**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**
| **(Mark One)**                                              | ** ** | ** **                                                                                                              |
|-------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------|
| x                                                           | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**   |
| **For the Quarterly Period Ended  September 30, 2005** |
| **Or**                                                      |
| o                                                           | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |

 

**For thetransition period from          to**

**Commission File No. 0-11321**

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**UNIVERSAL AMERICAN FINANCIAL CORP.**

(Exact name of registrantas specified in its charter)

| **New York**                                |   | **11-2580136**                          |
|---------------------------------------------|--------|-----------------------------------------|
| (State or other  jurisdiction of            |   | (IRS Employer  Identification No.) |
| incorporation or  organization)             |   | ** **                              |
| **Six International Drive, Suite 190** |   |                                    |
| **Rye  Brook, New York**                    |   | **10573**                               |
| (Address of  principal executive offices)   |   | (Zip code)                              |
| ** **                                  |   |                                    |
|                                        |   |                                    |
|                                        |   |                                    |

**(914) 934-5200**

(Registrant’s telephonenumber, including area code)

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days. Yes x  No o

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the ExchangeAct). Yes x No o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the ExchangeAct). Yes o  No x

Thenumber of shares of the registrant’s common stock, par value $0.01 per share,outstanding as of November 1, 2005 was 58,530,873.

 

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**UNIVERSAL AMERICAN FINANCIAL CORP.FORM 10-Q**

**CONTENTS**
|                                             | ** ** | ** **                                                                                  | ** ** | **Page No.** | ** ** |
|---------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|-------------------|------------|
| **PART I—FINANCIAL  INFORMATION** |       |                                                                                        |       |              |       |
| Item 1.                                     |       | Financial Statements (unaudited)                                                            |       |              |       |   |   |
|                                        |       | Consolidated  Balance Sheets                                                                |       |              | 4          |   |   |
|                                        |       | Consolidated Statements of Operations—Three Months                                     |       |              | 5          |   |   |
|                                        |       | Consolidated Statements of Operations—Nine Months                                      |       |              | 6          |   |   |
|                                        |       | Consolidated Statements of Stockholders’ Equity and  Comprehensive Income              |       |              | 7          |   |   |
|                                        |       | Consolidated Statements  of Cash Flows                                                      |       |              | 8          |   |   |
|                                        |       | Notes to Consolidated Financial Statements                                                  |       |              | 9          |   |   |
| Item 2.                                     |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations |       |              | 22         |   |   |
| Item 3.                                     |       | Quantitative and Qualitative Disclosure of Market Risk                                      |       |              | 53         |   |   |
| Item 4.                                     |       | Controls and Procedures                                                                     |       |              | 55         |   |   |
| **PART II—OTHER  INFORMATION**    |       |                                                                                        |       |              |       |
| Item  1.                                    |       | Legal  Proceedings                                                                          |       |              | 57         |   |   |
| Item 2.                                     |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                |       |              | 57         |   |   |
| Item 3.                                     |       | Defaults Upon Senior Securities                                                             |       |              | 57         |   |   |
| Item 4.                                     |       | Submission of Matters to a Vote of Security Holders                                         |       |              | 57         |   |   |
| Item  5.                                    |       | Other  Information                                                                          |       |              | 57         |   |   |
| Item 6.                                     |       | Exhibits                                                                                    |       |              | 58         |   |   |
| Signatures                                  |       |                                                                                        | 59         |              |       |

 

2

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As used in this QuarterlyReport on Form 10-Q, “Universal American,” “the Company,” “we,” “our,”and “us” refer to Universal American Financial 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 Reporton Form 10-Q and certain oral statements made from time to time byrepresentatives of the Company may be considered “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. TheCompany intends such forward-looking statements to be covered by the safeharbor provisions for forward-looking statements contained in Section 21Eof the Exchange Act and the Private Securities Litigation Reform Act of 1995.Such forward-looking statements relate to, without limitation, the Company’sfuture economic performance, plans and objectives for future operations andprojections of revenue and other financial items. Forward-looking statementscan be identified by the use of words such as “prospects,” “outlook,” “believes,”“estimates,” “intends,” “may,” “will,” “should,” “anticipates,” “expects” or “plans,”or the negative or other variation of these or similar words, or by discussionof trends and conditions, strategy or risks and uncertainties. Forward-lookingstatements are inherently subject to risks, trends and uncertainties, many ofwhich are beyond the Company’s ability to control or predict with accuracy andsome of which the Company might not even anticipate. Although the Companybelieves that the expectations reflected in such forward-looking statements arebased upon reasonable assumptions at the time made, it can give no assurancethat its expectations will be achieved. Future events and actual results,financial and otherwise, may differ materially from the results discussed inthe forward-looking statements. Readers are cautioned not to place unduereliance on these forward-looking statements.

Important factors that may cause actual results todiffer materially from forward-looking statements include, but are not limitedto, the risks and uncertainties set forth in this report in Item 2 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”, aswell as those other risks detailedin our filings with the SEC, including our Annual Reports on Form 10-K,Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.The Company assumes no obligation to update and supplement any forward-lookingstatements that may become untrue because of subsequent events, whether as aresult of new information, future events or otherwise.

3

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**PART 1.FINANCIAL INFORMATION**

**Item1. Financial Statements (Unaudited).**

**UNIVERSALAMERICAN FINANCIAL CORP.CONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                          | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                          | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| ** **                                                                                                          | ** ** | **(In thousands)**      | ** ** |
| ASSETS                                                                                                              |       |                         |       |                        |       |   |   |   |   |
| Investments (Note 6):                                                                                               |       |                         |       |                        |       |   |   |   |   |
| Fixed maturities available for sale, at fair value (amortized  cost: 2005, $1,250,400; 2004, $1,109,678)       |       |                         | $          | 1,306,227                   |       |   |   | $ | 1,170,822 |   |   |
| Equity securities, at fair value (cost: 2005,  $1,303; 2004, $749)                                                  |       |                         | 1,294      |                        |       |   | 755 |   |   |
| Policy loans                                                                                                        |       |                         | 23,549     |                        |       |   | 24,318 |   |   |
| Other invested assets                                                                                               |       |                         | 899        |                        |       |   | 1,187 |   |   |
| Total investments                                                                                                   |       |                         | 1,331,969  |                        |       |   | 1,197,082 |   |   |
| Cash and cash  equivalents                                                                                          |       |                         | 230,268    |                        |       |   | 181,257 |   |   |
| Accrued  investment income                                                                                          |       |                         | 13,081     |                        |       |   | 13,151 |   |   |
| Deferred policy  acquisition costs                                                                                  |       |                         | 261,746    |                        |       |   | 208,281 |   |   |
| Amounts due from  reinsurers                                                                                        |       |                         | 230,898    |                        |       |   | 212,501 |   |   |
| Due and unpaid  premiums                                                                                            |       |                         | 6,888      |                        |       |   | 6,474 |   |   |
| Present value of  future profits and other amortizing intangible assets                                             |       |                         | 52,713     |                        |       |   | 60,804 |   |   |
| Goodwill and  other indefinite lived intangible assets (Note 4)                                                     |       |                         | 73,000     |                        |       |   | 75,180 |   |   |
| Income taxes  receivable                                                                                            |       |                         | 2,001      |                        |       |   | 865 |   |   |
| Other assets                                                                                                        |       |                         | 66,858     |                        |       |   | 61,493 |   |   |
| Total assets                                                                                                        |       |                         | $          | 2,269,422                   |       |   |   | $ | 2,017,088 |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                          |       |                         |       |                        |       |   |   |   |   |
| LIABILITIES                                                                                                         |       |                         |       |                        |       |   |   |   |   |
| Policyholder  account balances                                                                                      |       |                         | $          | 494,155                     |       |   |   | $ | 478,373 |   |   |
| Reserves for  future policy benefits                                                                                |       |                         | 791,069    |                        |       |   | 759,325 |   |   |
| Policy and  contract claims—life                                                                               |       |                         | 14,150     |                        |       |   | 10,802 |   |   |
| Policy and  contract claims—health                                                                             |       |                         | 104,190    |                        |       |   | 94,526 |   |   |
| Loan payable  (Note 9)                                                                                              |       |                         | 97,125     |                        |       |   | 101,063 |   |   |
| Other long term  debt (Note 10)                                                                                     |       |                         | 75,000     |                        |       |   | 75,000 |   |   |
| Amounts due to  reinsurers                                                                                          |       |                         | 15,878     |                        |       |   | 6,023 |   |   |
| Deferred income  tax liability                                                                                      |       |                         | 20,259     |                        |       |   | 5,206 |   |   |
| Payable for  securities purchased                                                                                   |       |                         | 29,057     |                        |       |   | — |   |   |
| Other liabilities                                                                                                   |       |                         | 89,159     |                        |       |   | 67,349 |   |   |
| Total liabilities                                                                                                   |       |                         | 1,730,042  |                        |       |   | 1,597,667 |   |   |
| STOCKHOLDERS’  EQUITY (Note 8)                                                                                 |       |                         |       |                        |       |   |   |   |   |
| Common stock  (Authorized: 100 million shares, issued: 2005, 58.9 million shares; 2004,  55.3 million shares)  |       |                         | 589        |                        |       |   | 553 |   |   |
| Additional  paid-in capital                                                                                         |       |                         | 241,217    |                        |       |   | 172,525 |   |   |
| Accumulated other  comprehensive income                                                                             |       |                         | 41,674     |                        |       |   | 40,983 |   |   |
| Retained earnings                                                                                                   |       |                         | 256,337    |                        |       |   | 206,329 |   |   |
| Less: Treasury  stock (2005, 0.1 million shares; 2004, 0.1 million shares)                                          |       |                         | (437       | )                           |       |   | (969 | ) |   |
| Total stockholders’ equity                                                                                     |       |                         | 539,380    |                        |       |   | 419,421 |   |   |
| Total liabilities  and stockholders’ equity                                                                    |       |                         | $          | 2,269,422                   |       |   |   | $ | 2,017,088 |   |   |

 

See notes to unaudited consolidated financial statements.

4

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**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF OPERATIONS(Unaudited)**

| ** **                                       | ** ** | **Three months ended  September 30,**              | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                                          | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(In thousands, except  per share amounts)** | ** ** |
| Revenues:                                        |       |                                                              |       |   |   |
| Net premiums and policyholder fees earned        |       | $                                                                 | 213,224    |   | $ | 178,076 |   |
| Net investment income                            |       | 18,351                                                            |       | 16,475 |   |
| Realized gains on investments                    |       | 982                                                               |       | 5,485 |   |
| Fee and other income                             |       | 4,371                                                             |       | 3,685 |   |
| Total revenues                                   |       | 236,928                                                           |       | 203,721 |   |
| Benefits, claims  and expenses:                  |       |                                                              |       |   |   |
| Net change in future policy benefits             |       | 4,956                                                             |       | 2,537 |   |
| Net claims and other benefits                    |       | 145,381                                                           |       | 119,281 |   |
| Interest credited to policyholders               |       | 5,096                                                             |       | 4,737 |   |
| Net increase in deferred acquisition costs       |       | (15,016                                                           | )          | (16,304 | ) |
| Amortization of present value of future profits  |       | 2,047                                                             |       | 1,816 |   |
| Commissions                                      |       | 38,747                                                            |       | 35,413 |   |
| Commission and expense allowances on reinsurance |       | (15,307                                                           | )          | (12,952 | ) |
| Interest expense                                 |       | 2,826                                                             |       | 2,234 |   |
| Other operating costs and expenses               |       | 44,149                                                            |       | 37,641 |   |
| Total benefits, claims and expenses              |       | 212,879                                                           |       | 174,403 |   |
| Income before taxes                              |       | 24,049                                                            |       | 29,318 |   |
| Income tax  expense                              |       | 8,761                                                             |       | 9,776 |   |
| Net income                                       |       | $                                                                 | 15,288     |   | $ | 19,542 |   |
| Earnings per  common share:                      |       |                                                              |       |   |   |
| Basic                                            |       | $                                                                 | 0.26       |   | $ | 0.36 |   |
| Diluted                                          |       | $                                                                 | 0.25       |   | $ | 0.34 |   |

 

 

See notes to unaudited consolidated financial statements.

5

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**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTSOF OPERATIONS(Unaudited)**

| ** **                                       | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------|------------|
|                                                  | ** ** | **2005**                                           | ** ** | **2004** | ** ** |
| ** **                                       | ** ** | **(In thousands, except per share amounts)**       | ** ** |
| Revenues:                                        |       |                                               |       |   |   |
| Net premiums and policyholder fees earned        |       | $                                                  | 620,394    |   | $ | 460,524 |   |
| Net investment income                            |       | 52,366                                             |       | 48,636 |   |
| Realized gains on investments                    |       | 5,085                                              |       | 9,286 |   |
| Fee and other income                             |       | 12,904                                             |       | 10,437 |   |
| Total revenues                                   |       | 690,749                                            |       | 528,883 |   |
| Benefits, claims and  expenses:                  |       |                                               |       |   |   |
| Net change in future policy benefits             |       | 15,998                                             |       | 10,400 |   |
| Net claims and other benefits                    |       | 424,235                                            |       | 305,670 |   |
| Interest credited to policyholders               |       | 14,271                                             |       | 13,215 |   |
| Net increase in deferred acquisition costs       |       | (48,272                                            | )          | (47,527 | ) |
| Amortization of present value of future profits  |       | 4,918                                              |       | 3,687 |   |
| Commissions                                      |       | 114,613                                            |       | 104,913 |   |
| Commission and expense allowances on reinsurance |       | (44,107                                            | )          | (37,481 | ) |
| Interest expense                                 |       | 8,007                                              |       | 5,519 |   |
| Other operating costs and expenses               |       | 124,703                                            |       | 100,059 |   |
| Total benefits, claims and expenses              |       | 614,366                                            |       | 458,455 |   |
| Income before taxes                              |       | 76,383                                             |       | 70,428 |   |
| Income tax  expense                              |       | 26,375                                             |       | 23,960 |   |
| Net income                                       |       | $                                                  | 50,008     |   | $ | 46,468 |   |
| Earnings per  common share:                      |       |                                               |       |   |   |
| Basic                                            |       | $                                                  | 0.88       |   | $ | 0.85 |   |
| Diluted                                          |       | $                                                  | 0.85       |   | $ | 0.82 |   |

 

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**UNIVERSAL AMERICAN FINANCIAL CORP.CONSOLIDATED STATEMENTSOF STOCKHOLDERS’ EQUITYAND COMPREHENSIVE INCOME(Unaudited)**

| **Nine months ended September 30,** | ** ** | ** **              | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **Total** | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|-------------------|------------|----------------------------------|------------|-----------------------------------------------------------|------------|------------------------|------------|---------------------|------------|-----------|------------|
| ** **                                              | ** ** | **(In thousands)** | ** ** |
| **2004**                                                |       |                    |       |              |       |                             |       |                                                      |       |                   |       |                |       |      |       |   |   |
| Balance,  January 1, 2004                          |       |                    | $          | 541               |       |                             | $          | 164,355                                                   |       |                   | $          | 39,774              |       |      | $          | 142,458 |   | $ | (1,390 | ) | $ | 345,738 |   |
| Net income                                              |       |                    | —     |              |       | —                           |       |                                                      | —     |                   |       | 46,468              |       | —    |       | 46,468 |   |
| Other  comprehensive loss (Note 7)            |       |                    | —     |              |       | —                           |       |                                                      | (1,423     | )                      |       | —              |       | —    |       | (1,423 | ) |
| Comprehensive  income                                   |       |                    |       |              |       |                             |       |                                                      |       |                   |       |                |       |      |       | 45,045 |   |
| Issuance of  common stock (Note 8)            |       |                    | 10         |              |       | 3,705                            |       |                                                      | —     |                   |       | —              |       | —    |       | 3,715 |   |
| Stock-based  compensation                               |       |                    | —     |              |       | 415                              |       |                                                      | —     |                   |       | —              |       | —    |       | 415 |   |
| Loans to officers                                       |       |                    | —     |              |       | 76                               |       |                                                      | —     |                   |       | —              |       | —    |       | 76 |   |
| Treasury shares purchased,  at cost (Note 8)       |       |                    | —     |              |       | —                           |       |                                                      | —     |                   |       | —              |       | (319      | )          | (319 | ) |
| Treasury shares  reissued (Note 8)                 |       |                    | —     |              |       | 254                              |       |                                                      | —     |                   |       | —              |       | 746       |       | 1,000 |   |
| Balance,  September 30, 2004                       |       |                    | $          | 551               |       |                             | $          | 168,805                                                   |       |                   | $          | 38,351              |       |      | $          | 188,926 |   | $ | (963 | ) | $ | 395,670 |   |
| **2005**                                                |       |                    |       |              |       |                             |       |                                                      |       |                   |       |                |       |      |       |   |   |
| Balance, January 1,  2005                          |       |                    | $          | 553               |       |                             | $          | 172,525                                                   |       |                   | $          | 40,983              |       |      | $          | 206,329 |   | $ | (969 | ) | $ | 419,421 |   |
| Net income                                              |       |                    | —     |              |       | —                           |       |                                                      | —     |                   |       | 50,008              |       | —    |       | 50,008 |   |
| Other  comprehensive income (Note 7)               |       |                    | —     |              |       | —                           |       |                                                      | 691        |                   |       | —              |       | —    |       | 691 |   |
| Comprehensive  income                                   |       |                    |       |              |       |                             |       |                                                      |       |                   |       |                |       |      |       | 50,699 |   |
| Issuance of  common stock (Note 8)            |       |                    | 36         |              |       | 66,396                           |       |                                                      | —     |                   |       | —              |       | —    |       | 66,432 |   |
| Stock-based  compensation                               |       |                    | —     |              |       | 1,678                            |       |                                                      | —     |                   |       | —              |       | —    |       | 1,678 |   |
| Loans to officers                                       |       |                    |       |              |       | 20                               |       |                                                      | —     |                   |       | —              |       | —    |       | 20 |   |
| Treasury shares  purchased, at cost (Note 8)       |       |                    | —     |              |       | —                           |       |                                                      | —     |                   |       | —              |       | (45       | )          | (45 | ) |
| Treasury shares  reissued (Note 8)                 |       |                    | —     |              |       | 598                              |       |                                                      | —     |                   |       | —              |       | 577       |       | 1,175 |   |
| Balance,  September 30, 2005                       |       |                    | $          | 589               |       |                             | $          | 241,217                                                   |       |                   | $          | 41,674              |       |      | $          | 256,337 |   | $ | (437 | ) | $ | 539,380 |   |

 

 

See notes to unaudited consolidated financial statements.

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**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)**

| ** **                                                                                                                                            | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                                            | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| ** **                                                                                                                                            | ** ** | **(In thousands)**                             | ** ** |
| Cash flows from  operating activities:                                                                                                                |       |                                                |       |   |   |
| Net income                                                                                                                                            |       | $                                                   | 50,008     |   | 46,468 |   |
| Adjustments to reconcile  net income to net cash provided by operating activities, net of balances  acquired (see Note 3—Business Combinations): |       |                                                |       |   |   |
| Deferred income taxes                                                                                                                                 |       | 18,716                                              |       | 18,595 |   |
| Change in reserves for future policy benefits                                                                                                         |       | 22,921                                              |       | 10,005 |   |
| Change in policy and contract claims                                                                                                                  |       | 15,684                                              |       | (4,795 | ) |
| Change in deferred policy acquisition costs                                                                                                           |       | (48,272                                             | )          | (47,527 | ) |
| Amortization of present value of future profits and  other intangibles                                                                                |       | 4,918                                               |       | 3,687 |   |
| Net accretion of bond discount                                                                                                                        |       | (3,307                                              | )          | (2,612 | ) |
| Amortization of capitalized loan origination fees                                                                                                     |       | 626                                                 |       | 507 |   |
| Change in policy loans                                                                                                                                |       | 769                                                 |       | 693 |   |
| Change in accrued investment income                                                                                                                   |       | 70                                                  |       | 1,601 |   |
| Change in reinsurance balances                                                                                                                        |       | (10,180                                             | )          | 6,302 |   |
| Realized gains on investments                                                                                                                         |       | (5,085                                              | )          | (9,286 | ) |
| Change in income taxes payable                                                                                                                        |       | (1,457                                              | )          | (12,584 | ) |
| Other, net                                                                                                                                            |       | 28,104                                              |       | 97 |   |
| Net cash provided  by operating activities                                                                                                            |       | 73,515                                              |       | 11,151 |   |
| Cash flows from  investing activities:                                                                                                                |       |                                                |       |   |   |
| Proceeds from sale or redemption of fixed maturities                                                                                                  |       | 203,736                                             |       | 265,531 |   |
| Cost of fixed maturities purchased                                                                                                                    |       | (329,743                                            | )          | (247,243 | ) |
| Purchase of business, net of cash acquired (Note 3)                                                                                              |       | —                                              |       | (65,961 | ) |
| Change in due from / to broker                                                                                                                        |       | 28,931                                              |       | (21,666 | ) |
| Other investing activities                                                                                                                            |       | (4,039                                              | )          | (1,727 | ) |
| Net cash used by  investing activities                                                                                                                |       | (101,115                                            | )          | (71,066 | ) |
| Cash flows from  financing activities:                                                                                                                |       |                                                |       |   |   |
| Net proceeds from issuance of common stock                                                                                                            |       | 63,848                                              |       | 3,790 |   |
| Cost of treasury stock purchases                                                                                                                      |       | (45                                                 | )          | (319 | ) |
| Change in policyholder account balances                                                                                                               |       | 15,783                                              |       | 41,522 |   |
| Change in reinsurance on policyholder account  balances                                                                                               |       | 963                                                 |       | (34 | ) |
| Issuance of debt                                                                                                                                      |       | —                                              |       | 66,519 |   |
| Principal repayment on loan payable                                                                                                                   |       | (3,938                                              | )          | (4,391 | ) |
| Net cash provided  by financing activities                                                                                                            |       | 76,611                                              |       | 107,087 |   |
| Net increase in  cash and cash equivalents                                                                                                            |       | 49,011                                              |       | 47,172 |   |
| Cash and cash  equivalents at beginning of period                                                                                                     |       | 181,257                                             |       | 116,524 |   |
| Cash and cash  equivalents at end of period                                                                                                           |       | $                                                   | 230,268    |   | $ | 163,696 |   |
| Supplemental cash flow  information:                                                                                                                  |       |                                                |       |   |   |
| Cash paid during the period for interest                                                                                                              |       | $                                                   | 7,950      |   | $ | 5,449 |   |
| Cash paid during  the period for income taxes                                                                                                         |       | $                                                   | 7,535      |   | $ | 17,207 |   |

 

See notes to unaudited consolidated financial statements.

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**UNIVERSALAMERICAN FINANCIAL CORP. AND SUBSIDIARIESNOTES TO UNAUDITEDCONSOLIDATED FINANCIAL STATEMENTS**

**1.**                                                     *BASIS OF PRESENTATION*

*Basis ofPresentation*

Universal American Financial Corp. (the “Company” or “UniversalAmerican”) is a specialty health and life insurance holding company with anemphasis on providing a broad array of health insurance and managed careproducts and services to the growing senior population. Collectively, ourinsurance company subsidiaries are licensed to sell life and accident &health insurance and annuities in all fifty states, the District of Columbia,Puerto Rico and all the provinces of Canada. The principal insurance productscurrently sold by the Company are Medicare Supplement and Select, fixed benefitaccident and sickness disability insurance, senior life insurance and fixedannuities. The Company distributes these products through an independentgeneral agency system and a career agency system. The career agents focus onsales for Pennsylvania Life, Pyramid Life and Penncorp Life (Canada) while theindependent general agents sell for American Pioneer, American Progressive,Constitution and Union Bankers. Heritage operates Medicare Advantage plans inHouston and Beaumont Texas through SelectCare of Texas, L.L.C., and in Oklahomathrough SelectCare of Oklahoma, Inc., and our Medicare Advantage privatefee-for-service plans in nine states. CHCS, the Company’s administrativeservices company, acts as a service provider for both affiliated andunaffiliated insurance companies for senior market insurance and non-insuranceprograms.

The interim financial information herein is unaudited,but in the opinion of management, includes all adjustments (consisting ofnormal, recurring adjustments) necessary to present fairly the financial positionand results of operations for such periods. The results of operations for thethree months or nine months ended September 30, 2005 and 2004 are notnecessarily indicative of the results to be expected for the full year. Theaccompanying consolidated financial statements and notes should be read inconjunction with the Company’s Annual Report on Form 10-K for theyear ended December 31, 2004.

Certain reclassificationshave been made to prior year’s financial statements to conform to currentperiod classifications.

*Consolidation*

The consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States (“GAAP”) and consolidate the accountsof Universal American Financial Corp. (“Universal American”) and itssubsidiaries (collectively the “Company”), American Progressive Life &Health Insurance Company of New York (“American Progressive”), American PioneerLife Insurance Company (“American Pioneer”), American Exchange Life InsuranceCompany (“American Exchange”), SelectCare of Oklahoma, Inc. (formerlyEagle Life Insurance Company), Pennsylvania Life Insurance Company (“PennsylvaniaLife”), Peninsular Life Insurance Company (“Peninsular”), Union BankersInsurance Company (“Union Bankers”), Constitution Life Insurance Company (“Constitution”),Marquette National Life Insurance Company (“Marquette”), Penncorp LifeInsurance Company, a Canadian company (“Penncorp Life (Canada)”), The PyramidLife Insurance Company (“Pyramid Life”), Heritage Health Systems, Inc (“Heritage”)and CHCS Services, Inc. (“CHCS”). Heritage was acquired on May 28,2004. Operating results for Heritage prior to the date of its acquisition arenot included in Universal American’s consolidated results of operations. Allmaterial intercompany transactions and balances between Universal American andits subsidiaries have been eliminated.

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*Use of Estimates*

The preparation of ourfinancial statements in conformity with GAAP requires us to make estimates andassumptions that affect the amounts of assets and liabilities and disclosuresof assets and liabilities reported by us at the date of the financialstatements and the revenues and expenses reported during the reporting period. Asadditional information becomes available or actual amounts become determinable,the recorded estimates may be revised and reflected in operating results. Actualresults could differ from those estimates. In our judgment, the accountsinvolving estimates and assumptions that are most critical to the preparationof our financial statements are future policy benefits and claim liabilities,deferred policy acquisition costs, goodwill, present value of future profitsand other intangibles, the valuation of certain investments and income taxes. Therehave been no changes in our critical accounting policies during the currentyear.

*SignificantAccounting Policies*

For a description ofsignificant accounting policies, see Note 2—Summary of Significant AccountingPolicies in the notes to the Consolidated Financial Statements included in theCompany’s Annual Report on Form 10-K.

**2.**                                                     *RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS*

*Adoption of NewAccounting Standards*

TheCompany has various stock-based incentive plans for its employees, non-employeedirectors and its agents. Detailed information for activity in the Company’sstock plans can be found in Note 9—Stock-Based Compensation, to theconsolidated financial statements in the Company’s Annual Report on Form 10-K.As permitted by SFAS 123, the Company measures its stock-basedcompensation for employees and directors using the intrinsic value approachunder APB 25. Accordingly, the Company does not recognize compensationexpense upon the issuance of its stock options because the option terms arefixed and the exercise price equaled the market price of the underlying commonstock on the grant date. The Company complies with the provisions ofSFAS 123 by providing pro forma disclosures of net income and related pershare data giving consideration to the fair value method provisions ofSFAS 123. The Company uses a modified Black-Scholes option pricing modelto estimate fair value. For purposes of pro forma disclosures, the estimatedfair value of the options is amortized to expense over the options’ vestingperiods. The following table illustrates the effect on net income and earningsper share if the fair value based method had been applied during each periodpresented.

| ** **                                                                                                   | ** ** | **Three months ended  September  30,**            | ** ** | **Nine months ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2005**                                                              | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                   | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Reported net  income                                                                                         |       | $                                                                     | 15,288     |                                                | $          | 19,542 |   | $ | 50,008 |   | $ | 46,468 |   |
| Add back:  Stock-based compensation expense included in reported net income, net of tax                      |       | 547                                                                   |       | 271                                                 |       | 1,299 |   | 333 |   |
| Less: Stock based  compensation expense determined under fair value based method for all awards,  net of tax |       | (942                                                                  | )          | (754                                                | )          | (2,639 | ) | (1,412 | ) |
| Pro forma net  income                                                                                        |       | $                                                                     | 14,893     |                                                | $          | 19,059 |   | $ | 48,668 |   | $ | 45,389 |   |
| Net income per  share:                                                                                       |       |                                                                  |       |                                                |       |   |   |   |   |
| Basic, as reported                                                                                           |       | $                                                                     | 0.26       |                                                | $          | 0.36 |   | $ | 0.88 |   | $ | 0.85 |   |
| Basic, pro forma                                                                                             |       | $                                                                     | 0.25       |                                                | $          | 0.35 |   | $ | 0.86 |   | $ | 0.83 |   |
| Diluted, as reported                                                                                         |       | $                                                                     | 0.25       |                                                | $          | 0.34 |   | $ | 0.85 |   | $ | 0.82 |   |
| Diluted, pro  forma                                                                                          |       | $                                                                     | 0.25       |                                                | $          | 0.34 |   | $ | 0.83 |   | $ | 0.80 |   |

 

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Pro forma compensationexpense reflected for prior periods is not indicative of future compensationexpense that would be recorded by the Company if it were to adopt the fairvalue based recognition provisions of SFAS 123 for stock basedcompensation for its employees and directors. Future expense may vary basedupon factors such as the number of awards granted by the Company and thethen-current fair market value of such awards.

*Pending AccountingStandards*

In December 2004, the FASB issued SFAS No. 123(revised 2004), “Share-Based Payment” (“SFAS 123R”), which replacesSFAS 123 and supersedes APB Opinion No. 25, “Accounting for StockIssued to Employees”. SFAS 123(R) requires all companies to recognizecompensation costs for share-based payments to employees based on thegrant-date fair value of the award for financial statements for annual periodsbeginning after June 15, 2005. The pro forma disclosures previouslypermitted under SFAS 123 will no longer be an alternative to financialstatement recognition.

As permitted by SFAS 123,the Company currently accounts for share-based payments to employees using APB25’s intrinsic value method and, as such, generally recognizes no compensationcost for employee stock options. Accordingly, the adoption of SFAS 123(R)’sfair value method will have a significant impact on our results of operations,although it will have no impact on our overall financial position. The impactof adoption of SFAS 123(R) cannot be predicted at this time because itwill depend on levels of share-based payments granted in the future. However,had we adopted SFAS 123(R) in prior periods, the impact of that standardwould have approximated the impact of SFAS 123 as described in the abovedisclosure of pro forma net income and earnings per share. SFAS 123(R) alsorequires the benefits of tax deductions in excess of recognized compensationcost to be reported as a financing cash flow, rather than as an operating cashflow as required under current literature. This requirement will reduce netoperating cash flows and increase net financing cash flows in periods afteradoption. While the Company cannot estimate what those amounts will be in thefuture (because they depend on, among other things, when employees exercisestock options), the amount of operating cash flows recognized for such excesstax deductions were $2.6 million for the nine months ended September 30,2005. There were no operating cash flows recognized for such excess taxdeductions for the nine months ended September 30, 2004.

**3.**                                                     *BUSINESS COMBINATIONS*

*Acquisition ofHeritage Health Systems, Inc.*

On May 28, 2004, the Company acquired 100% of theoutstanding common stock of Heritage, a privately owned managed care companythat operates Medicare Advantage plans in Houston and Beaumont Texas, for $98million in cash plus transaction costs of $2.0 million. Heritage generates itsrevenues and profits from three sources. First, Heritage owns an interest inSelectCare of Texas, L.L.C. (“SelectCare”), a health plan that offers healthinsurance coverage to Medicare beneficiaries under a contract with CMS. Next,Heritage operates three separate Management Service Organizations (“MSO’s”)that manage the business of SelectCare and two affiliated Independent PhysicianAssociations (“IPA’s”). Last, Heritage participates in the net results derivedby these IPA’s. The acquisition was financed with $66.5 million of net proceedsderived from the amendment of the Company’s credit facility (See Note 9—LoanPayable) and $33.5 million of cash on hand. As of the date of acquisition,Heritage had approximately 16,000 Medicare members and annualized revenues ofapproximately $140 million. Operating results generated by Heritage prior to May 28,2004, the date of acquisition, are not included in the Company’s consolidatedfinancial statements.

As of May 28, 2005, the company finalized thepurchase accounting for the acquisition, resulting in an increase in the fairvalue of net tangible assets of Heritage of $4.8 million as of the date ofacquisition to $28.0 million, as a result of the resolution of pre-acquisitioncontingencies. The excess of the purchase 

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price over the fair valueof net tangible assets acquired was $72.0 million, which the Company allocatedto identifiable intangible assets. Based on this allocation, approximately$12.2 million was assigned to amortizing intangible assets, including $10.0million (net of deferred income taxes of $5.4 million), which was assigned tothe value of the membership in force and determined to have a weighted averagelife of 6 years and $2.2 million (net of deferred taxes of $1.2 million), whichwas assigned to the value of the IPA’s, and determined to have weighted averagelives of between 6 and 13 years. Approximately $5.2 million was allocated tonon-amortizing intangible assets, including $4.4 million assigned to the valueof trademarks and $0.8 million assigned to the value of Heritage’s licenses. Eachof these items was determined to have indefinite lives. The balance of $54.3million was assigned to goodwill.

Theconsolidated pro forma results of operations, assuming that Heritage waspurchased on January 1, 2004 are as follows:

| ** **                  | ** ** | **Three months ended  September 30,**                  | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                  | ** ** | **2005**                                                              | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                  | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Total revenue               |       | $                                                                     | 236,928    |                                                | $          | 203,721 |   | $ | 690,749 |   | $ | 586,354 |   |
| Income before  taxes        |       | $                                                                     | 24,049     |                                                | $          | 29,318 |   | $ | 76,383 |   | $ | 75,116 |   |
| Net income                  |       | $                                                                     | 15,288     |                                                | $          | 19,542 |   | $ | 50,008 |   | $ | 49,515 |   |
| Earnings per  common share: |       |                                                                  |       |                                                |       |   |   |   |   |
| Basic                       |       | $                                                                     | 0.26       |                                                | $          | 0.36 |   | $ | 0.88 |   | $ | 0.91 |   |
| Diluted                     |       | $                                                                     | 0.25       |                                                | $          | 0.34 |   | $ | 0.85 |   | $ | 0.88 |   |

 

The pro forma results ofoperations reflect management’s best estimate based upon currently availableinformation. The pro forma adjustments are applied to the historical financialstatements of Universal American and Heritage to account for the acquisition ofHeritage under the purchase method of accounting. In accordance with SFAS No. 141,“Business Combinations”, the total purchase cost was allocated to the assetsand liabilities of Heritage based on their relative fair values. Theseallocations are subject to valuations as of the date of the acquisition basedupon appraisals and other information at that time. Management has provided itsbest estimate of the fair values of assets and liabilities for the purpose ofthis pro forma information. The pro forma information presented above is fordisclosure purposes only and is not necessarily indicative of the results ofoperations that would have occurred if the acquisition had been consummated onthe dates assumed, nor is the pro forma information intended to be indicativeof Universal American’s future results of operations.

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**4.**                                                     *INTANGIBLE ASSETS*

Thefollowing table shows the Company’s acquired intangible assets that continue tobe subject to amortization and accumulated amortization expense.

| ** **                                         | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **Value  Assigned**              | ** ** | **Accumulated  Amortization**   | ** ** | **Value  Assigned** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                         | ** ** | **(In thousands)**          | ** ** |
| Senior Market Health  Insurance:                   |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Present value of future profits (“PVFP”) |       | $                                | 18,472     |                            |       | $ | 5,779 |   |   |   | $ | 18,472 |   |   |   | $ | 3,628 |   |   |
| Distribution Channel                               |       | 22,055                           |       |                            | 1,838      |   |   |   | 22,055 |   |   |   | 1,287 |   |   |
| Life  Insurance/Annuity—PVFP                  |       | 4,127                            |       |                            | 1,518      |   |   |   | 4,127 |   |   |   | 1,308 |   |   |
| Senior Managed  Care—Medicare Advantage:      |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| PVFP                                               |       | 15,381                           |       |                            | 3,014      |   |   |   | 18,554 |   |   |   | 1,667 |   |   |
| Value of IPA’s                                |       | 3,459                            |       |                            | 534        |   |   |   | 3,459 |   |   |   | 234 |   |   |
| Senior Administrative  Services                    |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| PVFP                                               |       | 7,672                            |       |                            | 7,189      |   |   |   | 7,672 |   |   |   | 7,035 |   |   |
| Value of future override fees                      |       | 1,796                            |       |                            | 377        |   |   |   | 1,796 |   |   |   | 172 |   |   |
| Total                                              |       | $                                | 72,962     |                            |       | $ | 20,249 |   |   |   | $ | 76,135 |   |   |   | $ | 15,331 |   |   |

 

Thefollowing table shows the changes in the present value of future profits andother amortizing intangible assets.

| ** **                    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30** | ** ** |
|-------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                    | ** ** | **2005**                                   | ** ** | **2004**                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                    | ** ** | **(In thousands)**                         | ** ** |
| Balance,  beginning of period |       | $54,760                                    |       | $62,352                                  |       | $60,804 |   | $44,047 |   |
| Additions and adjustments     |       | —                                     |       | 2,200                                    |       | (3,173 | ) | 22,376 |   |
| Amortization, net of interest |       | (2,047                                     | )          | (1,816                                   | )          | (4,918 | ) | (3,687 | ) |
| Balance, end of period        |       | $52,713                                    |       | $62,736                                  |       | $52,713 |   | $62,736 |   |

 

Estimatedfuture net amortization expense (in thousands) is as follows:

| 2005 (remainder  of year) |   | $      | 2,230  |   |
|---------------------------|--------|--------|--------|--------|
| 2006                      |   | 6,440  |   |
| 2007                      |   | 6,103  |   |
| 2008                      |   | 5,740  |   |
| 2009                      |   | 5,360  |   |
| Thereafter                |   | 26,840 |   |
|                      |   | $      | 52,713 |   |

 

Thecarrying amounts of goodwill and intangible assets with indefinite lives areshown below.

| ** **                                   | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **(In thousands)**      | ** ** |
| Senior Market  Health Insurance              |       |                         | $          | 8,760                       |       |   |   | $ | 8,760 |   |   |
| Senior Managed  Care—Medicare Advantage |       |                         | 59,883     |                        |       |   | 62,063 |   |   |
| Senior  Administrative Services              |       |                         | 4,357      |                        |       |   | 4,357 |   |   |
| Total                                        |       |                         | $          | 73,000                      |       |   |   | $ | 75,180 |   |   |

 

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**5.                  *EARNINGS PER SHARE***

Thereconciliation of the numerators and the denominators for the computation ofbasic and diluted EPS is as follows:

| ** **                                 | ** ** | **Three months ended September  30,** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                                       | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **Income  Numerator**                                          | ** ** | **Shares  Denominator** | ** ** | **Per Share   Amount** | ** ** | **Income  Numerator** | ** ** | **Shares  Denominator** | ** ** | **Per Share   Amount** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                                        | ** ** |
| Weighted average  common stock outstanding |       |                                                           |       |   |   |   | 58,568 |   |   |   |   |   |   |   |   |   |   |   | 54,960 |   |   |   |   |   |   |
| Less: Weighted  average treasury shares    |       |                                                           |       |   |   |   | (53 | ) |   |   |   |   |   |   |   |   |   |   | (133 | ) |   |   |   |   |   |
| Basic earnings  per share                  |       |                                                           | $          | 15,288 |   |   |   | 58,515 |   |   |   | $ | 0.26 |   |   |   | $ | 19,542 |   |   |   | 54,827 |   |   |   | $ | 0.36 |   |   |
| Effect of  dilutive securities             |       |                                                           |       |   |   |   | 2,097 |   |   |   |   |   |   |   |   |   |   |   | 1,897 |   |   |   |   |   |   |
| Diluted earnings per  share                |       |                                                           | $          | 15,288 |   |   |   | 60,612 |   |   |   | $ | 0.25 |   |   |   | $ | 19,542 |   |   |   | 56,724 |   |   |   | $ | 0.34 |   |   |

 

| ** **                                 | ** ** | **Nine months ended September  30,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                 | ** ** | **2005**                                                      | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | **Income  Numerator**                                         | ** ** | **Shares  Denominator** | ** ** | **Per Share   Amount** | ** ** | **Income  Numerator** | ** ** | **Shares  Denominator** | ** ** | **Per Share  Amount** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                                       | ** ** |
| Weighted average  common stock outstanding |       |                                                          |       |   |   |   | 56,694 |   |   |   |   |   |   |   |   |   |   |   | 54,619 |   |   |   |   |   |   |
| Less: Weighted average  treasury shares    |       |                                                          |       |   |   |   | (67 | ) |   |   |   |   |   |   |   |   |   |   | (162 | ) |   |   |   |   |   |
| Basic earnings  per share                  |       |                                                          | $          | 50,008 |   |   |   | 56,627 |   |   |   | $ | 0.88 |   |   |   | $ | 46,468 |   |   |   | 54,457 |   |   |   | $ | 0.85 |   |   |
| Effect of  dilutive securities             |       |                                                          |       |   |   |   | 2,050 |   |   |   |   |   |   |   |   |   |   |   | 1,968 |   |   |   |   |   |   |
| Diluted earnings per  share                |       |                                                          | $          | 50,008 |   |   |   | 58,677 |   |   |   | $ | 0.85 |   |   |   | $ | 46,468 |   |   |   | 56,425 |   |   |   | $ | 0.82 |   |   |

 

**6.                  *INVESTMENTS***

Fixed maturity securities are classified asinvestments available for sale and are carried at fair value, with theunrealized gain or loss, net of tax and other adjustments (deferred policyacquisition costs), included in accumulated other comprehensive income.

Theamortized cost and fair value of fixed maturities are as follows:

| ** **                             | ** ** | **September  30, 2005** | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | ** **                             | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Amortized**                          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Classification**                     | ** ** | **Cost**                               | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                             | ** ** | **(In thousands)**                | ** ** |
| U.S. Treasury  securities and          |       |                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |
| obligations of U.S. government         |       |                                   | $          | 139,553 |   |   |   | $ | 412 |   |   |   | $ | (991 | ) |   | $ | 138,974 |   |
| Corporate debt  securities             |       |                                   | 456,850    |   |   |   | 16,683 |   |   |   | (2,005 | ) |   | 471,528 |   |
| Foreign debt  securities(1)            |       |                                   | 210,043    |   |   |   | 39,667 |   |   |   | (43 | ) |   | 249,667 |   |
| Mortgage and  asset- backed securities |       |                                   | 443,954    |   |   |   | 4,074 |   |   |   | (1,970 | ) |   | 446,058 |   |
|                                   |       |                                   | $          | 1,250,400 |   |   |   | $ | 60,836 |   |   |   | $ | (5,009 | ) |   | $ | 1,306,227 |   |

 

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| ** **                             | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Classification**                     | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                             | ** ** | **(In thousands)**         | ** ** |
| U.S. Treasury  securities and          |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| obligations of U.S. government         |       |                            | $          | 87,552 |   |   |   | $ | 718 |   |   |   | $ | (327 | ) |   | $ | 87,943 |   |
| Corporate debt  securities             |       |                            | 486,142    |   |   |   | 27,467 |   |   |   | (1,830 | ) |   | 511,779 |   |
| Foreign debt  securities(1)            |       |                            | 209,583    |   |   |   | 28,797 |   |   |   | (33 | ) |   | 238,347 |   |
| Mortgage and  asset- backed securities |       |                            | 326,401    |   |   |   | 6,879 |   |   |   | (527 | ) |   | 332,753 |   |
|                                   |       |                            | $          | 1,109,678 |   |   |   | $ | 63,861 |   |   |   | $ | (2,717 | ) |   | $ | 1,170,822 |   |

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(1)          PrimarilyCanadian dollar denominated bonds owned by our Canadian insurance subsidiary.

Theamortized cost and fair value of fixed maturities by contractual maturity at September 30,2005 are shown below. Expected maturities may differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without call or prepayment penalties.

| ** **                              | ** ** | **Amortized**           | ** ** | **Fair**  | ** ** |
|-----------------------------------------|------------|-------------------------|------------|-----------|------------|
| ** **                              | ** ** | **Cost**                | ** ** | **Value** | ** ** |
| ** **                              | ** ** | **(In thousands)** | ** ** |
| Due in 1 year or  less                  |       | $                       | 53,961     |      | $          | 53,918 |   |
| Due after 1 year  through 5 years       |       | 233,394                 |       | 238,527   |       |
| Due after 5 years  through 10 years     |       | 326,056                 |       | 341,320   |       |
| Due after 10  years                     |       | 116,912                 |       | 130,010   |       |
| Mortgage - and  asset-backed securities |       | 520,077                 |       | 542,452   |       |
|                                    |       | $                       | 1,250,400  |      | $          | 1,306,227 |   |

 

The Company did not writedown the value of any fixed maturity securities during the nine months ended September 30,2005 or 2004.

**7.                  *COMPREHENSIVE INCOME***

The components of othercomprehensive income and the related tax effects for each component are asfollows:

| ** **                                                                                        | ** ** | **Three months ended September  30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2005**                                                       | ** ** | **2004** | ** ** |
| ** **                                                                                        | ** ** | **Gross of  Tax**                                         | ** ** | **Tax Effect** | ** ** | **Net of   Tax** | ** ** | **Gross of   Tax** | ** ** | **Tax Effect** | ** ** | **Net of   Tax** | ** ** |
| ** **                                                                                        | ** ** | **(In thousands)**                                        | ** ** |
| Net unrealized gain  (loss) arising during the year (net of deferred acquisition cost adjustment) |       |                                                           | $          | (12,754 | ) |   |   | $ | (4,463 | ) |   | $ | (8,291 | ) |   | $ | 31,216 |   |   |   | $ | 10,926 |   |   | $ | 20,290 |   |
| Less: Reclassification  adjustment for gains included in net income                               |       |                                                           | (982       | ) |   |   | (344 | ) |   | (638 | ) |   | (5,485 | ) |   |   | (1,920 | ) |   | (3,565 | ) |
| Net unrealized gains  (losses)                                                                    |       |                                                           | (13,736    | ) |   |   | (4,807 | ) |   | (8,929 | ) |   | 25,731 |   |   |   | 9,006 |   |   | 16,725 |   |
| Cash flow hedge                                                                                   |       |                                                           | 375        |   |   |   | 131 |   |   | 244 |   |   | (594 | ) |   |   | (208 | ) |   | (386 | ) |
| Currency translation  adjustments                                                                 |       |                                                           | 2,183      |   |   |   | 764 |   |   | 1,419 |   |   | 2,360 |   |   |   | 826 |   |   | 1,534 |   |
| Other comprehensive  income (loss)                                                                |       |                                                           | $          | (11,178 | ) |   |   | $ | (3,912 | ) |   | $ | (7,266 | ) |   | $ | 27,497 |   |   |   | $ | 9,624 |   |   | $ | 17,873 |   |

 

15

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| ** **                                                                                        | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2005**                                                | ** ** | **2004** | ** ** |
| ** **                                                                                        | ** ** | **Gross of   Tax**                            | ** ** | **Tax Effect** | ** ** | **Net of   Tax** | ** ** | **Gross of   Tax** | ** ** | **Tax Effect** | ** ** | **Net of   Tax** | ** ** |
| ** **                                                                                        | ** ** | **(In thousands)**                                 | ** ** |
| Net unrealized gain (loss) arising during the year  (net of deferred acquisition cost adjustment) |       |                                                    | $          | 3,990 |   |   |   | $ | 1,397 |   |   | $ | 2,593 |   |   | $ | 5,999 |   |   |   | $ | 2,100 |   |   | $ | 3,899 |   |
| Less: Reclassification adjustment for gains included  in net income                               |       |                                                    | (5,085     | ) |   |   | (1,780 | ) |   | (3,305 | ) |   | (9,286 | ) |   |   | (3,250 | ) |   | (6,036 | ) |
| Net unrealized gains (losses)                                                                     |       |                                                    | (1,095     | ) |   |   | (383 | ) |   | (712 | ) |   | (3,287 | ) |   |   | (1,150 | ) |   | (2,137 | ) |
| Cash flow hedge                                                                                   |       |                                                    | 595        |   |   |   | 208 |   |   | 387 |   |   | 351 |   |   |   | 123 |   |   | 228 |   |
| Currency translation adjustments                                                                  |       |                                                    | 1,563      |   |   |   | 547 |   |   | 1,016 |   |   | 747 |   |   |   | 261 |   |   | 486 |   |
| Other  comprehensive income (loss)                                                                |       |                                                    | $          | 1,063 |   |   |   | $ | 372 |   |   | $ | 691 |   |   | $ | (2,189 | ) |   |   | $ | (766 | ) |   | $ | (1,423 | ) |

 

**8.                  *STOCKHOLDERS’ EQUITY***

*Preferred Stock*

The Company has 2.0million authorized shares of preferred stock with no such shares issued oroutstanding at September 30, 2005 or December 31, 2004.

*Common Stock*

Thepar value of common stock is $.01 per share with 100 million shares authorizedfor issuance. Changes in the number of shares of common stock issued were asfollows:

| ** **                                            | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                            | ** ** | **2004** | ** ** |
| Common stock  issued, beginning of year               |       | 55,326,092                                          |       | 54,111,923 |   |
| Equity Offering                                       |       | 2,660,000                                           |       | — |   |
| Stock options  exercised                              |       | 811,824                                             |       | 1,001,074 |   |
| Agent stock award                                     |       | 78,167                                              |       | — |   |
| Stock purchases  pursuant to agents’ stock plans |       | 6,951                                               |       | 11,977 |   |
| Common stock issued, end  of period                   |       | 58,883,034                                          |       | 55,124,974 |   |

 

On June 22, 2005, theCompany issued 2.0 million shares of its common stock at a price of $23.61 pershare, in connection with a public offering pursuant to a shelf registration. Theissuance of these shares generated proceeds to the Company of $44.2 million,net of underwriters discount and other issuance costs. Additionally, 5.0million shares were sold by Capital Z Financial Services Fund II, L.P. and itsaffiliates (“Capital Z”), the Company’s largest shareholder, under the sameshelf registration. On July 20, 2005, the underwriters exercised theirover-allotment option and the Company issued an additional 660,000 shares ofits common stock at $23.61 per share, generating additional net proceeds of$14.8 million. Following the offering, Capital Z owned 20.2 million shares, or34.5% of Universal American’s outstanding common stock.

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*Treasury Stock*

TheBoard of Directors has approved a plan for the Company to repurchase up to 1.5million shares of the Company’s common stock in the open market.

| ** **                                         | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                                | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **Shares**                                              | ** ** | **Amount** | ** ** | **Weighted  Average  Cost Per   Share** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost Per   Share** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                                 | ** ** | **(In thousands)** | ** ** |
| Treasury stock,  beginning of year                 |       | 124,941                                                 |       |   | $ | 969 |   |   |   | $ | 7.75 |   |   | 192,863 |   |   | $ | 1,390 |   |   |   | $ | 7.21 |   |   |
| Shares repurchased                                 |       | 2,277                                                   |       |   | 45 |   |   |   | 19.82 |   |   | 30,448 |   |   | 319 |   |   |   | 10.49 |   |   |
| Shares distributed  in the form ofemployee bonuses |       | (74,081                                                 | )          |   | (577 | ) |   |   | 15.87 |   |   | (98,851 | ) |   | (746 | ) |   |   | 10.12 |   |   |
| Treasury stock, end of  period                     |       | 53,137                                                  |       |   | $ | 437 |   |   |   | $ | 8.22 |   |   | 124,460 |   |   | $ | 963 |   |   |   | $ | 7.74 |   |   |

 

Through September 30,2005, the Company had repurchased 793,396 shares at an aggregate cost of $4.5million. As of September 30, 2005, 706,604 shares remained available forrepurchase under the program. Additional repurchases may be made from time totime at prevailing prices, subject to restrictions on volume and timing.

*Accumulated OtherComprehensive Income*

Thecomponents of accumulated other comprehensive income are as follows:

| ** **                                 | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **(In thousands)**      | ** ** |
| Net unrealized appreciation on investments |       |                         | $          | 55,845                      |       |   |   | $ | 61,150 |   |   |
| Deferred  acquisition cost adjustment      |       |                         | (3,565     | )                           |       |   | (7,776 | ) |   |
| Foreign currency  translation gains        |       |                         | 10,408     |                        |       |   | 8,845 |   |   |
| Fair value of  cash flow swap              |       |                         | 1,426      |                        |       |   | 832 |   |   |
| Deferred tax on  the above                 |       |                         | (22,440    | )                           |       |   | (22,068 | ) |   |
| Accumulated other  comprehensive income    |       |                         | $          | 41,674                      |       |   |   | $ | 40,983 |   |   |

 

**9.                  *LOAN PAYABLE***

*Credit Facility, asAmended in May 2004*

In connection with the acquisition of Heritage on May 28,2004 (see Note 3 - Business Combinations), the Company amended the CreditAgreement by increasing the facility to $120 million from $80 million (the “AmendedCredit Agreement”), including an increase in the term loan portion to $105million from $36.4 million (the balance outstanding at May 28, 2004) andmaintaining the $15 million revolving loan facility. None of the revolving loanfacility has been drawn as of September 30, 2005. Under the Amended CreditAgreement, the spread over LIBOR was reduced to 225 basis points. Effective October 1,2005, the interest rate on the term loan is 6.1%. Principal repayments arescheduled at $5.3 million per year over a five-year period with a final paymentof $80.1 million due upon maturity on March 31, 2009.

The Company made regularly scheduled principalpayments of $3.9 million and paid interest of $4.0 million in connection withits credit facilities during the nine months ended September 30, 2005. Duringthe nine months ended September 30, 2004, the Company made regularlyscheduled principal payments of $4.4 million and paid interest of $2.0 million inconnection with its credit facilities.

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Thefollowing table shows the schedule of principal payments (in thousands)remaining on the Amended Credit Agreement, with the final payment in March 2009:

| 2005 (remainder  of year) |   | $      | 1,312  |   |
|---------------------------|--------|--------|--------|--------|
| 2006                      |   | 5,250  |   |
| 2007                      |   | 5,250  |   |
| 2008                      |   | 5,250  |   |
| 2009                      |   | 80,063 |   |
|                      |   | $      | 97,125 |   |

 

**10.**                                              *OTHER LONG TERM DEBT*

The Company has formed statutory business trusts,which exist for the exclusive purpose of issuing trust preferred securitiesrepresenting undivided beneficial interests in the assets of the trust,investing the gross proceeds of the trust preferred securities in juniorsubordinated deferrable interest debentures of the Company and engaging in onlythose activities necessary or incidental thereto. In accordance with theadoption of FIN 46R, the Company has deconsolidated the trusts. Separatesubsidiary trusts of the Company (the “Trusts”) have issued a combined $75.0million in thirty-year trust preferred securities that mature in 2032 and 2033.

The Company paid interestof $4.0 million in connection with the Junior Subordinated Debt during the ninemonths ended September 30, 2005 and paid interest of $3.5 million duringthe nine months ended September 30, 2004.

**11.**                                              *DERIVATIVE INSTRUMENTS—CASH FLOW HEDGE*

Effective September 4,2003, the Company entered into a swap agreement whereby it pays a fixed rate of6.7% on a $15.0 million notional amount relating to the December 2002trust preferred securities issuance, in exchange for a floating rate of LIBORplus 400 basis points, capped at 12.5%. The swap contract expires in December 2007.Effective April 29, 2004, the Company entered into a second swap agreementwhereby it pays a fixed rate of 6.98% on a $20.0 million notional amountrelating to the October 2003 trust preferred securities issuance, inexchange for a floating rate of LIBOR plus 395 basis points, capped at 12.45%. Theswap contract expires in October 2008. The swaps are designated andqualify as cash flow hedges, and changes in their fair value are recorded inaccumulated other comprehensive income. The combined fair value of the swapswas $1.5 million at September 30, 2005 and $0.8 million at December 31,2004 and is included in other assets.

**12.**                                              *STATUTORY FINANCIAL DATA*

The insurance subsidiaries are required to maintainminimum amounts of statutory capital and surplus as required by regulatoryauthorities. However, substantially more than such minimum amounts are neededto meet statutory and administrative requirements of adequate capital andsurplus to support the current level of our insurance subsidiaries’ operations.Each of the life insurance subsidiaries’ statutory capital and surplus exceedsits respective minimum statutory requirement at levels we believe aresufficient to support their current levels of operation. Additionally, theNational Association of Insurance Commissioners (“NAIC”) imposes regulatoryrisk-based capital (“RBC”) requirements on life insurance enterprises. At September 30,2005, all of our life insurance subsidiaries maintained ratios of totaladjusted capital to RBC in excess of the “authorized control level”. Thecombined statutory capital and surplus, including asset valuation reserve, ofthe U.S. life insurance subsidiaries totaled $149.2 million at September 30,2005 and $127.9 million at December 31, 2004.

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Our health plan affiliates are also required tomaintain minimum amounts of capital and surplus, as required by regulatoryauthorities and is also subject to RBC requirements. At September 30,2005, the statutory capital and surplus of each of our health plan affiliatesexceeds its minimum requirement and its RBC is in excess of the “authorizedcontrol level”. The statutory capital and surplus for our health plan affiliateswas $20.8 million at September 30, 2005 and $9.9 million at December 31,2004.

Penncorp Life (Canada)reports to Canadian regulatory authorities based upon Canadian statutoryaccounting principles that vary in some respects from U.S. statutory accountingprinciples. Penncorp Life (Canada)’s net assets based upon Canadian statutoryaccounting principles were C$62.9 million (US$54.1 million) as of September 30,2005 and were C$57.4 million (US$47.8 million) as of December 31, 2004. PenncorpLife (Canada) maintained a Minimum Continuing Capital and Surplus RequirementRatio (“MCCSR”) in excess of the minimum requirement at September 30,2005.

**13.**                                              *BUSINESS SEGMENT INFORMATION*

The Company’s principal business segments are based onproduct and include:  Senior MarketHealth Insurance; Senior Managed Care—Medicare Advantage; Specialty HealthInsurance; Life Insurance and Annuity; and Senior Administrative Services. TheCompany also reports the activities of our holding company in a separatecorporate segment. Prior to our Annual Report on Form 10-K for theyear ended December 31, 2004, the Company reported its segments based ondistribution channel. The Company’s former Senior Market Brokerage and CareerAgency segments have been replaced with the three new segments:  Senior Market Health Insurance, LifeInsurance and Annuity, and Specialty Health Insurance. The Senior Managed Care—MedicareAdvantage and Administrative Services segments remain unchanged. Managementbelieves that this new segmentation will provide even greater clarity to theresults of the Company. Reclassifications have been made to conform prior yearamounts to the current year presentation. A description of these segmentsfollows:

**Senior Market Health Insurance**—Thissegment consists primarily of our Medicare Supplement business and other seniormarket health products distributed through our career agency sales force andthrough our network of independent general agencies. This segment will alsoinclude the business that we generate through the sale of prescription drugplans by our insurance subsidiaries. See the “Significant Transactions andInitiatives” section of the Management’s Discussion and Analysis included inthis Form 10-Q.

**Senior Managed Care—Medicare Advantage—**TheSenior Managed Care - Medicare Advantage segment includes the operations ofHeritage and our other initiatives in managed care for seniors. Heritageoperates Medicare Advantage plans in Houston and Beaumont Texas, and inOklahoma, and our Medicare Advantage private fee-for-service plans in ninestates. Heritage’s Medicare Advantage plans are sold by our career agency salesforce and directly by employee representatives. Our Medicare Advantage privatefee-for-service plans are sold by career and independent agents.

**Specialty Health Insurance**—TheSpecialty Health Insurance segment includes specialty health insuranceproducts, primarily fixed benefit accident and sickness disability insurancesold to the middle income self-employed market in the United States and Canada.This segment also includes certain products that we no longer sell such as longterm care and major medical insurance. This segment’s products are distributedprimarily by our career agents.

**Life Insurance and Annuity**—Thissegment includes all of the life insurance and annuity business sold in theUnited States. This segment’s products include senior, traditional anduniversal life insurance and fixed annuities and are distributed through both independent general agents andour career agency distribution systems.

19

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**Senior Administrative Services**—Oursenior administrative services subsidiary acts as a third party administratorand service provider of senior market insurance products and geriatric caremanagement for both affiliated and unaffiliated insurance companies. Theservices provided include policy underwriting and issuance, telephone and face-to-faceverification, policyholder services, claims adjudication and payment, casemanagement, care assessment and referral to health care facilities.

**Corporate—**This segment reflectsthe activities of Universal American, including debt service, certain seniorexecutive compensation, and compliance with requirements resulting from ourstatus as a public company.

Intersegment revenues and expenses are reported on agross basis in each of the operating segments but eliminated in theconsolidated results. These intersegment revenues and expenses affect theamounts reported on the individual financial statement line items, but areeliminated in consolidation and do not change income before taxes. Thesignificant items eliminated include intersegment revenue and expense relatingto services performed by the Senior Administrative Services segment for ourother segments and interest on notes payable or receivable between theCorporate segment and the other operating segments.

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

| ** **                                   | ** ** | **Three months ended September 30,** | ** ** |
|----------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                                 | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **Segment  Revenue**                                     | ** ** | **Segment  Income** | ** ** | **Segment  Revenue** | ** ** | **Segment  Income** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                                  | ** ** |
| Senior Market  Health Insurance              |       | $                                                        | 99,830     |   | $ | 5,563 |   | $ | 90,725 |   | $ | 8,277 |   |   |
| Senior Managed  Care—Medicare Advantage |       | 62,707                                                   |       | 7,467 |   | 39,533 |   | 4,942 |   |   |
| Specialty Health  Insurance                  |       | 44,187                                                   |       | 6,836 |   | 43,400 |   | 7,338 |   |   |
| Life Insurance  and Annuity                  |       | 24,869                                                   |       | 4,304 |   | 21,701 |   | 3,711 |   |   |
| Senior  Administrative Services              |       | 14,573                                                   |       | 2,846 |   | 14,075 |   | 3,096 |   |   |
| Corporate                                    |       | 497                                                      |       | (3,949 | ) | 16 |   | (3,531 | ) |   |
| Intersegment  revenues                       |       | (10,779                                                  | )          | — |   | (10,938 | ) | — |   |   |
| Adjustments to  segment amounts:             |       |                                                     |       |   |   |   |   |   |   |   |
| Net realized gains(1)                        |       | 982                                                      |       | 982 |   | 5,485 |   | 5,485 |   |   |
| Premium revenue adjustment(2)                |       | 62                                                       |       | — |   | (276 | ) | — |   |   |
| Total                                        |       | $                                                        | 236,928    |   | $ | 24,049 |   | $ | 203,721 |   | $ | 29,318 |   |   |

 

| ** **                                   | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                                | ** ** | **2004** | ** ** |
| ** **                                   | ** ** | **Segment  Revenue**                                    | ** ** | **Segment  Income** | ** ** | **Segment  Revenue** | ** ** | **Segment  Income** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                                 | ** ** |
| Senior Market  Health Insurance              |       | $                                                       | 296,868    |   | $ | 20,841 |   | $ | 268,755 |   | $ | 24,240 |   |
| Senior Managed  Care—Medicare Advantage |       | 173,836                                                 |       | 21,597 |   | 51,491 |   | 5,780 |   |
| Specialty Health  Insurance                  |       | 132,013                                                 |       | 19,208 |   | 130,805 |   | 20,341 |   |
| Life Insurance  and Annuity                  |       | 71,071                                                  |       | 11,749 |   | 62,063 |   | 9,990 |   |
| Senior  Administrative Services              |       | 44,184                                                  |       | 9,502 |   | 42,000 |   | 9,583 |   |
| Corporate                                    |       | 606                                                     |       | (11,599 | ) | 86 |   | (8,791 | ) |
| Intersegment  revenues                       |       | (32,991                                                 | )          | — |   | (33,048 | ) | — |   |
| Adjustments to  segment amounts:             |       |                                                    |       |   |   |   |   |   |   |
| Net realized gains(1)                        |       | 5,085                                                   |       | 5,085 |   | 9,285 |   | 9,285 |   |
| Premium revenue adjustment(2)                |       | 77                                                      |       | — |   | (2,554 | ) | — |   |
| Total                                        |       | $                                                       | 690,749    |   | $ | 76,383 |   | $ | 528,883 |   | $ | 70,428 |   |

 

20

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(1)          We evaluate the resultsof operations of our segments based on income before realized gains and lossesand income taxes. Management believes that realized gains and losses are notindicative of overall operating trends.

(2)          We evaluate the resultsof our insurance segments based on incurred premium net of the change inunearned premium. The change in unearned premium is reported as part of the netincrease in future policy benefits in the consolidated statements of operations.Management believes that including the change in unearned premium in revenueprovides more indicative trends for the purpose of evaluating loss ratios.

Identifiableassets by segment are as follows:

| ** **                                   | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **(In thousands)**      | ** ** |
| Senior Market  Health Insurance              |       |                         | $          | 424,874                     |       |   |   | $ | 385,487 |   |   |
| Senior Managed  Care—Medicare Advantage |       |                         | 181,036    |                        |       |   | 136,349 |   |   |
| Specialty Health  Insurance                  |       |                         | 816,960    |                        |       |   | 732,680 |   |   |
| Life Insurance  and Annuity                  |       |                         | 755,858    |                        |       |   | 723,343 |   |   |
| Senior  Administrative Services              |       |                         | 21,234     |                        |       |   | 19,401 |   |   |
| Corporate                                    |       |                         | 722,683    |                        |       |   | 608,722 |   |   |
| Intersegment  assets(1)                      |       |                         | (653,223   | )                           |       |   | (588,894 | ) |   |
| Total Assets                                 |       |                         | $          | 2,269,422                   |       |   |   | $ | 2,017,088 |   |   |

----

(1)         Intersegmentassets include the elimination of the parent holding company’s investment inits subsidiaries as well as the elimination of other intercompany balances.

**14.**                                              *FOREIGN OPERATIONS*

A portionof the Company’s operations is conducted in Canada through Penncorp Life(Canada). These assets and liabilities are located in Canada where theinsurance risks are written. Revenues, excluding capital gains and losses, ofthe Company by geographic distribution by country are as follows:

| ** **    | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **    | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **    | ** ** | **(In thousands)**                              | ** ** |
| United States |       | $                                                    | 217,368    |                                                | $          | 181,439 |   | $ | 630,710 |   | $ | 469,356 |   |
| Canada        |       | 18,578                                               |       | 16,797                                              |       | 54,955 |   | 50,242 |   |
| Total         |       | $                                                    | 235,946    |                                                | $          | 198,236 |   | $ | 685,665 |   | $ | 519,598 |   |

 

Totalassets and liabilities of Penncorp Life (Canada), located entirely in Canada,are as follows:

| ** **  | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **  | ** ** | **(In thousands)**      | ** ** |
| Assets      |       |                         | $          | 270,165                     |       |   |   | $ | 233,741 |   |   |
| Liabilities |       |                         | $          | 207,202                     |       |   |   | $ | 188,125 |   |   |

 

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**Item2.—Management’s Discussion and Analysis of Financial Condition and Results ofOperations.**

**RESULTS OFOPERATIONS**

**Introduction**

The following discussionand analysis presents a review of the Company as of September 30, 2005,and its results of operations for the three months and nine months ended September 30,2005. This Management’s Discussion and Analysis of Financial Condition andResults of Operations should be read in conjunction with the consolidatedfinancial statements as well as the Management’s Discussion and Analysis ofFinancial Condition and Results of Operations included in the Company’s 2004Annual Report on Form 10-K.

**Overview**

Our principal businesssegments are based on product and include: Senior Market Health Insurance; Senior Managed Care—Medicare Advantage;Specialty Health Insurance; Life Insurance and Annuity; and SeniorAdministrative Services. We also report the activities of our holding companyin a separate corporate segment. Previously, we reported our segments based ondistribution channel. Our former Senior Market Brokerage and Career Agencysegments have been replaced with the three new segments: Senior Market HealthInsurance, Life Insurance and Annuity, and Specialty Health Insurance. OurSenior Managed Care—Medicare Advantage and Senior Administrative Servicessegments are unchanged. We believe that this new segmentation will provide evengreater clarity to our results. Reclassifications have been made to conformprior year amounts to the current year presentation. See “Note 13—BusinessSegment Information” in our consolidated financial statements included in this Form 10-Qfor a description of our segments.

**CriticalAccounting Policies**

Our consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States (“GAAP”). The preparation of ourfinancial statements in conformity with GAAP requires us to make estimates andassumptions that affect the amounts of assets and liabilities and disclosuresof assets and liabilities reported by us at the date of the financialstatements and the revenues and expenses reported during the reporting period. Asadditional information becomes available or actual amounts become determinable,the recorded estimates may be revised and reflected in operating results. Actualresults could differ from those estimates. Accounts that, in our judgment, aremost critical to the preparation of our financial statements include policyliabilities and accruals, deferred policy acquisition costs, intangible assets,valuation of certain investments and deferred income taxes. There have been nochanges in our critical accounting policies during the current quarter.

***Policyrelated liabilities***

We calculate and maintain reserves for the estimatedfuture payment of claims to our policyholders using the same actuarialassumptions that we use in the pricing of our products. For our accident andhealth insurance business, we establish an active life reserve for expectedfuture policy benefits, plus a liability for due and unpaid claims, claims inthe course of settlement and incurred but not reported claims. Many factors canaffect these reserves and liabilities, such as economic and social conditions,inflation, hospital and pharmaceutical costs, changes in doctrines of legalliability, premium rate increases and extra contractual damage awards. Therefore,the reserves and liabilities we establish are based on extensive estimates,assumptions and prior years’ statistics. When we acquire other insurancecompanies or blocks of insurance, our assessment of the adequacy of acquiredpolicy liabilities is subject to similar estimates and assumptions. Establishingreserves involves inherent uncertainties, and it is possible that actual claims

22

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couldmaterially exceed our reserves and have a material adverse effect on ourresults of operations and financial condition. Our net income dependssignificantly upon the extent to which our actual claims experience isconsistent with the assumptions we used in setting our reserves and pricing ourpolicies. If our assumptions with respect to future claims are incorrect, andour reserves are insufficient to cover our actual losses and expenses, we wouldbe required to increase our liabilities resulting in reduced net income and shareholders’equity.

***Deferredpolicy acquisition costs***

The cost of acquiring newbusiness, principally non-level commissions, agency production, policyunderwriting, policy issuance, and associated costs, all of which vary with,and are primarily related to the production of new and renewal business, aredeferred. For interest-sensitive life and annuity products, these costs areamortized in relation to the present value of expected gross profits on thepolicies arising principally from investment, mortality and expense margins inaccordance with SFAS No. 97, “Accounting and Reporting by InsuranceEnterprises for Certain Long-Duration Contracts and for Realized Gains andLosses from the Sale of Investments”. For other life and health products, thesecosts are amortized in proportion to premium revenue using the same assumptionsused in estimating the liabilities for future policy benefits in accordancewith SFAS No. 60, “Accounting and Reporting by Insurance Enterprises.”  Amortization of deferred acquisition costsfor Medicare supplement policies is periodically adjusted for significantchanges in benefit structures and differences in assumed premium rates on aprospective basis, consistent with assumptions used in the related reserves forfuture policy benefits. During 2005, the Company determined that the actualapproved rate increases and persistency were higher than assumed levels. Theprospective unlocking of these assumptions resulted in a slower amortization ofMedicare supplement deferred acquisition costs.

The determination ofexpected gross profits for interest-sensitive products is an inherentlyuncertain process that relies on assumptions including projected interestrates, the persistency of the policies issued as well as anticipated benefits,commissions and expenses. It is possible that the actual profits from thebusiness may vary materially from the assumptions used in the determination andamortization of deferred acquisition costs. Deferred policy acquisition costsare written off to the extent that it is determined that future policy premiumsand investment income or expected gross profits would not be adequate torecover the unamortized costs.

***Present****value of futureprofits and other intangibles*

Business combinationsaccounted for as a purchase result in the allocation of the purchaseconsideration to the fair values of the assets and liabilities acquired,including the present value of future profits, establishing such fair values asthe new accounting basis. The present value of future profits is based on anestimate of the cash flows of the in-force business acquired, discounted toreflect the present value of those cash flows. The discount rate selecteddepends upon the general market conditions at the time of the acquisition andthe inherent risk in the transaction. Purchase consideration in excess of thefair value of net assets acquired, including the present value of futureprofits and other identified intangibles, for a specific acquisition, isallocated to goodwill. Allocation of purchase price is performed in the periodin which the purchase is consummated. Adjustments, if any, in subsequentperiods relate to resolution of pre-acquisition contingencies and refinementsmade to estimates of fair value in connection with the preliminary allocation.

Amortization of presentvalue of future profits is based upon the pattern of the projected cash flowsof the in-force business acquired, over weighted average lives ranging from sixto forty years. Other identified intangibles are amortized over their estimatedlives.

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On a periodic basis,management reviews the unamortized balances of present value of future profits,goodwill and other identified intangibles to determine whether events orcircumstances indicate the carrying value of such assets is not recoverable, inwhich case an impairment charge would be recognized. Management believes thatno impairments of present value of future profits, goodwill or other identifiedintangibles existed as of September 30, 2005.

***Investmentvaluation***

Fair value of investmentsis based upon quoted market prices, where available, or on values obtained fromindependent pricing services. For certain mortgage and asset-backed securities,the determination of fair value is based primarily upon the amount and timingof expected future cash flows of the security. Estimates of these cash flowsare based upon current economic conditions, past credit loss experience andother circumstances.

We regularly evaluate theamortized cost of our investments compared to the fair value of thoseinvestments. Impairments of securities generally are recognized when a declinein fair value below the amortized cost basis is considered to beother-than-temporary. Generally, we consider a decline in fair value to beother-than-temporary when the fair value of an individual security is belowamortized cost for an extended period and we do not believe that recovery infair value is probable. Impairment losses for certain mortgage and asset-backedsecurities are recognized when an adverse change in the amount or timing ofestimated cash flows occurs, unless the adverse change is solely a result ofchanges in estimated market interest rates and we intend to hold the securityuntil maturity. The cost basis for securities determined to be impaired arereduced to their fair value, with the excess of the cost basis over the fairvalue recognized as a realized investment loss.

***Incometaxes***

We use the liabilitymethod to account for deferred income taxes. Under the liability method,deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective taxbases. Deferred tax assets and liabi­lities are measured using enacted taxrates expected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date of a change in tax rates.

We establish valuationallowances on our deferred tax assets for amounts that we determine will not berecoverable based upon our analysis of projected taxable income and our abilityto implement prudent and feasible tax planning strategies. Increases in thesevaluation allowances are recognized as deferred tax expense. Subsequentdeterminations that portions of the valuation allowances are no longernecessary are reflected as deferred tax benefits. To the extent that valuationallowances were established in conjunction with acquisitions, changes in thoseallowances are first applied to increasing or decreasing the goodwill (but notbelow zero) or other intangibles related to the acquisition and then applied asan increase or decrease in income tax expense.

During the nine monthsended September 30, 2005, we released approximately $1.1 million ofvaluation allowances on tax capital loss as a result of investments gains takenduring that period, including the release of $0.1 million during the thirdquarter. As of September 30, 2005 we have $2.6 million of valuationallowances on tax capital loss carryforwards remaining.

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**SignificantTransactions and Initiatives**

***SeniorMarket Initiatives***

We believe that attractivegrowth opportunities exist in providing a range of products, particularlyindividual health insurance, to the growing senior market. At present, morethan 41 million Americans are eligible for Medicare. According to the U.S.Census Bureau, more than 2 million Americans turn 65 in the United Stateseach year, and this number is expected to grow faster as the so-called babyboomers begin to turn 65. In addition, many large employers, who traditionallyhave provided retiree medical coverage, have begun to curtail their offerings. Finally,the passage of the Medicare Modernization Act of 2003 (the “MMA”) expanded thehealthcare options available to Medicare beneficiaries through private insurersby, among other things, increasing the reimbursement rates to Medicare managedcare plans (“Medicare Advantage”) and making available a subsidizedprescription drug insurance benefit pursuant to Part D. Taken together,these conditions present significant opportunities for us to increase the saleof our core products.

***MedicareSupplement***

In the past ten years, wehave become a successful provider of Medicare Supplement coverage as well asother products designed for the senior market. The primary elements of oursuccess have been broad and deep distribution, active risk management andopportunistic acquisitions. We believe that the market for Medicare Supplementproducts will continue to be vibrant, especially because many seniors may losesimilar coverage that had previously been offered to them as a retiree benefitby their former employers.

Recently, there has beenincreased competition from other Medicare Supplement carriers, as well as fromMedicare Advantage plans, which has affected our production of MedicareSupplement business. We believe that based on our established distributionforce, the markets that we serve (which are primarily non-urban markets) andthe development of our Part D initiatives, we will be able to maintain andgrow this block of business.

During the third quarter of2005, we experienced Medicare supplement claim costs that were higher than thethird quarter of the prior year, and higher than we had anticipated. Overallloss ratios for the segment increased 190 basis points to 71.7% for the thirdquarter of 2005 compared to 69.8% for the third quarter of 2004. The thirdquarter 2005 loss ratios were approximately 290 basis points higher than we hadanticipated for the quarter. The increase was primarily as a result ofhigher-than-anticipated outpatient doctor (Part B) and skilled nursingfacility utilization. Historically, we have experienced a trend of loss ratioimprovement throughout the year. We believe that this trend may not be assignificant in the future. We continue to actively pursue rate increases tooffset the trends in claim costs for this line.

We also experienced higherthan expected lapsation in our Medicare supplement business, largely caused bythe departure of three sales managers in one of our career companies. Thisrequired us to accelerate the amortization of the deferred acquisition cost andpresent value of future profits assets associated with the business thatlapsed. We believe, but cannot give assurances, that this type of activity willnot continue. However, increased competition in this market may result in morelapsation than we have experienced in the past, thus requiring fasteramortization of the deferred assets.

***MedicareAdvantage***

As a result of theincreased reimbursement rates from the Centers for Medicare and Medicaid Services(“CMS”) to Medicare Advantage plans, which allows them to offer more attractivebenefits, including enhanced prescription drug coverage pursuant to Part D,we believe that enrollment in Medicare Advantage programs is likely to increasein the coming years.

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During the third quarterof 2005, we expanded our private-fee-for-service (“PFFS”) product offering toseven additional states, for a total of nine states in which we currently offerthis product. In January 2006, we will begin to market this product in sixmore states, bringing the total number of states in which we will be sellingPFFS products to fifteen, representing 458 counties with approximately fivemillion Medicare eligible seniors. In addition, we have received approval fromCMS to offer an HMO product in three counties in Florida (Brevard, Broward andDade) in 2006.

***Medicare Part D***

Part D, which wasestablished by the Medicare Modernization Act of 2003, created a structure inwhich private insurance companies and Medicare Advantage plans will offerMedicare-sponsored prescription drug insurance plans to Medicare beneficiaries.The federal government will support Part D through a combination of directsubsidies of premium, risk adjustors, stop-loss reinsurance and risk corridors.Further, the federal government will provide additional subsidies to Medicarebeneficiaries who also qualify for Medicaid (“dual eligible”) and other lowincome subsidy (“LIS”) beneficiaries.

In March 2005,we entered into a strategic alliance with PharmaCare Management Services, Inc.(“PharmaCare”), a pharmacy benefits manager (“PBM”) that is a wholly ownedsubsidiary of CVS Corporation (“CVS”). CVS operates over 5,400 retail drugstores under the CVS/pharmacy name. PharmaCare is the fourth largest PBM in thenation, covering more than 30 million lives. The essential elements of thestrategic alliance are:

·       Threeof our insurance subsidiaries applied to the CMS to become a Prescription DrugPlan sponsor (“PDP”) in 32 of the 34 regions designated by CMS, therebybecoming eligible, upon final approval by CMS, to offer the Medicare-approvedplans in those regions.

·       ThePDP’s would contract with PharmaCare to provide the full range of PBM servicesrequired to operate the PDP’s.

·       Asubsidiary of PharmaCare would reinsure approximately half of the risk assumedby our PDP’s.

·       CVS/pharmacystores would assist in the marketing of our PDP’s on a non-exclusive basis,subject to the rules established by CMS.

In March 2005, threeof our insurance subsidiaries applied to become PDP’s in 32 of the 34 CMSregions, and subsequently received conditional approval from CMS to become asponsor in those regions*.*

In June 2005, our PDP’s,in consultation with PharmaCare, submitted bids for a wide range of Part Dproducts that we believe will be attractive to a variety of Medicarebeneficiaries and will, in our judgment, result in an appropriate financialreturn to our PDP’s. We submitted bids for the standard product prescribed byCMS, for products that are actuarially equivalent to the standard product andfor products with enhanced benefits.

On September 23,2005, CMS notified us that our bids were accepted in all 32 of the regions inwhich we bid.

***Dual Eligibles***

A dual eligible beneficiarywill have the right to enroll in a qualifying standard PDP product beginning November 15,2005. However, dual eligible beneficiaries who do not enroll themselves in aPDP will be automatically assigned on a pro rata basis by CMS to one of the PDP’swho meet applicable pricing regional benchmarks. We expect that most dualeligible beneficiaries will be automatically assigned.

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Recently, CMS released itscalculation of the national and regional benchmarks for standard plans. Thestandard bids of our PDP’s are below the benchmark in 26 regions, encompassingapproximately 4.5 million dual eligible beneficiaries. Based on the number ofother PDP sponsors whose bids are also below the benchmark in these regions,our preliminary estimate is that we will receive 350,000 automatic assignments,less those who choose a different plan. We estimate that our average basepremium will be $89.50 per member per month subject to further modification bythe risk adjustors. Dual eligible beneficiaries automatically will receive aninitial 8% risk adjustment, but the final risk adjustment will vary based uponthe health status of each covered beneficiary. The regions in which our bid wasnot below the benchmark were Regions 11 (Florida), 12 (Alabama and Tennessee),14 (Ohio), 28 (Arizona), 29 (Nevada) and 21 (California).

Dual eligiblebeneficiaries can change their PDP each month. As a result, there can be noassurance that the dual eligible beneficiaries who are automatically assignedto us will stay in our PDP’s.

***Low Income Subsidy***

Medicare beneficiaries whoqualify for the low income subsidy (“LIS”) can choose to enroll in the PDP oftheir choice. In May 2006, those beneficiaries who qualify for thissubsidy but do not so enroll will be automatically assigned by CMS to one of thePDP’s whose bids for the standard product fall below the applicable regionalbenchmark.

We estimate that there are3.5 million LIS beneficiaries in the regions in which our bids are below theapplicable regional benchmark. Since we cannot predict how many LISbeneficiaries will sign up for programs voluntarily, we cannot estimate thenumber of LIS beneficiaries who may be auto-assigned to our PDP’s.

***Marketing***

Thereare more than 30 million Medicare beneficiaries who will not be automaticallyassigned to PDP’s and are eligible to buy this coverage voluntarily. Enrollmentfor this population begins November 15, 2005 for a January 1, 2006effective date. Our efforts to market our products to this population will haveseveral components:

·       *Branding:*   Our PDP’s are marketed under the trademarkedbrand name, *Prescription Pathway**SM *.

·       *Current Policyholders:*   We are focusing on providinginformation and then selling our products to our existing policyholder base,principally our 300,000 existing Medicare Supplement policyholders.

·       *Agency Force:*   We are educating and mobilizing ourcareer and independent agents to offer our products in the 32 regions in whichour PDP’s are approved. To help educate Medicare beneficiaries about Part DPDP’s, we are offering local seminars hosted by our agents at senior centersand residential facilities.

·       *CVS Stores:*   We are continuing to work closely withPharmaCare and CVS to create appropriate marketing programs in the CVS storesconsistent with CMS marketing requirements, using our agents.

·       *Website andCall Center:*   We are providing information and enrollmentonline at our website and over the phone through our call center. Our website alsoprovides formulary and pharmacy searches, to enable prospective members todetermine if their prescription drug needs are addressed in our formularies andif their local pharmacy is part of our pharmacy network.

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***Alliance with Arkansas Blue Cross/Blue Shield***

We have entered into analliance with a PDP sponsored by Arkansas Blue Cross and Blue Shield, thelargest health insurer in Arkansas. The company affiliates have more than 2,700employees and serve approximately one-third of Arkansans, including more than113,000 Medicare supplement policyholders.

Pursuant to this alliance,CHCS Services, Inc., our senior administrative services company, willprovide all administrative services for this PDP’s entrance into the Part Dprogram in the Arkansas region. PharmaCare will provide all PBM services. Aninsurance company subsidiary of Universal American will provide 33.3%reinsurance to this PDP. The PDP sponsored by Arkansas Blue Cross and BlueShield has submitted a bid that qualifies for automatic enrollment of dualeligible and LIS beneficiaries.

There are significantrisks associated with our participation in the Medicare Part D program. Seethe “Risk Factor” section of this Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.

***ReinsuranceArrangement***

During the third quarterof 2005, we commenced a new reinsurance arrangement with PharmaCare Captive Re,Ltd. Under the terms of the agreement, we provide an insured drug benefit forthe employees of the State of Connecticut. The risk is reinsured to PharmaCare’sreinsurance subsidiary under a 100% quota share contract. We receive an underwritingfee of two percent of premium. Annualized premium in force on this block ofbusiness is approximately $260 million. As a result of this arrangement, bothdirect and ceded premium increased by approximately $65 million for thequarter, with no impact on net premium.

***EquityOffering***

On June 22, 2005, weissued 2.0 million shares of our common stock at a price of $23.61 per share,in connection with a public offering pursuant to a shelf registration. Theissuance of these shares generated proceeds to us of $44.2 million, net ofunderwriters discount and other issuance costs. Additionally, 5.0 millionshares were sold under the same shelf registration by Capital Z FinancialServices Fund II, L.P. and its affiliates (“Capital Z”), our largestshareholder. On July 20, 2005, the underwriters exercised theirover-allotment option and we issued an additional 660,000 shares of our commonstock at $23.61 per share, generating additional net proceeds of $14.8 million.Following the offering, Capital Z owned 20.2 million shares, or 34.5% of ouroutstanding common stock. See “Shelf Registration and Equity Offering” in theLiquidity section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations.

***Acquisition of Heritage Health Systems, Inc.***

On May 28, 2004, weacquired Heritage, a privately owned managed care company that operatesMedicare Advantage plans in Houston and Beaumont Texas, for $98 million in cashplus transaction costs of $2.0 million. The acquisition was financed with $66.5million of net proceeds derived from the amendment of our credit facility and$33.5 million of cash on hand. As of the date of acquisition, Heritage hadapproximately 16,000 Medicare members and annualized revenues of approximately$140 million. Operating results generated by Heritage prior to the date ofacquisition are not included in our consolidated financial statements.

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**Resultsof Operations—Consolidated Overview**

Thefollowing table reflects income from each of our segments(1) and containsa reconciliation to reported net income:

| ** **                                      | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                      | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                      | ** ** | **(In thousands)**                              | ** ** |
| Senior Market  Health Insurance(1)              |       | $                                                    | 5,563      |                                                | $          | 8,277 |   | $ | 20,841 |   | $ | 24,240 |   |
| Senior Managed  Care—Medicare Advantage(1) |       | 7,467                                                |       | 4,942                                               |       | 21,597 |   | 5,780 |   |
| Specialty Health  Insurance(1)                  |       | 6,836                                                |       | 7,338                                               |       | 19,208 |   | 20,341 |   |
| Life Insurance  and Annuity(1)                  |       | 4,304                                                |       | 3,711                                               |       | 11,749 |   | 9,990 |   |
| Senior  Administrative Services(1)              |       | 2,846                                                |       | 3,096                                               |       | 9,502 |   | 9,583 |   |
| Corporate(1)                                    |       | (3,949                                               | )          | (3,531                                              | )          | (11,599 | ) | (8,791 | ) |
| Realized gains                                  |       | 982                                                  |       | 5,485                                               |       | 5,085 |   | 9,285 |   |
| Income before income taxes(1)                   |       | 24,049                                               |       | 29,318                                              |       | 76,383 |   | 70,428 |   |
| Income taxes, excluding capital gains           |       | 8,510                                                |       | 7,856                                               |       | 25,688 |   | 20,710 |   |
| Income taxes on  capital gains                  |       | 251                                                  |       | 1,920                                               |       | 687 |   | 3,250 |   |
| Total income taxes                              |       | 8,761                                                |       | 9,776                                               |       | 26,375 |   | 23,960 |   |
| Net income                                      |       | $                                                    | 15,288     |                                                | $          | 19,542 |   | $ | 50,008 |   | $ | 46,468 |   |
| Per Share Data(Diluted):                        |       |                                                 |       |                                                |       |   |   |   |   |
| Net income                                      |       | $                                                    | 0.25       |                                                | $          | 0.34 |   | $ | 0.85 |   | $ | 0.82 |   |

 

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(1)          Weevaluate the results of operations of our segments based on income beforerealized gains and income taxes. Management believes that realized gains andlosses are not indicative of overall operating trends. This differs fromgenerally accepted accounting principles, which includes the effect of realizedgains in the determination of net income. The schedule above reconciles oursegment income to net income in accordance with generally accepted accountingprinciples.

***Three months ended September 30,2005 and 2004***

Net income for the third quarter of 2005 decreased 22%to $15.3 million, or $0.25 per diluted share, compared to $19.5 million, or$0.34 per diluted share in 2004. Net income for the third quarter of 2005 wasaffected by higher claim costs in our Medicare supplement business, whichreduced net income by $1.1 million, or $0.02 per diluted share, compared to thethird quarter of 2004, and increased lapsation of our Medicare supplement inforce business, which resulted in an acceleration of the amortization ofdeferred acquisition costs and present value of future profits that reduced netincome by $1.7 million, or $0.03 per diluted share. Additionally, net incomefor the third quarter of 2005 was reduced by after-tax expenses of $0.9million, or $0.01 per diluted share, relating to the implementation of our Part Dprogram. These items are offset, in part, by the growth in our Senior ManagedCare business, which added $1.6 million, or $0.03 per diluted share in 2005.

Net income for the third quarter of 2005 includesafter-tax realized investment gains of $0.7 million, or $0.01 per dilutedshare, which reflects the benefit from a $0.1 million release of a tax valuationallowance relating to net capital loss carryforwards. Net income for the thirdquarter of 2004 includes after-tax realized investment gains of $3.6 million,or $0.06 per diluted share.

Our overall effective tax rate was 36.4% for the thirdquarter of 2005, and 33.3% for the third quarter of 2004.

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Our Senior Market Health Insurance segment generatedsegment income of $5.6 million during the third quarter of 2005, a decrease of33% compared to $8.3 million in 2004. Segment income for the third quarter of2005 was affected by higher claim costs in our Medicare supplement lines andincreased lapsation of our Medicare supplement in force business, whichresulted in an acceleration of the amortization of deferred acquisition costsand present value of future profits. Additionally, segment income for the thirdquarter of 2005 was reduced by expenses of $0.7 million relating to theimplementation of our Part D program.

Our Senior Managed Care—Medicare Advantage segmentgenerated segment income of $7.5 million during the third quarter of 2005, anincrease of $2.6 million compared to $4.9 million in 2004, primarily as aresult of growth in the membership in our Medicare Advantage plans. Thissegment includes the results of Heritage and our other initiatives in Medicaremanaged care, including our Medicare Advantage private fee-for-service plans,since our acquisition or inception during the second quarter of 2004.

Our Specialty Health Insurance segment generatedsegment income of $6.8 million for the third quarter of 2005, a decrease of 7%compared to $7.3 million for the third quarter of 2004, primarily as a resultof higher claim costs, partially offset by the underwriting fees earned on thenew reinsurance arrangement with PharmaCare and the strengthening of the Canadiandollar.

Results for our Life Insurance and Annuity segmentimproved by $0.6 million, or 16%, to $4.3 million compared to the third quarterof 2004, primarily as a result of an increase in business.

Segment income for our Senior Administrative Servicessegment decreased by $0.3 million, or 8%, to $2.8 million, compared to thethird quarter of 2004, primarily as a result of the $0.7 million of expensesincurred in this segment relating to our implementation of Part D.

The loss from ourCorporate segment increased by $0.4 million, or 12%, compared to the thirdquarter of 2004. The increase was primarily due to higher interest cost as aresult of an increase in the weighted average interest rates, as compared tothe third quarter of 2004, offset partially by interest income earned on theproceeds from our equity offering in June 2005.

***Nine months ended September 30,2005 and 2004***

Net income for the first nine months of 2005 increased8% to $50.0 million, or $0.85 per diluted share, compared to $46.5 million, or$0.82 per diluted share in 2004. Net income for the third quarter of 2005 wasaffected by higher claim costs in our Medicare supplement business, whichreduced net income by $3.1 million, or $0.05 per diluted share, and increased lapsationof our Medicare supplement in force business, which resulted in an accelerationof the amortization of deferred acquisition costs and present value of futureprofits which reduced net income by $1.7 million, or $0.03 per diluted share.Additionally, net income for the first nine months of 2005 was reduced byafter-tax expenses of $1.5 million, or $0.03 per diluted share, relating to theimplementation of our Part D program. These items are offset, in part, bythe growth in our Senior Managed Care business, which added $10.3 million, or$0.18 per diluted share in 2005.

Net income for the first nine months of 2005 includesrealized investment gains, net of tax, of $4.4 million, or $0.08 per dilutedshare, which reflects the benefit from a $1.1 million release of a taxvaluation allowance relating to net capital loss carryforwards. The realizedinvestment gains during 2005 were generated as we took advantage of thetightening of the yield curve and sold longer duration investments. Net incomefor the first nine months of 2004 includes realized investment gains, net oftax, of $6.0 million, or $0.11 per diluted share.

Our overall effective tax rate was 34.5% for the firstnine months of 2005, reflecting the release of the valuation allowance notedabove, and 34.0% for the first nine months of 2004.

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Our Senior Market Health Insurance segment generatedsegment income of $20.8 million during the first nine months of 2005, a 14%decline compared to $24.2 million in 2004. Segment income for the first ninemonths of 2005 was affected by higher claim costs in our Medicare supplementlines and increased lapsation of our Medicare supplement in force business,which resulted in an acceleration of the amortization of deferred acquisitioncosts and present value of future profits. Additionally, segment income for thenine months ended September 30, 2005 was reduced by expenses of $1.1million relating to the implementation of our Part D program.

Our Senior Managed Care—Medicare Advantage segmentgenerated segment income of $21.6 million during the first nine months of 2005,an increase of $15.8 million, compared to $5.8 million in 2004, primarily dueto the inclusion of the results of Heritage for nine months in 2005 compared toonly four months in 2004 and the continued growth in membership in our MedicareAdvantage plans. This segment includes the results of Heritage and our otherinitiatives in Medicare managed care, including our Medicare Advantage privatefee-for-service plans, since our acquisition or inception during the secondquarter of 2004.

Our Specialty Health Insurance segment income of $19.2million for the first nine months of 2005 declined by 6% compared to $20.3million for the first nine months of 2004, primarily as a result of higherclaim costs, partially offset by the underwriting fees earned on the newreinsurance arrangement with PharmaCare and the strengthening of the Canadiandollar.

Results for our Life Insurance and Annuity segmentimproved by $1.8 million, or 18%, to $11.7 million compared to the first ninemonths of 2004, primarily as a result of an increase in business and lowerclaim costs.

Segment income for our Senior Administrative Servicessegment decreased by $0.1 million, or 1%, to $9.5 million compared to the firstnine months of 2004, primarily as a result of $1.2 million of expenses incurredin this segment relating to our implementation of Part D offset by growthin premiums managed.

The loss from ourCorporate segment increased by $2.8 million, or 32%, compared to the first ninemonths of 2004. The increase was due to higher interest cost as a result of anincrease in the amount of the debt outstanding during the year, relating to theamendment of our credit facility in connection with our acquisition ofHeritage, and an increase in the weighted average interest rates, as comparedto the first nine months of 2004.

**SegmentResults—Senior Market Health Insurance**

| ** **                                           | ** ** | **Three months ended   September 30,** | ** ** | **Nine months ended   September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                                   | ** ** | **2004**                                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                                    | ** ** |
| **Premiums:**                                        |       |                                                       |       |                                                      |       |   |   |   |   |
| Direct and assumed                                   |       | $                                                          | 142,952    |                                                      | $          | 141,609 |   | $ | 432,540 |   | $ | 428,155 |   |
| Ceded                                                |       | (44,292                                                    | )          | (52,038                                                   | )          | (139,357 | ) | (163,279 | ) |
| Net premiums                                         |       | 98,660                                                     |       | 89,571                                                    |       | 293,183 |   | 264,876 |   |
| Net investment  income                               |       | 1,145                                                      |       | 1,105                                                     |       | 3,507 |   | 3,183 |   |
| Other income                                         |       | 25                                                         |       | 49                                                        |       | 178 |   | 696 |   |
| Total revenue                                        |       | 99,830                                                     |       | 90,725                                                    |       | 296,868 |   | 268,755 |   |
| Policyholder benefits                                |       | 70,752                                                     |       | 62,490                                                    |       | 211,913 |   | 186,683 |   |
| Change in deferred  acquisition costs                |       | (7,919                                                     | )          | (8,245                                                    | )          | (26,902 | ) | (24,843 | ) |
| Amortization of  intangible assets                   |       | 1,262                                                      |       | 534                                                       |       | 2,694 |   | 1,483 |   |
| Commissions and  general expenses, net of allowances |       | 30,172                                                     |       | 27,669                                                    |       | 88,322 |   | 81,192 |   |
| Total benefits, claims and other deductions          |       | 94,267                                                     |       | 82,448                                                    |       | 276,027 |   | 244,515 |   |
| Segment income                                       |       | $                                                          | 5,563      |                                                      | $          | 8,277 |   | $ | 20,841 |   | $ | 24,240 |   |

 

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***Three months ended September 30,2005 and 2004***

Our Senior Market Health Insurance segment generatedincome of $5.6 million during the third quarter of 2005, a decrease of 33%compared to $8.3 million in 2004. Segment income for the third quarter of 2005was affected by higher claim costs in our Medicare supplement lines andincreased lapsation of our Medicare supplement in force business, whichresulted in an acceleration of the amortization of deferred acquisition costsand present value of future profits. Additionally, segment income for the thirdquarter of 2005 was reduced by expenses of $0.7 million relating to theimplementation of our Part D program.

**Revenues.**   Netpremiums for the Senior Market Health Insurance segment increased by $9.1million, or 10%, compared to the third quarter of 2004, due to increasedretention of our Medicare supplement business, rate increases and new sales.

**Benefits,Claims and Expenses.**   Policyholder benefitsincurred increased by $8.3 million, or 13%, compared to the third quarter of2004. Higher net premiums added approximately $6.5 million to policyholderbenefits and the increase in loss ratios added $1.7 million. Overall lossratios for the segment increased 190 basis points to 71.7% for the thirdquarter of 2005 compared to 69.8% for the third quarter of 2004, primarily as aresult of higher-than-anticipated outpatient doctor (Part B) and skillednursing facility incidence.

The increase in deferred acquisition costs was $0.3million less for the third quarter of 2005, compared to the increase in thethird quarter of 2004. During the quarter, three sales managers from PyramidLife, one of our career companies left our company and re-wrote a significantpart of their business with other carriers. We also noted a modest increase inthe lapsation of our Florida Medicare Select business. The excess lapsation ofour Medicare supplement in force business related to the departure of thesesales managers resulted in the acceleration of approximately $2.1 million inthe amortization of deferred acquisition costs. Excluding the effect of theexcess lapsation, the increase in deferred acquisition costs was $1.8 millionmore for the third quarter of 2005, compared to the third quarter of 2004,primarily as a result of higher retained premium and the effect of prospectiveunlocking resulting from higher than anticipated rate increases and better thananticipated persistency (excluding the lapses incurred from the departure ofthe sales managers discussed above).

The amortization of intangibles relates to intangiblesrecorded from the acquisition of Pyramid Life, and increased by $0.7 millioncompared to the third quarter of 2004, primarily due to the excess lapsation ofin force business from the departure of the sales managers, as noted above.

Commissionsand general expenses increased by $2.5 million, or 9%, compared to the thirdquarter of 2004. The following table details the components of commission andother operating expenses:

| ** **                                                 | ** ** | **Three months ended September 30,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2005**                                                 | ** ** | **2004** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                                  | ** ** |
| Commissions                                                |       | $                                                        | 20,531     |   | $ | 20,543 |   |
| Other operating  costs                                     |       | 18,897                                                   |       | 18,259 |   |
| Reinsurance  allowances                                    |       | (9,256                                                   | )          | (11,133 | ) |
| Commissions and general  expenses, net of allowances  |       | $                                                        | 30,172     |   | $ | 27,669 |   |

 

The ratio of commissionsto gross premiums decreased to 14.4% for the third quarter of 2005, from 14.5%for the third quarter of 2004. Other operating costs as a percentage of grosspremiums increased to 13.2% for the third quarter of 2005, compared to 12.9%for the third quarter of 2004, primarily due to the $0.7 million of expensesincurred in this segment relating to our implementation of Part D. Commissionand expense allowances received from reinsurers as a percentage of the premiumsceded decreased to 

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20.9%for the third quarter of 2005 from 21.4% for the third quarter of 2004,primarily due to the reduction in new business ceded and the effects of normallower commission allowances on our aging base of ceded renewal business.

***Nine months ended September 30,2005 and 2004***

Our Senior Market Health Insurance segment generatedsegment income of $20.8 million during the first nine months of 2005, a 14%decline compared to $24.2 million in 2004. Segment income for the first ninemonths of 2005 was affected by higher claim costs in our Medicare supplementlines and increased lapsation of our Medicare supplement in force business,which resulted in an acceleration of the amortization of deferred acquisitioncosts and present value of future profits. Additionally, segment income for thenine months ended September 30, 2005 was reduced by expenses of $1.1million relating to the implementation of our Part D program.

**Revenues.**   Netpremiums for the Senior Market Health Insurance segment increased by $28.3million, or 11%, compared to the first nine months of 2004, due to increased retentionof our Medicare supplement business, rate increases and new sales.

**Benefits,Claims and Expenses.**   Policyholder benefitsincurred increased by $25.2 million, or 14%, compared to the first nine monthsof 2004. Higher net premiums added approximately $20.5 million to policyholderbenefits and the increase in loss ratios added $4.8 million. Overall lossratios for the segment increased 180 basis points to 72.3% for the first ninemonths of 2005 compared to 70.5% for the first nine months of 2004, primarilyas a result of higher-than-anticipated outpatient doctor (Part B) andskilled nursing facility incidence.

The increase in deferred acquisition costs was $2.1million more for the first nine months of 2005, compared to the increase in thefirst nine months of 2004. The excess lapsation of our Medicare supplement inforce business related to the departure of three sales managers in the thirdquarter of 2005 and the increase in the lapsation of our Florida MedicareSelect business resulted in the acceleration of approximately $2.1 million inthe amortization of deferred acquisition costs. Excluding the effect of theexcess lapsation, the increase in deferred acquisition costs was $4.2 millionmore for the third quarter of 2005, compared to the third quarter of 2004,primarily as a result of higher retained premium and the effect of prospectiveunlocking resulting from higher than anticipated rate increases and better thananticipated persistency (excluding the lapses incurred from the departure ofthe sales managers discussed above). As a percentage of premium, the increasein deferred acquisition costs, excluding the effect of the excess lapsation,was 9.9% for the first nine months of 2005 compared to 9.4% for the first ninemonths of 2004.

The amortization of intangibles relates to intangiblesrecorded from the acquisition of Pyramid Life, and increased by $1.2 millioncompared to the first nine months of 2004, due to the excess lapsation of inforce business noted above.

Commissionsand general expenses increased by $7.1 million, or 9%, compared to the firstnine months of 2004. The following table details the components of commissionand other operating expenses:

| ** **                                            | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                            | ** ** | **2005**                                                | ** ** | **2004** | ** ** |
| ** **                                            | ** ** | **(In thousands)**                                 | ** ** |
| Commissions                                           |       | $                                                       | 61,966     |   | $ | 63,130 |   |
| Other operating  costs                                |       | 55,266                                                  |       | 54,265 |   |
| Reinsurance  allowances                               |       | (28,910                                                 | )          | (36,203 | ) |
| Commissions and general  expenses, net  of allowances |       | $                                                       | 88,322     |   | $ | 81,192 |   |

 

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The ratio of commissions to gross premiums decreasedto 14.3% for the first nine months of 2005, from 14.7% for the first ninemonths of 2004, as a result of lower overall commission rates associated withthe continued growth of our in force renewal premium. Other operating costs asa percentage of gross premiums were 12.8% for the first nine months of 2005,consistent with the first nine months of 2004. Commission and expenseallowances received from reinsurers as a percentage of the premiums ceded decreasedto 20.7% for the first nine months of 2005 from 22.2% for the first nine monthsof 2004, primarily due to the reduction in new business ceded and the effectsof normal lower commission allowances on our aging base of ceded renewalbusiness.

**SegmentResults—Senior Managed Care—Medicare Advantage**

| ** **                                                                              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004(2)** | ** ** |
| ** **                                                                              | ** ** | **(In thousands)**                              | ** ** |
| **Net premiums**                                                                   | ** ** | **$61,967**                                          | ** ** | **$39,323**                                         | ** ** | **$171,897** | ** ** | **$51,260** | ** ** |
| Net investment  and other income                                                        |       | 740                                                  |       | 210                                                 |       | 1,939 |   | 231 |   |
| Total revenue                                                                           |       | 62,707                                               |       | 39,533                                              |       | 173,836 |   | 51,491 |   |
| Medical expenses                                                                        |       | 44,564                                               |       | 27,672                                              |       | 123,579 |   | 36,314 |   |
| Amortization of  intangible assets                                                      |       | 644                                                  |       | 920                                                 |       | 1,647 |   | 1,186 |   |
| Commissions and  general expenses                                                       |       | 10,032                                               |       | 5,999                                               |       | 27,013 |   | 8,211 |   |
| Total benefits,  claims and other deductions                                            |       | 55,240                                               |       | 34,591                                              |       | 152,239 |   | 45,711 |   |
| Segment income                                                                          |       | $                                                    | 7,467      |                                                | $          | 4,942 |   | $ | 21,597 |   | $ | 5,780 |   |
| Depreciation,  amortization and interest                                                |       | 800                                                  |       | 1,039                                               |       | 2,093 |   | 1,345 |   |
| Earnings before  interest, taxes, depreciation and amortization (“EBITDA”)(1) |       | $                                                    | 8,267      |                                                | $          | 5,981 |   | $ | 23,690 |   | $ | 7,125 |   |

----

(1)          In addition to segmentincome, we also evaluate the results of our Medicare Advantage segment based onearnings before interest, taxes, depreciation and amortization (“EBITDA”). EBITDAis a common alternative measure of performance used by investors, financialanalysts and rating agencies. It is also a measure that is included in thefixed charge ratio required by the covenants for our outstanding bank debt. Accordingly,these groups use EBITDA, along with other measures, to estimate the value of acompany and evaluate the Company’s ability to meet its debt servicerequirements. While we consider EBITDA to be an important measure ofcomparative operating performance, it should not be construed as an alternativeto segment income or cash flows from operating activities (as determined inaccordance with generally accepted accounting principles).

(2)          Includes results for thefour months since acquisition or inception

Our Senior Managed Care - Medicare Advantage segmentincludes the operations of Heritage and our other initiatives in Medicaremanaged care, including our Medicare Advantage private fee-for-service plansand special needs plan. Heritage generates its revenues and profits from threesources. First, Heritage owns an interest in SelectCare, a health plan thatoffers coverage to Medicare beneficiaries in Houston and Beaumont, Texas, undera contract with CMS. Next, Heritage operates three separate Management ServiceOrganizations (“MSO’s”) that manage the business of SelectCare and twoaffiliated Independent Physician Associations (“IPA’s”). Lastly, Heritageparticipates in the profits derived from these IPA’s.

Starting in June 2004, American Progressive, aninsurance subsidiary of Universal American, began enrolling members in itsprivate fee-for-service (“PFFS”) product, a Medicare Advantage program thatallows its members to have more flexibility in the delivery of their healthcare services than other Medicare Advantage plans. In addition to premiumreceived from CMS, we receive modest premium payments from 

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the members. Beginning September 1,2005, we have expanded our PFFS product offering to Medicare eligibles in 258counties in seven new states. As part of this expansion Pyramid Life, an insurancesubsidiary of Universal American, began enrolling members in its PFFS product. Wehave been approved to expand the PFFS product to an additional 152 counties insix states on January 1, 2006.

In August 2005, SelectCare of Oklahoma, a whollyowned subsidiary of Heritage, began enrolling members in its Special Needs Plan(“SNP”), a Medicare Advantage program that provides health care managementservices to Medicare eligible seniors in nursing home facilities in tencounties in Oklahoma.

Thecomponents of the revenues and results within the segment are as follows:

| ** **                | ** ** | **Three months ended  September 30, 2005** | ** ** | **Nine months ended  September 30, 2005** | ** ** |
|---------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                | ** ** | **Revenue**                                                    | ** ** | **Segment  Income**                                           | ** ** | **Revenue** | ** ** | **Segment  Income** | ** ** |
| ** **                | ** ** | **(In thousands)**                                        | ** ** |
| Health Plan               |       | $                                                              | 56,560     |                                                          |       | $ | 2,552 |   |   | $ | 159,135 |   | $ | 7,416 |   |
| Affiliated IPA’s     |       | 30,335                                                         |       |                                                          | 3,526      |   |   | 87,990 |   | 9,083 |   |
| MSO’s and  Corporate |       | 8,630                                                          |       |                                                          | 1,317      |   |   | 24,461 |   | 4,730 |   |
| Private Fee-for  Service  |       | 5,852                                                          |       |                                                          | 72         |   |   | 13,815 |   | 368 |   |
| Eliminations              |       | (38,670                                                        | )          |                                                          | —     |   |   | (111,565 | ) | — |   |
| Total                     |       | $                                                              | 62,707     |                                                          |       | $ | 7,467 |   |   | $ | 173,836 |   | $ | 21,597 |   |

 

Intrasegment revenues are reported on a gross basis ineach of the above components of the Medicare Advantage segment. Theseintrasegment revenues are eliminated in the consolidation for the segmenttotals. The eliminations include premiums received by the IPA’s from the HealthPlan amounting to $30.2 million for the three months ended September 30,2005 and $87.6 million for the nine months ended September 30, 2005 andmanagement fees received by the MSO’s from the Health Plan and the IPA’s amountingto $8.5 million for the three months ended September 30, 2005 and $23.9million for the nine months ended September 30, 2005.

Heritage operates a health plan through SelectCare, aprovider sponsored organization (“PSO”). SelectCare offers a Medicare Advantagecoordinated care plan operating in southeastern Texas, including Beaumont andHouston, and receives its premiums primarily from CMS. SelectCare makescapitated risk payments to IPA’s or other medical groups in the Houston andBeaumont regions, two of which are affiliated IPA’s. In addition, SelectCareretains the risk for certain other types of care, primarily out of areaemergency and transplants. As of September 30, 2005, SelectCare had 23,270members enrolled. As of September 30, 2005, SelectCare of Oklahoma had 86members enrolled in its SNP. During the third quarter of 2005, the health planshad revenues of $56.6 million and reported a medical loss ratio of 82.2%. Forthe nine months ended September 30, 2005, the health plans had revenues of$159.1 million and reported a medical loss ratio of 82.1%.

Heritage participates in the profits from the twoaffiliated IPA’s that receive capitated payments from SelectCare. As of September 30,2005, the affiliated IPA’s managed the care for approximately 15,133 SelectCaremembers. During the third quarter of 2005, the IPA’s earned $3.5 million on$30.3 million in revenues received from SelectCare. For the nine months ended September 30,2005, the IPA’s earned $9.1 million on $88.0 million in revenues received fromSelectCare.

Heritage owns three MSO’s that provide comprehensivemanagement services to SelectCare and its affiliated IPA’s as part of long-termmanagement agreements. Services provided include strategic planning, providernetwork services, marketing, finance and accounting, enrollment, claimsprocessing, information systems, utilization review, credentialing and qualitymanagement. For the three months ended September 30, 2005, these MSO’searned $1.3 million of income on $8.6 million of fees collected. For the 

35

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nine months ended September 30,2005, these MSO’s earned $4.7 million of income on $24.5 million of feescollected.

As of September 30,2005, American Progressive and Pyramid Life had 3,739 members enrolled in theirPFFS plans. During the third quarter of 2005, American Progressive and PyramidLife collected $5.9 million of premium from CMS and the members, and reported amedical loss ratio of 75.5%. For the nine months ended September 30, 2005,American Progressive and Pyramid Life collected $13.8 million of premium fromCMS and the members, and reported a medical loss ratio of 73.2%.

*   Three monthsended September 30, 2005 and 2004*

Results for the Senior Managed Care segment for thethird quarter of 2005 are comparable for the first time to results for a fullquarter for the prior year.

**Revenues.**   Netpremiums for the Senior Managed Care segment increased by $22.6 million, or58%, compared to the third quarter of 2004, due to increased membership, asnoted above. Net investment income increased by $0.6 million, as a result of aprogram to invest excess cash in longer term securities.

**Benefits, Claims andExpenses.**   Policyholder benefits incurredincreased by $16.9 million, or 61%, compared to the third quarter of 2004, dueprimarily to the growth in business. Overall loss ratios for the segmentincreased by 150 basis points to 71.9% for the third quarter of 2005 from 70.4%for the third quarter of 2004. Commissions and general expenses increased by$4.0 million, or 67%, compared to the third quarter of 2004, due primarily tothe growth in business.

**SegmentResults—Specialty Health Insurance**

| ** **                                           | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                              | ** ** |
| **Premiums:**                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Direct and assumed                                   |       | $                                                    | 107,258    |                                                | $          | 42,364 |   | $ | 192,765 |   | $ | 128,910 |   |
| Ceded                                                |       | (70,397                                              | )          | (5,917                                              | )          | (81,712 | ) | (18,574 | ) |
| Net premiums                                         |       | 36,861                                               |       | 36,447                                              |       | 111,053 |   | 110,336 |   |
| Net investment  income                               |       | 6,980                                                |       | 6,670                                               |       | 19,977 |   | 19,979 |   |
| Other income                                         |       | 346                                                  |       | 283                                                 |       | 983 |   | 490 |   |
| Total revenue                                        |       | 44,187                                               |       | 43,400                                              |       | 132,013 |   | 130,805 |   |
| Policyholder  benefits                               |       | 26,463                                               |       | 23,330                                              |       | 76,995 |   | 70,741 |   |
| Change in  deferred acquisition costs                |       | (3,399                                               | )          | (2,013                                              | )          | (7,526 | ) | (5,784 | ) |
| Commissions and  general expenses, net of allowances |       | 14,287                                               |       | 14,745                                              |       | 43,336 |   | 45,507 |   |
| Total benefits,  claims and other deductions         |       | 37,351                                               |       | 36,062                                              |       | 112,805 |   | 110,464 |   |
| Segment income                                       |       | $                                                    | 6,836      |                                                | $          | 7,338 |   | $ | 19,208 |   | $ | 20,341 |   |

 

*   Three monthsended September 30, 2005 and 2004*

Our Specialty Health Insurance segment generatedsegment income of $6.8 million for the third quarter of 2005, a decrease of 7%compared to $7.3 million for the third quarter of 2004, primarily as a resultof higher claim costs, partially offset by the underwriting fees earned on thenew reinsurance arrangement with PharmaCare and the strengthening of theCanadian dollar. The operations of Penncorp Life (Canada), which are includedin our Specialty Health segment results, are transacted using the Canadiandollar as the functional currency. The Canadian dollar strengthened relative tothe U.S. dollar in 2005. The average conversion rate increased 9%, to C$0.8397per U.S.$1.00 for the third quarter of 2005, from C$0.7685 per U.S.$1.00 forthe third quarter of 2004. This strengthening added approximately $0.4 

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million of pre-tax incometo the Specialty Health segment results compared to the third quarter of 2004. Seediscussion below under the heading “Quantitative and Qualitative Disclosuresabout Market Risk” for additional information.

**Revenues.**   Bothdirect and ceded premium for the Specialty Health Insurance segment increasedapproximately $65.0 million in connection with the PharmaCare reinsuranceagreement discussed above. Net premiums increased by $0.4 million, or 1%,compared to the third quarter of 2004. Canadian business accounted forapproximately 43% of the net premiums of this segment for the third quarter of2005 and 40% of the net premiums for the third quarter of 2004. The strongerCanadian dollar and increased sales in Canada generated an increase in premiumsof approximately $1.5 million, which was offset by reductions of $0.6 millionin our U.S. fixed benefit accident and sickness line and $0.4 million in ourmajor medical and other lines.

**Benefits,Claims and Expenses.**   Policyholder benefitsincurred increased by $3.1 million, or 13%, compared to the third quarter of2004, primarily as a result of higher loss ratios for our long term care lines,our Canadian business and our U.S. fixed benefit accident and sickness line. Overallloss ratios for the segment increased to 71.8% during the third quarter of 2005compared to 64.0% in the third quarter of 2004.

The increase in deferred acquisition costs was $1.4million more in the third quarter of 2005 than the increase in the thirdquarter of 2004, primarily as a result of an increase in acquisition costs inour Canadian subsidiary, including production bonuses to Canadian agents, wherenew business sales are higher by 7%. The increase also was impacted as a resultof the higher foreign exchange rate for the quarter.

Commissions and generalexpenses decreased by $0.5 million, or 3%, in the third quarter of 2005compared to 2004. Reinsurance allowances increased by $1.3 million due to theunderwriting fees earned on the new reinsurance arrangement with PharmaCarethat was offset, in part, by increases in commissions and other acquisitioncosts.

*   Ninemonths ended September 30, 2005 and 2004*

Our Specialty Health Insurance segment income of $19.2million for the first nine months of 2005 declined by 6% compared to $20.3million for the first nine months of 2004, primarily as a result of higher claimcosts, partially offset by the underwriting fees earned on the new reinsurancearrangement with PharmaCare and the strengthening of the Canadian dollar. Theoperations of Penncorp Life (Canada), which are included in our SpecialtyHealth segment results, are transacted using the Canadian dollar as thefunctional currency. The Canadian dollar strengthened relative to the U.S.dollar in 2005. The average conversion rate increased 8%, to C$0.8171 perU.S.$1.00 for the first nine months of 2005, from C$0.7531 per U.S.$1.00 forthe first nine months of 2004. This strengthening added approximately $0.9million of pre-tax income to the Specialty Health segment results compared tothe first nine months of 2004. See discussion below under the heading “Quantitativeand Qualitative Disclosures about Market Risk” for additional information.

**Revenues.**   Bothdirect and ceded premium for the Specialty Health Insurance segment increasedapproximately $65.0 million in connection with the PharmaCare reinsuranceagreement discussed above. Net premiums increased by $0.7 million, or less than1%, compared to the first nine months of 2004. Canadian business accounted forapproximately 43% of the net premiums of this segment for the first nine monthsof 2005 and 39% of the net premiums for the first nine months of 2004. Thestronger Canadian dollar and increased sales in Canada generated an increase inpremiums of approximately $4.5 million, which was offset by reductions of $1.9million in our U.S. fixed benefit accident and sickness line, $0.7 million inour major medical and other lines and $0.5 million in our long term care line.

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**Benefits,Claims and Expenses.**   Policyholder benefitsincurred increased by $6.3 million, or 9%, compared to the first nine months of2004, primarily as a result of higher loss ratios for our U.S. fixed benefitaccident and sickness line, our Canadian business and our long term care line. Overallloss ratios for the segment increased to 69.3% during the first nine months of2005 compared to 64.1% in the first nine months of 2004.

The increase in deferred acquisition costs was $1.7million more in the first nine months of 2005 than the increase in the firstnine months of 2004, primarily as a result of an increase in acquisition costs,including bonuses to Canadian agents, where new business production is higherby 6%, the effect of which was even greater, as a result of the higher exchangerate for the first nine months of 2005.

Commissions and generalexpenses decreased by $2.2 million, or 5%, in the first nine months of 2005compared to 2004, primarily as a result of an increase in reinsuranceallowances of $1.3 million due to the underwriting fees earned on the newreinsurance arrangement with PharmaCare, as well as a reduction in commissionsfor long term care, as a result of our decision to discontinue marketing thatproduct.

**SegmentResults—Life Insurance and Annuity**

| ** **                                           | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                           | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                              | ** ** |
| **Premiums:**                                        |       |                                                 |       |                                                |       |   |   |   |   |
| Direct and assumed                                   |       | $                                                    | 20,111     |                                                | $          | 16,292 |   | $ | 57,164 |   | $ | 44,661 |   |
| Ceded                                                |       | (4,459                                               | )          | (3,277                                              | )          | (12,982 | ) | (8,044 | ) |
| Net premiums                                         |       | 15,652                                               |       | 13,015                                              |       | 44,182 |   | 36,617 |   |
| Net investment  income                               |       | 9,183                                                |       | 8,639                                               |       | 26,780 |   | 25,283 |   |
| Other income                                         |       | 34                                                   |       | 47                                                  |       | 109 |   | 163 |   |
| Total revenue                                        |       | 24,869                                               |       | 21,701                                              |       | 71,071 |   | 62,063 |   |
| Policyholder  benefits                               |       | 8,476                                                |       | 8,914                                               |       | 27,557 |   | 25,167 |   |
| Interest credited  to policyholders                  |       | 5,096                                                |       | 4,737                                               |       | 14,271 |   | 13,215 |   |
| Change in  deferred acquisition costs                |       | (3,698                                               | )          | (6,045                                              | )          | (13,844 | ) | (16,899 | ) |
| Amortization of  intangible assets                   |       | 18                                                   |       | 254                                                 |       | 210 |   | 693 |   |
| Commissions and  general expenses, net of allowances |       | 10,673                                               |       | 10,130                                              |       | 31,128 |   | 29,897 |   |
| Total benefits,  claims and other deductions         |       | 20,565                                               |       | 17,990                                              |       | 59,322 |   | 52,073 |   |
| Segment income                                       |       | $                                                    | 4,304      |                                                | $          | 3,711 |   | $ | 11,749 |   | $ | 9,990 |   |

 

*   Three monthsended September, 30, 2005 and 2004*

Results for our Life Insurance and Annuity segmentimproved by $0.6 million, or 16%, to $4.3 million compared to the third quarterof 2004, primarily as a result of an increase in business.

**Revenues.**   Netpremiums for the segment increased by $2.6 million, or 20%, compared to thethird quarter of 2004. Approximately $1.9 million of the increase relates tothe growth in premiums for our senior life product. The balance relates to anincrease in policy fees on our interest sensitive life and annuity business asa result of the growth in the level of deposits maintained for those products. Cededpremiums increased by approximately $1.2 million, primarily as a result of theincrease in our senior life premiums.

Our agents sold $9.3 million of fixed annuities duringthe third quarter of 2005 and $15.3 million during the third quarter of 2004. Annuitydeposits are not considered premiums for reporting in accordance with generallyaccepted accounting principles. The reduction in annuity sales was the resultof 

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lower interest creditingrates offered and our reduced emphasis on this business as we continue ourfocus more on providing health insurance alternatives to the growing seniormarket.

Net investment income increased by approximately $0.5million, or 6%, compared to the third quarter of 2004, as a result of theincrease in policyholder account balances as a result of the additionaldeposits received as noted above, offset by a decline in yields on theportfolio.

**Benefits, Claims andExpenses.**   Policyholder benefits incurreddecreased by $0.4 million, or 5%, compared to the third quarter of 2004. Policyholderbenefits declined by approximately $1.9 million as a result of favorablemortality, including a larger amount of reinsurance during the quarter tooffset claims, as compared to the third quarter of 2004. The favorablemortality was offset by $1.4 million due to the increase in business andrelated reserves. Interest credited increased by $0.4 million, due to theincrease in policyholder account balances as a result of continued annuitysales, offset by a reduction in our overall average credited rates. Theincrease in deferred acquisition costs was approximately $2.3 million lessduring the third quarter of 2005, as compared to the increase in 2004. This wasprimarily due to lower production of new senior life insurance and annuitybusiness during the quarter, resulting in a lower level of acquisition costs tocapitalize, as well as increased levels of amortization due to the growth inbusiness. Commissions and general expenses increased by $0.5 million, or 5%,compared to the third quarter of 2004, primarily as a result of the overallincrease in business in force.

*   Nine monthsended September, 30, 2005 and 2004*

Results for our Life Insurance and Annuity segmentimproved by $1.8 million, or 18%, to $11.7 million compared to the first ninemonths of 2004, primarily as a result of an increase in business and lower claimcosts.

**Revenues.**   Netpremiums for the segment increased by $7.6 million, or 21%, compared to thefirst nine months of 2004. Approximately $6.9 million of the increase relatesto the growth in premiums for our senior life product. Ceded premiums increasedby approximately $4.9 million, primarily as a result of the increase in oursenior life premiums.

Our agents sold $35.0 million of fixed annuitiesduring the first nine months of 2005 and $54.0 million during the first ninemonths of 2004. Annuity deposits are not considered premiums for reporting inaccordance with generally accepted accounting principles. The reduction inannuity sales was the result of lower interest crediting rates offered and ourreduced emphasis on this business as we continue our focus more on providinghealth insurance alternatives to the growing senior market.

Net investment income increased by approximately $1.5million, or 6%, compared to the first nine months of 2004, as a result of theincrease in policyholder account balances as a result of the additionaldeposits received as noted above, offset by a decline in yields on theportfolio.

**Benefits,Claims and Expenses.**   Policyholder benefitsincurred increased by $2.4 million, or 10%, compared to the first nine monthsof 2004. The increase in business and related reserves added approximately $4.7million to policyholder benefits during the first nine months of 2005, howeverthis was offset by $2.3 million as a result of favorable mortality, including alarger amount of reinsurance to offset claims, as compared to the first ninemonths of 2004. Interest credited increased by $1.0 million, due to theincrease in policyholder account balances as a result of continued annuitysales, offset by a reduction in our overall credited rates. The increase indeferred acquisition costs was $3.1 million less during the first nine monthsof 2005, as compared to the increase in 2004. This was primarily due to lowerproduction of new senior life insurance and annuity business during the firstnine months of 2005, resulting in a lower level of acquisition costs tocapitalize, as well as increased levels of amortization due to the growth in business.Commissions and general expenses increased by $1.2 million, or 4%, compared tothe first nine months of 2004, due to the growth in business.

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**SegmentResults—Senior Administrative Services**

| ** **                                                                              | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                              | ** ** | **(In thousands)**                              | ** ** |
| Affiliated Fee Revenue                                                                  |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Medicare supplement                                                                     |       |                                                 | $          | 7,484                                               |       |   | $ | 7,286 |   | $ | 23,035 |   | $ | 21,567 |   |
| Long term care                                                                          |       |                                                 | 687        |                                                |       | 658 |   | 1,957 |   | 2,063 |   |
| Life insurance                                                                          |       |                                                 | 760        |                                                |       | 910 |   | 2,489 |   | 3,012 |   |
| Other                                                                                   |       |                                                 | 825        |                                                |       | 774 |   | 2,316 |   | 2,156 |   |
| Total Affiliated Revenue                                                                |       |                                                 | 9,756      |                                                |       | 9,628 |   | 29,797 |   | 28,798 |   |
| Unaffiliated Fee  Revenue                                                               |       |                                                 |       |                                                |       |   |   |   |   |   |   |
| Medicare supplement                                                                     |       |                                                 | 1,938      |                                                |       | 1,943 |   | 6,096 |   | 6,449 |   |
| Long term care                                                                          |       |                                                 | 2,082      |                                                |       | 1,699 |   | 6,182 |   | 4,620 |   |
| Non-insurance products                                                                  |       |                                                 | 363        |                                                |       | 372 |   | 1,121 |   | 1,150 |   |
| Other                                                                                   |       |                                                 | 434        |                                                |       | 433 |   | 988 |   | 983 |   |
| Total Unaffiliated Revenue                                                              |       |                                                 | 4,817      |                                                |       | 4,447 |   | 14,387 |   | 13,202 |   |
| Total revenue                                                                           |       |                                                 | 14,573     |                                                |       | 14,075 |   | 44,184 |   | 42,000 |   |
| Amortization of present value of future profits                                         |       |                                                 | 119        |                                                |       | 104 |   | 358 |   | 313 |   |
| General expenses                                                                        |       |                                                 | 11,608     |                                                |       | 10,875 |   | 34,324 |   | 32,104 |   |
| Total expenses                                                                          |       |                                                 | 11,727     |                                                |       | 10,979 |   | 34,682 |   | 32,417 |   |
| Segment income                                                                          |       |                                                 | $          | 2,846                                               |       |   | $ | 3,096 |   | $ | 9,502 |   | $ | 9,583 |   |
| Depreciation,  amortization and interest                                                |       |                                                 | 544        |                                                |       | 535 |   | 1,618 |   | 1,605 |   |
| Earnings before  interest, taxes, depreciation and amortization (“EBITDA”)(1) |       |                                                 | $          | 3,390                                               |       |   | $ | 3,631 |   | $ | 11,120 |   | $ | 11,188 |   |

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(1)          Inaddition to segment income, we also evaluate the results of our SeniorAdministrative Services segment based on earnings before interest, taxes,depreciation and amortization (“EBITDA”). EBITDA is a common alternativemeasure of performance used by investors, financial analysts and ratingagencies. It is also a measure that is included in the fixed charge ratiorequired by the covenants for our outstanding bank debt. Accordingly, thesegroups use EBITDA, along with other measures, to estimate the value of acompany and evaluate the Company’s ability to meet its debt service requirements.While we consider EBITDA to be an important measure of comparative operatingperformance, it should not be construed as an alternative to segment income orcash flows from operating activities (as determined in accordance withgenerally accepted accounting principles).

Included in unaffiliatedrevenue are fees received to administer certain business of our insurancesubsidiaries that is 100% reinsured to an unaffiliated reinsurer, whichamounted to $1.0 million for the three months ended September 30, 2005,and $1.3 million for the three months ended September 30, 2004 and$3.1 million for the nine months ended September 30, 2005, and$4.2 million for the nine months ended September 30, 2004. Thesefees, together with the affiliated revenue, were eliminated in consolidation.

*Three months ended September 30, 2005 and 2004*

Segment income for our Senior Administrative Servicessegment decreased by $0.3 million, or 8%, to $2.8 million, compared to thethird quarter of 2004, primarily as a result of the $0.7 million of expensesincurred in this segment relating to our implementation of Part D.

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Service fee revenueincreased by $0.5 million, or 4%, compared to the third quarter of 2004. Affiliatedservice fee revenue increased by $0.1 million compared to the third quarter of2004 as a result of the increase in Medicare supplement business in force atour insurance subsidiaries offset, in part by a decline in revenues foradministration of affiliated life insurance business. Unaffiliated service feerevenue increased by $0.4 million compared to the third quarter of 2004,primarily due to an increase in fees for services for long term care products. Generalexpenses for the segment increased by $0.7 million, or 7%, due primarily as aresult of the expenses incurred in this segment relating to our implementationof Part D.

*Nine months ended September 30, 2005 and 2004*

Segment income for our Senior Administrative Servicessegment decreased by $0.1 million, or 1%, to $9.5 million compared to the firstnine months of 2004, primarily as a result of growth in premiums managed,offset by the $1.2 million of expenses incurred in this segment relating to ourimplementation of Part D.

Service fee revenueincreased by $2.2 million, or 5%, compared to the first nine months of 2004. Affiliatedservice fee revenue increased by $1.0 million compared to the first nine monthsof 2004 as a result of the increase in Medicare supplement business in force atour insurance subsidiaries offset, in part by a decline in revenues for administrationof affiliated life insurance business. Unaffiliated service fee revenueincreased by $1.2 million compared to the first nine months of 2004. Anincrease of $1.6 million, or 34%, for services for long term care products wasoffset, in part, by a decline in fees for Medicare supplement of $0.4 million. Generalexpenses for the segment increased by $2.3 million, or 7%, due to the Part Dimplementation costs, as well as an increase in business.

**Segment Results—Corporate**

Thefollowing table presents the primary components comprising the loss from thesegment:

| ** **                                         | ** ** | **Three months ended  September 30,** | ** ** | **Nine months ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                             | ** ** | **2004**                                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                              | ** ** |
| Interest                                           |       | $                                                    | 2,826      |                                                | $          | 2,234 |   | $ | 8,007 |   | $ | 5,519 |   |
| Amortization of  capitalized loan origination fees |       | 230                                                  |       | 220                                                 |       | 674 |   | 507 |   |
| Stock-based  compensation expense                  |       | —                                               |       | 23                                                  |       | 2 |   | 69 |   |
| Other parent  company expenses, net                |       | 893                                                  |       | 1,054                                               |       | 2,916 |   | 2,696 |   |
| Segment loss                                       |       | $                                                    | 3,949      |                                                | $          | 3,531 |   | $ | 11,599 |   | $ | 8,791 |   |

 

*Three months ended September 30, 2005 and 2004*

The loss from ourCorporate segment increased by $0.4 million, or 12%, compared to the thirdquarter of 2004. The increase was due to higher interest cost as a result of anincrease in the weighted average interest rates, as compared to the same periodof 2004, offset partially by interest income earned on the proceeds from ourequity offering in June 2005. Our combined outstanding debt was $172.1million at September 30, 2005 compared to $177.4 million at September 30,2004. The weighted average interest rate on our loan payable increased to 5.8%for the third quarter of 2005 from 3.8% for the third quarter of 2004. Theweighted average interest rate on our other long term debt also increased to7.4% for the third quarter of 2005 from 6.6% for the third quarter of 2004. See“Liquidity and Capital Resources” for additional information regarding our loanpayable and other long term debt.

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*Nine months ended September 30, 2005 and 2004*

The loss from ourCorporate segment increased by $2.8 million, or 32%, compared to the first ninemonths of 2004. The increase was due primarily to higher interest cost as aresult of an increase in the amount of the debt outstanding during the year,relating to the amendment of our credit facility in connection with ouracquisition of Heritage, and an increase in the weighted average interestrates, as compared to the same period of 2004, offset partially by interestincome earned on the proceeds from our equity offering in June 2005. Theweighted average interest rate on our loan payable increased to 5.3% for thefirst nine months of 2005 from 3.9% for the first nine months of 2004. Theweighted average interest rate on our other long term debt also increased to7.3% for the first nine months of 2005 from 7.1% for the first nine months of2004. See “Liquidity and Capital Resources” for additional informationregarding our loan payable and other long term debt.

**Liquidity and Capital Resources**

Our capital is used primarily to support the retainedrisks and growth of our insurance company subsidiaries and health plans and tosupport our parent company as an insurance holding company. In addition, we usecapital to fund our growth through acquisitions of other companies, blocks ofinsurance or administrative service business.

We require cash at our parent company to meet ourobligations under our credit facility and our outstanding debenture held by oursubsidiary, Pennsylvania Life. In January 2002, our parent company issueda debenture to Pennsylvania Life in conjunction with the transfer of thebusiness of Pennsylvania Life’s Canadian Branch to Penncorp Life (Canada). Theoutstanding balance on the debenture was $0.9 million at September 30,2005. We anticipate funding the repayment of the debenture from dividends ofPenncorp Life (Canada). We also require cash to pay the operating expensesnecessary to function as a holding company (applicable insurance departmentregulations require us to bear our own expenses), and to meet the costs ofbeing a public company.

We believe that our currentcash position, the availability of our $15.0 million revolving credit facility,the expected cash flows of our administrative service company and managementservice organizations (acquired in the acquisition of Heritage) and the surplusnote interest payments from American Exchange (as explained below) can supportour parent company obligations for the foreseeable future. However, there canbe no assurance as to our actual future cash flows or to the continuedavailability of dividends from our insurance company subsidiaries.

***Contractual Obligations and Commercial Commitments***

*Credit Facility, as Amended in May 2004*

In connection with the acquisition of Heritage on May 28,2004 (see Note 3—Business Combinations), the Company amended the CreditAgreement by increasing the facility to $120 million from $80 million (the “AmendedCredit Agreement”), including an increase in the term loan portion to $105million from $36.4 million (the balance outstanding at May 28, 2004) andmaintaining the $15 million revolving loan facility. None of the revolving loanfacility has been drawn as of September 30, 2005. Under the Amended CreditAgreement, the spread over LIBOR was reduced to 225 basis points from 275 basispoints. Effective October 1, 2005, the interest rate on the term loan is6.1%. Principal repayments are scheduled at $5.3 million per year over afive-year period with a final payment of $80.1 million due upon maturity on March 31,2009. The Company incurred additional loan origination fees of approximately $2.1million, which were capitalized and are being amortized on a straight-linebasis over the life of the Amended Credit Agreement along with the continuedamortization of the origination fees incurred in connection with the CreditAgreement. The Company pays an annual commitment fee of 50 basis points on theunutilized revolving loan facility. The obligations of the Company under theAmended Credit Facility are guaranteed 

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by WorldNet ServicesCorp., CHCS Services Inc., CHCS Inc., Quincy Coverage Corporation, UniversalAmerican Financial Services, Inc., Heritage, HHS-HPN Network, Inc.,Heritage Health Systems of Texas, Inc., PSO Management of Texas, LLC, HHSTexas Management, Inc. and HHS Texas Management LP (collectively the “Guarantors”)and secured by substantially all of the assets of each of the Guarantors. Inaddition, as security for the performance by the Company of its obligationsunder the Amended Credit Facility, the Company, WorldNet Services Corp., CHCSServices Inc., Heritage and HHS Texas Management, Inc. have each pledgedand assigned substantially all of their respective securities (but not morethan 65% of the issued and outstanding shares of voting stock of any foreignsubsidiary), all of their respective limited liability company and partnershipinterests, all of their respective rights, title and interest under any serviceor management contract entered into between or among any of their respectivesubsidiaries and all proceeds of any and all of the foregoing.

The Amended Credit Facility requires the Company andits subsidiaries to meet certain financial tests, including a minimum fixedcharge coverage ratio, a minimum risk based capital test and a minimumconsolidated net worth test. The Amended Credit Facility also containscovenants, which among other things, limit the incurrence of additionalindebtedness, dividends, capital expenditures, transactions with affiliates,asset sales, acquisitions, mergers, prepayments of other indebtedness, liensand encumbrances and other matters customarily restricted in such agreements.

The Amended Credit Facility contains customary eventsof default, including, among other things, payment defaults, breach ofrepresentations and warranties, covenant defaults, cross-acceleration,cross-defaults to certain other indebtedness, certain events of bankruptcy andinsolvency and judgment defaults.

The Company made regularly scheduled principalpayments of $3.9 million and paid interest of $4.0 million in connection withits credit facilities during the nine months ended September 30, 2005. Duringthe nine months ended September 30, 2004, the Company made regularlyscheduled principal payments of $4.4 million and paid interest of $2.0 million inconnection with its credit facilities.

Thefollowing table shows the schedule of principal payments (in thousands)remaining on the Amended Credit Agreement, with the final payment in March 2009:

| 2005 (remainder  of year) |   | $      | 1,312  |   |
|---------------------------|--------|--------|--------|--------|
| 2006                      |   | 5,250  |   |
| 2007                      |   | 5,250  |   |
| 2008                      |   | 5,250  |   |
| 2009                      |   | 80,063 |   |
|                      |   | $      | 97,125 |   |

 

*Other Long Term Debt*

The Company has formed statutory business trusts,which exist for the exclusive purpose of issuing trust preferred securitiesrepresenting undivided beneficial interests in the assets of the trust,investing the gross proceeds of the trust preferred securities in juniorsubordinated deferrable interest debentures of the Company (the “JuniorSubordinated Debt”) and engaging in only those activities necessary orincidental thereto. In accordance with the adoption of FIN 46R, the Company hasdeconsolidated the trusts.

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Separate subsidiary trusts of the Company (the “Trusts”)have issued a combined $75.0 million in thirty year trust preferred securities(the “Capital Securities”) as detailed in the following table:

| **Maturity Date** | ** ** | ** **              | ** ** | **Amount  Issued** | ** ** | **Term**                | ** **     | **Spread  Over LIBOR** | ** ** | **Rate as of  September 30,  2005** | ** ** |
|------------------------|------------|-------------------------|------------|--------------------|------------|-------------------------|----------------|-----------------------------|------------|----------------------------------------------------|------------|
| ** **             | ** ** | **(In thousands)** | ** ** | ** **         | ** ** | **(Basis points)** | ** **     | ** **                  | ** ** |
| December 2032     |       |                    | $          | 15,000             |       |                    | Fixed/Floating |                        |       | 400                                                | (1)        |   |   | 6.7 | % |   |
| March 2033        |       |                    | 10,000     |               |       | Floating                |           |                        | 400        |                                               |       |   | 7.6 | % |   |
| May 2033          |       |                    | 15,000     |               |       | Floating                |           |                        | 420        |                                               |       |   | 8.1 | % |   |
| May 2033          |       |                    | 15,000     |               |       | Fixed/Floating          |           |                        | 410        | (2)                                                |       |   | 7.4 | % |   |
| October 2033      |       |                    | 20,000     |               |       | Fixed/Floating          |           |                        | 395        | (3)                                                |       |   | 7.0 | % |   |
|                   |       |                    | $          | 75,000             |       |                    |           |                        |       |                                               |       |   |   |   |   |   |

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(1)          Effective September 2003,the Company entered into a swap agreement whereby it will pay a fixed rate of6.7% in exchange for a floating rate of LIBOR plus 400 basis points. The swapcontract expires in December 2007.

(2)          The rate on this issueis fixed at 7.4% for the first five years, after which it is converted to afloating rate equal to LIBOR plus 410 basis points.

(3)          Effective April 29,2004, the Company entered into a swap agreement whereby it will pay a fixedrate of 6.98% in exchange for a floating rate of LIBOR plus 395 basis points. Theswap contract expires in October 2008.

The Trusts have the right to call the CapitalSecurities at par after five years from the date of issuance (which ranged fromDecember 2002 to October 2003). The proceeds from the sale of theCapital Securities, together with proceeds from the sale by the Trusts of theircommon securities to the Company, were invested in thirty-year floating rateJunior Subordinated Debt of the Company. From the proceeds of the trustpreferred securities, $26.0 million was used to pay down debt during 2003. Thebalance of the proceeds has been used, in part to fund acquisitions, to providecapital to the Company’s insurance subsidiaries to support growth and to beheld for general corporate purposes.

The Capital Securities represent an undividedbeneficial interest in the Trusts’ assets, which consist solely of the JuniorSubordinated Debt. Holders of the Capital Securities have no voting rights. TheCompany owns all of the common securities of the Trusts. Holders of both theCapital Securities and the Junior Subordinated Debt are entitled to receivecumulative cash distributions accruing from the date of issuance, and payablequarterly in arrears at a floating rate equal to the three-month LIBOR plus aspread. The floating rate resets quarterly and is limited to a maximum of 12.5%during the first sixty months. Due to the variable interest rate for thesesecurities, the Company would be subject to higher interest costs if short-terminterest rates rise. The Capital Securities are subject to mandatory redemptionupon repayment of the Junior Subordinated Debt at maturity or upon earlierredemption. The Junior Subordinated Debt is unsecured and ranks junior andsubordinate in right of payment to all present and future senior debt of theCompany and is effectively subordinated to all existing and future obligationsof the Company’s subsidiaries. The Company has the right to redeem the JuniorSubordinated Debt after five years from the date of issuance.

The Company has the right at any time, and from timeto time, to defer payments of interest on the Junior Subordinated Debt for aperiod not exceeding 20 consecutive quarters up to each debenture’s maturitydate. During any such period, interest will continue to accrue and the Companymay not declare or pay any cash dividends or distributions on, or purchase, theCompany’s common stock nor make any principal, interest or premium payments onor repurchase any debt securities that rank equally with or junior to theJunior Subordinated Debt. The Company has the right at any time to dissolve theTrusts and cause the Junior Subordinated Debt to be distributed to the holdersof the Capital Securities. The 

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Company has guaranteed, ona subordinated basis, all of the Trusts’ obligations under the CapitalSecurities including payment of the redemption price and any accumulated andunpaid distributions to the extent of available funds and upon dissolution,winding up or liquidation but only to the extent the Trusts have fundsavailable to make such payments.

The Company paid interestof $4.0 million in connection with the Junior Subordinated Debt during the ninemonths ended September 30, 2005 and paid interest of $3.5 million duringthe nine months ended September 30, 2004.

*Lease Obligations*

We areobligated under certain lease arrangements for our executive and administrativeoffices in New York, Florida, Indiana, Tennessee, Texas, and Ontario, Canada. Annualminimum rental commitments, subject to escalation, under non-cancelableoperating leases (in thousands) are as follows:

| 2005 (remainder  of year) |   | $     | 632    |   |
|---------------------------|--------|-------|--------|--------|
| 2006                      |   | 2,605 |   |
| 2007                      |   | 2,588 |   |
| 2008                      |   | 2,328 |   |
| 2009 and  thereafter      |   | 9,236 |   |
| Totals                    |   | $     | 17,389 |   |

 

In addition to the above,Pennsylvania Life and Penncorp Life (Canada) are the named lessees on 71properties occupied by Career Agents for use as field offices. The CareerAgents reimburse Pennsylvania Life and Penncorp Life (Canada) the actual rentfor these field offices. The total annual rent paid by the Company andreimbursed by the Career Agents for these field offices during 2004 wasapproximately $1.1 million.

*Shelf Registration and Equity Offering*

On November 3, 2004, we filed a universal shelfregistration statement on Form S-3 with the U.S. Securities andExchange Commission (“SEC”), pursuant to which we may issue common stock,warrants and debt securities from time to time, up to an aggregate offering of$140 million. The registration statement also covers five million shares ofcommon stock that may be offered for sale by Capital Z Financial Services FundII, L.P (“Capital Z”), our largest shareholder. The shelf registration statementwas declared effective in December, 2004.

The shelf registration statement enables us to raisefunds from the offering of any individual security covered by the shelfregistration statement, as well as any combination thereof, through one or moremethods of distribution, subject to market conditions and our capital needs. Theterms of any offering pursuant to this shelf will be established at the time ofthe offering. We plan to use the proceeds from any future offering under theregistration statement for general corporate purposes, including, but notlimited to, working capital, capital expenditures, investments in subsidiaries,acquisitions and refinancing of debt. A more detailed description of the use ofproceeds will be included in any specific offering of securities in theprospectus supplement relating to the offering.

On June 22, 2005, we issued 2.0 million shares ofour common stock at a price of $23.61 per share, in connection with a publicoffering pursuant to the shelf registration. The issuance of these sharesgenerated proceeds to us of $44.2 million, net of underwriters discount andother issuance costs. Additionally, 5.0 million shares were sold byCapital Z Financial Services Fund II, L.P. and its affiliates (“Capital Z”),our largest shareholder, under the same shelf registration. On July 20,2005, the underwriters exercised their over-allotment option and we issued anadditional 660,000 shares of our common stock at $23.61 per 

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share, generatingadditional net proceeds of $14.8 million. Following the offering, Capital Zowned 20.2 million shares, or 34.5% of our outstanding common stock.

Subsequent to the offeringnoted above, the aggregate amount that remains available for offering under theshelf registration is $77.2 million.

*Obligations of the Parent Company to Affiliates*

In January 2002, ourparent company issued an $18.5 million, 8.5% debenture to Pennsylvania Life inconnection with the transfer of the business of Pennsylvania Life’s CanadianBranch to Penncorp Life (Canada). The debenture is scheduled to be repaid infull during 2005. As of September 30, 2005, the outstanding balance was$0.9 million. Our parent holding company paid $0.2 million in interest on thesedebentures during the nine months ended September 30, 2005 and $0.4 millionduring the nine months ended September 30, 2004. The interest on thesedebentures is eliminated in consolidation. Dividends from Penncorp Life(Canada) funded the interest and principal paid on the debenture to date and itis anticipated that they will fund all future payments made on this debenture.

*Sources of Liquidity to the Parent Company*

We have severalsources of liquidity to fund the obligations of the parent company and providethe capital required to grow our business. On an operating basis, we have fourdistinct and uncorrelated sources of cash flow as follows:

·       theexpected cash flows of our senior administrative services company,

·       theexpected cash flows of our senior managed care company (acquired in theacquisition of Heritage),

·       dividendpayments received from Penncorp Life (Canada), and

·       surplusnote principal and interest payments from American Exchange.

In addition, we have access to our unutilized $15.0million revolving credit facility. Finally, we have the ability, from time to time,to access the capital markets for additional capital. There can be no assuranceas to our actual future cash flows, from the continued availability ofdividends from our insurance company subsidiaries or from access to the capitalmarkets.

The issues affecting the profitability of the Companyduring the third quarter of 2005, as discussed in the Managements’ Discussionand Analysis, do not materially affect the sources of liquidity to the ParentCompany as discussed below. The increase in the Medicare supplement loss ratiosare confined to the insurance companies that we do not look to for significantcash flow. The deferred acquisition cost and present value of future profitincreased amortization is a non-cash item.

*Senior Administrative Services Company.  *Liquidityfor our senior administrative services subsidiary is measured by its ability topay operating expenses and pay dividends to our parent company. The primarysource of liquidity is fees collected from clients. We believe that the sourcesof cash for our senior administrative services company exceed scheduled uses ofcash and results in amounts available to dividend to our parent holdingcompany. We measure the ability of the senior administrative services companyto pay dividends based on its earnings before interest, taxes, depreciation andamortization (“EBITDA”). EBITDA for our Senior Administrative Services segmentwas $11.1 million for the nine months ended September 30, 2005, and was$11.2 million for the nine months ended September 30, 2004.

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*Senior Managed Care Company*.*  *Liquidity for our managed care company is measured byits ability to pay operating expenses and pay dividends to our parent company. Theprimary source of liquidity is management fees for administration of SelectCareand services provided to the IPA’s. Dividend payments by SelectCare to Heritageare subject to the approval of the insurance regulatory authorities of thestate of Texas, SelectCare’s state of domicile. SelectCare is not able to paydividends during 2005 without prior approval. We believe that the sources ofcash to our managed care holding company exceed scheduled uses of cash whichwill result in funds available to dividend to our parent holding company. Wemeasure the ability of the senior managed care holding company to pay dividendsbased on its EBITDA. EBITDA for our senior managed care holding company was$23.7 million for the nine months ended September 30, 2005, and was $7.1million for the nine months ended September 30, 2004.

*Penncorp Life (Canada) Dividends.  *PenncorpLife (Canada) is a Canadian insurance company. Canadian law provides that alife insurer may pay a dividend after such dividend declaration has beenapproved by its board of directors and upon at least 10 days prior notificationto the Superintendent of Financial Institutions. Such a dividend is limited toretained net income (based on Canadian GAAP) for the preceding two years, plusnet income earned for the current year. In considering approval of a dividend,the board of directors must consider whether the payment of such dividend wouldbe in contravention of the Insurance Companies Act of Canada. During the ninemonths ended September 30, 2005, PennCorp Life (Canada) paid dividends ofC$3.2 million (approximately US $2.7 million) to Universal American. During thefirst quarter of 2004, Penncorp Life (Canada) paid dividends of C$26.7 million(approximately US$20.0 million) to Universal American, relating to 2003 netincome. The amount of the dividend was larger than normal due to a benefitreceived by Penncorp Life (Canada) from an actuarial experience study thatallowed Penncorp Life (Canada) to reduce its policy benefit reserves at December 31,2003 on a Canadian GAAP basis. The actuarial experience study did not have animpact on Penncorp Life (Canada)’s policy benefit reserves on a U.S. GAAP basis.During the remainder of 2004, Penncorp Life (Canada) paid dividends totalingC$7.2 million (US$5.6 million) relating to net income for 2004. We anticipatethat Penncorp Life (Canada) will be able to pay dividends equal to its netincome earned during 2005, less $2.5 million.

*Insurance Subsidiaries—Surplus Note, Dividends andCapital Contributions*.*  *Cashgenerated by our insurance company subsidiaries may be made available to ourholding company, principally through periodic payments of principal andinterest on the surplus note owed to our holding company by our subsidiary,American Exchange. As of September 30, 2005, the principal amount of thesurplus note was $40.1 million. The note bears interest to our parent holdingcompany at LIBOR plus 325 basis points. We anticipate that the surplus notewill be primarily serviced by dividends from Pennsylvania Life, a wholly ownedsubsidiary of American Exchange, and by tax-sharing payments among theinsurance companies that are wholly owned by American Exchange and file aconsolidated Federal income tax return. American Exchange made principalpayments totaling $8.4 million during the nine months ended September 30,2005 and $11.5 million during the nine months ended September 30, 2004. AmericanExchange paid interest on the surplus note of $1.9 million during the ninemonths ended September 30, 2005 and $1.8 million during the nine monthsended September 30, 2004.

Our parent holding company made capital contributionsto American Exchange amounting to $20.7 million during 2005. In September 2005,Pennsylvania Life declared and paid a dividend in the amount of $2.5 million toAmerican Exchange. American Exchange made capital contributions of $12.0million to American Pioneer, $3.0 million to Union Bankers, $2.4 million toConstitution and $1.5 million to American Progressive during the nine monthsended September 30, 2005.

Our parent holding company made capital contributionsto American Exchange amounting to $9.9 million during the nine months ended September 30,2004. In March 2004, Pennsylvania Life declared and paid a dividend in theamount of $10.6 million to American Exchange. American Exchange made capital 

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contributions of $9.3million to Union Bankers, $6.7 million to American Pioneer and $4.0 million toAmerican Progressive during the nine months ended September 30, 2004.

Dividend payments by ourU.S. insurance companies to our holding company or to intermediate subsidiariesare limited by, or subject to the approval of the insurance regulatoryauthorities of each insurance company’s state of domicile. Such dividendrequirements and approval processes vary significantly from state to state. PennsylvaniaLife is able to pay ordinary dividends of up to $3.8 million to AmericanExchange during the remainder of 2005, without prior approval. Pyramid Life isable to pay ordinary dividends of up to $2.5 million to Pennsylvania Life (itsdirect parent) with prior notice to the Kansas Insurance Department andMarquette would be able to pay ordinary dividends of up to $0.3 million toConstitution (its direct parent) without the prior approval from the TexasInsurance Department during 2005. American Exchange, American Pioneer, AmericanProgressive, Constitution and Union Bankers had negative earned surplus at December 31,2004 and are not able to pay dividends in 2005 without special approval.

*Insurance Subsidiaries—Liquidity*

Liquidity for our insurance company subsidiaries ismeasured by their ability to pay scheduled contractual benefits, pay operatingexpenses, fund investment commitments, and pay dividends to their parentcompany. The principal sources of cash for our insurance operations includescheduled and unscheduled principal and interest payments on investments,premium payments, annuity deposits, and the sale or maturity of investments. Boththe sources and uses of cash are reasonably predictable and we believe thatthese sources of cash for our insurance company subsidiaries exceed scheduleduses of cash.

Liquidity is also affected by unscheduled benefitpayments including benefits under accident and health insurance policies, deathbenefits and interest-sensitive policy surrenders and withdrawals. Our accidentand health insurance policies generally provide for fixed-benefit amounts and,in the case of Medicare supplement policies, for supplemental payments toMedicare provider rates. Some of these benefits are subject to medical-costinflation and we have the capability to file for premium rate increases tomitigate rising medical costs. Our health insurance business is widelydispersed in the United States and Canada, which mitigates the risk ofunexpected increases in claim payments due to epidemics and events of acatastrophic nature. These accident and health polices are notinterest-sensitive and therefore are not subject to unexpected policyholderredemptions due to investment yield changes.

Some of our life insurance and annuity policies areinterest-sensitive in nature. The amount of surrenders and withdrawals isaffected by a variety of factors such as credited interest rates for similarproducts, general economic conditions and events in the industry that affectpolicyholders’ confidence. Although the contractual terms of substantially allof our in force life insurance policies and annuities give the holders theright to surrender the policies and annuities, we impose penalties for earlysurrenders. As of September 30, 2005 we held reserves that exceeded theunderlying cash surrender values of our net retained in force life insuranceand annuities by $36.2 million. Our insurance subsidiaries, in our view, havenot experienced any material changes in surrender and withdrawal activity inrecent years.

Changes in interest rates may affect the incidence ofpolicy surrenders and withdrawals. In addition to the potential impact onliquidity, unanticipated surrenders and withdrawals in a changed interest rateenvironment could adversely affect earnings if we were required to sellinvestments at reduced values in order to meet liquidity demands. We manage ourasset and liability portfolios in order to minimize the adverse earnings impactof changing market rates. We have segregated a portion of our investmentportfolio in order to match liabilities that are sensitive to interest ratemovements with fixed income securities containing similar characteristics tothe related liabilities, most notably the expected duration and requiredinterest spread. We believe that this asset/liability management processadequately covers the expected payment of benefits related to theseliabilities.

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As of September 30, 2005, our insurance companysubsidiaries held cash and cash equivalents totaling $137.2 million, as well asfixed maturity securities that could readily be converted to cash with carryingvalues (and fair values) of $1.3 billion.

The net yields on our cash and invested assetsdecreased to 4.8% for the nine months ended September 30, 2005, from 4.9%for the nine months ended September 30, 2004. A portion of thesesecurities are held to support the liabilities for policyholder accountbalances, which liabilities are subject to periodic adjustments to theircredited interest rates. The credited interest rates of the interest-sensitivepolicyholder account balances are determined by us based upon factors such asportfolio rates of return and prevailing market rates and typically follow thepattern of yields on the assets supporting these liabilities.

Our insurance subsidiaries are required to maintainminimum amounts of statutory capital and surplus as required by regulatoryauthorities. However, substantially more than such minimum amounts are neededto meet statutory and administrative requirements of adequate capital andsurplus to support the current level of our insurance subsidiaries’ operations.Each of the life insurance subsidiaries’ statutory capital and surplus exceedsits respective minimum statutory requirement at levels we believe aresufficient to support their current levels of operation. Additionally, theNational Association of Insurance Commissioners (“NAIC”) imposes regulatoryrisk-based capital (“RBC”) requirements on life insurance enterprises. At September 30,2005, all of our life insurance subsidiaries maintained ratios of totaladjusted capital to RBC in excess of the “authorized control level”. Thecombined statutory capital and surplus, including asset valuation reserve, ofthe U.S. life insurance subsidiaries totaled $149.2 million at September 30,2005 and $127.9 million at December 31, 2004. Statutory net income for thenine months ended September 30, 2005 was $4.5 million, and for the ninemonths ended September 30, 2004 was $3.6 million.

Our health plan affiliates are also required tomaintain minimum amounts of capital and surplus, as required by regulatoryauthorities and is also subject to RBC requirements. At September 30,2005, the statutory capital and surplus of each of our health plan affiliatesexceeds its minimum requirement and its RBC is in excess of the “authorizedcontrol level”. The statutory capital and surplus for our health plan affiliateswas $20.8 million at September 30, 2005 and $9.9 million at December 31,2004. Statutory net income for our health plan affiliates for the nine monthsended September 30, 2005 was $7.5 million and for the nine months ended September 30,2004 was $3.7 million.

Penncorp Life (Canada)reports to Canadian regulatory authorities based upon Canadian statutoryaccounting principles that vary in some respects from U.S. statutory accountingprinciples. Penncorp Life (Canada)’s net assets based upon Canadian statutoryaccounting principles were C$62.9 million (US$54.1 million) as of September 30,2005 and were C$57.4 million (US$47.8 million) as of December 31, 2004. Netincome based on Canadian generally accepted accounting principles was C$8.7million (US$7.1 million) for the nine months ended September 30, 2005, andC$7.8 million (US$5.4 million) for the nine months ended September 30,2004. Penncorp Life (Canada) maintained a Minimum Continuing Capital andSurplus Requirement Ratio (“MCCSR”) in excess of the minimum requirement at September 30,2005.

*Investments*

Our investment policy is to balance the portfolioduration to achieve investment returns consistent with the preservation ofcapital and maintenance of liquidity adequate to meet payment of policybenefits and claims. We invest in assets permitted under the insurance laws ofthe various states in which we operate. Such laws generally prescribe thenature, quality of and limitations on various types of investments that may bemade. We do not currently have investments in partnerships, special purpose entities,real estate, commodity contracts, or other derivative securities. We currentlyengage the services of three investment advisors under the direction of themanagement of our insurance company subsidiaries 

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and in accordance withguidelines adopted by the Investment Committees of their respective boards ofdirectors. Conning Asset Management Company manages the portfolio of all of ourUnited States subsidiaries, except for the portfolio of Pyramid Life, andcertain floating rate portfolios, which are managed by Hyperion Capital. MFCGlobal Investment Management manages our Canadian portfolio. We investprimarily in fixed maturity securities of the U.S. Government and its agenciesand in corporate fixed maturity securities with investment grade ratings of “BBB-”(Standard & Poor’s Corporation), “Baa3” (Moody’s Investor Service) orhigher. Our current policy is not to invest in derivative programs or otherhybrid securities, except for GNMA’s, FNMA’s and investment grade corporatecollateralized mortgage obligations.

As of September 30,2005, approximately 99% of our fixed maturity investments had investment graderatings from Standard & Poor’s Corporation or Moody’s Investor Service.There were no non-income producing fixed maturities as of September 30, 2005.We did not write down the value of any fixed maturity securities during thenine months ended September 30, 2005 or 2004.

**Effects of RecentlyIssued and Pending Accounting Pronouncements**

There was no materialimpact on our consolidated financial condition or results of operations as aresult of our adoption of recently issued accounting pronouncements. We do notanticipate any material impact from the future adoption of the pendingaccounting pronouncements, other than the adoption of Statement of FinancialAccounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS123R”). SFAS 123R requires all companies to recognize compensation costs forshare-based payments to employees based on the grant-date fair value of theaward for financial statements for annual periods beginning after June 15,2005. Refer to Consolidated Financial Statements (Unaudited) Note 2—Recent andPending Accounting Pronouncements.

**Risk Factors**

Our business is subject tosignificant risks. We advise you to carefully consider the following risks inaddition to those risks and speculative factors discussed in our filings withthe Securities and Exchange Commission, including our Annual Reports on Form 10-K,Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

*The Medicare Prescription Drug, Improvement andModernization Act of 2003 Made Changes to the Medicare Program That WillMaterially Impact Our Operations and Could Reduce Our Profitability andIncrease Competition for Members.*

The MedicarePrescription Drug, Improvement and Modernization Act of 2003, or MMA,substantially changed the Medicare program and will modify how we operate ourbusiness. Many of these changes will be effective for 2006 and, as we have notbeen able to fully assess the impact of these changes, we do not know whetherwe will be able to operate our business and Medicare Advantage plans at currentlevels of profitability or competitively. Although many of these changes aredesigned to benefit Medicare Advantage plans generally, certain provisions ofthe MMA may increase competition, create challenges for us with respect toeducating our existing and potential members about the changes, and createother risks and substantial and potentially adverse uncertainties, includingthe following:

·       Beginningin 2006, Medicare beneficiaries generally will have a more limited annualenrollment period during which they can choose to participate in a MedicareAdvantage plan or receive benefits under the traditional fee-for-serviceMedicare program. After the annual enrollment period, most Medicarebeneficiaries will not be permitted to change their Medicare benefits. The newannual enrollment process and subsequent “lock-in” provisions of the MMA mayadversely 

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affect our growth as itwill limit our ability to enter new service areas and market to or enroll newmembers in our established service areas outside of the annual enrollmentperiod.

·       As a result of the limitedannual enrollment period and the subsequent “lock-in” provisions of the MMA,our sales force, including our independent sales brokers and agents, may belimited in their ability to market our Medicare Advantage and PDP productsyear-round. Our agents rely substantially on sales commissions for theirincome. Given the limited annual sales window, it may become more difficult tofind agents to market and promote these products.

*There aresignificant risks associated with our participation in the Medicare Part Dprogram.*

Our participationin the Medicare Part D program involves a number of risks, including thefollowing:

·       CMS continues torelease regulations on Part D, including important requirementsrelated to the implementation and marketing of the Part D prescriptiondrug benefit plan. This will create challenges for planning and implementationof our Part D program, and there is no assurance that Congress or CMS willnot alter the program in a manner that will be detrimental to us.

·       Wewill incur significant expenditures of time and resources in developing thisprogram, and we may need to divert human resources from other areas of theCompany. Although we believe that we have the capability to meet our staffingneeds, it is possible that the fulfillment of our administrative duties inother areas may suffer.

·       Wecannot be certain that our products will be competitive, as compared to otherPDPs.

·       Weare making actuarial assumptions about the utilization of benefits in our PDPs.Because Part D is a newly created program, there is no historical basisfor these assumptions, and we cannot assure you that these assumptions willprove to be correct and that premiums will be sufficient to cover benefits.

·       Wecannot assure you that the market will accept and acquire insurance from ourPDPs, and therefore our anticipated sales under the program may generatesignificantly less revenue than our current expectations.

·       InOctober 2005, CMS automatically assigned approximately 350,000 dualeligibles to our PDP plans that are priced under the regional benchmarks. Wecannot guarantee that all 350,000 of these dual eligibles assigned to us willenroll in our PDPs, since they will have the right to enroll in a qualifyingstandard PDP product beginning November 15, 2005. In addition, becausedual eligible beneficiaries can change their PDP each month, we can not assureyou that the dual eligible beneficiaries who are automatically assigned to ourPDPs will remain in our PDP’s.

·       Part Dis a new program and the competitive landscape is uncertain. We expect toencounter competition from other PDP sponsors, some of whom may havesignificantly greater resources and brand recognition than we do. Our marketingarrangement with CVS is non-exclusive, and CVS has entered into marketingarrangements with our competitors. We cannot predict whether we will be able toeffectively compete in this new market.

·       Thecosts of developing and marketing our PDPs will vary based upon the size ofmembership in our PDPs. Given the uncertainties and risks described above, thecost of developing PDPs that will allow us to effectively compete in this newmarket could exceed our current expectations.

·       Companiesthat offer Medicare Advantage plans will be required to offer prescription drugbenefits in 2006 as part of their Medicare Advantage plans. Such combinedmanaged care plans offering drug benefits are, under the new law, called MA-PDs.It is not known at this time whether the governmental payments will be adequateto cover our actual costs for these new MA-PD benefits 

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or, in light of ourinexperience with this program, whether we will be able to profitably orcompetitively manage our MA-PDs.

·       Someenrollees may have chosen our Medicare Advantage plan in the past rather thanthose of our competitors or traditional Medicare fee-for-service because of thedrug benefit that we offer with our Medicare Advantage plans. We do not know atthis time whether our PDP or MA-PD benefits will be as or more attractive thanthose of our competitors. Additionally, Medicare beneficiaries that participatein a Medicare Advantage plan that enroll in a PDP will be automaticallydisenrolled from their Medicare Advantage plan. Accordingly, the existence ofnew PDPs in our service areas could result in our members intentionally orinadvertently disenrolling from our plans and reduce our membership andprofitability.

·       TheMMA provides for “risk corridors” that are expected to limit to some extent thelosses MA-PDs or PDPs would incur if their costs turned out to be higher thanthose in the per member per month, or PMPM, bids submitted to CMS in excess ofcertain specified ranges. For example, for 2006 and 2007 drug plans will bearall gains and losses up to 2.5% of their expected costs, but will be reimbursedfor 75% of the losses between 2.5% and 5%, and 80% of losses in excess of 5%. Itis anticipated that the initial risk corridors in 2006 and 2007 will providemore protection against excess losses than will be available beginning in 2008and future years as the thresholds increase and the reimbursement percentagesdecrease. In addition, we expect there will be a delay in obtainingreimbursement from CMS for reimbursable losses pursuant to the risk corridors. Forexample, if we incur reimbursable losses in 2006, we would not be reimbursed byCMS until 2007. In that event, we expect there would be a negative impact onour cash flows and financial condition as a result of being required to financeexcess losses until we are reimbursed. In addition, as the risk corridors aredesigned to be symmetrical, a plan whose actual costs fall below their expectedcosts would be required to reimburse CMS based on a similar methodology as setforth above. Furthermore, reconciliation payments for estimated upfront federalreinsurance payments, or, in some cases, the entire amount of the reinsurancepayments, for Medicare beneficiaries who reach the drug benefit’s catastrophicthreshold are made retroactively on an annual basis, which could expose plansto upfront costs in providing the benefit. Accordingly, it may be difficult toaccurately predict or report the operating results associated with our drugbenefits.

*CMS’s Risk Adjustment Payment System and BudgetNeutrality Factors Make Our Revenue and Profitability Difficult to Predict andCould Result In Material Retroactive Adjustments to Our Results of Operations.*

CMS has implemented a risk adjustment payment systemfor Medicare health plans to improve the accuracy of payments and establishincentives for Medicare plans to enroll and treat less healthy Medicarebeneficiaries. CMS is phasing-in this payment methodology with a riskadjustment model that bases a portion of the total CMS reimbursement paymentson various clinical and demographic factors including hospital inpatientdiagnoses, diagnosis data from ambulatory treatment settings, includinghospital outpatient facilities and physician visits, gender, age, and Medicaideligibility. CMS requires that all managed care companies capture, collect, andsubmit the necessary diagnosis code information to CMS twice a year forreconciliation with CMS’s internal database. As part of the phase-in, during2003, risk adjusted payments accounted for 10% of Medicare health planpayments, with the remaining 90% being reimbursed in accordance with the traditionalCMS demographic rate books. In 2004 and 2005, the portion of risk adjustedpayments was increased to 30% and 50%, respectively, and will increase to 75%in 2006 and 100% in 2007. As a result of this process, it is difficult topredict with certainty our future revenue or profitability. In addition, ourown risk scores for any period may result in favorable or unfavorableadjustments to the payments we receive from CMS and our Medicare premiumrevenue. There can be no assurance that we will be successful in accuratelyrecording diagnosis code information and enhancing our risk scores.

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Payments to MedicareAdvantage plans are also adjusted by a “budget neutrality” factor that wasimplemented in 2003 by Congress and CMS to prevent health plan payments frombeing reduced overall while, at the same time, directing risk adjusted paymentsto plans with more chronically ill enrollees. In general, this adjustment hasfavorably impacted payments to all Medicare Advantage plans. The President’sbudget for 2005 assumes the phasing out of the budget neutrality adjustmentsover a five year period from 2007 through 2011, that will have the effect ofreducing payments to Medicare Advantage plans in general. Consequently, ourplans’ premiums will be reduced unless our risk scores increase. Although ourrisk scores have increased historically, there is no assurance that theincreases will continue or, if they do, that they will be large enough tooffset the elimination of this adjustment.

*We may experiencefuture lapsation in our Medicare Supplement business.*

During the quarter ended September 30,2005, we experienced an unanticipated increase in lapsation of our MedicareSupplement business largely caused by the departure of three sales managers inone of our career companies, each of whom rewrote a significant part of theirbusiness with other carriers. This caused us to amortize the deferred policyacquisition costs and present value of future profit assets on these policiesover a shorter period than expected. We believe, but cannot give assurance,that this type of activity will not continue. However, increased competition inthe senior market may result in more lapsation than we have experienced in thepast, thus requiring an increase in non-cash pre-tax amortization expense.

*We may experiencehigher than expected loss ratios in our Medicare Supplement business.*

During the quarter ended September 30,2005, we experienced a higher than expected loss ratio on our MedicareSupplement business. As a result of higher than anticipated Part B costs(outpatient doctor costs) and skilled nursing facility incidence, we did notsee our historical pattern of seasonal reduction in loss ratios in the latterpart of the year. We are actively obtaining appropriate rate action in aneffort to reverse the trend in these numbers, however, we can make noassurances that future rate increases will be obtained, or if obtained, will besufficient. We also cannot give assurance that our Medicare Supplement lossratio will not continue to increase beyond what we currently anticipate.

**Item 3.**                        Quantitativeand Qualitative Disclosures About Market Risk.

In general, market riskrelates to changes in the value of financial instruments that arise fromadverse movements in interest rates, equity prices and foreign exchange rates. Weare exposed principally to changes in interest rates that affect the market pricesof our fixed income securities as well as the cost of our variable rate debt. Additionally,we are exposed to changes in the Canadian dollar that affects the translationof the financial position and the results of operations of our Canadiansubsidiary from Canadian dollars to U.S. dollars.

*Investment InterestRate Sensitivity*

Our profitability could be affected if we wererequired to liquidate fixed income securities during periods of rising and/orvolatile interest rates. However, we attempt to mitigate our exposure toadverse interest rate movements through a combination of active portfoliomanagement and by staggering the maturities of our fixed income investments toassure sufficient liquidity to meet our obligations and to address reinvestmentrisk considerations. Our insurance liabilities generally arise over relativelylong periods of time, which typically permits ample time to prepare for theirsettlement.

Certain classes of mortgage-backed securities aresubject to significant prepayment risk due to the fact that in periods ofdeclining interest rates, individuals may refinance higher rate mortgages totake 

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advantage of the lowerrates then available. We monitor and adjust our investment portfolio mix tomitigate this risk.

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

The sensitivity analysisof interest rate risk assumes an instantaneous shift in a parallel fashionacross the yield curve, with scenarios of interest rates increasing anddecreasing 100 and 200 basis points from their levels as of September 30,2005, and with all other variables held constant. A 100 basis point increase inmarket interest rates would result in a pre-tax decrease in the market value ofour fixed income investments of $69.5 million and a 200 basis point increase inmarket interest rates would result in $136.8 million decrease. Similarly, a 100basis point decrease in market interest rates would result in a pre-taxincrease in the market value of our fixed income investments of $74.8 millionand a 200 basis point decrease in market interest rates would result in a$154.2 million increase.

*Debt*

We pay interest on our term loan and a portion of ourtrust preferred securities based on the London Inter Bank Offering Rate (“LIBOR”)for one, two or three months. Due to the variable interest rate, the Companywould be subject to higher interest costs if short-term interest rates rise. Wehave attempted to mitigate our exposure to adverse interest rate movements byfixing the rate on $15.0 million of the trust preferred securities for a fiveyear period through the contractual terms of the security at inception and anadditional $35.0 million through the use of interest rate swaps.

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

Thesensitivity analysis of interest rate risk assumes scenarios of increases ordecreases in LIBOR of 100 and 200 basis points from their levels as of and forthe nine months ended September 30, 2005, and with all other variablesheld constant. The following table summarizes the impact of changes in LIBOR: 

| ** **                                                | ** ** | ** **                                | ** ** | ** **                                  | ** ** | **Effect of Change in LIBOR on Pre-tax Income  for the nine months ended September 30, 2005** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Description of Floating Rate Debt** | ** ** | **Weighted  Average  Interest Rate** | ** ** | **Weighted  Average  Balance  Outstanding** | ** ** | **200 Basis  Point  Decrease**                                                                                                                                 | ** ** | **100 Basis  Point  Decrease** | ** ** | **100 Basis  Point  Increase** | ** ** | **200 Basis  Point  Increase** | ** ** |
| ** **                                                | ** ** | **(in millions)**                    | ** ** |
| Loan Payable                                              |       |                                      | 5.28       | %                                           |       |                                                                                                                                                                | $          | 99.7 |   |   |   | $ | 1.5 |   |   |   | $ | 0.7 |   |   |   | $ | (0.7 | ) |   |   | $ | (1.5 | ) |   |
| Other long term  debt                                     |       |                                      | 7.29       | %                                           |       |                                                                                                                                                                | $          | 25.0 |   |   |   | 0.4 |   |   |   | 0.2 |   |   |   | (0.2 | ) |   |   | (0.4 | ) |   |
| Total                                                     |       |                                      |       |                                        |       |                                                                                                                                                                |       |   |   |   | $ | 1.9 |   |   |   | $ | 0.9 |   |   |   | $ | (0.9 | ) |   |   | $ | (1.9 | ) |   |

 

As noted above, we havefixed the interest rate on $50 million of our $175 million of total debt outstanding,leaving $125 million of the debt exposed to rising interest rates. As of September 30,2005 we had approximately $230 million of cash and cash equivalents and $113million in short duration floating rate investment securities. We anticipatethat the net investment income on this $343 million will be positively impactedby rising interest rates and will mitigate the negative impact of risinginterest rates on our debt.

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*Currency ExchangeRate Sensitivity*

Portions of our operations are transacted using theCanadian dollar as the functional currency. As of and for the nine months endedSeptember 30, 2005, approximately 12% of our assets, 8% of our revenues,excluding realized gains, and 15% of our income before realized gains and taxeswere derived from our Canadian operations. As of and for the nine months ended September 30,2004, approximately 11% of our assets, 10% of our revenues, excluding realizedgains, and 17% of our income before realized gains and taxes were derived fromour Canadian operations. Accordingly, our earnings and shareholder’s equity areaffected by fluctuations in the value of the U.S. dollar as compared to theCanadian dollar. Although this risk is somewhat mitigated by the fact that boththe assets and liabilities for our foreign operations are denominated inCanadian dollars, we are still subject to translation gains and losses.

We periodically conduct various analyses to gauge thefinancial impact of changes in the foreign currency exchange rate on ourfinancial condition. The ranges selected in these analyses reflect ourassessment of what is reasonably possible over the succeeding twelve-monthperiod.

A 10% strengthening of the U.S. dollar relative to theCanadian dollar, as compared to the actual average exchange rate for the ninemonths ended September 30, 2005, would have resulted in a decrease in ourincome before realized gains and taxes of approximately $1.0 million for thenine months ended September 30, 2005 and a decrease in our shareholders’equity of approximately $5.6 million at September 30, 2005. A 10%weakening of the U.S. dollar relative to the Canadian dollar would haveresulted in an increase in our income before realized gains and taxes ofapproximately $1.2 million for the nine months ended September 30, 2005 andan increase in shareholders’ equity of approximately $6.9 million at September 30,2005. Our sensitivity analysis of the effects of changes in foreign currencyexchange rates does not factor in any potential change in sales levels, localprices or any other variables.

The magnitude of changesreflected in the above analysis regarding interest rates and foreign currencyexchange rates should, in no manner, be construed as a prediction of futureeconomic events, but rather as a simple illustration of the potential impact ofsuch events on our financial results.

**Item 4.**                        Controlsand Procedures.

*Evaluation ofDisclosure Controls and Procedures*

Our management evaluated,with the participation of our principal executive and principal financialofficers, the effectiveness of our disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)), as of theend of the period covered by this report. Based on their evaluation, ourprincipal executive and principal financial officers concluded that ourdisclosure controls and procedures are effective to ensure that informationrequired to be disclosed by the Company in the reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the rules and forms of the Securities andExchange Commission.

*Change in InternalControl over Financial Reporting*

There has been no materialchange in our internal control over financial reporting (as defined in Rules 13a–15(f) and15d–15(f) under the Exchange Act) that occurred during the quarter ended September 30,2005 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

*InherentLimitations on Effectiveness of Controls*

Our management, including our Chief Executive Officerand Chief Financial Officer, does not expect that our disclosure controls andprocedures or our internal controls over financial reporting will prevent or 

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detect all error and allfraud. A control system, no matter how well designed and operated, can provideonly reasonable, not absolute, assurance that the objectives of the controlsystem are met. The design of a control system must reflect the fact that thereare resource constraints, and the benefits of controls must be consideredrelative to their costs. Further, because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance that misstatementsdue to error or fraud will not occur or that all control issues and instancesof fraud, if any, within Universal American have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons or bycollusion of two or more people. The design of any system of controls is basedin part on certain assumptions about the likelihood of future events, and therecan be no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions. Projections of any evaluation ofcontrols effectiveness to future periods are subject to risks. Over time,controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures.

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**PART II—OTHER INFORMATION**

**Item 1.**                        LegalProceedings.

The Company has litigationin the ordinary course of business, including claims for medical, disabilityand life insurance benefits, and in some cases, seeking punitive damages. Managementand counsel believe that after reserves and liability insurance recoveries,none of these will have a material adverse effect on the Company.

**Item 2.**                        UnregisteredSales of Equity Securities and Use of Proceeds.

**Issuer Purchases of Equity Securities**

| ** **                                        | **Period** | ** ** | ** ** | **Total  Number of  Shares  Purchased(1)** | ** ** | **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** | ** ** |
|---------------------------------------------------|------------|------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| July 1, 2005  - July 31, 2005           |       |       | 165        |                                            |       |                                         | $          | 23.27                                                                                                                                |       |                                                                                                                                |       | 165 |   |   |   | 707,042 |   |   |
| August 1,  2005 - August 31, 2005       |       |       | 90         |                                            |       |                                         | $          | 22.93                                                                                                                                |       |                                                                                                                                |       | 90 |   |   |   | 706,952 |   |   |
| September 1,  2005 - September 30, 2005 |       |       | 348        |                                            |       |                                         | $          | 22.63                                                                                                                                |       |                                                                                                                                |       | 348 |   |   |   | 706,604 |   |   |
| Total                                             |       |       | 603        |                                            |       |                                         |       |                                                                                                                                 |       |                                                                                                                                | 603        |   |   |   |   |   |   |

 

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(1)          All shares werepurchased in private transactions.

During 2000, our Board of Directors approved a planfor us to purchase up to 0.5 million shares of our common stock in the openmarket. Our Board approved an amendment to the plan to increase the totalshares authorized for purchase to 1.0 million in March 2002 and during December 2003approved a second amendment to increase the shares authorized for purchase to1.5 million. Pursuant to the plan, purchases may be made from time to time atprevailing prices, subject to restrictions on volume and timing.

Between October 28,2005 and November 9, 2005, the Company purchased the remaining sharesavailable under the plan, in open market transactions, at an average price pershare of $15.43 in accordance with Rule 10b-18 of the Securities ExchangeAct of 1934.

**Item 3.        DefaultsUpon Senior Securities.**

None

**Item 4.**                        Submissionof Matters to a Vote of Security Holders.

None

**Item 5.**                        OtherInformation.

None

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**Item 6.**                        Exhibits.

| 2.1                   |   | Agreement and Plan of Merger, dated as of  March 9, 2004, among Universal American Financial Corp., HHS Acquisition  Corp., Heritage Health Systems, Inc. and Carlyle Venture Partners, L.P.,  as the stockholder representative, incorporated by reference to Form 8-K  dated March 9, 2004.                                                                                  |
|---------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                   |   | Restated Certificate of  Incorporation of Universal American Financial Corp. incorporated by reference  to Exhibit 3.1 to the registrant’s Amendment No. 2 to the  Registration Statement (No. 333-62036) on Form S-3  filed on July 11, 2001.                                                                                                                       |
| 3.2                   |   | Amendment No. 1 to  the Restated Certificate of Incorporation of Universal American Financial  Corp., incorporated by reference to Exhibit 3 to Form 10-Q (File  No. 0-11321) for the quarter ended June 30, 2004, filed with  the SEC on August 9, 2004.                                                                                                            |
| 3.3                   |   | Amended and Restated  By-Laws of Universal American Financial Corp., incorporated by reference to  Exhibit A to Form 8-K (File No. 0-11321) dated  August 13, 1999.                                                                                                                                                                                                            |
| 4.1                   |   | Form of Indenture  dated as of December 2004 between Universal American Financial Corp. and  U.S. Bank National Association, as Trustee, incorporated by reference to  Exhibit 4.01 to Amendment No. 1 to the Company’s Registration  Statement on Form S-3 (File No. 333-120190) filed with  the Securities and Exchange Commission on December 10, 2004. |
| 4.2                   |   | Form of Indenture  dated as of December 2004 between Universal American Financial Corp. and  U.S. Bank National Association, as Trustee, incorporated by reference to  Exhibit 4.02 to Amendment No. 1 to the Company’s Registration  Statement on Form S-3 (File No. 333-120190) filed with  the Securities and Exchange Commission on December 10, 2004. |
| 4.3                   |   | Shareholders Agreement  dated July 30, 1999, among the Company, Capital Z Financial Services  Fund II, L.P., UAFC, L.P., AAM Capital Partners, L.P., Chase Equity  Associates, L.P., Richard A. Barasch and others, incorporated by reference to  Exhibit A of Form 8-K dated August 13, 1999.                                                                                 |
| 4.4                   |   | Registration Rights  Agreement, dated July 30, 1999, among the Company, Capital Z Financial  Services Fund II, L.P., Wand/Universal American Investments L.P.I.,  Wand/Universal American Investments L.P. II, Chase Equity Associates, L.P.,  Richard A. Barasch and others, incorporated by reference to Exhibit A to  Form 8-K dated August 13, 1999.                       |
| *10.1** **            |   | Quota Share Reinsurance  Agreement, dated June 30, 2005, among the Company and PharmaCare Captive  Re, Ltd.                                                                                                                                                                                                                                                                                   |
| *11.1** ** ** ** |   | Computation of Per Share  Earnings Data required by Statement of Financial Accounting Standards  No. 128, Earnings Per Share, is provided in Note 4 to the Consolidated  Financial Statements in this report.                                                                                                                                                                                 |
| *31.1                 |   | Certification of Chief  Executive Officer as required by Rule 13a-14(a) of the  Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                                                 |
| *31.2                 |   | Certification of Chief  Financial Officer as required by Rule 13a-14(a) of the  Securities Exchange Act of 1934 and Section 302 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                                                 |
| *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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*                    Filed orfurnished herewith.

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**SIGNATURE**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

|                              | ** ** | **UNIVERSAL AMERICAN FINANCIAL  CORP.** |
|------------------------------|------------|-----------------------------------------|
| Date: November 9,  2005 |       | By:                                     |   | /s/  ROBERT A. WAEGELEIN |
|                         |       |                                    |   | Robert A.  Waegelein |
|                         |       |                                    |   | *Executive  Vice President and* |
|                         |       |                                    |   | *Chief  Financial Officer* |

 

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