for 2008 from 86.2% for 2007. Backing out the impact of 2007 positive development and the false claims, the medical loss ratio for 2008 was 86.5%. Commissions and general expenses
increased by $17.5 million compared to 2007, due primarily to the growth in business.



Revenues.Net premiums for the PFFS business increased by $1.3 billion compared to 2006, primarily due to growth in membership.
Membership
increased to approximately 190,000 as of December 31, 2007
from approximately 18,000 as of December 31, 2006. Net investment income increased by $14.4 million, due primarily to growth in invested assets as a result of growth in business.

Benefits, Claims and Expenses.Medical expenses increased by $1.1 billion, compared to 2006, primarily due to growth in membership
combined
with an increase in the medical loss ratio. The PFFS medical loss ratio increased to 86.2% for 2007 from 78.9% for 2006 primarily due to more competitively priced products. Commissions and
general expenses increased by $152.8 million compared to 2006, due primarily to the growth in business.

For the year ended December 31,HMOs

2008

2007

2006(In thousands)Net premiums

$
663,120

$
507,466

$
333,386Net and other investment income


6,533


7,723


4,984Total revenue


669,653


515,189


338,370Medical expenses


505,954


393,939


244,405Amortization of intangible assets


4,056


3,844


3,479Commissions and general expenses


103,573


87,542


69,635Total benefits, claims and other deductions


613,583


485,325


317,519Income before taxes

$
56,070

$
29,864

$
20,851




Revenues.Net premiums for our HMOs increased by $155.7 million, or 31%, compared to 2007. Approximately $143.1 million of
the increase
was due to the growth in Medicare membership along with higher member risk scores and additional 2007 risk score revenue received during the year. Medicare membership increased to approximately 54,300
members at December 31, 2008 from approximately 45,700 at December 31, 2007. Revenue from the commercial business in Oklahoma increased $13.6 million due to growth in membership
and because 2007 included ten months of commercial operations whereas the 2008 included a full twelve months of operations.

Benefits, Claims and Expenses.Medical expenses increased by $112.0 million, or 28%, compared to 2007. Growth in Medicare
membership added
approximately $104.7 million and growth in commercial business added $11.8 million which was offset by $4.4 million due to a decrease in utilization of member benefits. The member
benefit ratio for the HMOs decreased to 76.3% for 2008, from 77.6% for 2007, as a result of $6.9 million of positive prior period reserve development, a $4.1 million 2007 risk score
adjustment recorded during the year and a decrease in utilization of member benefits. Commissions and general expenses, while increasing $16.0 million compared to 2007,

102

---



Table of Contents

decreased
as a percent of net premiums by 1.7% from 17.3% for 2007 to 15.6% for 2008. For 2007, start-up costs associated with the acquisition of members in new markets were incurred.



Revenues.Net premiums for our HMOs increased by $174.1 million, or 52%, compared to 2006, primarily due to growth in membership.
Medicare
membership increased to approximately 45,700 members at December 31, 2007 from approximately 35,400 at December 31, 2006. Additionally, in connection with the acquisition of Harmony
Health in March 2007, we acquired approximately 10,600 commercial members which represent approximately $28.3 million of the increase in net premiums. The Harmony Health commercial business had
a medical loss ratio of 87.4% for 2007. This commercial business is capitated through an arrangement with the seller, the Oklahoma City Clinic. Net investment income increased by $2.7 million,
due primarily to growth in invested assets as a result of growth in business.

Benefits, Claims and Expenses.Medical expenses increased by $149.5 million, or 61%, compared to 2006. Growth in Medicare
membership added
approximately $106.8 million and the Harmony Health commercial business added $24.7 million. Of the remaining $18.0 million balance, $9.1 million was due to an increase in
the medical loss ratio due to a change in the mix of business for new markets, and $8.9 million was due to increase of utilization of member benefits. The medical loss ratio for the HMOs
increased to 77.6% for 2007, from 73.3% for 2006, as a result of entering new markets, a change in the mix of business, as described previously, and an increase in utilization of member benefits and
provider compensation. The medical loss ratio for 2007 reflects the commercial business from the acquisition of Harmony Health. Excluding the commercial business, the loss ratio for the HMOs was
77.1%. Commissions and general expenses increased by $17.9 million compared to 2006, due primarily to the growth in business and an increase in commissions as more of the Medicare Advantage
product is being sold by our agents.

For the year ended December 31,PPOs

2008

2007

2006(In thousands)Net premiums

$


$


$
Net and other investment income








Total revenue








Medical expenses








Amortization of intangible assets








Commissions and general expenses


12,263





Total benefits, claims and other deductions


12,263





Loss before taxes

$
(12,263
)
$


$





Expenses.Commissions and general expenses amounted to $12.3 million in 2008 due to the costs of establishing provider networks in
preparation
for our initial launch of PPO plans in 2009.

103

---



Table of Contents

Segment ResultsMedicare Part D

For the year ended December 31,2008

2007

2006(In thousands)Direct and assumed premium

$
2,089,226

$
950,986

$
551,311Risk corridor adjustment/government reinsurance


9,273


(113,545
)

(69,137
)Direct and assumed premium after risk corridor adjustment


2,098,499


837,441


482,174Ceded premium


(296,372
)

(258,650
)

(237,363
)Net premium


1,802,127


578,791


244,811Other Part D incomePDMS


72,813


56,664


46,187Total Part D revenue


1,874,940


635,455


290,998Net investment and other income


21,130


7,083


3,141Total revenue


1,896,070


642,538


294,139Pharmacy benefits


1,533,090


427,195


213,909Amortization of intangible assets


16,022


4,437


Commissions and general expenses


219,514


94,018


31,040Total benefits, claims and other deductions


1,768,626


525,650


244,949Segment income before taxes

$
127,444

$
116,888

$
49,190


On
January 1, 2006, we began providing prescription drug benefits in accordance with Medicare Part D as a stand-alone benefit to Medicare eligible beneficiaries under our
Prescription PathwaySM PDPs. Through our strategic alliance with Caremark, we retain 50% of the Medicare Part D business of our Prescription PathwaySM PDPs.
PharmaCare Re reinsures the remainder on a 50% quota share basis. Additionally, as part of the strategic alliance, we created PDMS, which is 50% owned by us and 50% owned by Caremark. PDMS principally
performs marketing and risk management services on behalf of our Prescription PathwaySM PDPs. In February 2008, we announced that the parties are terminating this strategic alliance
effective December 31, 2008. Upon termination of the strategic alliance, Caremark and Universal American will each assume responsibility for the drug benefit of specified Prescription
PathwaySM plan members to achieve an approximately equal distribution of the value of business that has been generated by the strategic alliance. We will continue to operate PDPs derived
from this business under the name PrescribaRxSM.

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

On
September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held pharmacy benefits manager, or PBM, and sponsor of Community
CCRxSM, a national Medicare Part D plan with 1.2 million members. Prior to the acquisition, MemberHealth was a leading national Medicare Part D sponsor, offering
Medicare prescription drug plans in 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. MemberHealth, Inc. had more than 60,000 pharmacies in its pharmacy network and
covered 98 of the top 100 medications taken by Medicare beneficiaries.

104

---



Table of Contents

For
a discussion of the accounting for Part D see Notes 2 and 21 of the notes to the consolidated financial statements and critical accounting policies in our annual report
on Form 10-K. Our revenues and claims expense are based on earned premium and incurred pharmacy benefits for the reported enrolled membership. The membership information is subject
to reconciliation and refinement with CMS with respect to the allocation among all plans participating in the Part D program and is an on-going process. As a result of the
on-going reconciliation process, it is likely that the membership data upon which we based our results will change, with a corresponding change in the financial results for the segment. We
are unable to precisely quantify the impact of any potential change until the membership data for specific time periods is fully reconciled with CMS, however, based upon our past experience, we do not
believe that the effect of any change from the amounts reported as of December 31, 2008 is likely to be material.

Other
Part D incomePDMS represents our equity in the earnings of PDMS. We report this as revenue for segment reporting purposes in analyzing the ratio of net pharmacy
benefits incurred because the amount is incorporated in the calculation of the risk corridor adjustment reported to CMS. As discussed above and at Note 21 of the notes to the consolidated
financial statements, this strategic alliance was terminated, effective December 31, 2008. For consolidated reporting, we reflect this amount as a separate line following income from continuing
operations. See the reconciliation of segment revenues in Note 22 of the notes to the consolidated financial statements in this quarterly report on Form 10-K.



Our Medicare Part D income increased by $10.6 million, compared to the year ended December 31, 2007. We acquired
MemberHealth on September 21, 2007 and our results for the year ended December 31, 2008 reflect income of $89.4 million on MemberHealth's business, which is an increase of
$26.1 million over the prior year period. This was partially offset by a decrease in year to date earnings on Prescription PathwaySM business of $15.5 million compared with
the prior year period, primarily as a result of increases in prescription drug costs and changes in the calculation of the government risk corridor.

Membership.At December 31, 2008, our total membership for Medicare Part D was 1,835,000 members compared to 1,669,000 members
at
December 31, 2007, an increase of 166,000 members or 10% over December 31, 2007. The increase is principally attributable to growth from open enrollment, and dual
eligible members auto assigned to our plans in 2008. For Medicare Part D, we based our membership on enrollment information provided by CMS which indicated that, as of December 31, 2008,
approximately 1,835,000 members were enrolled. for which we were paid by CMS. At December 31, 2008, our Part D membership reflects approximately 1,308,000 members enrolled in our
Community CCRxSM PDP and 527,000 members enrolled in our Prescription PathwaySM business, which we participate in on a 50% basis. Prior to January 1, 2008, we
participated, on a 33.3% basis, in Arkansas BCBS which had approximately 25,000 members at December 31, 2007.

Revenues.Direct and assumed premium after risk corridor adjustment increased by $1,261.1 million, or 151%, compared to the prior
year period.
This growth resulted primarily from the inclusion of a full year of business for MemberHealth which generated $1,542.8 million of direct and assumed premium for the year ended
December 31, 2008 compared to $398.2 million in the three months after acquisition in 2007. The MemberHealth premium reflects $39.2 million of amortization of the below market
contract liability recorded in connection with the MemberHealth acquisition. The change in the government risk corridor adjustment increased revenue by an additional $122.8 million compared to
the year ended December 31, 2007. The government risk corridor adjustment from MemberHealth for the year ended December 31, 2008 was an increase in revenues of $13.3 million,
which was an increase of $93.4 million over the prior year as we acquired MemberHealth on September 21, 2007. The government risk corridor adjustment from our Prescription
PathwaySM business decreased revenue $1.4 million for the year ended December 31, 2008 compared to a decrease of $33.4 million for the same period in 2007. The 2008
revenues reflect a $3.9 million reduction related to the final 2007 CMS PDE reconciliation for Prescription PathwaySM business.

105

---



Table of Contents

Other Part D incomePDMS increased by $16.1 million compared to the year ended December 31, 2007 as a result of growth in
business at Prescription PathwaySM and increased revenue rates. Net investment and other income increased by $14.0 million principally as a result of the inclusion of revenue
earned by MemberHealth for third party services, partially offset by lower rates of return on investments.

Benefits, Claims and Expenses.Pharmacy benefits increased by $1,105.9 million compared to the year ended December 31, 2007.
The
MemberHealth business generated $1,262.2 million of benefits for the year ended December 31, 2008, which was an increase of $1,067.7 million over the prior year period due to the
acquisition of MemberHealth on September 21, 2007. The 2008 pharmacy benefits reflect a $2.0 million reduction related to the final 2007 CMS PDE reconciliation for MemberHealth. Pharmacy
benefits for our Prescription PathwaySM business increased by $38.2 million or 16% over the prior year period. The ratio of incurred prescription drug benefits to net premium for
our Medicare Part D business was 85.1% compared to 73.8% for 2007 primarily as a result of the impact in 2008 of the negative 2007 revenue adjustments discussed above as well as increased
benefits. Amortization of intangibles increased $11.6 million as the result of a full year of amortization of intangible assets recorded in connection with the acquisition of MemberHealth
compared with three months in 2007. Commissions and general expenses increased by $125.5 million, compared to the year ended December 31, 2007. Commissions and general expenses for our
PBM and CCRx business increased $121.8 million over the prior year as a result of a full year in 2008 compared to three months in 2007. The balance of the increase of $3.7 million
relates to the growth in our Prescription PathwaySM business.



Our Medicare Part D income increased by $67.7 million, or 138%, compared to 2006. This reflects $63.3 million on
MemberHealth's business since the date of acquisition on September 21, 2007 and is for a period of the year that typically represents the highest operating results for prescription drug plans
due to the seasonal nature of the benefits provided.

Membership.At December 31, 2007, our total membership for Medicare Part D was 1,669,000 members compared to 456,000 members
at
December 31, 2006, an increase of 1,213,000 members principally attributable to our acquisition of MemberHealth. For Prescription PathwaySM, we based our membership on enrollment
information provided by CMS which indicated that, as of December 31, 2007, approximately 480,000 members were enrolled, that we participate in on a 50% basis, for which we were paid by CMS.
This represents an increase of 11% over the December 31, 2006 membership of approximately 432,000. We also participated, on a 33.3% basis, in BCBS that had approximately 25,000 members at
December 31, 2007, and 24,000 at December 31, 2006. As a result of our acquisition of MemberHealth, our Part D membership as of December 31, 2007, also reflects
approximately 1,164,000 members enrolled in our Community CCRxSM PDP.

During
the third and fourth quarters of 2007, there were changes in estimates associated with our 2006 Medicare Part D reconciliations. These were mainly a result of additional
submissions of prescription drug event or 'PDE' data to CMS, and finalization of the 2006 membership adjustments between plans. This additional information affected our estimates of selected subsidies
from CMS and claims we pay for which we assume little or no risk, including reinsurance payments and low-income cost subsidies with a resulting impact on the risk corridor calculation for
2006. The net impact, after our 50% quota share reinsurance from PharmacareRe, was $0.8 million and $0.9 million in the third and fourth quarter, respectively.

Revenues.Direct and assumed premium increased by $399.7 million, or 72%, compared to 2006. This growth resulted primarily from
the
MemberHealth acquisition, which generated $398.2 million of direct and assumed premium in the fourth quarter of 2007. The change in the government risk corridor

106

---



Table of Contents

adjustment
reduced revenue by an additional $44.4 million compared to 2006. The government risk corridor adjustment from MemberHealth produced a reduction in revenues of $80.1 million.
The government risk corridor adjustment from our Prescription Pathway business yielded $36.2 less of a reduction in revenue in 2007 compared to 2006. The change in the risk corridor adjustment was
primarily due to the clarification of the CMS guidance regarding direct and indirect remuneration, known as DIR, and as a result of changes in estimates associated with the 2006 Medicare Part D
Reconciliations. Ceded premium increased $21.3 million from 2006, in relation to the increase in net premiums on Prescription PathwaySM business. Ceded reinsurance on the
MemberHealth business is minimal.

Other
Part D incomePDMS increased by $10.5 million compared to 2006 as a result of growth in business at PDMS. Net investment and other income increased by
$3.9 million as a result of growth in invested assets as result of growth in business.

Benefits, Claims and Expenses.Pharmacy benefits increased by $213.3 million compared to 2006. The MemberHealth business generated
$194.6 million of benefits since its acquisition, while benefits for our Prescription PathwaySM business increased by $18.7 million or 8.7% over 2006. During the second
quarter of 2007, CMS clarified their guidance regarding the treatment of DIR relative to catastrophic reinsurance claims. Previously, only rebates were netted against the claim costs that were subject
to the government's catastrophic reinsurance. Pursuant to the new guidance, other DIR must also be netted against those claim costs to determine the amount the government will cover. With respect to
Prescription PathwaySM business, this increased claims costs, net of our 50% quota share reinsurance, by approximately $7.0 million, including $5.8 million relating to
2006. The increase in claims costs was partially offset by an increase in the risk corridor adjustment. The clarification of the CMS guidance added approximately $7.0 million, net of our 50%
quota share reinsurance with respect to the Prescription PathwaySM business. Additionally, changes in estimates associated with our 2006 Medicare Part D reconciliations resulted
in a reduction of benefits by $14.9 million, net of our 50% quota share, with the balance of the increase due to an increase in membership. The ratio of incurred prescription drug benefits to
net premium for 2007 was 73.8% compared to 87.4% for 2006. Commissions and general expenses increased by $63.0 million, compared to 2006. MemberHealth added $56.0 million since its
acquisition. The balance of the increase of $7.0 million relates to the growth in our Prescription PathwaySM business.

107

---



Table of Contents



For the year ended December 31,2008

2007

2006(In thousands)Premiums:Direct and assumed

$
701,763

$
921,275

$
982,625Ceded


(307,488
)

(479,112
)

(474,155
)Net premiums


394,275


442,163


508,470Net investment income


60,189


71,189


65,449Other income


1,120


1,311


3,467Total revenue


455,584


514,663


577,386Policyholder benefits


302,608


332,971


373,377Interest credited to policyholders


14,736


17,819


18,346Change in deferred acquisition costs


14,273


15,389


(16,110
)Amortization of intangible assets


3,319


3,530


4,094Goodwill impairment


3,893





Commissions and general expenses, net of allowances


111,910


130,848


161,837Total benefits, claims and other deductions


450,739


500,557


541,544Segment income before taxes

$
4,845

$
14,106

$
35,842




Our Traditional Insurance segment income before taxes decreased by $9.3 million compared to 2007, due to $3.9 million
impairment of goodwill and lower earnings on specialty health and life insurance and annuity businesses, partially offset by increased earnings on Medicare supplement business. The declines were
primarily due to lower investment income. The overall loss ratio for the segment was 76.8% for 2008, compared with 75.3% for last year. Individual loss ratios for 2008 were 75.2% for Medicare
supplement, compared with 73.4% for last year, due to higher skilled nursing facility claims and aging of the business; 91.7% for specialty health, compared with 90.1% for last year and 65.8% for life
and annuity, compared with 67.1% for last year.

Revenues.Net premium declined by $47.9 million or 11% and was primarily caused by the continued effect of lapsation of our
Medicare
supplement in force products. Below is a summary of premium for the segment by major lines of business.

Year ended December 31,2008

2007Gross

Ceded

Net

Gross

Ceded

Net(In thousands)Medicare supplement

$
373,990

$
(99,539
)
$
274,451

$
429,041

$
(117,924
)
$
311,117Specialty health


251,217


(184,209
)

67,008


414,256


(340,848
)

73,408Life insurance and annuity


76,556


(23,740
)

52,816


77,978


(20,340
)

57,638Total premium

$
701,763

$
(307,488
)
$
394,275

$
921,275

$
(479,112
)
$
442,163


Both
direct and ceded premiums for specialty health declined by $153 million as a result of the termination of the State of Connecticut reinsurance agreement effective
June 30, 2008.

Net
investment income decreased by $11.0 million as a result of less invested assets caused by less business in force as well as lower interest rates.

108

---



Table of Contents

Benefits, Claims and Expenses.Policyholder benefits incurred and interest credited to policyholders declined by $33.4 million, or
10%,
compared to 2007. This decline was principally caused by a net reduction in Medicare supplement benefits of $21.8 million as well as declines in the levels of Specialty Health and Life and
Annuity benefits as a result of a decline in the business partially offset by an increase in the Medicare Supplement loss ratio to 75.2% for 2008 from 73.4% for last year.

During
our annual valuation of the recovery of goodwill, we concluded that the fair value of the Traditional reporting unit had declined, and as a result, we recorded an impairment
charge of $3.9 million to eliminate its goodwill. For further discussion of this adjustment, refer to Note 4 of notes to consolidated financial statements elsewhere in this Annual Report
on Form 10K.

Commissions
and general expenses, net of reinsurance allowances, decreased by $18.9 million, or 15%, compared to 2007. The following table details the components of commission and
other operating expenses, net of allowances:

Year ended
December 31,2008

2007(In thousands)Commissions

$
63,752

$
86,483Other operating costs


80,200


84,561Reinsurance allowances


(32,042
)

(40,196
)Commissions and general expenses, net of allowances

$
111,910

$
130,848


The
lower level of commissions is associated with the continued aging of our in force renewal premium and less new business production, which has higher commission rates. Other operating
costs were $4.4 million lower for 2008 compared to 2007 as a result of lower acquisition expenses due to less new business production and lower fixed costs. Reinsurance allowances received from
reinsurers decreased $8.2 million for 2008 from 2007, primarily due to the non-renewal of the State of Connecticut agreement with PharmaCare Re on July 1, 2008 as well as a
reduction in new business ceded and the effects of normal lower commission allowances on our aging base of ceded renewal business.



Our traditional insurance segment income decreased by $21.7 million, or 61%, compared to 2006. Results for our Medicare
supplement business declined by $9.7 million compared to 2006 primarily as a result of a lower level of in force business as a result of the effect of higher levels of lapsation of our Medicare
supplement in force business in 2007 and 2006 and an increase in our Medicare supplement medical loss ratio. A significant portion of the lapsation was attributable to Medicare supplement
policyholders who switched to our PFFS coverage. Our specialty health insurance income decreased by $6.3 million, or 62%, compared to 2006, primarily as the result of increased medical costs
and an increase in the amortization of deferred costs in 2007 compared to 2006, partially offset by higher net investment income. Income from our life insurance and annuity business declined by
$4.1 million, compared to 2006, primarily as a result of higher commissions and general expenses.

109

---



Table of Contents

Revenues.Net premium declined by $66.3 million or 13%, and was primarily caused by the continued effect of higher lapsation of our
Medicare
supplement in force products. Below is a summary of premium for the segment by major lines of business:

Premium

Year ended December 31,2007

2006Gross

Ceded

Net

Gross

Ceded

Net(In thousands)Medicare Supplement

$
429,041

$
(117,924
)
$
311,117

$
514,582

$
(146,131
)
$
368,451Specialty Health


414,256


(340,848
)

73,408


389,629


(311,186
)

78,443Life Insurance & Annuity


77,978


(20,340
)

57,638


78,414


(16,838
)

61,576Total Premium

$
921,275

$
(479,112
)
$
442,163

$
982,625

$
(474,155
)
$
508,470


Benefits, Claims and Expenses.Policyholder benefits incurred declined by $40.4 million, or 11%, compared to 2006. Overall loss
ratios for the
segment increased to 75.3% for 2007 compared to 73.4% for 2006. The decline in benefits was principally caused by a reduction in Medicare supplement benefits of $41.5 million as a result of a
decline in the business partially offset by an increase in the Medicare supplement loss ratio that increased benefits by $2.8 million compared to 2006.

There
was net amortization of deferred acquisition costs in 2007 compared to an increase in deferred acquisition costs in 2006, an increase to expense of $31.5 million. We
incurred lower commissions and other acquisition costs during 2007 as a result of lower production, resulting in a decrease in the costs capitalized of $31.6 million compared to 2006.
Amortization was flat compared to 2006, with excess amortization caused by higher levels of lapsation of our Medicare supplement products, due to many of these policyholders switching to our PFFS
product. This was offset by a reduction in amortization on a smaller block of continuing business.

Commissions
and general expenses, net of reinsurance allowances, decreased by $31.0 million, or 19%, compared to 2006. The following table details the components of commission and
other operating expenses:

Year ended
December 31,2007

2006(In thousands)Commissions

$
86,483

$
107,219Other operating costs


84,561


102,380Reinsurance allowances


(40,196
)

(47,762
)Commissions and general expenses, net of allowances

$
130,848

$
161,837


The
ratio of commissions to gross premiums decreased to 9.4% for 2007, from 10.9% for 2006, as a result of lower overall commission rates associated with the continued growth of our in
force renewal premium and less new business production that has higher commission rates. Other operating costs as a percentage of gross premiums were 9.2% for 2007, compared to 10.4% for 2006 as a
result of lower acquisition expenses due to lower new business production and lower fixed costs. Commission and expense allowances received from reinsurers as a percentage of the premiums ceded
decreased to 8.4% for 2007 from 10.1% for 2006, primarily due to the reduction in new business ceded and the effects of normal lower commission allowances on our aging base of ceded renewal business.

110

---



Table of Contents

Segment ResultsSenior Administrative Services

For the year ended December 31,2008

2007

2006(In thousands)Affiliated fee revenueMedicare supplement

$
19,560

$
23,342

$
27,962Part D


27,873


25,057


20,887PFFS





18,382


Long term care


2,460


2,234


2,869Life insurance


4,307


2,169


2,170Other


6,479


8,440


4,117Total affiliated revenue


60,679


79,624


58,005Unaffiliated fee revenueMedicare Advantage


11,795


11,528


8,191Medicare supplement


5,462


5,848


6,963Long term care


5,777


7,020


8,269Non-insurance products


830


1,426


1,303Part D


200


1,345


1,475Other


145


163


808Total unaffiliated revenue


24,209


27,330


27,009Total revenue


84,888


106,954


85,014Amortization of present value of future profits


367


441


494General expenses


62,501


82,389


68,680Total expenses


62,868


82,830


69,174Segment income before taxes

$
22,020

$
24,124

$
15,840


Unaffiliated
revenue reflects fees received to administer selected business of our insurance subsidiaries that is 100% reinsured to an unaffiliated reinsurer. These fees amounted to
$2.3 million, $2.8 million and $3.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. In 2007 we performed administrative functions for the
affiliated PFFS line that the affiliated entities performed directly in 2008. We eliminated these fees, together with the affiliated revenue, in consolidation.



Segment income before taxes for our Senior Administrative Services segment decreased by $2.1 million, or 9%, to
$22.0 million for the year ended December 31, 2008, as compared to 2007. This decrease is primarily the result of reduced levels of unaffiliated service fee revenues.

Revenue
declined by $22.1 million, or 21%, during the year ended December 31, 2008, compared to 2007. Affiliated service fee revenue decreased by $18.9 million
primarily as a result of the loss of fee income associated with the administration of our PFFS business that our affiliated entities performed directly in 2008 and a decline in Medicare supplement
revenues on a smaller book of business partially offset by an increase in Part D revenues on a growing block of business. Unaffiliated service fee revenue decreased by $3.1 million, due
primarily to a decrease in services performed for unaffiliated Part D and long term care business. General expenses for the segment decreased by $19.9 million, or 24%, primarily due to
the decline of the affiliated PFFS business.

111

---



Table of Contents



Segment income for our Senior Administrative Services segment increased by $8.3 million, or 52%, to $24.1 million for the
year ended December 31, 2007, as compared to 2006. This increase is primarily the result of the growth in business administered.

Revenue
increased by $21.9 million, or 26%, during 2007 compared to 2006. Affiliated service fee revenue increased by $21.6 million primarily as a result the growth in fees
for the administration of our Medicare Advantage business as well as Part D prescription drug plans on behalf of our insurance subsidiaries. The increase in other fees relates to the
administration of affiliated business that was previously performed by PennCorp Life Canada, which we sold. Revenue declined for the administration of our Medicare supplement business due primarily to
a reduction of in force policies. Unaffiliated service fee revenue increased by $0.32 million, due primarily to an increase in administrative services performed for unaffiliated Medicare
Advantage clients that more than offset a reduction in services performed for unaffiliated Medicare supplement and long term care business. General expenses for the segment increased by
$13.7 million, or 20%, primarily attributed to the growth of the affiliated Medicare Advantage and Part D business as well as the integration of the Canadian operations.

Segment ResultsCorporate

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

For the year ended December 31,2008

2007

2006(In thousands)Interest expense

$
23,694

$
20,480

$
12,821Early extinguishment of debt





1,343


Amortization of capitalized loan origination fees


1,048


1,128


933Stock-based compensation expense


6,369


4,572


2,613Other parent company expenses, net of revenues


6,838


7,517


6,076Segment loss before taxes

$
37,949

$
35,040

$
22,443




The loss from our Corporate segment increased by $2.9 million, or 8%, for the year ended December 31, 2008 compared to
the 2007. The increase was due primarily to an increase in interest costs and the cost of stock based compensation, partially offset by lower other parent company expenses, net of revenues and the
non-recurring early extinguishment of debt costs incurred in 2007.

The
increase in interest cost of $3.2 million is due primarily to the increase in the average balance of our debt outstanding, offset in part by a reduction in the interest rates
charged on the debt, as compared to 2007. While our combined outstanding debt decreased by $28.5 million to $430.6 million at December 31, 2008 from $459.1 million at
December 31, 2007, the balance at December 31, 2007 had increased significantly from $165.6 million at December 31, 2006, due primarily to the refinancing of our credit
facility in connection with the acquisition of MemberHealth in September 2007. The weighted average interest rate on our loan payable was 4.6% for 2008 compared to 6.4% for 2007. The weighted average
interest rate on our other long term debt was 7.4% for 2008 compared to 7.9% for 2007. See "Liquidity and Capital Resources" for additional information regarding our loan payable and other long term
debt.

112

---



Table of Contents

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

The
decrease in other parent company expenses, net of revenues was primarily due to the reversal of a 2007 bonus accrual that was $5.6 million in excess of the final amounts
approved in 2008 by the compensation committee, partially offset by a decrease of $2.1 million in net investment income, an increase in the costs of restricted stock awards, legal fees
associated with the defense and settlement of a shareholder's lawsuit and other, individually insignificant, unfavorable expense variances.



The loss from our Corporate segment increased by $12.6 million, or 56%, for the year ended December 31, 2007 compared to
2006. The increase was due primarily to the increase in interest costs, the cost associated with the early extinguishment of debt and the cost of stock based compensation, offset by an increase in net
investment income.

The
increase in interest cost of $7.7 million is due primarily to the increase in our debt outstanding, offset in part by a reduction in the interest rates charged on the debt, as
compared to 2006. Our combined outstanding debt increased by $293.5 million to $459.1 million at December 31, 2007 from $165.6 million at December 31, 2006. The
increase in the outstanding debt was due primarily to the refinancing of our credit facility in connection with the acquisition of MemberHealth in September 2007. The weighted average interest rate on
our loan payable was 6.4% for 2007 compared to 7.3% for 2006. The weighted average interest rate on our other long term debt was 7.9% for 2007 compared to 7.8% for 2006. The early extinguishment of
debt, in connection with the refinancing and the redemption of the trust preferred securities from Statutory Trust 1, resulted in the immediate amortization of the related capitalized loan origination
fees, resulting in a pre-tax expense of approximately $1.3 million. See "Liquidity and Capital Resources" for additional information regarding our loan payable and other long term
debt.

The
increase in stock-based compensation resulted primarily from the awards, in 2007, to officers and other employees. The increase in other parent company expenses was primarily due to
outside legal costs in connection with the class action lawsuits and the proposed management buy-out.

113

---





Table of Contents

Contractual Obligations and Commercial Commitments

Our contractual obligations as of December 31, 2008, are shown below.

Payments Due by PeriodContractual Obligations

Total

Less than
1 Year

13
Years

35
Years

More than
5 Years(In thousands)Long Term Debt Obligations(1):Trust preferred securities(2)

$
288,674

$
8,105

$
16,211

$
13,782

$
250,576Loan payable(3)


376,030


18,490


36,510


321,030


Operating Lease Obligations


27,421


5,970


11,134


6,851


3,466Purchase Obligations(4)


5,400


5,400








Policy Related Liabilities(5):Policyholder account balances


504,090


55,538


100,978


84,512


263,062Reserves for future policy benefits


888,005


48,438


91,057


83,813


664,697Policy and contract claims


740,983


665,283


75,700





Total

$
2,830,603

$
807,224

$
331,590

$
509,988

$
1,181,801


---

114

---



Table of Contents



Liquidity and Capital Resources

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

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

We
believe that our current cash position, the expected cash flows of our administrative service company and our senior managed care company, our PBM business in MemberHealth and the
surplus note interest and principal payments from American Exchange will support our current parent company obligations. However, there can be no assurance as to our actual future cash flows or to the
continued availability of dividends from our insurance company subsidiaries.

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

2007 Credit Facility

In connection with the MemberHealth transaction, as described in Note 3Business Combinations to our consolidated
financial statements set forth above, we refinanced our credit facility with a new credit facility consisting of a $350 million term loan and a $150 million revolver. We used a portion
of the proceeds from the refinancing to repay in full the amounts outstanding on the previous credit facility. Interest under the new credit facility is currently based on LIBOR plus a spread of 62.5
basis points. In addition, we currently pay a commitment fee on the unutilized revolving loan facility at an annualized rate of 10.0 basis points. In accordance with the credit agreement for the new
credit facility, the spread and fee are determined based on our consolidated leverage ratio. Effective December 31, 2008, the interest rate on the term loan portion of the new credit facility
was 4.46%. We had not drawn on the revolving loan facility as of the date of this report. As a result of the value received pursuant to the settlement agreement discussed in Significant Transactions
and Initiatives, on April 23, 2008 we prepaid $25 million of principal under the new facility, under an approved waiver.

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

115

---



Table of Contents

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



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



The
Company incurred additional loan origination fees of approximately $4.7 million, which were capitalized and are being amortized on a straight-line basis, which
does not differ significantly from the effective yield basis, over the life of the 2007 Credit Facility. The early extinguishment of the Amended Credit Facility triggered the immediate amortization of
the related capitalized loan origination fees, resulting in a pre-tax expense of approximately $0.9 million.

Under
the terms of the new credit facility, we must make principal repayments quarterly at the rate of $3.5 million per year over a five-year period and a final
payment of $308.4 million due upon maturity in September, 2012. The following table shows the schedule of principal payments remaining on the new credit facility as of December 31, 2008:

2007 Credit Facility(in thousands)2009

$
3,5002010


3,5002011


3,5002012


310,125$
320,625


116

---



Table of Contents

Interest Rate Swaps

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

The
Company paid $1.4 million in interest in connection with the $250 million of interest rate swap agreements pertaining to our credit facility during the year ended
December 31, 2008, but did not make any payments during 2007. There were no swap agreements pertaining to our credit facility during 2006.

Short Term Facility

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

Principal and Interest Payments

The Company made regularly scheduled principal payments of $3.5 million plus the $25.0 million prepayment discussed above
during the year ended December 31, 2008, $3.5 million during 2007, and $5.3 million during 2006 in connection with its credit facilities. During 2007, the Company repaid the
$87.9 million balance outstanding on its Amended Credit Facility in connection with the refinancing noted above.

The
Company paid interest of $13.7 million during 2008, $9.9 million during 2007, and $6.9 million during 2006 in connection with its credit facilities. Due to the
variable interest rate on the 2007 Credit Facility, for the portion not covered by the interest rate swaps would be subject to higher interest costs to the Company if short term interest rates rise.

Other Long Term Debt

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

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

117

---



Table of Contents

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

Maturity Date

Amount
Issued

Term

Spread Over
LIBOR

Rate as of
December 31,
2008(In thousands)



(Basis points)April 2033

$
10,000

Floating


400


8.8
%May 2033


15,000

Floating


420


6.4
%May 2033


15,000

Fixed/Floating


410
(1)

6.3
%October 2033


20,000

Fixed/Floating


395
(2)

7.5
%March 2037


50,000

Fixed/Floating


275
(3)

7.7
%$
110,000


---

The
Trusts have the right to call the Capital Securities at par after five years from the date of issuance (which ranged from December 2002 to March 2007). The proceeds from the sale of
the Trust Preferred Securities, together with proceeds from the sale by the Trusts of their common securities to our parent holding company, were invested in thirty-year floating rate
Junior Subordinated Debt of our parent holding company. The proceeds have been used, in part to fund acquisitions, to provide capital to our insurance subsidiaries to support growth and to be held for
general corporate purposes.

The
Capital Securities represent an undivided beneficial interest in the Trusts' assets, which consist solely of the Junior Subordinated Debt. Holders of the Capital Securities have no
voting rights. Our parent holding company owns all of the common securities of the Trusts. Holders of both the Capital Securities and the Junior Subordinated Debt are entitled to receive cumulative
cash distributions accruing from the date of issuance, and payable quarterly in arrears at a floating rate equal to the three-month LIBOR plus a spread. The floating rate resets quarterly and is
limited to a maximum of 12.5% during the first sixty months. Due to the variable interest rate for these securities, we may be subject to higher interest costs if short-term interest rates
rise. The Capital Securities are subject to mandatory redemption upon repayment of the Junior Subordinated Debt at maturity or upon earlier redemption. The Junior Subordinated Debt is unsecured and
ranks junior and subordinate in right of payment to all present and future senior debt of our parent holding company and is effectively subordinated to all existing and future obligations of the
Company's subsidiaries. Our parent holding company has the right to redeem the Junior Subordinated Debt after five years from the date of issuance.

Our
parent holding company has the right at any time, and from time to time, to defer payments of interest on the Junior Subordinated Debt for a period not exceeding 20 consecutive
quarters up to each debenture's maturity date. During any such period, interest will continue to accrue and our parent holding company may not declare or pay any cash dividends or distributions on, or
purchase, our common stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank equally with or junior to the Junior Subordinated Debt. Our parent
holding

118

---



Table of Contents

company
has the right at any time to dissolve the Trusts and cause the Junior Subordinated Debt to be distributed to the holders of the Capital Securities. We have guaranteed, on a subordinated basis,
all of the Trusts' obligations under the Capital Securities including payment of the redemption price and any accumulated and unpaid distributions to the extent of available funds and upon
dissolution, winding up or liquidation but only to the extent the Trusts have funds available to make such payments. The Capital Securities have not been and will not be registered under the
Securities Act of 1933, as amended, and will only be offered and sold under an applicable exemption from registration requirements under the Securities Act.

The
Company paid $8.3 million in interest in connection with the Junior Subordinated Debt during the year ended December 31, 2008, $8.7 million during 2007, and
$5.8 million during 2006.

Lease Obligations

We are obligated under lease arrangements for our executive and administrative offices in New York, Florida, Indiana, Texas, Wisconsin,
Oklahoma, Ohio and Washington, D.C. Rent expense was $7.1 million for the year ended December 31, 2008, $5.8 million for 2007 and $4.4 million for 2006. Annual minimum
rental commitments, subject to escalation, under non-cancelable operating leases (in thousands) are as follows:

(In thousands)2008

$
5,9702009


5,7542010


5,3802011


4,1362012


2,715Thereafter


3,466Total

$
27,421


In
addition to the above, Pennsylvania Life is the named lessee on 43 properties occupied by career agents for use as field offices. The career agents reimburse Pennsylvania Life the
actual rent for these field offices. The total annual rent paid by the Company and reimbursed by the career agents for these field offices during 2008 was approximately $4.0 million.

Shelf Registration

On November 3, 2004, we filed a universal shelf registration statement on Form S-3 with the
U.S. Securities and Exchange Commission or the SEC, pursuant to which we may issue common stock, warrants and debt securities from time to time, up to an aggregate offering of
$140 million. The registration statement also covered five million shares of common stock that may be offered for sale by Capital Z Financial Services Fund II, L.P., known as Capital Z,
then our largest shareholder. The SEC declared the shelf registration statement effective in December 2004.

The
shelf registration statement or a successor registration statement would enable us to raise funds from the offering of any individual security covered by the shelf registration
statement, as well as any combination thereof, through one or more methods of distribution, subject to market conditions and our capital needs. The We would he establish terms of any offering pursuant
to this or a successor registration statement will be established at the time of the offering. We plan would expect to use the proceeds from any future offering under the registration statement or a
successor registration statement for general corporate purposes, such as working capital, capital expenditures, investments in subsidiaries, acquisitions and refinancing of debt. We will include a
more detailed description of the use

119

---



Table of Contents

of
proceeds of any specific offering of securities in the prospectus supplement relating to any particular offering.

The
aggregate amount that remains available for offering under the 2004 shelf registration statement is $77.2 million as of December 31, 2008.

Sources of Liquidity to the Parent Company

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



In
addition, we have access to funds under existing credit facilities. We have $150.0 million available under the revolving portion of our new Credit Facility. In March of 2007,
we drew down all $50 million available under our then-existing short-term Revolving Credit Facility to finance capital needs at our insurance company subsidiaries to
support the growth of our business. We then repaid the entire $50.0 million balance on July 18, 2007, when it was determined that it was not immediately needed, using cash received in
our May 2007 equity raise.

We
also have the ability, from time to time, to access the capital markets for additional capital. In March 2007, we issued $50 million of trust preferred securities. In addition,
in connection with the May 8, 2007 announcement of the signing of definitive agreements to acquire MemberHealth (see Note 3Business Combinations of the Notes to the
Consolidated Financial Statements included in this Annual Report on Form 10-K), we have issued preferred stock for aggregate proceeds of $350 million, at $20 per common
equivalent share, to four private equity investment fund groups. We issued $100 million of preferred stock during the second quarter of 2007
and the balance in September 2007. There can be no assurance as to our actual future cash flows from the continued availability of dividends from our insurance company subsidiaries or from access to
the capital markets to support our growth and expansion initiatives.

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

Senior Managed Care Company.Liquidity for our managed care company is measured by its ability to pay operating expenses and pay
dividends to our
parent company. The primary source of liquidity is management fees for administration of our health plan affiliates and services provided to the IPA's. Dividend payments by our HMO affiliates to
Heritage are subject to the approval of the insurance regulatory authorities of our HMO affiliates' respective states of domicile. SCOT is not able to pay dividends during 2008 without prior approval.
However, we believe that the sources of cash to our managed care holding company exceed scheduled uses of cash which will result in funds being available to pay dividends to our parent holding
company.

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

120

---



Table of Contents

Insurance SubsidiariesSurplus Note, Dividends and Capital Contributions.Cash generated by our insurance company subsidiaries
will be
made available to our holding company, principally through periodic payments of principal and interest on the surplus note owed to our holding company by our subsidiary, American Exchange. As of
December 31, 2008, the principal amount of the surplus note was $5.6 million. The note bears interest to our parent holding company at LIBOR plus 250 basis points. We anticipate that the
surplus note will be primarily serviced by dividends from PDMS. American Exchange made principal payments totaling $12.0 million during the year ended December 31,
2008 and $10.0 million during the year ended December 31, 2007 and $12.5 million during the year ended December 31, 2006. American Exchange paid interest on the surplus
note of $0.6 million during the year ended December 31, 2008 and $1.9 million during the year ended December 31, 2007 and $2.5 million during the year ended
December 31, 2006.

On
June 29, 2007 and December 31, 2007, Pyramid issued two $30.0 million surplus notes payable to our holding company. The notes are repayable through annual
principal payments beginning March 29, 2009, based on a schedule, provided that capital and surplus are sufficient to maintain risk-based capital levels of 450% or greater. At
December 31, 2008, Pyramid's risk-based capital ratio was below 450%. The surplus notes can be pre-paid (with prior approval by the state of Kansas) to the extent that
Pyramid's risk-based capital levels exceed 450%. The notes bear interest to our parent holding company at fixed rates of 7.7% and 7.3%, respectively, for the term of the notes.

Our
parent holding company did not make capital contributions to American Exchange during 2008. American Exchange made a capital contribution of $7.0 million to Pyramid and
recorded a capital contribution of $6.5 million to Marquette during 2008. In 2008, no dividends were declared or paid to American Exchange from its subsidiaries.

Our
parent holding company made capital contributions to American Exchange amounting to $81.0 million during 2007. American Exchange made capital contributions of
$44.0 million to American Progressive, $32.0 million to Pyramid and $5.0 million to Marquette during 2007. In December 2007, Pennsylvania Life declared and paid a dividend in the
amount of $21.0 million to American Exchange. American Exchange made a capital contribution of $20.0 million to Pyramid.

Our
parent holding company made cash capital contributions to American Exchange amounting to $43.5 million during 2006. During May 2006, our parent holding company contributed its
interest in PDMS to American Exchange. On the date of the contribution, our interest in PDMS was $4.1 million. In January 2006, Pyramid Life declared and paid a dividend in the amount of
$10.8 million to Pennsylvania Life. In December 2006, American Pioneer declared and paid a dividend in the amount of $9.4 million to American Exchange. American Exchange made capital
contributions of $16.0 million to American Progressive, $4.5 million to American Pioneer and $4.3 million to Constitution during the year ended December 31, 2006.

Dividend
payments by our insurance companies to our holding company or to intermediate subsidiaries are limited by, or subject to the approval of the insurance regulatory authorities of
each insurance company's state of domicile. Such dividend requirements and approval processes vary significantly from state to state. Pennsylvania Life, Pyramid Life and American Progressive are able
to pay ordinary dividends of up to$20.8 million, $9.0 million and $8.5 million, respectively, to American Exchange (their direct
parent) and American Exchange is able to pay ordinary dividends of up to $46.2 million to Universal American in 2009 without the prior approval from the insurance department for their
respective states of domicile.

Insurance SubsidiariesLiquidity

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

121

---



Table of Contents

unscheduled
principal and interest payments on investments, premium payments, annuity deposits, and the sale or maturity of investments. Both the sources and uses of cash are reasonably predictable
and we believe that these sources of cash for our insurance company subsidiaries exceed scheduled uses of cash.

Liquidity
is also affected by unscheduled benefit payments including benefits under accident and health insurance policies, death benefits and interest-sensitive policy surrenders and
withdrawals.

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

Some
of our life insurance and annuity policies are interest-sensitive in nature. The amount of surrenders and withdrawals is affected by a variety of factors such as credited interest
rates for similar products, general economic conditions and events in the industry that affect policyholders' confidence. Although the contractual terms of substantially all of our in force life
insurance policies and annuities give the holders the right to surrender the policies and annuities, we impose penalties for early surrenders. As of December 31, 2008 we held reserves that
exceeded the underlying cash surrender values of our net retained in force life insurance and annuities by $22 million. Our insurance subsidiaries, in our view, have not experienced any
material changes in surrender and withdrawal activity in recent years.

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

122

---



Table of Contents

At
December 31, 2008, we held cash and cash equivalents totaling $511 million and fixed maturity securities that could readily be converted to cash with carrying values of
$1.0 billion.

The
net yields on our cash and invested assets decreased to 4.9% for the year ended December 31, 2008, from 5.4% for 2007 and 5.1% for 2006. A portion of these securities are held
to support the liabilities for policyholder account balances, which liabilities are subject to periodic adjustments to their credited interest rates. The credited interest rates of the
interest-sensitive policyholder account balances are determined by us based upon factors such as portfolio rates of return and prevailing market rates and typically follow the pattern of yields on the
assets supporting these liabilities.

Our
domestic insurance subsidiaries are required to maintain minimum amounts of statutory capital and surplus as required by regulatory authorities. However, substantially more than the
statutory minimum amounts are needed to meet statutory and administrative requirements of adequate capital and surplus to support the current level of our insurance subsidiaries' operations. Each of
our insurance subsidiaries' statutory capital and surplus exceeds its respective minimum statutory requirement at levels we believe are sufficient to support their current levels of operation.
Additionally, the National Association of Insurance Commissioners, known as the NAIC, imposes regulatory risk-based capital ("RBC") requirements on life insurance enterprises. At
December 31,
2008, all of our insurance subsidiaries maintained ratios of total adjusted capital to RBC in excess of the "authorized control level" except for Marquette. Effective January 1, 2009, Marquette
novated its PFFS business to its affiliate Pyramid Life. As a result of this novation, it is anticipated that Marquette's ratio of total adjusted capital to risk-based capital will exceed
the authorized control level. The combined statutory capital and surplus, including asset valuation reserve, of our U.S. insurance subsidiaries totaled $525.5 million at December 31,
2008 and $486.1 million at December 31, 2007. Our U.S. insurance subsidiaries generated statutory net income of $67.8 million for the year ended December 31, 2008,
$114.6 million for 2007 and $29.3 million for 2006.

Our
HMO affiliates are also required by regulatory authorities to maintain minimum amounts of capital and surplus and are also subject to RBC requirements. At December 31, 2007,
the statutory capital and surplus of each of our HMO affiliates exceeds its minimum requirement and its RBC is in excess of the "authorized control level." The statutory capital and surplus for our
HMO affiliates was $86.6 million at December 31, 2008 and $64.3 million at December 31, 2007. Statutory net income for our HMO affiliates was $29.1 million for the
year ended December 31, 2008, $15.3 million for 2007, and $17.3 million for 2006.

Effective
January 1, 2009 the NAIC has adopted SSAP No. 98,Treatment of Cash Flows When Quantifying Changes in Valuation and
Impairments.SSAP No. 98 effectively changes the impairment trigger from an undiscounted cash flow basis test to a discounted test. In addition, SSAP No. 98
changes the method of valuing the new cost basis of the impaired security from an undiscounted cash flow basis to a fair value basis. Had we adopted SSAP No. 98 on December 31, 2008, we
would have recognized an additional $69.3 million of realized losses, pre-tax, for other-than-temporary impairments of investments on a statutory basis,
however, the actual impairment recorded will depend upon conditions at the measurement date.

Reinsurance

We evaluate the financial condition of our reinsurers and monitor concentrations of credit risk to minimize our exposure to significant
losses from reinsurer insolvencies. We are obligated to pay claims in the event that a reinsurer to whom we have ceded an insured claim fails to meet its obligations under the reinsurance agreement.
As of December 31, 2008, all of our primary reinsurers were rated "A" or better by A.M. Best, except for PharmaCare Re, which is unrated. We have secured a letter of credit from
PharmaCare Re that we believe will adequately support the risks ceded. We do not know of

123

---



Table of Contents

any
instances where any of our reinsurers have been unable to pay any policy claims on any reinsured business.

Investments

Our investment policy is to balance the portfolio duration to achieve investment returns consistent with the preservation of capital
and maintenance of liquidity adequate to meet payment of policy benefits and claims. We invest in assets permitted under the insurance laws of the various states in which we operate. Such laws
generally prescribe the nature, quality of and limitations on various types of investments that may be made. We do not currently have investments in partnerships, special purpose entities, real
estate, commodity contracts, or other derivative securities. We currently engage the services of an investment advisor, Conning Asset Management Company, under the direction of the management of our
insurance company subsidiaries and in accordance with guidelines adopted by the Investment Committees of their respective boards of directors.

We
invest primarily in fixed maturity securities of the U.S. Government and its agencies and in corporate fixed maturity securities with investment grade ratings of BBB- or
higher by S&P or Baa3 or higher by Moody's Investor Service. As of December 31, 2008, approximately 98% of our fixed maturity investments had investment grade ratings from S&P or Moody's. As of
December 31, 2008, we held $7.0 million par value of Lehman Brothers holdings that were non-income producing. These were the only non-income producing securities
in our investment portfolio. As of December 31, 2008, we held securities with par values of approximately $140 million with exposure to subprime mortgages. The market value of these
securities was $38 million at December 31, 2008, representing approximately 2% of our cash and invested assets. The collateral for these securities is substantially all first lien
mortgages. These securities have an average rating of AA- by Standard & Poors. During the year ended December 31, 2008, we recognized an
other-than-temporary impairment totaling $48.0 million in the value of our securities with exposure to subprime mortgages. In addition, we have recognized an
other-than-temporary impairment of $6.1 million on Lehman Brothers holdings and $5.7 million on other corporate bond and mortgage backed securities for a total
year-to-date impairment of $11.8 million at December 31, 2008 in addition to the impairment on subprime holdings. For the year ended December 31, 2007, we
recognized an other-than-temporary impairment totaling $41.0 million in the value of our securities with exposure to subprime, all in the fourth quarter.

We
have recently adopted a more conservative approach to our investment portfolio, which focuses more on capital preservation than on generation of investment yield. As a result, as of
December 31, 2008, approximately 33% of our portfolio is in cash equivalents, largely in government money funds, and, in the aggregate, approximately 62% of our portfolio are securities backed
by the US government or its agencies.

Federal Income Taxation of the Company

We file a consolidated life-nonlife return for Federal income tax purposes that reflects all US subsidiaries,
as well as Heritage and its subsidiaries and American Exchange and its subsidiaries. At December 31, 2008, the Company had a net operating loss carryforward of approximately $4.4 million
that expires in 2025. The use of the net operating loss carryforward is limited to $1.6 million per year under the Internal Revenue Code.

The
Company establishes valuation allowances based upon an analysis of projected taxable income and its ability to implement prudent and feasible tax planning strategies. The Company
carried valuation allowances on its deferred tax assets of $4.4 million at December 31, 2008 and $3.1 million at December 31, 2007, primarily related to the tax benefits
associated with a New York state net operating loss carryforward. At December 31, 2008, the Company recorded a deferred tax asset at an amount that was more likely than not to be realized under
SFAS No. 109. During the second quarter we

124

---



Table of Contents

released
a deferred tax valuation allowance of $10.4 million that had been recorded in the first quarter of 2008 in connection with other-than-temporary impairments
taken in that period.

During
2005, the Company incurred creditable foreign taxes related to dividends from PennCorp Life Canada, its defined previously Canadian subsidiary, generating a foreign tax credit
carryforward, for which a deferred tax asset of approximately $0.8 million was established. A valuation allowance for the entire amount was established because the Company lacked sufficient
foreign source income to realize the benefit for the foreign tax credit. As foreign source income was generated in 2006, the valuation allowance related to the foreign tax credit carryforward was
released.

Management
believes it is more likely than not that the Company will realize the recorded value of its net deferred tax assets.

Some
of our U.S. insurance company subsidiaries are taxed as life insurance companies as provided in the Internal Revenue Code. The Omnibus Budget Reconciliation Act of 1990 amended the
Internal Revenue Code to require a portion of the expenses incurred in selling insurance products capitalized and amortized over a period of years, as opposed to an immediate deduction in the year
incurred. Instead of measuring actual selling expenses, the amount capitalized for tax purposes is based on a percentage of premiums. In general, the capitalized amounts are subject to amortization
over a ten-year period. Since this change only affects the timing of the deductions, it does not, assuming stability of rates, affect the provisions for taxes reflected in our financial
statements prepared in accordance with GAAP. However, by deferring deductions, the change has the effect of increasing
our current tax expense and reducing statutory surplus. There was no material increase in our current income tax provision for any of the three years in the period ended December 31, 2008.

The
Jobs Creation Tax Act of 2004, known as the Jobs Act, contains a provision that placed a two year moratorium on the imposition of tax on distributions from Policyholder
Surplus Accounts ("PSAs"), the Phase III tax. Additionally, the ordering rules were changed to allow for the first dollar of any distribution to reduce the PSA. At December 31, 2008 and
2007, we had $7.1 million in deferred tax liabilities for potential Phase III tax. In accordance with the Jobs Act, distributions during 2005 and 2006 from an insurance company that has
a PSA will be treated as a distribution from its PSA account; however, the distribution will not be subject to Federal income tax. We received the approval of the Insurance Departments of the
respective companies for the transactions that could trigger the elimination of the potential tax and made such distributions during 2006. Upon the confirmation of the elimination of the potential
Phase III tax on the PSAs, the deferred tax liability will be released and will reduce deferred tax expense.

In
July 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement
109("FIN 48") that provides criteria for recognition, measurement, presentation and disclosure of uncertain tax positions. The Company adopted FIN 48 on
January 1, 2007. The Company has no material uncertain tax positions and no cumulative adjustment was required or recorded as a result of the implementation of FIN 48. The Company
recognizes accrued interest and penalties related to uncertain tax positions in income tax expense when incurred. No material interest and penalties related to uncertain tax positions were accrued at
December 31, 2008.

Effects of Recently Issued and Pending Accounting Pronouncements

A summary of recent and pending accounting pronouncements is provided in Note 2 of the Consolidated Financial Statements in the
Annual Report on Form 10-K under the captions "Recently Adopted Accounting Standards" and "Future Adoption of
Accounting Standards." We do not anticipate any material impact from the future adoption of the pending accounting pronouncements discussed in that note.

125

---



Table of Contents

ITEM 7AQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Investment Interest Rate Sensitivity

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

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

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

The
sensitivity analysis of interest rate risk assumes an instantaneous shift in a parallel fashion across the yield curve, with scenarios of interest rates increasing and decreasing 100
and 200 basis points from their levels as of December 31, 2008, and with all other variables held constant. The following table summarizes the impact of the assumed changes in market interest
rates.

December 31, 2008

Effect of Change in Market Interest Rates on
Market Value of Fixed Income Portfolio as of
December 31, 2008Market Value of
Fixed Income
Portfolio

200 Basis
Point
Decrease

100 Basis
Point
Decrease

100 Basis
Point
Increase

200 Basis
Point
Increase(in millions)$1,032.4

$
54.6

$
28.1

$
(28.1
)
$
(59.8
)


Debt

We pay interest on our term loan and a portion of our trust preferred securities based on the London Inter Bank Offering Rate ("LIBOR")
for one, two or three months. Due to the variable interest rate, the Company would be subject to higher interest costs if short-term interest rates rise. We have attempted to mitigate our
exposure to adverse interest rate movements by fixing the rate on $65.0 million of the trust preferred securities for a five year period through the contractual terms of the security at
inception, of which $50.0 million remains fixed through March 2012, and an additional $35.0 million through the use of interest rate swaps. In December 2007, we exercised our option to
redeem all $15.0 million of the trust preferred securities scheduled to mature December 2032, which was covered by an interest rate swap. In October 2008, the remaining $20 million
interest rate swap expired.

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

126

---





Table of Contents

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

The
sensitivity analysis of interest rate risk assumes scenarios increases or decreases in LIBOR of 100 and 200 basis points from their levels as of and for the year ended
December 31, 2008, and with all other variables held constant. The following table summarizes the impact of changes in LIBOR.

Effect of Change in LIBOR on Pre-tax Income
for the year ended December 31, 2008Weighted
Average
Balance
OutstandingDescription of Floating
Rate Debt

Weighted
Average
Interest Rate

200 Basis
Point
Decrease

100 Basis
Point
Decrease

100 Basis
Point
Increase

200 Basis
Point
Increase(in millions)Loan Payable


4.08
%
$
80.6

$
1.6

$
0.8

$
(0.8
)
$
(1.6
)Other long term debt


7.28
%
$
43.4


0.9


0.4


(0.4
)

(0.9
)Total







$
2.5

$
1.2

$
(1.2
)
$
(2.5
)


As discussed previously, we have fixed the interest rate on $300 million of our $431 million of total debt outstanding,
$250 million through the use of swaps on our credit facility and $50 million through the contractual terms of the trust preferred security at inception, leaving $131 million of
the debt exposed to rising interest rates, as of December 31, 2008. We had approximately $511 million of cash and cash equivalents as of December 31, 2008. We anticipate that any
increase or decrease in the interest cost of our debt as a result of an increase in interest rates will be mitigated by an increase or decrease in the net investment income from our cash and cash
equivalents.

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

ITEM 8FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements and supplementary schedules are listed in the accompanying Index to Consolidated Financial Statements and
Financial Statement Schedules in this Annual Report on Form 10-K on Page F-1.

ITEM 9CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

127

---



Table of Contents

ITEM 9ACONTROLS AND PROCEDURES



The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the
reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is
accumulated and communicated to management, including the Company's Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.



Our disclosure controls and procedures and our internal controls over financial reporting may not prevent or detect all errors and all
fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of a control
system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Further, because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, within Universal
American have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls
can also be circumvented by the individual acts of some persons or by collusion of two or more people. The design of any system of controls is based in part on assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness
to future periods are subject to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.



An evaluation was carried out under the supervision and with the participation of the Company's management, including our Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2008. Based on this evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2008, at a reasonable assurance level, to timely
alert management to material information required to be included in our periodic filings with the Securities and Exchange Commission.



Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in
Rule 13a-15(f) under the Exchange Act). A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management
assessed our internal control over financial reporting as of December 31, 2008, the end of our fiscal year. Management based its assessment on criteria established in
Internal Control

128

---



Table of Contents

Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we determined that, as of December 31, 2008, the Company's internal
control over financial reporting was effective based on those criteria.

The
effectiveness of our internal control over financial reporting as of December 31, 2008 has been audited by Ernst & Young LLP, an independent registered public
accounting firm, as stated in their report which is included on page F-3 of our consolidated financial statements included in this Annual Report on Form 10-K.



There were no changes in our internal controls over financial reporting during the quarter ended December 31, 2008 that have
materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

ITEM 9BOTHER INFORMATION

None

129

---



Table of Contents

PART III

ITEM 10DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by Item 10 is incorporated into Part III of this Annual Report on Form 10-K
by reference to our definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 2009.

ITEM 11EXECUTIVE COMPENSATION

The information required by Item 11 is incorporated into Part III of this Annual Report on Form 10-K
by reference to our definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 2009.

ITEM 12SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by Item 12 is incorporated into Part III of this Annual Report on Form 10-K
by reference to our definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 2009.

ITEM 13CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by Item 13 is incorporated into Part III of this Annual Report on Form 10-K
by reference to our definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 2009.

ITEM 14PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by Item 14 is incorporated into Part III of this Annual Report on Form 10-K
by reference to our definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on May 28, 2009.

130

---



Table of Contents

PART IV

ITEM 15(a)EXHIBITS AND FINANCIAL STATEMENT SCHEDULES





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

2.1

Agreement and Plan of Merger and Reorganization dated as of May 7, 2007 among Universal American Financial Corp., MH Acquisition I Corp., MH Acquisition II LLC, MHRx LLC, MemberHealth,
 Inc. and the shareholder representative named therein (filed as Exhibit 2.1 to the Registrant's Current Report on Form 8-K filed May 11, 2007, and incorporated by reference herein).2.2

Settlement Agreement and Amendment to Merger Agreement, dated as of March 5, 2008 (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated March 10, 2008, and
incorporated by reference herein).3.1

Restated Certificate of Incorporation of Universal American Financial Corp. (filed as Exhibit 3.1 to the Registrant's Amendment No. 2 to the Registration Statement on Form S-3 (File
No. 333-62036) filed on July 11, 2001, and incorporated by herein reference herein).3.2

Certificate of Amendment of the Certificate of Incorporation of Universal American Financial Corp. (filed as Exhibit 3 to the Registrant's Quarterly Report on Form 10-Q (File No. 0-11321)
 for the quarter ended June 30, 2004, and incorporated by reference herein).3.3

Certificate of Amendment to Universal American's Certificate of Incorporation for the Series A Preferred Stock (filed as Exhibit 3.1 to the Registrant's Current Report on Form 8-K dated
May 7, 2007, and incorporated by reference herein).3.4

Certificate of Amendment to Universal American's Certificate of Incorporation for the Series B Preferred Stock (filed as Exhibit 3.2 to the Registrant's Current Report on Form 8-K dated
May 7, 2007, and incorporated by reference herein).


131

---



Table of Contents

3.5

Certificate of Amendment to Universal American's Certificate of Incorporation dated August 24, 2007 (filed as Exhibit 3(i).1 to the Registrant's Current Report on Form 8-K dated
August 24, 2007, and incorporated by reference herein).3.6

Certificate of Amendment to Universal American's Certificate of Incorporation changing the name of the Company from Universal American Financial Corp. to Universal American Corp. dated November 30,
 2007 (filed as Exhibit 99.1 to the Registrant's Current Report on Form 8-K dated December 3, 2007, and incorporated by reference herein).3.7*

Amended and Restated By-Laws of Universal American Corp.4.1

Form of Indenture dated as of December 2004 between Universal American Financial Corp. and U.S. Bank National Association, as Trustee (filed as Exhibit 4.01 to Amendment No. 1 to the
Registrant's Registration Statement on Form S-3 (File No. 333-120190) filed with the Securities and Exchange Commission on December 10, 2004, and incorporated by reference herein).4.2

Form of Indenture dated as of December 2004 between Universal American Financial Corp. and U.S. Bank National Association, as Trustee (filed as Exhibit 4.02 to Amendment No. 1 to the
Registrant's Registration Statement on Form S-3 (File No. 333-120190) filed with the Securities and Exchange Commission on December 10, 2004, and incorporated by reference herein).4.3

Registration Rights Agreement, dated July 30, 1999, among the Company, Capital Z Financial Services Fund II, L.P., Wand/Universal American Investments L.P.I., Wand/Universal American
Investments L.P. II, Chase Equity Associates, L.P., Richard A. Barasch and others (filed as Exhibit A to the Registrant's Current Report on Form 8-K dated August 13, 1999, and incorporated by reference herein).4.4

Guarantee Agreement, dated as of March 22, 2007, by Universal American Financial Corp., as Guarantor, and Wilmington Trust Company, as Trustee (filed as Exhibit 4.3 to the Registrant's
Current Report on Form 8-K dated March 22, 2007, and incorporated by reference herein).4.5

Indenture, dated as of March 22, 2007, between Universal American Financial Corp. and Wilmington Trust Company, as Trustee, relating to Fixed/Floating Rate Junior Subordinated Debentures Due 2037
(filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K dated March 22, 2007, and incorporated by reference herein).4.6

Stockholders' Agreement, dated as of September 21, 2007, among Universal American Financial Corp. and the security holders listed on the signature pages thereto (filed as Exhibit 4.1 to the
Registrant's Current Report on Form 8-K dated September 24, 2007, and incorporated by reference herein).10.1

Employment Agreement dated July 30, 1999, between Registrant and Richard A. Barasch (filed as Exhibit D to the Registrant's Current Report on Form 8-K/A dated March 14, 2001 and
incorporated by reference herein).10.2

Employment Agreement dated July 30, 1999, between Registrant and Gary Bryant (filed as Exhibit E to the Registrant's Current Report on Form 8-K/A dated March 14, 2001 and
incorporated by reference herein).10.3

Employment Agreement dated July 30, 1999, between Registrant and Robert Waegelein (filed as Exhibit E to the Registrant's Current Report on Form 8-K/A dated March 14, 2001 and
incorporated by reference herein).


132

---



Table of Contents

10.4

Employment Agreement dated March 9, 2004, by and among the Company, Heritage Health Systems, Inc. and Theodore M. Carpenter, Jr. (filed as Exhibit 10.18 to the Registrant's Current Report on
Form 8-K dated January 18, 2007, and incorporated by reference herein).10.5*

Employment Letter dated March 7, 2008, between Registrant and John Wardle.10.6

1998 Incentive Compensation Plan (filed as Annex A to the Registrant's Definitive Proxy Statement filed on Form 14A dated April 29, 1998, and incorporated by reference
herein).10.7

Amendment No. 1 to Universal American Financial Corp. 1998 Incentive Compensation Plan (filed as Amendment No. 1 to the Registrant's Registration Statement on Form S-4 (Registration
No. 333-120190) filed on December 10, 2004, and incorporated by reference herein).10.8

Agent Equity Plan for Agents of Penn Union Companies (filed as Amendment 1 to the Registrant's Registration Statement on Form S-2, dated July 13, 2000, and incorporated by reference
herein).10.9

Agent Equity Plan for Regional Managers and Sub Managers of Penn Union Companies (filed as Amendment 1 to the Registrant's Registration Statement on Form S-2, dated July 13, 2000, and
incorporated by reference herein).10.10

Agreement dated as of July 6, 2000, between ALICOMP, a division of ALICARE, Inc. and Universal American Financial Corp., as amended (filed as Exhibit 10.1 to the Registrant's
Form 10-Q/A (Amendment No. 1) for the period ended September 30, 2003, dated December 23, 2003, and incorporated by reference herein).10.11

Quota Share Reinsurance Agreement, dated June 30, 2005, among the Company and PharmaCare Captive Re, Ltd. (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended September 30, 2005, and incorporated by reference herein).10.12

Agreement and Plan of Merger and Reorganization, dated as of May 7, 2007, among Universal American, MH Acquisition I Corp., MH Acquisition II LLC, MHRx LLC, MemberHealth, Inc., and
Welsh, Carson, Anderson & Stowe IX, L.P., as the Shareholder Representative thereunder (filed as Exhibit A to the proxy statement contained in Amendment No. 2 to the Registrant's Registration Statement on Form S-4 (File
No. 333-143822) filed with the Securities and Exchange Commission on July 16, 2007, and incorporated by reference herein).10.13

Stage 1 securities purchase agreement dated May 7, 2007 among Lee-Universal Holdings, LLC, Welsh, Carson, Anderson & Stowe X, L.P., Union Square Universal Partners,
 L.P., Perry Partners, L.P., Perry Partners International, Inc., Perry Commitment Fund, L.P. and Perry Commitment Master Fund, L.P. (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated
May 7, 2007, and incorporated by reference herein).10.14

Stage 2 securities purchase agreement dated May 7, 2007 among Lee-Universal Holdings, LLC, Welsh, Carson, Anderson & Stowe X, L.P., Union Square Universal Partners,
 L.P., Perry Partners, L.P., Perry Partners International, Inc., Perry Commitment Fund, L.P. and Perry Commitment Master Fund, L.P. (filed as Exhibit 10.2 to the Registrant's Current Report on Form 8-K dated
May 7, 2007, and incorporated by reference herein).10.15

Credit Agreement dated as of September 18, 2007, among Universal American Financial Corp., each lender from time to time party thereto, and Bank of America, N.A., as Administrative Agent, Swing
Line Lender and L/C Issuer (filed as Exhibit 10.26 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007, and incorporated by reference herein).


133

---



Table of Contents

10.16

Settlement Agreement and Amendment to Merger Agreement, dated as of March 5, 2008 (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K dated March 10, 2008, and
incorporated by reference herein).10.17*

Amendment to Agreement and Plan of Merger and Reorganization, dated as of December 31, 2008.12.1*

Statement re Computation of Ratio of Earnings to Fixed Charges.21.1*

List of Subsidiaries.23.1*

Consent of Ernst & Young LLP23.2*

Consent of Ernst & Young LLP31.1*

Certification of Chief Executive Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934.31.2*

Certification of Chief Financial Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934.32.1*

Certification of the Chief Executive Officer and Chief Financial Officer, as required by Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.99.1*

Audited Financial Statements of Part D Management Services, LLC.


---

134

---





Table of Contents

SIGNATURES

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

UNIVERSAL AMERICAN CORP.March 9, 2009

/s/ RICHARD A. BARASCH Richard A. Barasch Chairman of the Board, President and
    Chief Executive Officer


Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the following
capacities and on the dates indicated.

Signature and Title

Date/s/ RICHARD A. BARASCH Richard A. Barasch Chairman of the Board, President,
Chief Executive Officer and Director
(Principal Executive Officer)

March 9, 2009/s/ ROBERT A. WAEGELEIN Robert A. Waegelein Executive Vice President and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)

March 9, 2009/s/ BARRY W. AVERILL Barry W. Averill Director

March 9, 2009/s/ SALLY CRAWFORD Sally Crawford Director

March 9, 2009/s/ MATTHEW ETHERIDGE Matthew Etheridge Director

March 9, 2009


135

---



Table of Contents

Signature and Title

Date/s/ MARK GORMLEY Mark Gormley Director

March 9, 2009/s/ MARK M. HARMELING Mark M. Harmeling Director

March 9, 2009/s/ LINDA LAMEL Linda Lamel Director

March 9, 2009/s/ ERIC LEATHERS Eric Leathers Director

March 9, 2009/s/ PATRICK J. MCLAUGHLIN Patrick J. McLaughlin Director

March 9, 2009/s/ THOMAS A. SCULLY Thomas A. Scully Director

March 9, 2009/s/ ROBERT A. SPASS Robert A. Spass Director

March 9, 2009


136

---



Table of Contents

Signature and Title

Date/s/ SEAN TRAYNOR Sean Traynor Director

March 9, 2009/s/ ROBERT F. WRIGHT Robert F. Wright Director

March 9, 2009/s/ JAY YANG Jay Yang Director

March 9, 2009


137

---





Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES  INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES OF THE REGISTRANT:Report of Independent Registered Public Accounting Firm


F-2Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting


F-3Consolidated Balance Sheets as of December 31, 2008 and 2007


F-4Consolidated Statements of Operations for the Three Years Ended December 31,
2008


F-5Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss) for the Three
Years Ended December 31, 2008


F-6Consolidated Statements of Cash Flows for the Three Years Ended December 31,
2008


F-7Notes to Consolidated Financial Statements


F-8Schedule ISummary of Investments Other Than Investments in Related
Parties


F-81Schedule IICondensed Financial Information of Registrant


F-82Schedule IIISupplementary Insurance Information


F-87Schedule IVReinsurance (incorporated in Note 13 to the Consolidated Financial Statements)Schedule VValuation and Qualifying Accounts


F-88


Other
schedules were omitted because they were not applicable

---





Table of Contents

Report of Independent Registered Public Accounting Firm

The
Board of Directors and Stockholders of
Universal American Corp.

We
have audited the accompanying consolidated balance sheets of Universal American Corp. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements
of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial
statement schedules listed in the Index at Item 15(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion
on these financial statements and schedules based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Universal American Corp. and
subsidiaries at December 31, 2008 and 2007 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in
conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a
whole, present fairly in all material respects the information set forth therein.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Universal American Corp.'s internal control over financial
reporting as of December 31, 2008, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 9, 2009 expressed an unqualified opinion thereon.

/s/ ERNST & YOUNG LLP


New
York, New York
March 9, 2009

F-2

---



Table of Contents

Report of Independent Registered Public Accounting Firm

The
Board of Directors and Stockholders of
Universal American Corp.

We
have audited Universal American Corp.'s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal
ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Universal American Corp.'s management is responsible for
maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's
Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the effectiveness of the company's internal control over financial reporting based on our
audit.

We
conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and
performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A
company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures
that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because
of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In
our opinion, Universal American Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on the COSO
criteria.

We
also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Universal American Corp. and
subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the three
years in the period ended December 31, 2008, and our report dated March 9, 2009 expressed an unqualified opinion thereon.

/s/ ERNST & YOUNG LLP


New
York, New York
March 9, 2009

F-3

---





Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES        CONSOLIDATED BALANCE SHEETS        December 31, 2008 and 2007        (In thousands)

2008

2007ASSETSInvestments:Fixed maturities available for sale, at fair value (amortized cost: 2008, $1,075,078; 2007, $1,125,381)

$
1,032,393

$
1,124,849Policy loans


22,274


21,560Other invested assets


1,649


1,526Total investments


1,056,316


1,147,935Cash and cash equivalents


511,032


667,685Accrued investment income


13,214


13,364Deferred policy acquisition costs


237,630


245,511Amounts due from reinsurers


220,986


286,426Due and unpaid premiums


79,361


100,351Present value of future profits and other amortizing intangible assets


192,742


213,518Goodwill and other indefinite lived intangible assets


530,031


606,972Income taxes receivable


38,032


31,145CMS contract deposit receivables


609,293


394,225Other Part D receivables


154,049


181,696Advances to agents


60,017


61,076Other assets


168,009


139,352Total assets

$
3,870,712

$
4,089,256LIABILITIES AND STOCKHOLDERS' EQUITYLIABILITIESPolicyholder account balances

$
396,700

$
434,859Reserves for future policy benefits


625,012


616,450Policy and contract claimslife


10,133


12,213Policy and contract claimshealth


729,070


735,364Advance premium


7,183


25,232Loan payable


320,625


349,125Other long term debt


110,000


110,000Amounts due to reinsurers


30,640


68,557Deferred income tax liability


6,877


28,687Other Part D liabilities


149,523


157,048Other liabilities


168,865


200,655Total liabilities


2,554,628


2,738,190Commitments and contingencies (Note 17)STOCKHOLDERS' EQUITYPreferred Stock (Authorized: 3 million shares):Series A (Designated: 300,000 shares, issued and outstanding: 2008, 42,105 shares, liquidation value $37,137; 2007, 47,105 shares, liquidation value
$94,210)


42


47Series B (Designated: 300,000 shares, issued and outstanding: 2008, 0 shares, liquidation value $0; 2007, 127,895 shares, liquidation value
$255,790)





128Common stockvoting (Authorized: 200 million shares, issued and outstanding: 2008, 87.4 million shares; 2007, 75.0 million
shares)


874


750Common stocknon-voting (Authorized 30 million shares)





Additional paid-in capital


870,520


890,882Accumulated other comprehensive loss


(36,422
)

(66
)Retained earnings


558,675


463,583Less: Treasury stock (2008, 7.2 million shares; 2007, 0.3 million shares)


(77,605
)

(4,258
)Total stockholders' equity


1,316,084


1,351,066Total liabilities and stockholders' equity

$
3,870,712

$
4,089,256


See notes to consolidated financial statements.

F-4

---





Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF OPERATIONS        For the Three Years Ended December 31, 2008        (In
thousands, per share amounts in dollars)

2008

2007

2006Revenues:Direct premium and policyholder fees earned

$
5,177,108

$
3,677,749

$
1,883,579Reinsurance premiums assumed


47,818


39,937


32,187Reinsurance premiums ceded


(624,472
)

(776,267
)

(718,624
)Net premiums and policyholder fees earned


4,600,454


2,941,419


1,197,142Net investment income


81,270


106,970


75,459Fee and other income


37,130


26,412


27,645Net realized (losses) gains on investments


(59,681
)

(40,178
)

4,818Total revenues


4,659,173


3,034,623


1,305,064Benefits, Claims and Expenses:Claims and other benefits


3,832,438


2,365,451


907,449Change in reserves for future policy benefits


4,408


6,668


11,332Interest credited to policyholders


14,736


17,819


18,346Change in deferred acquisition costs


14,273


15,963


(16,684
)Amortization of intangible assets


23,763


12,251


8,067Commissions


147,125


167,145


116,708Reinsurance commission and expense allowances


(65,707
)

(71,221
)

(74,247
)Interest expense


23,694


20,480


12,821Early extinguishment of debt





1,343


Goodwill impairment


3,893





Other operating costs and expenses


582,059


422,762


273,703Total benefits, claims and other deductions


4,580,682


2,958,661


1,257,495Income from continuing operations, before equity in earnings of unconsolidated subsidiary


78,491


75,962


47,569Equity in earnings of unconsolidated subsidiary


72,813


56,664


46,187Income from continuing operations, before income taxes


151,304


132,626


93,756Provision for income taxes


56,212


48,554


32,610Income from continuing operations


95,092


84,072


61,146Discontinued Operations:Income from discontinued operations, net of income taxes








9,788Gain on sale of discontinued operations, net of taxes








48,372Income from discontinued operations








58,160Net income

$
95,092

$
84,072

$
119,306Earnings per common share:Basic (Note 2):Continuing operations

$
1.09

$
1.20

$
1.04Discontinued operations








0.99Net income

$
1.09

$
1.20

$
2.03Diluted:Continuing operations

$
1.08

$
1.18

$
1.02Discontinued operations








0.97Net income

$
1.08

$
1.18

$
1.99Weighted average shares outstanding:Weighted average common shares outstanding


74,997


64,175


59,256Less weighted average treasury shares


(3,635
)

(556
)

(717
)Basic weighted shares outstanding (Note 2)


71,362


63,619


58,539Weighted average common equivalent of preferred shares outstanding


16,157


6,609


Effect of dilutive securities


342


1,261


1,447Diluted weighted shares outstanding


87,861


71,489


59,986


See notes to consolidated financial statements.

F-5

---





Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)        For the Three Years Ended
December 31, 2008        (In thousands)

Preferred
Stock
Series A

Preferred
Stock
Series B

Common
Stock

Additional
Paid-In
Capital

Accumulated
Other
Comprehensive
Income (Loss)

Retained
Earnings

Treasury
Stock

TotalBalance, January 1, 2006

$


$


$
590

$
242,433

$
39,896

$
260,205

$
(11,240
)
$
531,884Net income

















119,306





119,306Other comprehensive loss














(38,013
)







(38,013
)Comprehensive income























81,293Issuance of common stock








9


4,616











4,625Stock-based compensation











5,460











5,460Repayments of loans to officers











12











12Treasury shares purchased, at cost




















(207
)

(207
)Treasury shares reissued











21








821


842Balance, December 31, 2006








599


252,542


1,883


379,511


(10,626
)

623,909Net income

















84,072





84,072Other comprehensive loss














(1,949
)







(1,949
)Comprehensive income























82,123Preferred stock issuance


47


128





331,932











332,107Issuance of common stock








9


9,109











9,118Stock-based compensation











10,683











10,683Repayments of loans to officers











38











38Acquisition of MemberHealth








142


283,358











283,500Treasury shares reissued











3,220








6,368


9,588Balance, December 31, 2007


47


128


750


890,882


(66
)

463,583


(4,258
)

1,351,066Net income

















95,092





95,092Other comprehensive loss














(36,356
)







(36,356
)Comprehensive income























58,736Preferred stock conversion


(5
)

(128
)

133














Issuance of common stock








11


4,843











4,854Stock-based compensation











9,469











9,469Purchase price adjustment for acquisition of MemberHealth








(20
)

(34,521
)










(34,541
)Treasury shares purchased, at cost




















(74,821
)

(74,821
)Treasury shares reissued











(153
)







1,474


1,321Balance, December 31, 2008

$
42

$


$
874

$
870,520

$
(36,422
)
$
558,675

$
(77,605
)
$
1,316,084


See notes to consolidated financial statements.

F-6

---





Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES        CONSOLIDATED STATEMENTS OF CASH FLOWS        For the Three Years Ended December 31, 2008        (In
thousands)

2008

2007

2006Cash flows from operating activities:Net income

$
95,092

$
84,072

$
119,306Adjustments to reconcile net income to net cash provided by operating activities, net of balances acquired:Income from discontinued operations








(9,788
)Gain on sale of discontinued operations








(48,372
)Equity in earnings of unconsolidated subsidiary


(72,813
)

(56,664
)

(46,187
)Distribution from unconsolidated subsidiary


67,500


58,371


40,500Deferred income taxes


7,050


(24,931
)

3,439Realized losses (gains) on investments


59,681


40,178


(4,818
)Amortization of intangible assets


23,763


12,251


8,067Impairment of goodwill


3,893





Net amortization of bond premium


2,171


1,356


2,162Changes in operating assets and liabilities:Deferred policy acquisition costs


14,273


15,963


(16,684
)Reserves for future policy benefits


8,562


15,953


14,563Policy and contract claims payable


(8,374
)

232,336


93,475Reinsurance balances


25,839


(86,932
)

20,793Due and unpaid advance premium, net


3,246


44,958


3,223Income taxes payable


(7,076
)

(6,791
)

(1,221
)Other Part D receivables


27,647


141,635


(85,871
)Other Part D liabilities


(7,525
)

(52,707
)

106,601Other, net


(60,180
)

(65,089
)

(7,334
)Cash provided by operating activitiescontinuing operations


182,749


354,134


191,854Cash provided by operating activitiesdiscontinued operations








13,655Cash provided by operating activities


182,749


354,134


205,509Cash flows from investing activities:Proceeds from sale or redemption of fixed maturity investments


221,142


246,636


178,751Cost of fixed maturity investments purchased


(233,276
)

(307,822
)

(186,396
)Proceeds from sale of subsidiary, net of cash sold





5,392


Purchase of business and return of purchase price, net of cash acquired


40,990


(307,931
)

(10,407
)Purchase of fixed assets


(20,935
)

(7,417
)

(15,227
)Return of investment in unconsolidated subsidiary





2,629


Other investing activities


735


917


935Cash provided by (used in) investing activitiescontinuing operations


8,656


(367,596
)

(32,344
)Cash (used in) provided by investing activitiesdiscontinued operations





(19,836
)

101,840Cash provided by (used in) investing activities


8,656


(387,432
)

69,496Cash flows from financing activities:Net proceeds from issuance of common and preferred stock, net of tax effect


7,662


347,068


6,551Cost of treasury stock purchases


(74,821
)




(207
)Receipts from CMS contract deposits


3,498,773


1,284,919


904,659Withdrawals from CMS contract deposits


(3,713,841
)

(1,710,472
)

(770,475
)Deposits and interest credited to policyholder account balances


17,051


19,761


44,005Surrenders and other withdrawals from policyholder account balances


(54,382
)

(70,090
)

(53,714
)Distribution from discontinued operations








4,372Principal repayment on loan payable and other long term debt


(28,500
)

(156,438
)

(5,250
)Issuance of new debt





450,000


Payment of debt issue costs





(5,895
)

Cash (used in) provided by financing activitiescontinuing operations


(348,058
)

158,853


129,941Cash used in financing activitiesdiscontinued operations








(1,715
)Cash (used in) provided by financing activities


(348,058
)

158,853


128,226Net (decrease) increase in cash and cash equivalents


(156,653
)

125,555


403,231Cash and cash equivalents at beginning of year


667,685


542,130


138,899Cash and cash equivalents at end of year

$
511,032

$
667,685

$
542,130


See notes to consolidated financial statements.

F-7

---





Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND COMPANY BACKGROUND

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

In
2006, we began offering PDPs pursuant to Medicare Part D under the Prescription PathwaySM brand through our Pennsylvania Life Insurance Company, American
Progressive Life & Health Insurance Company of New York and Marquette National Life Insurance Company subsidiaries, in connection with a strategic alliance with Caremark Rx, Inc., known
as Caremark, formerly PharmaCare Management Services, Inc., a third party pharmacy benefits manager, or PBM, and a wholly-owned subsidiary of CVS Caremark Corp. The strategic alliance with
CVS/Caremark was terminated as of December 31, 2008. In connection with termination, we divided the membership between Universal American and CVS/Caremark, transferring 236,000 members to
CVS/Caremark. The remaining 280,000 will continue under our Prescriba Rx PDP, our successor to Prescription PathwaySM, under which we will participate on a 100% basis in the plan. On
September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held PBM and sponsor of Community CCRxSM, a national Medicare Part D
prescription drug benefit plan. Effective on the date of the acquisition, we transferred all of the PDP business of MemberHealth, Inc. except New York business into Pennsylvania Life and we
transferred the New York PDP business into American Progressive. In connection with this acquisition,
we reconstituted MemberHealth, Inc. into a limited liability company and named it MemberHealth, L.L.C. See Note 3Business Combinations.

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

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

On
December 1, 2006, the Company completed the sale of PennCorp Life Insurance Company ("PennCorp Life Canada"), its Canadian subsidiary. Consequently, the Company has accounted
for the operations of PennCorp Life Canada as discontinued operations. See Note 23Discontinued Operations.

F-8

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation:We have prepared the accompanying consolidated financial statements in conformity with U.S. generally
accepted accounting
principles or U.S.GAAP for interim reporting in accordance with Article 10 of the Securities and Exchange Commission's Regulation S-X, and consolidate the accounts of
Universal American and its subsidiaries:



During
2005, we entered into a strategic alliance with Caremark and created Part D Management Services, L.L.C., known as PDMS. PDMS is 50% owned by Universal American and 50%
owned by Caremark. We do not control PDMS and therefore we do not consolidate PDMS is not consolidated in our financial statements. We account for our investment in PDMS on the equity basis and
include it in other assets. PDMS principally performs marketing and risk management services on behalf of our Prescription PathwaySM PDP, for which it receives fees and other
remuneration from our PDPs and Caremark. Together with Caremark, on February 13, 2008, we announced that the strategic alliance would end as of December 31, 2008, subject to regulatory
approval. On July 31, 2008, PDMS received approval from the Centers for Medicare and Medicaid Services (CMS) of the Novation Agreement for Change of Ownership of a Medicare Prescription Drug
Plan (PDP) Line of Business. As such, effective January 1, 2009, PDMS will no longer manage the strategic alliance and will not earn revenue or incur expenses related to the 2009 PDP year. PDMS
will continue to operate in 2009 solely to service the run-off activity related to pharmacy claims, rebates, and revenue related to prior PDP years. Upon dissolution of PDMS in 2009,
following the run-out of prior year PDP claims, the economic interest of PDMS would be split equally between us and Caremark to match the 50% voting and ownership rights held by each
entity. (see Note 21Unconsolidated Subsidiary)

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

Use of Estimates:Our consolidated financial statements have been prepared in accordance with Generally Accepted Accounting
Principles, known as
GAAP. The preparation of our financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the

F-9

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

Investments:The Company follows Statement of Financial Accounting Standards No. 115, "Accounting for Certain Debt and
Equity Securities,"
known as FAS 115. FAS 115 requires that debt and equity securities be classified into one of three categories and accounted for as follows:



Unrealized
gains and losses on available for sale securities are excluded from earnings and reported as accumulated other comprehensive income (loss), net of tax and deferred policy acquisition cost
adjustments unless the losses are determined to be other-than-temporary.

As
of December 31, 2008 and 2007, we classified all fixed maturity securities as available for sale and carried them at fair value, with the unrealized gain or loss, net of tax
and deferred policy acquisition cost adjustments, included in accumulated other comprehensive income (loss). We stated policy loans at the unpaid principal balance. We carried short-term
investments at cost, which approximates fair value. Other invested assets consist principally of equity securities, mortgage loans and collateral loans. We carried equity securities at current fair
value. We carried mortgage loans at the unpaid principal balance. We carried the collateral loans at the underlying value of their collateral that is the cash surrender value of life insurance.

The
fair value for fixed maturity securities is largely determined by third party pricing service market prices. The typical inputs that third party pricing services use are



F-10

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



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

We
regularly evaluate the amortized cost of our investments compared to the fair value of those investments. We generally recognize impairments of securities when we consider a decline
in fair value below the amortized cost basis to be other-than-temporary. The evaluation includes the intent and ability to hold the security to recovery, and we consider it on
an individual security basis, not on a portfolio basis. We generally recognize impairment losses for mortgage-backed and asset-backed securities when an adverse change in the amount or timing of
estimated cash flows occurs, unless the adverse change is solely a result of changes in estimated market interest rates. We also recognized impairment losses when we determine declines in fair values
based on quoted prices to be other than temporary.

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



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

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

F-11

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



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

Realized
investment gains and losses on the sale of securities are based on the specific identification method.

We
generally record investment income when earned. We amortize premiums and discounts arising from the purchase of mortgage-backed and asset-backed securities into investment income over
the estimated remaining term of the securities, adjusted for anticipated prepayments. We use the prospective method to account for the impact on investment income of changes in the estimated future
cash flows for these securities. We amortize premiums and discounts on other fixed maturity securities using the interest method over the remaining term of the security.

Deferred Policy Acquisition Costs:We defer the cost of acquiring new business, principally non-level commissions, agency
production,
policy underwriting, policy issuance, and associated costs, all of which vary with, and are primarily related to the production of new and renewal business. For interest-sensitive life and annuity
products, we amortize these costs in relation to the present value of expected gross profits on the policies arising principally from investment, mortality and expense margins in accordance with FAS
No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments". The determination of
expected gross profits for interest-sensitive products is an inherently uncertain process that relies on assumptions such as projected interest rates, the persistency of the policies issued as well as
anticipated benefits, commissions and expenses. It is possible that the actual profits from the business may vary materially from the assumptions used in the determination and amortization of deferred
acquisition costs, known as DAC.

For
other life and health products, we amortize DAC in proportion to premium revenue using the same assumptions used in estimating the liabilities for future policy benefits in
accordance with FAS No. 60, "Accounting and Reporting by Insurance Enterprises." Under FAS No. 60, any unamortized DAC relating to lapsed policies must be amortized as of the date of the
lapse.

We
test for the recoverability of DAC at least annually. To the extent that we determine that the present value of future policy premiums and investment income or the net present value
of expected gross profits would not be adequate to recover the unamortized costs, we would write off the excess

F-12

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

deferred
policy acquisition costs. Based on our review of DAC recoverability, we determined the DAC was recoverable.



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

F-13

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Amortizing intangible assets:We must estimate and make assumptions regarding the useful life we assign to our amortizing
intangible assets. Set
forth below are our annual amortization policies for each of the main categories of amortizing intangible assets:

Description

Weighted
Average Life
At Acquisition

Amortization BasisInsurance policies acquired


79

The pattern of projected future cash flows for the policies acquired over the estimated weighted average life of the policies
acquiredDistribution channel acquired


30

Straight line over the estimated life of the assetMembership base acquired


710

Straight line over the estimated weighed average life of the membership baseTrademarks/tradenames


9

Straight line over the estimated weighted average life of the trademarks/tradenamesLicenses


15

Straight line over the estimated weighed average life of the licensesProvider contracts


10

Straight line over the estimated weighted average life of the contractsNon-compete


7

Straight line over the length of the agreementAdministrative service contracts


6

The pattern of projected future cash flows for the customer contracts acquired over the estimated weighted average life of the
contractsHospital network contracts


10

The pattern of projected future cash flows for the hospital network contracts acquired over the estimated weighted average life
of the contracts


In
accordance with SFAS No. 144,Accounting for the Impairment and Disposal of Long-Lived Assets, we periodically
review amortizing intangible assets whenever adverse events or changes in circumstances indicate the carrying value of the asset may not be recoverable. In assessing

F-14

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

recoverability,
we must make assumptions regarding estimated future cash flows and other factors to determine if an impairment loss may exist, and, if so, estimate fair value. If these estimates or
their related assumptions change in the future, we may be required to record impairment losses for these assets. There were no impairment losses relating to our amortizing intangible assets during
2008.

Goodwill:SFAS No. 142,Goodwill and Other Intangible Assets, or
SFAS 142, requires
that goodwill balances be reviewed for impairment, at the reporting unit level, at least annually for impairment or more frequently if events occur or circumstances change that would indicate that a
triggering event, as defined in SFAS 142, has occurred. A reporting unit is defined as an operating segment or one level below an operating segment. Our reporting units are equivalent to our
operating segments.

The
goodwill impairment test follows a two step process as defined in SFAS 142. In the first step, the fair value of a reporting unit is compared to its carrying value. If the
carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the
reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. This allocation is similar to a purchase price allocation performed in
purchase accounting. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss shall be recognized in an amount equal to that excess.

Our
strategy, long-range business plan, and annual planning process support our goodwill impairment tests. These tests are based primarily on an evaluation of future
discounted cash flows under several scenarios. Outcomes from the discounted cash flow analysis were compared to other market approach valuation methodologies for reasonableness. We used a range of
discount rates that correspond to a market-based weighted-average cost of capital. Key assumptions, including changes in membership, premium yields, medical cost trends and certain government contract
extensions, are consistent with those utilized in our long-range business plan and annual planning process. Other assumptions include levels of economic capital, future business growth,
earnings projections, assets under management for the Traditional reporting unit and the weighted average cost of capital used for purposes of discounting. Decreases in the amount of economic capital
allocated to a reporting unit, decreases in business growth, decreases in earnings projections and increases in the weighted average cost of capital will all cause the reporting unit's fair value to
decrease. If these assumptions differ from actual, the estimates underlying our goodwill impairment tests could be adversely affected.

The
Company performed its annual goodwill assessment for the individual reporting units as of October 1, 2008. The conclusion reached as a result of the annual goodwill impairment
testing for 2008 was that the fair value of each reporting unit, for which goodwill had been allocated, was in excess of the respective reporting unit's carrying value (the first step of the goodwill
impairment test), except for the Traditional reporting unit. The Company concluded that the fair value of the Traditional reporting unit had declined, due to decreasing sales outlooks and the
lapsation of Medicare supplement policies. As a result of the step 2 analysis, the allocation of the fair value of the Traditional reporting units to its respective assets and liabilities as of
October 1, 2008 indicated an implied level of goodwill of $0. Therefore, the Company recorded an impairment charge of $3.9 million of goodwill for the Traditional reporting unit.

Recognition of Premium Revenues and Policy BenefitsMedicare Products:Medicare is a federal program that provides persons
age 65 and
over and some disabled persons under the age of 65 certain

F-15

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

hospital
and medical insurance benefits. Hospitalization benefits are provided under Part A, without the payment of any premium, for up to 90 days per incident of illness plus a lifetime
reserve aggregating 60 days. Eligible beneficiaries are required to pay an annually adjusted premium to the federal government to be eligible for physician care and other services under
Part B. Beneficiaries eligible for Part A and Part B coverage under traditional Medicare are still required to pay out-of-pocket deductibles and
coinsurance. Prescription drug benefits are provided under Part D. The Centers for Medicare and Medicaid Services, known as CMS, an agency of the United States Department of Health and Human
Services, administers the Medicare program. We contract with CMS under the Medicare Advantage program to provide a comprehensive array of health insurance benefits including wellness programs to
Medicare eligible persons under HMO, PPO, PFFS and stand-alone Part D plans in exchange for contractual payments received from CMS, usually a fixed payment per member per month.

We
routinely monitor the collectability of specific accounts, the aging of receivables, historical retroactivity trends, as well as prevailing and anticipated economic conditions, and
reflect any required adjustments in the current period's revenue.

Premiums
received pursuant to Medicare Advantage contracts with CMS for Medicare enrollees are recorded as revenue in the month in which members are entitled to receive service. Premiums
collected in advance are deferred. Accounts receivable from CMS and health plan members for coordinating physician services and inpatient, outpatient and ancillary care are included in other assets
and are recorded net of estimated bad debts. It is the Company's practice to accrue revenue in addition to the premiums received from CMS based upon changes to hierarchical condition categories (HCC)
risk scores not then considered by CMS and based solely on the analysis of claims information and confirmed chart data that is in the possession of the Company. Certain commissions are deferred and
recognized in relation to the corresponding revenues for which they are earned, no longer than a
one-year period. Policies and contract claims include actual claims reported but not paid and estimates of health care services incurred but not reported. The estimated claims incurred but
not reported are based on historical data, current enrollment, health service utilization statistics and other related information. Although considerable variability is inherent in such estimates,
management believes that the liability is adequate. Changes in assumptions for medical costs caused by changes in actual experience could cause these estimates to change in the near term.



CMS uses monthly rates per person for each county to determine the fixed monthly payments per member to pay to health benefit plans,
including our HMO, PFFS and PPO plans. CMS has implemented a risk adjustment model which apportions premiums paid to all health plans according to health severity. The risk adjustment model uses
health status indicators, or risk scores, to improve the accuracy of payment. The CMS risk adjustment model pays more for members with predictably higher costs. Under this risk adjustment methodology,
diagnosis data from inpatient and ambulatory treatment settings are used to calculate the risk adjusted premium payment to us. All health benefit organizations must capture, collect, and submit the
necessary diagnosis code information to CMS within prescribed deadlines. Accordingly, we collect, capture, and submit the necessary and available diagnosis data to CMS within prescribed deadlines. We
estimate risk adjustment revenues based upon the diagnosis data submitted to CMS and ultimately accepted by CMS. The risk adjustment revenues are periodically reconciled by CMS and the settlement
could result in adjustments to premium revenue. The stand-

F-16

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

alone
PDP payment methodology is based on the risk adjustment model, however, we do not have access to diagnosis data with respect to our stand-alone PDP members. We are reliant on CMS to capture and
collect the necessary diagnosis information for these members. Changes in revenues from CMS for our Medicare products resulting from the periodic changes in risk adjustment scores for our membership
are recognized when the amounts become determinable and the collectability is reasonably assured. Our monthly premium payment from CMS could change materially, either favorably or unfavorably, as a
result of changes in the risk scores for the underlying membership of our plans.



We analyze the membership for our Medicare Part D, HMO, PFFS and PPO plans in our administrative system and reconcile to the
enrollment provided by CMS. Our revenues and claims expense are based on the enrollment information provided by CMS. There are timing differences between the addition of members to our administrative
system and the approval, or accretion, of the member by CMS before we are paid for that member by CMS. Additionally, the
monthly payments from CMS include adjustments to reflect changes in membership as a result of retroactive terminations, additions or other changes. Current period revenues are adjusted to reflect
retroactive changes in membership.



We provide prescription drug coverage in accordance with Medicare Part D as a stand-alone benefit to Medicare-eligible
beneficiaries, known as Part D benefits, through our PDPs under multiple contracts with from the CMS. On January 1, 2006, we began providing Part D benefits under our Prescription
PathwaySM plans pursuant to a strategic alliance with CVS Caremark. The Prescription PathwaySM PDPs sponsored by subsidiaries of Universal American were reinsured, on a 50%
coinsurance funds withheld basis, to PharmaCare Re, a subsidiary of CVS/Caremark. The strategic alliance with CVS/Caremark was terminated as of December 31, 2008. In connection with
termination, we divided the membership between Universal American and CVS/Caremark, transferring 236,000 members to CVS/Caremark.

The
remaining 280,000 will continue under our Prescriba Rx PDP, our successor to Prescription PathwaySM, under which we will participate on a 100% basis in the plan. In
connection with our acquisition of MemberHealth on September 21, 2007, we began providing Part D benefits through the Community CCRx PDP. Our Medicare contracts with CMS renew annually.

In
general, prescription drug benefits under Part D PDPs may vary in terms of coverage levels and out-of-pocket costs for beneficiary premiums, deductibles
and co-insurance. However, all Part D PDPs must offer either "standard coverage" or its actuarial equivalent (with out-of-pocket threshold and deductible
amounts that do not exceed those of standard coverage). These defined "standard" benefits represent the minimum level of benefits mandated by Congress. We also offer other PDPs containing benefits in
excess of standard coverage limits for an additional beneficiary premium.

F-17

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Our PDPs receive monthly payments from CMS and members which generally represent our bid amount for providing insurance coverage. The payments from CMS reflect the health status of the
beneficiary and risk sharing provisions, as discussed below. We recognize premium revenue for providing this insurance coverage during each month in which members are entitled to benefits.



Our CMS payment is subject to risk sharing through the Medicare Part D risk corridor provisions. The risk corridor provisions
permit our PDPs and CMS to share the risk associated with the ultimate costs of the Part D benefit. The risk corridor provisions compare a plan's actual prescription drug costs to their
targeted costs, as reflected in their bids ("target amount') and could result in positive or negative adjustments to the CMS payment, that are reported through premium revenues. Variances exceeding,
or below, certain thresholds may result in CMS making additional payments to us, or requiring us to refund to CMS a portion of the payments we received. Actual prescription drug costs subject to risk
sharing with CMS are limited to the costs that are, or would have been, incurred under the CMS defined "standard" benefit plan. We estimate and recognize an adjustment to premium revenues related to
the risk corridor payment, at the contract level, based upon prescription drug claims experience to date, net of manufacturer rebates and other Part D revenues, at the end of each reporting
period. Accordingly, this estimate does not consider future prescription drug claims experience. We record a receivable or payable in the consolidated balance sheets based on the expected settlement.
The estimate of the settlement associated with risk corridor provisions requires us to consider factors that may not be certain, including, among others, member eligibility differences with CMS.

Our
CMS payments also include catastrophic reinsurance allowances and Federal subsidies (CMS contract deposits) for which we do not bear risk. These subsidies represent reimbursements
from CMS for claims we pay for which we assume little or no risk. A large percentage of claims paid above the out-of-pocket or catastrophic threshold for which we are not at
risk are reimbursed by CMS through the reinsurance subsidy for PDPs offering the standard coverage. Low-income cost subsidies represent reimbursements from CMS for all or a portion of the
deductible, the coinsurance and co-payment amounts above the out-of-pocket threshold for low-income beneficiaries. Monthly prospective payments from CMS
for reinsurance and low-income cost subsidies are based on assumptions submitted with our annual bid. A reconciliation and related settlement of CMS's prospective subsidies against actual
prescription drug costs we paid is made after the end of the year. We account for these subsidies as deposits in our consolidated balance sheets and as a financing activity in our consolidated
statements of cash flows. We do not recognize premium revenues or claims expense for these subsidies. Receipt and payment activity is accumulated at the contract level and recorded in our consolidated
balance sheets as a CMS contract deposit account asset or liability depending on the net contract balance at the end of the reporting period.

In
order to allow plans offering enhanced benefits the maximum flexibility in designing alternative prescription drug coverage, CMS provided a demonstration payment option in lieu of the
reinsurance subsidy for plans offering enhanced coverage, or coverage beyond CMS's defined standard benefits. The demonstration payment option is an arrangement in which CMS pays a capitation amount
to a plan for assuming the government's portion of prescription drug costs in the catastrophic layer of coverage. The capitation amount represents a fixed monthly amount per member to provide
prescription drug coverage in the catastrophic layer. We chose the demonstration payment option for

F-18

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

all
of our enhanced benefit plans. This capitation amount, derived from our annual bid submissions, is recorded as premium revenue. The variance between the capitation amount and actual drug costs in
the catastrophic layer is subject to risk sharing as part of the risk corridor settlement.

Settlement
of the reinsurance and low-income cost subsidies as well as the risk corridor payment is based on a reconciliation made by CMS approximately 9 months after
the close of each calendar year. This reconciliation process requires us to submit claims data necessary for CMS to administer the program. In October 2008, we received the reconciliation settlement
data from CMS for the 2007 Plan year. These amounts were settled on a preliminary basis in the fourth quarter. However, the Company has requested a reopening of the 2007 Plan year. The Company does
not expect any reopening to have a material impact on the consolidated financial statements. In October 2007, we received the reconciliation settlement data from CMS for the 2006 Plan year. These
amounts were settled on a preliminary basis in the fourth quarter of 2007. However, CMS reopened the 2006 Plan year which resulted in the settlement of additional amounts for that Plan year in June
2008. The reopening did not have a material impact on the consolidated financial statements.

At
December 31, 2008, the balance due from CMS for both plans for the 2008 Plan year was approximately $547 million, including approximately $529 million for
reinsurance and low-income cost subsidies and $18 million for the risk corridor and the balance due from CMS for both plans for the 2007 Plan year was approximately
$103 million, including approximately $86 million for reinsurance and low-income cost subsidies and $17 million for the risk corridor. The Company received payment of
$80 million for a reopening of the 2007 Plan year on January 2, 2009 and continues to work with CMS to settle the remaining amounts for the 2007 Plan year. At December 31, 2008,
the balance due from both plans to CMS for 2006 Plan year was approximately $9 million, including approximately $5 million for reinsurance and low-income cost subsidies and
$4 million for the risk corridor.

At
December 31, 2007, the balance due from CMS from both plans for the 2007 Plan year was approximately $451 million, including approximately $406 million for
reinsurance and low-income cost subsidies and $45 million for the risk corridor. The balance due to CMS from both plans for the 2006 Plan year was approximately $23 million,
including approximately $12 million for reinsurance and low-income cost subsidies and $11 million for the risk corridor.

During
2008 and 2007, we also paid Part D benefits for individuals who ultimately were determined to be members of other plans. At December 31, 2008 and 2007, in connection
with both the Prescription PathwaySM and Community CCRx plans, we have established a receivable totaling $17.4 million and $24.2 million, respectively, for these claims
which is included in other Part D receivables on the consolidated balance sheets. Membership information continues to be reconciled and refined by CMS with respect to the enrollment of members
among all plans participating in the Part D program. Additionally, we have established a liability totaling $6.2 million and $11.2 million, at December 31, 2008 and 2007,
respectively, included in policy and contract claims-health on the consolidated balance sheets, for our estimate of claims paid by state Medicaid programs on behalf of members of our PDPs. As these
membership differences are resolved, it is likely that the membership data upon which we based our results for prior plan years will change, with a corresponding change in the financial results for
the segment. We are unable to precisely quantify the impact of any potential change until the membership data is fully reconciled with CMS; however, we do not believe that any change from the amounts
reported as of December 31, 2008 or 2007 is likely to be material.

F-19

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recognition of Prior Plan Year Settlements under Medicare Part D and Private Fee-For-Service Plans:The Medicare
Part D prescription drug benefit program sponsored by the federal government commenced in 2006. This business is detail-oriented and relatively complex. The following factors affect the amount
due from CMS:



An
extended period of time after the close of the annual coverage period (December 31st) is required for the government to reconcile each member's PDEs and provide
back to each plan the information the plans need to finalize the accounting for this coverage. The federal government has a stated time schedule for providing information back to the plans for, among
other items, revenue adjustments based on risk scores, member eligibility by plan to reconcile the plan to plan reimbursements and the calculation of the final settlement with the federal government
for low-income cost subsidies, reinsurance and risk corridor payments. Reconciliation and related settlement of CMS's prospective subsidies, including reinsurance payments and
low-income cost subsidies, as well as the risk corridor is made after the end of each plan year. In August 2008, we received Medicare Part D risk score adjustment settlement data
from CMS for the 2007 plan year. Furthermore, in October 2008, we received Medicare Part D reconciliation settlement data from CMS for the 2007 Plan year. The net impact of these final 2007
settlements for our Prescription Pathways and Community CCRx plans combined, which were recorded in the third quarter, was a reduction of revenues of $4.7 million ($0.03 per diluted share for
the year ended December 31, 2008) and a reduction of claims expense of $2.4 million ($0.02 per diluted share for the year ended December 31, 2008). The effect of these adjustments
related to the portion of the 2007 plan year prior to our acquisition of MemberHealth was recorded as an adjustment to goodwill as part of our final purchase GAAP accounting. These adjustments
increased goodwill by $7.9 million, (See Note 3Business Combinations). The reconciliation and settlement process with CMS for the Part D coverage within Medicare
Advantage PFFS plans is similar to Medicare Part D plans with the two exceptions: (1) PFFS plans are ineligible for aggregate risk corridor payments; and (2) prospective monthly
catastrophic reinsurance payments to PFFS plans are based on CMS estimated average reinsurance payments to other Medicare AdvantagePrescription Drug (MA-PD) plans for their
Part D coverage. In October 2008, we received notification from CMS of an adjustment to our catastrophic reinsurance reimbursement for the Part D coverage within our PFFS plans for the
2007 Plan year. The impact of this adjustment, which was recorded in the third quarter, was a reduction of revenues of $4.5 million ($0.03 per diluted share for the year ended
December 31, 2008). In addition, during August 2008 we received 2007 plan year risk score adjustment settlement data from CMS for our Medicare Advantage HMO plans. The impact of this
adjustment, which was recorded in the third quarter, was an increase net income before taxes of $4.1 million ($0.03 per diluted share for the year ended December 31, 2008).

Recognition of Premium Revenues and Policy Benefits for Accident & Health Insurance Products:We record premiums when
due and recognize them
as revenue over the period to which the premiums

F-20

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

relate.
We recognize benefits and expenses associated with earned premiums as we earne the related premiums so as to result in recognition of profits over the life of the policies. We accomplish this
association by recording a provision for future policy benefits and amortizing deferred policy acquisition
costs. The liability for future policy benefits for accident & health policies consists of active life reserves and the estimated present value of the remaining ultimate net cost of incurred
claims. Active life reserves consist primarily of unearned premiums and additional reserves. We compute the additional reserves on the net level premium method using assumptions for future investment
yield, mortality and morbidity experience. The assumptions are based on past experience. We establish claim reserves for future payments not yet due on incurred claims, primarily relating to
individual disability and long term care insurance and group long-term disability insurance products. We initially establish these reserves based on past experience, continuously reviewed
and updated with any related adjustments recorded to current operations. Claim liabilities represent policy benefits due for unpaid claims, consisting primarily of claims in the course of settlement
and a liability for incurred but not yet reported claims, known as IBNR.

Recognition of Revenues, Contract Benefits and Expenses for Investment and Universal Life Type Policies:Revenues for universal
life-type policies and investment products consist of mortality charges for the cost of insurance and surrender charges assessed against policyholder account balances during the period. We
do not reflect amounts received for investment and universal life type products as premium revenue; rather we account for these amounts as deposits, with the related liability reflected in
policyholder account balances. We expense benefit claims incurred in excess of policyholder account balances. We determine the liability for policyholder account balances for universal
life-type policies and investment products under FAS 97 following a "retrospective deposit" method. The retrospective deposit method establishes a liability for policy benefits at
an amount determined by the account or contract balance that accrues to the benefit of the policyholder, which consists principally of policy account values before any applicable surrender charges. As
of September 30, 2006, we ceased selling annuity products. For the annuity products sold prior to September 30, 2006, we offered sales inducements in the form of first year only bonus
interest rates, which ranged from 1% to 4%, on some of our annuity products. Including the bonus interest rates, our current credited rates on our annuity products range from 2.5% to 7.25%. Minimum
guaranteed interest rates on our annuity products range from 1.5% to 5.5%. For universal life products, current credited rates range from 3% to 5.25%. Minimum guaranteed interest rates on our
universal life products range from 3% to 5.25%. These rates represent the minimum guaranteed base crediting rate of 3.0% and a first year guaranteed bonus credit of up to 2.0%. As of
December 31, 2008, we ceased selling interest sensitive life products.

Recognition of Premium Revenues and Policy Benefits for Traditional Life Products:We generally recognize premiums from
traditional life policies as
revenue when due. We matche benefits and expenses with this revenue so as to result in the recognition of profits over the life of the contracts. We accomplish this matching by recording a provision
for future policy benefits and the deferral and subsequent amortization of policy acquisition costs. The liability for future policy benefits represents the present value of future benefits to be paid
to or on behalf of policyholders, less the future value of net premiums and we calculate it based on actuarially recognized methods using morbidity and mortality tables, which we modify to reflect our
actual experience when appropriate. The liability for unpaid claims, including IBNR, reflects estimates of amounts to fully settle known reported claims related to insured events that we estimate have
occurred, but have not yet been reported to us.

F-21

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recognition of Administrative Service Revenue:We generally recognize fees for administrative services over the period for which
we are obligated to
provide service.

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

We
establish valuation allowances based upon an analysis of projected taxable income and our ability to implement prudent and feasible tax planning strategies. We carried valuation
allowances on deferred tax assets of $4.4 million at December 31, 2008 and $3.1 million at December 31, 2007. To the extent that valuation allowances were established in
conjunction with acquisitions, changes in those allowances are first applied to goodwill (but not below zero) or other intangibles related to the acquisition, for acquisitions occurring before
January 1, 2009, and then are applied to income tax expense. At December 31, 2008, we assessed the amount of the deferred tax asset that was more likely than not to be realized under
SFAS No. 109,Accounting for Income Taxes, and concluded that we can record tax benefits related to our realized losses relating to our
investments for financial statement purposes.

We
adopted Financial Accounting Standards Board or FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109"
effective January 1, 2007please see Recently Adopted Accounting Standards elsewhere in Note 2.

Reinsurance:We reflect amounts recoverable under reinsurance contracts in total assets as amounts due from reinsurers rather
than netting those
amounts against the related policy asset or liability. We account for the cost of reinsurance related to long-duration contracts over the life of the underlying reinsured policies using
assumptions consistent with those used to account for the underlying policies. We evaluate the financial condition of our reinsurers and monitor concentrations of credit risk to minimize our exposure
to significant losses from reinsurer insolvencies. We are obligated to pay claims in the event that a reinsurer to whom we have ceded an insured claim fails to meet its
obligations under the reinsurance agreement. As of December 31, 2008, all of our primary reinsurers were rated "A" or better by A.M. Best, except for PharmaCare Re, which is unrated. We
have secured a letter of credit from PharmaCare Re that we believe will adequately support the risks ceded. We do not know of any instances where any of our reinsurers have been unable to pay any
policy claims on any reinsured business.

Foreign Currency Translation:We translate the financial statement accounts of our discontinued Canadian operations, which are
denominated in
Canadian dollars, into U.S. dollars as follows:



F-22

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



Derivative InstrumentsCash Flow Hedge:We use interest rate swap agreements to manage risk arising from interest rate
volatility.
Interest rate swap agreements, which are cash flow hedges, are contracts to exchange interest payments on a specified principal or notional amount for a specified period. By using derivatives to
manage risk, we expose ourselves to credit risk and additional market risk. Credit risk is the exposure to loss if a counterparty fails to perform under the terms of the derivative contract. We
minimize credit risk by entering into transactions with counterparties that maintain high credit ratings. Market risk is the exposure to changes in the market price of the underlying instrument and
the related derivative. These price changes result from movements in interest rates, and as a result, assets and liabilities will appreciate or depreciate in market value. We recognize these
derivative instruments on the consolidated balance sheets at their fair value, based on external quotes provided by banks. We report the fair value of the derivative instruments as assets or
liabilities in other assets or other liabilities.

On
the date we enter into the interest rate swap contract we may designate it as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to
a recognized asset or liability, or a cash flow hedge, if specified criteria are met. At the inception of the contract, we formally document all relationships between the hedging instrument and the
hedged item, as well as its risk-management objective and strategy for undertaking each hedge transaction. We also formally assess, both at the hedge's inception and on an ongoing basis,
whether the derivative used in hedging transactions are highly effective in offsetting changes in the cash flows of the hedged items.

For
a derivative designated as a cash flow hedge, we record the effective portion of changes in the fair value of the derivative in accumulated other comprehensive income (loss) and
recognize it in the income statement when the hedged item affects results of operations. If we determine that



we
discontinue hedge accounting prospectively.

If
we discontinue hedge accounting, we will continue to carry the derivative at fair value, with change in the fair value of the derivative recognized in the current period results of
operations. When we discontinue hedge accounting because it is probable that a forecasted transaction will not occur, we recognize the accumulated gains and losses included in other accumulated other
comprehensive income (loss) immediately in results of operations.

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

F-23

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

At
December 31, 2008 and 2007, we allocated earnings between common and participating preferred stock as follows:

2008

2007(In thousands)Net income attributable to common stock

$
77,537

$
76,160Undistributed income allocated to participating preferred stock


17,555


7,912Net income

$
95,092

$
84,072


Diluted
EPS gives the dilutive effect of the participating preferred stock and stock options outstanding during the year. We excluded 3,770,080 stock options from the computation of
diluted EPS at December 31, 2008 because they were antidilutive. At December 31, 2007, we excluded 450,185 stock options.

Stock Based Compensation:We have various stock-based incentive plans for our employees, non-employee directors and agents.
Detailed
information for activity in our stock plans can be found in Note 9Stock-Based Compensation. As of January 1, 2006, the Company adopted FASB Statement of Financial Accounting
Standards No. 123Revised, "Share-Based Payment," or FAS 123-R, using the modified prospective method. FAS 123-R requires companies to
recognize compensation costs for share-based payments to employees and non-employee directors based on the grant date fair value of the award and permits them to amortize this fair value
over the grantees' service period. The provisions of this standard require the fair value to be calculated using a valuation model such as the Black-Scholes or binomial-lattice models. We have elected
to use the Black-Scholes valuation model to value employee stock options, as we had done for our previous pro forma stock compensation disclosures. Under the modified prospective method, we recognize
compensation cost for the fair value of the unvested portion of existing arrangements as of January 1, 2006, as well as the fair value for all new share-based arrangements. We have not restated
prior periods, as is allowed under the modified retrospective basis, but will continue to disclose them on a pro forma basis in the notes to the consolidated financial statements, as previously
reported. See Note 9Stock-Based Compensation for additional information.

Prior
to 2006, as permitted by FAS 123, we measured our stock-based compensation for employees and directors using the intrinsic value approach under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees," or APB 25, and related interpretations. Accordingly, we did not recognize compensation expense upon the issuance of our stock
options because the option terms are fixed and the exercise price equaled the market price of the underlying common stock on the grant date. For options issued to employees with an exercise price that
is less than market on the date of grant we recognized an expense for the difference between the exercise price and the value of the options on the date of grant.

We
determine stock-based compensation for agents based on Emerging Issues Task Force Issue No. 96-18, "Accounting for Equity Instruments that are Issued to Other than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services", or EITF 96-18. We expense the fair value of the awards over the vesting period of each award.

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

F-24

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

the
time of purchase. At December 31, 2008, cash equivalents contained $541.4 million of government money market funds. Supplemental cash flow information for interest and income taxes
paid for continuing and discontinued operations is as follows:

2008

2007

2006(In thousands)Supplemental cash flow information from continuing operations:Cash paid for interest

$
22,721

$
18,679

$
12,758Cash paid for income taxes

$
52,215

$
103,007

$
25,800Non-cash financing activities:(Return) issuance of common stock in connection with MemberHealth acquisition (See Note 3Business Combinations)

$
(34,541
)
$
283,500

$
Supplemental cash flow information from discontinued operations:Cash paid for income taxes

$


$


$
5,994


Reclassifications:We have made reclassifications to the December 31, 2007 balance sheet with respect to classification of
assets and
liabilities related to HMO Part D components. These reclassifications had no effect on net income or earnings per share as previously stated.



Amendments to the Impairment Guidance of EITF Issue No. 99-20In January 2009, FASB issued FASB Staff Position or FSP No.
EITF 99-20-1, "Amendments to the Impairment Guidance of EITF Issue No. 99-20," or FSP EITF 99-20-1. The FSP amends the
impairment guidance of Emerging Issues Task Force ("EITF") Issue No. 99-20, "Recognition of Interest Income and Impairment of Purchased Beneficial Interest and Beneficial Interest
that Continue to Be Held by a Transferor in Securitized Financial Assets," by removing the exclusive reliance upon market participant assumptions about future cash flows when evaluating impairment of
securities within its scope. FSP EITF 99-20-1 requires companies to follow the impairment guidance in Statement of Financial Accounting Standards ("SFAS")
No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), which permits the use of reasonable management judgment of the probability that the holder will
be unable to collect all amounts due. The FSP is effective
prospectively for interim and annual reporting periods ending after December 15, 2008. We adopted the FSP on December 31, 2008 and the adoption did not have a material effect on our
consolidated financial statements.

Fair Value MeasurementsOn January 1, 2008, we adopted SFAS No. 157, "Fair Value Measurements," issued in September 2006. For financial
statement elements currently required to be measured at fair value, SFAS 157 redefines fair value, establishes a framework for measuring fair value under U.S. GAAP and enhances
disclosures about fair value measurements. The new definition of fair value focuses on the price, called an exit price that would be received to sell the asset or paid to transfer the liability
regardless of whether an observable liquid market price existed. An exit price valuation will include margins for risk even if they are not observable. As we obtain release from risk,

F-25

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

the
margins for risk will also be released through net realized capital gains or losses in net income. SFAS 157 provides guidance on how to measure fair value, when required, under existing
accounting standards. SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels, which we call
Levels 1, 2, and 3.

We
applied the provisions of SFAS 157 prospectively to financial assets and financial liabilities that we are required to measure at fair value under existing U.S. GAAP. We
determined that there was no effect to our opening retained earnings or current period statement of operations from the implementation of SFAS 157. See Note 6 for additional information
regarding SFAS 157.

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



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

In
October 2008, the FASB issued FSP FAS No. 157-3, "Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active." This FSP clarifies
the application of SFAS 157 in a market that is not active and provides an example to illustrate key considerations in the determination of the fair value of a financial asset when the market
for that asset is not active. The principal key considerations illustrated in FSP FAS 157-3 example are the use of an entity's own assumptions about future cash flows and
appropriately risk-adjusted discount rates, appropriate risk adjustments for nonperformance and liquidity risks, and the reliance that an entity should place on quotes that do not reflect
the results of market transactions. FSP FAS 157-3 was preceded by a press release that was jointly issued by the Office of the Chief Accountant of the SEC and the FASB staff on
September 30, 2008 which provided immediate clarification on fair value accounting based on the measurement guidance of SFAS 157. FSP FAS 157-3 was effective upon
issuance. FSP FAS 157-3 did not have an impact on our consolidated financial statements.

Deferred Acquisition CostsIn September 2005, the American Institute of Certified Public Accountants issued Statement of Position 05-1,
"Accounting by Insurance Enterprises for Deferred Acquisition Costs ("DAC") in Connection with Modifications or Exchanges of Insurance Contracts" ("SOP 05-1").
SOP 05-1 provides guidance on accounting by insurance enterprises for DAC on internal replacements of insurance and investment contracts. An internal replacement is a modification
in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature
or coverage within a contract. Modifications that result in a replacement contract that is substantially

F-26

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

changed
from the replaced contract should be accounted for as an extinguishment of the replaced contract. Unamortized DAC, unearned revenue liabilities and deferred sales inducements from the replaced
contract must be written-off. Modifications that result in a contract that is substantially unchanged from the replaced contract should be accounted for as a continuation of the replaced
contract. SOP 05-1 was effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged. Initial application
of SOP 05-1 should be as of the beginning of the entity's fiscal year. We adopted SOP 05-1 effective January 1, 2007. Adoption of this statement did not
have a material effect on our consolidated financial statements.

Income TaxesIn June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxesan
Interpretation of FASB Statement 109" ("FIN 48"). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements
uncertain tax positions that the company has taken or expects to take on a tax return. The interpretation requires companies to recognize the tax benefits of uncertain tax positions only where the
position is "more likely than not" to be sustained assuming examination by tax authorities. The amount recognized would be the amount that represents the largest amount of tax benefit that is greater
than 50% likely of being realized upon ultimate settlement with the taxing authority. A liability would be recognized for any benefit claimed, or expected to be claimed, in a tax return in excess of
the benefit recorded in the financial statements, along with any interest and penalty (if applicable) on the excess.

FIN 48
requires a tabular reconciliation of the change in the aggregate unrecognized tax benefits claimed, or expected to be claimed, in tax returns and disclosure relating to
accrued interest and penalties for unrecognized tax benefits. Discussion is also required for those uncertain tax positions where it is reasonably possible that the estimate of the tax benefit will
change significantly in the next 12 months. FIN 48 was effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48, effective January 1,
2007, did not have a material effect on our consolidated financial statements.



Disclosures about Derivative Instruments and Hedging ActivitiesIn March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133" ("SFAS 161"). SFAS 161 amends and expands disclosures about an entity's derivative and hedging
activities with the intent of providing users of financial statements with an enhanced understanding of (a) how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under SFAS 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity's
financial position, financial performance, and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008,
with early application encouraged. SFAS 161 encourages, but does not require, comparative disclosures. We adopted SFAS 161 on January 1, 2009. The adoption of SFAS 161 is
expected to result in expanded disclosures related to derivative instruments and hedging activities.

F-27

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Business CombinationsIn December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business Combinations" ("SFAS 141(R)"). This
statement replaces SFAS No. 141, "Business Combinations" ("SFAS 141") and establishes the principles and requirements for how the acquirer in a
business combination: (a) measures and recognizes the identifiable assets acquired, liabilities assumed, and any noncontrolling interests in the acquired entity, (b) measures and
recognizes positive goodwill acquired or a gain from bargain purchase (negative goodwill), and (c) determines the disclosure information that is decision-useful to users of financial statements
in evaluating the nature and financial effects of the business combination. Some of the significant changes to the existing accounting guidance on business combinations made by SFAS 141(R)
include the following:



SFAS 141(R)
is effective for and shall be applied prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting
period beginning on or after
December 15, 2008, with earlier adoption prohibited. Assets and liabilities that arose from business combinations with acquisition dates prior to the SFAS 141(R) effective date shall not
be adjusted upon adoption of SFAS 141(R) with certain exceptions for acquired deferred tax assets and acquired income tax positions. The adoption of SFAS 141(R) on January 1,
2009, did not have a material effect on our consolidated financial statements but will impact any future acquisitions.

Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51In December 2007, the FASB issued SFAS
No. 160, "Noncontrolling Interests in Consolidated Financial Statements" ("SFAS 160"). This statement amends Accounting Research Bulletin No. 51, "Consolidated Financial
Statements" ("ARB 51"). Noncontrolling interest refers to the minority interest portion of the equity of a subsidiary that is not attributable directly or indirectly to a parent. SFAS 160
establishes accounting and reporting standards that require for-profit entities that prepare consolidated financial statements to: (a) present noncontrolling interests as a
component of equity, separate from

F-28

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

the
parent's equity, (b) separately present the amount of consolidated net income attributable to noncontrolling interests in the income statement, (c) consistently account for changes
in a parent's ownership interests in a subsidiary in which the parent entity has a controlling financial interest as equity transactions, (d) require an entity to measure at fair value its
remaining interest in a subsidiary that is deconsolidated, and (e) require an entity to provide sufficient disclosures that identify and clearly distinguish between interests of the parent and
interests of noncontrolling owners. SFAS 160 applies to all for-profit entities that prepare consolidated financial statements, and affects those for-profit entities
that have outstanding noncontrolling interests in one or more subsidiaries or that deconsolidate a subsidiary. SFAS 160 is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008 with earlier adoption prohibited.

The
adoption of SFAS 160 on January 1, 2009 did not have a material effect on our consolidated financial statements.

3. BUSINESS COMBINATIONS



On September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held pharmacy benefits
manager, or PBM, and sponsor of Community CCRxSM, a national Medicare Part D plan with 1.2 million members. Prior to the acquisition, MemberHealth was a leading national
Medicare Part D sponsor, offering Medicare prescription drug plans in 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. MemberHealth, Inc. had more than
60,000 pharmacies in its pharmacy network and covered 98 of the top 100 medications taken by Medicare beneficiaries.

We
paid the original purchase price of $630 million, apportioned 55% in cash and 45% in our common stock valued at $20 per share. We paid transaction costs of approximately
$12 million in cash. In addition to the purchase price, the transaction contemplated an additional three year earn-out tied to target earnings from the MemberHealth business. The
maximum aggregate amount potentially payable under the performance-based earn-out was $150 million, payable in cash and our common stock. On December 31, 2008, the maximum
potential payable was amended so that there is no longer a stock portion of the earn-out payment; therefore, the maximum potential payout for any earn-out has been reduced from
$150 million to $82.5 million, representing the 55% cash portion only. Additionally, there was no
earn-out earned for 2008, thus further reducing the maximum potential earn-out from $82.5 million to $55 million for 2009 and 2010.

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

F-29

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. BUSINESS COMBINATIONS (Continued)

December 31,
2008. We reflected this amortization in direct premium and policyholder fees earned in the consolidated statements of operations.

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

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

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

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

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

F-30

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. BUSINESS COMBINATIONS (Continued)

deferred
taxes of $3.6 million, as an adjustment to goodwill and we reported the post-acquisition amount as a reduction of third quarter claims expense.

After
giving effect to the settlement and the final allocation adjustments discussed above, the excess of the purchase price over the fair value of net tangible assets acquired, adjusted
for deferred income taxes, was approximately $607.6 million:

Description

Amount
(In thousands)

Weighted
Average Life
At Acquisition

Amortization BasisMembership base acquired

$
135,426


10

Straight line over the estimated life of the membership baseTrademarks/trade names


20,433


9

Straight line over the estimated life of the trademarks/trade namesLicenses


3,500


15

Straight line over the estimated life of the licensesGoodwill


448,215




Non amortizingTotal excess of purchase price over tangible book value

$
607,574


The
membership base represents the present value of the estimated future profits of the membership base at the date of the acquisition.

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

To
fund the cash required to close the transaction and to provide us with capital to support our organic growth, investment funds operated by Lee Equity Partners, LLC, Perry
Capital, LLC, Union Square Partners Management, LLC, the successor to Capital Z Management, LLC, and Welsh, Carson, Anderson & Stowe X, L.P., acquired shares of our
Series A and Series B preferred stock valued at $20 per equivalent share of our common stock. These funds invested a total of approximately $350 million, of which they funded
$100 million in the second quarter of 2007, and the remainder effective September 21,
2007. The preferred stock is convertible into shares of our common stock and does not bear a dividend. See Note 8Stockholders' Equity to the consolidated financial statements
included elsewhere in this annual report on Form 10-K, for additional information regarding the preferred stock. We did not register the preferred stock under the Securities Act of
1933, as amended, and it may not be subsequently offered or sold by investors in the United States absent registration or an applicable exemption from the registration requirement.

F-31

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. BUSINESS COMBINATIONS (Continued)

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

September 21, 2007(In thousands)AssetsCash and cash equivalents

$
74,215Amortizing intangible assets:Membership base


135,426Trademarks/trade names


20,433Licenses


3,500Goodwill


448,215Due and unpaid premium


135,218CMS deposit contract receivable


91,347Other Part D receivables


92,120Deferred taxes


16,886Other


28,424Total Assets

$
1,045,784LiabilitiesPolicy related liabilities

$
297,437Due to reinsurers


72,243Other


115,161Total Liabilities


484,841Equity


560,943Total Liabilities and Equity

$
1,045,784


We
have not included operating results generated by MemberHealth prior to September 21, 2007, the date of acquisition, in our consolidated financial statements. The unaudited
consolidated pro forma results of operations, assuming that we purchased MemberHealth on January 1, 2006 are as follows:

Years Ended December 31,2007

2006(in thousands)Total revenue

$
4,276,228

$
2,545,138Income from continuing operations before taxes

$
181,634

$
168,259Net income from continuing operations

$
115,139

$
108,513Earnings per common share:Basic

$
1.34

$
1.35Diluted

$
1.32

$
1.32


The
pro forma information presented above is for disclosure purposes only and is not necessarily indicative of the results of operations that would have occurred if we had consummated
the acquisition on the date assumed, nor is the pro forma information intended to be indicative of our future results of operations.

F-32

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. BUSINESS COMBINATIONS (Continued)



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

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

Description

Amount
(In thousands)

Weighted
Average Life
At Acquisition

Amortization BasisMembership base acquired

$
6,072


10

Straight line over the estimated life of the membership baseNon-compete agreement


1,018


7

Straight line over the length of the agreementGoodwill


9,962




Non amortizingTotal excess of purchase price over tangible book value

$
17,052




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

F-33

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. INTANGIBLE ASSETS

The following table shows the Company's acquired intangible assets that continue to be subject to amortization and accumulated amortization expense:

December 31, 2008

December 31, 2007Weighted
Average
Life
(Years)Value
Assigned

Accumulated
Amortization

Value
Assigned

Accumulated
Amortization(In thousands)Traditional Insurance:Policies in forceHealth


9

$
18,473

$
13,069

$
18,473

$
12,252Distribution channel


30


26,684


5,770


22,055


3,492Policies in forceLife/Annuity


7


4,127


2,465


4,127


2,241Medicare Part D:Membership base


10


135,426


17,267


138,000


3,795Trademarks/tradenames


9


20,433


2,895


18,000


550Licenses


15


3,500


297


5,000


92Senior Managed CareMedicare Advantage:Membership base


7


23,988


9,785


23,988


7,542Provider contracts


10


15,539


5,462


15,539


3,853Non-compete


7


1,425


325


1,425


121Senior Administrative Services:Administrative service contracts


6


7,671


7,628


7,671


7,526Hospital network contracts


10


1,797


1,358


1,797


1,093Total


17

$
259,063

$
66,321

$
256,075

$
42,557


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

2008

2007

2006(In thousands)Balance, beginning of year

$
213,518

$
54,738

$
50,724Additions and adjustments


2,987


171,031


12,081Amortization, net of interest


(23,763
)

(12,251
)

(8,067
)Balance, end of year

$
192,742

$
213,518

$
54,738


See
Note 3Business Combinations for a discussion of the acquisitions that gave rise to the additions during 2008 and 2007. During the first quarter of 2006, Heritage
acquired an additional interest in the earnings of one of its risk pools, effective as of January 1, 2006, for $12.1 million. The purchase price was allocated to the amortizing
intangible assetProvider Contracts and represents the present value of the estimated future cash flows related to the additional interest, and will be amortized over ten years.
Amortization, net of interest increased in 2008 over 2007 as a result of a full year of amortization of intangible assets recognized in 2008 in connection with the September 2007 acquisition of
MemberHealth vs. 3 months in 2007.

F-34

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. INTANGIBLE ASSETS (Continued)

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

2009

$
23,6322010


23,1842011


21,3342012


21,1712013


21,040Thereafter


82,381$
192,742


Changes
in the carrying amounts of goodwill and intangible assets with indefinite lives (other non-amortizing intangible assets consist primarily of trademarks and licenses)
are shown below:

December 31,
2007

Additions

Adjustments

December 31,
2008(In thousands)Traditional InsuranceGoodwill

$
3,893

$


$
(3,893
)
$
Medicare Part DGoodwill


520,764





(72,549
)

448,215Senior Managed CareMedicare Advantage:Goodwill


67,928


1,646


(2,145
)

67,429Other


10,030








10,030SubtotalSenior Managed CareMedicare Advantage


77,958


1,646


(2,145
)

77,459Senior Administrative ServicesGoodwill


4,357








4,357Total

$
606,972

$
1,646

$
(78,587
)
$
530,031


The
Company performed its annual goodwill assessment for the individual reporting units as of October 1 2008. The conclusion reached as a result of the annual goodwill impairment
testing for 2008 was that the fair value of each reporting unit, for which goodwill had been allocated, was in excess of the respective reporting unit's carrying value (the first step of the goodwill
impairment test), except for
the Traditional reporting unit. The Company concluded that the fair value of the Traditional reporting unit had declined, due to decreasing sales outlooks and the lapsation of Medicare supplement
policies. As a result of the step 2 analysis, the allocation of the fair value of the Traditional reporting units to its respective assets and liabilities as of October 1, 2008 indicated an
implied level of goodwill of $0. Therefore, the Company recorded an impairment charge of $3.9 million of goodwill for the traditional reporting unit.

The
decrease in goodwill for Medicare Part D was due to the reduction in the purchase price for MemberHealth of $81.9 million, net of $9.4 million of increases to
goodwill as a result of our completion of the purchase price allocation process for the acquisition, including the finalization of the valuation and, measurement of the asset acquired. For a full
discussion of the MemberHealth purchase price adjustment see Note 3Business Combinations. The decrease in goodwill in Senior Managed CareMedicare Advantage was the
result of the pre-acquisition tax adjustment related to the Heritage acquisition and the settlement of pre-acquisition adjustments in connection with the Harmony Health
acquisition.

F-35

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

5. INVESTMENTS

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

December 31, 2008Classification

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair
Value(In thousands)U.S. Treasury securities and obligations of U.S. Government

$
33,963

$
1,372

$


$
35,335Government sponsored agencies


90,030


4,999





95,029Other political subdivisions


9,993


133


(241
)

9,885Corporate debt securities


441,681


4,055


(25,453
)

420,283Foreign debt securities


32,779


41


(1,930
)

30,890Mortgage-backed and asset-backed securities


466,632


8,109


(33,770
)

440,971$
1,075,078

$
18,709

$
(61,394
)
$
1,032,393




December 31, 2007Classification

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair
Value(In thousands)U.S. Treasury securities and obligations of U.S. government

$
34,510

$
378

$
(2
)
$
34,886Government sponsored agencies


95,975


2,750





98,724Other political subdivisions


5,558


34


(57
)

5,536Corporate debt securities


431,002


7,772


(6,633
)

432,141Foreign debt securities


29,363


472


(194
)

29,641Mortgage-backed and asset-backed securities


528,973


4,494


(9,546
)

523,921$
1,125,381

$
15,900

$
(16,432
)
$
1,124,849


At
December 31, 2008, gross unrealized losses of $33.8 million on mortgage-backed and asset-backed securities reflect unrealized losses of $13.5 million on subprime
residential mortgage loans, as discussed below, and $20.3 related to obligations of other mortgage-backed securities and other asset-backed securities. The value of a majority of these securities is
depressed due to the deterioration of value in the mortgage-backed securities market and related businesses. Corporate debt securities have gross unrealized losses of $25.5 million at
December 31 2008. These unrealized losses relate to corporate securities across all sectors, and reflect the general depressed market conditions that existed at December 31, 2008.
Management and the Investment Committee have evaluated these holdings, with input from our investment managers, and do not believe them to be other-than-temporarily impaired.

F-36

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

5. INVESTMENTS (Continued)

The
amortized cost and fair value of fixed maturities at December 31, 2008 by contractual maturity are shown below. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

Amortized
Cost

Fair
Value(In thousands)Due in 1 year or less

$
73,781

$
73,228Due after 1 year through 5 years


397,655


391,922Due after 5 years through 10 years


98,367


95,333Due after 10 years


38,643


30,939Mortgage and asset-backed securities


466,632


440,971$
1,075,078

$
1,032,393


The
fair value and unrealized loss as of December 31, 2008 for fixed maturities, aggregated by investment category and length of time that individual securities have been in a
continuous unrealized loss position, are shown below:

Less than 12 Months

12 Months or Longer

TotalClassification

Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss

Fair
Value

Unrealized
Loss(In thousands)U.S. Treasury securities and obligations of U.S. Government

$
53

$


$


$


$
53

$
Corporate debt securities


183,289


13,104


51,937


12,590


235,226


25,694Foreign debt securities


26,803


1,318


1,872


612


28,675


1,930Mortgage-backed and asset-backed securities


79,877


9,748


57,370


24,022


137,247


33,770Total fixed maturities

$
290,022

$
24,170

$
111,179

$
37,224

$
401,201

$
61,394


Fixed
maturity securities in an unrealized loss position were diversified, representing 213 different securities as of December 31, 2008. Collectively, the unrealized loss for
these securities was less than 13% of their amortized cost. The fair value for these securities was approximately 83% of their par value. Individually, the fair value for approximately 80% of these
securities was greater than 75% of its respective amortized cost.

The
group of securities in an unrealized loss position for less than twelve months was comprised of 145 securities. Collectively, the unrealized loss for the securities in this group was
8% of their amortized cost. The fair value for the securities in this group was 86% of their par value. The majority of the securities in the group are depressed due to the deterioration of value in
the mortgage-backed security market, financial companies and related businesses.

The
group of securities depressed for twelve months or more was comprised of 68 securities. Collectively, the unrealized loss for the securities in this group was approximately 25% of
their amortized cost. The fair value for the securities in this group was 76% of their par value. Individually, the fair value for approximately 51% of these securities was greater than 75% of its
respective amortized cost. Mortgage and asset-backed securities, which is comprised primarily of obligations of

F-37

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

5. INVESTMENTS (Continued)

federal
agencies, represents approximately 52% of the total fair value for the more than twelve month group. Corporate debt securities represent approximately 47% of the total fair value of the more
than twelve month group. There were 28 corporate debt securities with a market value less than 90% of amortized cost with a combined unrealized loss of $11.9 million. The majority of the
securities in the group are depressed due to the deterioration of value in the mortgage-backed security market and related businesses, subprime securities in particular. Subprime securities in the
portfolio represented $10.8 million of the $24.0 million unrealized loss on the 12 months or longer mortgage-backed securities A description of the factors considered in
determining that recording an other-than-temporary impairment was not warranted are outlined below.

As
part of the Company's ongoing security monitoring process by a committee of investment and accounting professionals, the Company has reviewed its investment portfolio and recorded an
other-than-temporary decline in the value of certain of our securities with exposure to subprime mortgages totaling $48.0 million in the year ended December 31,
2008. In addition, we recorded $11.8 million in other-than-temporary impairments on corporate and other mortgage backed securities. We recorded $41.0 million in
other-than-temporary impairments on certain subprime mortgages for the year ended December 31, 2007. We did not write down the value of any fixed maturity securities
during 2006.



We hold securities with exposure to subprime residential mortgages. Subprime mortgage lending is the origination of residential
mortgage loans to customers with weak credit profiles. The slowing U.S. housing market, greater use of mortgage products with low introductory interest rates, generally referred to as "teaser rates,"
and relaxed underwriting standards for some originators of subprime loans have led to higher delinquency and loss rates. These factors combined with heightened capital constraints on financials
institutions have caused a significant reduction in market liquidity and repricing of risk, which has led to a decrease in the market valuation of these securities sector wide.

As
of December 31, 2008, we held subprime securities with par values of $140.3 million, an amortized cost of $51.4 million and a market value of $38.3 million
representing approximately 2.4% of our cash and invested assets, with collateral comprised substantially of first lien mortgages. The majority of these securities are in senior or senior-mezzanine
level tranches, which have preferential liquidation characteristics, and have an average rating of AA- by Standard & Poors, a division of the McGraw Hill Companies, Inc.,
known as S&P, or equivalent.

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

Vintage Year

Amortized
Cost

Market
Value

Unrealized
Loss(In thousands)2003

$
6,243

$
3,991

$
(2,252
)2004


3,308


2,692


(616
)2005


24,928


16,764


(8,164
)2006


12,177


10,388


(1,789
)2007


4,706


4,486


(220
)Totals

$
51,362

$
38,321

$
(13,041
)


F-38

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

5. INVESTMENTS (Continued)

We
continuously review our subprime holdings stressing multiple variables, such as cash flows, prepayment speeds, default rates and loss severity, and comparing current base case loss
expectations to the loss required to incur a principal loss, or breakpoint. This breakpoint currently exceeds the base case loss expectation for 21 out of a total of 32 holdings to varying degrees. We
expect delinquency and loss rates in the subprime mortgage sector to continue to increase in the near term but at a decreasing rate. Those securities with a greater variance between the breakpoint and
base case can withstand this further deterioration. However, holdings where the base case is closer to the breakpoint are more likely to incur a principal loss. We utilize third party pricing services
to provide or estimate market prices. The major inputs used by third party pricing services include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and
estimated cash flows and prepayment speeds. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price, as has recently been
the case with many of our subprime holdings.

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

2008 Quarter Ended2007

March 31

June 30

September 30

December 31

2008

Cumulative(In thousands)Subprime

$
40,997

$
29,800

$
11,771

$
2,329

$
4,064

$
47,964

$
88,961Other structured








1,384


2,432


829


4,645


4,645Corporate











7,177





7,177


7,177$
40,997

$
29,800

$
13,155

$
11,938

$
4,893

$
59,786

$
100,783


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

The
components of the change in unrealized gains and losses for fixed maturity securities included in the consolidated statements of stockholders' equity are as follows:

2008

2007

2006(In thousands)Change in net unrealized gains and losses:Fixed maturities

$
(42,153
)
$
(2,295
)
$
(6,772
)Other invested assets





(8
)

26Adjustment relating to deferred policy acquisition costs


6,393


(670
)

2,160Change in net unrealized losses before income tax


(35,760
)

(2,973
)

(4,586
)Income tax benefit


12,516


1,040


1,605Change in net unrealized losses

$
(23,244
)
$
(1,933
)
$
(2,981
)


F-39

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

5. INVESTMENTS (Continued)

The
details of net investment income are as follows:

2008

2007

2006(In thousands)Investment Income:Fixed maturities

$
59,170

$
62,090

$
59,013Cash and cash equivalents


21,303


44,428


15,315Policy loans


1,971


1,342


1,332Other


632


1,095


1,350Gross investment income


83,076


108,955


77,010Investment expenses


(1,806
)

(1,985
)

(1,551
)Net investment income

$
81,270

$
106,970

$
75,459


The
two Lehman Brothers securities were the only non-income producing fixed maturity securities for the year ended December 31, 2008. There were no
non-income producing fixed maturity securities for the years ended December 31, 2007 or 2006.

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

2008

2007

2006(In thousands)Realized gains:Fixed maturities

$
1,788

$
324

$
3,860Other


12


2,073


1,186Total realized gains


1,800


2,397


5,046Realized losses:Fixed maturities


(61,020
)

(41,641
)

(184
)Equity securities and other invested assets


(461
)

(934
)

(44
)Total realized losses


(61,481
)

(42,575
)

(228
)Net realized (losses) gains

$
(59,681
)
$
(40,178
)
$
4,818


At
December 31, 2008 and 2007, we held unrated or less-than-investment grade corporate debt securities as follows:

2008

2007(In thousands)Carrying value (estimated fair value)

$
22,492

$
19,286Percentage of total assets


0.6
%

0.5
%


The
holdings of less-than-investment grade securities are diversified and the largest investment in any one such security was $5.4 million, or 0.1% of
total assets at December 31, 2008, and $6.6 million, or 0.2% of total assets at December 31, 2007.

F-40

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

5. INVESTMENTS (Continued)

We
have reflected investments held by various states as security for our policyholders within those states in fixed maturities. These investments had carrying values of
$41.9 million at December 31, 2008 and $41.6 million at December 31, 2007.

6. FAIR VALUE MEASUREMENTS

We carry fixed maturity investments, equity securities and interest rate swaps at fair value in our consolidated financial statements. These fair value disclosures consist of information
regarding the valuation of these financial instruments, followed by the fair value measurement disclosure requirements of SFAS 157.

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



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

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

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

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

F-41

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6. FAIR VALUE MEASUREMENTS (Continued)

The following table presents our assets and liabilities that we carry at fair value by SFAS 157 hierarchy levels, as of December 31, 2008 (in thousands):

Total

Level 1

Level 2

Level 3Assets:Fixed maturities, available-for-sale

$
1,032,393

$


$
1,028,449

$
3,944Equity securities


490








490Total assets

$
1,032,883

$


$
1,028,449

$
4,434Liabilities:Interest rate swaps

$
20,298

$


$
20,298

$



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



The valuation methodologies used to determine the fair values of assets and liabilities under the "exit price" notion of
SFAS 157 reflect market participant objectives and are based on the application of the fair value hierarchy that prioritizes observable market inputs over unobservable inputs. We determine the
fair value of our financial assets and liabilities based upon quoted market prices where available. Fair values of our interest rate swap liabilities reflect adjustments for counterparty credit
quality, our credit standing, liquidity and, where appropriate, risk margins on unobservable parameters. The following is a discussion of the methodologies used to determine fair values for the
financial instruments listed in the above table.



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



Based
on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices through recent
reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported
trades, the third party

F-42

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6. FAIR VALUE MEASUREMENTS (Continued)

pricing
services may use matrix or model processes to develop a security price where the pricing services develop future cash flow expectations based upon collateral performance, discounted at an
estimated market rate. The pricing for mortgage-backed and asset-backed securities reflects estimates of the rate of future prepayments of principal over the remaining life of the securities. The
pricing services derive these estimates based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying
collateral.

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

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

The
following table presents the fair value of the significant asset sectors within the SFAS 157 Level 3 securities as of December 31, 2008:

Fair Value

% of Total
Fair Value(In thousands)Mortgage and asset-backed securities

$
1,862


42.0
%Corporate


2,082


47.0
%Equity securities


490


11.0
%Total Level 3 securities

$
4,434


100.0
%


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



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

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

F-43

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6. FAIR VALUE MEASUREMENTS (Continued)



We classify the fair values of financial instruments within Level 3 if there are no observable markets for the instruments or,
in the absence of active markets, the majority of the inputs used to determine the fair value of the instruments are based on assumptions about market participant assumptions. Rollforward tables for
each quarter from January 1, 2008 to December 31, 2008 for the Level 3 financial instruments for which we have used significant unobservable inputs in the fair value measurement
on a recurring basis are presented below:

Fixed
Maturities

Equity
Securities

Total(thousands)Fair value as of January 1, 2008

$
7,757

$
490

$
8,247Net purchases and sales


(379
)




(379
)Unrealized losses included in AOCI(1),(2)


(289
)




(289
)Fair value as of March 31, 2008


7,089


490


7,579Net purchases and sales


(20
)




(20
)Net transfers out


(2,372
)




(2,372
)Unrealized losses included in AOCI(1),(2)


(121
)




(121
)Fair value as of June 30, 2008


4,576


490


5,066Net purchases and sales


(40
)




(40
)Net transfers in


168





168Unrealized losses included in AOCI(1),(2)


65





65Fair value as of September 30, 2008


4,769


490


5,259Net purchases and sales


1





1Net transfers out


(621
)




(621
)Unrealized losses included in AOCI(1),(2)


(205
)




(205
)Fair value as of December 31, 2008

$
3,944

$
490

$
4,434


---

F-44

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7. INCOME TAXES

The parent holding company files a consolidated return for federal income tax purposes that includes all of the non-life insurance company subsidiaries, including
Heritage. American Exchange and its subsidiaries file a separate consolidated federal income tax return.

The
Company's federal and state income tax expense (benefit) for continuing operations is as follows:

2008

2007

2006(In thousands)CurrentUnited States

$
49,162

$
66,074

$
26,865DeferredUnited States


7,050


(17,520
)

5,745Total tax expense

$
56,212

$
48,554

$
32,610


A
reconciliation of the "expected" tax expense at 35% with the Company's actual tax expense applicable to operating income before taxes reported in the Consolidated Statements of
Operations for continuing operations is as follows:

2008

2007

2006(In thousands)Expected tax expense

$
52,956

$
46,419

$
32,814State taxes


1,067


(636
)

2,465Change in valuation allowance


1,289


2,931


(2,736
)Other, net


900


(160
)

67Actual tax expense

$
56,212

$
48,554

$
32,610


In
addition to federal and state income tax, the Company's insurance company subsidiaries are subject to state premium taxes, which are included in other operating costs and expenses in
the consolidated statements of operations.

Deferred
income taxes reflect the net tax effects of temporary differences between the carrying value of assets and liabilities for financial reporting purposes and the amount used for
income tax

F-45

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7. INCOME TAXES (Continued)

purposes.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities for continuing operations are as follows:

2008

2007(In thousands)Deferred tax assets:Reserves for future policy benefits

$
26,314

$
8,033Loss carryforwards


5,690


5,072Asset valuation differences


18,907


40,925Deferred revenues


342


351Unrealized losses on investments


19,612


36Total gross deferred tax assets


70,865


54,417Less valuation allowance


(4,433
)

(3,144
)Net deferred tax assets


66,432


51,273Deferred tax liabilities:Deferred policy acquisition costs


(2,782
)

(6,882
)Present value of future profits


(65,362
)

(70,900
)Other


(5,165
)

(2,178
)Total gross deferred tax liabilities


(73,309
)

(79,960
)Net deferred tax liability

$
(6,877
)
$
(28,687
)


At
December 31, 2008, the Company (exclusive of American Exchange and its subsidiaries) had net operating loss carryforwards of approximately $4.4 million that expire in
2025. The use of the net operating loss carryforward is limited to $1.6 million per year under the Internal Revenue Code.

The
Company establishes valuation allowances based upon an analysis of projected taxable income and its ability to implement prudent and feasible tax planning strategies. The Company
carried valuation allowances on its deferred tax assets of $4.4 million at December 31, 2008 and $3.1 million at December 31, 2007. During 2008, the Company established a
deferred tax asset of $1.3 million for state net operating loss carry forwards; concurrently, a valuation allowance of $1.3 million also was established. At December 31, 2008, we
assessed the amount of the deferred tax asset that was more likely than not to be realized under SFAS No. 109, Accounting for Income Taxes, and concluded that we can record tax benefits related
to our realized losses relating to our investments for financial statement purposes. During the second quarter we released a deferred tax valuation allowance of $10.4 million that had been
recorded in the first quarter of 2008 in connection with other-than-temporary impairments taken in that period. Management believes it is more likely than not that the Company
will realize the recorded value of its net deferred tax assets.

In
July 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxesan Interpretation of FASB Statement
109("FIN 48") that provides criteria for recognition, measurement, presentation and disclosure of uncertain tax positions. The Company adopted FIN 48 on
January 1, 2007. The Company has no material uncertain tax positions and no cumulative adjustment was required or recorded as a result of the implementation of FIN 48. The Company
recognizes accrued interest and penalties related to uncertain tax positions in income tax expense when incurred.

F-46

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7. INCOME TAXES (Continued)

No
material interest and penalties related to uncertain tax positions were accrued at December 31, 2008.

A
federal tax return, generally, is open for examination for three years from the date on which it is filed, or, if applicable, from the extended due date unless the statue is extended
by mutual consent. The Company has not entered into any agreement to extend the statute of limitations of any state tax return for any jurisdiction. In connection with the examination of the Company's
2005 federal tax return, the statute of limitations was extended to December 31, 2010. Consequently, federal tax returns for the years ending December 31, 2005 through 2008 are open.
Certain earlier returns remain open to the extent that net operating loss carry forwards were used or generated in those years. Also, various state tax returns remain open for examination under
specific state statutes of limitation for an additional period of time.

Currently,
the Company's 2005 federal tax return and the pre-acquisition MemberHealth 2006 and 2007 federal tax returns are under examination by the Internal Revenue Service.
While no adjustments have yet been proposed that would impact any unrecognized tax benefits, it is reasonably possible that a change may occur within the next twelve months. It is not possible to
determine the range of this possible adjustment.

8. STOCKHOLDERS' EQUITY



We have 3.0 million authorized shares of preferred stock, of which we have designated 300,000 shares as Series A
preferred stock and 300,000 shares as Series B preferred stock. The holders of both Series A preferred stock and Series B preferred stock possess specified rights whereby they
may, in specified circumstances, convert the shares directly or indirectly into shares of common stock. In addition, we have the right to convert the shares of our Series B preferred stock to
common stock, in the ratio of 100 shares of common stock for each share of Series B preferred stock, from and after the first anniversary of the issuance of the shares of Series B
preferred stock. On November 24, 2008, we converted all of the then-outstanding 132,895 shares of Series B preferred stock into 13,289,500 shares of our common stock.

At
December 31, 2008, there were 42,105 shares of Series A preferred stock outstanding and no shares of Series B preferred stock outstanding. At December 31,
2007, there were 47,105 shares of Series A preferred stock outstanding and 127,895 shares of Series B preferred stock outstanding, all of which were issued in connection with raising
cash to fund the MemberHealth acquisition and to provide Universal American with capital to support its organic growth. See Note 3 of Notes to Consolidated Financial Statements for additional
information.

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

F-47

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. STOCKHOLDERS' EQUITY (Continued)

placement
of Series A preferred stock and Series B preferred stock to WCAS X and other investors that closed on May 15, 2007.



Subject to the exceptions described below, each share of Series A preferred stock ranks equally in all respects and has the same
rights, powers and preferences, and the same qualifications, and limitations, as our Series B preferred stock:

Rank.The Series A preferred stock ranks



Dividends.Holders of shares of Series A preferred stock are entitled to participate equally and ratably with the holders of shares
of common
stock in all dividends and distributions paid on the shares of common stock as if, immediately prior to each record date for payment of a dividend or distribution on the common stock, the shares of
Series A preferred stock then outstanding were converted into shares of common stock.

Liquidation Preference.In the event that we voluntarily or involuntarily liquidate, dissolve or wind up, the holders of shares of
Series A
preferred stock are, with respect to each such share of Series A preferred stock, entitled to receive the greater of



Neither
a consolidation or merger nor a sale or transfer of all or any part of our assets for cash, securities or other property, is considered a liquidation, dissolution or winding up.

F-48

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. STOCKHOLDERS' EQUITY (Continued)

Voting Rights.Holders of shares of Series A preferred stock are not entitled to vote on any matter submitted to a vote of our
shareholders,
but are entitled to prior written notice of, and are entitled to attend and observe, all special and annual meetings of our shareholders. However, so long as any
shares of Series A preferred stock are outstanding, we will not, without the written consent or affirmative vote by holders of at least a majority of the outstanding shares of Series A
preferred stock, voting as a single and separate class:



Merger or Consolidation.Unless approved by holders of the shares of Series A preferred stock, we will not merge or consolidate
into, or sell,
transfer or lease all or substantially all of our property to any other entity, unless the successor, transferee or lessee entity expressly assumes the due and punctual performance and observance of
each and every covenant and condition described above to be performed and observed by us and expressly agrees to exchange, at the holder's option, shares of Series A preferred stock for shares
of the surviving entity's capital stock on terms substantially similar to the terms described above.

Conversion upon Transfer.Any share of Series A preferred stock owned by any equity investor that was an original purchaser of the
share or
any affiliate of an equity investor is not convertible into common stock so long as such share of Series A preferred stock is owned by that equity investor or affiliate. At any time when a
share of Series A preferred stock is not or ceases to be owned by an equity investor or an affiliate of an equity investor, the share of Series A preferred stock, without any further
action or deed on our part or any other individual, entity or group, will automatically convert into the number of fully paid and non-assessable shares of common stock determined by
dividing $2,000 by the conversion price in effect at the time of conversion. The initial conversion price is $20.

Exchange of Shares.Under the securities purchase agreements that governed the original issue of the Series A preferred stock, we
have agreed
that, at an equity investor's request, we will exchange all or any shares of Series A preferred stock held by the equity investor for a like number of shares of Series B preferred stock;
provided that, prior to the consummation of any exchange, the equity investor shall have obtained a clearance, approval or waiver, under specified laws governing insurance companies or the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, or shall have
represented to us that no clearance, approval or waiver is not required in connection with such an exchange.



Subject to the exceptions described below, each share of our Series B preferred stock ranks equally in all respects and has the
same dividend and other rights, powers and liquidation and other preferences, and the same qualifications, limitations and restrictions as our Series A preferred stock.

Voting Rights.In addition to the voting rights described above, holders of our Series B preferred stock may vote with holders of
our common
stock together as one class on all matters submitted for a vote of holders of our common stock. Holders of our Series B preferred stock are entitled to a number

F-49

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. STOCKHOLDERS' EQUITY (Continued)

of
votes equal to the number of votes to which the shares of our common stock issuable upon conversion of their shares of Series B Preferred Stock would have been entitled if those shares of
common stock had been outstanding at the time of the applicable record date.

Right to Convert.A holder of our Series B preferred stock has the right, at any time and from time to time, to convert any or all
of the
holder's shares of Series B into the number of fully paid and non-assessable shares of common stock determined by dividing $2,000 by the conversion price in effect at the time of
conversion. The initial conversion price is $20.

We
have the right to require the holder of each share of our Series B preferred stock, from and after the first anniversary of the date of original issuance of the share, from
time to time, at our option, to convert the share of Series B preferred stock into fully paid and non-assessable shares of our common stock at the applicable conversion price. The
number of shares of common stock into which one share of the Series B preferred stock is convertible is determined by dividing the preferred share price by the conversion price in effect at the
time of conversion.



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

Years ended December 31,

2008

2007

2006Common stock outstanding, beginning of year


74,952,177


59,890,500


59,042,685Conversion of Preferred B into common stock


13,289,500





Return of stock issued and stock issued in connection with MemberHealth acquisition (See Note 3Business Combinations)


(2,027,071
)

14,175,000


Exercise of stock options


1,184,237


861,633


827,075Agent stock award





2,801


16,040Stock purchases pursuant to agents' stock purchase and deferred compensation plans


48,257


22,243


4,700Common stock outstanding, end of year


87,447,100


74,952,177


59,890,500




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



We have approved share repurchase plans that have authorized us to repurchase up to $100 million of shares of our common stock.
Through December 31, 2008, we had repurchased 6.7 million shares of our common stock for an aggregate amount of $71.8 million, under these programs. Subsequent to year end,
through March 3, 2009, we repurchased an additional 1.7 million shares for $14.8 million. As of March 3, 2009, we have $13.4 million that remains available to

F-50

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. STOCKHOLDERS' EQUITY (Continued)

repurchase
additional shares under these plans. We are not obligated to repurchase any specific number of shares under the programs or to make repurchases at any specific time or price.

Changes
in treasury stock were as follows:

For the year ended December 31,2008

2007Shares

Amount

Weighted
Average
Cost Per
Share

Shares

Amount

Weighted
Average
Cost Per
Share(In thousands)

(In thousands)Treasury stock beginning of year


285,545

$
4,258

$
14.91


712,868

$
10,626

$
14.91Shares repurchased


7,028,154


74,821


10.65








Shares distributed in the form of employee bonuses


(119,312
)

(1,474
)

12.36


(427,323
)

(6,368
)

22.44Treasury stock, end of period


7,194,387

$
77,605

$
10.79


285,545

$
4,258

$
14.91




The components of accumulated other comprehensive loss are as follows:

As of December 31,

2008

2007(In thousands)Net unrealized loss on investments

$
(42,685
)
$
(533
)Deferred acquisition cost adjustment


6,617


225Foreign currency translation gains


332


485Fair value of cash flow swap on debt


(20,298
)

(279
)Deferred income taxes


19,612


36Total accumulated other comprehensive loss

$
(36,422
)
$
(66
)


9. STOCK BASED COMPENSATION



On May 28, 1998, our shareholders approved the 1998 Incentive Compensation Plan, known as the 1998 ICP. The 1998 ICP superseded
the Company's 1993 Incentive Stock Option Plan. Options previously granted under the Company's Incentive Stock Option Plan will remain outstanding in accordance with their terms and the terms of the
respective plans. The 1998 ICP provides for grants of stock options, stock appreciation rights or SARs, restricted stock, deferred stock, other stock-related awards, and performance or annual
incentive awards that may be settled in cash, stock, or other property.

The
total number of shares of our common stock reserved and available for delivery to participants in connection with awards under the 1998 ICP, prior to amendment on August 23,
2007, was



F-51

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCK BASED COMPENSATION (Continued)



provided,
however, that the total number of shares of common stock with respect to which incentive stock options, or ISOs, may be granted, may not exceed 1.5 million. On August 23, 2007,
our shareholders approved an amendment to increase the number of shares of common stock authorized for issuance under the 1998 ICP by 5.0 million shares. As of December 31, 2008, a total
of 19.3 million
shares were eligible for grant under the plan, giving effect to the potential conversion of our Series A preferred stock. We have awarded a total of 13.0 million shares under the plan,
of which 6.4 million shares were reserved for delivery under outstanding options awarded under the 1998 ICP. As of December 31, 2008, 6.3 million shares were available for future
awards.

Executive
officers, directors, and other officers and employees of our parent holding company or any subsidiary, as well as other persons who provide services to us, are eligible to
receive awards under the 1998 ICP, which is administered by our Board of Directors or a committee established pursuant to the plan. Our Board has designated its Compensation Committee to administer
the 1998 ICP. The committee, may, in its discretion, accelerate the exercisability, the lapsing of restrictions, or the expiration of deferral or vesting periods of any award, and any accelerated
exercisability, lapse, expiration and vesting occurs automatically in the case of a change in control of the Company, except to the extent otherwise determined by the committee at the date of grant or
thereafter. The committee has not yet exercised any of its discretion noted above, except that in the case of some options issued under the plan, the committee has determined to restrict the automatic
vesting on change of control.



In accordance with the 1998 ICP, we may grant stock to our officers and non-officer employees. We expense the
non-officer grants over the year for which the award relates. We granted awards to non-officer employees of 1,156 shares with a fair value of $10.08 per share for 2008 in
January 2009, 344 shares with a fair value of $22.90 per share for 2007 in January 2008, and 196 shares with a fair value of $18.56 per share for 2006 in January 2007.



We have historically granted restricted stock to executive officers in connection with their bonuses. This restricted stock vests
ratably over four years. We value restricted stock awards at an amount equal to the market price of our common stock on the date of grant. We generally issue these restricted stock awards out of
treasury shares. We recognize compensation expense for restricted stock awards on a straight line basis over the vesting period. In 2008, executive officers were awarded 96,468 shares with a fair
value of $10.35 per share for 2007 performance and in 2007 they were awarded 86,627 shares with a fair value of $18.47 per share for 2006 performance, and in 2006 they were awarded 53,745 shares with
a fair value of $15.35 per share for 2005 performance.

F-52

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCK BASED COMPENSATION (Continued)

A
summary of the status of our non-vested restricted stock awards as of December 31, 2008, and changes during the three years then ended, is set forth below:

2008

2007

2006Nonvested Restricted Stock

Shares

Weighted
Average
Grant-
Date Fair
Value

Shares

Weighted
Average
Grant-
Date Fair
Value

Shares

Weighted Average Grant- Date Fair Value(In thousands)



(In thousands)



(In thousands)Nonvested at beginning of year


518

$
21.06


149

$
12.60


157

$
12.05Granted


119


11.04


427


22.44


54


15.35Vested


(150
)

19.62


(58
)

12.12


(51
)

11.05Forfeited


(16
)

23.83








(11
)

11.78Nonvested at end of year


471

$
18.89


518

$
21.06


149

$
13.60


The
total fair value of shares of restricted stock that vested during the year ended December 31, 2008 was $1.8 million. The total fair value of shares of restricted stock
that vested during 2007 was $1.1 million and the total fair value of shares of restricted stock vested during 2006 was $0.8 million.



Qualifying agents of our insurance subsidiaries can purchase shares of our common stock pursuant to our Agents Stock Purchase Plan.
Participants purchase shares on the open market at fair value; accordingly, we do not recognize expense. Through the Agents Stock Purchase Plan, agents purchased 5,700 shares at a weighted average
price of $10.96 per share in 2008, 1,600 shares at a weighted average price of $18.86 per share in 2007, and 4,700 shares at a weighted average price of $14.38 per share in 2006.



We also offer shares of common stock for sale to our agents pursuant to our Deferred Compensation Plan for Agents or DCP. Under the
DCP, agents may elect to defer receipt of between 5% and 100% of their first year commission, which deferral will be matched by a contribution by us, initially set at 25% of the amount of the
deferral, up to a maximum of 5% of the agent's commissions. Both the agent's participation in the DCP and our obligation to match the agent's deferral are subject to the agent satisfying and
continuing to satisfy minimum earning, production and persistency standards. Participants purchase shares under the plan at market price and, accordingly, we do not recognize expenses except for the
fair value of the shares representing the Company match on the date of the contribution to the DCP. Agents deferred commissions amounted to $0.3 million in 2008, $0.3 million in 2007,
and $0.2 million in 2006.



We have various stock-based incentive plans for our employees and non-employee directors, which operate under the 1998 ICP,
and for our agents. We issue new shares upon the exercise of options granted under these plans. Beginning January 1, 2006, we adopted FAS 123-R using the modified prospective
method, and began recognizing compensation cost for share-based payments to employees

F-53

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCK BASED COMPENSATION (Continued)

and
non-employee directors based on the grant date fair value of the award, which we amortize over the grantees' service period. We have elected to use the Black-Scholes valuation model to
value employee stock options, as we had done for our previous pro forma stock compensation disclosures. The adoption of FAS 123-R did not have a material effect on our method of
computing compensation costs for options as compared to that used to prepare the pro forma disclosures in prior periods.

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

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

For options granted in:2008

2007Risk free interest rates

1.33%3.15%

4.01%5.16%Dividend yields

0.0%

0.0%Expected volatility

35.60%49.31%

35.39%42.53%Expected lives of options (in years)

3.55.0

3.06.0Weighted-average grant-date fair value

$2.85

$7.91


A
summary of the status of our Company's stock option plans during the three years ended December 31, 2008 and changes during the years ending on those dates is set forth below:

2008

2007

2006Options

Weighted
Average
Exercise
Price

Options

Weighted
Average
Exercise
Price

Options

Weighted
Average
Exercise
Price(In thousands)



(In thousands)



(In thousands)Outstandingbeginning of year


5,676

$
12.71


4,325

$
7.73


4,823

$
6.81Granted


1,191


13.91


2,356


21.15


439


15.36Exercised


(1,184
)

3.55


(861
)

10.18


(827
)

5.57Terminated


(43
)

17.14


(144
)

16.37


(110
)

11.55Outstandingend of year


5,640

$
14.85


5,676

$
12.71


4,325

$
7.73Options exercisable at end of year


3,159

$
12.00


3,395

$
7.21


3,632

$
6.40


F-54

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCK BASED COMPENSATION (Continued)

The weighted average remaining contractual term for the options outstanding was 3.7 years and 4.0 years at December 31, 2008 and 2007, respectively. The weighted
average remaining contractual term for the options exercisable was 3.1 years at December 31, 2008. The aggregate intrinsic value of options outstanding at December 31, 2008 was
approximately $10.2 million. The aggregate intrinsic value of options exercisable at December 31, 2008 was $10.0 million.

The
total intrinsic value of options exercised during the year ended December 31, 2008 was $7.7 million and was $10.2 million for 2007. As of December 31,
2008, the total compensation cost related to non-vested awards not yet recognized was $12.7 million, which we expect to recognize over a weighted average period of 1.3 years.

We
received cash from the exercise of stock options of $4.2 million for the year ended December 31, 2008, $8.8 million for 2007 and $4.6 million for 2006.
FAS 123-R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as
required under the prior statement. The amount of financing cash flows recognized for these excess tax deductions was $2.8 million for the year ended December 31, 2008. The amount of
operating cash flows recognized for such excess tax deductions was $5.8 million for 2007 and was $1.9 million for 2006.

A
summary of the weighted average fair value of options granted during the three years ended December 31, 2008 is presented below:

2008

2007

2006Options

Weighted-
Average
Fair Value

Options

Weighted-
Average
Fair Value

Options

Weighted-
Average
Fair Value(In thousands)



(In thousands)



(In thousands)Above market


754

$
2.60


18

$
4.47


28

$
5.38At market


437


3.26


2,338


7.94


411


4.37Below market

















Total granted


1,191

$
2.85


2,356

$
7.91


439

$
5.32


The
following table summarizes information about stock options outstanding at December 31, 2008:

Range of Exercise Prices

Number
Outstanding at
December 31, 2008

Weighted-
Average
Remaining
Contractual Life

Weighted-
Average
Exercise Price

Number
Exercisable at
December 31, 2008

Weighted-
Average
Exercise Price(In thousands)





(In thousands)$3.15


515

0.6 years

$
3.15


515

$
3.153.2514.71


2,064

3.7 years


10.20


1,239


8.1715.5019.59


1,704

3.4 years


17.45


1,057


17.1620.5323.83


1,357

5.5 years


23.10


348


23.07$3.1523.83


5,640

3.7 years

$
14.85


3,159

$
12.00


F-55

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCK BASED COMPENSATION (Continued)

A
summary of the activity relating to the options awarded by the Company for employees, directors and agents is as follows:

Employees

Directors

Agents &
Others

Total

Range of
Exercise Prices(In thousands)Balance, January 1, 2006


3,968


347


508


4,823Granted


349


62


28


439

$13.75$19.25Exercised


(710
)

(12
)

(105
)

(827
)
$1.88$15.88Terminated


(88
)

(9
)

(13
)

(110
)
$3.15$19.21Balance, December 31, 2006


3,519


388


418


4,325Granted


2,213


126


17


2,356

$15.07$23.83Exercised


(550
)

(77
)

(234
)

(861
)
$2.00$19.21Terminated


(102
)

(19
)

(23
)

(144
)
$7.40$22.67Balance, December 31, 2007


5,080


418


178


5,676Granted


1,055


136





1,191

$9.62$20.77Exercised


(1,120
)

(52
)

(12
)

(1,184
)
$2.25$23.30Terminated


(40
)

(3
)




(43
)
$6.51$23.83Balance, December 31, 2008


4,975


499


166


5,640Vested, December 31, 2008


2,747


267


145


3,159




We generally grant options to eligible employees at a price not less than the market price of our common stock on the date of the
grant. Option holders may exercise their options subject to the terms prescribed by the individual grant agreement. During 2008, we issued 928,531 options to management in connection with the
management bonus and 126,500 to new employees. During 2007, we issued 1,116,000 options issued to management in connection with the management bonus, 116,750 to new employees, and 980,500 in
connection with the acquisition of MemberHealth. During 2006, we issued approximately 307,000 options to management in connection with the management bonus and 42,000 to new employees. Holders
genereally must exercise vested options not later than the expiration date of the option, or within a specified duration following termination of employment. Prior to September 2005, options issued to
employees had a term of ten years. Options issued to employees after August 2005 have terms ranging from 5 to 7 years. We made these awards at a price equal to or greater than market on the
date of grant; therefore, we did not recognize any compensation cost for these awards prior to 2006. Total expense relating to the above grants was $5.9 million for the year ended
December 31, 2008 and $4.2 million for the year ended December 31, 2007.



Directors of the Company are eligible for options under the 1998 ICP. The 1998 ICP provides that unless otherwise determined by the
Board, each non-employee director automatically receives an option to purchase 10,000 shares of Common Stock upon his or her initial election to the Board, and at each annual meeting of
shareholders at which he or she qualifies as a non-employee director. We also grant the non-employee directors for American Progressive would be granted an option to purchase
1,500

F-56

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCK BASED COMPENSATION (Continued)

shares
of Common Stock at each annual meeting. During 2008, there were approximately 136,000 options issued to directors. During 2007, there were approximately 126,000 options issued to directors.
Unless otherwise determined by the Board, the non-employee director options will have
an exercise price equal to 100% of the fair market value per share on the date of grant and will become exercisable in three equal installments after each of the first, second and third anniversaries
of the date of grant based on continued service as a director. We grant these options at a price equal to market; therefore, we did not recognize compensation expense for these awards prior to 2006.
Total expense relating to the above plans was $0.5 million for the year ended December 31, 2008 and $0.3 million for the year ended December 31, 2007.



We may grant options to agents based on production pursuant to the 1998 ICP. These options vest in equal installments over a two year
period and expire five years from the date of grant. We set the exercise prices at between 110% and 125% of the fair market value of Universal American common stock on the date of the award. During
2008 we did not award independent agents any options for 2007 sales performance. In 2007, we awarded independent agents approximately 17,250 options with a weighted average exercise price of $23.30
per share for 2006 sales performance. During 2006, we awarded independent agents approximately 28,000 options with a weighted average exercise price of $19.25 per share for 2005 sales performance.

Beginning
in 2005, we began granting awards of common stock to some other qualifying agents. These awards vest over five years. During 2008, we did not award the qualifying agents any
stock grants for 2007 sales performance. During 2007, we awarded the qualifying agents stock grants of approximately 5,447 shares with a fair value of $18.62 per share for 2006 sales performance.
During 2006, we awarded the qualifying agents stock grants of approximately 17,000 shares with a fair value of $16.07 per share for 2005 sales performance.

We
expense the fair values of the awards over the vesting period of each award. Total expense relating to the above plans was $0.3 million for the year ended December 31,
2008, $0.3 million for 2007, and $0.9 million for 2006.

10. STATUTORY FINANCIAL DATA

Our insurance subsidiaries are required to maintain minimum amounts of statutory capital and surplus as required by regulatory authorities. However, substantially more than such minimum
amounts are needed to meet statutory and administrative requirements of adequate capital and surplus to support the current level of our insurance subsidiaries' operations. Each of the insurance
subsidiaries' statutory capital and surplus exceeds its respective minimum statutory requirement or are at levels we believe are sufficient to support their currently anticipated levels of operation.
Additionally, the National Association of Insurance Commissioners ("NAIC") imposes regulatory risk-based capital ("RBC") requirements on life insurance enterprises. At December 31,
2008, all of our insurance subsidiaries, except for Marquette, maintained ratios of total adjusted capital to RBC in excess of the "authorized control level". Effective January 1, 2009,
Marquette novated its PFFS business to its affiliate Pyramid Life. As a result of this novation, it is anticipated that Marquette's ratio of total adjusted capital to risk-based capital
will exceed the authorized control level. The combined statutory capital and surplus, including asset valuation reserve, of the insurance subsidiaries totaled

F-57

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

10. STATUTORY FINANCIAL DATA (Continued)

$525.5 million
at December 31, 2008 and $486.1 million at December 31, 2007. For the year ended December 31, 2008, the insurance subsidiaries generated statutory net
income of $67.8 million. For the year ended December 31, 2007, the insurance subsidiaries generated a statutory net income of $114.6 million. The insurance subsidiaries generated
statutory net income of $29.3 million for the year ended December 31, 2006.

Our
health plan affiliates are also required to maintain minimum amounts of capital and surplus, as required by regulatory authorities and are also subject to RBC requirements. At
December 31, 2008, the statutory capital and surplus of each of our health plan affiliates exceeds its minimum requirement and its RBC is in excess of the "authorized control level". The
statutory capital and surplus for our health plan affiliates was $86.6 million at December 31, 2008 and $64.3 million at December 31, 2007. Statutory net income for our
health plan affiliates was $29.1 million for the year ended December 31, 2008, $15.3 million for the year ended December 31, 2007 and $17.3 million for the year
ended December 31, 2006.

Effective
January 1, 2009 the NAIC has adopted SSAP No. 98,Treatment of Cash Flows When Quantifying Changes in Valuation and
Impairments.SSAP No. 98 effectively changes the impairment trigger from an undiscounted cash flow basis test to a discounted test. In addition, SSAP No. 98
changes the method of valuing the new cost basis of the impaired security from an undiscounted cash flow basis to a fair value basis. Had we adopted SSAP No. 98 on December 31, 2008, we
would have recognized an additional $69.3 million of realized losses, pre-tax, for other-than-temporary impairments of investments on a statutory basis,
however, the actual impairment recorded will depend upon conditions at the measurement date.

F-58

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11. ACCIDENT AND HEALTH POLICY AND CONTRACT CLAIM LIABILITIES

Activity in the accident & health policy and contract claim liability is as follows:

2008

2007

2006(In thousands)Balance at beginning of year

$
735,364

$
193,391

$
107,156Less reinsurance recoverables


(56,580
)

(54,615
)

(29,258
)Net balance at beginning of year


678,784


138,776


77,898Balances acquired





280,982


Incurred related to:Current year


3,846,808


1,881,554


857,898Prior year development


(44,803
)

(1,485
)

(628
)Total incurred


3,802,005


1,880,069


857,270Paid related to:Current year


3,210,310


1,463,482


720,901Prior years


574,495


157,561


75,491Total paid


3,784,805


1,621,043


796,392Net balance at end of year


695,984


678,784


138,776Plus reinsurance recoverables


33,086


56,580


54,615Balance at end of year

$
729,070

$
735,364

$
193,391


The
negative medical cost amount, noted as "prior year development" in the table above, represents favorable adjustments as a result of prior year claim estimates being settled for
amounts less than originally anticipated. These favorable developments occur due to differences between the actual medical utilization and other components of medical cost trends, and actual claim
processing and payment patterns compared to the assumptions for claims trend and completion factors used to estimate our claim liabilities.

The
claim reserve balances at December 31, 2007 ultimately settled during 2008 for $44.8 million less than originally estimated, representing 2.4% of the incurred claims
recorded in 2007. The majority of the favorable development of 2007 claim reserves resulted from our Senior Managed CareMedicare Advantage segment, including $35.2 million relating
to our PFFS business and $6.9 million relating to our HMO business. The actual claims trends were lower than the original estimate of trend factors as a result of:



Additionally,
our original estimate of the completion factors used to establish reserves at December 31, 2007, which were based upon historical patterns, were lower than the
actual pattern that emerged during 2008. The actual patterns reflect a shortening of the cycle time associated with provider claim submissions and changes in claim payment and recovery patterns
associated with continued enhancements made in our claims processing functions for our PFFS product.

F-59

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11. ACCIDENT AND HEALTH POLICY AND CONTRACT CLAIM LIABILITIES (Continued)

We
have adjusted for the favorable historical trend and completion factor experience together with our knowledge of recent events that may impact current trends and completion factors
when establishing our reserves at December 31, 2008. However, based on our historical experience, it is reasonably likely that our actual trend and completion factors may vary from the factors
used in our December 31, 2008 estimates.

During
the fourth quarter of 2008, we determined that a number of PFFS claims had been submitted to us by fictitious providers, as well as by some actual providers seeking reimbursement
for services that were not rendered. We believe that these activities are part of a pattern that has targeted traditional Medicare, as well as several Medicare Advantage PFFS plans including ours. We
estimate that we paid approximately $18.9 million in benefits as a result of these false claims, mostly incurred in the fourth quarter of 2008, which reduced our fourth quarter profits by
approximately $0.14 per share. These false claims, which we reflected in claims and other benefits in the consolidated statements of operations, did not have any impact on our prior year claim reserve
development, as discussed above.

During
2007, the claim reserve balances at December 31, 2006 ultimately settled for $1.5 million less than originally estimated, representing 0.2% of the incurred claims
recorded in 2006. During 2006, the claim reserve balances at December 31, 2005 ultimately settled for $0.6 million more than originally estimated, representing 0.1% of the incurred
claims recorded in 2005.

In
2007, we acquired MemberHealth. The "balances acquired" line item in the table above represents the accident and health claim liabilities acquired in this transaction.

12. DEFERRED POLICY ACQUISITION COSTS

Details with respect to deferred policy acquisition costs are as follows:

2008

2007

2006(In thousands)Balance, beginning of year

$
245,511

$
262,144

$
243,300Capitalized costs, net of reinsurance commissions and allowances


43,659


55,070


87,810Adjustment relating to unrealized gains (losses) on fixed maturities


6,392


(670
)

2,160Amortization


(57,932
)

(71,033
)

(71,126
)Balance, end of year

$
237,630

$
245,511

$
262,144


During
2007, we experienced an increase in the amount of lapses on our Medicare supplement business, resulting in an increased level of DAC amortization. During 2008, we have seen
improved persistency on this business, requiring less amortization of DAC.

We
have approximately $238 million of unamortized DAC as of December 31, 2008. Approximately $84 million relates to our Life and Annuity business which we have
entered into an agreement to reinsure. We anticipate that the closing will take place during the second quarter of 2009. Upon the closing of the reinsurance agreement, the Life & Annuity DAC
will be written off as part of the net gain or loss on the transaction.

F-60

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. REINSURANCE

In the normal course of business, the Company reinsures portions of certain policies that it underwrites. The Company enters into reinsurance arrangements with unaffiliated reinsurance
companies to limit our exposure on individual claims and to limit or eliminate risk on our non-core or underperforming blocks of business. Accordingly, the Company is party to various
reinsurance agreements on its life and accident and health insurance risks. The Company's traditional accident and health insurance products are generally reinsured under quota share coinsurance
treaties with unaffiliated insurers, while the life insurance risks are reinsured under either quota share coinsurance or yearly-renewable term treaties with unaffiliated insurers. Under quota share
coinsurance treaties, the Company pays the reinsurer an agreed upon percentage of all premiums and the reinsurer reimburses the Company that same percentage of any losses. In addition, the reinsurer
pays the Company certain allowances to cover commissions, cost of administering the policies and premium taxes. Under yearly-renewable term treaties, the reinsurer receives premiums at an agreed upon
rate for its share of the risk on a yearly- renewable term basis. The Company also uses excess of loss reinsurance agreements for certain policies whereby the Company limits its loss in excess of
specified thresholds. The Company's quota share coinsurance agreements are generally subject to cancellation on 90 days notice for future business, but policies reinsured prior to cancellation
remain reinsured as long as they remain in force.

We
evaluate the financial condition of our reinsurers and monitors concentrations of credit risk to minimize our exposure to significant losses from reinsurer insolvencies. We are
obligated to pay claims in the event that any reinsurer to whom we have ceded an insured claim fails to meet its obligations under the reinsurance agreement.

We
have several quota share reinsurance agreements in place with General Re Life Corporation, Hannover Life Re of America and Swiss Re Life & Health America, which are rated "A"
or better by A.M. Best. These agreements cover various insurance products, primarily Medicare supplement, long term care and senior life policies, written or acquired by us and contain ceding
percentages ranging between 15% and 100%. Effective January 1, 2004, our retention on all new Medicare supplement business was 100%. Therefore, we no longer reinsure new Medicare supplement
business.

We
have reinsured our Prescription PathwaySM PDPs to PharmaCare Re on a 50% coinsurance funds withheld basis. During 2008, we ceded approximately $277.9 million of
premium as a result of this agreement. Pennsylvania Life also assumes risks of an unaffiliated prescription drug plan on a 33.3% quota share basis. The contract for the 33.3% assumed business was
terminated as of January 1, 2008.

During
the third quarter of 2005, we commenced a reinsurance arrangement with PharmaCare Re. Under the terms of the agreement, we provided an insured drug benefit for the employees of
the State of Connecticut. The risk was reinsured to PharmaCare Re under a 100% quota share contract. The agreement with the State of Connecticut as well as the quota share contract with PharmaCare Re
terminated effective June 30, 2008. Amounts recoverable from PharmaCare Re are supported by a letter of credit equal to the total unpaid claims and claim reserves for this business, but no less
than $35.0 million. During 2008, we received an underwriting fee of 1% of premium. There was approximately $171.8 million of both direct and ceded premium as a result of this agreement.
During 2007, there was approximately $325.0 million of both direct and ceded premium as a result of this agreement.

F-61

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. REINSURANCE (Continued)

During
2008, we ceded premiums of $449.8 million to PharmaCare Re, $58.4 million to General Re, $49.2 million to Hannover and $10.6 million to Swiss Re,
representing 8.6%, 1.1%, 1% and 0.2% respectively of our total direct and assumed premiums. During 2007, we ceded premiums of $580.3 million to PharmaCare Re, $67.8 million to General
Re, $58.8 million to Hannover and $12.2 million to Swiss Re, representing 15%, 2%, 2% and 0.3% respectively of our total direct and assumed premiums. During 2006, we ceded premiums of
$530.2 million to PharmaCare Re, $80.5 million to General Re, $74.1 million to Hannover and $12.4 million to Swiss Re, representing 28%, 4%, 4% and 1% respectively of our
total direct and assumed premiums.

Amounts
recoverable from all our reinsurers were as follows:

2008

2007(In thousands)ReinsurerPharmaCare Re

$
12,271

$
65,512General Re


82,487


85,899Hannover


56,253


59,579Swiss Re


24,290


23,769Other


45,685


51,667Total

$
220,986

$
286,426


At
December 31, 2008, the total amount recoverable from reinsurers of $221.0 million included $203.7 million recoverable on future policy benefits and unpaid claims,
$13.1 million in funds held and $4.2 million for amounts due from reinsurers on paid claims, commissions and expense allowances net of premiums reinsured. At December 31, 2007,
the total amount recoverable from reinsurers of $286.4 million included $238.7 million recoverable on future policy benefits and unpaid claims, $13.6 million in funds held and
$34.1 million for amounts due from reinsurers on paid claims, commissions and expense allowances net of premiums reinsured.

F-62

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

13. REINSURANCE (Continued)

A
summary of reinsurance is presented below:

Year Ended December 31,2008

2007

2006(In thousands)PremiumsLife insurance

$
73,387

$
74,431

$
73,437Accident and health


5,103,721


3,603,318


1,810,142Total gross premiums


5,177,108


3,677,749


1,883,579Ceded to other companiesLife insurance


(23,740
)

(20,340
)

(17,055
)Accident and health


(600,732
)

(755,927
)

(701,569
)Total ceded premiums


(624,472
)

(776,267
)

(718,624
)Assumed from other companiesLife insurance


3,169


3,693


4,364Accident and health


44,649


36,244


27,823Total assumed premium


47,818


39,937


32,187Net amountLife insurance


52,816


57,784


60,746Accident and health


4,547,638


2,883,635


1,136,396Total net premium

$
4,600,454

$
2,941,419

$
1,197,142Percentage of assumed to net premiumLife insurance


6
%

6
%

7
%Accident and health


1
%

1
%

2
%Total assumed to total net


1
%

1
%

3
%Claims recovered

$
552,635

$
695,158

$
657,565




As of December 31,2008

2007

2006(In thousands)Life insurance in forceGross amount

$
2,915,595

$
2,962,286

$
3,003,885Ceded to other companies


(887,677
)

(853,767
)

(793,966
)Assumed from other companies


72,620


80,692


92,083Net amount

$
2,100,538

$
2,189,211

$
2,302,002Percentage of assumed to net in force


3
%

4
%

4
%


F-63

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

14. LOAN PAYABLE



In connection with the MemberHealth transaction, the Company refinanced its Amended Credit Facility and Revolving Credit Facility with
a new credit facility (the "2007 Credit Facility") consisting of a $350 million term loan and a $150 million revolver (See Note 3Business Combinations). A portion of
the proceeds from the refinancing was used to repay in full the amounts outstanding on its previous credit facility and revolving credit facility. Interest under the 2007 Credit Facility is currently
based on LIBOR plus a spread of 62.5 basis points. In addition, the Company currently pays a commitment fee on the unutilized revolving loan facility at an annualized rate of 10 basis points. In
accordance with the credit agreement for the 2007 Credit Facility, the spread and fee are determined based on the Company's consolidated leverage ratio. Effective December 31, 2008, the
interest rate on the term loan portion of the 2007 Credit Facility was 4.46%. The Company had not drawn on the revolving loan facility as of the date of this report. As a result of the value received
pursuant to the settlement agreement discussed in Note 3Business Combinations, on April 23, 2008 we prepaid $25 million of principal under the new facility, under an
approved waiver.

Our
obligations under the 2007 Credit Facility are guaranteed by our subsidiaries, Heritage Health Systems, Inc. and MemberHealth LLC and if, and only if, a rating
condition exists whereby the Company is either no longer rated by S&P or such rating falls below BBB-, this facility would be secured by substantially all of the assets of each of the
Guarantors. In March 2008, S&P placed a rating of BB+ on the Company that triggered this added security requirement.

The
Company incurred additional loan origination fees of approximately $4.7 million, which were capitalized and are being amortized on a straight-line basis, which
does not differ significantly from the effective yield basis, over the life of the 2007 Credit Facility. The early extinguishment of the Amended Credit Facility triggered the immediate amortization of
the related capitalized loan origination fees, resulting in a pre-tax expense of approximately $0.9 million.

Under
the terms of the 2007 Credit Facility, we must make principal repayments quarterly at the rate of $3.5 million per year over a five-year period with a final
payment of $308.4 million due upon maturity in September, 2012. The following table shows the schedule of principal payments remaining on the new credit facility as of December 31, 2008:

2007 Credit
Facility
(in thousands)2009

$
3,5002010


3,5002011


3,5002012


310,125$
320,625


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

F-64

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

14. LOAN PAYABLE (Continued)

rate
payment based on a fixed 4.14% locked in base rate. In entering the swap with Calyon Corporate and Investment Bank, we agreed to swap our floating rate interest payment based on the floating
LIBOR base rate on a notional amount of $125 million in exchange for a fixed interest rate payment based on a fixed 4.13% locked in based rate. (See Note 16Derivative
InstrumentsCash Flow Hedges).



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



The Company made regularly scheduled principal payments of $3.5 million plus the $25.0 million prepayment discussed above
during the year ended December 31, 2008, $3.5 million during 2007, and $5.3 million during 2006 in connection with its credit facilities. During 2007, the Company repaid the
$87.9 million balance outstanding on its Amended Credit Facility in connection with the refinancing noted above. The Company paid interest of $13.0 million during 2008,
$9.9 million during 2007, and $6.9 million during 2006 in connection with its credit facilities.

The
following table sets forth certain summary information with respect to total borrowings of the Company:

As of December 31,

Year Ended December 31,Amount
Outstanding

Interest
Rate

Maximum
Amount
Outstanding

Weighted
Average
Amount
Outstanding(1)

Weighted
Average
Interest
Rate(2)(In thousands)



(In thousands)

(In thousands)2008

$
320,625


4.46
%
$
349,125

$
330,595


4.06
%2007

$
349,125


5.63
%
$
350,000

$
163,571


6.50
%2006

$
90,563


7.61
%
$
95,813

$
93,820


7.31
%


---

F-65

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

15. OTHER LONG TERM DEBT

The Company has formed separate statutory business trusts (the "Trusts"), which exist for the exclusive purpose of issuing trust preferred securities representing undivided beneficial
interests in the assets of the trust, investing the gross proceeds of the trust preferred securities in junior subordinated deferrable interest debentures of the Company (the "Junior Subordinated
Debt") and engaging in only those activities necessary or incidental thereto. In accordance with the adoption of FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities,"
the Company does not consolidate the trusts. In March, 2007 we issued $50 million of trust preferred securities at a fixed interest rate of 7.7%. On December 4, 2007, the Company paid in
full the amounts outstanding on the $15 million of thirty year trust preferred securities issued in December 2002. The early extinguishment triggered the immediate amortization of the
unamortized balance of related capitalized loan origination fees, resulting in a pre-tax expense of approximately $0.4 million.

As
of December 31, 2008, the Trusts have an outstanding balance of a combined $110.0 million in thirty year trust preferred securities (the "Capital Securities") as
detailed in the following table:

Maturity Date

Amount
Issued

Term

Spread Over
LIBOR

Rate as of
December 31, 2008(In thousands)



(Basis points)April 2033

$
10,000

Floating


400


8.8
%May 2033


15,000

Floating


420


6.4
%May 2033


15,000

Fixed/Floating


410
(1)

6.3
%October 2033


20,000

Fixed/Floating


395
(2)

7.5
%March 2037


50,000

Fixed/Floating


275
(3)

7.7
%$
110,000


---

The
Trusts have the right to call the Capital Securities at par after five years from the date of issuance (which ranged from December 2002 to March 2007). The proceeds from the sale of
the Capital Securities, together with proceeds from the sale by the Trusts of their common securities to the Company, were invested in thirty-year floating rate Junior Subordinated Debt of
the Company. From the proceeds of the trust preferred securities, $26.0 million was used to pay down debt during 2003. The balance of the proceeds has been used, in part to fund acquisitions,
to provide capital to the Company's insurance subsidiaries to support growth and to be held for general corporate purposes.

The
Capital Securities represent an undivided beneficial interest in the Trusts' assets, which consist solely of the Junior Subordinated Debt. Holders of the Capital Securities have no
voting rights. The Company owns all of the common securities of the Trusts. Holders of both the Capital Securities and the Junior Subordinated Debt are entitled to receive cumulative cash
distributions accruing from the

F-66

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

15. OTHER LONG TERM DEBT (Continued)

date
of issuance, and payable quarterly in arrears at a floating rate equal to the three-month LIBOR plus a spread. The floating rate resets quarterly and is limited to a maximum of 12.5% during the
first sixty months. Due to the variable interest rate for these securities, the Company would be subject to higher interest costs if short-term interest rates rise. The Capital Securities
are subject to mandatory redemption upon repayment of the Junior Subordinated Debt at maturity or upon earlier redemption. The Junior Subordinated Debt is unsecured and ranks junior and subordinate in
right of payment to all present and future senior debt of the Company and is effectively subordinated to all existing and future obligations of the Company's subsidiaries. The Company has the right to
redeem the Junior Subordinated Debt after five years from the date of issuance.

The
Company has the right at any time, and from time to time, to defer payments of interest on the Junior Subordinated Debt for a period not exceeding 20 consecutive quarters up to each
debenture's maturity date. During any such period, interest will continue to accrue and the Company may not declare or pay any cash dividends or distributions on, or purchase, the Company's common
stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank equally with or junior to the Junior Subordinated Debt. The Company has the right at any time
to dissolve the Trusts and cause the Junior Subordinated Debt to be distributed to the holders of the
Capital Securities. The Company has guaranteed, on a subordinated basis, all of the Trusts' obligations under the Capital Securities including payment of the redemption price and any accumulated and
unpaid distributions to the extent of available funds and upon dissolution, winding up or liquidation but only to the extent the Trusts have funds available to make such payments.

The
Company paid $8.3 million in interest in connection with the Junior Subordinated Debt during the year ended December 31, 2008, $8.7 million during 2007, and
$5.8 million during 2006.

16. DERIVATIVE INSTRUMENTSCASH FLOW HEDGE

On December 4, 2007, we entered into two separate interest rate swap agreements, one with Citibank, and one with Calyon Corporate and Investment Bank to hedge the variability of
cash flows to be paid under the new credit facility described in Note 14Loan Payable in the Notes to the Consolidated Financial Statements. In entering into the swap with Citibank,
we agreed to swap our floating rate interest payment based on the floating three-month LIBOR base rate on a notional amount of $125 million in exchange for a fixed interest rate payment based
on a 4.14% locked-in fixed rate. In entering into the swap with Calyon, we agreed to swap our floating rate interest payment based on the floating three-month LIBOR base rate on a notional
amount of $125 million in exchange for a fixed interest rate payment based on a 4.13% locked-in fixed rate. The objective of the hedges is to eliminate the variability of cash flows
in the interest payments on the a combined $250 million amount of the variable rate term loan portion of our new credit facility, which is due to changes in the LIBOR base rate, through
September 2012. We expect changes in the cash flows of the interest rate swap to exactly offset the changes in cash flows from interest rate payments attributable to fluctuations in the LIBOR base
rate on the $250 million portion of the variable rate term loan portion of our new credit facility. The combined fair value of these swaps was a $20.3 million liability at
December 31, 2008 and a $0.3 million liability at December 31, 2007. Based on the fact that, at inception, the critical terms of the hedging instrument and the hedged forecasted
transaction were the same, we have concluded that we expect changes in cash flows attributable to the risk being hedged to be completely offset by the hedging derivative, and have designated these
swaps as cash flow hedges. As a result, we reflected the unrealized loss on these hedges in accumulated other comprehensive income (loss). We have performed

F-67

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

16. DERIVATIVE INSTRUMENTSCASH FLOW HEDGE (Continued)

subsequent
assessments of hedge effectiveness by verifying and documenting that the critical terms of the hedging instrument and the forecasted transaction have not changed during the period.

The
Company paid $1.4 million in interest in connection with the $250 million of interest rate swap agreements pertaining to our credit facility during the year ended
December 31, 2008, but did not make any payments during 2007. There were no swap agreements pertaining to our credit facility during 2006.

Effective
September 4, 2003, we entered into a swap agreement whereby we pay a fixed rate of 6.7% on a $15.0 million notional amount relating to the December 2002 trust
preferred securities issuance, in exchange for a floating rate of LIBOR plus 400 basis points, capped at 12.5%. This swap contract expired in December 2007. Effective April 29, 2004, we entered
into a second swap agreement whereby we pay a fixed rate of 6.98% on a $20.0 million notional amount relating to the October 2003 trust preferred securities issuance, in exchange for a floating
rate of LIBOR plus 395 basis points, capped at 12.45%. This swap contract expired in October 2008. The fair value of this swap was $0 at December 31, 2008 and $0.3 million at
December 31, 2007 and is reflected in other assets. During the year ended December 31, 2008, we reported a net $0.3 million in realized gains relating to the increase in the fair
value of the cash flow swap agreement. During the year ended December 31, 2007, we reported a realized loss of $0.9 million relating to the reduction in the fair value of the cash flow
swap agreement.

17. COMMITMENTS AND CONTINGENCIES



Plaintiff Arthur Tsutsui filed a derivative action on December 30, 2005, in the Supreme Court for New York State, Westchester
County. The defendants inTsutsui v. Barasch, et al., index no. 05-22523, are our officers Richard A. Barasch, Robert A. Waegelein
and Gary W. Bryant, as well as all of the directors sitting on our board of directors as of the time the complaint was filed. The Tsutsui action alleges that the same alleged misstatements that were
the subject of earlier actions, which have now all been dismissed or voluntarily withdrawn, constituted a breach of fiduciary duty by the officer defendants and the directors that caused us to sustain
damages. The Tsutsui action also seeks recovery of any proceeds derived by the officer and director defendants from the sale of our stock that the plaintiff claims was in breach of their fiduciary
duties. The defendants filed a motion to dismiss the complaint for failure to state a claim, as well as on other grounds. The Court granted this motion, and the plaintiff has appealed the dismissal.



On July 25, 2007, plaintiffs filed a purported class action entitledElizabeth A. Conolly, Thomas
McCormack, Shelly Z. Zhang, Green Meadows Partners, James Stellato and Rocco Sorrentino v. Universal American Financial Corporation, Richard A. Barasch, Lee Equity Partners LLC, Perry
Capital LLC, Union Square Partners Management LLC, Welsh, Carson, Anderson & Stowe, Barry Averill, Bradley E. Cooper, Mark M. Harmeling, Bertram Harnett, Linda H. Lamel, Eric W.
Leathers, Patrick J. McLaughlin, Robert A.

F-68

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

17. COMMITMENTS AND CONTINGENCIES (Continued)

Spass, and Robert F. Wright, index no. 07-13422, in the Supreme Court for New York State, Westchester County. The complaint alleged
that



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

On
May 6, 2008, the parties entered into a stipulation of settlement dated as of May 1, 2008, pursuant to which they agreed to settle this action. The settlement
stipulation provides for the amendment of our by-laws to require specified procedures in the event of related party transactions described in the amendment, and to require that we maintain
a committee that has as a member at least one independent member of our board of directors to oversee the process of preparing bids to the federal Centers for Medicare & Medicaid Services by
the MemberHealth Part D plans. The stipulation also provides for the payment of the plaintiffs' legal fees in an amount not to exceed $800,000. The Court has approved the payment of the
plaintiffs' legal fees, which we paid in December 2008, and other terms of the settlement. The parties have consummated the settlement, and this case has therefore concluded.



We have litigation in the ordinary course of our business, including claims for medical, disability and life insurance benefits, and in
some cases, seeking punitive damages. Management believes that after liability insurance recoveries, none of these actions will have a material adverse effect on the Company.



We are obligated under lease arrangements for our executive and administrative offices in New York, Florida, Indiana, Texas, Wisconsin,
Oklahoma, Ohio and Washington, D.C. Rent expense was $7.1 million for the year ended December 31, 2008, $5.8 million for 2007 and $4.4 million for 2006. Annual minimum
rental commitments, subject to escalation, under non-cancelable operating leases (in thousands) are as follows:

2009

$
5,9702010


5,7542011


5,3802012


4,1362013


2,715Thereafter


3,466Total

$
27,421


In
addition to the above, Pennsylvania Life is the named lessee on 43 properties occupied by career agents for use as field offices. The career agents reimburse Pennsylvania Life the
actual rent for these field offices. The total annual rent paid by the Company and reimbursed by the career agents for these field offices during 2008 and 2007 was approximately $4.0 million
and $2.9 million, respectively.

F-69

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

18. UNIVERSAL AMERICAN CORP. 401(k) SAVINGS PLAN

Effective April 1, 1992, we adopted the Universal American Corp. 401(k) Savings Plan. The 401(k) plan is a voluntary contributory plan under which employees may elect to defer
compensation for federal income tax purposes under Section 401(k) of the Internal Revenue Code of 1986. The employee is entitled to participate in the 401(k) plan by contributing through
payroll deductions up to 100% of the employee's compensation. The participating employee is not taxed on these contributions until they are distributed. Amounts credited to employee's accounts under
the 401(k) plan are invested by the employer-appointed investment committee. Currently, we match employee contributions with our
common stock in amounts equal to 100% of the employee's first 1% of contributions and 50% of the employee's next 4% of contributions to a maximum matching contribution of 3% of the employee's eligible
compensation. Our matching contributions vest at the rate of 25% per plan year, starting at the end of the second year. We made discretionary matching contributions under the 401(k) plan of
$2.2 million in 2008, $1.2 million in 2007 and $0.7 million in 2006. Employees must to hold the employer contribution in our common stock until vested, at which point the employee
has the option to transfer the amount to any of the other investments available under the 401(k) plan. The 401(k) plan held 610,131 shares of our common stock at December 31, 2008, which
represented 22% of total plan assets and 440,334 shares at December 31, 2007, which represented 33% of total plan assets. Generally, a participating employee is entitled to distributions from
the 401(k) plan upon termination of employment, retirement, death or disability. 401(k) plan participants who qualify for distributions may receive a single lump sum, have the assets transferred to
another qualified plan or individual retirement account, or receive a series of specified installment payments.

In
connection with the September 21, 2007 acquisition of MemberHealth, Inc., the Company assumed responsibility for administration of the MemberHealth, Inc.
Retirement Savings Plan. The MemberHealth savings plan is a voluntary contributory plan under which employees could elect to defer compensation for federal income tax purposes under
Section 401(k) of the Internal Revenue Code of 1986. Eligible employees were entitled to participate in the MemberHealth savings plan by contributing through payroll deductions up to 75% of the
employee's compensation. The participating employee does not pay tax on these contributions until they are distributed. Moreover, the employer's contributions vest after 5 years of credited
service. MemberHealth matched employee contributions at an amount equal to 50% of the first 6% of the employee's contribution not to exceed 3% of employee compensation. We made matching contributions
under our 401(k) plan of $0.1 million in 2007. Effective January 1, 2008, the MemberHealth savings plan was merged into our 401(K) plan.

19. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS

We used the following methods and assumptions estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:



F-70

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

19. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)



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

Other invested assets:Other invested assets consists of collateralized loans which are carried at the underlying collateral value,
cash value of
life insurance and mortgage loans which are carried at the aggregate unpaid balance. The determination of fair value for these invested assets is not practical because there is no active trading
market for such invested assets and therefore, the carrying value is a reasonable estimate of fair value. Equity securities are carried at fair value, based on quoted market price.

Cash and cash equivalents and policy loans:For cash and cash equivalents and policy loans, the carrying amount is a reasonable
estimate of fair
value.

Cash flow swap:The cash flow swap is carried at fair value, obtained from external quotes provided by banks.

Investment contract liabilities:For annuity contracts, the carrying amount is the policyholder account value; estimated fair value
equals the
policyholder account value less surrender charges.

Loan payable and trust preferred securities:For the loan payable and trust preferred securities fair value represents the present
value of
contractual cash flows discounted at current spreads for equivalent credit quality.

F-71

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

19. DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS (Continued)

The
estimated fair values of the Company's financial instruments are as follows:

2008

2007Carrying
Amount

Fair Value

Carrying
Amount

Fair Value(In thousands)

(In thousands)Financial assets:Fixed maturities available for sale

$
1,032,393

$
1,032,393

$
1,124,849

$
1,124,849Policy loans


22,274


22,274


21,560


21,560Other invested assets


1,649


1,649


1,526


1,526Cash and cash equivalents


511,032


511,032


667,685


667,685Cash flow swap


(20,298
)

(20,298
)

(21
)

(21
)Financial liabilities:Investment contract liabilities


237,752


228,160


274,049


260,732Loan payable


320,625


271,880


349,125


349,125Trust preferred securities


110,000


92,802


110,000


110,000


20. OTHER COMPREHENSIVE INCOME (LOSS)

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

For the Year ended December 31, 2008

Before Tax
Amount

Tax Expense
(Benefit)

Net of Tax
Amount(In thousands)Net unrealized loss arising during the year (net of SFAS 115 reserve adjustment for deferred acquisition costs)

$
(95,441
)
$
(33,404
)
$
(62,037
)Reclassification adjustment for losses included in net income


59,681


20,888


38,793Net unrealized losses


(35,760
)

(12,516
)

(23,244
)Cash flow hedge


(20,019
)

(7,006
)

(13,013
)Foreign currency translation adjustment


(153
)

(54
)

(99
)Other comprehensive loss

$
(55,932
)
$
(19,576
)
$
(36,356
)




For the Year ended December 31, 2007

Before Tax
Amount

Tax Expense
(Benefit)

Net of Tax
Amount(In thousands)Net unrealized loss arising during the year (net of SFAS 115 reserve adjustment for deferred acquisition costs)

$
(43,151
)
$
(15,104
)
$
(28,047
)Reclassification adjustment for losses included in net income


40,178


14,064


26,114Net unrealized losses


(2,973
)

(1,040
)

(1,933
)Cash flow hedge


(279
)

(97
)

(182
)Foreign currency translation adjustment


252


86


166Other comprehensive loss

$
(3,000
)
$
(1,051
)
$
(1,949
)


F-72

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

20. OTHER COMPREHENSIVE INCOME (LOSS) (Continued)



For the Year ended December 31, 2006

Before Tax
Amount

Tax Expense
(Benefit)

Net of Tax
Amount(In thousands)From continuing operations:Net unrealized gain arising during the year (net of SFAS 115 reserve adjustment for deferred acquisition costs)

$
232

$
81

$
151Reclassification adjustment for gains included in net income


(4,818
)

(1,686
)

(3,132
)Net unrealized losses


(4,586
)

(1,605
)

(2,981
)Cash flow hedge


(1,543
)

(540
)

(1,003
)Foreign currency translation adjustment


(9
)

(3
)

(6
)Other comprehensive loss from continuing operations


(6,138
)

(2,148
)

(3,990
)From discontinued operations:Net unrealized gain arising during the year (net of SFAS 115 reserve adjustment for deferred acquisition costs)


(3,752
)

(1,314
)

(2,438
)Reclassification adjustment for gains included in net income


(38,364
)

(13,427
)

(24,937
)Net unrealized losses


(42,116
)

(14,741
)

(27,375
)Foreign currency translation adjustment


(10,227
)

(3,579
)

(6,648
)Other comprehensive loss from discontinued operations


(52,343
)

(18,320
)

(34,023
)Total other comprehensive loss

$
(58,481
)
$
(20,468
)
$
(38,013
)


21. UNCONSOLIDATED SUBSIDIARY

During 2005, we entered into a strategic alliance with Caremark and created PDMS, which is 50% owned by Universal American and 50% owned by Caremark. PDMS principally performs marketing
and risk management services on behalf of our Prescription PathwaySM PDPs and Caremark for which it receives fees and other remuneration from our PDPs and Caremark. We do not control
PDMS and therefore PDMS is not consolidated in our financial statements. Our investment in PDMS is accounted for on the equity basis and is included in other assets. At December 31, 2008, our
investment in the equity in PDMS was $6.9 million and at December 31, 2007, our share in the equity of PDMS was $1.6 million. Our share in the income or loss of PDMS is included
in "equity in earnings (loss) of unconsolidated subsidiary." For 2008, our share in the net income was $72.8 million. For 2007, our share in the net income was $56.7 million and for
2006, our share in the net income was $46.2 million. During 2008, PDMS made distributions to its owners aggregating $135.0 million. Our share of these distributions was
$67.5 million. During 2007, PDMS made distributions to its owners aggregating $122.0 million. Our share of these distributions was $61.0 million. During 2006, PDMS made
distribution to its owners aggregating $81.0 million. Our share of these distributions was $40.5 million.

F-73

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

21. UNCONSOLIDATED SUBSIDIARY (Continued)

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

As of December 31,

2008

2007(In thousands)AssetsCash and investments

$
580

$
701Other


14,436


6,071Total Assets

$
15,016

$
6,772Liabilities and EquityAccrued expenses and other

$
1,148

$
3,530Equity


13,868


3,242Total liabilities and equity

$
15,016

$
6,772




Years ended December 31,

2008

2007

2006(in thousands)Total revenue

$
149,348

$
121,267

$
102,328Total expenses


3,722


7,939


9,954Income

$
145,626

$
113,328

$
92,374


On
February 13, 2008, UAC and Caremark announced that the strategic alliance would end as of December 31, 2008, subject to regulatory approval. On July 31, 2008,
PDMS received approval from the Centers for Medicare and Medicaid Services (CMS) of the Novation Agreement for Change of Ownership of a Medicare Prescription Drug Plan (PDP) Line of Business. As such,
effective January 1, 2009, PDMS will no longer manage the strategic alliance and will not earn revenue or incur expenses related to the 2009 PDP year. PDMS will continue to operate in 2009
solely to service the run-off activity related to pharmacy claims, rebates, and revenue related to prior PDP years. As there has been no change in the nature of operations during the year
ended December 31, 2008, the accompanying financial statements have been prepared on a going concern basis. Upon dissolution of PDMS in 2009, following the run-out of prior year PDP
claims, the economic interest of PDMS would be split equally between UAC and Caremark to match the 50% voting and ownership rights held by each entity.

22. BUSINESS SEGMENT INFORMATION

Our business segments are based on product and consist of



F-74

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

22. BUSINESS SEGMENT INFORMATION (Continued)



We
also report the activities of our holding company in a separate segment. A description of these segments follows:

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



Medicare Part DThis segment consists of



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

F-75

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

22. BUSINESS SEGMENT INFORMATION (Continued)

Traditional InsuranceThis segment consists of



Senior Administrative ServicesOur senior administrative services subsidiary acts as a third party administrator and service provider of senior market
insurance products and geriatric care management for both affiliated and unaffiliated insurance companies.

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

We
report intersegment revenues and expenses on a gross basis in each of the operating segments but eliminate them in the consolidated results. These intersegment revenues and expenses
affect the amounts reported on the individual financial statement line items, but we eliminate them in consolidation and they do not change income before taxes. The most significant items eliminated
are intersegment revenue and expense relating to services performed by the Senior Administrative Services segment for our other segments and interest on notes payable or receivable between the
Corporate segment and the operating segments.

F-76

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

22. BUSINESS SEGMENT INFORMATION (Continued)

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

2008

2007

2006Revenue

Income (Loss)
Before
Income Taxes

Revenue

Income (Loss)
Before
Income Taxes

Revenue

Income (Loss)
Before
Income Taxes(In thousands)Senior Managed CareMedicare Advantage

$
2,420,693

$
94,625

$
1,943,451

$
52,726

$
450,635

$
10,509Medicare Part D


1,896,070


127,444


642,538


116,888


294,139


49,190Traditional Insurance (3)


455,584


4,845


514,663


14,106


577,386


35,842Senior Administrative Services


84,888


22,020


106,954


24,124


85,014


15,840Corporate


3,426


(37,949
)

5,747


(35,040
)

1,408


(22,443
)Intersegment revenues


(68,994
)




(81,886
)




(62,149
)

Adjustments to segment amounts:Net realized (losses) gains(1)


(59,681
)

(59,681
)

(40,178
)

(40,178
)

4,818


4,818Equity in earnings of unconsolidated subsidiary(2)


(72,813
)




(56,664
)




(46,187
)

Total

$
4,659,173

$
151,304

$
3,034,625

$
132,626

$
1,305,064

$
93,756


---

F-77

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

22. BUSINESS SEGMENT INFORMATION (Continued)

Identifiable
assets by segment are as follows:

As of December 31,

2008

2007(In thousands)Senior Managed CareMedicare Advantage

$
978,846

$
1,050,336Medicare Part D


1,133,596


1,313,538Traditional Insurance


1,508,127


1,475,299Senior Administrative Services


20,330


30,903Corporate


1,661,194


1,753,467Intersegment assets(1)


(1,431,381
)

(1,533,780
)Total Assets

$
3,870,712

$
4,089,763


---

23. DISCONTINUED OPERATIONS

On December 1, 2006, we completed the sale of UAFC (Canada) Inc. Pursuant to the purchase agreement, we sold all of the outstanding shares of UAFC (Canada) Inc.,
owner of our Canadian insurance subsidiary, PennCorp Life Canada, to a venture 70% owned by La Capitale and 30% owned by GMF, for an aggregate purchase price of approximately $131 million or
CAD$146 million in cash, on the terms and conditions set forth in the purchase agreement. The purchase rice was comprised of $121.9 million or CAD$137.0 million, in cash, plus an
amount equal to the balance of net earnings generated by PennCorp Life Canada during the period from January 1, 2006 through the closing date, December 1, 2006, approximately
$8.4 million or CAD$9.9 million. We have accounted for the operations of PennCorp Life Canada as discontinued operations beginning in the third quarter of 2006. We have reclassified all
prior period amounts to conform to this presentation.

The
sale resulted in an after-tax realized gain of approximately $48.4 million and generated after tax cash proceeds of approximately $95 million comprised of
approximately $84 million of cash received at closing plus approximately $8.4 million in March 2007 for the net earnings of PennCorp Life Canada for 2006 through the closing date plus an
additional $2.6 million that we received upon the release of escrow in December 2008. We paid U.S. income tax on this sale of approximately $28.2 million in March 2007.

During
2006, PennCorp Life Canada paid dividends of CAD$4.9 million (approximately US$4.4 million) to Universal American. During 2005, PennCorp Life Canada became subject
to a 5% withholding tax on dividends paid to Universal American. The withholding tax paid on the dividends from PennCorp Life Canada in 2006 was CAD$0.2 million (approximately
US$0.2 million).

In
order to mitigate the risk fluctuations in the value of the U.S. dollar as compared to the Canadian dollar between the date of the purchase agreement to the closing of the
transaction, in connection with the sale of PennCorp Life Canada, on September 5, 2006, we entered into a financial hedging currency collar, which set the upper value of the exchange rate at
CAD$0.9124 per US$1.00 and the lower value of the exchange rate at CAD$0.8900 per US$1.00. The spot exchange rate was CAD$0.8993 per US$1.00 at the time Universal American entered into the hedging
transaction. At the

F-78

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

23. DISCONTINUED OPERATIONS (Continued)

closing,
the spot exchange rate was CAD$0.8733 per US$1.00 and the financial hedging currency collar was terminated. The resulting gain on the financial hedging currency collar on the closing date was
approximately $2.2 million, which was included with the gain on the sale.

Summarized
financial information for our discontinued operations is presented below.

2006(In thousands)Total revenue

$
73,795Total expenses


58,430Income before realized gains and income taxes


15,365Realized gains


630Income before provision for taxes


15,995Provision for income taxes


6,207Income from operations of subsidiary held for sale


9,788Gain on sale:Gain on sale


77,776Taxes on gain on sale


29,404Net gain on sale


48,372Income from discontinued operations

$
58,160


24. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The quarterly results of operations are presented below. Due to the use of weighted average shares outstanding when determining the denominator for earnings per share, the sum of the
quarterly per common share amounts may not equal the full year per common share amounts.

Three Months Ended2008

March 31,

June 30,

September 30,

December 31,(In thousands)Total revenue

$
1,224,787

$
1,242,041

$
1,097,999

$
1,100,286(Loss) income from continuing operations before income taxes


(55,313
)

28,561


77,140


100,916(Benefit) provision for income taxes


(9,313
)

193


28,328


37,004Net (loss) income

$
(46,000
)
$
28,368

$
48,812

$
63,912(Loss) earnings per common share:Basic:Net (loss) income

$
(0.50
)
$
0.32

$
0.57

$
0.75Diluted:Net (loss) income

$
(0.50
)
$
0.32

$
0.56

$
0.75


F-79

---



Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

24. CONDENSED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) (Continued)



Three Months Ended2007

March 31,

June 30,

September 30,

December 31,(In thousands)Total revenue

$
618,419

$
703,311

$
738,163

$
974,530Income from continuing operations before income taxes


5,801


35,640


42,920


48,265Provision for income taxes


1,440


13,365


15,775


17,974Net income

$
4,361

$
22,275

$
27,145

$
30,291Earnings per common share:Basic:Net income

$
0.07

$
0.36

$
0.40

$
0.33Diluted:Net income

$
0.07

$
0.35

$
0.40

$
0.33


During
the year ended 2008, the Company recognized other-than-temporary impairments in the value of certain of its securities with exposure to subprime mortgages
totaling $48.0 million. During the fourth quarter of 2007, the
Company recognized other-than-temporary impairments in the value of certain of its securities with exposure to subprime mortgages totaling $41.0 million.

F-80

---





Table of Contents

Schedule ISummary of Investments Other Than Investments in Related Parties        UNIVERSAL AMERICAN CORP.        December 31, 2008 and 2007

December 31, 2008Classification

Face
Value

Amortized
Cost

Fair
Value

Carrying
Value(In thousands)U.S. Treasury securities and obligations of U.S. Government

$
33,155

$
33,963

$
35,335

$
35,335Government sponsored agencies


90,314


90,030


95,029


95,029Other political subdivisions


10,035


9,993


9,885


9,885Corporate debt securities


441,943


441,681


420,283


420,283Foreign debt securities


32,958


32,779


30,890


30,890Mortgage-backed and asset-backed securities


565,537


466,632


440,971


440,971Sub-total

$
1,173,942


1,075,078

$
1,032,393


1,032,393Policy loans





22,274





22,274Other invested assets





1,649





1,649Total investments




$
1,099,001




$
1,056,316December 31, 2007Classification

Face
Value

Amortized
Cost

Fair
Value

Carrying
Value(In thousands)U.S. Treasury securities and obligations of U.S. Government

$
34,150

$
34,510

$
34,886

$
34,886Government sponsored agencies


96,314


95,975


98,724


98,724Other political subdivisions


5,600


5,558


5,536


5,536Corporate debt securities


425,853


431,002


432,141


432,141Foreign debt securities


29,501


29,363


29,641


29,641Mortgage-backed and asset-backed securities


593,267


528,973


523,921


523,921Sub-total

$
1,184,685


1,125,381

$
1,124,849


1,124,849Policy loans





21,560





21,560Other invested assets





1,526





1,526Total investments




$
1,148,467




$
1,147,935


See
notes to condensed financial statements.

F-81

---





Table of Contents

Schedule IICondensed Financial Information of Registrant        UNIVERSAL AMERICAN CORP.        (Parent Company)        CONDENSED BALANCE SHEETS
       December 31, 2008 and 2007

2008

2007(In thousands)ASSETSCash and cash equivalents

$
165,029

$
171,466Investments in subsidiaries, at equity


1,472,592


1,474,568Advances to agents


19,530


31,995Surplus note receivable from affiliate


65,550


77,550Due from affiliates


37,115


35,081Deferred loan origination fees


6,202


7,123Income taxes receivable


29


6,785Deferred income tax asset


8,057


Other assets


8,690


13,388Total assets

$
1,782,794

$
1,817,956LIABILITIES AND STOCKHOLDERS' EQUITYLoan payable

$
320,625

$
349,125Other long term debt


110,000


110,000Fair value of cash flow hedges


20,298


Deferred income tax liability





618Accounts payable and other liabilities


15,787


7,147Total liabilities


466,710


466,890Total stockholders' equity


1,316,084


1,351,066Total liabilities and stockholders' equity

$
1,782,794

$
1,817,956


See
notes to condensed financial statements.

F-82

---





Table of Contents

UNIVERSAL AMERICAN CORP.        (Parent Company)        CONDENSED STATEMENTS OF OPERATIONS        For the Three Years Ended December 31, 2008

2008

2007

2006(In thousands)REVENUES:Surplus note investment incomeaffiliated

$
570

$
1,783

$
2,749Net investment incomeunaffiliated


3,411


5,506


994Realized (loss) gain


(449
)

(928
)

1,219Other income


80


343


408Total revenues


3,612


6,704


5,370EXPENSES:Selling, general and administrative expenses


2,045


13,859


7,924Stock compensation expense


6,369


4,572


2,624Interest expenseloan payable


15,467


11,642


6,953Interest expenseother long term debt


8,227


8,838


5,867Total expenses


32,108


38,911


23,368Loss before income taxes and equity in income of subsidiaries


(28,496
)

(32,207
)

(17,998
)Income tax benefit


11,946


11,394


754Loss before equity in income of subsidiaries


(16,550
)

(20,813
)

(17,244
)Equity in income of subsidiaries, net of taxes


111,642


104,885


62,544Equity in income (loss) of unconsolidated subsidiary








15,846Income from continuing operations


95,092


84,072


61,146Discontinued Operations:Equity in income from discontinued operations, net of taxes








9,788Gain on sale of discontinued operations








48,372Income from discontinued operations








58,160Net income

$
95,092

$
84,072

$
119,306


See
notes to condensed financial statements.

F-83

---





Table of Contents

UNIVERSAL AMERICAN CORP.        (Parent Company)        CONDENSED STATEMENTS OF CASH FLOWS        For the Three Years Ended December 31, 2008

2008

2007

2006(In thousands)Cash flows from operating activities:Net income

$
95,092

$
84,072

$
119,306Adjustments to reconcile net income to net cash used in operating activities:Equity in income of discontinued operations








(9,788
)Gain on sale of discontinued operation








(48,372
)Equity in income of subsidiaries


(111,642
)

(104,885
)

(62,544
)Equity in income of unconsolidated subsidiary








(15,845
)Distribution from unconsolidated subsidiary








12,000Realized loss (gain)


449


928


(1,219
)Stock based compensation


6,663


4,878


2,624Change in amounts due to/from subsidiaries


(2,034
)

(13,353
)

(4,809
)Amortization of deferred loan origination fees


1,048


2,510


918Change in income taxes receivable


6,756





Deferred income taxes


(1,571
)

(2,999
)

2,310Change in other assets and liabilities


13,348


(499
)

(8,693
)Cash used in operating activities


8,109


(29,348
)

(14,112
)Cash flows from investing activities:Issuance of surplus note to affiliate





(60,000
)

Redemption of surplus note due from affiliate


12,000


10,000


12,500Capital contributions to subsidiaries





(81,000
)

(44,750
)Purchase of business and return of purchase price


40,990


(358,286
)

Purchase of agent advances from subsidiaries, net of collections


12,464


4,740


(28,299
)Other investing activities








1,667Cash provided by (used in) investing activitiescontinuing operations


65,454


(484,546
)

(58,882
)Cash provided by (used in) investing activitiesdiscontinued operations





(19,836
)

104,812Cash provided by (used in) investing activities


65,454


(504,382
)

45,930Cash flows from financing activities:Net proceeds from issuance of common stock


7,661


14,961


6,550Proceeds from issuance of preferred stock





332,107


Purchase of treasury stock


(74,821
)




(206
)Issuance of new debt





450,000


Principal repayment on debt


(28,500
)

(156,438
)

(5,250
)Dividends received from subsidiaries


15,660


12,043


13,015Other financing activities





(5,895
)

36Cash provided by (used in) financing activities


(80,000
)

646,778


14,145Net increase (decrease) in cash and cash equivalents


(6,437
)

113,048


45,963Cash and cash equivalents:At beginning of year


171,466


58,418


12,455At end of year

$
165,029

$
171,466

$
58,418Supplemental disclosure of cash flow information:Cash paid during the year for:Interest

$
22,721

$
18,679

$
12,758Income taxes

$
36,950

$
39,100

$
10,100


See notes to condensed financial statements.

F-84

---





Table of Contents

UNIVERSAL AMERICAN CORP.        (Parent Company)        NOTES TO CONDENSED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

In the parent-company-only financial statements, the parent company's investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiaries since
date of acquisition. The parent company's share of net income of its wholly owned unconsolidated subsidiaries is included in its net income using the equity method. Certain reclassifications have been
made to prior years' financial statements to conform to current period presentation. Parent-company-only financial statements should be read in conjunction with the Company's consolidated
financial statements.

2. AGENT ADVANCES

Universal American's insurance subsidiaries advance commissions to their respective agents for business submitted by the agents. Universal American has agreements with certain of its
insurance subsidiaries whereby it will purchase the related receivables. The advances are recovered as the commissions are earned through the balance of the policy period.

3. DERIVATIVE INSTRUMENTSCASH FLOW HEDGE

On December 4, 2007, we entered into two separate interest rate swap agreements, one with Citibank, and one with Calyon Corporate and Investment Bank to hedge the variability of
cash flows to be paid under the new credit facility described in Note 14Loan Payable in the Notes to the Consolidated Financial Statements. In entering into the swap with Citibank,
we agreed to swap our floating rate interest payment based on the floating three-month LIBOR base rate on a notional amount of $125 million in exchange for a fixed interest rate payment based
on a 4.14% locked-in fixed rate. In entering into the swap with Calyon, we agreed to swap our floating rate interest payment based on the floating three-month LIBOR base rate on a notional
amount of $125 million in exchange for a fixed interest rate payment based on a 4.13% locked-in fixed rate. The objective of the hedges is to eliminate the variability of cash flows
in the interest payments on the a combined $250 million amount of the variable rate term loan
portion of our new credit facility, which is due to changes in the LIBOR base rate, through September 2012. We expect changes in the cash flows of the interest rate swap to exactly offset the changes
in cash flows from interest rate payments attributable to fluctuations in the LIBOR base rate on the $250 million portion of the variable rate term loan portion of our new credit facility. The
combined fair value of these swaps was a $20.3 million liability at December 31, 2008 and a $0.3 million liability at December 31, 2007. Based on the fact that, at
inception, the critical terms of the hedging instrument and the hedged forecasted transaction were the same, we have concluded that we expect changes in cash flows attributable to the risk being
hedged to be completely offset by the hedging derivative, and have designated these swaps as cash flow hedges. As a result, we reflected the unrealized loss on these hedges in accumulated other
comprehensive income (loss). We have performed subsequent assessments of hedge effectiveness by verifying and documenting that the critical terms of the hedging instrument and the forecasted
transaction have not changed during the period.

Effective
September 4, 2003, we entered into a swap agreement whereby we pay a fixed rate of 6.7% on a $15.0 million notional amount relating to the December 2002 trust
preferred securities issuance, in exchange for a floating rate of LIBOR plus 400 basis points, capped at 12.5%. This swap contract expired in December 2007. Effective April 29, 2004, we entered
into a second swap agreement whereby we pay a fixed rate of 6.98% on a $20.0 million notional amount relating to the October 2003 trust preferred securities issuance, in exchange for a floating
rate of LIBOR plus 395 basis points,

F-85

---



Table of Contents

UNIVERSAL AMERICAN CORP.

(Parent Company)

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)

3. DERIVATIVE INSTRUMENTSCASH FLOW HEDGE (Continued)

capped
at 12.45%. This swap contract expired in October 2008. The fair value of this swap was $0 at December 31, 2008 and $0.3 million at December 31, 2007 and is reflected in
other assets. During the year ended December 31, 2008, we reported a net $0.3 million in realized gains relating to the increase in the fair value of the cash flow swap agreement. During
the year ended December 31, 2007, we reported a realized loss of $0.9 million relating to the reduction in the fair value of the cash flow swap agreement.

4. UNCONSOLIDATED SUBSIDIARY

In the second quarter of 2005, Universal American entered into a joint venture with Caremark and
created PDMS, which is 50% owned by each Universal American and Caremark. The Company and Caremark each made additional contributions of $1.3 million to PDMS in January 2006. Our share of the
earnings of PDMS for the period January 1, 2006 through May 15, 2006 was $15.8 million. PDMS made distributions to its owners aggregating $24.0 million for the period
January 1, 2006 through May 15, 2006. Universal American's share of the distributions was $12.0 million. On May 15, 2006, Universal American contributed its share of PDMS
to American Exchange.

5. DISCONTINUED OPERATIONS

On December 1, 2006, the Company completed the sale of UAFC (Canada) Inc., including PennCorp Life Canada. The sale generated an after-tax realized gain of
approximately $48.4 million. Universal American has accounted for the operations of PennCorp Life Canada as discontinued operations. All prior period amounts have been reclassified to conform
to this presentation. Refer to Note 23 of the notes to consolidated financial statements in the Annual Report on Form 10-K for a description of the transaction.

F-86

---





Table of Contents

Schedule IIISUPPLEMENTAL INSURANCE INFORMATION        UNIVERSAL AMERICAN CORP.        (In thousands)

Deferred
Acquisition
Costs

Reserves for
Future Policy
Benefits

Unearned
Premiums

Policy and
Contract
Claims

Net
Premium
Earned

Net
Investment
Income

Policyholder
Benefits

Net Change
in DAC

Other
Operating
Expense2008Senior Managed CareMedicare Advantage

$


$


$


$
257,309

$
2,404,067

$
16,626

$
2,001,163

$


$
324,905Medicare part D











408,802


1,802,127


1,052


1,533,090





235,536Traditional Insurance


237,630


1,021,712





73,092,


394,275


60,189


317,344


14,273


119,122Senior Administrative Services


























62,868Corporate

















3,345








41,272Intersegment and other adjustments














(15
)

58


(15
)




(68,876
)Segment Total

$
237,630

$
1,021,712

$


$
739,203

$
4,600,454

$
81,270

$
3,851,582

$
14,273

$
714,8272007Senior Managed CareMedicare Advantage

$


$


$


$
303,281

$
1,920,309

$
23,142

$
1,611,824

$
574

$
278,327Medicare part D











352,688


578,791


6,685


427,195





98,455Traditional Insurance


245,511


1,051,309





91,608


442,163


71,189


350,790


15,389


134,378Senior Administrative Services


























82,830Corporate

















5,398








41,664Intersegment and other adjustments














156


556


129





(82,894
)Segment Total

$
245,511

$
1,051,309

$


$
747,577

$
2,941,419

$
106,970

$
2,389,938

$
15,963

$
552,7602006Senior Managed CareMedicare Advantage

$
574

$


$


$
77,815

$
444,663

$
5,972

$
332,248

$
(574
)
$
108,452Medicare part D











44,052


244,811


3,079


213,909





31,040Traditional Insurance


261,570


1,085,686





92,845


508,470


65,449


391,723


(16,110
)

165,931Senior Administrative Services


























69,174Corporate

















994








23,476Intersegment and other adjustments














(802
)

(35
)

(753
)




(61,021
)Segment Total

$
262,144

$
1,085,686

$


$
214,712

$
1,197,142

$
75,459

$
937,127

$
(16,684
)
$
337,052


---

F-87

---





Table of Contents

Universal American Corp.        Schedule V        Valuation and Qualifying Accounts

(In Thousands)

Balance
Jan 1

Charged to
Statement of
Operations

Write-offs
against
allowance

Acquisition
and Other
Adjs.

Balance
Dec 312008Due and unpaid premiums(1)

$
7,298

$
2,432

$
(8,881
)
$
2,433

$
3,282Other Part D receivables(1)


13,836


7,959


(6,378
)

662


16,079Advances to agents


4,682


5,730








10,412Other assets(3)


18,100


2,817


(552
)

449


20,814Deferred income taxes


3,144


1,289








4,4332007Due and unpaid premiums(1)

$
3,230

$
2,079

$
(89
)
$
2,078

$
7,298Other Part D receivables(2)


5,830





(4,372
)

12,378


13,836Advances to agents


3,494


1,188








4,682Other assets(3)





17,548





552


18,100Deferred income taxes


2,949


195








3,1442006Due and unpaid premiums(1)

$


$
1,615

$


$
1,615

$
3,230Other Part D receivables(1)





2,915





2,915


5,830Advances to agents


2,756


738








3,494Other assets














Deferred income taxes


213


2,736








2,949


---

F-88

---