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



FORM 10-Q

(Mark One)ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended June 30, 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)




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

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

Large accelerated filer o

Accelerated filer ý

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

Smaller reporting 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

As of July 31, 2008, 68,674,462 shares of the registrant's common stock were issued and outstanding.



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Table of Contents



TABLE OF CONTENTS



Item

Description

PagePART I

Financial Information1

Financial Statements (unaudited):Consolidated Balance Sheets


4Consolidated Statements of OperationsThree Months


5Consolidated Statements of OperationsSix Months


6Consolidated Statements of Stockholders' Equity and Comprehensive
Income


7Consolidated Statements of Cash Flows


8Notes to Consolidated Financial Statements


92

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


413

Quantitative and Qualitative Disclosures About Market Risk


764

Controls and Procedures


77PART II



Other Information1

Legal Proceedings


791A

Risk Factors


792

Unregistered Sales of Equity Securities and Use of Proceeds


793

Defaults Upon Senior Securities


794

Submission of Matters to a Vote of Security Holders


805

Other Information


806

Exhibits


81Signatures


85


1

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Table of Contents

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

DISCLOSURE REGARDING FORWARD LOOKING STATEMENTS

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



You
may identify forward-looking statements by the use of 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. Readers should not place undue
reliance on these forward-looking statements.

2

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Table of Contents

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

3

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Table of Contents

PART I

ITEM 1FINANCIAL STATEMENTS (Unaudited)

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands, except number of shares)

June 30,
2008

December 31,
2007(Unaudited)ASSETSInvestments (Note 6):Fixed maturities available for sale, at fair value (amortized cost: 2008, $1,091,809; 2007, $1,125,381)

$
1,078,304

$
1,124,849Policy loans


21,659


21,560Other invested assets


1,560


1,526Total investments


1,101,523


1,147,935Cash and cash equivalents (Note 2)


452,717


667,685Accrued investment income


12,735


13,364Deferred policy acquisition costs


237,559


245,511Amounts due from reinsurers


227,974


286,426Due and unpaid premiums


355,658


100,351Present value of future profits and other amortizing intangible assets (Note 5)


204,680


213,518Goodwill and other indefinite lived intangible assets (Note 5)


530,137


606,972Income taxes receivable


59,800


31,145CMS contract deposits receivables


340,482


394,225Other Part D receivables


169,304


181,696Advances to agents


64,761


61,076Other assets


147,419


139,859Total assets

$
3,904,749

$
4,089,763LIABILITIES AND STOCKHOLDERS' EQUITYLIABILITIESPolicyholder account balances

$
415,819

$
434,859Reserves for future policy benefits


622,451


616,450Policy and contract claimslife


11,137


12,213Policy and contract claimshealth


798,462


737,189Advance premium


7,759


25,232Loan payable (Note 11)


322,375


349,125Other long term debt (Note 12)


110,000


110,000Amounts due to reinsurers


40,760


67,239Deferred income tax liability


22,188


28,687Other Part D liabilities


140,152


157,048Other liabilities


164,887


200,655Total liabilities


2,655,990


2,738,697Commitments and contingencies (Note 14)STOCKHOLDERS' EQUITY (Note 8)Preferred stock (Authorized: 3 million shares):Series A (Designated: 300,000 shares, issued and outstanding: 2008, 42,105 shares, liquidation value $84,210; 2007, 47,105 shares, liquidation vale $94,210)


42


47Series B (Designated: 300,000 shares, issued and outstanding: 2008, 132,895 shares, liquidation value $265,790; 2007, 127,895 shares, liquidation value $255,790)


133


128Common stockvoting (Authorized: 200 million shares, issued and outstanding: 2008, 73.3 million shares; 2007, 75.0 million shares)


733


750Common stocknon voting (Authorized: 30 million shares)





Additional paid-in capital


861,589


890,882Accumulated other comprehensive loss (Notes 8 and 15)


(6,781
)

(66
)Retained earnings


445,951


463,583Less: Treasury stock (2008, 4.6 million shares; 2007, 0.3 million shares)


(52,908
)

(4,258
)Total stockholders' equity


1,248,759


1,351,066Total liabilities and stockholders' equity

$
3,904,749

$
4,089,763


See notes to unaudited consolidated financial statements.

4

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three Months Ended June 30, 2008 and 2007

(Unaudited)

(In thousands, per share amounts in dollars)

2008

2007Revenues:Direct premium and policyholder fees earned

$
1,416,724

$
858,241Reinsurance premiums assumed


12,384


8,018Reinsurance premiums ceded


(204,184
)

(195,974
)Net premiums and policyholder fees earned


1,224,924


670,285Net investment income


19,476


26,618Fee and other income


10,926


6,872Net realized losses on investments


(13,285
)

(264
)Total revenues


1,242,041


703,511Benefits, Claims and Expenses:Claims and other benefits


1,045,160


554,926Increase in reserves for future policy benefits


1,268


535Interest credited to policyholders


3,383


4,323Change in deferred acquisition costs


3,268


1,825Amortization of intangible assets (Note 5)


9,926


1,873Commissions


36,758


43,749Reinsurance commission and expense allowances


(16,876
)

(18,433
)Interest expense


5,793


4,924Other operating costs and expenses


140,081


87,269Total benefits, claims and other deductions


1,228,761


680,991Income before equity in earnings of unconsolidated subsidiary


13,280


22,520Equity in earnings of unconsolidated subsidiary (Note 16)


15,281


13,120Income before income taxes


28,561


35,640Provision for income taxes


193


13,365Net income

$
28,368

$
22,275Earnings per common share:Basic (Note 2)

$
0.32

$
0.36Diluted

$
0.32

$
0.35Weighted average shares outstanding:Weighted average common shares outstanding


73,198


60,143Less weighted average treasury shares


(3,249
)

(618
)Basic weighted shares outstanding (Note 2)


69,949


59,525Weighted average common equivalent of preferred shares outstanding


17,500


2,528Effect of dilutive securities


291


1,317Diluted weighted shares outstanding


87,740


63,370


See
notes to unaudited consolidated financial statements.

5

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

For the Six Months Ended June 30, 2008 and 2007

(Unaudited)

(In thousands, per share amounts in dollars)

2008

2007Revenues:Direct premium and policyholder fees earned

$
2,849,535

$
1,653,872Reinsurance premiums assumed


23,833


16,646Reinsurance premiums ceded


(430,793
)

(412,335
)Net premiums and policyholder fees earned


2,442,575


1,258,183Net investment income


43,757


48,980Fee and other income


22,787


13,126Net realized (losses) gains on investments


(42,293
)

1,640Total revenues


2,466,826


1,321,929Benefits, Claims and Expenses:Claims and other benefits


2,158,681


1,052,666Increase in reserves for future policy benefits


3,632


3,786Interest credited to policyholders


7,522


9,028Change in deferred acquisition costs


10,799


12,159Amortization of intangible assets (Note 5)


11,826


3,982Commissions


76,014


78,790Reinsurance commission and expense allowances


(34,626
)

(36,623
)Interest expense


12,097


8,363Other operating costs and expenses


278,966


174,661Total benefits, claims and other deductions


2,524,911


1,306,812(Loss) income before equity in earnings of unconsolidated subsidiary


(58,085
)

15,117Equity in earnings of unconsolidated subsidiary (Note 16)


31,333


26,323(Loss) income before income taxes


(26,752
)

41,440Provision for income taxes


(9,120
)

14,805Net (loss) income

$
(17,632
)
$
26,635(Loss) earnings per common share:Basic (Note 2)

$
(0.20
)
$
0.44Diluted

$
(0.20
)
$
0.43Weighted average shares outstanding:Weighted average common shares outstanding


73,819


60,056Less weighted average treasury shares


(1,875
)

(642
)Basic weighted shares outstanding (Note 2)


71,944


59,414Weighted average common equivalent of preferred shares outstanding


17,500


1,271Effect of dilutive securities


536


1,322Diluted weighted shares outstanding


89,980


62,007


See
notes to unaudited consolidated financial statements.

6

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

AND COMPREHENSIVE INCOME

For the Six Months Ended June 30, 2008 and 2007

(Unaudited)
(In thousands)

Preferred
Stock
Series A

Preferred
Stock
Series B

Common
Stock

Additional
Paid-In
Capital

Accumulated
Other
Comprehensive
(Loss) Income

Retained
Earnings

Treasury
Stock

Total2007Balance, January 1, 2007

$


$


$
599

$
252,542

$
1,883

$
379,511

$
(10,626
)
$
623,909Net income

















26,635





26,635Other comprehensive loss (Note 15)














(8,776
)







(8,776
)Comprehensive income























17,859Issuance of common stock (Note 8)


30


20


4


100,041











100,095Stock-based compensation (Note 9)











2,205











2,205Treasury shares reissued (Note 8)











609








2,010


2,619Balance, June 30, 2007

$
30

$
20

$
603

$
355,397

$
(6,893
)
$
406,146

$
(8,616
)
$
746,6872008Balance, January 1, 2008

$
47

$
128

$
750

$
890,882

$
(66
)
$
463,583

$
(4,258
)
$
1,351,066Net loss

















(17,632
)




(17,632
)Other comprehensive loss (Note 15)














(6,715
)







(6,715
)Comprehensive loss























(24,347
)Preferred stock conversion


(5
)

5

















Issuance of common stock (Note 8)








3


1,272











1,275Equity transactions related to the acquisition of MemberHealth (Note 4)








(20
)

(34,521
)










(34,541
)Stock-based compensation (Note 9)











4,112











4,112Treasury shares purchased, at cost (Note 8)




















(50,067
)

(50,067
)Treasury shares reissued (Note 8)











(156
)







1,417


1,261Balance, June 30, 2008

$
42

$
133

$
733

$
861,589

$
(6,781
)
$
445,951

$
(52,908
)
$
1,248,759


See notes to unaudited consolidated financial statements.

7

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Six Months Ended June 30, 2008 and 2007

(Unaudited)

(In thousands)

2008

2007Cash flows from operating activities:Net (loss) income

$
(17,632
)
$
26,635Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities, net of balances acquired:Equity in earnings of unconsolidated subsidiary


(31,333
)

(26,323
)Distribution from unconsolidated subsidiary


27,000


27,500Deferred income taxes


(1,656
)

3,006Realized losses (gains) on investments


42,293


(1,640
)Amortization of intangible assets


11,825


3,982Net amortization of bond premium


898


784Changes in operating assets and liabilities:Deferred policy acquisition costs


10,799


12,159Reserves for future policy benefits


6,001


8,877Policy and contract claims payable


60,197


290,933Reinsurance balances


30,558


(35,176
)Due and unpaid advance premium, net


(272,475
)

119,294Income taxes payable/receivable


(28,207
)

2,042Other Part D receivables


12,392


(26,476
)Other Part D liabilities


(16,896
)

(4,888
)Other, net


(31,793
)

(12,984
)Cash (used in) provided by operating activities


(198,029
)

387,725Cash flows from investing activities:Proceeds from sale or redemption of fixed maturity investments


223,190


135,967Cost of fixed maturity investments purchased


(232,562
)

(221,097
)Proceeds from sale of subsidiary, net of cash sold (Note 4)





5,102Purchase of business and return of purchase price, net of cash acquired (Note 4)


40,990


(17,722
)Purchase of fixed assets


(9,737
)

(3,003
)Other investing activities


621


460Cash provided by (used in) investing activitiescontinuing operations


22,502


(100,293
)Cash used in investing activitiesdiscontinued operations (Note 2)





(19,836
)Cash provided by (used in) investing activities


22,502


(120,129
)Cash flows from financing activities:Net proceeds from issuance of common stock, net of tax effect


1,913


100,095Cost of treasury stock purchases


(50,067
)

Receipts from CMS contract deposits


1,583,804


436,067Withdrawals from CMS contract deposits


(1,530,061
)

(384,812
)Deposits and interest credited to policyholder account balances


8,690


10,177Surrenders and other withdrawals from policyholder account balances


(26,970
)

(33,924
)Issuance of new debt





98,000Principal repayment on loan payable and other long term debt


(26,750
)

(2,625
)Cash (used in) provided by financing activities


(39,441
)

222,978Net (decrease) increase in cash and cash equivalents


(214,968
)

490,574Cash and cash equivalents at beginning of period


667,685


542,130Cash and cash equivalents at end of period

$
452,717

$
1,032,704


See notes to unaudited consolidated financial statements.

8

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. ORGANIZATION AND COMPANY BACKGROUND

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

In
2006, we began offering PDPs pursuant to Medicare Part D under the Prescription PathwaySM brand through Pennsylvania Life Insurance Company, American Progressive
Life & Health Insurance Company of New York and Marquette National Life Insurance Company, in connection with a strategic alliance with Caremark Rx, Inc., formerly PharmaCare Management
Services, Inc., a third party pharmacy benefits manager or PBM and a wholly-owned subsidiary of CVS Caremark Corp. In February 2008, we announced that the parties are terminating this strategic
alliance effective December 31, 2008, subject to regulatory approvals. 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
currently operate Medicare Advantage PFFS plans through American Progressive, The Pyramid Life Insurance Company and Marquette as well as Medicare Advantage health plans in Houston
and Beaumont, Texas through SelectCare of Texas, L.L.C., in North Texas through SelectCare Health Plans, Inc., and in Oklahoma through SelectCare of Oklahoma, Inc. and
GlobalHealth, Inc. All of these companies are our subsidiaries. In addition, beginning in 2007, we expanded into new health plan markets in Wisconsin.

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

On
September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held PBM and sponsor of Community CCRxSM , a national
Medicare Part D 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 converted MemberHealth, Inc. into a
limited liability company and renamed it MemberHealth, L.L.C.. See Note 4Business Combinations.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation:We have prepared the accompanying consolidated financial statements in conformity with U.S. generally accepted accounting principles or GAAP
and consolidate the accounts of Universal American and its subsidiaries:



9

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



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

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

The
interim financial information in this report is unaudited, but in the opinion of management, includes all adjustments, including normal, recurring adjustments necessary to present
fairly the financial position and results of operations for the periods reported. The results of operations for the six months ended June 30, 2008 and 2007 are not necessarily indicative of the
results to be expected for the full year. You should read the accompanying consolidated financial statements and notes in conjunction with our Annual Report on Form 10-K for the
fiscal year ended December 31, 2007.

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

10

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Net income (loss) attributable to common stock

$
22,691

$
21,368

$
(14,182
)
$
26,077Undistributed income (loss) allocated to participating preferred stock


5,677


907


(3,450
)

558Net income (loss)

$
28,368

$
22,275

$
(17,632
)
$
26,635


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

Reserve Development:The PFFS medical loss ratio decreased to 85.0% for the second quarter of 2008 from 85.4% for the second quarter of 2007 primarily due to
$11.5 million favorable development of 2007 claim experience. The PFFS medical loss ratio increased to 87.7% for the first six months of 2008 from 86.2% for the first six months of 2007
primarily due to higher medical costs levels partially offset by $1.5 million favorable development of 2007 claim experience.

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

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

11

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

the
time of purchase. Supplemental cash flow information for interest and income taxes paid for continuing and discontinued operations is as follows:

Six months ended
June 30,2008

2007(In thousands)Supplemental cash flow information from continuing operations:Cash paid for interest

$
11,353

$
8,075Cash paid for income taxes

$
34,300

$
35,009Non-cash financing activities:Return of common stock in connection with MemberHealth acquisition (See Note 4Business Combinations.)

$
(34,541
)
$



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

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

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

3. RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS

Business Combination:On December 4, 2007, the Financial Accounting Standards board, or FASB, issued Statement of Financial Accounting Standards
No. 141(R), Business Combinations, known as SFAS 141(R) and Statement No. 160, Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements, an
amendment of ARB No. 51, known as SFAS 160. These standards will significantly change the financial accounting and reporting of business combination transactions and noncontrolling or
minority interests in business entities. SFAS 141(R) is required to be adopted concurrently with FAS 160 and is effective for business combination transactions for which the acquisition
date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Early adoption is prohibited. Companies will not be required to adjust assets and
liabilities that arose from business combinations with acquisition dates prior to the SFAS 141R effective date, with specified exceptions for acquired deferred tax assets and acquired income
tax positions. We expect to adopt SFAS 141(R) on January 1, 2009, and have not yet determined whether or to what extent SFAS 141 (R) will affect our results of operations
and financial condition.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

3. RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS (Continued)

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

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

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



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.

4. BUSINESS COMBINATIONS



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

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. BUSINESS COMBINATIONS (Continued)

payable
under the performance-based earn-out was $150 million, payable in cash and our common stock.

Subsequent
to December 31, 2007, we determined that expected operating income for 2008 from the MemberHealth business, which we acquired in September 2007, would be less than
previously forecast. The reason for the decline in expected income was that premium payments to MemberHealth would be lower than anticipated based upon the bids submitted by MemberHealth in June 2007
for its 2008 Part D plans, and later accepted by CMS. The premium payments were lower primarily as a result of incorrect information concerning the risk scores in the MemberHealth bids. In
accounting for the issue relating to the 2008 bids, we recorded an acquisition liability of $39.2 million for the below-market contract that we will amortize into income over the contract
period, January 1, 2008 to December 31, 2008. We amortized $9.9 million of this acquisition liability in the quarter ended June 30, 2008, and $19.8 million for the
six months ended June 30, 2008. We reflected this amortization in direct premium and policyholder fees earned in the consolidated statements of operations.

We
also discovered after December 31, 2007 that MemberHealth incorrectly calculated its expected risk corridor receivable in its first quarter 2007 financial statements, resulting
in an overstatement of pre-tax income for the first quarter of 2007 of approximately $26 million. In our financial statements for the year ended December 31, 2007 included in
our filed Form 10K, we adjusted the acquired financial statements 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, goodwill was reduced by the amount of the cash and common shared
received, $82 million in total, and liabilities were adjusted in relation to the $16 million forgiveness.

We
have performed the initial purchase accounting for the MemberHealth acquisition. We have prepared the purchase price allocation for the MemberHealth acquisition on a preliminary basis
and it is subject to changes as new facts and circumstances emerge. In addition, as discussed above, we have adjusted the purchase price to reflect the settlement agreement. Once we finalize the
purchase price, we will adjust the purchase price allocation to reflect the final values. After giving effect to the settlement, the excess of the purchase price over the fair value of net tangible
assets acquired, adjusted

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. BUSINESS COMBINATIONS (Continued)

for
deferred income taxes, was approximately $602.3 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

$
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


442,971




Non amortizingTotal excess of purchase price over tangible book value

$
602,330


15

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. BUSINESS COMBINATIONS (Continued)

The
following condensed balance sheet sets forth the amounts assigned to assets and liabilities for MemberHealth on the date of acquisition, as adjusted to reflect the settlement
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


442,971Due and unpaid premium


135,218CMS deposit contract receivable


102,856Other Part D receivables


92,120Deferred taxes


10,621Other


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 reflected operating results generated by MemberHealth prior to September 21, 2007, the date of acquisition, in our consolidated financial statements. The unaudited
consolidated pro forma results of operations, assuming that we purchased MemberHealth on January 1, 2007 are as follows:

Three months ended
June 30, 2007

Six months ended
June 30, 2007(In thousands)Total revenue

$
1,133,184

$
2,216,527Income before taxes

$
60,973

$
32,283Net income

$
37,547

$
20,804Income per common share:Basic

$
0.47

$
0.26Diluted

$
0.46

$
0.26


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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

4. BUSINESS COMBINATIONS (Continued)

financial
statements contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

The
pro forma information presented above is for disclosure purposes only and is not necessarily indicative of the results of operations that would have occurred if the acquisition had
been consummated on the date assumed, nor is the pro forma information intended to be indicative of our future results of operations.



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

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

Description

Amount
(In thousands)

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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

5. INTANGIBLE ASSETS

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

June 30, 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

$
12,658

$
18,473

$
12,252Distribution channel


30


26,684


4,631


22,055


3,492Policies in forceLife/Annuity


7


4,127


2,310


4,127


2,241Medicare Part D:Membership base


10


135,426


10,496


138,000


3,795Trademarks/trade names


9


20,433


1,760


18,000


550Licenses


15


3,500


181


5,000


92Senior Managed CareMedicare Advantage:Membership base


7


23,988


8,663


23,988


7,542Provider contracts


10


15,539


4,658


15,539


3,853Non-compete


7


1,425


223


1,425


121Senior Administrative Services:Administrative service contracts


6


7,671


7,577


7,671


7,526Hospital network contracts


10


1,797


1,226


1,797


1,093Total


17

$
259,063

$
54,383

$
256,075

$
42,557


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

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Balance, beginning of period

$
214,606

$
62,007

$
213,518

$
54,738Additions and adjustments





(2,289
)

2,988


7,089Amortization


(9,926
)

(1,873
)

(11,826
)

(3,982
)Balance, end of period

$
204,680

$
57,845

$
204,680

$
57,845


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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

5. INTANGIBLE ASSETS (Continued)

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

2008 remainder of year

$
12,0272009


23,6322010


23,1842011


21,3342012


21,1712013


21,040Thereafter


82,292$
204,680


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

December 31,
2007

Additions

Adjustments

June 30,
2008(In thousands)Traditional Insurance:Goodwill

$
3,893

$
1,646

$


$
5,539Other


4,867








4,867SubtotalTraditional Insurance


8,760


1,646





10,406Medicare Part DGoodwill


520,764





(77,793
)

442,971Senior Managed CareMedicare Advantage:Goodwill


67,928





(688
)

67,240Other


5,163








5,163SubtotalSenior Managed CareMedicare Advantage


73,091





(688
)

72,403Senior Administrative ServicesGoodwill


4,357








4,357Total

$
606,972

$
1,646

$
(78,481
)
$
530,137


Other
non-amortizing intangible assets consist primarily of trademarks and licenses. The addition of goodwill for Traditional Insurance was a result of an acquisition, the
decrease in goodwill in Senior Managed CareMedicare Advantage was the result of the settlement of pre-acquisition adjustments in connection with the Harmony Health acquisition
and the decrease in goodwill for Medicare Part D was the result of $4.1 million in post-closing adjustments on MemberHealth and the $81.9 million MemberHealth purchase
price adjustment in 2008. For a full discussion of the MemberHealth purchase price adjustment see Note 4Business Combinations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

6. INVESTMENTS

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

June 30, 2008Classification

Amortized
Cost

Gross
Unrealized
Gains

Gross
Unrealized
Losses

Fair
Value(In thousands)U.S. Treasury securities and obligations of U.S. Government

$
35,325

$
333

$
(100
)
$
35,558Government sponsored agencies


98,990


2,368


(7
)

101,351Other political subdivisions


7,558


13


(177
)

7,394Corporate debt securities


440,534


5,082


(12,055
)

433,561Foreign debt securities


32,955


323


(698
)

32,580Mortgage-backed and asset-backed securities


476,447


5,170


(13,757
)

467,860$
1,091,809

$
13,289

$
(26,794
)
$
1,078,304




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





98,725Other political subdivisions


5,558


34


(57
)

5,535Corporate 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
June 30, 2008, gross unrealized losses on mortgage-backed and asset-backed securities reflect unrealized losses of $3,689 on subprime residential mortgage loans, as discussed
below. The remaining unrealized losses of $10,068 relate primarily to obligations of commercial mortgage-backed securities and other asset-backed securities. The value of a majority of these
securities is depressed due to the deterioration of value in the mortgage-backed securities market and related businesses, however 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

6. INVESTMENTS (Continued)

The
amortized cost and fair value of fixed maturity investments at June 30, 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

$
60,405

$
60,809Due after 1 year through 5 years


359,041


360,728Due after 5 years through 10 years


139,069


136,711Due after 10 years


56,847


52,196Mortgage and asset-backed securities


476,447


467,860$
1,091,809

$
1,078,304


Subprime Residential Mortgage Loans

We hold securities with exposure to subprime residential mortgages. Subprime mortgage lending is the origination of residential
mortgage loans to customers with weak credit profiles. The slowing U.S. housing market, greater use of mortgage products with low introductory interest rates, generally referred to as "teaser rates,"
and relaxed underwriting standards for some originators of subprime loans have recently 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; the year of issuance is known as the vintage year. These factors have caused a significant reduction in market liquidity and
repricing of risk, which has led to a decrease in the market valuation of these securities sector wide.

As
of June 30, 2008, we held subprime securities with par values of $143 million, an amortized cost of $60 million and a market value of $56 million
representing approximately 3.6% 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 & Poor's, a division of the McGraw Hill Companies, Inc., known as S&P,
or equivalent. Two of these securities have experienced credit downgrades. Further, twelve securities, including the two already downgraded, with an amortized cost

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

6. INVESTMENTS (Continued)

of
approximately $15 million have been placed on negative credit watch. The following table presents our exposure to subprime residential mortgages by vintage year.

Vintage Year

Amortized
Cost

Fair
Value

Unrealized
Loss(In thousands)2003

$
6,636

$
5,497

$
(1,139
)2004


3,695


3,457


(238
)2005


26,462


22,524


(3,938
)2006


16,899


18,400


1,5012007


6,377


6,502


125Totals

$
60,069

$
56,380

$
(3,689
)


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

At
December 31, 2007, we recognized an other than temporary impairment on fourteen 2006 and 2007 vintage year subprime holdings, resulting in a pre-tax realized loss
on investment of $41.0 million. As of June 30, 2008, we recognized an additional other than temporary impairment on the same fourteen securities impaired at December 31, 2007 plus
four additional subprime holdings. Total impairment year-to-date on these eighteen subprime holdings was $41.5 million, of which we recognized $11.7 million in
the second quarter. In addition, during the second quarter of 2008, we recognized an other than temporary impairment of $1.4 million on two commercial mortgage backed securities reducing the
carrying value of these two securities to $1.1 million at June 30, 2008.

We
continue to review the estimated fair values indicated by pricing provided by the third party pricing services however, we can not assure that there will not be any further
impairments on these securities, until the market as a whole stabilizes.

7. FAIR VALUE MEASUREMENTS

We carry fixed maturity investments, equity securities and interest rate swaps at fair value in our consolidated financial statements. These fair value disclosures consist of information
regarding the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. FAIR VALUE MEASUREMENTS (Continued)

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

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

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

Total

Level 1

Level 2

Level 3Assets:Fixed maturities, available-for-sale

$
1,078,304

$


$
1,073,728

$
4,576Equity securities


490








490Total assets

$
1,078,794

$


$
1,073,728

$
5,066Liabilities:Interest rate swaps

$
470

$


$
470

$



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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. FAIR VALUE MEASUREMENTS (Continued)



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 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
those expectations 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 estimates in turn reflect 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 service 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 have
also classified internal

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. FAIR VALUE MEASUREMENTS (Continued)

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 June 30, 2008:

Fair
Value

% of
Total
Fair
Value(In thousands)Mortgage and asset-backed securities

$
4,576


90.3
%Equity securities


490


9.7
%Total Level 3 securities

$
5,066


100
%


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



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 from
April 1, 2008 to June 30, 2008 and from January 1, 2008
to June 30, 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:

25

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

7. FAIR VALUE MEASUREMENTS (Continued)

Fixed Maturities

Equity Securities

Total(thousands)Fair value as of January 1, 2008

$
7,757

$
490

$
8,247Net payments, purchases and sales


(379
)




(379
)Net transfers in/(out)








Unrealized losses included in AOCI(1),(2)


(289
)




(289
)Fair value as of March 31, 2008


7,089


490


7,579Net payments, purchases and sales


(20
)




(20
)Net transfers in/(out)


(2,372
)




(2,372
)Unrealized losses included in AOCI(1),(2)


(121
)




(121
)Fair value as of June 30, 2008

$
4,576

$
490

$
5,066


---

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. For a description of our Series A preferred stock and Series B preferred stock,
see Note 6Stockholders' Equity in the notes to consolidated financial statements contained in our Annual Report on Form 10-K for the fiscal year ended
December 31, 2007.

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

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

26

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

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.



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:

Six months ended June 30,

2008

2007Common stock outstanding, beginning of year


74,952,177


59,890,500Return of stock issued in connection with MemberHealth acquisition (See Note 4Business Combinations)


(2,027,071
)

Stock options exercised


365,237


354,231Agent stock award





2,543Stock purchases pursuant to agents' stock purchase and deferred compensation plans


2,207


21,443Common stock outstanding, end of period


73,292,550


60,268,717




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 with an estimated aggregate 5.9 million shares of our common stock available for
repurchase. We currently have 1.0 million shares of our common stock available pursuant to a share repurchase program approved by our board of directors in November 2005. In February 2008, our
board of directors approved the repurchase of up to $50 million of our common shares during an 18-month period beginning on February 18,
2008. Through June 30, 2008, we have repurchased 4.4 million shares of our common stock for an aggregate amount of $50.0 million, completing this program. In June 2008, Universal
American Corp. announced that our Board of Directors has approved the repurchase of up to an additional $50 million of the Company's common shares. We are not obligated to repurchase any
specific number of shares under the programs or to make repurchases at any specific time or price.

27

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

8. STOCKHOLDERS' EQUITY (Continued)

Changes in treasury stock were as follows:

For the six months ended June 30,2008

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


4,446,955


50,067


11.26








Shares distributed in the form of employee bonuses


(114,312
)

(1,417
)

12.39


(134,823
)

(2,010
)

14.91Treasury stock, end of period


4,618,188

$
52,908

$
11.46


578,045

$
8,616

$
14.91




The components of accumulated other comprehensive loss are as follows:

June 30,
2008

December 31,
2007(In thousands)Net unrealized depreciation on investments

$
(13,505
)
$
(532
)Deferred acquisition cost adjustment


3,071


224Foreign currency translation gains


455


485Fair value of cash flow swap on debt


(453
)

(279
)Deferred tax


3,651


36Total accumulated other comprehensive loss

$
(6,781
)
$
(66
)


9. STOCK-BASED COMPENSATION

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



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

28

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

9. STOCK-BASED COMPENSATION (Continued)

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

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

For options granted in:2008

Prior yearsRisk free interest rates


1.97%  2.75%


4.01%  5.16%Dividend yields


0.0%


0.0%Expected volatility


35.60%  41.45%


35.39%  42.53%Expected lives of options (in years)


3.5  5.0


3.0  6.0


The
weighted-average grant-date fair value was $2.74 for options granted during the first six months of 2008 and was $7.23 for options granted during the first six months of
2007.

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

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

Options
(In thousands)

Weighted
Average
Exercise
Price

Weighted
Average
Remaining
Contractual
Term
(In years)

Aggregate
Intrinsic
Value
(In thousands)Outstanding, January 1, 2007


4,325

$
7.73


4.0Granted


1,191


19.02Exercised


(354
)

10.31Forfeited or expired


(78
)

15.58Outstanding, June 30, 2007


5,084

$
10.07


3.7

$
57,027Exercisable, June 30, 2007


3,879

$
7.54


3.4

$
53,313Outstanding, January 1, 2008


5,676

$
12.71


4.0Granted


1,105


14.08Exercised


(365
)

3.27Forfeited or expired


(43
)

17.14Outstanding, June 30, 2008


6,373

$
13.44


3.9

$
12,611Exercisable, June 30, 2008


3,671

$
9.19


2.9

$
12,608


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

29

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

9. STOCK-BASED COMPENSATION (Continued)

As
of June 30, 2008, the total compensation cost related to non-vested awards not yet recognized was $15.2 million, which we expect to recognize over a weighted
average period of 1.5 years.

We
received cash of $1.3 million from the exercise of stock options during the first six months of 2008 and cash of $3.7 million from the exercise of stock options during
first six months of 2007. FAS 123-R also requires us to report 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. We recognized $1.1 million of financing cash flows for these excess tax deductions for the six months ended
June 30, 2008 and $0.7 million for the six months ended June 30, 2007.



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

Six months ended June 30,2008

2007Non-vested Restricted Stock

Shares
(In thousands)

Weighted
Average
Grant-Date
Fair Value

Shares
(In thousands)

Weighted
Average
Grant-Date
Fair ValueNon-vested at beginning of year


518

$
21.06


148

$
13.60Granted


114


10.99


135


19.43Vested


(81
)

16.03


(58
)

12.12Forfeited











Non-vested at end of period


551

$
19.71


225

$
17.46


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

10. STATUTORY FINANCIAL DATA

Regulatory authorities require our insurance subsidiaries to maintain minimum amounts of statutory capital and surplus. However, our insurance subsidiaries need substantially more than
these minimum amounts to meet statutory and administrative requirements of adequate capital and surplus to support the current level of their operations. Each of the insurance subsidiaries' statutory
capital and surplus exceeds its respective minimum statutory requirement at levels we believe are sufficient to support their current levels of operation. Additionally, the National Association of
Insurance Commissioners, known as NAIC, imposes regulatory risk-based capital or RBC requirements on life insurance enterprises. At June 30, 2008, all of our insurance subsidiaries
maintained ratios of total

30

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

10. STATUTORY FINANCIAL DATA (Continued)

adjusted
capital to RBC in excess of the "authorized control level." The combined statutory capital and surplus, including asset valuation reserve, of our insurance subsidiaries totaled
$439.1 million at June 30, 2008 and $486.1 million at December 31, 2007. For the six months ended June 30, 2008, the insurance subsidiaries generated a combined
statutory net loss of $25.9 million. For the six months ended June 30, 2007, the insurance subsidiaries generated combined statutory net income of $38.8 million.

Regulatory
authorities also require our health plan affiliates to maintain minimum amounts of capital and surplus, and these affiliates are also subject to RBC requirements. At
June 30, 2008, the statutory capital and surplus of each of our health plan affiliates exceeds its minimum requirement and its RBC is in excess of the "authorized control level." The combined
statutory capital and surplus for our health plan affiliates was $73.9 million at June 30, 2008 and $64.3 million at December 31, 2007. Combined statutory net income for
our health plan affiliates was $10.8 million for the six months ended June 30, 2008 and $9.0 million for the six months ended June 30, 2007.

11. LOAN PAYABLE



In connection with the MemberHealth transaction, we refinanced our amended credit facility and revolving credit facility with a new
credit facility consisting of a $350 million term loan and a $150 million revolver. For a description of the MemberHealth transaction, see Note 4Business Combinations
above. We used a portion of the proceeds from the refinancing to repay in full the amounts outstanding on our previous credit facilities. Interest under the new credit facility is currently based on
LIBOR plus a spread of 62.5 basis points. In addition, we currently pay a commitment fee on the unutilized revolving loan facility at an annualized rate of 10 basis points. In accordance with the
credit agreement for the new credit facility, the spread and fee are determined based on our consolidated leverage ratio. Effective June 30, 2008, the interest rate on the term loan portion of
the new credit facility was 3.55%. We had not drawn on the revolving loan facility as of the date of this report. As a result of the value received pursuant to the settlement agreement discussed in
Note 4, on April 23, we prepaid $25 million of principal under the new facility, under an approved waiver.

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

2007 Credit
Facility(In thousands)2008 (remainder of the year)

$
1,7502009


3,5002010


3,5002011


3,5002012


310,125$
322,375


31

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

11. LOAN PAYABLE (Continued)



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



We made regularly scheduled principal payments of $1.8 million plus the $25.0 million prepayment discussed above during
the six months ended June 30, 2008 and regularly scheduled principal payments of $2.6 million during the six months ended June 30, 2007, in connection with our credit facilities.
During 2007, we repaid the $87.9 million balance outstanding on our old credit facility in connection with the refinancing described above.

We
paid interest of $7.1 million during the six months ended June 30, 2008 and $4.2 million during the six months ended June 30, 2007, in connection with our
credit facilities.

12. OTHER LONG TERM DEBT

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

We
paid $4.3 million in interest in connection with the junior subordinated debentures issued in connection with the trust preferred securities during the six months ended
June 30, 2008, and $3.8 million during the six months ended June 30, 2007.

13. DERIVATIVE INSTRUMENTSCASH FLOW HEDGE

On December 4, 2007, we entered into two separate interest rate swap agreements, one with Citibank, and one with Calyon Corporate and Investment Bank to hedge the variability of
cash flows to be paid under the new credit facility described in Note 11Loan Payable above. In entering into the swap with Citibank, we agreed to swap our floating rate interest
payment based on the floating three-month LIBOR base rate on a notional amount of $125 million in exchange for a fixed interest rate payment based on a 4.14% locked-in fixed rate.
In entering into the swap with Calyon, we agreed to swap our floating rate interest payment based on the floating three-month LIBOR base rate on a notional amount of $125 million in exchange
for a fixed interest rate payment based on a 4.13% locked-in fixed rate. The objective of the hedges is to eliminate the variability of cash flows in the interest payments on the a
combined $250 million amount of the variable rate term loan portion of our

32

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

13. DERIVATIVE INSTRUMENTSCASH FLOW HEDGE (Continued)

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 ($0.5) million at June 30, 2008. We have reflected this fair value in other liabilities. Based on the fact that, at inception, the critical terms of the hedging
instrument and the hedged forecasted transaction were the same, we have concluded that we expect changes in cash flows attributable to the risk being hedged to be completely offset by the hedging
derivative, and have designated these swaps as cash flow hedges. As a result, we reflected the unrealized loss on these hedges in accumulated other comprehensive (loss) income. We will perform
subsequent assessments of hedge effectiveness by verifying and documenting whether the critical terms of the hedging instrument and the forecasted transaction have changed during the period, rather
than by quantifying the relevant changes in cash flows.

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

14. COMMITMENTS AND CONTINGENCIES



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

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

33

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

14. COMMITMENTS AND CONTINGENCIES (Continued)



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



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

On
May 6, 2008, the parties entered into a stipulation of settlement dated as of May 1, 2008, pursuant to which they have agreed to settle this action. The settlement
stipulation provides for the amendment of our by-laws to require specified procedures in the event of related party transactions
described in the amendment, and to require that we maintain a committee that includes at least one independent member of our board of directors to oversee the process of preparing bids for the
MemberHealth Part D plans. The stipulation also provides for the payment of the plaintiffs' legal fees in an amount not to exceed $800 thousand. Our directors and officers insurance
carrier has provisionally agreed to pay 75% of this amount. The payment of the plaintiffs' legal fees and other terms of the settlement are subject to the approval of the Court, which it considered at
an August 4, 2008 hearing. Shareholders who are members of the class proposed to be certified in the settlement have received notice describing the full terms of the settlement.



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

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Table of Contents

UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

15. OTHER COMPREHENSIVE (LOSS) INCOME

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

Three months ended June 30,2008

2007Before Tax
Amount

Tax Expense
(Benefit)

Net of Tax
Amount

Before Tax
Amount

Tax Expense
(Benefit)

Net of Tax
Amount(In thousands)Net unrealized loss arising during the year (net of deferred acquisition costs)

$
(20,402
)
$
(7,141
)
$
(13,261
)
$
(14,459
)
$
(5,060
)
$
(9,399
)Reclassification adjustment for losses included in net income


13,285


4,650


8,635


264


92


172Net unrealized loss


(7,117
)

(2,491
)

(4,626
)

(14,195
)

(4,968
)

(9,227
)Cash flow hedge


10,262


3,592


6,670








Foreign currency translation adjustment


29


10


19


116


40


76Other comprehensive (loss) income

$
3,174

$
1,111

$
2,063

$
(14,079
)
$
(4,928
)
$
(9,151
)




Six months ended June 30,2008

2007Before Tax
Amount

Tax Expense
(Benefit)

Net of Tax
Amount

Before Tax
Amount

Tax Expense
(Benefit)

Net of Tax
Amount(In thousands)Net unrealized loss arising during the year (net of deferred acquisition costs)

$
(52,419
)
$
(18,347
)
$
(34,072
)
$
(11,992
)
$
(4,197
)
$
(7,795
)Reclassification adjustment for losses (gains) included in net income


42,293


14,803


27,490


(1,640
)

(574
)

(1,066
)Net unrealized loss


(10,126
)

(3,544
)

(6,582
)

(13,632
)

(4,771
)

(8,861
)Cash flow hedge


(174
)

(60
)

(114
)







Foreign currency translation adjustment


(30
)

(11
)

(19
)

131


46


85Other comprehensive loss

$
(10,330
)
$
(3,615
)
$
(6,715
)
$
(13,501
)
$
(4,725
)
$
(8,776
)


16. UNCONSOLIDATED SUBSIDIARY

During 2005, we entered into a strategic alliance with Caremark and created PDMS, which is 50% owned by us and 50% owned by Caremark. PDMS principally performs marketing and risk
management services on behalf of our Prescription PathwaySM PDPs and Caremark, for which it receives fees and other remuneration from our Prescription PathwaySM PDPs and
Caremark. We do not control PDMS and therefore we have not consolidated PDMS in our financial statements. We account for our investment in PDMS on an equity basis and reflect it in other assets. Our
investment in PDMS was $6.0 million at June 30, 2008 and $1.6 million at December 31, 2007. We reflect our share in the income or loss of PDMS in equity in earnings of
unconsolidated subsidiary. Our share in the net income of PDMS was $31.3 million for the six months ended June 30, 2008 and $26.3 million for the six months ended June 30,
2007. PDMS made distributions to its owners aggregating $54.0 million during the six months ended June 30, 2008. Our share of those distributions was $27.0 million. PDMS

35

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

16. UNCONSOLIDATED SUBSIDIARY (Continued)

made
distributions to its owners aggregating $55.0 million during the six months ended June 30, 2007. Our share of those distributions was $27.5 million.

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

June 30,
2008

December 31,
2007Unaudited
(In thousands)AssetsCash and investments

$
1,159

$
701Other


11,702


6,071Total Assets

$
12,861

$
6,772Liabilities and EquityAccrued expenses and other

$
953

$
3,530Equity


11,908


3,242Total liabilities and equity

$
12,861

$
6,772




Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(Unaudited)Total revenue

$
31,612

$
27,122

$
64,442

$
54,268Total expenses


1,051


883


1,777


1,622Net income

$
30,561

$
26,239

$
62,665

$
52,646


17. BUSINESS SEGMENT INFORMATION

Our business segments are based on product and consist of



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

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



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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

17. BUSINESS SEGMENT INFORMATION (Continued)



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 business generally
sees higher claims experience in the early quarters of the year, with lower claims experience in the later quarters of the year, resulting in a pattern of increasing reported net income attributable
to the Part D business.

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. This business provides the following
services:



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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

17. BUSINESS SEGMENT INFORMATION (Continued)



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

We
report intersegment revenues and expenses on a gross basis in each of the operating segments but eliminate them in the consolidated results. These intersegment revenues and expenses
affect the amounts reported on the individual financial statement line items, but we eliminate them in consolidation and they do not change income before taxes. The most significant items eliminated
are intersegment revenue and expense relating to services performed by the Senior Administrative Services segment for our other segments and interest on notes payable or receivable between the
Corporate segment and the operating segments.

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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

17. BUSINESS SEGMENT INFORMATION (Continued)

Financial
data by segment, with a reconciliation of segment revenues and segment income (loss) before income taxes to total revenue and net income in accordance with generally accepted
accounting principles is as follows:

Three months ended June 30,2008

2007Revenue

Income
(Loss)
Before
Income
Taxes

Revenue

Income
(Loss)
Before
Income
Taxes(In thousands)Senior Managed CareMedicare Advantage

$
623,150

$
33,365

$
494,175

$
20,348Medicare Part D


527,013


10,647


86,358


9,198Traditional Insurance


113,608


2,151


129,255


8,512Senior Administrative Services


22,144


6,385


26,295


5,490Corporate


1,435


(10,702
)

1,255


(7,644
)Intersegment revenues


(16,743
)




(20,443
)

Adjustments to segment amounts:Net realized losses(1)


(13,285
)

(13,285
)

(264
)

(264
)Equity in earnings of unconsolidated subsidiary(2)


(15,281
)




(13,120
)

Total

$
1,242,041

$
28,561

$
703,511

$
35,640




Six months ended June 30,2008

2007Revenue

Income
(Loss)
Before
Income
Taxes

Revenue

Income
(Loss)
Before
Income
Taxes(In thousands)Senior Managed CareMedicare Advantage

$
1,189,869

$
33,736

$
876,191

$
26,340Medicare Part D


1,100,176


(18,987
)

192,260


14,187Traditional Insurance


235,577


3,169


264,166


3,343Senior Administrative Services


44,714


12,409


51,860


11,327Corporate


2,104


(14,786
)

1,908


(15,397
)Intersegment revenues


(31,988
)




(39,773
)

Adjustments to segment amounts:Net realized (losses) gains(1)


(42,293
)

(42,293
)

1,640


1,640Equity in earnings of unconsolidated subsidiary(2)


(31,333
)




(26,323
)

Total

$
2,466,826

$
(26,752
)
$
1,321,929

$
41,440






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UNIVERSAL AMERICAN CORP. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

17. BUSINESS SEGMENT INFORMATION (Continued)



Identifiable assets by segment are as follows:

June 30,
2008

December 31,
2007(In thousands)Traditional Insurance

$
1,366,332

$
1,475,299Medicare Part D


1,219,813


1,313,538Senior Managed CareMedicare Advantage


1,097,345


1,050,336Senior Administrative Services


25,851


30,903Corporate


1,574,478


1,753,467Intersegment assets(1)


(1,379,070
)

(1,533,780
)Total Assets

$
3,904,749

$
4,089,763






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

Introduction

The following discussion and analysis presents a review of our Company as of June 30, 2008 and our results of operations for the
three and six months ended June 30, 2008 and 2007. You should read the following analysis of our consolidated results of operations and financial condition in conjunction with the consolidated
financial statements and related consolidated footnotes included elsewhere in this quarterly report on Form 10-Q as well as the consolidated financial statements and related
consolidated footnotes and the Management's Discussion and Analysis of Financial Condition and Results of Operations included in our annual report on Form 10-K for the year ended
December 31, 2007.

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 the quarter ended June 30, 2007. 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. We have split Part D from our Senior Market Health segment and formed a new segment to include both our Prescription
PathwaySM product and 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. See
"Note 17Business Segment Information" in our consolidated financial statements included in this quarterly report on Form 10-Q for a description of our segments.

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



Critical Accounting Policies

We have prepared our consolidated financial statements in accordance with U.S. 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 assets and liabilities and disclosures of assets and
liabilities reported by us at the date of the financial statements and the revenues and expenses reported during the reporting period. As additional information becomes available or actual amounts
become determinable, we may revise the recorded

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estimates
and reflect them in operating results. Actual results could differ from those estimates. The accounts that, in our judgment, are most critical to the preparation of our financial statements
are:



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



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

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

Liability Type

June 30, 2008

December 31, 2007Amount

% of
Total
Policy
Liabilities

Amount

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

$
415,819


23
%
$
434,859


24
%Future policy benefit reserves:Traditional life insurance


207,413


11
%

202,258


11
%Accident and health


415,038


22
%

414,192


23
%Total future policy benefit reserves


622,451


33
%

616,450


34
%Policy and contract claimsaccident and health:Due and unpaid claims


521,766


28
%

435,073


24
%Incurred but not reported claims ("IBNR")


276,696


15
%

302,116


17
%Total accident and health claim liabilities


798,462


43
%

737,189


41
%Policy and contract claimslife


11,137


1
%

12,213


1
%Total policy liabilities

$
1,847,869


100
%
$
1,800,711


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

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decline
to reflect surrenders and other withdrawals, including withdrawals relating to the cost of insurance and expense charges. We review the interest crediting rates periodically and adjust them
with certain minimum levels below which the crediting rate cannot fall as deemed necessary.



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 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 incurred but not yet

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

Accident & Health Claims Liability

Direct and Assumed

Net of Reserves Ceded to ReinsurersJune 30,
2008

% of
Total
Policy
Liabilities

December 31,
2007

% of
Total
Policy
Liabilities

June 30,
2008

December 31,
2007($ In thousands)Due & unpaid claims:Medicare Part D

$
423,314


23
%
$
352,688


20
%
$
402,092

$
336,218Medicare AdvantageHMO


74,754


4
%

59,058


3
%

71,499


53,563Otherspecialty


23,698


1
%

23,327


1
%

8,829


9,106Total due & unpaid claims


521,766


28
%

435,073


24
%

482,420


398,887IBNR:Medicare supplement


47,264


3
%

46,834


3
%

33,667


33,653Medicare AdvantagePFFS


219,996


12
%

246,048


13
%

219,275


240,832Otherspecialty


9,436



%

9,234


1
%

7,538


7,240Total IBNR


276,696


15
%

302,116


17
%

260,480


281,725Total accident and health claim liabilities

$
798,462


43
%
$
737,189


41
%
$
742,900

$
680,612


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 used in estimating our IBNR is that the completion factor pattern, adjusted for known changes in claim inventory levels and claim payment processes, remains consistent over a specified
rolling period. This period, ranging from 3 to 12 months, is dependent on the type of business valued. Completion factors

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

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

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



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.

Our
historical assumptions have not varied significantly during the six months ended June 30, 2008 from the actual amounts experienced to the extent that the variance resulted in
a material adverse impact on reserves and net income, other than $1.5 million favorable development of 2007 claims experience on our PFFS business, which is discussed in connection with Segment
ResultsSenior Managed CareMedicare Advantage, later in this section. We have included a summary of the activity

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



The following table illustrates the sensitivity of our accident and health IBNR payable at June 30, 2008 to identified
reasonably possible changes to the estimated weighted average completion factors and health care cost trend rates. However, it is possible that the actual completion factors and health care cost trend
rates will develop differently from our historical patterns and therefore could be outside of the ranges illustrated below.

Completion Factor(1):

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

Increase
(Decrease) in
Net Accident
& Health
IBNR

(Decrease)
Increase
in Factor

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

$
2,909


(3
)%
$
(11,535
)(2)%

$
1,939


(2
)%
$
(7,690
)(1)%

$
969


(1
)%
$
(3,845
)1%

$
(968
)

1
%
$
3,8562%

$
(1,934
)

2
%
$
7,7133%

$
(2,900
)

3
%
$
11,569






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



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

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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:



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

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

We
use a prospective unlocking approach to account for DAC for our Medicare supplement business. We use assumptions for future rate increases, persistency and benefit-design in the
determination of DAC. Actual experience may vary from assumed trends, but we do not change these assumptions unless prospective unlocking is triggered. If prospective unlocking is triggered, we revise
the assumptions to
bring them in line with emerging experience. Annually, during our third fiscal quarter, we perform an analysis to determine whether prospective unlocking is triggered as a result of significant
changes in the actual premium rate increase experience. At the point when prospective unlocking is triggered, we modify the DAC model prospectively with assumptions for all components. If and when
prospective unlocking is triggered, there is not an immediate impact on the DAC balance. Rather, prospective unlocking affects the pattern of the future amortization of the DAC balance. Prospective
unlocking also prospectively affects the reserves for future policy benefits for Medicare supplement business and accordingly, similar assumption revisions would occur.

We
determined, based on our annual tests for potential unlocking of assumptions for DAC for our Medicare supplement business performed in the third quarter of 2007, that there were no
significant changes in the actual premium rate increase experience. Accordingly, we did not prospectively unlock the assumptions for DAC for our Medicare supplement business during 2007. The balance
of DAC for our Medicare supplement business as of June 30, 2008 was approximately $105.3 million.

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



Business combinations accounted for as a purchase result in the allocation of the purchase consideration to the fair values of the
assets and liabilities acquired, including the present value of future profits, establishing such fair values as the new accounting basis. The present value of future

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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.

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 acquired.Distribution channel acquired


30

Straight line over the estimated life of the asset.Membership base acquired


7-10

Straight line over the estimated weighed average life of the membership base acquired.Trademarks/trade names


9

Straight line over the estimated weighted average life of the trademarks/trade names.Licenses


15

Straight line over the estimated weighed average life of the licenses.Provider contracts


10

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


7

Straight line over the length of the agreement.Administrative service contracts


6

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


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



The fair value for the majority of our fixed maturity and equity securities is determined by third party pricing service market prices.
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 prepayments
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

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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.

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, each price was classified into Level 1, 2, or 3. Most prices provided by third party pricing services are classified 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 June 30, 2008 (in
thousands):

Fair
Value

% of Total
Fair ValueLevel 1

$



Level 2


1,073,728


99.5
%Level 3


5,066


0.5
%$
1,078,794


100.0
%


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

Due
to a general lack of transparency in the process that brokers use to develop prices, most valuations that are based on broker's prices are classified as Level 3. Internal
model priced securities, primarily consisting of private placement asset-backed securities, are also classified as Level 3 because this model pricing includes significant
non-observable inputs. Private placement equity securities are classified 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 June 30, 2008 (in thousands):

Fair
Value

% of Total
Fair ValueMortgage and asset-backed securities

$
4,576


90.3
%Equity securities


490


9.7
%Total Level 3 securities

$
5,066


100
%


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

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We regularly evaluate the amortized cost of our investments compared to the fair value of those investments. We generally recognize
impairments of securities when we consider a decline in fair value below the amortized cost basis to be other-than-temporary. The evaluation includes the intent and ability to
hold the security to recovery, and is considered on an individual security basis, not on a portfolio basis. Impairment losses are recognized when declines in fair values based on quoted prices are
determined 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 declines in the fair value of
investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition or near term recovery
prospects, the effects of changes in interest rates or credit spreads and the recovery period. Our accounting policy requires that we assess a decline in the value of a security below its cost or
amortized cost basis to determine if the decline is other-than-temporary. If we deem the security to be other-than-temporarily impaired, we record a
charge in net realized capital losses equal to the difference between the fair value and cost or amortized cost basis of the security. The fair value of the
other-than-temporarily impaired investment
becomes its new cost basis. We have a security monitoring process overseen by our Investment Committee, consisting of investment and accounting professionals that identify securities that, due to
certain characteristics, as described below, are subjected 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 considered in evaluating whether a decline in value is other-than-temporary include:



Each
quarter, during this analysis, we assert our intent and ability to retain until recovery those securities judged to be temporarily impaired. Once identified, trading on these
securities is restricted 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 recently led to higher delinquency and loss rates, especially with regards to securities issued in 2006 and 2007 that are
collateralized by interests in mortgages originated in 2006 and 2007; the year of issuance is known as the vintage year. These factors have caused a significant reduction in market liquidity and
repricing of risk, which has led to a decrease in the market valuation of these securities sector wide.

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As
of June 30, 2008, we held subprime securities with par values of $143 million, an amortized cost of $60 million and a market value of $56 million
representing approximately 3.6% 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. Two of these securities have experienced credit downgrades. Further, twelve securities, including the two already downgraded, with an amortized cost of approximately $15 million
have been placed on negative credit watch. The following table presents our exposure to subprime residential mortgages by vintage year.

Vintage Year

Amortized
Cost

Fair
Value

Unrealized Gain
(Loss)(In thousands)2003

$
6,636

$
5,497

$
(1,139
)2004


3,695


3,457


(238
)2005


26,462


22,524


(3,938
)2006


16,899


18,400


1,5012007


6,377


6,502


125Totals

$
60,069

$
56,380

$
(3,689
)


We
continuously review our subprime holdings stressing multiple variables, such as cash flows, prepayment speeds, default rates and loss severity, and comparing current base case loss
expectations to the loss required to incur a principal loss, or breakpoint. This breakpoint currently exceeds the base case loss expectation for all but 2 holdings to varying degrees. We expect
delinquency and loss rates in the subprime mortgage sector to continue to increase in the near term. Those securities with a greater variance between the breakpoint and base case can withstand this
further deterioration. However, holdings where the base case is closer to the breakpoint, principally holdings from the 2006 and 2007 vintage years, are more likely to incur a principal loss. We
utilize third party pricing services to provide or estimate market prices. The major inputs used by third party pricing services include, but are not limited to, reported trades, benchmark yields,
issuer spreads, bids, offers, and estimated cash flows and prepayment speeds. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a
security price, as has recently been the case with many of our subprime holdings.

At
December 31, 2007, we recognized an other than temporary impairment on fourteen 2006 and 2007 vintage year subprime holdings, resulting in a pre-tax realized loss
on investment of $41.0 million. As of June 30, 2008, we recognized an additional other than temporary impairment on the same fourteen securities impaired at December 31, 2007 plus
four additional subprime holdings. Total impairment year-to-date on these eighteen subprime holdings was $41.5 million, of which $11.7 million was recognized in
the second quarter. In addition, during the second quarter of 2008, we recognized an other than temporary impairment of $1.4 million on two commercial mortgage backed securities reducing the
carrying value of these two securities to $1.1 million at June 30, 2008.

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.



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

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tax
bases. We measure deferred tax assets and liabilities using enacted tax rates that we expect to apply to taxable income in the years in which we expect to recover or settle those temporary
differences. We recognize in income the effect on deferred tax assets and liabilities of a change in tax rates in the period that includes the enactment date of a change in tax rates.

We
establish valuation allowances on our deferred tax assets for amounts that we determine will not be recoverable based upon our analysis of projected taxable income and our ability to
implement prudent and feasible tax planning strategies. We recognize increases in these valuation allowances as deferred tax expense. We reflect portions of the valuation allowances subsequently
determined to be no longer necessary as deferred tax benefits. To the extent that 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 and then apply those changes as an increase or decrease in income tax expense.

We
carried valuation allowances on deferred tax assets of $3.1 million at June 30, 2008 and December 31, 2007 primarily related to the tax benefits associated with a
New York state net operating loss carryforward. At June 30, 2008, we assessed the amount of the deferred tax asset that was more likely than not to be realized under SFAS No. 109,
Accounting for Income Taxes, and concluded that we can record tax benefits related to our realized losses relating to our investments for financial statement purposes. As a result, 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.

Significant Transactions and Initiatives



We entered the Medicare Advantage business in 2004 with the acquisition of Heritage Health Systems, Inc. which operates Medicare
Advantage coordinated care plans in Texas, Oklahoma and Wisconsin. We have continued to increase our marketing of Medicare Advantage plans for Medicare HMOs and PFFS.

As
of June 30, 2008 our HMO enrollment has increased to approximately 54,600 members. We elected not to renew our Medicare Advantage HMO contract in Florida for 2008, and as of
January 1, 2008 we had no HMO membership in Florida.

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

In
late 2007, we began efforts to cultivate provider relationships to establish Medicare Advantage preferred provider organizations, known as PPOs. In December 2007, we advised CMS of
our intent to market PPO products and as of June 30, 2008, we had contracted with providers in several markets. We are preparing to seek CMS authorization to begin actively marketing PPO
products in October 2008 for effective dates of January 1, 2009. We expect that CMS will provide final authorizations of these plans in late August or early September. While we cannot provide
assurances that we will receive all necessary authorizations from CMS, based upon our experience with Medicare Advantage products, we are confident necessary approvals will be obtained in a majority
of the plans for which we sought approval.



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

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government
pays a portion of the premium for this insurance, and the individuals who enroll pay the balance, if any. The Federal government will also provide additional subsidies in the form of
premium support and coverage of the cost-sharing elements of the plan to specified low income Medicare beneficiaries. For the 2008 plan year, we offered, through our insurance
subsidiaries, our Community 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 eligibles and
low income subsidy beneficiaries who are dually eligible for Medicare and Medicaid in these regions.

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.

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



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

Subsequent
to December 31, 2007, we determined that expected operating income for 2008 from the MemberHealth business, which we acquired in September 2007, will be less than
previously forecast. The reason for the decline in expected income is that premium payments to MemberHealth will be lower than anticipated based upon the bids submitted to, and later accepted by CMS
from MemberHealth in June 2007 for its 2008 Part D plans. The premium payments are lower primarily as a result of incorrect information concerning the risk scores in the MemberHealth bids. In
accounting for the issue relating to the 2008 bids, we recorded an acquisition liability of $39.2 million for the below-market contract that is being amortized into income over the contract
period, January 1, 2008 to December 31, 2008. We amortized $19.8 million of this acquisition liability in the six months ended June 30, 2008, $9.9 million per
quarter. This amortization is reflected in direct premium and policyholder fees earned in the consolidated statements of operations.

We
also discovered after December 31, 2007 that MemberHealth incorrectly calculated its expected risk corridor receivable in its first quarter 2007 financial statements, resulting
in an overstatement of pre-tax income for the first quarter of 2007 of approximately $26 million. In our financial statements for the year ended December 31, 2007 included in
our filed Form 10K, we adjusted the acquired

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financial
statements to reflect the impact of this error, through an adjustment to purchase GAAP accounting, which reduced receivables and increased goodwill by $23 million, the
after-tax amount of the misstatement.

In
connection with these issues, in March 2008, we concluded a settlement agreement under which the sellers of MemberHealth delivered approximately $98 million of value, including
$47 million in cash, 2,027,071 shares of our common stock and $15 million in future amounts due to the sellers, which have been forgiven. We have retired the shares.

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
preferred stock valued at $20 per equivalent share of our common stock. The preferred stock is convertible into shares of our common stock. The preferred stock does not bear a dividend, and we can
require exchange of the preferred stock into common stock after one year. See Note 8Stockholders' Equity to the consolidated financial statements included elsewhere in this
quarterly report on Form 10-Q, for additional information regarding the preferred stock. These funds invested a total of approximately $350 million, of which they funded
$100 million in the second quarter of 2007, and the remainder effective September 21, 2007. We did not register the preferred stock under the Securities Act of 1933, as amended, and it
may not be subsequently offered or sold by investors in the United States absent registration or an applicable exemption from the registration requirement.

Results of OperationsConsolidated Overview

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

Three months ended
June 30,

Six Months ended
June 30,2008

2007

2008

2007(In thousands)Senior Managed CareMedicare Advantage(1)

$
33,365

$
20,348

$
33,736

$
26,340Medicare Part D(1)


10,647


9,198


(18,987
))

14,187Traditional Insurance(1)


2,151


8,512


3,169


3,343Senior Administrative Services(1)


6,385


5,490


12,409


11,327Corporate(1)


(10,702
)

(7,644
)

(14,786
)

(15,397
)Net realized gains (losses) on investments


(13,285
)

(264
))

(42,293
))

1,640Income (losses) before provision for income taxes(1)


28,561


35,640


(26,752
)

41,440(Benefit) provision for income taxes


193


13,365


(9,120
)

14,805Net income (loss)

$
28,368

$
22,275

$
(17,632
)
$
26,635Earnings (loss) per common share (diluted)

$
0.32

$
0.35

$
(0.20
)
$
0.43


---

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Net income for the three months ended June 30, 2008 was $28.4 million, or $0.32 per diluted share, compared to net income
of $22.3 million, or $0.35 per diluted share for the three months ended June 30, 2007. The net income for the second quarter of 2008 includes realized investment losses of
$13.3 million, relating primarily to the recognition of other than temporary impairments on investments, and income taxes of $0.2 million, including the release of a tax valuation
allowance of $10.4 million that had been set up in the first quarter of 2008 in connection with impairments taken in that period. Net income for the second quarter of 2007 includes realized
investment losses, net of tax, of $0.2 million, and income taxes of $13.4 million. Our effective tax rate was 0.7% for the second quarter of 2008, and 37.5% for the second quarter of
2007. The decline in the effective tax rate in the second quarter of 2008 is due primarily to the reversal of the tax valuation allowance established in the first quarter. Excluding the effects of
this reversal, the effective tax rate in the second quarter of 2008 was 36.5%

Our
Senior Managed CareMedicare Advantage segment generated segment income of $33.4 million in the three months ended June 30, 2008, an increase of
$13.0 million compared to the three months ended June 30, 2007, primarily due to $11.5 million of positive 2007 PFFS reserve development and improved HMO results, partially offset
by $1.5 million of start-up costs associated with the PPO and a higher medical loss ratio in PFFS, adjusted to exclude the effects of the positive reserve development.

Our
Medicare Part D income increased by $1.4 million, compared to the second quarter of 2007. MemberHealth was acquired on September 21, 2007 and the three months
ended June 30, 2008 includes income of $4.8 million on MemberHealth's business, offset by a decline in the earnings generated by Prescription PathwaySM business, primarily
as a result of increases in prescription drug costs.

Our
Traditional Insurance segment income decreased by $6.4 million, compared to the second quarter of 2007, due to decreased earnings on Medicare supplement, specialty health and
life insurance and annuity businesses, compared to the second quarter of 2007. The overall loss ratio for the segment was 77.6% for the quarter ended June 30, 2008, compared with 72.3% for the
same period last year. Individual loss ratios for the quarter ended June 30, 2008 were 76.9% for Medicare supplement, compared with 71.3% for the same period last year due to higher skilled
nursing facility claims; 88.0% for specialty health, compared with 84.2% for the same period last year and 68.0% for life and annuity, compared with 62.2% for the same period last year.

Segment
income for our Senior Administrative Services segment increased by $0.9 million, or 16%, to $6.4 million for the second quarter of 2008, as compared to the same
period of 2007. This increase is
primarily the result of reduced levels of general expenses beyond the reduction associated with the loss of affiliated private-fee-for-service business.

The
loss from our Corporate segment increased by $3.1 million, or 40%, for the second quarter of 2008 compared to the second quarter of 2007. This was due primarily to increases
in other parent company expenses, net of revenues, interest costs, and the cost of stock based compensation.



The net loss for the six months ended June 30, 2008 was $17.6 million, or $0.20 per diluted share, compared to net income
of $26.6 million, or $0.43 per diluted share for the six months ended June 30, 2007. The net loss for the first half of 2008 includes realized investment losses of $42.3 million,
relating primarily to the recognition of other than temporary impairment of investments, and income tax

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benefits
of $9.1 million. Net income for the first half of 2007 includes realized investment gains, net of tax, of $1.1 million, relating primarily to the gain on the sale of Peninsular.
Our effective tax rate was 34.1% for the first half of 2008, and 35.7% for the first half of 2007.

Our
Senior Managed CareMedicare Advantage segment generated segment income of $33.7 million in the six months ended June 30, 2008, an increase of
$7.4 million compared to the same period in 2007, primarily due to growth in PFFS membership and improved HMO results, partially offset by $2.8 million of start-up costs
associated with the establishment of our PPO networks and a higher medical loss ratio in PFFS.

Our
Medicare Part D income decreased by $33.2 million, compared to the first six months of 2007. MemberHealth was acquired on September 21, 2007 and the six months
ended June 30, 2008 includes a loss of $28.2 million on MemberHealth's business, as this is a period of the year that typically generates operating losses for prescription drug plans due
to the seasonal nature of the benefits provided. In addition, the year to date earnings on Prescription PathwaySM business decreased by $5.0 million, primarily as a result of
increases in prescription drug costs.

Our
Traditional Insurance segment income decreased by $0.2 million, compared to the first six months of 2007, due to increased earnings on Medicare supplement business, offset by
lower earnings on specialty health and life insurance and annuity. The overall loss ratio for the segment was 77.4% for the six months ended June 30, 2008, compared with 75.7% for the same
period last year. Individual loss
ratios for the six months ended June 30, 2008 were 76.5% for Medicare supplement, compared with 74.9% for the same period last year; 90.3% for specialty health, compared with 87.6% for the same
period last year and 65.5% for life and annuity, compared with 64.8% for the same period last year.

Segment
income for our Senior Administrative Services segment increased by $1.1 million, or 10%, to $12.4 million for the first six months of 2008, as compared to the same
period of 2007. This increase is primarily the result of reduced levels of general expenses beyond the reduction associated with the loss of affiliated
private-fee-for-service business.

The
loss from our Corporate segment decreased by $0.6 million, or 4%, for the first six months of 2008 compared to the first six months of 2007. The improvement was due primarily
to significantly lower officer bonus expenses and an increase in net investment income, partially offset by an increase in interest costs, and the cost of stock based compensation.

Segment ResultsSenior Managed CareMedicare Advantage

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Net premiums

$
619,443

$
487,849

$
1,181,128

$
866,947Net investment and other income


3,706


6,326


8,741


9,245Total revenue


623,149


494,175


1,189,869


876,192Medical expenses


514,797


407,974


1,005,087


725,000Amortization of intangible assets


1,014


889


2,028


1,859Commissions and general expenses


73,973


64,964


149,018


122,993Total benefits, claims and other deductions


589,784


473,827


1,156,133


849,852Segment income

$
33,365

$
20,348

$
33,736

$
26,340


Our
Senior Managed CareMedicare Advantage segment includes the operations of our private fee-for-service business, known as PFFS, and
our coordinated care plans, which we refer to as HMO's, that 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

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and
independent agents currently sell PFFS through American Progressive, Pyramid Life and Marquette in approximately 3,100 counties across 47 states. Our HMO products are sold by our career and
independent agents and directly by employee representatives. In addition, beginning in 2008, this segment includes start up costs associated with the establishment of an affiliated PPO.



Our Senior Managed CareMedicare Advantage segment generated segment income of $33.4 million in the three months
ended June 30, 2008, an increase of $13.0 million compared to the three months ended June 30, 2007, primarily due to $11.5 million of positive 2007 PFFS reserve development
and improved HMO results, partially offset by $1.5 million of start-up costs associated with the establishment of our PPO networks and a higher medical loss ratio in PFFS, adjusted
to exclude the effects of the positive reserve development.



Our Senior Managed CareMedicare Advantage segment generated segment income of $33.7 million in the six months ended
June 30, 2008, an increase of $7.4 million compared to the same period in 2007, primarily due to growth in PFFS membership and improved HMO results, partially offset by
$2.8 million of start-up costs associated with the establishment of our PPO networks and a higher medical loss ratio in PFFS.

PFFS

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Net premiums

$
456,858

$
357,008

$
865,866

$
621,474Net investment and other income


2,434


4,421


5,695


5,667Total revenue


459,292


361,429


871,561


627,141Medical expenses


388,500


304,889


759,641


535,831Commissions and general expenses


48,724


45,384


98,772


80,887Total benefits, claims and other deductions


437,224


350,273


858,413


616,718Net income before taxes

$
22,068

$
11,156

$
13,148

$
10,423


Membership.For a discussion of the accounting for Medicare Advantage policies, including PFFS, see Note 2 of the notes to the consolidated financial
statements in our annual report on Form 10-K 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 June 30, 2008 is likely to be material.



Revenues.Net premiums for the PFFS business increased by $99.9 million compared to the three
months ended June 30, 2007, primarily due to growth in membership. Membership increased to approximately 188,000 as of June 30, 2008 from approximately 179,000 as of June 30,
2007. As a result of the increase in the number of members, the member months for the three months ended June 30, 2008 increased to approximately 585,000 from approximately 493,000 for the
three months ended June 30, 2007. Net investment and other income decreased by $2.0 million, due primarily to lower yields of invested assets as a result of a decline in short term
interest rates.

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Benefits, Claims and Expenses.Medical expenses increased by $83.6 million, compared to the second quarter of 2007, primarily due to growth in membership
partially offset by $11.5 million of positive 2007 reserve development.. The PFFS medical loss ratio decreased to 85.0% for the second quarter of 2008 from 85.4% for the second quarter of 2007
as a result of the positive development mentioned above. Backing out this positive development, the medical loss ratio for the second quarter of 2008 was 87.5%. The increase in this adjusted medical
loss ratio compared to the same period in 2007 is primarily due to more competitively priced products. Commissions and general expenses increased by $3.3 million compared to the second quarter
of 2007, due primarily to the growth in business.



Revenues.Net premiums for the PFFS business increased by $244.4 million compared to the six
months ended June 30, 2007, primarily due to growth in membership. Membership increased to approximately 188,000 as of June 30, 2008 from approximately 179,000 as of June 30,
2007. As a result of the increase in the number of members, the member months for the six months ended June 30, 2008 increased to approximately 1,127,000 from approximately 880,000 for the six
months ended June 30, 2007. Net investment income was comparable to investment income for the six months ended June 30, 2007.

Benefits, Claims and Expenses.Medical expenses increased by $223.8 million, compared to the six months ended June 30, 2007, primarily due to growth
in membership combined with an increase in the medical loss ratio. Year to date 2008 results include $1.5 million of positive prior period reserve development. The PFFS medical loss ratio
increased to 87.7% for the six months ended June 30, 2008 from 86.2% for the six months ended June 30, 2007 primarily due to more competitively priced products. Commissions and general
expenses increased by $17.9 million compared to the six months ended June 30, 2007, due primarily to the growth in business.

HMOs

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Net premiums

$
162,585

$
130,841

$
315,262

$
245,473Net investment and other income


1,272


1,905


3,046


3,578Total revenue


163,857


132,746


318,308


249,051Medical expenses


126,297


103,085


245,446


189,169Amortization of intangible assets


1,014


889


2,028


1,859Commissions and general expenses


23,760


19,580


47,464


42,106Total benefits, claims and other deductions


151,071


123,554


294,938


233,134Net income before taxes

$
12,786

$
9,192

$
23,370

$
15,917




Revenues.Net premiums for our HMOs increased by $31.7 million, or 24%, compared to the second
quarter of 2007, primarily due to growth in membership of 16% combined with higher member risk scores. Medicare membership increased to approximately 54,600 members at June 30, 2008 from
approximately 47,100 at June 30, 2007.

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Benefits, Claims and Expenses.Medical expenses increased by $23.2 million, or 23%, compared to the second quarter of 2007 driven primarily by growth in
membership of 16% combined with higher member risk scores. The medical loss ratio for the HMOs decreased to 77.7% for the second quarter of 2008, from 78.8% for the second quarter of 2007, due to
improved revenue yields and lower utilization of benefits. Commissions and general expenses, while increasing by $4.2 million compared to 2007, decreased as a percent of net premiums by 0.4%
from 15.0% in the second quarter of 2007 to 14.6% in the second quarter of 2008.



Revenues.Net premiums for our HMOs increased by $69.8 million, or 28%, compared to the first
six months of 2007. Approximately $53.0 million of the increase was due to the growth in Medicare membership along with higher member risk scores. Medicare membership increased to approximately
54,600 members at June 30, 2008 from approximately 47,100 at June 30, 2007. Revenue from the commercial business in Oklahoma increased $9.5 million due to growth in membership and
because the six months ended June 30, 2007 included four months of commercial operations whereas the six months ended June 30, 2008 included a full six months of operations.

Benefits, Claims and Expenses.Medical expenses increased by $56.3 million, or 30%, compared to the first six months of 2007. Growth in Medicare membership
added approximately $47.7 million and growth in commercial business added $8.2 million. The remaining $0.4 million was due to an increase in utilization of member benefits. The
medical loss ratio for the HMOs increased to 77.9% for the first six months of 2008, from 77.1% for the first six months of 2007, as a result of an increase in utilization of member benefits and
provider compensation. Commissions and general expenses, while increasing $5.4 million compared to 2007, decreased as a percent of net premiums by 2.1% from 17.2% in the first six months of
2007 to 15.1% in the first six months of 2008. The six months ended June 30, 2007 also included start-up costs associated with the acquisition of members in new markets.

PPOs

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Net premiums

$


$


$


$
Net investment and other income











Total revenue











Medical expenses











Amortization of intangible assets











Commissions and general expenses


1,489





2,782


Total benefits, claims and other deductions


1,489





2,782


Net loss before taxes

$
(1,489
)
$


$
(2,782
)
$





Expenses.Commissions and general expenses increased by $1.5 million compared to the second
quarter of 2007 due to the costs of establishing the PPO networks.

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Expenses.Commissions and general expenses increased by $2.8 million compared to the six
months ended June 30, 2007 due to the costs of establishing the PPO networks.

Segment ResultsMedicare Part D

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Direct and assumed premium

$
530,615

$
137,659

$
1,054,157

$
271,742Risk corridor adjustment/government reinsurance


56,613


4,149


182,924


50,384Direct and assumed premium after risk corridor adjustment


587,228


141,808


1,237,081


322,126Ceded premiums


(80,326
)

(69,660
)

(179,413
)

(158,531
)Net premiums


506,902


72,148


1,057,668


163,595Other Part D income (loss)PDMS


15,281


13,120


31,333


26,323Total Part D revenue


522,183


85,268


1,089,001


189,918Net investment and other income


4,830


1,090


11,175


2,342Total revenue


527,013


86,358


1,100,176


192,260Pharmacy benefits


455,144


67,783


999,595


159,170Amortization of intangibles


7,999





7,999


Commissions and general expenses


53,223


9,377


111,569


18,903Total benefits, claims and other deductions


516,366


77,160


1,119,163


178,073Segment (loss) income

$
10,647

$
9,198

$
(18,987
)
$
14,187


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. We reinsure 50% of the business of our Prescription PathwaySM PDPs to PharmaCare Re.

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

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

Other
Part D incomePDMS represents our equity in the earnings or loss of PDMS. We report this as revenue for segment reporting purposes in analyzing the ratio of net
pharmacy benefits incurred because the amount is incorporated in the calculation of the risk corridor adjustment. For consolidated

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reporting,
this amount is included as a separate line following income from continuing operations. See the reconciliation of segment revenues in Note 17 of the notes to the consolidated
financial statements in this quarterly report on Form 10-Q.



Our Medicare Part D income increased by $1.4 million, compared to the second quarter of 2007. MemberHealth was acquired
on September 21, 2007 and the three months ended June 30, 2008 includes income of $4.8 million on MemberHealth's business, partially offset by a decline in the earnings generated
by Prescription PathwaySM business, primarily as a result of increases in prescription drug costs and changes in the calculation of the government risk corridor that changes the
seasonality of reported amounts.

Membership.At June 30, 2008, our total membership for Medicare Part D was 1,802,000 members compared to 491,000 members at June 30, 2007, an
increase of 1,311,000 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 June 30, 2008, approximately 507,000 members were enrolled, that we participate in on a 50% basis, for which we were paid by CMS. This represents an increase of 3%
over the June 30, 2007 membership of approximately 491,000. As a result of our acquisition of MemberHealth, our Part D membership as of June 30, 2008, also includes approximately
1,295,000 members enrolled in our Community CCRxSM PDP. Prior to January 1, 2008, we participated, on a 33.3% basis, in BCBS that had approximately 24,000 members at
June 30, 2007.

Revenues.Direct and assumed premium increased by $393.0 million, or 285%, compared to the second quarter of 2007. This growth resulted primarily from the
acquisition of MemberHealth which generated $388.3 million of direct and assumed premium in the second quarter of 2008. The MemberHealth premium includes $9.9 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
$52.5 million compared to the second quarter of 2007. The government risk corridor adjustment from MemberHealth was an increase in revenues of $46.8 million. The government risk corridor
adjustment from our Prescription PathwaySM business was $5.7 million more of an increase in revenue in the three months ended June 30, 2008 compared to three months ended
June 30, 2007.

Other
Part D incomePDMS increased by $2.2 million compared to the second quarter of 2007 as a result of growth in business at Prescription
PathwaySM. Net investment and other income increased by $3.7 million principally as a result of $4.6 million of PBM revenues from MemberHealth, partially offset by lower
rates of return on investments.

Benefits, Claims and Expenses.Pharmacy benefits increased by $387.4 million, compared to the second quarter of 2007. The MemberHealth business generated
$380.2 million of benefits in the quarter, while benefits for our Prescription PathwaySM business increased by $7.2 million or 10.6% over the second quarter of 2007. The
ratio of incurred prescription drug benefits to net premium in 2008 for Prescription PathwaySM was 98.6% compared to 94.0% for 2007. Amortization of intangibles increased
$8.0 million as the result of amortization of intangible assets recorded in connection with the acquisition of MemberHealth. Commissions and general expenses increased by $43.8 million,
compared to the second quarter of 2007. MemberHealth added $42.9 million during the quarter. The balance of the increase of $0.9 million relates to the growth in our Prescription
PathwaySM business.

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Our Medicare Part D income decreased by $33.2 million, compared to the first six months of 2007. MemberHealth was
acquired on September 21, 2007 and the six months ended June 30, 2008 includes a loss of $28.2 million on MemberHealth's business, as this is a period of the year that typically
generates operating losses for prescription drug plans due to the seasonal nature of the benefits provided. In addition, the year to date earnings on Prescription PathwaySM business
decreased by $5.0 million, primarily as a result of increases in prescription drug costs and changes in the calculation of the government risk corridor that changes the seasonality of reported
amounts.

Membership.At June 30, 2008, our total membership for Medicare Part D was 1,802,000 members compared to 491,000 members at June 30, 2007, an
increase of 1,311,000 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 June 30, 2008, approximately 507,000 members were enrolled, that we participate in on a 50% basis, for which we were paid by CMS. This represents an increase of 3%
over the June 30, 2007 membership of approximately 491,000. As a result of our acquisition of MemberHealth, our Part D membership as of June 30, 2008, also includes approximately
1,295,000 members enrolled in our Community CCRxSM PDP. Prior to January 1, 2008, we participated, on a 33.3% basis, in BCBS that had approximately 24,000 members at
June 30, 2007.

Revenues.Direct and assumed premium increased by $782.4 million, or 288%, compared to the first six months of 2007. This growth resulted primarily from the
acquisition of MemberHealth which generated
$769.9 million of direct and assumed premium for the six months ended June 30, 2008. The MemberHealth premium includes $19.8 million of amortization of the below market contract
liability recorded in connection with the MemberHealth acquisition. The change in the government risk corridor adjustment increased revenue by an additional $132.5 million compared to the six
months ended June 30, 2007. The government risk corridor adjustment from MemberHealth was an increase in revenues of $124.7 million. The government risk corridor adjustment from our
Prescription PathwaySM business was $7.8 million more of an increase in revenue in the first six months of 2008 compared to 2007.

Other
Part D incomePDMS increased by $5.0 million compared to the first six months of 2007 as a result of growth in business at Prescription
PathwaySM. Net investment and other income increased by $8.8 million principally as a result of $8.9 million of PBM revenues from MemberHealth, partially offset by lower
rates of return on investments.

Benefits, Claims and Expenses.Pharmacy benefits increased by $840.4 million, compared to the first six months of 2007. The MemberHealth business generated
$826.0 million of benefits for the six months ended June 30, 2008, while benefits for our Prescription PathwaySM business increased by $14.4 million or 9% over the
first six months of 2007. The ratio of incurred prescription drug benefits to net premium for 2008 was 94.5% compared to 97.3% for 2007. Amortization of intangibles increased $8.0 million as
the result of amortization of intangible assets recorded in connection with the acquisition of MemberHealth. Commissions and general expenses increased by $92.7 million, compared to the first
six months of 2007. MemberHealth added $91.4 million during 2008. The balance of the increase of $1.3 million relates to the growth in our Prescription PathwaySM business.

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Segment ResultsTraditional Insurance

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Premiums:Direct and assumed

$
218,631

$
226,035

$
445,742

$
461,208Ceded


(120,051
)

(115,563
)

(241,953
)

(233,388
)Net premiums


98,580


110,472


203,789


227,820Net investment income


14,767


17,854


31,189


35,363Other income


261


929


599


983Total revenue


113,608


129,255


235,577


264,166Policyholder benefits


76,489


79,886


157,642


172,460Interest credited to policyholders


3,382


4,323


7,522


9,029Change in deferred acquisition costs


3,268


1,764


10,799


11,987Amortization of intangible assets


811


874


1,615


1,902Commissions and general expenses, net of allowances


27,507


33,896


54,830


65,445Total benefits, claims and other deductions


111,457


120,743


232,408


260,823Segment income

$
2,151

$
8,512

$
3,169

$
3,343




Our Traditional Insurance segment income decreased by $6.4 million, compared to the second quarter of 2007, due to decreased
earnings on Medicare supplement, specialty health and life insurance and annuity businesses, compared to the second quarter of 2007. The overall loss ratio for the segment was 77.6% for the quarter
ended June 30, 2008, compared with 72.3% for the same period last year. Individual loss ratios for the quarter ended June 30, 2008 were 76.9% for Medicare supplement, compared with 71.3%
for the same period last year due to higher skilled nursing facility claims; 88.0% for specialty health, compared with 84.2% for the same period last year and 68.0% for life and annuity, compared with
62.2% for the same period last year.

Revenues.Net premium declined by $11.9 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:

Premium

Three months ended June 30,2008

2007Gross

Ceded

Net

Gross

Ceded

Net(In thousands)Medicare supplement

$
92,628

$
(24,844
)
$
67,784

$
106,027

$
(29,174
)
$
76,853Specialty health


106,682


(89,431
)

17,251


100,098


(81,311
)

18,787Life insurance and annuity


19,321


(5,776
)

13,545


19,910


(5,078
)

14,832Total premium

$
218,631

$
(120,051
)
$
98,580

$
226,035

$
(115,563
)
$
110,472


Net
investment income decreased by $3.1 million as a result of lower invested assets caused by less business in force as well as lower interest rates.

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Benefits, Claims and Expenses.Policyholder benefits incurred declined by $3.4 million, or 4%, compared to the second quarter of 2007. This decline was
principally caused by a net reduction in Medicare supplement benefits of $2.7 million as a result of a decline in the business partially offset by an increase in the loss ratio to 76.9% for the
second quarter of 2008 from 71.3% for the same period last year.

Change
in deferred acquisition costs increased $1.5 million compared to the second quarter of 2007. This increase is primarily due to less capitalization of commissions and
expenses as a result of lower sales of new business and less business in force as compared to a year ago.

Commissions
and general expenses, net of reinsurance allowances, decreased by $6.4 million, or 19%, compared to the second quarter of 2007. The following table details the
components of commission and other operating expenses:

Three months ended
June 30,2008

2007(In thousands)Commissions

$
15,678

$
23,649Other operating costs


20,399


20,547Reinsurance allowances


(8,570
)

(10,300
)Commissions and general expenses, net of allowances

$
27,507

$
33,896


The
lower level of commissions is associated with the continued aging of our in force renewal premium and less new business production that has higher commission rates. Other operating
costs were essentially flat for the quarter ended June 30, 2008, compared to the second quarter of 2007. Commission and expense allowances received from reinsurers decreased for the second
quarter of 2008 from the second quarter of 2007, primarily due to the reduction in new business ceded and the effects of normal lower commission allowances on our aging base of ceded renewal business.



Our Traditional Insurance segment income decreased by $0.2 million, compared to the first six months of 2007, due to increased
earnings on Medicare supplement business, offset by lower earnings on specialty health and life insurance and annuity. The overall loss ratio for the segment was 77.4% for the six months ended
June 30, 2008, compared with 75.7% for the same period last year. Individual loss ratios for the six months ended June 30, 2008 were 76.5% for Medicare supplement, compared with 74.9%
for the same period last year; 90.3% for specialty health, compared with 87.6% for the same period last year and 65.5% for life and annuity, compared with 64.8% for the same period last year.

Revenues.Net premium declined by $24.0 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:

Six months ended June 30,2008

2007Gross

Ceded

Net

Gross

Ceded

Net(In thousands)Medicare supplement

$
194,008

$
(52,344
)
$
141,664

$
222,298

$
(61,618
)
$
160,680Specialty health


212,871


(178,234
)

34,637


199,760


(162,036
)

37,724Life insurance and annuity


38,863


(11,375
)

27,488


39,150


(9,734
)

29,416Total premium

$
445,742

$
241,953

$
203,789

$
461,208

$
233,388

$
227,820


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Benefits, Claims and Expenses.Policyholder benefits incurred declined by $14.8 million, or 9%, compared to the first six months of 2007. This decline was
principally caused by a net reduction in Medicare supplement benefits of $11.9 million as a result of a decline in the business partially offset by an increase in the loss ratio to 76.5% for
the first six months of 2008 from 74.9% for the same period last year.

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

Commissions
and general expenses, net of reinsurance allowances, decreased by $10.6 million, or 16%, compared to the first six months of 2007. The following table details the
components of commission and other operating expenses:

Six months ended
June 30,2008

2007(In thousands)Commissions

$
32,732

$
44,155Other operating costs


39,528


42,095Reinsurance allowances


(17,430
)

(20,805
)Commissions and general expenses, net of allowances

$
54,830

$
65,445


The
lower level of commissions is associated with the continued aging of our in force renewal premium and less new business production that has higher commission rates. Other operating
costs were lower for the first six months of 2008, compared to the first six months of 2007 as a result of lower acquisition expenses due to less new business production and lower fixed costs.
Commission and expense allowances received from reinsurers decreased for the first six months of 2008 from the first six months of 2007, primarily due to the reduction in new business ceded and the
effects of normal lower commission allowances on our aging base of ceded renewal business.

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Segment ResultsSenior Administrative Services

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Affiliated fee revenueMedicare supplement

$
5,198

$
5,772

$
10,379

$
12,227Part D


6,995


6,133


14,021


12,335PFFS





4,615





7,711Long term care


582


576


1,127


1,199Life insurance


1,088


476


1,742


950Other


1,507


2,099


3,599


4,079Total affiliated revenue


15,370


19,671


30,868


38,501Unaffiliated fee revenueMedicare Advantage


3,675


2,587


7,213


5,066Medicare supplement


1,384


1,461


2,877


3,016Long term care


1,382


1,720


2,997


3,592Non-insurance products


226


416


478


807Part D


64


399


200


796Other


43


41


81


82Total unaffiliated revenue


6,774


6,624


13,846


13,359Total revenue


22,144


26,295


44,714


51,860Amortization of present value of future profits


101


110


183


220General expenses


15,658


20,695


32,122


40,313Total expenses


15,759


20,805


32,305


40,533Segment income

$
6,385

$
5,490

$
12,409

$
11,327


Unaffiliated
revenue includes fees received to administer certain business of our insurance subsidiaries that is 100% reinsured to an unaffiliated reinsurer. These fees amounted to
$0.6 million and $0.6 million for the three months ended June 30, 2008 and 2007, respectively and $1.2 million and $1.3 million for the six months ended
June 30, 2008 and 2007, respectively. In 2007 we performed certain administrative functions for the affiliated PFFS line that are performed directly by the affiliated entities in 2008. These
fees, together with the affiliated revenue, were eliminated in consolidation.



Segment income for our Senior Administrative Services segment increased by $0.9 million, or 16%, to $6.4 million for the
second quarter of 2008, as compared to the same period of 2007. This increase is primarily the result of reduced levels of general expenses beyond the reduction associated with the loss of affiliated
private-fee-for-service business.

Revenue
declined by $4.2 million, or 16%, during the second quarter of 2008 compared to the second quarter of 2007. Affiliated service fee revenue decreased by $4.3 million
primarily as a result of the loss of fee income associated with the administration of our PFFS business that was performed directly by the affiliated entities in 2008 partially offset by an increase
in Part D revenues on a growing block of business. Unaffiliated service fee revenue increased by $0.2 million, due primarily to an increase in services performed for unaffiliated
Medicare Advantage business, partially offset by a decrease in additional administrative services performed for clients for the other unaffiliated lines of business. General expenses for the segment
decreased by $5.0 million, or 24%, primarily attributed to the decline of the affiliated PFFS business.

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Segment income for our Senior Administrative Services segment increased by $1.1 million, or 10%, to $12.4 million for the
first six months of 2008, as compared to the same period of 2007. This increase is primarily the result of reduced levels of general expenses beyond the reduction associated with the loss of
affiliated private-fee-for-service business.

Revenue
declined by $7.1 million, or 14%, during the first six months of 2008 compared to the first six months of 2007. Affiliated service fee revenue decreased by
$7.6 million primarily as a result of the loss of fee income associated with the administration of our PFFS business that was performed directly by the affiliated entities 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 increased by
$0.5 million, due primarily to an increase in services performed for unaffiliated Medicare Advantage business, partially offset by a decrease in additional administrative
services performed for clients for the other unaffiliated lines of business. General expenses for the segment decreased by $8.2 million, or 20%, primarily attributed to the decline of the
affiliated PFFS business.

Segment ResultsCorporate

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

Three months ended
June 30,

Six months ended
June 30,2008

2007

2008

2007(In thousands)Interest expense

$
5,800

$
4,924

$
12,095

$
8,363Amortization of capitalized loan origination fees


262


288


524


568Stock-based compensation expense


1,632


971


3,237


2,107Other parent company expenses, net of revenues


3,008


1,461


(1,070
)

4,359Segment loss

$
10,702

$
7,644

$
14,786

$
15,397




The loss from our Corporate segment increased by $3.1 million, or 40%, for the second quarter of 2008 compared to the second
quarter of 2007. This was due primarily to increases in other parent company expenses, net of revenues, interest costs, and the cost of stock based compensation.

The
increase in interest cost of $0.9 million is due primarily to the increase in our debt outstanding, offset in part by a reduction in the interest rates charged on the debt, as
compared to the second quarter of 2007. Our combined outstanding debt increased by $169.5 million to $432.4 million at June 30, 2008 from $262.9 million at June 30,
2007. 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 4.6% for the second quarter of 2008 compared to 7.1% for the second quarter of 2007. The weighted average interest rate on our other long term debt was 7.3% for
the second quarter of 2008 compared to 7.8% for the second quarter of 2007. 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 the second half of 2007 and the first half of 2008, to officers and other employees approved by the
compensation committee.

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The
increase in other parent company expenses, net of revenues was primarily due to, a decrease of $0.5 million in net investment income, an increase in the costs of restricted
stock awards and other, individually insignificant, unfavorable expense variances.



The loss from our Corporate segment decreased by $0.6 million, or 4%, for the first six months of 2008 compared to the first six
months of 2007. The improvement was due primarily to significantly lower officer bonus expenses and an increase in net investment income, partially offset by an increase in interest costs, and the
cost of stock based compensation.

The
increase in interest cost of $3.7 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 the first six months of 2007. Our combined outstanding debt increased by $169.5 million to $432.4 million at June 30, 2008 from $262.9 million at
June 30, 2007. 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 4.7% for the first six months of 2008 compared to 7.3% for the first six months of 2007. The weighted average interest rate on our other long
term debt was 7.5% for the first six months of 2008 compared to 7.8% for the first six months of 2007. 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 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 by the compensation committee and paid in 2008, an increase of $0.5 million in net investment income, partially offset by an increase in the costs of restricted stock awards and other,
individually insignificant, unfavorable expense variances.



We use our capital primarily 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
(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 can 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.

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2007 Credit Facility

In connection with the MemberHealth transaction, as described in Note 4Business Combinations to our Consolidated
Financial Statements set forth above, we refinanced our Amended Credit Facility and Revolving 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 June 30, 2008, the interest rate on the
term loan portion of the new credit facility was 3.55%. We had not drawn on the revolving loan facility as of the date of this report. As a result of the value to be received pursuant to the
settlement agreement discussed in Significant Transactions and Initiatives, on April 23, 2008 we have prepaid $25 million of principal under the new facility, under an approved waiver.

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

Our
new credit facility requires us and our subsidiaries to meet certain financial tests, including a minimum consolidated leverage ratio and a minimum risk based capital test. Our new
credit facility also contains covenants, which among other things, under certain conditions, limit the incurrence of liens or additional indebtedness; investments; fundamental changes such as mergers,
dissolution, consolidation, disposition of assets; restricted payments such as dividends by us; changing the nature of our business; transactions with affiliates; limitations on dividends by
subsidiaries and other burdensome arrangements; use of proceeds; amendments of organization documents; prepayments of other indebtedness; restricted subsidiaries and other matters customarily
restricted in such agreements. Our new credit facility contains customary events of default, including, among other things, payment defaults, breach of covenants or representations and warranties;
cross-defaults to certain other indebtedness; certain events of bankruptcy and insolvency; judgment defaults and change of control.

We
incurred additional loan origination fees of approximately $4.7 million, which 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 new credit facility. The early extinguishment of our old credit facility triggered the immediate amortization of the related
capitalized loan origination fees, resulting in a pre-tax expense of approximately $0.9 million during the third quarter of 2007.

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

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maturity
in September, 2012. The following table shows the schedule of principal payments remaining on the new credit facility as of June 30, 2008, including the $25 million prepayment,
discussed above.

2007 Credit
Facility(in thousands)2008

$
1,7502009


3,5002010


3,5002011


3,5002012


310,125$
322,375


Interest Rate Swap

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

Short Term Facility

On January 18, 2007, we requested and received from the administrative agent for the lenders under 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

We made regularly scheduled principal payments of $1.8 million during the six months ended June 30, 2008 and
$2.6 million during the six months ended June 30, 2007 in connection with the credit facilities. In addition, we made a $25 million prepayment on April 23, 2008 in
connection with an approved waiver as discussed above. We repaid the $87.9 million balance outstanding on our Amended Credit Facility in connection with the refinancing noted above.

We
paid interest of $7.1 million during the six months ended June 30, 2008 and $4.2 million during the six months ended June 30, 2007 in connection with our
credit facilities. Due to the variable interest rate on the new credit facility, the portion not covered by the interest rate swaps would be subject to higher interest costs to us if short term
interest rates rise.

Other Long Term Debt

We have formed statutory business trusts, which exist for the exclusive purpose of issuing trust preferred securities representing
undivided beneficial interests in the assets of the trust, investing the gross proceeds of the trust preferred securities in junior subordinated deferrable interest debentures of our parent holding
company and engaging in only those activities necessary or incidental thereto. In

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accordance
with the adoption of FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities," we do not consolidate the trusts.

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

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

Maturity Date

Amount Issued

Term

Spread Over
LIBOR

Rate as of
June 30,
2008(In thousands)



(Basis points)April 2033

$
10,000

Floating


400


6.7
%May 2033


15,000

Floating


420


6.9
%May 2033


15,000

Fixed/Floating


410
(1)

6.8
%October 2033


20,000

Fixed/Floating


395
(2)

7.0
%March 2037


50,000

Fixed/Floating


275
(3)

7.7
%$
110,000


---

We
paid $4.3 million in interest in connection with the junior subordinated debt during the six months ended June 30, 2008 and $3.8 million during the six months
ended June 30, 2007.

Sources of Liquidity to the Parent Company

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



As
of June 30, 2008, the parent company had readily available cash of $126 million. In addition, we have access to funds under existing credit facilities. We have
$150.0 million available under the revolving portion of our new credit facility. 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.

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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 4Business Combinations of the notes to the
consolidated financial statements included in this quarterly report on Form 10-Q), we issued preferred stock for aggregate proceeds of $350 million, at $20 per common
equivalent share, to four private equity investment fund groups. We also issued $100 million of preferred stock during the second quarter of 2007 and the balance in September 2007. There can be
no assurance as to our actual future cash flows from the continued availability of dividends from our insurance company subsidiaries or from access to the capital markets to support our growth and
expansion initiatives.

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 HealthPlan 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.

PBM Subsidiary.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.

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 Life. As of June 30,
2008, the principal amount of the surplus note was $11.6 million. The note bears interest to our parent holding company at 25 basis points over the interest rate on the new credit facility. We
anticipate that the surplus note will be primarily serviced by dividends from Pennsylvania Life, a wholly owned subsidiary of American Exchange and by distributions from PDMS, and by
tax-sharing payments among the insurance companies that are wholly owned by American Exchange and are included in the consolidated Federal income tax return filed by American Exchange.
American Exchange made principal payments totaling $6.0 million during the six months ended June 30, 2008 and $5.0 million during the six months ended June 30, 2007.
American Exchange paid interest on the surplus note of $0.4 million during the six months ended June 30, 2008 and $1.1 million during the six months ended June 30, 2007.

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

Dividend
payments by our insurance companies to our parent holding company or to intermediate subsidiaries are limited by, or subject to the approval of the insurance regulatory
authorities of each

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insurance
company's state of domicile. Such dividend requirements and approval processes vary significantly from state to state. Pennsylvania Life is able to pay ordinary dividends of up to
$51.1 million to American Exchange (its direct parent) and American Exchange is able to pay ordinary dividends of up to $26.1 million to Universal American in 2008 without the prior
approval from the insurance department for their respective states of domicile.

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

Insurance SubsidiariesLiquidity

Liquidity for our insurance company subsidiaries is measured by their ability to pay scheduled contractual benefits, pay operating
expenses, fund investment commitments, and pay dividends to their parent company. The principal sources of cash for our insurance operations include scheduled and unscheduled principal and interest
payments on investments, premium payments, annuity deposits, and the sale or maturity of investments. Both the sources and uses of cash are reasonably predictable and we believe that these sources of
cash for our insurance company subsidiaries exceed scheduled uses of cash.

Liquidity
is also affected by unscheduled benefit payments 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.

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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 June 30, 2008 we held reserves
that exceeded the underlying cash surrender values of our net retained in force life insurance and annuities by $24 million. Our insurance subsidiaries, in our view, have not experienced any
material changes in surrender and withdrawal activity in recent years.

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

At
June 30, 2008, we held cash and cash equivalents totaling $453 million and fixed maturity securities that we could readily convert to cash with carrying values and fair
values of $1.1 billion.

The
net yields on our cash and invested assets increased to 5.2% for the six months ended June 30, 2008, from 5.1% for the six months ended June 30, 2007. 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, or the NAIC, imposes regulatory risk-based capital or RBC requirements on life insurance enterprises. At
December 31, 2007, all of our insurance subsidiaries maintained ratios of total adjusted capital to RBC in excess of the "authorized control level". The combined statutory capital and surplus,
including asset valuation reserve, of our U.S. insurance subsidiaries totaled $439.1 million at June 30, 2008 and $486.1 million at December 31, 2007. Our
U.S. insurance subsidiaries generated statutory net loss of $25.9 million for the six months ended June 30, 2008 and income of $38.8 million for the six months ended
June 30, 2007.

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 June 30, 2008, 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 $73.9 million at June 30, 2008 and $64.3 million at December 31, 2007. Statutory net income for our HMO affiliates was $10.8 million for the six
months ended June 30, 2008 and $9.0 million for the six months ended June 30, 2007.

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Investments

Our investment policy is to balance the portfolio duration to achieve investment returns consistent with the preservation of capital
and maintenance of liquidity adequate to meet payment of policy benefits and claims. We invest in assets permitted under the insurance laws of the various states in which we operate. These laws
generally prescribe the nature, quality of and limitations on various types of investments that may be made. We do not currently have investments in partnerships, special purpose entities, real
estate, commodity contracts, or other derivative securities. We currently engage the services of two investment advisors under the direction of the management of our insurance company subsidiaries and
in accordance with guidelines adopted by the Investment Committees of their respective boards of directors. Conning Asset Management Company manages the portfolio of all of our subsidiaries, except
for the portfolios of Pyramid Life, SelectCare of Texas, L.L.C. and certain floating rate portfolios, which are managed by Hyperion Capital.

We
invest primarily in fixed maturity securities of the U.S. Government and its agencies and in corporate fixed maturity securities with investment grade ratings of
BBB- or higher by S&P or Baa3 or higher by Moody's Investor Service. As of June 30, 2008, approximately 98% of our fixed maturity investments had investment grade ratings from S&P
or Moody's Investor Service. There were no non-income producing fixed maturities as of June 30, 2008. As of June 30, 2008, we held securities with par values of approximately
$143 million with exposure to subprime mortgages. The market value of these securities was $56 million at June 30, 2008, representing approximately 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 equivalent rating of AA. Twelve securities we own with an amortized cost of
approximately $15 million have been placed on negative watch by Moody's or S&P. During the six months ended June 30, 2008, we recognized other than temporary impairment totaling
$41.5 million in the value of our securities with exposure to subprime mortgages plus $1.4 million in the value of two commercial mortgage backed securities.. We did not write down the
value of any fixed maturity securities during the six months ended June 30, 2007.

Federal Income Taxation of the Company

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

Effects of Recently Issued and Pending Accounting Pronouncements

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

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ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Investment Interest Rate Sensitivity

Our profitability could be affected if we were required to liquidate fixed income securities during periods of rising and/or volatile
interest rates. However, we attempt to mitigate our exposure to adverse interest rate movements through a combination of active portfolio management and by staggering the maturities of our fixed
income investments to assure sufficient liquidity to meet our obligations and to address reinvestment risk considerations. Our investment policy is to attempt to balance our portfolio duration to
achieve investment returns consistent with the preservation of capital and to meet payment 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 June 30, 2008, and with all other variables held constant. The following table summarizes the impact of the assumed changes in market interest
rates.

Effect of Change in Market Interest Rates on Market Value
of Fixed Income Portfolio as of June 30, 2008June 30, 2008200 Basis
Point Decrease

100 Basis
Point Decrease

100 Basis
Point Increase

200 Basis
Point IncreaseMarket Value of
Fixed Income Portfolio(in millions)$1,078.3

$70.4

$37.3

$(37.3)

$(76.1)


Debt

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

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

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

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accompanying
analyses should not be construed as a prediction of future economic events, but rather, be treated as a simple illustration of the potential impact of such events on our financial
results.

The
sensitivity analysis of interest rate risk assumes scenarios increases or decreases in LIBOR of 100 and 200 basis points from their levels as of and for the six months ended
June 30, 2008, and with all other variables held constant. The following table summarizes the impact of changes in LIBOR.

Effect of Change in LIBOR on Pre-tax Income for the six months ended June 30, 2008Description of Floating Rate Debt

Weighted
Average
Interest Rate

Weighted
Average
Balance Outstanding

200 Basis
Point
Decrease

100 Basis
Point
Decrease

100 Basis
Point
Increase

200 Basis
Point
Increase(in millions)Loan Payable


4.35
%
$
89.3

$
0.9

$
0.4

$
(0.4
)
$
(0.9
)Other long term debt


7.59
%
$
40.0


0.4


0.2


(0.2
)

(0.4
)Total







$
1.3

$
0.6

$
(0.6
)
$
(1.3
)


As
noted above, we have fixed the interest rate on $320 million of our $449 million of total debt outstanding, leaving $129 million of the debt exposed to rising
interest rates, as of June 30, 2008. We had approximately $453 million of cash and cash equivalents as of June 30, 2008. We anticipate that any increase or decrease in the
interest cost of our debt as a result of an increase in interest rates will be mitigated by an increase or decrease in the net investment income from our cash and cash equivalents.

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

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

ITEM 4Controls and Procedures



We maintain 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 our 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

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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 certain assumptions about the likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of 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.



We carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2008. Based on this evaluation, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2008, at a reasonable assurance level, to timely alert management to
material information required to be included in our periodic filings with the Securities and Exchange Commission.



There were no changes in our internal controls over financial reporting during the quarter ended June 30, 2008 that have
materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II

ITEM 1LEGAL PROCEEDINGS

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

ITEM 1ARISK FACTORS

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

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

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

Maximum
Number
of Shares That
May
Yet Be
Purchased
Under the Plans
or Programs(1)April 1, 2008  April 30, 2008











3,427,820May 1, 2008  May 31, 2008


1,800,640

$
10.87


1,800,640


1,552,775June 1, 2008  June 30, 2008


602,076

$
11.13


595,800


5,870,714Total


2,402,716





2,396,440


---

Recent Sales of Unregistered Securities

None.

ITEM 3DEFAULTS UPON SENIOR SECURITIES

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

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

We
held our annual meeting of shareholders on June 3, 2008. The following describes the actions taken at the annual meeting.

Election of Directors.At the annual meeting, our shareholders re-elected thirteen nominees to serve as members of our board of directors until our 2009 annual
meeting of shareholders, or until their successors are duly elected and qualified. The tabulation of votes for each of the nominees was as follows:

Number of VotesNominee

For

WithheldBarry W. Averill


76,781,962


2,526,209Richard A. Barasch


76,732,311


2,575,860Sally W. Crawford


78,267,341


1,040,830Matthew W. Etheridge


76,782,162


2,526,009Mark K. Gormley


76,757,415


2,550,756Charles E. Hallberg


76,757,658


2,550,513Mark M. Harmeling


78,463,865


844,306Linda H. Lamel


76,812,436


2,495,735Eric W. Leathers


76,757,708


2,550,463Patrick J. McLaughlin


78,463,915


844,256Robert A. Spass


76,211,868


3,096,303Sean M. Traynor


76,757,458


2,550,713Robert F. Wright


77,483,568


1,824,603


As
we described in our current report on Form 8-K filed July 30, 2008, Mr. Hallberg has resigned from our board of directors and has been replaced by
Thomas A. Scully as a designee of one of our equity investors, and Mr. Etheridge has been replaced by Jay Yang as a designee of another of our equity investors, although
Mr. Etheridge remains on our board.

Ratification of the Election of Independent Auditors.At our annual meeting our shareholders approved the proposal to ratify the appointment of Ernst &
Young LLP as our independent auditors for the fiscal year ending December 31, 2008. Tabulation of the votes for the proposal was as follows:

Number of Votes
For

Number of Votes
Against

Number of
Abstentions

Number of
Broker Non-Votes79,054,478


253,193


500





ITEM 5OTHER INFORMATION

None.

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ITEM 6EXHIBITS

| |     |  |                                                                                                                                                                                                                                                                                                                                                                                                  
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 (File No. 0-11321) filed May 11, 2007, and
incorporated by reference herein).
| | 3.1 |  | Restated Certificate of Incorporation of Universal American Financial Corp. (filed as Exhibit 3.1 to Amendment No. 2 to the Registrant's
Registration Statement on Form S-3 (File No. 333-62036) filed on July 11, 2001, and incorporated by reference herein).                                                                                                                                  
| | 3.2 |  | Certificate of Amendment of the Certificate of Incorporation of Universal American Financial Corp. (filed as Exhibit 3 to the Registrant's
Quarterly Report on Form 10-Q (File No. 0-11321) for the quarter ended September 30, 2004, filed August 9, 2004, and incorporated by reference herein).                                                                                               
| | 3.3 |  | Amended and Restated By-Laws of Universal American Corp. (filed as Exhibit 3.3 to the Registrant's Quarterly Report on Form 10-Q (File
No. 0-11321) for the quarter ended March 31, 2008, filed on May 12, 2008, and incorporated by reference herein).                                                                                                                                          
| | 3.4 |  | Certificate of Amendment to the Certificate of Incorporation of Universal American Financial Corp. for the Series A Preferred Stock (filed as
Exhibit 3.1 to the Registrant's Current Report on Form 8-K (File No. 0-11321) filed May 11, 2007, and incorporated by reference herein).                                                                                                           
| | 3.5 |  | Certificate of Amendment of the Certificate of Incorporation of Universal American Financial Corp. for the Registrant's Series B Preferred Stock
(filed as Exhibit 3.2 to the Registrant's Current Report on Form 8-K (File No. 0-11321) filed May 11, 2007, and incorporated by reference herein).                                                                                              
| | 4.1 |  | Form of Senior Indenture dated as of December 2004 between Universal American Financial Corp. and U.S. Bank National Association, as Trustee (filed
as Exhibit 4.01 to Amendment No. 1 to the Registrant's Registration Statement on Form S-3 (File No. 333-120190) filed with the Securities and Exchange Commission on December 10, 2004, and incorporated by reference
herein).               
| | 4.2 |  | Form of Subordinated Indenture dated as of December 2004 between Universal American Financial Corp. and U.S. Bank National Association, as Trustee
(filed as Exhibit 4.02 to Amendment No. 1 to the Registrant's Registration Statement on Form S-3 (File No. 333-120190) filed with the Securities and Exchange Commission on December 10, 2004, and incorporated by reference
herein).         
| | 4.3 |  | Guarantee Agreement, dated as of March 22, 2007, by Universal American Financial Corp., as Guarantor, and Wilmington Trust Company, as Trustee
(filed as Exhibit 4.3 to the Registrant's Current Report on Form 8-K filed March 28, 2007, and incorporated by reference herein).                                                                                                                 
| | 4.4 |  | Indenture, dated as of March 22, 2007, between Universal American Financial Corp. and Wilmington Trust Company, as Trustee, relating to
Fixed/Floating Rate Junior Subordinated Debentures Due 2037 (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed March 28, 2007, and incorporated by reference herein).                                                            
| | 4.5 |  | Stockholders' Agreement, dated as of September 21, 2007, among Universal American Corp. and security holders listed on the signature pages
thereto (filed as Exhibit 4.1 to the Registrant's Current Report on Form 8-K filed September 25, 2007, and incorporated by reference herein).                                                                                                         

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|      |  |                                                                                                                                                                                                                                                                                                                                                                                                          
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.1  |  | Employment Agreement dated July 30, 1999, between Registrant and Richard A. Barasch (filed as Exhibit D to the Registrant's Current Report
on Form 8-K/A filed March 19, 2001 and incorporated by reference herein).                                                                                                                                                                                     
|10.2  |  | Letter dated April 9, 2008, correcting clerical error in Employment Agreement dated July 30, 1999, between Registrant and Richard A.
Barasch. (filed as Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q (File No. 0-11321) for the quarter ended March 31, 2008, filed on May 12, 2008, and incorporated by reference herein).                                                            
|10.3  |  | Employment Agreement dated July 30, 1999, between Registrant and Gary Bryant (filed as Exhibit E to the Registrant's Current Report on
Form 8-K/A filed March 19, 2001 and incorporated by reference herein).                                                                                                                                                                                            
|10.4  |  | Employment Agreement dated July 30, 1999, between Registrant and Robert Waegelein (filed as Exhibit E to the Registrant's Current Report on
Form 8-K/A filed March 19, 2001 and incorporated by reference herein).                                                                                                                                                                                       
|10.5  |  | Employment Letter dated September 17, 2002, between the Company and Jason Israel (filed as Exhibit 10.17 to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 2005, filed March 16, 2006, and incorporated by reference herein).                                                                                                                                               
|10.6  |  | Employment Agreement dated March 9, 2004, by and among the Company, Heritage Health Systems, Inc. and Theodore M. Carpenter, Jr. (filed as
Exhibit 10.18 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005, filed March 16, 2006, and incorporated by reference herein).                                                                                               
|10.7  |  | 1998 Incentive Compensation Plan (filed as Exhibit A to the Registrant's Definitive Proxy Statement on Form 14A filed April 29, 1998,
and incorporated by reference herein).                                                                                                                                                                                                                             
|10.8  |  | First Amendment to the Universal American Financial Corp. 1998 Incentive Compensation Plan (filed as Exhibit 10.1 to the Registrant's
Registration Statement on Form S-3 (Registration No. 333-120190) filed on November 3, 2004, and incorporated by reference herein).                                                                                                                                 
|10.9  |  | Agent Stock Plan for Agents of Pennsylvania Life and PennCorp Canada (filed as part of Amendment 1 to the Registrant's Registration Statement on
Form S-2, dated July 13, 2000, and incorporated by reference herein).                                                                                                                                                                                   
|10.10 |  | Agent Equity Plan for Regional Managers and Sub Managers of Pennsylvania Life and PennCorp Canada (filed as part of Amendment 1 to the Registrant's
Registration Statement on Form S-2, dated July 13, 2000, and incorporated by reference herein).                                                                                                                                                      
|10.11 |  | Agreement dated as of September 14, 2000, by and between ALICOMP, a division of ALICARE, Inc. and Universal American Financial Corp., as
amended (filed as Exhibit 10.1 to Amendment No. 1 to the Registrant's Form 10-Q/A for the period ended September 30, 2003, filed December 23, 2003, and incorporated by reference herein).                                                                      
|10.12 |  | Amended and Restated Credit Agreement dated as of May 28, 2004, among Universal American Financial Corp., various lending institutions and Bank
of America, N.A., as the Administrative Agent, the Collateral Agent and the L/C Issuer (filed as Exhibit 10 to the Registrant's Current Report on Form 8-K filed June 1, 2004, and incorporated herein by reference).                                    
|10.13 |  | First Amendment to Amended and Restated Credit Agreement dated as of September 2, 2005 among Universal American Financial Corp., the Banks party
to the Credit Agreement and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.12 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005, filed March 16, 2006, and incorporated by
reference herein).

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|      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.14 |  | Waiver and Second Amendment to Amended and Restated Credit Agreement dated as of December 30, 2005 among Universal American Financial Corp., the
Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.13 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2005, filed March 16, 2006, and
incorporated by reference herein).            
|10.15 |  | Waiver and Third Amendment to Amended and Restated Credit Agreement dated as of November 29, 2006, among Universal American Financial Corp., the
Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed January 24, 2007, and incorporated by reference herein).                                                 
|10.16 |  | Credit Agreement dated as of January 18, 2007, among Universal American Financial Corp., one or more Lending Institutions, and Bank of America,
N.A., as the Administrative Agent and the L/C Issuer (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed January 24, 2007, and incorporated by reference herein).                                                                                        
|10.17 |  | Addendum II for Item 1A to Agreement dated as of September 14, 2000, between ALICOMP, a division of ALICARE, Inc. and Universal
American Financial Corp. (filed as Exhibit 10.13 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2004, filed March 16, 2005, and incorporated by reference herein).                                                                                               
|10.18 |  | Quota Share Reinsurance Agreement, dated as of June 30, 2005, between Pennsylvania Life Insurance Company and PharmaCare Captive Re, Ltd.
(filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, filed November 9, 2007, and incorporated by reference herein).                                                                                                      
|10.19 |  | Fourth Amendment dated as of March 22, 2007, to Amended and Restated Credit Agreement dated as of May 28, 2004 among Universal American
Financial Corp., the Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, filed
May 10, 2007, and incorporated by reference herein).
|10.20 |  | First Amendment dated as of March 22, 2007, to Credit Agreement dated as of January 18, 2007, among Universal American Financial Corp., the
Banks party to the Credit Agreement, and Bank of America, N.A., as the Administrative Agent (filed as Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, filed May 10, 2007, and
incorporated by reference herein).                
|10.21 |  | Stage 1 Securities Purchase Agreement dated as of May 7, 2007 among Universal American Financial Corp. and the several investors party
thereto (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File No. 0-11321) filed May 11, 2007, and incorporated by reference herein).                                                                                                                               
|10.22 |  | Stage 2 Securities Purchase Agreement dated as of May 7, 2007 among Universal American Financial Corp. and the several investors party
thereto. (filed as Exhibit 10.2 to the Registrant's Current Report on Form 8-K (File No. 0-11321) filed May 11, 2007, and incorporated by reference herein).                                                                                                                              
|10.23 |  | Fifth Amendment dated as of May 7, 2007to Amended and Restated Credit Agreement dated as of May 28, 2004, among Universal American
Financial Corp., the Banks party to the Amended and Restated Credit Agreement, and Bank of America, N.A., as Administrative Agent (filed as Exhibit 10.1 to the Registrant's Current Report on Form 8-K (File No. 0-11321) filed
May 17, 2007, and incorporated by reference herein).         

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|      |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|----- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.24 |  | Second Amendment dated as of May 7, 2007to Credit Agreement dated as of January 18, 2007, among Universal American Financial Corp., the
Banks party to the Credit Agreement, and Bank of America, N.A., as Administrative Agent (filed as Exhibit 10.2 to the Registrant's Current Report on Form 8-K (File No. 0-11321) filed May 17, 2007, and incorporated by reference
herein).                                                                  
|10.25 |  | Fourth Amendment dated as of March 22, 2007, to Amended and Restated Credit Agreement dated as of May 28, 2004 among Universal American
Financial Corp., the Banks party to the Credit Agreement and Bank of America, N.A., as the Administrative Agent. (filed as Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 (File
No. 0-11321), filed May 10, 2007, and incorporated by reference herein).
|10.26 |  | First Amendment as of dated March 22, 2007, to Credit Agreement dated as of January 18, 2007, among Universal American Financial Corp., one
or more Lending Institutions, and Bank of America, N.A., as the Administrative Agent and L/C Issuer (filed as Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 (File No. 0-11321)
filed May 10, 2007, and incorporated by reference herein).          
|10.27 |  | Credit Agreement dated as of September 18, 2007, among Universal American Financial Corp., each lender from time to time party thereto, and Bank
of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer (filed as Exhibit 10.26 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2007 (File No. 0-11321) filed
November 9, 2007, and incorporated by reference herein).                    
|11.1* |  | Statement re Computation of per share Earnings (contained in the Consolidated Statements of Operations in this Report).                                                                                                                                                                                                                                                                                                                              
|31.1* |  | Certification of Chief Executive Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934.                                                                                                                                                                                                                                                                                                                                      
|31.2* |  | Certification of Chief Financial Officer, as required by Rule 13a-14(a) of the Securities Exchange Act of 1934.                                                                                                                                                                                                                                                                                                                                      
|32.1* |  | Certification of the Chief Executive Officer and Chief Financial Officer, as required by Rule 13a-14(b) of the Securities Exchange Act of 1934
and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                     

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SIGNATURES

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

UNIVERSAL AMERICAN CORP.August 8, 2008

/s/RICHARD A. BARASCHRichard A. Barasch Chief Executive OfficerAugust 8, 2008

/s/ROBERT A. WAEGELEINRobert A. Waegelein Executive Vice President and
Chief Financial Officer
(Principal Accounting Officer)


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