**UNITED STATESSECURITIES 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 June 30,  2007** |
| **OR**                                                 |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**Forthe transition period from              to             **

**Commissionfile Number: 0-11321**

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

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

 

**SixInternational Drive, Suite 190, Rye Brook, New York 10573**(Address of principalexecutive offices and zip code)

**(914) 934-5200**(Registrant’s telephonenumber, including area code)

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Indicate by checkmark 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

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the ExchangeAct. (Check one):

| Large accelerated  filer  o |   | Accelerated  filer  x |   | Non-accelerated  filer  o |
|---------------------------------------|--------|---------------------------------|--------|-------------------------------------|

 

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

Asof July 31, 2007, 59,742,258 shares of the registrant’s common stock wereissued and outstanding.

 

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**TABLEOF CONTENTS**
|              | ** ** | **Item** | ** ** | **Description** | ** ** | **Page**                                                                                      |
|--------------|------------|----------|------------|-----------------|------------|-----------------------------------------------------------------------------------------------|
| PART 1  |       |     |       |            |       | Financial Information                                                                         |   |   |
|         |       |     | 1          |            |       | Financial Statements (unaudited):                                                             |   |   |
|         |       |     |       |            |       | Consolidated Balance Sheets                                                                   |   | 4 |
|         |       |     |       |            |       | Consolidated Statements of Operations—Three Months                                       |   | 5 |
|         |       |     |       |            |       | Consolidated Statements of Operations—Six Months                                         |   | 6 |
|         |       |     |       |            |       | Consolidated Statements of Stockholders’ Equity and  Comprehensive Income                |   | 7 |
|         |       |     |       |            |       | Consolidated Statements of Cash Flows                                                         |   | 8 |
|         |       |     |       |            |       | Notes to Consolidated Financial Statements                                                    |   | 9 |
|         |       |     | 2          |            |       | Management’s Discussion and Analysis of Financial  Condition and   Results of Operations |   | 34 |
|         |       |     | 3          |            |       | Quantitative and Qualitative Disclosures About Market  Risk                                   |   | 65 |
|         |       |     | 4          |            |       | Controls  and Procedures                                                                      |   | 66 |
| PART II |       |     |       |            |       | Other Information                                                                             |   |   |
|         |       |     | 1          |            |       | Legal Proceedings                                                                             |   | 68 |
|         |       |     | 1A         |            |       | Risk Factors                                                                                  |   | 68 |
|         |       |     | 2          |            |       | Unregistered Sales of Equity Securities and Use of  Proceeds                                  |   | 68 |
|         |       |     | 3          |            |       | Defaults Upon Senior Securities                                                               |   | 68 |
|         |       |     | 4          |            |       | Submission of Matters to a Vote of Security Holders                                           |   | 68 |
|         |       |     | 5          |            |       | Other Information                                                                             |   | 68 |
|         |       |     | 6          |            |       | Exhibits                                                                                      |   | 69 |
|         |       |     |       |            |       | Signatures                                                                                    |   | 73 |

 

2

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As used in this QuarterlyReport on Form 10-Q, “Universal American,” “we,” “our,” and “us”refer to Universal American Financial Corp. and its subsidiaries, except wherethe context otherwise requires or as otherwise indicated.

**DISCLOSUREREGARDING FORWARD LOOKING STATEMENTS**

Portions of the information in this Quarterly Reporton Form 10-Q, including, but not limited to, those set forth under “RiskFactors” and “Management’s Discussion and Analysis of Financial Condition andResults of Operations”, and certain oral statements made from time to time byour representatives may be considered “forward-looking statements” within themeaning of Section 21E of the Securities Exchange Act of 1934, as amended,and the Private Securities Litigation Reform Act of 1995. We intend suchforward-looking statements to be covered by the safe harbor provisions forforward-looking statements contained in Section 21E of the Exchange Actand the Private Securities Litigation Reform Act of 1995. Such forward-lookingstatements relate to, without limitation, the identification of acquisitioncandidates and the completion of transactions with them, our future economicperformance, plans and objectives for future operations and projections ofrevenue and other financial items. Forward-looking statements can be identifiedby the use of words such as “prospects,” “outlook,” “believes,” “estimates,” “intends,”“may,” “will,” “should,” “anticipates,” “expects” or “plans,” or the negativeor other variation of these or similar words, or by discussion of trends andconditions, strategy or risks and uncertainties. Forward-looking statements areinherently subject to risks, trends and uncertainties, many of which are beyondour ability to control or predict with accuracy and some of which we might noteven anticipate. Although we believe that the expectations reflected in suchforward-looking statements are based upon reasonable assumptions at the timemade, we can give no assurance that its expectations will be achieved. Futureevents and actual results, financial and otherwise, may differ materially fromthe results discussed in the forward-looking statements. Readers are cautionednot to place undue reliance on these forward-looking statements.

Important factorsthat may cause actual results to differ materially from forward-lookingstatements include, but are not limited to, the risks and uncertainties setforth in this report in Item 1A “Risk Factors” and Item 2 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”, theCurrent Report on Form 8-K dated August 8, 2007 and Item 1“Business”, Item 1A “Risk Factors” and Item 7 “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” inour Annual Report on Form 10-K for the fiscal year ended December 31,2006,as well as other reports that we file with the Securities and ExchangeCommission. We assume no obligation to update or supplement any forward-lookingstatements that may become untrue because of subsequent events, whether as a resultof new information, future events or otherwise.

3

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**PART I**

**ITEM 1—FINANCIALSTATEMENTS (Unaudited)**

**UNIVERSALAMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In thousands)**
|                                                                                                                                          | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                               | ** ** | **(Unaudited)**         | ** ** | ** **                  | ** ** |
| ASSETS                                                                                                                                   |       |                    |       |                        |       |   |   |   |   |
| Investments (Note 5):                                                                                                               |       |                    |       |                        |       |   |   |   |   |
| Fixed maturities  available for sale, at fair value  (amortized cost: 2007, $1,191,126; 2006, $1,110,323)                                |       |                    | $          | 1,176,925                   |       |   |   | $ | 1,112,086 |   |   |
| Policy loans                                                                                                                             |       |                    | 21,596     |                        |       |   | 22,032 |   |   |
| Other invested  assets                                                                                                                   |       |                    | 1,736      |                        |       |   | 1,725 |   |   |
| Total investments                                                                                                                        |       |                    | 1,200,257  |                        |       |   | 1,135,843 |   |   |
| Cash and cash  equivalents (Note 2)                                                                                                 |       |                    | 1,032,704  |                        |       |   | 542,130 |   |   |
| Accrued investment  income                                                                                                               |       |                    | 13,374     |                        |       |   | 12,927 |   |   |
| Deferred policy  acquisition costs                                                                                                       |       |                    | 252,460    |                        |       |   | 262,144 |   |   |
| Amounts due from  reinsurers                                                                                                             |       |                    | 294,805    |                        |       |   | 293,350 |   |   |
| Due and unpaid  premiums                                                                                                                 |       |                    | 79,158     |                        |       |   | 11,043 |   |   |
| Present value of  future profits and other amortizing intangible assets (Note 4)                                                    |       |                    | 57,845     |                        |       |   | 54,738 |   |   |
| Goodwill and other  indefinite lived intangible assets (Note 4)                                                                     |       |                    | 81,136     |                        |       |   | 71,332 |   |   |
| Income taxes  receivable                                                                                                                 |       |                    | 5,780      |                        |       |   | — |   |   |
| Other Part D  receivables (Note 2)                                                                                             |       |                    | 106,517    |                        |       |   | 85,871 |   |   |
| Advances to agents                                                                                                                       |       |                    | 70,556     |                        |       |   | 48,912 |   |   |
| Other assets                                                                                                                             |       |                    | 76,424     |                        |       |   | 66,752 |   |   |
| Total assets                                                                                                                             |       |                    | $          | 3,271,016                   |       |   |   | $ | 2,585,042 |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                |       |                    |       |                        |       |   |   |   |   |
| LIABILITIES                                                                                                                              |       |                    |       |                        |       |   |   |   |   |
| Policyholder  account balances (Note 2)                                                                                             |       |                    | $          | 461,442                     |       |   |   | $ | 485,189 |   |   |
| Reserves for  future policy benefits                                                                                                     |       |                    | 609,374    |                        |       |   | 600,497 |   |   |
| Policy and  contract claims—life                                                                                                    |       |                    | 12,343     |                        |       |   | 12,901 |   |   |
| Policy and  contract claims—health                                                                                                  |       |                    | 496,220    |                        |       |   | 201,811 |   |   |
| Advance premium                                                                                                                          |       |                    | 213,568    |                        |       |   | 26,120 |   |   |
| CMS contract  deposits for amounts not at risk (Note 2)                                                                             |       |                    | 185,439    |                        |       |   | 134,184 |   |   |
| Loan payable  (Note 9)                                                                                                              |       |                    | 137,938    |                        |       |   | 90,563 |   |   |
| Other long term  debt (Note 10)                                                                                                     |       |                    | 125,000    |                        |       |   | 75,000 |   |   |
| Amounts due to  reinsurers                                                                                                               |       |                    | 67,024     |                        |       |   | 100,397 |   |   |
| Income taxes  payable                                                                                                                    |       |                    | —     |                        |       |   | 20,502 |   |   |
| Deferred income  tax liability                                                                                                           |       |                    | 20,329     |                        |       |   | 19,573 |   |   |
| Other Part D  liabilities                                                                                                           |       |                    | 101,711    |                        |       |   | 106,599 |   |   |
| Other liabilities                                                                                                                        |       |                    | 93,941     |                        |       |   | 87,797 |   |   |
| Total liabilities                                                                                                                        |       |                    | 2,524,329  |                        |       |   | 1,961,133 |   |   |
| Commitments and contingencies (Note 12)                                                                                             |       |                    |       |                        |       |   |   |   |   |
| STOCKHOLDERS’ EQUITY (Note 6)                                                                                                  |       |                    |       |                        |       |   |   |   |   |
| Preferred stock (Authorized: 2 million shares):                                                                                     |       |                    |       |                        |       |   |   |   |   |
| Series A  (Designated: 300 thousand shares, issued: 2007, 30,473 shares)                                                       |       |                    | 30         |                        |       |   | — |   |   |
| Series B  (Designated: 300 thousand shares, issued: 2007, 19,573 shares)                                                       |       |                    | 20         |                        |       |   | — |   |   |
| Common stock  (Authorized: 100 million shares, issued: 2007, 60.3 million shares;  2006, 59.9 million shares)   |       |                    | 603        |                        |       |   | 599 |   |   |
| Additional paid-in  capital                                                                                                              |       |                    | 355,397    |                        |       |   | 252,542 |   |   |
| Accumulated other  comprehensive (loss) income (Notes 6 and 13)                                                                     |       |                    | (6,893     | )                           |       |   | 1,883 |   |   |
| Retained earnings                                                                                                                        |       |                    | 406,146    |                        |       |   | 379,511 |   |   |
| Less: Treasury  stock (2007, 0.6 million shares; 2006, 0.7 million shares)                                                     |       |                    | (8,616     | )                           |       |   | (10,626 | ) |   |
| Total  stockholders’ equity                                                                                                         |       |                    | 746,687    |                        |       |   | 623,909 |   |   |
| Total liabilities  and stockholders’ equity                                                                                         |       |                    | $          | 3,271,016                   |       |   |   | $ | 2,585,042 |   |   |

 

See notes to unaudited consolidated financial statements.

4

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**UNIVERSALAMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSFor the Three Months Ended June 30, 2007 and 2006(Unaudited)(In thousands, per share amounts in dollars)**
|                                                                                            | ** ** | **2007**       | ** ** | **2006**                        | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------|------------|---------------------------------|------------|
| Revenues:                                                                                  |       |           |       |                            |       |
| Direct premium and policyholder fees earned                                                |       | $              | 858,241    |                            | $          | 477,741 |   |
| Reinsurance premiums assumed                                                               |       | 8,018          |       | 8,230                           |       |
| Reinsurance premiums ceded                                                                 |       | (195,974       | )          | (183,307                        | )          |
| Net premiums and policyholder fees earned                                                  |       | 670,285        |       | 302,664                         |       |
| Net investment income                                                                      |       | 26,618         |       | 18,320                          |       |
| Fee and other income                                                                       |       | 6,872          |       | 7,026                           |       |
| Net realized gains (losses) on investments                                                 |       | (264           | )          | 48                              |       |
| Total revenues                                                                             |       | 703,511        |       | 328,058                         |       |
| Benefits, Claims and  Expenses:                                                            |       |           |       |                            |       |
| Claims and other benefits                                                                  |       | 554,926        |       | 235,012                         |       |
| Increase in reserves for future policy benefits                                            |       | 535            |       | 1,102                           |       |
| Interest credited to policyholders                                                         |       | 4,323          |       | 4,740                           |       |
| Change in deferred acquisition costs                                                       |       | 1,825          |       | (4,407                          | )          |
| Amortization of intangible assets (Note 4)                                            |       | 1,873          |       | 2,111                           |       |
| Commissions                                                                                |       | 43,749         |       | 30,487                          |       |
| Reinsurance commission and expense allowances                                              |       | (18,433        | )          | (19,310                         | )          |
| Interest expense                                                                           |       | 4,924          |       | 3,186                           |       |
| Other operating costs and expenses                                                         |       | 87,269         |       | 64,175                          |       |
| Total benefits, claims and other deductions                                                |       | 680,991        |       | 317,096                         |       |
| Income from continuing operations, before equity in  earnings of unconsolidated subsidiary |       | 22,520         |       | 10,962                          |       |
| Equity in earnings of unconsolidated subsidiary  (Note 14)                            |       | 13,120         |       | 12,867                          |       |
| Income from continuing operations, before income  taxes                                    |       | 35,640         |       | 23,829                          |       |
| Provision for income taxes                                                                 |       | 13,365         |       | 8,467                           |       |
| **Income from continuing operations**                                                      | ** ** | **22,275**     | ** ** | **15,362**                      | ** ** |
| Discontinued Operations  (Note 16):                                                   |       |           |       |                            |       |
| Income from discontinued operations, net of income  taxes                                  |       | —         |       | 2,748                           |       |
| **Net income**                                                                             | ** ** | **$**          | **22,275** | ** **                      | **$**      | **18,110** | ** ** |
| **Earnings per common share:**                                                             | ** ** | ** **     | ** ** | ** **                      | ** ** |
| **Basic:**                                                                                 | ** ** | ** **     | ** ** | ** **                      | ** ** |
| Income from continuing operations                                                          |       | $              | 0.36       |                            | $          | 0.26 |   |
| Income from discontinued operations                                                        |       | —         |       | 0.05                            |       |
| **Net income**                                                                             | ** ** | **$**          | **0.36**   | ** **                      | **$**      | **0.31** | ** ** |
| **Diluted:**                                                                               | ** ** | ** **     | ** ** | ** **                      | ** ** |
| Income from continuing operations                                                          |       | $              | 0.35       |                            | $          | 0.26 |   |
| Income from discontinued operations                                                        |       | —         |       | 0.04                            |       |
| **Net income**                                                                             | ** ** | **$**          | **0.35**   | ** **                      | **$**      | **0.30** | ** ** |
| **Weighted average shares  outstanding:**                                                  | ** ** | ** **     | ** ** | ** **                      | ** ** |
| Weighted average common equivalent of preferred  shares outstanding                        |       | 2,527,473      |       | —      |       |
| Weighted average common shares outstanding                                                 |       | 60,142,648     |       | 59,116,355                      |       |
| Less weighted average treasury shares                                                      |       | (617,606       | )          | (697,710                        | )          |
| **Basic weighted shares outstanding**                                                      | ** ** | **62,052,515** | ** ** | **58,418,645**                  | ** ** |
| Effect of dilutive securities                                                              |       | 1,317,103      |       | 1,403,467                       |       |
| **Diluted  weighted shares outstanding**                                                   | ** ** | **63,369,618** | ** ** | **59,822,112**                  | ** ** |

 

See notes to unaudited consolidated financial statements.

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**UNIVERSALAMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSFor the Six Months Ended June 30, 2007 and 2006(Unaudited)(In thousands, per share amounts in dollars)**

| ** **                                                                                 | ** ** | **2007**       | ** ** | **2006**       | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------|------------|----------------|------------|
| Revenues:                                                                                  |       |           |       |           |       |
| Direct premium and policyholder fees earned                                                |       | $              | 1,653,872  |           | $          | 945,491 |   |
| Reinsurance premiums assumed                                                               |       | 16,646         |       | 16,546         |       |
| Reinsurance premiums ceded                                                                 |       | (412,335       | )          | (367,299       | )          |
| Net premiums and policyholder fees earned                                                  |       | 1,258,183      |       | 594,738        |       |
| Net investment income                                                                      |       | 48,980         |       | 35,666         |       |
| Fee and other income                                                                       |       | 13,126         |       | 13,266         |       |
| Net realized gains on investments                                                          |       | 1,640          |       | 47             |       |
| Total revenues                                                                             |       | 1,321,929      |       | 643,717        |       |
| Benefits, Claims and  Expenses:                                                            |       |           |       |           |       |
| Claims and other benefits                                                                  |       | 1,052,666      |       | 471,569        |       |
| Increase in reserves for future policy benefits                                            |       | 3,786          |       | 5,907          |       |
| Interest credited to policyholders                                                         |       | 9,028          |       | 9,210          |       |
| Change in deferred acquisition costs                                                       |       | 12,159         |       | (8,486         | )          |
| Amortization of intangible assets (Note 4)                                                 |       | 3,982          |       | 4,478          |       |
| Commissions                                                                                |       | 78,790         |       | 61,968         |       |
| Reinsurance commission and expense allowances                                              |       | (36,623        | )          | (37,109        | )          |
| Interest expense                                                                           |       | 8,363          |       | 6,228          |       |
| Other operating costs and expenses                                                         |       | 174,661        |       | 121,036        |       |
| Total benefits, claims and other deductions                                                |       | 1,306,812      |       | 634,801        |       |
| Income from continuing operations, before equity in  earnings of unconsolidated subsidiary |       | 15,117         |       | 8,916          |       |
| Equity in earnings of unconsolidated subsidiary (Note  14)                                 |       | 26,323         |       | 22,674         |       |
| Income from continuing operations, before income  taxes                                    |       | 41,440         |       | 31,590         |       |
| Provision for income taxes                                                                 |       | 14,805         |       | 11,296         |       |
| **Income from continuing operations**                                                      | ** ** | **26,635**     | ** ** | **20,294**     | ** ** |
| Discontinued Operations  (Note 16):                                                        |       |           |       |           |       |
| Income from discontinued operations, net of income  taxes                                  |       | —         |       | 4,836          |       |
| **Net income**                                                                             | ** ** | **$**          | **26,635** | ** **     | **$**      | **25,130** | ** ** |
| **Earnings per common share:**                                                             |       |           |       |           |       |
| **Basic:**                                                                                 |       |           |       |           |       |
| Income from continuing operations                                                          |       | $              | 0.44       |           | $          | 0.35 |   |
| Income from discontinued operations                                                        |       | —         |       | 0.08           |       |
| **Net income**                                                                             | ** ** | **$**          | **0.44**   | ** **     | **$**      | **0.43** | ** ** |
| **Diluted:**                                                                               |       |           |       |           |       |
| Income from continuing operations                                                          |       | $              | 0.43       |           | $          | 0.34 |   |
| Income from discontinued operations                                                        |       | —         |       | 0.08           |       |
| **Net income**                                                                             | ** ** | **$**          | **0.43**   | ** **     | **$**      | **0.42** | ** ** |
| **Weighted average shares  outstanding:**                                                  |       |           |       |           |       |
| Weighted average common equivalent of preferred  shares outstanding                        |       | 1,270,718      |       | —         |       |
| Weighted average common shares outstanding                                                 |       | 60,055,995     |       | 59,086,395     |       |
| Less weighted average treasury shares                                                      |       | (642,394       | )          | (724,282       | )          |
| **Basic weighted shares outstanding**                                                      | ** ** | **60,684,319** | ** ** | **58,362,113** | ** ** |
| Effect of dilutive securities                                                              |       | 1,322,324      |       | 1,507,105      |       |
| **Diluted  weighted shares outstanding**                                                   | ** ** | **62,006,643** | ** ** | **59,869,218** | ** ** |

 

See notes to unaudited consolidated financial statements.

6

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**UNIVERSALAMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITYAND COMPREHENSIVE INCOMEFor the Six Months Ended June 30, 2007 and 2006(Unaudited)(In thousands)**
|                                                  | ** ** | **Series A  Preferred  Stock** | ** ** | **Series B  Preferred  Stock** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other  Compre-  hensive  Income  (Loss)** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|-------------------|------------|----------------------------------|------------|----------------------------------------------------------|------------|------------------------|------------|---------------------|------------|-----------|------------|
| **2006**                                         |       |                                |       |                                |       |              |       |                             |       |                                                     |       |                   |       |                |       |      |       |   |   |   |   |   |   |   |   |   |   |
| Balance, January 1, 2006                    |       |                                | $          | —                              |       |              |       | $                                | —     |                                                     |       |                   | $          | 590                 |       |      |       | $ | 242,433 |   |   |   | $ | 39,896 |   |   | $ | 260,205 |   | $ | (11,240 | ) | $ | 531,884 |   |
| Net income                                       |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | —     |      |       |   | — |   |   | 25,130 |   | — |   | 25,130 |   |
| Other comprehensive loss (Note 13)          |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | —     |      |       |   | (21,909 | ) |   | — |   | — |   | (21,909 | ) |
| Comprehensive income                             |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | —     |      |       |   | — |   |   | — |   | — |   | 3,221 |   |
| Issuance of stock (Note 6)                  |       |                                | —     |                                |       |              | —     |                             |       |                                                     | 2          |                   |       |                | 970        |      |       |   | — |   |   | — |   | — |   | 972 |   |
| Stock-based compensation (Note 7)           |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | 2,298      |      |       |   | — |   |   | — |   | — |   | 2,298 |   |
| Treasury shares purchased, at cost (Note 6) |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | —     |      |       |   | — |   |   | — |   | (44 | ) | (44 | ) |
| Treasury shares reissued (Note 6)           |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | 22         |      |       |   | — |   |   | — |   | 821 |   | 843 |   |
| Balance, June 30, 2006                      |       |                                | $          | —                              |       |              |       | $                                | —     |                                                     |       |                   | $          | 592                 |       |      |       | $ | 245,723 |   |   |   | $ | 17,987 |   |   | $ | 285,335 |   | $ | (10,463 | ) | $ | 539,174 |   |
| **2007**                                         |       |                                |       |                                |       |              |       |                             |       |                                                     |       |                   |       |                |       |      |       |   |   |   |   |   |   |   |   |   |   |
| Balance, January 1, 2007                    |       |                                | $          | —                              |       |              |       | $                                | —     |                                                     |       |                   | $          | 599                 |       |      |       | $ | 252,542 |   |   |   | $ | 1,883 |   |   | $ | 379,511 |   | $ | (10,626 | ) | $ | 623,909 |   |
| Net income                                       |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | —     |      |       |   | — |   |   | 26,635 |   | — |   | 26,635 |   |
| Other comprehensive loss (Note 13)          |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | —     |      |       |   | (8,776 | ) |   | — |   | — |   | (8,776 | ) |
| Comprehensive income                             |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | —     |      |       |   | — |   |   | — |   | — |   | 17,859 |   |
| Issuance of stock (Note 6)                  |       |                                | 30         |                                |       |              | 20         |                             |       |                                                     | 4          |                   |       |                | 100,041    |      |       |   | — |   |   | — |   | — |   | 100,095 |   |
| Stock-based compensation (Note 7)           |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | 2,205      |      |       |   | — |   |   | — |   | — |   | 2,205 |   |
| Treasury shares purchased, at cost (Note 6) |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | —     |      |       |   | — |   |   | — |   | — |   | — |   |
| Treasury shares reissued (Note 6)           |       |                                | —     |                                |       |              | —     |                             |       |                                                     | —     |                   |       |                | 609        |      |       |   | — |   |   | — |   | 2,010 |   | 2,619 |   |
| Balance,  June 30, 2007                     |       |                                | $          | 30                                  |       |              |       | $                                | 20         |                                                     |       |                   | $          | 603                 |       |      |       | $ | 355,397 |   |   |   | $ | (6,893 | ) |   | $ | 406,146 |   | $ | (8,616 | ) | $ | 746,687 |   |

 

See notes to unaudited consolidated financial statements.

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**UNIVERSAL AMERICANFINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSFor the Six Months Ended June 30, 2007 and 2006(Unaudited)(In thousands)**
|                                                                                                                      | ** ** | **2007**     | ** ** | **2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|--------------|------------|----------|------------|
| Cash flows from operating activities:                                                                                |       |         |       |     |       |
| Net income                                                                                                           |       | $            | 26,635     |     | $          | 25,130 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities, net of balances acquired or sold: |       |    |       |     |       |
| Income from discontinued  operations                                                                                 |       | —       |       | (4,836   | )          |
| Equity in earnings of  unconsolidated subsidiary                                                                     |       | (26,323      | )          | (22,674  | )          |
| Distribution from  unconsolidated subsidiary                                                                         |       | 27,500       |       | 18,500   |       |
| Deferred income taxes                                                                                                |       | 3,006        |       | (8,982   | )          |
| Realized gains on investments                                                                                        |       | (1,640       | )          | (47      | )          |
| Amortization of present  value of future profits and other intangibles                                               |       | 3,982        |       | 4,478    |       |
| Net amortization of bond  premium                                                                                    |       | 784          |       | 1,144    |       |
| Change in deferred policy  acquisition costs                                                                         |       | 12,159       |       | (8,486   | )          |
| Change in reserves for  future policy benefits                                                                       |       | 8,877        |       | 6,778    |       |
| Change in policy and  contract claims payable                                                                        |       | 290,933      |       | 58,122   |       |
| Change in reinsurance  balances                                                                                      |       | (35,176      | )          | (8,634   | )          |
| Change in advance and due  premium, net                                                                              |       | 119,294      |       | 68,173   |       |
| Change in income taxes  payable (receivable)                                                                         |       | 2,042        |       | 9,205    |       |
| Change in other  Part D receivables                                                                             |       | (26,476      | )          | (61,388  | )          |
| Change in other  Part D liabilities                                                                             |       | (4,888       | )          | 35,228   |       |
| Advances to agents, net                                                                                              |       | 751          |       | (5,011   | )          |
| Other, net                                                                                                           |       | (13,735      | )          | 2,886    |       |
| Cash from operating  activities—continuing operations                                                           |       | 387,725      |       | 109,586  |       |
| Cash from operating  activities—discontinued operations                                                         |       | —       |       | 7,274    |       |
| Cash from operating  activities                                                                                      |       | 387,725      |       | 116,860  |       |
| Cash flows from investing activities:                                                                                |       |         |       |     |       |
| Proceeds from sale or  redemption of fixed maturities                                                                |       | 135,967      |       | 51,871   |       |
| Cost of fixed maturities  purchased                                                                                  |       | (221,097     | )          | (62,392  | )          |
| Proceeds from sale of  discontinued operations, net of cash sold (Note 16)                                      |       | 8,364        |       | —   |       |
| Taxes paid for gain on  sale of discontinued operations (Note 16)                                               |       | (28,200      | )          | —   |       |
| Proceeds from sale of  subsidiary, net of cash sold (Note 17)                                                   |       | 5,102        |       | —   |       |
| Purchase of business, net  of cash acquired                                                                          |       | (17,722      | )          | (12,075  | )          |
| Purchase of fixed assets                                                                                             |       | (3,003       | )          | (6,185   | )          |
| Other investing  activities                                                                                          |       | 460          |       | 929      |       |
| Cash from investing  activities—continuing operations                                                           |       | (120,129     | )          | (27,852  | )          |
| Cash from investing  activities—discontinued operations                                                         |       | —       |       | (4,071   | )          |
| Cash used for investing  activities                                                                                  |       | (120,129     | )          | (31,923  | )          |
| Cash flows from financing activities:                                                                                |       |         |       |     |       |
| Net proceeds from  issuance of common and preferred stock                                                            |       | 100,095      |       | 1,535    |       |
| Cost of treasury stock  purchases                                                                                    |       | —       |       | (43      | )          |
| Receipts from CMS  contract deposits                                                                                 |       | 436,067      |       | 507,394  |       |
| Withdrawals from CMS  contract deposits                                                                              |       | (384,812     | )          | (303,750 | )          |
| Deposits and interest  credited to policyholder account balances                                                     |       | 10,177       |       | 30,087   |       |
| Surrenders and other  withdrawals from policyholder account balances                                                 |       | (33,924      | )          | (26,215  | )          |
| Dividends from  discontinued operation                                                                               |       | —       |       | 4,372    |       |
| New debt issued, net of  issue costs                                                                                 |       | 98,000       |       | —   |       |
| Principal repayment on  loan payable                                                                                 |       | (2,625       | )          | (2,625   | )          |
| Cash from financing  activities—continuing operations                                                           |       | 222,978      |       | 210,755  |       |
| Cash from financing  activities—discontinued operations                                                         |       | —       |       | (4,372   | )          |
| Cash from financing  activities                                                                                      |       | 222,978      |       | 206,383  |       |
| Net increase in cash and  cash equivalents                                                                           |       | 490,574      |       | 291,320  |       |
| Cash and cash equivalents  at beginning of year                                                                      |       | 542,130      |       | 138,899  |       |
| Cash and cash equivalents  at end of period                                                                          |       | 1,032,704    |       | 430,219  |       |
| Less cash and cash  equivalents of discontinued operations at end of period                                          |       | —       |       | (779     | )          |
| Cash and cash equivalents of continuing operations at  end of period                                                 |       | $            | 1,032,704  |     | $          | 429,440 |   |

 

See notes to unaudited consolidated financial statements.

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**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**1.   ORGANIZATION AND COMPANY BACKGROUND**

Universal AmericanFinancial Corp. (“we,” “our,” “us,” the “Company,” or “Universal American”) isa specialty health and life insurance holding company with an emphasis onproviding a broad array of health insurance and managed care products andservices to the growing senior population. Universal American was incorporatedin the State of New York in 1981. Collectively, our insurance companysubsidiaries are licensed to sell life and accident and health insuranceand annuities in all fifty states, the District of Columbia, Canada and PuertoRico. The principal insurance products currently sold by the Company areMedicare Advantage private fee-for-service plans (“PFFS”), Medicareprescription drug benefit plans (“PDPs”), Medicare Supplement, fixed benefitaccident and sickness disability insurance and senior life insurance. TheCompany distributes these products through an independent general agency systemand a career agency system. The career agents sell for Pennsylvania LifeInsurance Company (“Pennsylvania Life”) and The Pyramid Life Insurance Company(“Pyramid Life”) while the independent general agents sell for American PioneerLife Insurance Company (“American Pioneer”), American Progressive Life & HealthInsurance Company of New York (“American Progressive”), Constitution LifeInsurance Company (“Constitution”), Marquette National Life Insurance Company (“Marquette”)and Union Bankers Insurance Company (“Union Bankers”).

In 2006, we began offeringPDPs pursuant to Medicare Part D (“Part D”) through Pennsylvania Lifeand American Progressive, in connection with a strategic alliance withPharmaCare Management Services, Inc. (“PharmaCare”), a third partypharmacy benefits manager (“PBM”) and wholly-owned subsidiary of CVS CaremarkCorporation (“CVS”).

The Company operatesMedicare Advantage health plans in Texas through SelectCare of Texas, L.L.C.and SelectCare HealthPlans, Inc., in Oklahoma through SelectCare ofOklahoma, Inc. and GlobalHealth, Inc. (“GlobalHealth”) and in Floridathrough American Pioneer HealthPlans, Inc. and our Medicare Advantageprivate fee-for-service plans (“PFFS”) through American Progressive and PyramidLife.

CHCS Services, Inc. (“CHCS”),the Company’s administrative services company, acts as a service provider forboth affiliated and unaffiliated insurance companies for senior marketinsurance and non-insurance programs.

On December 1, 2006,the Company completed the sale of PennCorp Life Insurance Company (“PennCorpLife Canada”), its Canadian subsidiary. Consequently, the Company has accountedfor the operations of PennCorp Life Canada as discontinued operations. Allprior period amounts have been reclassified to conform to this presentation.See Note 16—Discontinued Operations.

**2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

***Basis of Presentation:***   Theaccompanying consolidated financial statements have been prepared in accordancewith accounting principles generally accepted in the United States (“GAAP”) andconsolidate the accounts of Universal American and its subsidiaries:  American Progressive, American Pioneer,American Exchange Life Insurance Company (“American Exchange”), PennsylvaniaLife, Union Bankers, Constitution, Marquette, Pyramid Life, Heritage HealthSystems, Inc. (“Heritage”) and CHCS. During 2005, we entered into astrategic alliance with PharmaCare and created Part D Management Services,L.L.C. (“PDMS”). PDMS is 50% owned by us and 50% owned by PharmaCare. We do notcontrol PDMS and therefore PDMS is not consolidated in our financialstatements. Our investment in PDMS is accounted for on an equity basis and isincluded in other assets. PDMS principally performs marketing and risk managementservices on behalf of our PDPs and PharmaCare Captive Re, Ltd. (“PharmaCare Re”),a wholly-owned subsidiary of PhamaCare, for which it receives fees and otherremuneration from our PDPs 

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and PharmaCare. Asnoted above, the operations of PennCorp Life Canada are reported asdiscontinued operations.

For the insurancesubsidiaries, GAAP differs from statutory accounting practices prescribed orpermitted by regulatory authorities. All material intercompany transactions andbalances between Universal American and its subsidiaries have been eliminated.

The interim financialinformation herein is unaudited, but in the opinion of management, includes alladjustments (including normal, recurring adjustments) necessary to presentfairly the financial position and results of operations for such periods. Theresults of operations for the six months ended June 30, 2007 and 2006 arenot necessarily 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 thefiscal year ended December 31, 2006.

***Use of Estimates:***   Thepreparation of our financial statements in conformity with GAAP requires us tomake estimates and assumptions that affect the amounts of assets andliabilities and disclosures of assets and liabilities reported by us at thedate of the financial statements and the revenues and expenses reported duringthe reporting period. As additional information becomes available or actualamounts become determinable, the recorded estimates may be revised andreflected in operating results. Actual results could differ from thoseestimates. In our judgment, the accounts involving estimates and assumptionsthat are most critical to the preparation of our financial statements arefuture policy benefits and claim liabilities, deferred policy acquisitioncosts, goodwill, present value of future profits and other intangibles, thevaluation of certain investments and income taxes. There have been no changesin our critical accounting policies during the current year.

***Supplemental Cash Flow Information:  ***Cashand cash equivalents include cash on deposit, money market funds, and shortterm investments that had an original maturity of three months or less from thetime of purchase. Included in cash and cash equivalents at June 30, 2007is $226 million relating to our PDPs that cannot be used for other lines ofbusiness or general corporate purposes. Supplemental cash flow information forinterest and income taxes paid for continuing and discontinued operations is asfollows:

| ** **                                                        | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                        | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| ** **                                                        | ** ** | **(in thousands)**                       | ** ** |
| Supplemental cash flow  information from continuing operations:   |       |                                          |       |   |   |
| Cash paid for interest                                            |       | $                                             | 8,075      |   | $ | 6,218 |   |
| Cash paid for income taxes                                        |       | $                                             | 35,009     |   | $ | 9,700 |   |
| Supplemental cash flow  information from discontinued operations: |       |                                          |       |   |   |
| Cash paid for  income taxes                                       |       | $                                             | —     |   | $ | 3,815 |   |

*** ***

***Significant Accounting Policies:  ***Fora description of significant accounting policies, seeNote 2—Summary of Significant Accounting Policies in the notes to theconsolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2006.

***Recognition ofPremium Revenues and Policy Benefits for Medicare Advantage Policies:***   Premiumsreceived pursuant to Medicare Advantage contracts with CMS for Medicareenrollees are recorded as revenue in the month in which members are entitled toreceive service. Premiums collected in advance are deferred. Accountsreceivable from CMS and health plan members for coordinating physician servicesand inpatient, outpatient and ancillary care are included in other assets.Certain commissions are deferred and recognized in relation to thecorresponding revenues for which they are earned. Policies and contract claimsinclude actual claims reported but not paid and estimates of health careservices incurred but not reported. The estimated claims incurred but notreported are based on historical data, current enrollment, health serviceutilization statistics and other related information. Although considerablevariability is 

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inherent in such estimates, managementbelieves that the liability is adequate. Changes in assumptions for medicalcosts caused by changes in actual experience could cause these estimates tochange in the near term.

There are timingdifferences between the addition of members to our administrative system andthe approval, or accretion, of the member by CMS before we are paid for thatmember by CMS. We analyze the membership in our administrative system and theenrollment provided by CMS. Due to the significant growth of the business andthe limited historical experience, we recognize these timing delays and thatCMS may not approve the enrollee. The results for our PFFS business are basedon a membership level as of June 30, 2007 of approximately 179,000, whichis approximately 10,000 members below membership level included in ouradministrative system, representing approximately 47,000 member months. In thesucceeding quarters, we analyze the member information used in our consolidatedfinancial statements and adjust our membership based on members subsequentlyapproved by CMS. Although we are unable to precisely quantify the impact of anypotential member change from that used in our consolidated financial results,we do not believe that any change from the amounts reported as June 30,2007 is likely to be material.

***Accounting for Prescription Drug Benefits underMedicare Part D:***   Effective January 1,2006, we began providing prescription drug coverage in accordance with Part Das a stand-alone benefit to Medicare-eligible beneficiaries under PDPs.

In general, prescriptiondrug benefits under Part D PDPs may vary in terms of coverage levels andout-of-pocket costs for beneficiary premiums, deductibles and co-insurance.However, all Part D PDPs must offer either “standard coverage” or itsactuarial equivalent (with out-of-pocket threshold and deductible amounts thatdo not exceed those of standard coverage). These defined “standard” benefitsrepresent the minimum level of benefits mandated by Congress. We also offerother PDPs containing benefits in excess of standard coverage limits for anadditional beneficiary premium.

Our PDPs receive monthlypayments from CMS which generally represent our bid amount for providinginsurance coverage. We recognize premium revenue for providing this insurancecoverage during each month in which members are entitled to benefits. Our CMSpayments also include catastrophic reinsurance allowances and Federal subsidies(CMS contract deposits) for which we do not bear risk.

Part D premiumrevenue is subject to risk corridor adjustment, which permits our PDPs and CMSto share the risk associated with the ultimate costs of the Part D benefit.The risk corridor adjustments may be positive or negative based upon theapplication of risk corridors that compare a plan’s actual prescription drugcosts to their targeted costs, as reflected in their bids (“target amount’).Variances exceeding, or below, certain thresholds may result in CMS makingadditional payments to us or requiring us to refund to CMS a portion of thepayments we received. Actual prescription drug costs subject to risk sharingwith CMS are limited to the costs that are, or would have been, incurred underthe CMS defined “standard” benefit plan. We estimate and recognize anadjustment to premium revenues related to the risk corridor payment adjustmentbased upon prescription drug claims experience to date, net of manufacturerrebates and other Part D revenues, at the end of each reporting period.Accordingly, this estimate does not consider future prescription drug claimsexperience. We record a receivable for rebates due to us which is included inother Part D receivables.

Certain subsidiesrepresent reimbursements from CMS for claims we pay for which we assume littleor no risk, including reinsurance payments and low-income cost subsidies. Alarge percentage of claims paid above the out-of-pocket or catastrophicthreshold for which we are not at risk are reimbursed by CMS through thereinsurance subsidy for PDPs offering the standard coverage. Low-income costsubsidies represent reimbursements from CMS for all or a portion of thedeductible, the coinsurance and the co-payment amounts for low-incomebeneficiaries. We account for these subsidies as a deposit in our balance sheetand as a financing activity in our statement of cash flows. We do not recognizepremium revenue or claims expense for these subsidies. Receipt and paymentactivity is accumulated at the contract level and 

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recordedin the balance sheet as a CMS contract deposit account asset or liabilitydepending on the net contract balance at the end of the reporting period. Areconciliation and related settlement of CMS’s prospective subsidies againstactual prescription drug costs we paid will be made after the end of the year.

We recognize pharmacybenefit costs as incurred. We have subcontracted the pharmacy claimsadministration to PharmaCare. Certain of our PDPs receive all or a portion ofthe rebates from drug manufacturers on prescriptions filled. A significantportion of these rebates are reflected as a reduction in pharmacy benefit costswith the balance offset against the catastrophic reinsurance claims reimbursedby CMS, for which we are not at risk. Pharmacy benefit costs are based on ratesas contracted with PharmaCare.

The PDPs sponsored bysubsidiaries of Universal American are reinsured, on a 50% coinsurance fundswithheld basis, to PharmaCare Re. Pennsylvania Life also assumes, on a 33.3%quota share basis, risks of an unaffiliated prescription drug plan. Thecontract for the 33.3% assumed business will be terminated as of December 31,2007, however, under the termination provisions of the contract, PennsylvaniaLife will receive an amount equal to two years of thereinsurance profits generated by the block of business.

We based our membershipfor Part D on enrollment information provided by CMS which indicated that,as of June 30, 2007, approximately 491,000 members were enrolled in ourPDPs for which we were paid by CMS. This includes approximately 467,000 membersin our PDPs that we participate in on a 50% basis and 24,000 members in theunaffiliated PDP that we participate in on a 33.3% basis. Our revenues andclaims expense are based on earned premium and incurred pharmacy benefits forthe reported enrolled membership. During 2006 and 2007, we also paid claims forindividuals who ultimately were determined to be members of other plans. At June 30,2007, we have a receivable of $34.0 million for these claims which is includedin other Part D receivables on the consolidated balance sheet. CMScontinues to reconcile and refine information with respect to the enrollment ofmembers and claims submitted for 2006 for all plans participating in the Part Dprogram. Additionally, as of June 30, 2007, we have a liability of $30.4million, included in policy and contract claims—health on the consolidatedbalance sheet, for our estimate of claims paid by state Medicaid programs onbehalf of members of our PDPs. As a result of the continuing reconciliationprocess, it is likely that the membership data upon which we based our resultswill change, with a corresponding change in the financial results for thesegment. We are unable to precisely quantify the impact of any potential changeuntil the membership data is fully reconciled with CMS; however, we do notbelieve that any change from the amounts reported as of June 30, 2007 islikely to be material.

***Reclassifications:***   Certainreclassifications have been made to prior years’ financial statements toconform to current period presentation.

**3.   RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS**

***Deferred Acquisition Costs******—In***September 2005,the American Institute of Certified Public Accountants issued Statement ofPosition 05-1, “Accounting by Insurance Enterprises for DeferredAcquisition Costs (“DAC”) in Connection with Modifications or Exchanges ofInsurance Contracts” (“SOP 05-1”). SOP 05-1 provides guidance onaccounting by insurance enterprises for DAC on internal replacements ofinsurance and investment contracts. An internal replacement is a modificationin product benefits, features, rights or coverages that occurs by the exchangeof a contract for a new contract, or by amendment, endorsement, or rider to acontract, or by the election of a feature or coverage within a contract.Modifications that result in a replacement contract that is substantiallychanged from the replaced contract should be accounted for as an extinguishmentof the replaced contract. Unamortized DAC, unearned revenue liabilities anddeferred sales inducements from the replaced contract must be written-off.Modifications that result in a contract that is substantially unchanged fromthe replaced contract should be accounted for as a continuation of the replacedcontract. SOP 05-1 is effective for internal replacements occurring infiscal years beginning after December 15, 2006, with earlier adoption 

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encouraged. Initialapplication of SOP 05-1 should be as of the beginning of the entity’sfiscal year. The Company adopted SOP 05-1 effective January 1, 2007.Adoption of this statement did not have a material effect on the Company’sconsolidated financial statements.

***Income Taxes******—In*** June 2006,the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes-an Interpretation of FASB Statement 109” (“FIN 48”). FIN 48prescribes a comprehensive model for how a company should recognize, measure,present, and disclose in its financial statements uncertain tax positions thatthe company has taken or expects to take on a tax return. The interpretationrequires public companies to recognize the tax benefits of uncertain taxpositions only where the position is “more likely than not” to be sustainedassuming examination by tax authorities. The amount recognized would be theamount that represents the largest amount of tax benefit that is greater than50% likely of being realized upon ultimate settlement with the taxingauthority. A liability would be recognized for any benefit claimed, or expectedto be claimed, in a tax return in excess of the benefit recorded in thefinancial statements, along with any interest and penalty (if applicable) onthe excess. FIN 48 will require a tabular reconciliation of the change in theaggregate unrecognized tax benefits claimed, or expected to be claimed, in taxreturns and disclosure relating to accrued interest and penalties forunrecognized tax benefits. Discussion will also be required for those uncertaintax positions where it is reasonably possible that the estimate of the taxbenefit will change significantly in the next 12 months. FIN 48 iseffective for fiscal years beginning after December 15, 2006. The adoptionof FIN 48 did not have a material effect on the Company’s consolidatedfinancial statements.

***Fair Value******—***In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). Thisstatement defines fair value, establishes a framework for measuring fair valueunder accounting principles generally accepted in the United States, andenhances disclosures about fair value measurements. SFAS 157 provides guidanceon how to measure fair value when required under existing accounting standards.The statement establishes a fair value hierarchy that prioritizes the inputs tovaluation techniques used to measure fair value into three broad levels (“Level1, 2 and 3”). Level 1 inputs are observable inputs that reflect quoted pricesfor identical assets or liabilities in active markets the Company has theability to access at the measurement date. Level 2 inputs are observableinputs, other than quoted prices included in Level 1, for the asset orliability. Level 3 inputs are unobservable inputs reflecting the reportingentity’s estimates of the assumptions that market participants would use inpricing the asset or liability (including assumptions about risk). Quantitativeand qualitative disclosures will focus on the inputs used to measure fair valuefor both recurring and non-recurring fair value measurements and the effects ofthe measurements in the financial statements. SFAS 157 is effective for fiscalyears beginning after November 15, 2007, with earlier applicationencouraged only in the initial quarter of an entity’s fiscal year. Adoption ofthis statement is not expected to have a material impact on the Company’sconsolidated financial statements.

In February 2007, theFASB issued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities” (“SFAS 159”). This statement provides companies with anoption to report selected financial assets and liabilities at fair value. SFAS159’s objective is to reduce both complexity in accounting for financialinstruments and the volatility in earnings caused by measuring related assetsand liabilities differently. SFAS 159 also establishes presentation anddisclosure requirements designed to facilitate comparisons between companiesthat choose different measurement attributes for similar types of assets andliabilities. SFAS 159 does not eliminate disclosure requirements included inother accounting standards, including requirements for disclosures about fairvalue measurements included in SFAS 157, and SFAS 107, Disclosures about FairValue of Financial Instruments. SFAS 159 is effective as of the beginning of anentity’s first fiscal year beginning after November 15, 2007. Earlyadoption is permitted as of the beginning of the previous fiscal year providedthat the entity makes that choice in the first 120 days of that fiscal year andalso elects to apply the provisions of SFAS 157. Adoption of this statement is notexpected to have a material impact on the Company’s consolidated financialstatements.

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**4.   INTANGIBLEASSETS**

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

| ** **                                    | ** ** | **Weighted  Average** | ** ** | **June 30, 2007** | ** ** | **December 31, 2006** | ** ** |
|-----------------------------------------------|------------|-----------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **Life  (Years)**     | ** ** | **Value  Assigned**         | ** ** | **Accumulated  Amortization**   | ** ** | **Value  Assigned** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                    | ** ** | ** **            | ** ** | ** **                  | ** ** | **(In thousands)**         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Senior Health Insurance:                      |       |                  |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Policies in force                             |       |                  | 9          |                        |       | $                               | 18,473     |   |   | $ | 11,199 |   |   | $ | 18,473 |   |   | $ | 9,786 |   |   |
| Distribution Channel                          |       |                  | 30         |                        |       | 22,055                          |       |   | 3,124 |   |   | 22,055 |   |   | 2,757 |   |   |
| Life  Insurance/Annuity—PVFP             |       |                  | 7          |                        |       | 4,127                           |       |   | 2,033 |   |   | 4,127 |   |   | 1,912 |   |   |
| Senior Managed  Care—Medicare Advantage: |       |                  |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Membership base                               |       |                  | 7          |                        |       | 21,452                          |       |   | 6,434 |   |   | 15,381 |   |   | 5,428 |   |   |
| Provider contracts                            |       |                  | 10         |                        |       | 15,539                          |       |   | 3,049 |   |   | 15,539 |   |   | 2,244 |   |   |
| Non-compete                                   |       |                  | 7          |                        |       | 1,018                           |       |   | 49 |   |   | — |   |   | — |   |   |
| Senior Administrative  Services               |       |                  |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Administrative service contracts              |       |                  | 6          |                        |       | 7,671                           |       |   | 7,463 |   |   | 7,671 |   |   | 7,399 |   |   |
| Hospital network Contracts                    |       |                  | 10         |                        |       | 1,797                           |       |   | 936 |   |   | 1,797 |   |   | 779 |   |   |
| Total                                         |       |                  | 17         |                        |       | $                               | 92,132     |   |   | $ | 34,287 |   |   | $ | 85,043 |   |   | $ | 30,305 |   |   |

 

Thefollowing table shows the changes in the amortizing intangible assets:

| ** **                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Balance,  beginning of period |       | $                                               | 62,007     |                                          | $          | 60,432 |   | $ | 54,738 |   | $ | 50,724 |   |
| Additions and adjustments     |       | (2,289                                          | )          | 5                                             |       | 7,089 |   | 12,081 |   |
| Amortization, net of interest |       | (1,873                                          | )          | (2,110                                        | )          | (3,982 | ) | (4,478 | ) |
| Balance, end of period        |       | $                                               | 57,845     |                                          | $          | 58,327 |   | $ | 57,845 |   | $ | 58,327 |   |

 

On March 1, 2007, the Company acquired Harmony Health, Inc.(“Harmony”), a provider-owned company that operates GlobalHealth, a MedicareAdvantage and Commercial managed care plan in Oklahoma City, Oklahoma for $18.2million in cash, including direct costs of acquisition of $0.2 million. Harmonyis a majority-owned subsidiary of the Oklahoma City Clinic. Founded in 2002,GlobalHealth currently has approximately 4,000 Medicare Advantage members withannualized revenue of approximately $38 million. Under the terms of theagreement, the Oklahoma City Clinic has entered into a long-term agreement withUniversal American to provide healthcare services to GlobalHealth members. Inaddition, Oklahoma City Clinic has retained the risk for commercial businessunder a global capitation arrangement.

14

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Thetangible book value at the date of acquisition was $3.8 million. The excess ofpurchase price over the tangible book value was $16.9 million, gross ofdeferred taxes of $2.5 million, and was allocated as follows:

| **Description**                                          | ** ** | ** **        | ** ** | **Amount** | ** ** | **Weighted  Average Life  At Acquisition**      | ** **                                                    | **Amortization Basis** |
|----------------------------------------------------------|------------|-------------------|------------|------------|------------|-------------------------------------------------|---------------------------------------------------------------|------------------------|
| ** **                                               | ** ** | **(in millions)** | ** ** | ** ** | ** ** | ** **                                      |
| Membership base acquired                                 |       | $                 | 6.1        |       | 10         |                                            | Straight line over the  estimated life of the membership base |
| Non-compete agreement                                    |       | 1.0               |       | 7          |       | Straight line over the  length of the agreement |
| Goodwill                                                 |       | 9.8               |       | —     |       | Non amortizing                                  |
| Total excess of purchase price over tangible book  value |       | $                 | 16.9       |       |       |                                            |                                                          |

 

During the first quarter of 2006, Heritage acquired anadditional interest in the earnings of one of its risk pools, effective as of January 1,2006, for $12.1 million. The purchase price was allocated to the amortizingintangible asset—Provider Contracts and represents the present value of theestimated future cash flows related to the additional interest, and will beamortized over ten years.

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

| 2007 remainder of  year |   | $      | 3,782  |   |
|-------------------------|--------|--------|--------|--------|
| 2008                    |   | 7,200  |   |
| 2009                    |   | 6,818  |   |
| 2010                    |   | 6,002  |   |
| 2011                    |   | 4,063  |   |
| 2012                    |   | 3,900  |   |
| Thereafter              |   | 26,080 |   |
|                    |   | $      | 57,845 |   |

 

Changesin the carrying amounts of goodwill and intangible assets with indefinite livesare shown below:

| ** **                                                 | ** ** | **December 31,  2006** | ** ** | **Additions** | ** ** | **Adjustments** | ** ** | **June 30,  2007** | ** ** |
|------------------------------------------------------------|------------|-----------------------------|------------|---------------|------------|-----------------|------------|-------------------------|------------|
| ** **                                                 | ** ** | **(In thousands)**     | ** ** |
| Senior Market Health  Insurance:                           |       |                        |       |          |       |            |       |                    |       |   |   |   |   |   |   |
| Goodwill                                                   |       |                        | $          | 3,893         |       |            |       | $                       | —     |   |   |   | $ | — |   |   | $ | 3,893 |   |
| Other                                                      |       |                        | 4,867      |          |       |            | —     |                    |       |   | — |   |   | 4,867 |   |
| Subtotal—Senior Market  Health Insurance              |       |                        | 8,760      |          |       |            | —     |                    |       |   | — |   |   | 8,760 |   |
| Senior Managed  Care—Medicare Advantage:              |       |                        |       |          |       |            |       |                    |       |   |   |   |   |   |   |
| Goodwill                                                   |       |                        | 53,052     |          |       |            | 9,804      |                    |       |   | — |   |   | 62,856 |   |
| Other                                                      |       |                        | 5,163      |          |       |            | —     |                    |       |   | — |   |   | 5,163 |   |
| Subtotal—Senior  Managed Care—Medicare Advantage |       |                        | 58,215     |          |       |            | 9,804      |                    |       |   | — |   |   | 68,019 |   |
| Senior  Administrative Services—Goodwill              |       |                        | 4,357      |          |       |            | —     |                    |       |   | — |   |   | 4,357 |   |
| Total                                                      |       |                        | $          | 71,332        |       |            |       | $                       | 9,804      |   |   |   | $ | — |   |   | $ | 81,136 |   |

 

15

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Other non-amortizingintangible assets consist primarily of trademarks and licenses. The addition ofgoodwill for Senior Managed Care—Medicare Advantage was the result of theacquisition of Harmony.

**5.**   INVESTMENTS

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

| ** **                                                   | ** ** | **June 30, 2007** | ** ** |
|--------------------------------------------------------------|------------|-----------------------------|------------|
| **Classification**                                           | ** ** | ** **                  | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**     | ** ** |
| U.S. Treasury  securities and obligations of U.S. government |       | $                      | 174,606    |   |   | $  | 165 |   |   |   | $  | (1,564 | ) |   | $  | 173,207 |   |
| Corporate debt  securities                                   |       | 429,496                     |       |   | 4,588 |   |   |   | (9,199 | ) |   | 424,885 |   |
| Foreign debt  securities                                     |       | 30,848                      |       |   | 244 |   |   |   | (638 | ) |   | 30,454 |   |
| Mortgage-backed  and asset-backed securities                 |       | 556,176                     |       |   | 1,353 |   |   |   | (9,150 | ) |   | 548,379 |   |
|                                                         |       | $                           | 1,191,126  |   |   | $ | 6,350 |   |   |   | $ | (20,551 | ) |   | $ | 1,176,925 |   |
|                                                              |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                   | ** ** | **December 31, 2006** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|
| **Classification**                                           | ** ** | ** **                      | ** ** | **Amortized  Cost** | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**         | ** ** |
| U.S. Treasury  securities and obligations of U.S. government |       | $                          | 115,315    |   |   | $  | 308 |   |   |   | $  | (1,067 | ) |   | $  | 114,556 |   |
| Corporate debt  securities                                   |       | 431,455                         |       |   | 7,739 |   |   |   | (4,424 | ) |   | 434,770 |   |
| Foreign debt  securities                                     |       | 32,120                          |       |   | 427 |   |   |   | (359 | ) |   | 32,188 |   |
| Mortgage-backed  and asset-backed securities                 |       | 531,433                         |       |   | 2,904 |   |   |   | (3,765 | ) |   | 530,572 |   |
|                                                         |       | $                               | 1,110,323  |   |   | $ | 11,378 |   |   |   | $ | (9,615 | ) |   | $ | 1,112,086 |   |
|                                                              |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Theamortized cost and fair value of fixed maturities at June 30, 2007 by contractualmaturity are shown below. Expected maturities will differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without call or prepayment penalties.

| ** **                            | ** ** | **Amortized  Cost**     | ** ** | **Fair  Value** | ** ** |
|---------------------------------------|------------|-------------------------|------------|-----------------|------------|
| ** **                            | ** ** | **(In thousands)** | ** ** |
| Due in 1 year or  less                |       | $                       | 80,586     |            | $          | 81,162 |   |
| Due after 1 year  through 5 years     |       | 297,007                 |       | 298,541         |       |
| Due after 5 years  through 10 years   |       | 188,560                 |       | 183,673         |       |
| Due after 10  years                   |       | 68,795                  |       | 65,169          |       |
| Mortgage and  asset-backed securities |       | 556,178                 |       | 548,380         |       |
|                                  |       | $                       | 1,191,126  |            | $          | 1,176,925 |   |

 

**6.   STOCKHOLDERS’EQUITY**

*Preferred Stock*

The Company has 2.0million authorized shares of preferred stock, of which 300,000 shares weredesignated by our board of directors as Series A Preferred Stock and300,000 shares as Series B Preferred Stock. Both Series A PreferredStock and Series B Preferred Stock possess certain rights whereby sharesof such Preferred Stock may, in certain circumstances, be converted directly orindirectly into shares of common stock.

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*Series A Participating Convertible Preferred Stock*

Subject to the exceptions described below, each shareof Series A Preferred Stock ranks equally in all respects and has the samerights, powers and preferences, and the same qualifications, and limitations,as our Series B Preferred Stock:

*Rank.*   TheSeries A Preferred Stock ranks (i) senior and prior to ourcommon stock and each other class or series of our equity securities, whethercurrently issued or issued in the future, that by its terms ranks junior to theSeries A Preferred Stock (whether with respect to payment of dividends,rights upon liquidation, dissolution or winding up of our affairs, orotherwise) (ii) on a parity with each other class or series of our equitysecurities, whether currently issued or issued in the future, that do not bytheir terms expressly provide that they rank senior to or junior to the Series APreferred Stock whether with respect to payment of dividends, rights uponliquidation, dissolution or winding up of our affairs, or otherwise (all ofsuch equity securities are collectively referred to herein as the “ParitySecurities”), and (iii) junior to each other class or series of our equitysecurities, whether currently issued or issued in the future, that by theirterms rank senior to the Series A Preferred Stock.

*Dividends.**  *Holders of shares of Series A Preferred Stockare entitled to participate equally and ratably with the holders of shares ofcommon stock in all dividends and distributions paid on the shares of commonstock as if, immediately prior to each record date for payment of such dividendor distribution on the common stock, the shares of Series A PreferredStock then outstanding were converted into shares of common stock.

*LiquidationPreference.*   In the event that we voluntarily orinvoluntarily liquidate, dissolve or wind up, the holders of shares of Series APreferred Stock are, with respect to each such share of Series A PreferredStock, entitled to receive the greater of (i) (A) prior to the firstanniversary of the original issuance in respect of such share of Series APreferred Stock, $2,000 per share and (B) on or after the firstanniversary of the original issuance in respect of such share of Series APreferred Stock, $1.00 per such share of Series A Preferred Stock, in eachcase plus an amount equal to any dividends or distributions payable thereon andremaining unpaid thereon and (ii) at any time, the payment such holderswould have received had such holders, immediately prior to our liquidation,dissolution or winding up, converted such share of Series A PreferredStock into shares of common stock, in each case before any payment ordistribution is made on any shares of common stock. Neither a consolidation ormerger nor a sale or transfer of all or any part of our assets for cash,securities or other property, is considered a liquidation, dissolution orwinding up.

*VotingRights.*   Holders of shares of Series APreferred Stock are not entitled to vote on any matter submitted to a vote ofour shareholders, but are entitled to prior written notice of, and are entitledto attend and observe, all special and annual meetings of our shareholders. Notwithstandingthe foregoing and so long as any shares of Series A Preferred Stock areoutstanding, we will not, without the written consent or affirmative vote byholders of at least a majority of the outstanding shares of Series APreferred Stock, voting as a single and separate class: (i) amend, alteror repeal any provision of our certificate of incorporation (by any means,including by merger, consolidation, reclassification, or otherwise) so as to,or in a manner that would, adversely affect the preferences, rights, privilegesor powers of the Series A Preferred Stock; or (ii) increase theauthorized or issued number of shares of Series A Preferred Stock.

*Mergeror Consolidation.*   Unless approved by holders ofthe shares of Series A Preferred Stock, we will not merge or consolidateinto, or sell, transfer or lease all or substantially all of our property toany other entity, unless the successor, transferee or lessee entity (i) expresslyassumes the due and punctual performance and observance of each and everycovenant and condition described above to be performed and observed by us and (ii) expresslyagrees to exchange, at the holder’s option, shares of Series A PreferredStock for shares of the surviving entity’s capital stock on terms substantiallysimilar to the terms described above.

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*Conversionupon Transfer.*   Any share of Series APreferred Stock owned by any equity investor or any affiliate of an equityinvestor shall not be convertible into common stock so long as such share of Series APreferred Stock is owned by such equity investor or such affiliate of an equityinvestor. At any time when a share of Series A Preferred Stock is not orceases to be owned by an equity investor or an affiliate of an equity investor,such share of Series A Preferred Stock, without any further action or deedon our part or any other individual, entity or group, shall automaticallyconvert into the number of fully paid and non-assessable shares of common stockdetermined by dividing (A) $2,000 by (B) the conversion price ineffect at the time of conversion. The initial conversion price is $20.

*Exchange of Shares.*   Underthe securities purchase agreements, we have agreed that, at an equity investor’srequest, we will exchange all or any shares of Series A Preferred Stockheld by such equity investor at such time for a like number of shares of Series BPreferred Stock; provided that, prior to the consummation of any such exchange,such equity investor shall have obtained a clearance, approval or waiver, undercertain laws governing insurance companies or the HSR Act or shall have representedto us that such clearance, approval or waiver is not required in connectionwith such an exchange.

*Series B Participating Convertible Preferred Stock*

Subject to the exceptions described below, each shareof our Series B Preferred Stock ranks equally in all respects and has thesame rights (including with respect to dividends), powers and preferences(including liquidation preference), and the same qualifications, limitationsand restrictions as our Series A Preferred Stock.

*VotingRights.*   In addition to the voting rightsdescribed above, holders of our Series B Preferred Stock may vote withholders of our common stock (together as one class) on all matters submittedfor a vote of holders of our common stock. Holders of our Series BPreferred Stock are entitled to a number of votes equal to the number of votesto which the shares of our common stock issuable upon conversion of such sharesof Series B Preferred Stock would have been entitled if such shares ofcommon stock had been outstanding at the time of the applicable record date.

*Rightto Convert.*   A holder of our Series BPreferred Stock has the right, at any time and from time to time, to convertany or all of such holder’s shares of Series B Preferred Stock into thenumber of fully paid and non-assessable shares of common stock determined bydividing (A) $2,000 by (B) the conversion price in effect at the timeof conversion. The initial conversion price is $20.

We have the right to require the holder of each shareof our Series B Preferred Stock, from and after the first anniversary ofthe date of original issuance of such share, from time to time, at our option,to convert such share of Series B Preferred Stock into fully paid andnon-assessable shares of our common stock at the applicable conversion price. Thenumber of shares of common stock into which one share of the Series BPreferred Stock shall be convertible shall be determined by dividing (A) thepreferred share price by (B) the conversion price in effect at the time ofconversion.

At June 30, 2007, there were 30,473 shares of Series Apreferred stock outstanding and 19,573 share of Series B preferred stockoutstanding, all of which were issued in connection with the stage 1 securitiespurchase agreement. There were no such shares issued or outstanding at December 31,2006.

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*Common Stock*

TheCompany currently has 100 million shares of common stock, par value $0.01 pershare, authorized for issuance. Changes in the number of shares of common stockissued were as follows:

| **Six months ended June 30,**                                        | ** ** | ** ** | ** ** | **2007**   | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------|------------|
| Common stock outstanding,  beginning of year                                             |       | 59,890,500 |       | 59,042,685 |       |
| Stock options  exercised                                                                 |       | 354,231    |       | 125,176    |       |
| Agent stock award                                                                        |       | 2,543      |       | (507       | )          |
| Stock purchases  pursuant to agents’ stock purchase and deferred compensation plans |       | 21,443     |       | 2,500      |       |
| Common stock outstanding,  end of period                                                 |       | 60,268,717 |       | 59,169,854 |       |

 

**Treasury Stock**

TheCompany currently has 984,472 shares of common stock available to purchasepursuant to share repurchase program approved by the Company’s Board ofDirectors in November 2005. Changes in treasury stock were as follows:

| ** **                                          | ** ** | **For the six months ended June 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                                            | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **Shares**                                                          | ** ** | **Amount** | ** ** | **Weighted  Average  Cost Per  Share** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost Per  Share** | ** ** |
| ** **                                          | ** ** | ** **                                                          | ** ** | **(In thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** | **(In thousands)** | ** ** | ** ** | ** ** |
| Treasury stock  beginning of year                   |       | 712,868                                                             |       |   | $ | 10,626 |   |   |   | $ | 14.91 |   |   | 751,473 |   |   | $ | 11,240 |   |   |   | $ | 14.96 |   |   |
| Shares  repurchased                                 |       | —                                                              |       |   | — |   |   |   | — |   |   | 3,039 |   |   | 44 |   |   |   | 14.32 |   |   |
| Shares  distributed in the form of employee bonuses |       | (134,823                                                            | )          |   | (2,010 | ) |   |   | 14.91 |   |   | (54,901 | ) |   | (821 | ) |   |   | 14.96 |   |   |
| Treasury stock, end of  period                      |       | 578,045                                                             |       |   | $ | 8,616 |   |   |   | $ | 14.91 |   |   | 699,611 |   |   | $ | 10,463 |   |   |   | $ | 14.95 |   |   |

 

*Accumulated OtherComprehensive Income*

Thecomponents of accumulated other comprehensive income are as follows:

| ** **                                                 | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                                                 | ** ** | **(In thousands)** | ** ** |
| Continuing  Operations:                                    |       |                    |       |                        |       |   |   |
| Net unrealized appreciation (depreciation)  on investments |       | $                       | (14,204    | )                           |       | $ | 1,769 |   |   |
| Deferred  acquisition cost adjustment                      |       | 3,236                   |       |                        | 895        |   |   |
| Foreign currency  translation gains                        |       | 364                     |       |                        | 233        |   |   |
| Deferred tax                                               |       | 3,711                   |       |                        | (1,014     | ) |   |
| Total accumulated other  comprehensive income (loss)       |       | $                       | (6,893     | )                           |       | $ | 1,883 |   |   |

 

***7.*****  ****STOCK-BASED COMPENSATION**

The Company has variousstock-based incentive plans for its employees, non-employee directors andagents. The Company issues new shares upon the exercise of options grantedunder such stock-based incentive plans. Detailed information for activity inthe Company’s stock-based incentive plans can be found in Note 8—Stock-BasedCompensation to the financial statements in our Annual Report on Form 10-Kfor the year ended December 31, 2006.

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*Stock Option Awards*

Beginning January 1, 2006, the Company adoptedFAS 123-R using the modified prospective method, and began recognizingcompensation cost for share-based payments to employees and non-employeedirectors based on the grant date fair value of the award, which is amortizedover the grantees’ service period. The Company elected to use the Black-Scholesvaluation model to value employee stock options, as it had done for itsprevious pro forma stock compensation disclosures. The adoption of FAS 123-Rdid not have a material effect on the Company’s method of computingcompensation costs for options as compared to that used to prepare the proforma disclosures in prior periods.

Thefair value for these options was estimated at the date of grant using aBlack-Scholes option pricing model with the following range of assumptions:

| ** **                            | ** ** | **For options granted in:** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2007**                                   | ** ** | **Prior years** | ** ** |
| Risk free  interest rates             |       | 4.50% – 5.16%               |       | 3.12% – 5.28% |   |
| Dividend yields                       |       | 0.0%                                       |       | 0.0% |   |
| Expected  volatility                  |       | 36.06% – 41.75%             |       | 40.00% – 47.23% |   |
| Expected lives of  options (in years) |       | 3.0 – 4.75                  |       | 3.0 – 9.0 |   |

 

The weighted-average grant-date fair value was $7.23for options granted during the first six months of 2007 and was $5.26 foroptions granted during the first six months of 2006.

The Company did not capitalize any cost of stock-basedcompensation for its employees or non-employee directors. Future expense mayvary based upon factors such as the number of awards granted by the Company andthe then-current fair market value of such awards.

Asummary of option activity for the six months ended June 30, 2007 and June 30,2006 is presented below:

| **Stock Options**             | ** ** | ** **              | ** ** | **Options**         | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|-------------------------|------------|---------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **(in thousands)** | ** ** | **(in years)** | ** ** | **(in thousands)**                | ** ** | ** **                                          | ** ** |
| Outstanding,  January 1, 2006 |       |                    | 4,823      |                |       |                                   | $          | 6.81                                                |       |                            |       | 5.2 |   |   |   |   |   |   |
| Granted                            |       |                    | 429        |                |       |                                   | 15.37      |                                                |       |                            |       |   |   |   |   |   |   |
| Exercised                          |       |                    | (125       | )                   |       |                                   | 7.84       |                                                |       |                            |       |   |   |   |   |   |   |
| Forfeited or  expired              |       |                    | (37        | )                   |       |                                   | 13.52      |                                                |       |                            |       |   |   |   |   |   |   |
| Outstanding,  June 30, 2006   |       |                    | 5,090      |                |       |                                   | $          | 7.40                                                |       |                            |       | 4.4 |   |   |   | $ | 34,547 |   |   |
| Exercisable,  June 30, 2006   |       |                    | 3,872      |                |       |                                   | $          | 6.41                                                |       |                            |       | 4.2 |   |   |   | $ | 27,724 |   |   |
| Outstanding, January 1, 2007  |       |                    | 4,325      |                |       |                                   | $          | 7.73                                                |       |                            |       | 4.0 |   |   |   |   |   |   |
| Granted                            |       |                    | 1,191      |                |       |                                   | 19.02      |                                                |       |                            |       |   |   |   |   |   |   |
| Exercised                          |       |                    | (354       | )                   |       |                                   | 10.31      |                                                |       |                            |       |   |   |   |   |   |   |
| Forfeited or  expired              |       |                    | (78        | )                   |       |                                   | 15.58      |                                                |       |                            |       |   |   |   |   |   |   |
| Outstanding,  June 30, 2007   |       |                    | 5,084      |                |       |                                   | $          | 10.07                                               |       |                            |       | 3.7 |   |   |   | $ | 57.027 |   |   |
| Exercisable,  June 30, 2007   |       |                    | 3,879      |                |       |                                   | $          | 7.54                                                |       |                            |       | 3.4 |   |   |   | $ | 53,313 |   |   |

 

The total intrinsic value of options exercised duringthe first six months of 2007 was $3.5million and the total intrinsic value ofoptions exercised during the first six months of 2006 was $0.8 million.

20

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As of June 30, 2007, the total compensation costrelated to non-vested awards not yet recognized was $8.8 million, which isexpected to be recognized over a weighted average period of 1.6 years.

Cash received from theexercise of stock options during the first six months of 2007 was $3.7 millionand cash received from the exercise of stock options during first six months of2006 was $1.0 million. FAS 123-R also requires the benefits of taxdeductions in excess of recognized compensation cost to be reported as afinancing cash flow, rather than as an operating cash flow as required underthe prior statement. The amount of financing cash flows recognized for suchexcess tax deductions was $0.7 million for the six months ended June 30,2007 and was $0.6 million for the six months ended June 30, 2006.

*Employee StockAwards*

Inaccordance with the Company’s 1998 Incentive Compensation Plan, the Company maygrant restricted stock to its officers and non-officer employees. Restrictedstock issued to non-officer employees vests upon issuance. Executive officershave been granted restricted stock in connection with their bonuses. Thisrestricted stock vests ratably over four years. Restricted stock awards arevalued equal to the market price of the Company’s common stock on the date ofgrant and are generally issued out of treasury shares. Compensation expense forrestricted stock awards is recognized on a straight line basis over the vestingperiod. A summary of the status of the Company’s non-vested restricted stockawards is presented below: 

| ** **                                | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| **Non-vested Restricted Stock** | ** ** | ** **                                        | ** ** | **Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** | **Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
| ** **                                | ** ** | **(in thousands)**                           | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Non-vested at  beginning of year          |       |                                              | 148        |   |   |   | $ | 13.60 |   |   |   | 157 |   |   |   | $ | 12.05 |   |   |
| Granted                                   |       |                                              | 135        |   |   |   | 19.43 |   |   |   | 54 |   |   |   | 15.35 |   |   |
| Vested                                    |       |                                              | (58        | ) |   |   | 12.12 |   |   |   | (51 | ) |   |   | 11.05 |   |   |
| Forfeited                                 |       |                                              | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Non-vested at end of  period              |       |                                              | 225        |   |   |   | $ | 17.46 |   |   |   | 160 |   |   |   | $ | 13.47 |   |   |
|                                           |            |                                                   |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The total fair value ofshares of restricted stock vested during the six months ended June 30,2007 was $1.1 million and the total fair value of shares of restricted stockvested during the six months ended June 30, 2006 was $0.8 million.

***8.*  ****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 insurance subsidiaries’ statutory capital and surplus exceeds itsrespective minimum statutory requirement at levels we believe are sufficient tosupport their current levels of operation. Additionally, the NationalAssociation of Insurance Commissioners (“NAIC”) imposes regulatory risk-basedcapital (“RBC”) requirements on life insurance enterprises. At June 30,2007, all of our insurance subsidiaries maintained ratios of total adjustedcapital to RBC in excess of the “authorized control level”. The combinedstatutory capital and surplus, including asset valuation reserve, of theinsurance subsidiaries totaled $372.6 million at June 30, 2007 and $242.9million at December 31, 2006. For the six months ended June 30, 2007,the insurance subsidiaries generated statutory net income of $38.8 million. Forthe six months ended June 30, 2006, the insurance subsidiaries generated astatutory net income of $9.2 million.

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Our health plan affiliatesare also required to maintain minimum amounts of capital and surplus, asrequired by regulatory authorities and are also subject to RBC requirements. AtJune 30, 2007, the statutory capital and surplus of each of our healthplan affiliates exceeds its minimum requirement and its RBC is in excess of the“authorized control level”. The statutory capital and surplus for our healthplan affiliates was $57.3 million at June 30, 2007 and $44.0 million at December 31,2006. Statutory net income for our health plan affiliates was $9.0 millionfor the six months ended June 30, 2007 and $7.7 million for the six monthsended June 30, 2006.

***9.*****  ****LOANPAYABLE**

*Amended CreditAgreement*

In connection with the acquisition of Heritage on May 28,2004, the Company amended its then existing credit agreement by increasing thefacility to $120.0 million from $80.0 million (the “Amended Credit Agreement”),including an increase in the term loan portion to $105.0 million from $36.4million (the balance outstanding at May 28, 2004) and maintaining the$15.0 million revolving loan facility. None of the revolving loan facility hasbeen drawn as of June 30, 2007. Under the Amended Credit Agreement, thespread over LIBOR was reduced to 225 basis points. Effective July 1, 2007,the interest rate on the term loan was 7.6%. Principal repayments are scheduledat $5.3 million per year over a five-year period with a final payment of $80.1million due upon maturity on March 31, 2009.

The Company made regularly scheduled principalpayments of $2.6 million during the six months ended June 30, 2007 and$2.6 million during the six months ended June 30, 2006, in connection withits 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:

| 2007 (remainder  of the year) |   | $      | 2,625  |   |
|-------------------------------|--------|--------|--------|--------|
| 2008                          |   | 5,250  |   |
| 2009                          |   | 80,063 |   |
|                          |   | $      | 87,938 |   |

 

On January 18, 2007, the Company requested andreceived, from the administrative agent for the bank group an additionalshort-term revolving credit facility of $50.0 million. On March 13, 2007,the Company drew down all $50.0 million of the new short-term revolving creditfacility. This new short-term revolving credit facility has a maturity date of September 30,2007 and bears interest at a spread of 75 basis points over the three monthLIBOR rate. The initial rate was 6.1%. On July 18, 2007, the Company fullypaid off the $50.0 million balance on this revolving credit facility, includingaccrued interest of $0.3 million.

The Company paid interestof $4.2 million during the six months ended June 30, 2007 and $3.4 millionduring the six months ended June 30, 2006, in connection with its creditfacilities.

***10.*****  ****OTHER LONGTERM DEBT**

The Company has formed separate statutory businesstrusts (the “Trusts”), which exist for the exclusive purpose of issuing trustpreferred securities representing undivided beneficial interests in the assetsof the trust, investing the gross proceeds of the trust preferred securities injunior subordinated deferrable interest debentures of the Company (the “JuniorSubordinated Debt”) and engaging in only those activities necessary orincidental thereto. In accordance with the adoption of FASB Interpretation No. 46(R),“Consolidation of Variable Interest Entities,” the Company does not consolidatethe trusts. In March, 2007 we issued $50 million of trust preferred securitiesat a fixed interest rate of 7.7%. As of June 30, 2007, the Trusts haveissued a combined $125.0 million in thirty year trust preferred securities.

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The Company paid $3.8million in interest in connection with the Junior Subordinated Debt during thesix months ended June 30, 2007, and $2.8 million during the six monthsended June 30, 2006.

***11.*****  ****DERIVATIVEINSTRUMENTS—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 inDecember 2007. Effective April 29, 2004, the Company entered into asecond swap agreement whereby it pays a fixed rate of 6.98% on a $20.0 millionnotional amount relating to the October 2003 trust preferred securitiesissuance, in exchange for a floating rate of LIBOR plus 395 basis points,capped at 12.45%. The swap contract expires in October 2008. The combinedfair value of the swaps was $0.9 million at June 30, 2007 and $1.2 millionat December 31, 2006 and is included in other assets. We had applied the“short-cut method” to determine effectiveness and the swaps were initiallydesignated as cash flow hedges, with changes in their fair value recorded inaccumulated other comprehensive income. In 2006, the SEC affirmed itsinterpretation that prohibits the use of the “short-cut method” for all fairvalue hedges of fixed-rate trust preferred securities, as well as cash flowhedges of the variable cash flows associated with variable-rate trust preferredsecurities, whenever the issuer has the ability to defer interest payments attheir election. As a result, these cash flow hedges are no longer deemedeffective. In the fourth quarter of 2006, the fair value of the hedge wasreversed out of accumulated other comprehensive income and reported in realizedgains in our consolidated income statement. Any future changes in the fairvalue will also be reported in realized gains. During the six months endedJune 30, 2007, $0.3 million relating to the reduction in the fair value ofthe cash flow swap agreements was reported as a realized loss.

***12.*****  ****COMMITMENTSAND CONTINGENCIES**

***Securities Class Action and Derivative Litigation***

In previous filings, the Company reported on the KempAction, which was a consolidated class action against the Company and RichardA. Barasch, Robert A. Waegelein and Gary W. Bryant (the “Officer Defendants”)that was pending in the United States District Court for the Southern Districtof New York. Following the Court’s dismissal of the amended consolidatedcomplaint in January 2007, and the filing of a second amended consolidatedcomplaint by plaintiffs in March 2007, and the service by defendants inMay 2007 of a motion to dismiss the second amended consolidated complaint,the Kemp Action was brought to a conclusion on July 16, 2007, when theCourt entered a stipulation and order dismissing the consolidated case withprejudice and without costs.

Two cases that were based upon the factual allegationsof the Kemp Action and that were filed derivatively by shareholders purportingto act on behalf of the Company, and not as class actions, are still pending.One of these was filed by Green Meadows Partners LLP (the “Green MeadowsAction”) on December 13, 2005, in the United States District Court for theSouthern District of New York, and has been assigned to the same judge who presidedover the Kemp Action. In the Green Meadows Action, plaintiffs seek contributionunder Section 10(b) and 21D of the Securities Exchange Act of 1934 onthe ground that if the Company is found liable to have violated the securitieslaws in the Kemp Action, then the Officer Defendants are liable forcontribution. The Green Meadows Action also asserts three claims under statelaw for breach of fiduciary duty against the Officer Defendants.

On July 19, 2006, the plaintiff in the GreenMeadows Action filed a Verified Amended Shareholder Derivative Complaint (the“GM Amended Complaint”). The GM Amended Complaint adds as new defendantsMr. Wehner, Capital Z Financial Services Fund II, L.P. (“Capital Z”) andthree directors of the Company who are affiliated with Capital Z, namelyBradley E. Cooper, Robert A. Spass and Eric W. Leathers. Capital Z is thelargest shareholder of the Company. The GM Amended Complaint carries 

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forward the legal claimsasserted in the original complaint against the original defendants (withadditional allegations), and adds new claims (i) against the new directordefendants for alleged breach of fiduciary duty in connection with a secondaryoffering in June 2005 that included five million shares of the Company’scommon stock that had been owned by Capital Z and (ii) against Capital Zfor alleged unjust enrichment with respect to the proceeds Capital Z realizedfrom the sale of the five million shares it formerly owned in the secondaryoffering. On September 8, 2006, defendants served a motion to dismiss theGM Amended Complaint. On October 26, 2006 (prior to the response date forplaintiff), the Court entered an order staying the case for 90 days. OnJanuary 22, 2007 (prior to the expiration of the previous stay), the Courtentered an order staying the case for an additional 120 days.

The second derivative action was filed by plaintiffArthur Tsutsui (the “Tsutsui Action”) on December 30, 2005, in the SupremeCourt for New York State, Westchester County. The defendants in the TsutsuiAction are the three Officer Defendants named in the other actions, as well asall of the directors sitting on the Company’s Board of Directors as of the timethe complaint was filed. The Tsutsui Action alleges that the same allegedmisstatements that are the subject of the Kemp Action constituted a breach offiduciary duty by the Officer Defendants and the directors that caused theCompany to sustain damages. The Tsutsui Action also seeks recovery of anyproceeds derived by the Officer Defendants from the sale of Company stock thatwas in breach of their fiduciary duties. Defendants in the Tsutsui Action fileda motion to dismiss the complaint on June 9, 2006. On August 17,2006, the Court issued an order staying the case until such time (i) asthe Kemp Action is fully and finally resolved or settled, or (ii) theGreen Meadows Action is fully and finally resolved, or shareholders in thatcase receive notice of a proposed settlement.

In view of the dismissalwith prejudice of the Kemp Action, the Company intends promptly to seekdismissal in the entirety of both the Green Meadows Action and the TsutsuiAction. Management believes that after liability insurance recoveries, neitherof these actions will have a material adverse effect on the Company.

***Class Action Litigation Relating to AcquisitionProposal***

Between October 25, 2006 and November 6,2006, six purported class actions were filed in New York state courts againstthe Company and other defendants concerning the acquisition proposal receivedby the Company on October 24, 2006, from members of management led byRichard A. Barasch, the Company’s Chairman and Chief Executive Officer, andprivate equity firms Capital Z Partners, Ltd., Lee Equity Partners, LLC, PerryCapital, LLC and Welsh, Carson, Anderson & Stowe X, L.P. to acquireall of the Company’s publicly held common stock for $18.15 per share in cash(the “Offer”). Three of these actions were filed in the Supreme Court for NewYork County as *Stellato v. Universal American FinancialCorp., et al.* (06-116006) (“Stellato”),*GreenMeadows Partners LLP v. Barasch, et al.* (603724-06) (“GreenMeadows II”), and *Sorrentino v. Barasch et al*. (06-603853)(“Sorrentino”).

The Stellato action alleged that the offer was made atan “unfair price, under unfair terms and through improper means” and sought aninjunction preventing the Offer from being consummated, or in the alternative,monetary damages. The Green Meadows II action alleged that Mr. Barasch anddirectors Bradley Cooper, Eric Leathers and Robert Spass dominate the board ofdirectors of the Company, and have breached their fiduciary duties by, amongother things, making a buyout proposal that “fails to take into account thevalue of UHCO, its improving financial results and its value in comparison toother similar companies.”  The actionsought, among other things, an injunction preventing defendants from carryingout an unfair transaction, and monetary damages. The Sorrentino action alsoalleged board domination by Messers. Barasch, Cooper, Leathers, and Spass, andasserted that the Offer price is “unconscionable, unfair and grossly inadequateand constitutes unfair dealing.”  Theaction sought an injunction preventing the Offer from being consummated orrescinding the Offer, or, in the alternative, monetary damages.

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Three other actions pertaining to the Offer were filedin the Supreme Court for Westchester County as *Conolly v.Universal American Financial Corp, et al.* (06-21712) (“Conolly”),*McCormack v. Averill et al.*(06-21365)(“McCormack”), and *Zhang v. Barasch et al.*(21672-06) (“Zhang”). The Conolly action alleged that the shareholderagreement to which Mr. Barasch and Capital Z are parties “deter[s]potential bids for the Company at a premium to the presently offered price,”and that the sponsors of the offer (excluding Mr. Barasch) are members ofa “club” of elite private equity funds under investigation for violations ofthe anti-trust laws that have resulted in “driv[ing] down the prices ofpotential acquisition targets.”  TheConolly action further asserted that the director defendants have breachedtheir fiduciary duties to maximize shareholder value by, among other things,failing immediately to reject the Offer. The complaint sought an injunctionprohibiting consummation of the Offer, or in the alternative, monetary damages.The McCormack action also asserted that the buyout offer is “the product ofunfair dealing” by the management of the Company and its largest shareholder,Capital Z, and sought an injunction ordering the directors to fulfill theirfiduciary duties, and/or enjoining any transaction based upon the Offer, aswell as monetary damages. The Zhang action asserted that the Offer price wasunfair and failed to take into account the value of the Company; it soughtinjunctive relief and/or damages.

On January 11, 2007, the New York Supreme Court,Westchester County, signed an order consolidating each of the six actions inthe Commercial Division of Westchester Court under the caption, *In re Universal American Financial Corp. Buyout Offer Shareholder Litigation*(the “Consolidated Action”). The defendants named in theconsolidation order included the Company, Mr. Barasch and the othersponsors of the offer, including Capital Z, as well as eight other members ofthe Company’s board of directors. The court’s order provided that the plaintiffwould file a consolidated amended complaint, and the defendants’ time torespond would extend to 40 days thereafter. The consolidated amended complainthas not yet been filed.

On May 25, 2007, the Court in the Consoldiated Actionsheld a status conference with counsel for all parties. Prior to the conference,counsel for plaintiffs advised the Court by letter that plaintiffs intended tofile a consolidated amended complaint that would allege, among other things,that the merger agreement and related arrangements through which the Companywould acquire MemberHealth would have the effect of transferring control of theCompany at a price that is unfair to shareholders of the Company (other than tothose shareholders who participated in the Offer).

At the May 25th conference, the Court granted the plaintiffsin the Consolidated Actions approximately two weeks to file an amendedconsolidated complaint. However, as of July 13, 2007, when the next statusconference with the Court was conducted, plaintiffs had not filed an amendedconsolidated complaint. In view of their failure to do so, the Court directedthat the case would be dismissed without prejudice and without costs followingresolution of a procedural issue relating to consolidation of the sixconstituent cases.

***Class Action Litigation Relating to MergerProposal***

On July 25, 2007, apurported class action entitled “Elizabeth A. Conolly, Thomas McCormack, ShellyZ. Zhang, Green Meadows Partners, James Stellato and Rocco Sorrentino vs.Universal American Financial Corporation, Richard A. Barasch, Lee EquityPartners LLC, Perry Capital LLC, Union Square Partners Management LLC, Welsh,Carson, Anderson & Stowe, Barry Averill, Bradley E. Cooper, Mark M.Harmeling, Bertram Harnett, Linda H. Lamel, Eric W. Leathers, Patrick J.McLaughlin, Robert A. Spass, and Robert F. Wright” (the “Merger Class Action”)was filed in the Supreme Court for New York State, Westchester County. Thecomplaint alleges that (i) the defendants who are directors of the Companyallegedly breached fiduciary duties they owed to the Company’s shareholders inconnection with the Company entering into its previously announced mergeragreement to acquire MemberHealth, Inc. and concurrent agreements withcertain equity investors for such equity investors to acquire securities in theCompany (collectively, the “Transactions”), and the defendants who are equityinvestors purportedly aided and abetted that breach; and (ii) thedefendants who are directors of the Company allegedly 

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breachedtheir duty of candor to the Company’s shareholders by failing to disclosematerial information concerning the Transactions. The plaintiffs seek, amongother things, an injunction against the consummation of the Transactions anddamages in an amount to be determined. The Company has reviewed the complaintand believes the lawsuit is without merit, and intends to defend against theclaims vigorously.

***Other Litigation***

The Company has litigationin the ordinary course of its business, including claims for medical,disability and life insurance benefits, and in some cases, seeking punitivedamages. Management believes that after liability insurance recoveries, none ofthese actions will have a material adverse effect on the Company.

**13.   OTHERCOMPREHENSIVE INCOME**

Thecomponents of other comprehensive income, and the related tax effects for eachcomponent, are as follows:

| ** **                                                                         | ** ** | **Three months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                            | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | **Before Tax  Amount**                         | ** ** | **Tax Expense  (Benefit)** | ** ** | **Net of Tax  Amount** | ** ** | **Before Tax  Amount** | ** ** | **Tax Expense  (Benefit)** | ** ** | **Net of Tax  Amount** | ** ** |
| ** **                                                                         | ** ** | **(In thousands)**                             | ** ** |
| **From continuing  operations:**                                                   |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  unrealized loss arising during  the  year (net of deferred acquisition costs) |       |                                                | $          | (14,459 | ) |   |   | $ | (5,060 | ) |   |   | $ | (9,399 | ) |   |   | $ | (10,124 | ) |   |   | $ | (3,544 | ) |   | $ | (6,580 | ) |
| Reclassification  adjustment for losses (gains) included  in net income            |       |                                                | 264        |   |   |   | 92 |   |   |   | 172 |   |   |   | (48 | ) |   |   | (17 | ) |   | (31 | ) |
| Net  unrealized loss                                                               |       |                                                | (14,195    | ) |   |   | (4,968 | ) |   |   | (9,227 | ) |   |   | (10,172 | ) |   |   | (3,561 | ) |   | (6,611 | ) |
| Cash  Flow Hedge                                                                   |       |                                                | —     |   |   |   | — |   |   |   | — |   |   |   | 56 |   |   |   | 19 |   |   | 37 |   |
| Foreign  currency translation adjustment                                           |       |                                                | 116        |   |   |   | 40 |   |   |   | 76 |   |   |   | 62 |   |   |   | 22 |   |   | 40 |   |
| Other  comprehensive loss from continuing operations                               |       |                                                | (14,079    | ) |   |   | (4,928 | ) |   |   | (9,151 | ) |   |   | (10,054 | ) |   |   | (3,520 | ) |   | (6,534 | ) |
| **From discontinued  operations:**                                                 |       |                                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  unrealized loss arising during  the  year (net of deferred acquisition costs) |       |                                                | —     |   |   |   | — |   |   |   | — |   |   |   | (8,083 | ) |   |   | (2,830 | ) |   | (5,253 | ) |
| Reclassification  adjustment for gains  included in  net income                    |       |                                                | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   | — |   |
| Net  unrealized loss                                                               |       |                                                | —     |   |   |   | — |   |   |   | — |   |   |   | (8,083 | ) |   |   | (2,830 | ) |   | (5,253 | ) |
| Foreign  currency translation adjustment                                           |       |                                                | —     |   |   |   | — |   |   |   | — |   |   |   | 2,052 |   |   |   | 718 |   |   | 1,334 |   |
| Other  comprehensive loss from discontinued operations                             |       |                                                | —     |   |   |   | — |   |   |   | — |   |   |   | (6,031 | ) |   |   | (2,112 | ) |   | (3,919 | ) |
| Total other comprehensive loss                                                     |       |                                                | $          | (14,079 | ) |   |   | $ | (4,928 | ) |   |   | $ | (9,151 | ) |   |   | $ | (16,085 | ) |   |   | $ | (5,632 | ) |   | $ | (10,453 | ) |

 

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| ** **                                                                         | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | **Before Tax  Amount**                       | ** ** | **Tax Expense  (Benefit)** | ** ** | **Net of Tax  Amount** | ** ** | **Before Tax  Amount** | ** ** | **Tax Expense  (Benefit)** | ** ** | **Net of Tax  Amount** | ** ** |
| ** **                                                                         | ** ** | **(In thousands)**                           | ** ** |
| **From continuing  operations:**                                                   | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Net  unrealized loss arising during  the year (net of  deferred acquisition costs) |       |                                              | $          | (11,992 | ) |   |   | $ | (4,197 | ) |   |   | $ | (7,795 | ) |   |   | $ | (20,392 | ) |   |   | $ | (7,138 | ) |   | $ | (13,254 | ) |
| Reclassification  adjustment for gains  included in net income                     |       |                                              | (1,640     | ) |   |   | (574 | ) |   |   | (1,066 | ) |   |   | (47 | ) |   |   | (16 | ) |   | (31 | ) |
| Net  unrealized loss                                                               |       |                                              | (13,632    | ) |   |   | (4,771 | ) |   |   | (8,861 | ) |   |   | (20,439 | ) |   |   | (7,154 | ) |   | (13,285 | ) |
| Cash  Flow Hedge                                                                   |       |                                              | —     |   |   |   | — |   |   |   | — |   |   |   | 226 |   |   |   | 79 |   |   | 147 |   |
| Foreign  currency translation adjustment                                           |       |                                              | 131        |   |   |   | 46 |   |   |   | 85 |   |   |   | 42 |   |   |   | 15 |   |   | 27 |   |
| Other  comprehensive loss from continuing operations                               |       |                                              | (13,501    | ) |   |   | (4,725 | ) |   |   | (8,776 | ) |   |   | (20,171 | ) |   |   | (7,060 | ) |   | (13,111 | ) |
| **From discontinued  operations:**                                                 |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net  unrealized loss arising during  the year (net of  deferred acquisition costs) |       |                                              | —     |   |   |   | — |   |   |   | — |   |   |   | (15,322 | ) |   |   | (5,363 | ) |   | (9,959 | ) |
| Reclassification  adjustment for gains  included in net income                     |       |                                              | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   | — |   |
| Net  unrealized loss                                                               |       |                                              | —     |   |   |   | — |   |   |   | — |   |   |   | (15,322 | ) |   |   | (5,363 | ) |   | (9,959 | ) |
| Foreign  currency translation adjustment                                           |       |                                              | —     |   |   |   | — |   |   |   | — |   |   |   | 1,786 |   |   |   | 625 |   |   | 1,161 |   |
| Other  comprehensive loss from discontinued operations                             |       |                                              | —     |   |   |   | — |   |   |   | — |   |   |   | (13,536 | ) |   |   | (4,738 | ) |   | (8,798 | ) |
| Total other comprehensive loss                                                     |       |                                              | $          | (13,501 | ) |   |   | $ | (4,725 | ) |   |   | $ | (8,776 | ) |   |   | $ | (33,707 | ) |   |   | $ | (11,798 | ) |   | $ | (21,909 | ) |

 

**14.   UNCONSOLIDATED SUBSIDIARY**

During 2005, we enteredinto a strategic alliance with PharmaCare and created PDMS, which is 50% ownedby Universal American and 50% owned by PharmaCare. PDMS principally performsmarketing and risk management services on behalf of our PDPs and PharmaCare forwhich it receives fees and other remuneration from our PDPs and PharmaCare. Wedo not control PDMS and therefore PDMS is not consolidated in our financialstatements. Our investment in PDMS is accounted for on an equity basis and isincluded in other assets. Our investment in PDMS was $4.8 million at June 30,2007 and $6.0 million at December 31, 2006. Our share in the income orloss of PDMS is included in “equity in earnings of unconsolidated subsidiary.”  Our share in the net income of PDMS was $26.3million for the six months ended June 30, 2007 and was $22.7 million forthe six months ended June 30, 2006. PDMS made distributions to its ownersaggregating $55.0 million during the six months ended June 30, 2007. Ourshare of these distributions was $27.5 million. PDMS made distributions to itsowners aggregating $37.0 million during the six months ended June 30, 2006.Our share of these distributions was $18.5 million.

Thecondensed financial information for 100% of PDMS is as follows:

| ** **                   | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **                   | ** ** | **(In thousands)** | ** ** |
| ** **                   | ** ** | **(Unaudited)**         | ** ** | ** **            | ** ** |
| *Assets*                     |       |                    |       |                  |       |   |   |   |   |
| Cash and investments         |       |                    | $          | 6,525                 |       |   |   | $ | 7,237 |   |   |
| Other                        |       |                    | 4,246      |                  |       |   | 10,234 |   |   |
| Total Assets                 |       |                    | $          | 10,771                |       |   |   | $ | 17,471 |   |   |
| *Liabilities  and Equity*    |       |                    |       |                  |       |   |   |   |   |
| Accrued expenses and  other  |       |                    | $          | 1,211                 |       |   |   | $ | 5,558 |   |   |
| Equity                       |       |                    | 9,560      |                  |       |   | 11,913 |   |   |
| Total liabilities and equity |       |                    | $          | 10,771                |       |   |   | $ | 17,471 |   |   |

 

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| ** **     | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|----------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **     | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **     | ** ** | **(Unaudited)**                                 | ** ** |
| Total revenue  |       | $                                               | 27,122     |                                          | $          | 27,712 |   | $ | 54,268 |   | $ | 48,816 |   |
| Total expenses |       | 883                                             |       | 1,978                                         |       | 1,622 |   | 3,468 |   |
| Income         |       | $                                               | 26,239     |                                          | $          | 25,734 |   | $ | 52,646 |   | $ | 45,348 |   |

 

**15.  **BUSINESSSEGMENT INFORMATION

The Company’s principal business segments are based onproduct and include:  Senior Managed Care—MedicareAdvantage, Senior Market Health Insurance, Specialty Health Insurance, LifeInsurance and Annuity and Senior Administrative Services. The Company alsoreports the activities of our holding company in a separate segment.Reclassifications have been made to conform prior year amounts to the currentyear presentation. A description of these segments follows:

**SeniorManaged Care—Medicare Advantage—****The**Senior ManagedCare—Medicare Advantage segment includes the operations of our initiatives inmanaged care for seniors and other Medicare beneficiaries. We operate varioushealth plans, including SelectCare of Texas, that offer coverage to Medicarebeneficiaries under a contract with CMS in Southeastern Texas, Oklahoma,Wisconsin and Florida. The health plans are sold by our career and independentagents and directly by employee representatives. In connection with the healthplans, we operate separate Management Service Organizations (“MSO’s”) thatmanage that business and affiliated Independent Physician Associations (“IPA’s”).We participate in the net results derived from these affiliated IPA’s. OurMedicare Advantage private fee-for-service plans, also under a contract withCMS, are sold by our career and independent agents. We currently market PFFSproducts in 2,600 counties throughout 35 states.

**SeniorMarket Health Insurance—****This**segment consists of ourMedicare Supplement business and other senior market health productsdistributed through our career agency sales force and through our network ofindependent general agencies, as well as our Medicare Part D plans,including the equity in the income or loss of PDMS, that began offeringprescription drug coverage for seniors on January 1, 2006. The inclusionof the operating results from our Medicare Part D business with those ofour Medicare Supplement business has resulted in an increase in the level ofseasonality in our reported results during a given calendar year. Thesebusinesses generally see higher claim experience in the early quarters of theyear, with lower claims experience in the later quarters of the year, resultingin a pattern of increasing reported net income attributable to thosebusinesses.

**SpecialtyHealth Insurance—****This**segment includes specialtyhealth insurance products, primarily fixed benefit accident and sicknessdisability insurance sold to the middle income self-employed market in theUnited States. This segment also includes certain products that we no longersell such as long term care and major medical insurance. This segment’sproducts are distributed primarily by our career agents. The results for thissegment for prior periods have been restated to exclude the results forPennCorp Life Canada, since it is now classified as discontinued operations.

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**LifeInsurance and Annuity—****This**segment includes all of thelife insurance and annuity business sold in the United States. This segment’sproducts include senior, traditional and universal life insurance and fixedannuities and are distributed through both independent general agents and ourcareer agency distribution systems.

**SeniorAdministrative Services—****Our**senior administrative servicessubsidiary acts as a third party administrator and service provider of seniormarket insurance products and geriatric care management for both affiliated andunaffiliated insurance companies. The services provided include policyunderwriting and issuance, telephone and face-to-face verification,policyholder services, agent licensing, commission payment, claims adjudication,case management, care assessment, referral to health care facilities andadministration of our Part D prescription drug plans on behalf of oursubsidiaries which commenced on January 1, 2006. In 2007, we beganadministration for private-fee-for-service business.

**Corporate—****This** segmentreflects the activities of Universal American, including debt service, certainsenior executive compensation, and compliance with requirements resulting fromour status 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 operating segments.

Financialdata by segment, including a reconciliation of segment revenues and segmentincome (loss) before income taxes to total revenue and net income in accordancewith generally accepted accounting principles is as follows:

| ** **                                                 | ** ** | **Three months ended June 30,** | ** ** | ** **                                |
|------------------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------------|
| ** **                                                 | ** ** | **2007**                                            | ** ** | **2006**                                  | ** ** | ** ** |
| ** **                                                 | ** ** | **Revenue**                                         | ** ** | **Income  (Loss)  Before  Income  Taxes** | ** ** | **Revenue** | ** ** | **Income  (Loss)  Before  Income  Taxes** | ** ** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                             | ** ** | ** **                                |
| Senior Managed  Care—Medicare Advantage.              |       | $                                                   | 494,175    |                                      | $ | 20,348 |   | $ | 111,297 |   | $ | 10,371 |   |   |
| Senior Market  Health Insurance                            |       | 165,355                                             |       | 11,011                                    |   | 173,975 |   | 8,316 |   |   |
| Specialty Health  Insurance                                |       | 24,231                                              |       | 1,484                                     |   | 24,323 |   | 2,949 |   |   |
| Life Insurance  and Annuity                                |       | 26,027                                              |       | 5,213                                     |   | 24,999 |   | 3,758 |   |   |
| Senior  Administrative Services                            |       | 26,295                                              |       | 5,490                                     |   | 21,758 |   | 4,775 |   |   |
| Corporate                                                  |       | 1,255                                               |       | (7,642                                    | ) | 135 |   | (6,388 | ) |   |
| Intersegment  revenues                                     |       | (20,443                                             | )          | —                                    |   | (15,610 | ) | — |   |   |
| Adjustments to segment  amounts:                           |       |                                                |       |                                      |   |   |   |   |   |   |
| Net realized gains (losses)(1)                             |       | (264                                                | )          | (264                                      | ) | 48 |   | 48 |   |   |
| Equity in (earnings) loss of unconsolidated  subsidiary(2) |       | (13,120                                             | )          | —                                    |   | (12,867 | ) | — |   |   |
| Total—Continuing  Operations                          |       | $                                                   | 703,511    |                                      | $ | 35,640 |   | $ | 328,058 |   | $ | 23,829 |   |   |

 

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| ** **                                                 | ** ** | **Six months ended June 30,** | ** ** | ** **                                |
|------------------------------------------------------------|------------|---------------------------------------------------|------------|-------------------------------------------|
| ** **                                                 | ** ** | **2007**                                          | ** ** | **2006**                                  | ** ** | ** ** |
| ** **                                                 | ** ** | **Revenue**                                       | ** ** | **Income  (Loss)  Before  Income  Taxes** | ** ** | **Revenue** | ** ** | **Income  (Loss)  Before  Income  Taxes** | ** ** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                           | ** ** | ** **                                |
| Senior Managed  Care—Medicare Advantage               |       | $                                                 | 876,191    |                                      | $ | 26,340 |   | $ | 202,332 |   | $ | 19,603 |   |   |
| Senior Market  Health Insurance                            |       | 356,574                                           |       | 4,123                                     |   | 352,765 |   | 7,456 |   |   |
| Specialty Health  Insurance                                |       | 48,480                                            |       | 4,897                                     |   | 49,215 |   | 4,351 |   |   |
| Life Insurance  and Annuity                                |       | 51,372                                            |       | 8,510                                     |   | 50,041 |   | 4,800 |   |   |
| Senior  Administrative Services                            |       | 51,860                                            |       | 11,327                                    |   | 41,962 |   | 7,202 |   |   |
| Corporate                                                  |       | 1,908                                             |       | (15,397                                   | ) | 350 |   | (11,869 | ) |   |
| Intersegment  revenues                                     |       | (39,773                                           | )          | —                                    |   | (30,321 | ) | — |   |   |
| Adjustments to segment  amounts:                           |       |                                              |       |                                      |   |   |   |   |   |   |
| Net realized gains (losses)(1)                             |       | 1,640                                             |       | 1,640                                     |   | 47 |   | 47 |   |   |
| Equity in (earnings) loss of unconsolidated  subsidiary(2) |       | (26,323                                           | )          | —                                    |   | (22,674 | ) | — |   |   |
| Total—Continuing  Operations                          |       | $                                                 | 1,321,929  |                                      | $ | 41,440 |   | $ | 643,717 |   | $ | 31,590 |   |   |

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

(2)       Wereport the equity in the earnings of unconsolidated subsidiary as revenue forour Senior Market Health Insurance segment for purposes of analyzing the ratioof net pharmacy benefits incurred because the amount is incorporated in thecalculation of the risk corridor adjustment. For consolidated reporting, thisamount is included as a separate line in income from continuing operations.

Identifiableassets by segment are as follows:

| ** **                                   | ** ** | **June 30,**                                                                                                | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2007**                                                                                                         | ** ** | **2006**              | ** ** |
| ** **                                   | ** ** | **(In thousands)**                                                                                          | ** ** |
| Senior Managed  Care—Medicare Advantage |       | $1,094,000                  |       |                  | $          | 390,413 |   |   |
| Senior Market  Health Insurance              |       | 783,203                                                                                                          |       |                  | 819,056    |   |   |
| Specialty Health  Insurance                  |       | 507,783                                                                                                          |       |                  | 527,486    |   |   |
| Life Insurance  and Annuity                  |       | 707,836                                                                                                          |       |                  | 731,003    |   |   |
| Senior  Administrative Services              |       | 35,087                                                                                                           |       |                  | 31,326     |   |   |
| Corporate                                    |       | 1,068,610                                                                                                        |       |                  | 816,908    |   |   |
| Intersegment assets(1)                       |       | (925,505                                                                                                         | )          |                  | (731,150   | ) |   |
| Total Assets                                 |       | $                                                                                                                | 3,271,016  |                  |       | $ | 2,585,042 |   |   |
|                                              |            |                                                                                                                  |            |                       |            |  |  |  |  |

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

**16.   DISCONTINUEDOPERATIONS**

On December 1, 2006, the Company completed thesale of UAFC (Canada) Inc., including PennCorp Life Canada. Pursuant to thePurchase Agreement, the Company sold all of the outstanding shares of UAFC(Canada) Inc., owner of the Company’s Canadian insurance subsidiary, PennCorpLife Canada, to a venture 70% owned by La Capitale and 30% owned by GMF, for anaggregate purchase price of 

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approximately $131 million(CAD$146 million) in cash, on the terms and conditions set forth in the PurchaseAgreement (the “Sale”). The purchase price is comprised of $121.9 million(CAD $137.0 million) in cash, plus an amount equal to the balance of netearnings generated by PennCorp Life Canada during the period from January 1,2006 through the closing date, December 1, 2006, approximately$8.4 million (CAD $9.9 million). Universal American has accounted forthe operations of PennCorp Life Canada as discontinued operations beginning inthe third quarter of 2006. All prior period amounts have been reclassified toconform to this presentation.

The sale resulted in an after-tax realized gain ofapproximately $48.4 million and generated after tax cash proceeds ofapproximately $95 million comprised of approximately $84 million of cashreceived at closing plus approximately $8.4 million in March 2007 for thenet earnings of PennCorp Life Canada for 2006 through the closing date plus anadditional $2.6 million due upon the release of escrow in December 2008,subject to any claims. U.S. income tax on the sale of PennCorp Life Canada ofapproximately $28.2 million was paid in March 2007.

During the second quarter of 2006, PennCorp LifeCanada paid dividends of C$4.9 million (approximately US$4.4 million) toUniversal American. During 2005, PennCorp Life Canada became subject to a 5%withholding tax on dividends paid to Universal American. The withholding taxpaid on the dividends from PennCorp Life Canada in 2006 was C$0.2 million(approximately US$0.2 million).

In order to mitigate the risk fluctuations in thevalue of the U.S. dollar as compared to the Canadian dollar between the date ofthe purchase agreement and the closing of the transaction, in connection withthe sale of PennCorp Life Canada, on September 5, 2006, Universal Americanentered into a financial hedging currency collar, which set the upper value ofthe exchange rate at CAD$0.9124 per U.S. $1.00 and the lower value of theexchange rate at CAD$0.8900 per U.S. $1.00. The spot exchange rate wasCAD$0.8993 per U.S. $1.00 at the time Universal American entered into thehedging transaction. At the closing, the spot exchange rate was CAD$0.8733 perU.S. $1.00 and the financial hedging currency collar was terminated. Theresulting gain on the financial hedging currency collar on the closing date wasapproximately $2.2 million, which was included with the gain on the sale.

Summarizedfinancial information for our discontinued operations is presented below.

| ** **                           | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                           | ** ** | **  2007   **          | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| Total revenue                        |       |                                            | $          | —                                        |       |   | $ | 20,292 |   |   | $ | — |   |   | $ | 40,354 |   |
| Total expenses                       |       |                                            | —     |                                          |       | 15,224 |   |   | — |   |   | 31,991 |   |
| Income before  provision for taxes   |       |                                            | —     |                                          |       | 5,068 |   |   | — |   |   | 8,363 |   |
| Provision for income taxes           |       |                                            | —     |                                          |       | 2,320 |   |   | — |   |   | 3,527 |   |
| Income from discontinued  operations |       |                                            | $          | —                                        |       |   | $ | 2,748 |   |   | $ | — |   |   | $ | 4,836 |   |

 

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Totalassets and liabilities of PennCorp Life Canada, located entirely in Canada, areas follows:

| ** **                         | ** ** | **June 30,  2007** | ** ** | **December 1,  2006** | ** ** |
|------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                         | ** ** | **(In thousands)** | ** ** |
| **Assets**                         |       |                    |       |                       |       |   |   |   |   |
| Cash and  investments              |       |                    | $          | —                     |       |   |   | $ | 266,607 |   |   |
| Deferred policy  acquisition costs |       |                    | —     |                       |       |   | 33,942 |   |   |
| Other assets                       |       |                    | —     |                       |       |   | 19,025 |   |   |
| Total assets                       |       |                    | $          | —                     |       |   |   | $ | 319,574 |   |   |
| **Liabilities**                    | ** ** |                    |       |                       |       |   |   |   |   |
| Policyholder  liabilities          |       |                    | $          | —                     |       |   |   | $ | 223,656 |   |   |
| Other liabilities                  |       |                    | —     |                       |       |   | 6,385 |   |   |
| Total liabilities                  |       |                    | $          | —                     |       |   |   | $ | 230,041 |   |   |

 

**17.   SALE OFSUBSIDIARY**

On January 19, 2007,the Company completed the sale of Peninsular Life Insurance Company, aninactive subsidiary, for approximately $7.9 million, resulting in a pre-taxgain of $2.0 million, which is included in net realized gains. At closing, $7.4million of cash was received. The remaining $0.5 million is due upon therelease of funds held in escrow in part, 30 days following the delivery of astatement of capital and surplus as of the closing date and the balance in January 2008,subject to any claims against the escrowed funds.

**18.   PENDINGACQUISITION**

On October 25, 2006, the Company announced thatits Board of Directors had received a proposal from members of management ledby Richard A. Barasch, Universal American’s Chairman and Chief ExecutiveOfficer, and private equity firms Capital Z Partners, Ltd. (“Capital Z”), LeeEquity Partners, LLC (“Lee Equity”), Perry Capital, LLC (“Perry Capital”) andWelsh, Carson, Anderson & Stowe X, L.P. (“Welsh, Carson”) to acquireall of Universal American’s publicly held common stock for $18.15 per share incash. Universal American’s Board of Directors has established a SpecialCommittee consisting of four independent directors to review and evaluate theproposal and any strategic alternatives to the proposal that may be availableto Universal American. On March 5, 2007, the Special Committee announcedthat it had rejected the management-led proposal, and on May 8, 2007,Universal American announced that the investor group had withdrawn its offerand that the Special Committee was disbanded by the Board of Directors.

On May 8, 2007, Universal American announced thatit had entered into a definitive agreement to acquire MemberHealth, Inc.,a privately-held pharmacy benefits manager and sponsor of CCRx, a nationalMedicare Part D plan with more than 1.1 million members (the “MemberHealthTransaction”). The purchase price will be approximately $630 million,consisting of 55% in cash and 45% in Universal American common stock valued at$20 per share, plus potential performance-based consideration of up to $150million. The transaction, which is expected to close late in the third quarterof 2007, is subject to customary closing conditions, including approval by theshareholders of Universal American and appropriate regulatory approvals.

To fund the cash required to close the MemberHealthTransaction and to provide Universal American with the capital it needs tosupport its organic growth, private equity funds operated by Lee EquityPartners LLC, Perry Capital LLC, Union Square Partners Management, LLC (thesuccessor to Capital Z Management, LLC) and Welsh, Carson, Anderson and Stowe(collectively, the “Equity Investors”), will acquire securities in UniversalAmerican valued at $20 per share. Pursuant to a Securities 

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Purchase Agreement (the “Stage1 Securities Purchase Agreement”) with the Equity Investors, Universal Americansold to the Equity Investors in a private placement an aggregate of 30,473shares of Series A Preferred Stock and 19,527 shares of Series BPreferred Stock. Pursuant to a second Securities Purchase Agreement (the “Stage2 Securities Purchase Agreement”) with the Equity Investors, Universal Americanwill issue and sell to the Equity Investors an aggregate of 125,000 shares of Series BPreferred Stock (a portion of which may be issued to and purchased by an EquityInvestor under the Stage 2 Purchase Agreement instead in the form of Series APreferred Stock at the request of such Investor).

The total amount to be invested by the EquityInvestors in accordance with the Stage 1 Securities Purchase Agreement andStage 2 Securities Purchase Agreement will be approximately $350 million, ofwhich $100 million was funded in the second quarter of 2007 with the balance tobe funded in conjunction with the closing of the MemberHealth Transaction.

The Series A Preferred Stock and Series BPreferred Stock have not been registered under the Securities Act of 1933, asamended, and they may not be subsequently offered or sold by investors in theUnited States absent registration or an applicable exemption from theregistration requirement. This report does not constitute an offer to sell orthe solicitation of an offer to buy any security and shall not constitute anoffer, solicitation or sale of any securities in any jurisdiction in which suchoffer, solicitation or sale would be unlawful prior to registration orqualification under the securities laws of such jurisdiction.

In connection with the MemberHealth Transaction, theCompany anticipates refinancing its Amended Credit Facility and Revolving CreditFacility with a new credit facility consisting of a $350 million term loan anda $150 million revolver. A portion of the proceeds from the refinancing will beused to repay in full the outstanding amounts on the Amended Credit Facilityand Revolving Credit Facility. The early extinguishment of this debt willtrigger the immediate amortization of the related capitalized loan originationfees, resulting in a pre-tax expense of approximately $1.1 million.

Although there is no assurance, we expect theMemberHealth transaction to close by the end of the third quarter. The proxyhas been mailed and we are scheduled to have our shareholders’ meeting on August 23,2007. The state insurance regulators and CMS are proceeding with their reviewof the transaction.

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**ITEM 2—**MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Introduction**

The following discussionand analysis presents a review of the Company as of June 30, 2007 and itsresults of operations for the three and six months ended June 30, 2007 and2006. The following analysis of our consolidated results of operations andfinancial condition should be read in conjunction with the consolidatedfinancial statements and related consolidated footnotes as well as the Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded in our Annual Report on Form 10-K for the year endedDecember 31, 2006.

**Overview**

Our principal business segments are based on ourproducts and include:  Senior ManagedCare—Medicare Advantage, Senior Market Health Insurance, Specialty HealthInsurance, Life Insurance and Annuity and Senior Administrative Services. Wealso report the activities of our holding company in a separate segment.Reclassifications have been made to conform prior year amounts to the currentyear presentation. See “Note 15—Business Segment Information” in ourconsolidated financial statements included in this Quarterly Report onForm 10-Q for a description of our segments.

Inter-segment revenues andexpenses are reported on a gross basis in each of the operating segments buteliminated in the consolidated results. These inter-segment revenues andexpenses affect the amounts reported on the individual financial statement lineitems, but are eliminated in consolidation and do not change income beforetaxes. The significant items eliminated include inter-segment revenue andexpense relating to services performed by the Senior Administrative Servicessegment for our other segments and interest on notes payable or receivablebetween the Corporate segment and the other operating segments.

**Critical AccountingPolicies**

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 financial statementsand 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.Actual results could differ from those estimates. Accounts that, in ourjudgment, are most critical to the preparation of our financial statementsinclude future policy benefits and claim liabilities, deferred policyacquisition costs, goodwill, present value of future profits and otherintangible assets, the valuation of certain investments and deferred incometaxes. There have been no changes in our critical accounting policies duringthe current quarter.

***Policy related liabilities***

We calculate and maintain reserves for the estimatedfuture payment of claims to our policyholders using actuarial assumptions thatare consistent with the assumptions we use in the pricing of our products. Forour accident and health insurance business, we establish an active life reservefor expected future policy benefits, plus a liability for due and unpaid claimsand incurred but not reported claims. Our net income depends upon the extent towhich our actual claims experience is consistent with the assumptions we usedin setting our reserves and pricing our policies. If our assumptions withrespect to future claims are incorrect, and our reserves are insufficient tocover our actual losses and expenses, we would be required to increase ourliabilities resulting in reduced net income and shareholders’ equity.

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Asummary of the liabilities by category is presented in the following table:

| ** **                                            | ** ** | **June 30, 2007**    | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------------------------|------------|--------------------------------|------------|---------------------------------|------------|
| **Liability Type**                               | ** ** | ** **                     | ** ** | **Amount**                      | ** ** | **% of  Total  Policy  Liabilities** | ** ** | **Amount** | ** ** | **% of  Total  Policy  Liabilities** | ** ** |
| ** **                                            | ** ** | **($ in thousands)** | ** ** |
| Policyholder Account  Balances                        |       | $                              | 461,442    |                            |       | 29 | % |   | $ | 485,189 |   |   | 37 | % |   |
| Future Policy Benefit  Reserves:                      |       |                           |       |                            |       |   |   |   |   |   |   |   |   |
| Traditional life insurance                            |       | 196,951                        |       |                            | 12         | % |   | 189,243 |   |   | 14 | % |   |
| Accident and health                                   |       | 412,423                        |       |                            | 26         | % |   | 411,254 |   |   | 32 | % |   |
| Total Future  Policy Benefit Reserves                 |       | 609,374                        |       |                            | 39         | % |   | 600,497 |   |   | 46 | % |   |
| Policy and contract  claims—Accident and Health: |       |                           |       |                            |       |   |   |   |   |   |   |   |   |
| Due and Unpaid Claims                                 |       | 142,109                        |       |                            | 9          | % |   | 105,272 |   |   | 8 | % |   |
| Incurred but not reported claims (“IBNR”)   |       | 354,111                        |       |                            | 22         | % |   | 96,539 |   |   | 8 | % |   |
| Total Accident  and Health Claim Liabilities          |       | 496,220                        |       |                            | 31         | % |   | 201,811 |   |   | 16 | % |   |
| Policy and  contract claims—Life                 |       | 12,343                         |       |                            | 1          | % |   | 12,901 |   |   | 1 | % |   |
| Total Policy Liabilities                              |       | $                              | 1,579,379  |                            |       | 100 | % |   | $ | 1,300,398 |   |   | 100 | % |   |
|                                                       |            |                                |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Policyholder Account Balances***

Policyholder accountbalances represent the balance that accrues to the benefit of the policyholder,otherwise known as the account value, as of the financial statement date.Account values are increased for additional deposits received and interestcredited based on the account value. Account values are reduced by surrendersand other withdrawals, including withdrawals relating to the cost of insuranceand expense charges. The interest crediting rates are reviewed periodically andadjusted (with certain minimum levels below which the crediting rate cannotfall).

***Future Policy Benefit Reserves—Traditional LifeInsurance Policies***

The liability for futurepolicy benefits represents the present value of future benefits to be paid toor on behalf of policyholders, less the future value of net premiums and iscalculated based on actuarially recognized methods using morbidity andmortality tables, which are modified to reflect the Company’s actual experiencewhen appropriate.

***Future Policy Benefit Reserves—Accident and HealthPolicies***

The liability for future policy benefits representsthe present value of future benefits to be paid to or on behalf ofpolicyholders, less the future value of net premiums and is calculated based onactuarially recognized methods using morbidity and mortality tables, which are modifiedto reflect the Company’s actual experience when appropriate.

For our fixed benefit accident and sickness and ourlong term care products, we establish a reserve for future policy benefits atthe time each policy is issued based on the present value of future benefitpayments less the present value of future premiums. (It should be noted that weno longer issue new long term care policies, however our current policies arerenewably annually at the discretion of the policyholder, as evidenced by the policyholdercontinuing to make premium payments.)  Inestablishing these reserves, we must evaluate assumptions about mortality,morbidity, lapse rates and the rate at which new claims are submitted to us. Weestimate the future policy benefits reserve for these products using the 

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above assumptions andactuarial principles. For long-duration insurance contracts, these originalassumptions are used throughout the life of the policy and generally are notsubsequently modified.

A portion of our reservesfor long-term care products also reflect our estimates relating to memberscurrently receiving benefits. These reserves are estimated primarily usingrecovery and mortality rates, as described above.

***Policy and Contract Claims—Accident and HealthPolicies***

ThePolicy and Contract Claims liability for our Accident and Health Policiesincludes a liability for unpaid claims, including claims in the course ofsettlement, as well as a liability for incurred but not yet reported claims(“IBNR”). Our IBNR, by major product grouping is as follows:

| ** **                                                     | ** ** | **Direct and Assumed** | ** ** | ** **              | ** ** | **Net of Reserves Ceded to  Reinsurers** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|-------------------------|------------|--------------------------------------------------------------|------------|
| **Accident & Health Claims Liability** | ** ** | ** **                       | ** ** | **June 30,  2007** | ** ** | **% of  Total  Policy  Liabilities**                    | ** ** | **December 31,  2006** | ** ** | **% of  Total  Policy  Liabilities** | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
| ** **                                                     | ** ** | **($ In thousands)**        | ** ** |
| Due & Unpaid  Claims:                                 |       |                             |       |                    |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Medicare Part D                                           |       | $                                | 56,091     |                    |       | 4                                                            | %          |   |   | $ | 44,052 |   |   |   | 4 | % |   | $ | 28,269 |   |   | $ | 22,179 |   |   |
| Medicare Advantage—Health Plans                           |       | 64,064                           |       |                    | 4          | %                                                            |       |   | 44,830 |   |   |   | 3 | % |   | 57,315 |   |   | 42,865 |   |   |
| Other—Specialty                                           |       | 21,954                           |       |                    | 1          | %                                                            |       |   | 16,390 |   |   |   | 1 | % |   | 9,153 |   |   | 4,000 |   |   |
| Total  Due & Unpaid Claims                            |       | 142,109                          |       |                    | 9          | %                                                            |       |   | 105,272 |   |   |   | 8 | % |   | 94,737 |   |   | 69,044 |   |   |
| IBNR:                                                          |       |                             |       |                    |       |                                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Medicare Supplement                                            |       | 51,653                           |       |                    | 3          | %                                                            |       |   | 51,860 |   |   |   | 4 | % |   | 34,869 |   |   | 37,801 |   |   |
| Medicare Advantage—Private Fee-For-Service                |       | 295,353                          |       |                    | 19         | %                                                            |       |   | 32,985 |   |   |   | 3 | % |   | 295,353 |   |   | 32,985 |   |   |
| Other—Specialty                                           |       | 7,105                            |       |                    | —     | %                                                            |       |   | 11,694 |   |   |   | 1 | % |   | 6,180 |   |   | 11,695 |   |   |
| Total IBNR                                                     |       | 354,111                          |       |                    | 22         | %                                                            |       |   | 96,539 |   |   |   | 8 | % |   | 336,402 |   |   | 82,481 |   |   |
| Total Accident and  Health Claim Liabilities                   |       | $                                | 496,220    |                    |       | 31                                                           | %          |   |   | $ | 201,811 |   |   |   | 16 | % |   | $ | 431,139 |   |   | $ | 151,525 |   |   |
|                                                                |            |                                  |            |                         |            |                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Many factors can affect these reserves andliabilities, such as economic and social conditions, inflation, hospital andpharmaceutical costs, changes in doctrines of legal liability, premium rateincreases and extra contractual damage awards. Therefore, the reserves andliabilities we establish are based on extensive estimates, assumptions andprior years’ statistics. When we acquire other insurance companies or blocks ofinsurance, our assessment of the adequacy of acquired policy liabilities issubject to similar estimates and assumptions. Establishing reserves involvesinherent uncertainties, and it is possible that actual claims could materiallyexceed our reserves and have a material adverse effect on our results of operationsand financial condition.

We develop our estimate for IBNR using actuarialmethodologies and assumptions, primarily based upon historical claim paymentand claim receipt patterns, as well as historical medical cost trends.Depending on the period for which incurred claims are estimated, we apply adifferent method in determining our estimate. For periods prior to the mostrecent three months, the key assumption used in estimating our IBNR is that thecompletion factor pattern remains consistent over a rolling 12-monthperiod after adjusting for known changes in claim inventory levels and knownchanges in claim payment processes. Completion factors result from thecalculation of the percentage of claims incurred during a given period thathave historically been adjudicated as of the reporting period. For the mostrecent three months, the incurred claims are estimated primarily from a trendanalysis based upon per member per 

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month (“PMPM”) claimstrends developed from our historical experience in the preceding months,adjusted for known changes in estimates of recent hospital and drug utilizationdata, provider contracting changes, changes in benefit levels, product mix, andseasonality.

The completion factor method is used for the months ofincurred claims prior to the most recent three months because the historicalpercentage of claims processed for those months is at a level sufficient toproduce a consistently reliable result. Conversely, for the most recent threemonths of incurred claims, the volume of claims processed historically is notat a level sufficient to produce a reliable result, which therefore requires usto examine historical trend patterns as the primary method of evaluation. Dueto the significant growth in our Private fee-for-service business and thelimited historical claims experience in our expansion regions, we havedetermined our reserve based on our pricing for the product. The amounts abovereflect the estimated potential medical and other expenses payable based uponassumptions used in determining the loss ratio for the pricing of our Privatefee-for-service products.

Medical cost trends potentially are more volatile thanother segments of the economy. The drivers of medical cost trends includeincreases in the utilization of hospital facilities, physician services,prescription drugs, and new medical technologies, as well as the inflationaryeffect on the cost per unit of each of these expense components. Other externalfactors such as government-mandated benefits or other regulatory changes,increases in medical services, an aging population, catastrophes, and epidemicsalso may impact medical cost trends. Internal factors such as claims processingcycle times, changes in medical management practices and changes in provider contractsalso may impact our ability to accurately predict estimates of historicalcompletion factors or medical cost trends. All of these factors are consideredin estimating IBNR and in estimating the PMPM claims trend for purposes ofdetermining the reserve for the most recent three months. Additionally, wecontinually prepare and review follow-up studies to assess the reasonablenessof the estimates generated by our process and methods over time. The results ofthese studies are also considered in determining the reserve for the mostrecent three months. Each of these factors requires significant judgment bymanagement.

Our historical assumptionshave not varied significantly from the actual amounts experienced to the extentthat such variance resulted in a material adverse impact on reserves and netincome. A summary of the activity in our accident & health policy andcontract claim liability is included in Note 9—Accident & HealthPolicy and Contract Claim Liabilities in the Notes to the Consolidated FinancialStatements included in our Annual Report on Form 10-K for the yearended December 31, 2006.

***Sensitivity Analysis***

The following table illustrates the sensitivity of ouraccident and health IBNR payable at June 30, 2007 to certain reasonablypossible changes to the estimated weighted average completion factors andhealth care cost trend rates. However, it is possible that the actualcompletion factors and health care cost trend rates will develop differentlyfrom our historical patterns and therefore could be outside of the rangesillustrated below.

| **Completion Factor(a):**           | ** ** | **Claims Trend Factor(b):**                                        | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| **(Decrease)  Increase  in Factor** | ** ** | **Increase  (Decrease) in  Net Accident  & Health  IBNR** | ** ** | **(Decrease)  Increase  in Factor** | ** ** | **(Decrease)  Increase in  Net Accident  & Health  IBNR** | ** ** |   |
| ** **                               | ** ** | **($ in thousands)**                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| (3)%                                     |       |                                                                         | $          | 418 |   |   |   | (3 | )% |   |   | $ | (17,315 | ) |   |   |
| (2)%                                     |       |                                                                         | $          | 280 |   |   |   | (2 | )% |   |   | $ | (11,542 | ) |   |   |
| (1)%                                     |       |                                                                         | $          | 142 |   |   |   | (1 | )% |   |   | $ | (5,769 | ) |   |   |
| 1%                                       |       |                                                                         | $          | (134 | ) |   |   | 1 | % |   |   | $ | 5,786 |   |   |   |
| 2%                                       |       |                                                                         | $          | (271 | ) |   |   | 2 | % |   |   | $ | 11,568 |   |   |   |
| 3%                                       |       |                                                                         | $          | (408 | ) |   |   | 3 | % |   |   | $ | 17,350 |   |   |   |
|                                          |            |                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(a)           Reflects estimatedpotential changes in medical and other expenses payable caused by changes incompletion factors for incurred months prior to the most recent three months. 

(b)          Reflectsestimated potential changes in medical and other expenses payable caused bychanges in annualized claims trend used for the estimation of per member permonth incurred claims for the most recent three months for our MedicareSupplement business. Due to the significant growth in our Privatefee-for-service business and the limited historical claims experience in ourexpansion regions, we have determined our reserve based on our pricing for theproduct. The amounts above reflect the estimated potential changes in medicaland other expenses payable caused by changes in the loss ratio for our Privatefee-for-service business.

***Policy and Contract Claims—Life Policies***

The liability for unpaidclaims, including IBNR, include estimates of amounts to fully settle knownreported claims as well as claims related to insured events that the Companyestimates have been incurred, but have not yet been reported to the Company.

***Deferred policy acquisition costs***

The cost of acquiring new business, principallynon-level commissions, agency production, policy underwriting, policy issuance,and associated costs, all of which vary with, and are primarily related to theproduction of new and renewal business, are deferred. For interest-sensitivelife and annuity products, these costs are amortized in relation to the presentvalue of expected gross profits on the policies arising principally frominvestment, mortality and expense margins in accordance with FAS No. 97,“Accounting and Reporting by Insurance Enterprises for Certain Long-DurationContracts and for Realized Gains and Losses from the Sale of Investments”. Thedetermination of expected gross profits for interest-sensitive products is aninherently uncertain process that relies on assumptions including projectedinterest rates, the persistency of the policies issued as well as anticipatedbenefits, commissions and expenses. It is possible that the actual profits fromthe business may vary materially from the assumptions used in the determinationand amortization of deferred acquisition costs (“DAC”).

For other life and health products, these costs areamortized in proportion to premium revenue using the same assumptions used inestimating the liabilities for future policy benefits in accordance with FASNo. 60, “Accounting and Reporting by Insurance Enterprises.”

The Company utilizes a prospective unlocking approachto account for DAC for its Medicare supplement business. Assumptions for futurerate increases, persistency and benefit-design are used in the determination ofDAC. Actual experience may vary from assumed trends, however these assumptionsare not changed unless prospective unlocking is triggered. Prospectiveunlocking revises the assumptions to bring them in line with emergingexperience. Annually, during its third fiscal quarter, the Company performs ananalysis to determine whether unlocking is triggered as a result of significantchanges in the actual premium rate increase experience. At the point whenunlocking is triggered, the DAC model is modified prospectively withassumptions for all components, including rate increases, persistency, benefitdesign and expenses updated based on actual experience. If and when unlockingof assumptions is triggered, there is not immediate impact on the DAC balance.Rather, the unlocking impacts the pattern of the future amortization of the DACbalance. The reserves for future policy benefits for Medicare supplementbusiness also are impacted prospectively by unlocking and according, similarassumption revisions would occur.

At January 1, 2005, prospective unlocking wastriggered due to the actual trend in premium rates of 11.6% exceeding theassumed trend of 10%. The balance of DAC for Medicare supplement business as ofJanuary 1, 2005 was approximately $81 million. The prospective unlockinghad the effect of slowing the 

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future amortization ofDAC, as compared to the anticipated amortization had the prospective unlockingnot been triggered. Prospective unlocking also had the effect of slowing thefuture increase in benefit reserves, as compared to the anticipated increasehad the unlocking not been triggered.

During the third quarter of 2006, the annual test forunlocking was performed and we determined that there were no significantchanges in the actual premium rate increase experience. Accordingly, there wasno prospective unlocking of assumptions for DAC for the Company’s Medicaresupplement business during 2006. However, based on current premium rate trends,we believe that it is likely that unlocking will be triggered during 2007. Thebalance of DAC for Medicare supplement business as of June 30, 2007 wasapproximately $110.0 million. Should the unlocking be triggered in 2007, weanticipate the amortization subsequent to the unlocking will be slower in theinitial quarters subsequent to unlocking by between $0.2 million and $0.5million per quarter, and then it will increase.

Deferred policyacquisition costs are written off to the extent that it is determined thatpresent value of future policy premiums and investment income or the netpresent value of expected gross profits would not be adequate to recover theunamortized costs.

***Present value of future profits and other intangibles***

Business combinations accounted for as a purchaseresult in the allocation of the purchase consideration to the fair values ofthe assets and liabilities acquired, including the present value of futureprofits, establishing such fair values as the new accounting basis. The presentvalue of future profits is based on an estimate of the cash flows of the inforce business acquired, discounted to reflect the present value of those cashflows. The discount rate selected depends upon the general market conditions atthe time of the acquisition and the inherent risk in the transaction. Purchaseconsideration in excess of the fair value of net assets acquired, including thepresent value of future profits and other identified intangibles, for aspecific acquisition, is allocated to goodwill. Allocation of purchase price isperformed in the period in which the purchase is consummated. Adjustments, ifany, in subsequent periods relate to resolution of pre-acquisitioncontingencies and refinements made to estimates of fair value in connectionwith the preliminary allocation.

Otheramortizing assets include acquired life and accident & health policybases, managed care membership bases, provider contracts, customer contractsand hospital network contracts. Below is a table reflecting our amortizationpolicies for each of these items:

| **Description**                   | ** ** | ** ** | ** ** | **Weighted  Average Life  At Acquisition**                                                                                                    | ** ** | **Amortization Basis** |
|-----------------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|
| Insurance policies  acquired      |       | 7-9        |       | The pattern of projected  future cash flows for the policies acquired over the estimated weighted  average life of the policies acquired.          |
| Distribution Channel  acquired    |       | 30         |       | Straight line over the  estimated life of the asset.                                                                                               |
| Membership base acquired          |       | 7          |       | The pattern of projected  future cash flows for the membership base acquired over the estimated  weighted average life of the membership base      |
| Provider Contracts                |       | 10         |       | Straight line of the  estimated weighted average life of the contracts                                                                             |
| Administrative Service  Contracts |       | 6          |       | The pattern of projected  future cash flows for the customer contracts acquired, over the estimated  weighted average life of the contracts        |
| Hospital network contracts        |       | 10         |       | The pattern of projected future cash flows for the  hospital network contracts acquired over the estimated weighted average life  of the contracts |

 

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At least annually,management reviews the unamortized balances of present value of future profits,goodwill and other identified intangibles to determine whether events or circumstancesindicate the carrying value of such assets is not recoverable, in which case animpairment charge would be recognized. Management believes that no impairmentsof present value of future profits, goodwill or other identified intangiblesexisted as of June 30, 2007.

***Investment valuation***

Fair value of investments is based upon quoted marketprices, where available, or on values obtained from independent pricingservices. For certain mortgage-backed and asset-backed securities, thedetermination of fair value is based primarily upon the amount and timing ofexpected future cash flows of the security. Estimates of these cash flows arebased upon current economic conditions, past credit loss experience and othercircumstances.

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. The evaluation is based on the intent and ability to holdthe security to recovery, and is considered on an individual security basis,not on a portfolio basis. 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-backed andasset-backed securities are recognized when an adverse change in the amount ortiming of estimated cash flows occurs, unless the adverse change is solely aresult of changes in estimated market interest rates and we intend to hold thesecurity until recovery. The cost basis for securities determined to beimpaired are reduced to their fair value, with the excess of the cost basisover the fair value recognized as a realized investment loss.

***Income taxes***

We use the liability method to account for deferredincome taxes. Under the liability method, deferred tax assets and liabilitiesare recognized for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of existing assets andliabilities and their respective tax bases. Deferred tax assets and liabilitiesare measured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled. The effect on deferred tax assets and liabilities of a change in taxrates is recognized in income in the period that includes the enactment date ofa change in tax rates.

We establish valuation allowances on our deferred taxassets for amounts that we determine will not be recoverable based upon ouranalysis of projected taxable income and our ability to implement prudent andfeasible tax planning strategies. Increases in these valuation allowances arerecognized as deferred tax expense. Subsequent determinations that portions ofthe valuation allowances are no longer necessary are reflected as deferred taxbenefits. To the extent that valuation allowances were established inconjunction with acquisitions, changes in those allowances are first applied toincreasing or decreasing the goodwill (but not below zero) or other intangiblesrelated to the acquisition and then applied as an increase or decrease inincome tax expense.

During the six months ended June 30, 2007, weadded approximately $0.6 million of valuation allowances on tax capital losscarryforwards, resulting from a portion of the tax capital loss that wasgenerated from the sale of Peninsular during that period. As of June 30,2007 we have $0.8 million of valuation allowances on tax capital losscarryforwards remaining.

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**SignificantTransactions and Initiatives**

***Medicare Advantage***

We entered the Medicare Advantage business in 2004with the acquisition of Heritage Health Systems, Inc. which operatesMedicare Advantage coordinated care plans in Southeastern Texas and began offeringnew PFFS plans in 2 states. During 2006, we increased the marketing of PFFSplans to a total of 15 states.

For 2007, we have expanded into new markets for ourMedicare HMO and PFFS plans. We currently offer our Medicare Advantagecoordinated care plans in 3 new markets; Florida, north Texas and Wisconsin.Through our insurance subsidiaries American Progressive and Pyramid Life, wecurrently offer our PFFS products in 35 states in 2007. We incurredapproximately $25 million of additional costs in order to execute theseexpansion initiatives during the third and fourth quarters of 2006 and thefirst quarter of 2007. As of August 1, 2007 our enrollment in PFFS planshas increased to approximately 200,000 members.

On June 15, 2007, CMS announced the voluntaryparticipation by us and certain other sponsors of Medicare Advantage PFFS plansto temporarily suspend marketing activities of non-group, individual PFFS planseffective June 22, 2007 until CMS provides us with its approval that oursystems and management controls meet all of the conditions specified in CMS’s2008 Call Letter and May 25, 2007 guidance, which we call collectively,the “Conditions”. While in the process of enhancing our systems and managementcontrols to satisfy the Conditions, Congress passed legislation for theexpiration of the continuous enrollment period for PFFS on July 31, 2007,which effectively ends the 2007 PFFS selling season, except for individuals whoturn 65 thereafter, and could result in a material adverse effect to our projectionsbased upon a longer selling season. That notwithstanding, we requested CMS’sreview and approval of our enhanced systems and management controls that wesatisfy the Conditions and will be ready to market non-group, individual PFFSfor the 2008 selling season. Subsequent to that review, CMS has notified us thatwe may resume the marketing of individual PFFS plans.

In addition, CMS announced that the 2008 PFFS sellingseason will run from November 15, 2007 through March 31, 2008, whichis shorter than the 2007 selling season, which was extended by CMS beyond March 31,2007. The shorter than anticipated 2008 selling season could have a materialadverse effect on our business and results of operations.

On March 1, 2007, theCompany acquired Harmony Health, Inc. (“Harmony”), a provider-ownedcompany that operates GlobalHealth, Inc. (“GlobalHealth”), a MedicareAdvantage HMO plan and commercial managed care plan in Oklahoma City, OK for$18.2 million in cash. Harmony was a majority-owned subsidiary of the OklahomaCity Clinic. Founded in 2002, GlobalHealth currently has approximately 4,000Medicare Advantage members with annualized revenue of approximately $38million. Under the terms of the agreement, the Oklahoma City Clinic has enteredinto a long-term agreement with Universal American to provide healthcare servicesto GlobalHealth members. In addition, the Oklahoma City Clinic has retained therisk for commercial business under a global capitation arrangement.

***Medicare Part D***

Effective January 1, 2006, private insurers werepermitted to sponsor insured stand-alone PDPs pursuant to Part D, whichwas established by the MMA. A portion of the premium for this insurance is paidby the Federal government, and the balance, if any, is paid by the individualswho enroll. The Federal government will also provide additional subsidies inthe form of premium support and coverage of the cost-sharing elements of theplan to certain low income Medicare beneficiaries. For the 2007 plan year, wehave been approved to offer, through our insurance subsidiaries, ourPrescription Pathway SM prescription drug plans in all 32 regions designated by CMS in which webid, which excludes only Hawaii and Alaska. In addition, we are entitled toreceive auto assignment of dual eligibles and low income 

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subsidy (“LIS”)beneficiaries who are dually eligible for Medicare and Medicaid in 28 of the 32CMS regions. These regions include all of the 26 regions for which we wereeligible to receive auto assignees in 2006, plus two new regions. We believethat this new program provides increased opportunities to offer a much neededcoverage and to further serve our target markets.

Through our strategicalliance with PharmaCare, we retain 50% of the Medicare Part D business ofour PDPs. The remainder is reinsured to PharmaCare Re on a 50% quota sharebasis. Additionally, as part of the strategic alliance, we created PDMS, whichis 50% owned by us and 50% owned by PharmaCare. PDMS principally performsmarketing and risk management services on behalf of our PDPs and PharmaCare Re.

***Medicare Supplement***

Medicare supplement insurance reimburses thepolicyholder for certain expenses that are not covered by standard Medicarecoverage such as deductibles and co-pays. This coverage is designed for peoplewho want the freedom to choose providers who participate in the standardMedicare program and limit their out of pocket costs to the fixed annualpremiums they pay, as opposed to the more restrictive networks that exist inMedicare Advantage healthplan markets And the co-payments and deductibles thatexist in PFFS plans. We believe that the market for Medicare supplementproducts will continue to be attractive, especially because many seniors maylose similar coverage that had previously been offered to them as a retireebenefit by their former employers.

In the last 15 months,there has been increased competition from other Medicare supplement carriers,as well as from Medicare Advantage plans, which has affected our production andpersistency of Medicare supplement business. As a result, we continue toexperience higher than expected lapsation in our Medicare supplement business.This excess lapsation has accelerated the amortization of the deferredacquisition cost and present value of future profits assets associated with thebusiness that lapsed. We cannot give assurances that lapsation of our Medicaresupplement business will decline, requiring faster amortization of the deferredcosts.

**Results ofOperations**

The inclusion of theoperating results from our Medicare Part D business with those of ourMedicare Supplement business has resulted in an increase in the level ofseasonality in our reported results during a given calendar year. Thesebusinesses generally see higher claim experience in the early quarters of theyear, with lower claims experience in the later quarters of the year, resultingin a pattern of increasing reported net income over the calendar yearattributable to those businesses. The following table reflects income from eachof our segments(1) and contains a reconciliation to reported net income:

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**Operations—Consolidated Overview**

| ** **                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six Months ended  June 30,** | ** ** |
|-------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                      | ** ** | **2007**                                        | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                      | ** ** | **(In thousands)**                         | ** ** |
| Senior Managed  Care—Medicare Advantage(1) |       | $                                               | 20,348     |                                          | 10,371     |   | $ | 26,340 |   | $ | 19,603 |   |
| Senior Market  Health Insurance(1)              |       | 11,011                                          |       | 8,316                                         |       | 4,123 |   | 7,456 |   |
| Specialty Health  Insurance(1)(2)               |       | 1,484                                           |       | 2,949                                         |       | 4,897 |   | 4,351 |   |
| Life Insurance  and Annuity(1)                  |       | 5,213                                           |       | 3,758                                         |       | 8,510 |   | 4,800 |   |
| Senior  Administrative Services(1)              |       | 5,490                                           |       | 4,775                                         |       | 11,327 |   | 7,202 |   |
| Corporate(1)                                    |       | (7,642                                          | )          | (6,388                                        | )          | (15,397 | ) | (11,869 | ) |
| Net realized  (losses) gains on investments     |       | (264                                            | )          | 48                                            |       | 1,640 |   | 47 |   |
| Income before  income taxes(1)                  |       | 35,640                                          |       | 23,829                                        |       | 41,441 |   | 31,590 |   |
| Provision for income taxes                      |       | 13,365                                          |       | 8,467                                         |       | 14,805 |   | 11,296 |   |
| **Income  from continuing operations**          | ** ** | **22,275**                                      | ** ** | **15,362**                                    | ** ** | **26,635** | ** ** | **20,294** | ** ** |
| Income from  discontinued operations(2)         |       | —                                          |       | 2,748                                         |       | — |   | 4,836 |   |
| **Net  income**                                 | ** ** | **$**                                           | **22,275** | ** **                                    | **$**      | **18,110** | ** ** | **$** | **26,635** | ** ** | **$** | **25,130** | ** ** |
| **Earnings per common share  (diluted):**       |       |                                            |       |                                          |       |   |   |   |   |
| Income from continuing operations               |       | $                                               | 0.35       |                                          | $          | 0.26 |   | $ | 0.43 |   | $ | 0.34 |   |
| Income from discontinued operations             |       | —                                          |       | 0.04                                          |       | — |   | 0.08 |   |
| **Net  income**                                 | ** ** | **$**                                           | **0.35**   | ** **                                    | **$**      | **0.30** | ** ** | **$** | **0.43** | ** ** | **$** | **0.42** | ** ** |

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(1)          We evaluate the resultsof operations of our segments based on income before realized gains and incometaxes. Management believes that realized gains and losses are not indicative ofoverall operating trends. This differs from generally accepted accountingprinciples, which includes the effect of realized gains in the determination ofnet income. The schedule above reconciles our segment income to net income inaccordance with generally accepted accounting principles.

(2)          Priorperiods adjusted to reflect the operations of our Canadian subsidiary asdiscontinued operations.

***Three months ended June 30, 2007 and 2006***

Net income for the quarter ended June 30, 2007increased to $22.3 million, or $0.35 per diluted share, compared to $18.1million, or $0.30 per diluted share for the second quarter of 2006. Income fromcontinuing operations, after taxes, was $22.3 million, or $0.35 per dilutedshare for the second quarter of 2007 compared to income from continuingoperations, after taxes, of $15.4 million, or $0.26 per diluted share for thesecond quarter of 2006. Income from continuing operations for 2007 includesrealized investment losses, net of tax, of $0.2 million. Our effective taxrate for continuing operations was 37.5% for the second quarter of 2007, and35.5% for the second quarter of 2006.

The second quarter of 2006 included income fromdiscontinued operations, after taxes of $2.7 million or $0.04 per diluted share.

Our Senior Managed Care—Medicare Advantage segmentgenerated segment income of $20.3 million in the second quarter of 2007,an increase of $10.0 million, compared to $10.4 million for the second quarterof 2006, primarily due to growth in business.

Segment income for the second quarter of 2007 for ourSenior Market Health Insurance segment increased by $2.7 million to $11.0million, compared to the second quarter of 2006. Segment income for ourMedicare Supplement business improved by $1.4 million compared to the secondquarter of 2006 primarily as a result of lower levels of lapsation of ourMedicare Supplement in force business, which 

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resulted in loweramortization of deferred acquisition costs as compared to the second quarter of2006. Segment income for our Part D business increased by $1.3 millioncompared to the second quarter of 2006.

Our Specialty Health Insurance segment incomedecreased by $1.5 million, or 50%, compared to the second quarter of 2006,primarily as the result of an adjustment to commissions during the secondquarter of 2007.

Segment income from our Life Insurance and Annuitysegment increased by $1.5 million, compared to the second quarter of 2006,primarily as a result of an increase in investment income and more favorablemortality.

Segment income for our Senior Administrative Servicessegment increased by $0.7 million, or 15%, to $5.5 million for the secondquarter of 2007, as compared to the same period of 2006. This increase isprimarily the result of the growth in business administered.

The loss from ourCorporate segment increased by $1.3 million, or 20%, for the three months endedJune 30, 2007 compared to the three months ended June 30, 2006. Theincrease was due primarily to the increase in interest costs, offset by anincrease in net investment income.

***Six Months Ended June 30, 2007 and 2006***

Net income for the six months ended June 30, 2007increased to $26.6 million, or $0.43 per diluted share, compared to $25.2million, or $0.42 per diluted share for the first six months of 2006. Incomefrom continuing operations, after taxes, was $26.6 million, or $0.43 perdiluted share for the first six months of 2007 compared to income fromcontinuing operations, after taxes, of $20.3 million, or $0.34 per dilutedshare for the first six months of 2006. Income from continuing operations for2007 includes realized investment gains, net of tax, of $1.1 millionrelating primarily to the gain on the sale of Peninsular. Our effective taxrate for continuing operations was 35.7% for the first six months of 2007, and35.8% for the first six months 2006. The effective tax rate for the first sixmonths of 2007 includes a one-time benefit relating to state taxes of $0.7million.

The first six months of 2006 included income fromdiscontinued operations, after taxes of $4.8 million or $0.08 per diluted share.

Our Senior Managed Care—Medicare Advantage segmentgenerated segment income of $26.3 million during the first six months of2007, an increase of $6.7 million, compared to $19.6 million for the first sixmonths of 2006, primarily due to growth in business.

Segment income for the first six months of 2007 forour Senior Market Health Insurance segment decreased by $3.3 million to $4.1million, compared to the first six months of 2006. Results for our MedicareSupplement business declined by $4.2 million compared to the first six monthsof 2006 primarily as a result of the continued effect of higher levels oflapsation of our Medicare Supplement in force business, which resulted inaccelerated amortization of deferred acquisition costs. A significant portionof the lapsation was attributable to the more than 16,000 Medicare Supplementpolicyholders who switched to our PFFS coverage (primarily during the firstquarter) which generated $10.6 million of amortization of deferredacquisition costs. Income for our Part D business increased by $0.9 millioncompared to the first six months of 2006.

Our Specialty Health Insurance segment incomeincreased by $0.5 million, or 13%, compared to the first six months of 2006,primarily as the result of higher net investment income, partially offset by anincrease in the loss ratios for the segment.

Segment income from our Life Insurance and Annuitysegment increased by $3.7 million, compared to the first six months of 2006,primarily as a result of an increase in investment income and more favorablemortality.

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Segment income for our Senior Administrative Servicessegment increased by $4.1 million, or 57%, to $11.3 million for the first sixmonths of 2007, as compared to the same period of 2006. This increase isprimarily the result of the growth in business administered.

The loss from ourCorporate segment increased by $3.5 million, or 30%, for the six months ended June 30,2007 compared to the six months ended June 30, 2006. The increase was dueprimarily to increases in interest costs, other parent company expenses, andstock-based compensation.

**Segment Results—Senior Managed Care—Medicare Advantage**

| ** **                                  | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                        | ** ** |
| Net premiums                                |       | $                                              | 487,849    |                                          | $          | 110,036 |   | $ | 866,947 |   | $ | 199,995 |   |
| Net investment  and other income            |       | 6,326                                          |       | 1,261                                         |       | 9,244 |   | 2,337 |   |
| Total revenue                               |       | 494,175                                        |       | 111,297                                       |       | 876,191 |   | 202,332 |   |
| Medical expenses                            |       | 407,974                                        |       | 80,680                                        |       | 725,001 |   | 146,880 |   |
| Amortization of  intangible assets          |       | 889                                            |       | 870                                           |       | 1,859 |   | 1,740 |   |
| Commissions and  general expenses           |       | 64,964                                         |       | 19,376                                        |       | 122,991 |   | 34,109 |   |
| Total benefits, claims and other deductions |       | 473,827                                        |       | 100,926                                       |       | 849,851 |   | 182,729 |   |
| Segment income                              |       | $                                              | 20,348     |                                          | $          | 10,371 |   | $ | 26,340 |   | $ | 19,603 |   |

 

Our Senior Managed Care—MedicareAdvantage segment includes the operations of our initiatives in managed carefor seniors. We operate various health plans that offer coverage to Medicarebeneficiaries, under contracts with CMS, in Southeastern Texas, Oklahoma,Florida, Wisconsin and North Texas. The health plans are sold by our career andindependent agents and directly by employee representatives. Our MedicareAdvantage PFFS plans, also under a contract with CMS, are sold by our careerand independent agents through American Progressive and Pyramid Life inapproximately 2,500 counties across 35 states.

***Three months ended June 30, 2007 and 2006***

Our Senior Managed Care—MedicareAdvantage segment generated segment income of $20.3 million in the secondquarter of 2007, an increase of $10.0 million, compared to $10.4 million forthe second quarter of 2006, primarily due to growth in business due to ourexpansion of PFFS plan offerings from 500 counties in 15 states to 2,500counties in 35 states.

***Six months ended June 30, 2007 and 2006***

Our Senior Managed Care—Medicare Advantage segmentgenerated segment income of $26.3 million during the first six months of2007, an increase of $6.7 million, compared to $19.6 million for thefirst six months of 2006, primarily due to growth in business due to ourexpansion of PFFS plan offerings from 500 counties in 15 states to 2,500counties in 35 states.

45

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**Healthplans**

| ** **                                  | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                        | ** ** |
| Net premiums                                |       | $                                              | 130,841    |                                          | $          | 82,128 |   | $ | 245,473 |   | $ | 155,801 |   |
| Net investment  and other income            |       | 1,905                                          |       | 1,055                                         |       | 3,577 |   | 2,060 |   |
| Total revenue                               |       | 132,746                                        |       | 83,183                                        |       | 249,050 |   | 157,861 |   |
| Medical expenses                            |       | 103,085                                        |       | 60,125                                        |       | 189,169 |   | 114,691 |   |
| Amortization of  intangible assets          |       | 889                                            |       | 870                                           |       | 1,859 |   | 1,740 |   |
| Commissions and  general expenses           |       | 19,580                                         |       | 15,234                                        |       | 42,105 |   | 27,838 |   |
| Total benefits, claims and other deductions |       | 123,554                                        |       | 76,229                                        |       | 233,133 |   | 144,269 |   |
| Segment income                              |       | $                                              | 9,192      |                                          | $          | 6,954 |   | $ | 15,917 |   | $ | 13,592 |   |

 

***Three months ended June 30, 2007 and 2006***

*Revenues.**  *Net premiums for the Healthplansincreased by $48.7 million, or 59%, compared to the second quarter of2006. Approximately $41.4 million of the increase was due to growth inmembership to approximately 47,600 members from 32,900 in the second quarter of2006. In connection with the acquisition of Harmony Health in March 2007,we acquired approximately 10,600 commercial members, which representsapproximately $8.4 million of the increase in revenues and had a lossratio of 86.8% for the second quarter of 2007. This commercial business iscapitated through an arrangement with the seller, the Oklahoma City Clinic. Theseincreases were partially offset by $1.0 million decrease in revenues dueto a decrease in the average premium PMPM as a result of a change in the mix ofbusiness with the opening of our new healthplans, which have a lower premiumPMPM. Net investment income increased by $0.9 million, due primarily togrowth in invested assets as a result of growth in business.

*Benefits, Claims andExpenses.**  *Medicalexpenses increased by $43.0 million, or 71%, compared to the secondquarter of 2006. Growth in membership added approximately $29.6 millionand the Harmony Health commercial business added $7.3 million. The balanceof $6.1 million was due to an increase in the loss ratio due to a changein the mix of business as described previously and a modest increase inutilization of member benefits. Overall loss ratios for the healthplansincreased to 78.8% for the second quarter of 2007, from 73.2% for the secondquarter of 2006. The second quarter of 2007 included commerial business fromthe acquisition of Harmony Health. Excluding the commercial business, the lossratio for the healthplans was 78.2%. Commissions and general expenses increasedby $4.3 million compared to the second quarter of 2006, due primarily tothe growth in business, as well as an increase in commissions, as more of theMedicare Advantage product is being sold by our agents.

***Six months ended June 30, 2007 and 2006***

*Revenues.**  *Net premiums for the Healthplansincreased by $89.7 million, or 58%, compared to the first six months of 2006.Approximately $79.6 million of the increase was due to growth inmembership to approximately 47,600 members from 32,900 in the second quarter of2006. The Harmony Health commercial business represented approximately$11.1 million of the increase in revenues and has a loss ratio of 87.4%for the six months ended June 30, 2007. These increases were partiallyoffset by $1.1 million decrease in revenues due to a decrease in theaverage premium PMPM as a result of a change in the mix of business with theopening of our new healthplans, which have a lower premium PMPM. Net investmentincome increased by $1.5 million, due primarily to growth in investedassets as a result of growth in business.

*Benefits, Claims andExpenses.**  *Medicalexpenses increased by $74.5 million, or 65%, compared to the first sixmonths of 2006. Growth in membership added approximately $57.8 million andthe Harmony 

46

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Health commercialbusiness added $9.7 million. The balance of $7.0 million was due toan increase in the loss ratio due to a change in the mix of business asdescribed previously. Overall loss ratios for the healthplans increased to77.1% for the first six months of 2007, from 73.6% for the first six months of2006, as a result of a change in the mix of business as described previouslyand a modest increase in utilization of member benefits. The first six monthsof 2007 included commerial business from the acquisition of Harmony Health. Excludingthe commercial business, the loss ratio for the healthplans was 76.6%. Commissionsand general expenses increased by $14.3 million compared to the first sixmonths of 2006, due primarily to the growth in business, as well as an increasein commissions, as more of the Medicare Advantage product is being sold by ouragents.

**Private Fee-for-Service**

| ** **                                  | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                  | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                  | ** ** | **(In thousands)**                        | ** ** |
| Net premiums                                |       | $                                              | 357,008    |                                          | $          | 27,908 |   | $ | 621,474 |   | $ | 44,194 |   |
| Net investment  and other income            |       | 4,421                                          |       | 206                                           |       | 5,667 |   | 277 |   |
| Total revenue                               |       | 361,429                                        |       | 28,114                                        |       | 627,141 |   | 44,471 |   |
| Medical expenses                            |       | 304,889                                        |       | 20,555                                        |       | 535,832 |   | 32,189 |   |
| Commissions and  general expenses           |       | 45,384                                         |       | 4,142                                         |       | 80,886 |   | 6,271 |   |
| Total benefits, claims and other deductions |       | 350,273                                        |       | 24,697                                        |       | 616,718 |   | 38,460 |   |
| Segment (loss) income                       |       | $                                              | 11,156     |                                          | $          | 3,417 |   | $ | 10,423 |   | $ | 6,011 |   |

 

*Membership.**  *A discussion of the accounting for Medicare AdvantagePolicies, including PFFS, is included in Note 2 of the notes to theconsolidated financial statements in this Quarterly Report on Form 10-Q.There are timing differences between the addition of members to ouradministrative system and the approval, or accretion, of the member by CMSbefore we are paid for that member by CMS. We analyze the membership in ouradministrative system and the enrollment provided by CMS. Due to thesignificant growth of the business and the limited historical experience, werecognize these timing delays and that CMS may not approve the enrollee. Theresults for our PFFS business are based on a membership level as of June 30,2007 of approximately 179,000, which is approximately 10,000 members belowmembership level included in our administrative system, representingapproximately 47,000 member months. In the succeeding quarters, we analyze themember information used in our consolidated financial statements and adjust ourmembership based on members subsequently approved by CMS. Although we are unableto precisely quantify the impact of any potential member change from that usedin our consolidated financial results, we do not believe that any change fromthe amounts reported as June 30, 2007 is likely to be material.

***Three months ended June 30, 2007 and 2006***

*Revenues.**  *Net premiums for the PrivateFee-for-service business increased by $329.1 million, or 1,179%, comparedto the second quarter of 2006. Approximately $299.4 million of theincrease was due to growth in membership to approximately 179,000 members from15,000 in the second quarter of 2006. The balance of the increase of$29.7 million was due to an increase in the average premium PMPM. Netinvestment income increased by $4.2 million, due primarily to growth ininvested assets as a result of growth in business.

*Benefits, Claims andExpenses.**  *Medicalexpenses increased by $284.3 million, or 1,383%, compared to the secondquarter of 2006. Growth in membership added approximately $242.4 million.The balance of $41.9 million was due to an increase in the loss ratio.Overall loss ratios increased to 85.4% for the second quarter of 2007, which includes approximately 1% benefit of positive prior perioddevelopment, from 

47

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73.7% for thesecond quarter of 2006 primarily due to more competitively priced products. Commissionsand general expenses increased by $41.2 million compared to the secondquarter of 2006, due primarily to the growth in business.

***Six months ended June 30, 2007 and 2006***

*Revenues.**  *Net premiums for the PrivateFee-for-service business increased by $577.3 million, or 1,306%, comparedto the first six months of 2006. Approximately $532.3 million of theincrease was due to growth in membership. The balance of the increase of$45.0 million was due to an increase in the average premium PMPM. Netinvestment income increased by $5.4 million, due primarily to growth ininvested assets as a result of growth in business.

*Benefits, Claims andExpenses.**  *Medicalexpenses increased by $503.6 million, or 1,565%, compared to the first sixmonths of  2006. Growth in membershipadded approximately $420.5 million. The balance of $83.2 million wasdue to an increase in the loss ratio. Overall loss ratios increased to 86.2%for the first six months of 2007 from 72.8% for the first six months of 2006primarily due to more competitively priced products. Commissions and generalexpenses increased by $74.6 million compared to the first six months of2006, due primarily to the growth in business.

**Segment Results—Senior Market Health Insurance**

| ** **                                           | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                        | ** ** |
| **Premiums:**                                        | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Direct and assumed                                   |       | $                                              | 247,835    |                                          | $          | 257,787 |   | $ | 544,424 |   | $ | 531,821 |   |
| Ceded                                                |       | (98,834                                        | )          | (100,109                                      | )          | (220,149 | ) | (207,642 | ) |
| Net premiums                                         |       | 149,001                                        |       | 157,678                                       |       | 324,275 |   | 324,179 |   |
| Other Part D  income (PDMS)                     |       | 13,120                                         |       | 12,867                                        |       | 26,323 |   | 22,674 |   |
| Net investment  income                               |       | 2,772                                          |       | 2,631                                         |       | 5,555 |   | 4,601 |   |
| Other income                                         |       | 462                                            |       | 799                                           |       | 421 |   | 1,311 |   |
| Total revenue                                        |       | 165,355                                        |       | 173,975                                       |       | 356,574 |   | 352,765 |   |
| Policyholder  benefits                               |       | 122,614                                        |       | 129,155                                       |       | 279,516 |   | 274,733 |   |
| Change in  deferred acquisition costs                |       | 918                                            |       | (1,713                                        | )          | 9,708 |   | (4,501 | ) |
| Amortization of  intangible assets                   |       | 784                                            |       | 994                                           |       | 1,776 |   | 2,289 |   |
| Commissions and  general expenses, net of allowances |       | 30,028                                         |       | 37,223                                        |       | 61,451 |   | 72,788 |   |
| Total benefits, claims and other deductions          |       | 154,344                                        |       | 165,659                                       |       | 352,451 |   | 345,309 |   |
| Segment income                                       |       | $                                              | 11,011     |                                          | $          | 8,316 |   | $ | 4,123 |   | $ | 7,456 |   |

 

Our Senior Market HealthInsurance segment historically has included our Medicare supplement businessand other health insurance products designed for the senior market. On January 1,2006, we began providing prescription drug benefits in accordance with MedicarePart D as a stand-alone benefit to Medicare eligible beneficiaries underPDPs. We reinsure 50% of the business of our PDPs to PharmaCare Re. The totalresults for the segment are presented above. Results for our Medicaresupplement and Part D businesses are separately presented below on acomparative basis.

***Three months ended June 30, 2007 and 2006***

Segment income for thesecond quarter of 2007 increased by $2.7 million to $11.0 million,compared to the second quarter of 2006. Income for our Medicare supplementbusiness increased by $1.4 million compared to the second quarter of 2006primarily as a result of lower levels of lapsation of our Medicare 

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supplementin force business, which resulted in lower amortization of deferred acquisitioncosts as compared to the second quarter of 2006. Income for our Part Dbusiness increased by $1.3 million compared to the second quarter of 2006.

***Six months ended June 30, 2007 and 2006***

Segment income for thefirst six months of 2007 decreased by $3.3 million to $4.1 million,compared to the first six months of 2006. Results for our Medicare supplement businessdeclined by $4.2 million compared to the first six months of 2006primarily as a result of the effect of higher levels of lapsation of ourMedicare supplement in force business in the first half of 2007 compared to thefirst half of 2006, which resulted in accelerated amortization of deferredacquisition costs. A significant portion of the lapsation was attributable tothe more than 16,000 Medicare supplement policyholders who switched to our PFFScoverage (primarily during the first quarter) which generated$10.6 million of amortization of deferred acquisition costs. Income forour Part D business increased by $0.9 million compared to the firstsix months of 2006.

**Medicare Supplement**

| ** **                                           | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                        | ** ** |
| Premiums:                                            |       |                                           |       |                                          |       |   |   |   |   |
| Direct and assumed                                   |       | $                                              | 106,027    |                                          | $          | 127,782 |   | $ | 222,298 |   | $ | 267,001 |   |
| Ceded                                                |       | (29,174                                        | )          | (36,221                                       | )          | (61,618 | ) | (77,067 | ) |
| Net premiums                                         |       | 76,853                                         |       | 91,561                                        |       | 160,680 |   | 189,934 |   |
| Net investment  income                               |       | 1,687                                          |       | 1,995                                         |       | 3,234 |   | 3,483 |   |
| Other income                                         |       | 457                                            |       | 781                                           |       | 400 |   | 1,276 |   |
| Total revenue                                        |       | 78,997                                         |       | 94,337                                        |       | 164,314 |   | 194,693 |   |
| Policyholder  benefits                               |       | 54,832                                         |       | 65,722                                        |       | 120,345 |   | 144,434 |   |
| Change in  deferred acquisition costs                |       | 918                                            |       | (1,713                                        | )          | 9,708 |   | (4,501 | ) |
| Amortization of  intangible assets                   |       | 784                                            |       | 994                                           |       | 1,776 |   | 2,289 |   |
| Commissions and  general expenses, net of allowances |       | 20,650                                         |       | 28,878                                        |       | 42,549 |   | 58,316 |   |
| Total benefits, claims and other deductions          |       | 77,184                                         |       | 93,881                                        |       | 174,378 |   | 200,538 |   |
| Segment (loss)                                       |       | $                                              | 1,813      |                                          | $          | 456 |   | $ | (10,064 | ) | $ | (5,845 | ) |

 

***Three months ended June 30, 2007 and 2006***

*Revenues.**  *Net premiums for our Medicare supplement businessdeclined by $14.7 million, or 16%, compared to the second quarter of 2006,due to the continued effect of higher lapsation of our Medicare supplement inforce business, offset, in part by the effect of rate increases on theremaining in force business. We had $436.0 million of annualized premiumin force at the end of the second quarter of 2007 compared to $524.9 millionat the end of the second quarter of 2006.

*Benefits,Claims and Expenses.**  *Policyholderbenefits incurred declined by $10.9 million, or 17%, compared to thesecond quarter of 2006. The reduction in business, as noted above, resulted ina reduction in benefits of $10.6 million. The decrease in the loss ratio furtherreduced benefits by $0.3 million to benefits compared to the secondquarter of 2006. Overall loss ratios for our Medicare supplement businessdecreased 50 basis points to 71.3% for the second quarter of 2007 comparedto 71.8% for the second quarter of 2006.

There was net amortization of deferred acquisitioncosts in the second quarter of 2007 compared to an increase in deferredacquisition costs in the second quarter of 2006, an increase to expense of$2.6 million. 

49

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Two factors contributed tothe decrease. First, amortization increased by approximately $2.4 million,primarily as a result of higher levels of lapsation of our Medicare supplementbusiness, compared to the second quarter of 2006. Second, we incurred lowercommissions and other acquisition costs as a result of lower production,resulting in a decrease in the costs capitalized of $5.0 million.

Commissionsand general expenses, net of reinsurance allowances, decreased by $8.2 million,or 28%, compared to the second quarter of 2006. The following table details thecomponents of commission and other operating expenses:

| ** **                                           | ** ** | **Three months ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                         | ** ** |
| Commissions                                          |       | $                                               | 12,732     |   | $ | 17,312 |   |
| Other operating  costs                               |       | 12,570                                          |       | 18,308 |   |
| Reinsurance  allowances                              |       | (4,652                                          | )          | (6,742 | ) |
| Commissions and general  expenses, net of allowances |       | $                                               | 20,650     |   | $ | 28,878 |   |

 

The ratio of commissionsto gross premiums decreased to 12.0% for the second quarter of 2007, from 13.5%for the second quarter of 2006, as a result of lower overall commission ratesassociated with the continued growth of our in force renewal premium and lessnew business production that has higher commission rates. Other operating costsas a percentage of gross premiums were 11.9% for the second quarter of 2007,compared to 14.3% for the second quarter of 2006, primarily as a result oflower acquisition expenses due to lower new business production and lower fixedcosts. Commission and expense allowances received from reinsurers as apercentage of the premiums ceded decreased to 15.9% for the second quarter of2007 from 18.6% for the second quarter of 2006, primarily due to the reductionin new business ceded and the effects of normal lower commission allowances onour aging base of ceded renewal business.

***Six months ended June 30,2007 and 2006***

*Revenues.**  *Net premiums for our Medicare supplement businessdeclined by $29.3 million, compared to the first six months of 2006, dueto the continued effect of higher lapsation of our Medicare supplement in forcebusiness, offset, in part by the effect of rate increases on the remaining inforce business. Approximately 16,000 Medicare supplement policyholders switchedto our PFFS coverage during the first six months of 2007, primarily during thefirst quarter. As a result of the transfer of these policyholders to our PFFSproducts, our annualized Medicare supplement premium in force decreased byapproximately $36 million, however, our annualized Medicare Advantage PFFSpremium in force increased by approximately $141 million. The averageannual premium of our Medicare supplement in force business increasedapproximately 10.8% compared to the first six months of 2006.

*Benefits, Claims andExpenses.**  *Policyholderbenefits incurred declined by $24.1 million, or 17%, compared to the firstsix months of 2006. The reduction in business, as noted above, resulted in areduction in benefits of $22.2 million. The decrease in the loss ratio furtherreduced benefits by $1.8 million to benefits compared to the first sixmonths of 2006. Overall loss ratios for our Medicare supplement businessdecreased 111 basis points to 74.9% for the first six months of 2007 comparedto 76.0% for the first six months of 2006.

There was net amortizationof deferred acquisition costs in the first six months of 2007 compared to anincrease in deferred acquisition costs in the first six months of 2006, anincrease to expense of $14.2 million. Two factors contributed to thedecrease. First, amortization increased by approximately $3.2 million,primarily as a result of higher levels of lapsation of our Medicare supplementbusiness, 

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comparedto the first six months of 2006. Second, we incurred lower commissions andother acquisition costs as a result of lower production, resulting in adecrease in the costs capitalized of $11.0 million.

Commissionsand general expenses, net of reinsurance allowances, decreased by $15.8 million,or 27%, compared to the first six months of 2006. The following table detailsthe components of commission and other operating expenses:

| ** **                                           | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                      | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                       | ** ** |
| Commissions                                          |       | $                                             | 25,877     |   | $ | 36,022 |   |
| Other operating  costs                               |       | 26,492                                        |       | 36,869 |   |
| Reinsurance  allowances                              |       | (9,820                                        | )          | (14,575 | ) |
| Commissions and general  expenses, net of allowances |       | $                                             | 42,549     |   | $ | 58,316 |   |

 

The ratio of commissions to gross premiums decreasedto 11.6% for the first six months of 2007, from 13.5% for the first six monthsof 2006, as a result of lower overall commission rates associated with thecontinued growth of our in force renewal premium and less new business productionthat has higher commission rates. Other operating costs as a percentage ofgross premiums were 11.9% for the first six months of 2007, compared to 13.8%for the first six months of 2006 as a result of lower acquisition expenses dueto lower new business production and lower fixed costs. Commission and expenseallowances received from reinsurers as a percentage of the premiums cededdecreased to 15.9% for the first six months of 2007 from 18.9% for the firstsix months of 2006, primarily due to the reduction in new business ceded andthe effects of normal lower commission allowances on our aging base of cededrenewal business.

**Medicare Part D**

| ** **                                                 | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                       | ** ** | **2006**                                     | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                        | ** ** |
| Direct and assumed  premium                                |       | $                                              | 137,659    |                                         | $          | 138,701 |   | $ | 271,742 |   | $ | 259,492 |   |
| Risk corridor adjustment                                   |       | 4,149                                          |       | (8,696                                       | )          | 50,384 |   | 5,328 |   |
| Direct and assumed  premium after risk corridor adjustment |       | 141,808                                        |       | 130,005                                      |       | 322,126 |   | 264,820 |   |
| Ceded premiums                                             |       | (69,660                                        | )          | (63,888                                      | )          | (158,531 | ) | (130,575 | ) |
| Net premiums                                               |       | 72,148                                         |       | 66,117                                       |       | 163,595 |   | 134,245 |   |
| Other Part D income  (loss)—PDMS                 |       | 13,120                                         |       | 12,867                                       |       | 26,323 |   | 22,674 |   |
| Total Part D  revenue                                 |       | 85,268                                         |       | 78,984                                       |       | 189,918 |   | 156,919 |   |
| Net investment and other  income                           |       | 1,090                                          |       | 654                                          |       | 2,342 |   | 1,153 |   |
| Total revenue                                              |       | 86,358                                         |       | 79,638                                       |       | 192,260 |   | 158,072 |   |
| Pharmacy benefits                                          |       | 67,783                                         |       | 63,433                                       |       | 159,171 |   | 130,299 |   |
| Commissions and general  expenses, net of allowances       |       | 9,377                                          |       | 8,345                                        |       | 18,902 |   | 14,472 |   |
| Total benefits, claims  and other deductions               |       | 77,160                                         |       | 71,778                                       |       | 178,073 |   | 144,771 |   |
| Segment income                                             |       | $                                              | 9,198      |                                         | $          | 7,860 |   | $ | 14,187 |   | $ | 13,301 |   |

 

During the second quarter, CMS clarified theirguidance regarding the treatment of direct and indirect remuneration (“DIR”)relative to catastrophic reinsurance claims. Previously, only rebates were netagainst the claim costs that were subject to the government’s catastrophicreinsurance. Pursuant to the new guidance, other DIR must also be net againstthose claim costs to determine the amount the government will cover. This increasedclaims costs, before our 50% quota share reinsurance, by approximately$14.0 million, including $11.7 million relating to 2006. The increasein claim costs was partially offset by an increase in the risk corridoradjustment due to our PDP from CMS. The net impact, after our 50% quota sharereinsurance was $1.8 million, including $1.6 million relating to2006.

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*Membership.**  *A discussion of the accounting for Part D isincluded in Notes 2 and 14 of the notes to the consolidated financialstatements in this Quarterly Report on Form 10-Q. We based ourmembership for Part D on enrollment information provided by CMS whichindicated that, as of June 30, 2007, approximately 491,000 members wereenrolled in our PDPs for which we were paid by CMS, an increase of 12% over June 30,2006 membership levels. The 2007 membership includes approximately 467,000members in our PDPs that we participate in on a 50% basis and 24,000 members inthe unaffiliated PDP that we participate in on a 33.3% basis. The enrollmentinformation provided by CMS for the second quarter of 2006 indicated that, asof June 30, 2006, approximately 440,000 members were enrolled in our PDPsfor which we were paid by CMS, including approximately 418,000 members in ourPDPs that we participate in on a 50% basis and 22,000 members in theunaffiliated PDP that we participate in on a 33.3% basis. Our revenues and claimsexpense are based on earned premium and incurred pharmacy benefits for thereported enrolled membership. The membership information continues to bereconciled and refined by CMS with respect to the enrollment of members amongall plans participating in the Part D program. As a result of thecontinuing reconciliation process, it is likely that the membership data uponwhich we based our results will change, with a corresponding change in thefinancial results for the segment. We are unable to precisely quantify theimpact of any potential change until the membership data is fully reconciledwith CMS; however, we do not believe that any change from the amounts reportedas of June 30, 2007 is likely to be material.

***Three months ended June 30, 2007 and 2006***

Our PDP incomeincreased by $1.3 million, or 17%, compared to the second quarter of 2006.

*Revenues.**  *Direct and assumed premium declined by $1.0 million,or 1%, compared to the second quarter of 2006. This decline was driven by a 12%decrease in the average per member per month premium due to more competitivepricing of our PDP products partially offset by the 12% increase in membermonths for the quarter. The change in the government risk corridor adjustmentadded $12.8 million to revenue, as compared to the second quarter of 2006,primarily due to the clarification by CMS in their guidance regarding thetreatment of DIR relative to the government catastrophic reinsurance claims andits impact on the risk corridor calculation. Other Part D revenue representsour share in the earnings or loss of PDMS. We report this as revenue forsegment reporting purposes in analyzing the ratio of net pharmacy benefitsincurred because the amount is incorporated in the calculation of the riskcorridor adjustment. For consolidated reporting, this amount is included as aseparate line in income from continuing operations. See reconciliation ofsegment revenues in Note 15 of the Notes to the Consolidated FinancialStatements in this Quarterly Report on Form 10-Q.

*Benefits, Claims andExpenses.**  *Pharmacybenefit increased by $4.4 million or 7% over the second quarter of 2006. Theclarification of the CMS guidance added approximately $7.0 million, net ofour 50% quota share reinsurance, and was offset by a higher level of rebates. Theratio of incurred prescription drug benefits to net premium for the secondquarter of 2007 was 94.0% compared to 95.9% for the second quarter of 2006. Part Dbenefit designs result in Plans sharing in a greater portion of theresponsibility for total pharmacy costs in the early stages of a member’s planperiod and less in the later stages. Based on the coverage provided, weanticipate that results for our Part D business will be seasonal, withhigher benefit ratios in the first and second quarters, decreasing in the thirdand fourth quarters. Changes in the benefit ratios are partially offset as aresult of the risk corridor adjustments. Commissions and general expensesincreased by $1.0 million, or 12% as a result of the increase in themembership.

***Six months ended June 30, 2007 and 2006***

Our PDP income increased by $0.9 million, or 7%,compared to the first six months of 2006.

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*Revenues.**  *Direct and assumed premium increased by $12.3 million,or 5% over the first six months of 2006. This growth was driven by the 23%increase in member months for the first six months of 2007, partially offset bya 15% decrease in the average per member per month premium due to morecompetitive pricing of our PDP products. The change in the government risk corridoradjustment added $45.1 million million to revenue, as compared to thefirst six months of 2006, primarily, due to the clarification of the CMS guidance.Other Part D revenue represents our share in the earnings or loss of PDMS.We report this as revenue for segment reporting purposes in analyzing the ratioof net pharmacy benefits incurred because the amount is incorporated in thecalculation of the risk corridor adjustment. For consolidated reporting, thisamount is included as a separate line in income from continuing operations. Seereconciliation of segment revenues in Note 15 of the Notes to theConsolidated Financial Statements in this Quarterly Report on Form 10-Q.

*Benefits, Claims andExpenses.**  *Pharmacybenefit increased by $28.9 million or 22% over the first six months of2006. The clarification of the CMS guidance added approximately $7.0 million,net of our 50% quota share reinsurance, and the balance of the increase was dueto the increase in membership. The ratio of incurred prescription drug benefitsto net premium for the first six months of 2007 was 97.3% compared to 97.1% forthe first six months of 2006. Part D benefit designs result in Planssharing in a greater portion of the responsibility for total pharmacy costs inthe early stages of a member’s plan period and less in the later stages. Basedon the coverage provided, we anticipate that results for our Part Dbusiness will be seasonal, with higher benefit ratios in the first and secondquarters, decreasing in the third and fourth quarters. Changes in the benefitratios are partially offset as a result of the risk corridor adjustments. Commissionsand general expenses increased by $4.4 million, or 31% as a result of theincrease in the membership.

**Segment Results—Specialty Health Insurance**

| ** **                                           | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                        | ** ** |
| Premiums:                                            |       |                                           |       |                                          |       |   |   |   |   |
| Direct and assumed                                   |       | $                                              | 100,098    |                                          | $          | 97,534 |   | $ | 199,760 |   | $ | 189,758 |   |
| Ceded                                                |       | (81,311                                        | )          | (77,707                                       | )          | (162,036 | ) | (149,690 | ) |
| Net premiums                                         |       | 18,787                                         |       | 19,827                                        |       | 37,724 |   | 40,068 |   |
| Net investment  income                               |       | 5,333                                          |       | 4,489                                         |       | 10,612 |   | 9,054 |   |
| Other income                                         |       | 111                                            |       | 7                                             |       | 144 |   | 93 |   |
| Total revenue                                        |       | 24,231                                         |       | 24,323                                        |       | 48,480 |   | 49,215 |   |
| Policyholder  benefits                               |       | 15,825                                         |       | 16,198                                        |       | 33,054 |   | 34,304 |   |
| Change in  deferred acquisition costs                |       | (125                                           | )          | (511                                          | )          | 169 |   | (1,052 | ) |
| Commissions and  general expenses, net of allowances |       | 7,047                                          |       | 5,687                                         |       | 10,360 |   | 11,612 |   |
| Total benefits, claims and other deductions          |       | 22,747                                         |       | 21,374                                        |       | 43,583 |   | 44,864 |   |
| Segment income                                       |       | $                                              | 1,484      |                                          | $          | 2,949 |   | $ | 4,897 |   | $ | 4,351 |   |

 

***Three months ended June 30, 2007 and 2006***

Our Specialty Health Insurance segment incomedecreased by $1.5 million, or 50%, compared to the second quarter of 2006,primarily as the result of an adjustment to commissions during the secondquarter of 2007.

*Revenues.**  *Direct premium increased by $4.3 million,compared to the second quarter of 2006, as a result of an increase in premiumrelated to the PharmaCare Re reinsurance agreement for the State of Connecticutemployees. These premiums are 100% ceded, thus there is no effect on netpremium. Net 

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premiums declined byapproximately $1.0 million, or 5%, compared to the second quarter of 2006,primarily as a result of a decline of $1.0 million in our U.S. fixedbenefit accident and sickness line.

Net investment income increased by approximately $0.8million, or 19%, compared to the second quarter of 2006 primarily as a resultof an increase in portfolio yields.

*Benefits,Claims and Expenses.**  *Policyholderbenefits incurred declined by $0.4 million, or 2%, compared to the secondquarter of 2006, primarily as a result of the decline in premium, offset inpart by an increase in the overall loss ratio for the segment to 84.2% for thesecond quarter of 2007 compared to 81.7% for the second quarter of 2006.

Net capitalization of deferred acquisition costs inthe second quarter of 2007 decreased compared to the increase in deferredacquisition costs in the second quarter of 2006, an increase to expense of$0.4 million. This was primarily due to an increase in amortization duringthe second quarter of 2007 as compared to the second quarter of 2006.

Commissions and general expenses increased by$1.4 million, or 24%, compared to the second quarter of 2006, primarily asa result of an increase in commissions. During the second quarter of 2007, theCompany recorded a pre-tax adjustment that increased incurred commissions by$2.1 million, as a result of an understatement of incurred commissions inthe first quarter of 2007 by the same amount. The after-tax impact of the adjustmentwas $1.4 million. Upon the identification of the understatement, theCompany took the following steps to reduce the likelihood of suchunderstatement from occurring in the future by: (i) adding additionalanalytical procedures to ensure the accuracy of incurred commissions and (ii) strengtheningthe management review of commission trends.

The Company analyzed the impact of the understatementto determine whether it was material to the current or prior periods. TheCompany considered both qualitative and quantitative factors in assessingmateriality in order to evaluate misstatements in financial statements.

Although there was noimpact on year to date earnings for either the Company as a whole or theSpecialty Health Insurance segment as a result of the adjustment, the earningsfor the first quarter of 2007 were overstated and the earnings for the secondquarter of 2007 are understated. However, the Company does not believe theseimpacts are material to the earnings trend analysis, because the pattern ofearnings for the Company are heavily weighted to the second, third and fourthquarters.

***Six months ended June 30, 2007 and 2006***

Our Specialty Health Insurance segment incomeincreased by $0.5 million, or 13%, compared to the first six months of2006, primarily as the result of higher net investment income, partially offsetby an increase in the loss ratios for the segment.

*Revenues.**  *Direct premium increased by $13.2 million,compared to the first six months of 2006, as a result of an increase in premiumrelated to the PharmaCare Re reinsurance agreement for the State of Connecticutemployees. These premiums are 100% ceded, thus there is no effect on netpremium. Net premiums declined by approximately $2.3 million, or 6%,compared to the first six months of 2006, primarily as a result of a decline of$2.0 million in our U.S. fixed benefit accident and sickness line and $0.5million in our long term care line.

Net investment income increased by approximately$1.6 million, or 17%, compared to the first six months of 2006 primarilyas a result of an increase in portfolio yields.

*Benefits,Claims and Expenses.**  *Policyholderbenefits incurred declined by $1.3 million, or 4%, compared to the first sixmonths of 2006, primarily as a result of the decline in premium, offset in partby an increase in the overall loss ratios for the segment to 87.6% for thefirst six months of 2007 compared to 85.6% for the first six months of 2006.

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There was net amortization of deferred acquisitioncosts in the first six months of 2007 compared to an increase in deferredacquisition costs in the first six months of 2006, an increase to expense of$1.2 million. This was primarily due to an increase in net amortization duringthe first six months of 2007 as compared to the first six months of 2006.

Commissions and generalexpenses decreased by $1.3 million, or 11%, compared to the first sixmonths of 2006, primarily as a result of lower general expenses.

**Segment Results—Life Insurance and Annuity**

| ** **                                           | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                        | ** ** |
| **Premiums:**                                        | ** ** | ** **                                     | ** ** | ** **                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Direct and assumed                                   |       | $                                              | 19,910     |                                          | $          | 19,385 |   | $ | 39,150 |   | $ | 38,582 |   |
| Ceded                                                |       | (5,077                                         | )          | (4,268                                        | )          | (9,734 | ) | (8,093 | ) |
| Net premiums                                         |       | 14,833                                         |       | 15,117                                        |       | 29,416 |   | 30,489 |   |
| Net investment  income                               |       | 10,835                                         |       | 9,815                                         |       | 21,517 |   | 19,396 |   |
| Other income                                         |       | 359                                            |       | 67                                            |       | 439 |   | 156 |   |
| Total revenue                                        |       | 26,027                                         |       | 24,999                                        |       | 51,372 |   | 50,041 |   |
| Policyholder  benefits                               |       | 9,229                                          |       | 10,210                                        |       | 19,061 |   | 21,530 |   |
| Interest credited  to policyholders                  |       | 4,323                                          |       | 4,740                                         |       | 9,028 |   | 9,210 |   |
| Change in  deferred acquisition costs                |       | 971                                            |       | (2,183                                        | )          | 2,111 |   | (2,933 | ) |
| Amortization of  intangible assets                   |       | 88                                             |       | 122                                           |       | 122 |   | 198 |   |
| Commissions and  general expenses, net of allowances |       | 6,203                                          |       | 8,352                                         |       | 12,540 |   | 17,236 |   |
| Total benefits, claims and other deductions          |       | 20,814                                         |       | 21,241                                        |       | 42,862 |   | 45,241 |   |
| Segment income                                       |       | $                                              | 5,213      |                                          | $          | 3,758 |   | $ | 8,510 |   | $ | 4,800 |   |

 

***Three months ended June 30, 2007 and 2006***

Segment income from our Life Insurance and Annuitysegment increased by $1.5 million, compared to the second quarter of 2006,primarily as a result of an increase in investment income and more favorablemortality.

*Revenues.**  *Net premiums for the segment decreased by $0.3 million,or 2%, compared to the second quarter of 2006, primarily as a result of thedecline of $0.4 million in our traditional life business due to the sale,in 2006, of our group life insurance business.

Since September 30, 2006, we are no longerissuing annuity product as we continue to focus more on providing healthinsurance alternatives to the growing senior market. Our agents sold $7.7 millionof fixed annuities during the second quarter of 2006. Annuity deposits are notconsidered premiums for reporting in accordance with generally acceptedaccounting principles.

Net investment income increased by approximately$1.0 million, or 10%, compared to the second quarter of 2006, primarily asa result of an increase in portfolio yields.

*Benefits, Claims andExpenses.**  *Policyholderbenefits incurred declined by $1.0 million, or 10%, compared to the secondquarter of 2006. The decline in business reduced policyholder benefits byapproximately $0.2 million and claim costs were lower by approximately$0.8 million as a result of more favorable mortality in the second quarterof 2007 compared to the second quarter of 2006. There was net amortization ofdeferred acquisition costs in the second quarter of 2007 compared to anincrease in deferred acquisition costs in the second quarter of 2006, anincrease to expense of $3.2 million. This was primarily due to lowerproduction of new life insurance and annuity business during the second quarterof 

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2007, resulting ina lower level of acquisition costs to capitalize, partially offset by loweramortization on a smaller block of business, as compared to the second quarterof 2006. Commissions and general expenses, net of allowances decreased by$2.2 million, or 26%, compared to the second quarter of 2006, primarilydue to the lower production levels of new life insurance an annuity business,as noted above.

***Six months ended June 30, 2007 and 2006***

Segment income from our Life Insurance and Annuitysegment increased by $3.7 million, compared to the first six months of2006, primarily as a result of an increase in investment income and morefavorable mortality.

*Revenues.**  *Net premiums for the segment decreased by $1.1 million,or 4%, compared to the first six months of 2006, primarily as a result of thedecline of $1.1 million in our traditional life business due to the sale,in 2006, of our group life insurance business.

Since September 30, 2006, we are no longerissuing annuity product as we continue to focus more on providing health insurancealternatives to the growing senior market. Our agents sold $18.5 millionof fixed annuities during the first six months of 2006. Annuity deposits arenot considered premiums for reporting in accordance with generally acceptedaccounting principles.

Net investment income increased by approximately$2.1 million, or 11%, compared to the first six months of 2006, primarilyas a result of an increase in portfolio yields.

*Benefits,Claims and Expenses.**  *Policyholderbenefits incurred declined by $2.5 million, or 12%, compared to the firstsix months of 2006. The decline in business reduced policyholder benefits byapproximately $0.8 million and claim costs were lower by approximately$1.7 million as a result of more favorable mortality in the first six months of2007 compared to the first six months of 2006. There was net amortization ofdeferred acquisition costs in the first six months of 2007 compared to anincrease in deferred acquisition costs in the first six months of 2006, anincrease to expense of $5.0 million. This was primarily due to lowerproduction of new life insurance and annuity business during the first sixmonths of 2007, resulting in a lower level of acquisition costs to capitalize,partially offset by lower amortization on a smaller block of business, ascompared to the first six months of 2006. Commissions and general expenses, netof allowances decreased by $4.7 million, or 27%, compared to the first sixmonths of 2006, primarily due to the lower production levels of new lifeinsurance an annuity business, as noted above.

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**Segment Results—Senior Administrative Services**

| ** **                                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                       | ** ** | **2006**                                      | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                        | ** ** |
| Affiliated fee revenue                           |       |                                           |       |                                          |       |   |   |   |   |
| Medicare supplement                              |       | $                                              | 5,772      |                                          | $          | 6,905 |   | $ | 12,227 |   | $ | 14,627 |   |
| Part D                                      |       | 6,133                                          |       | 5,970                                         |       | 12,335 |   | 9,899 |   |
| Private Fee-for-service                          |       | 4,615                                          |       | —                                        |       | 7,711 |   | — |   |
| Long term care                                   |       | 576                                            |       | 765                                           |       | 1,199 |   | 1,520 |   |
| Life insurance                                   |       | 476                                            |       | 524                                           |       | 950 |   | 1,065 |   |
| Other                                            |       | 2,099                                          |       | 645                                           |       | 4,079 |   | 1,426 |   |
| Total affiliated revenue                         |       | 19,671                                         |       | 14,809                                        |       | 38,501 |   | 28,537 |   |
| Unaffiliated fee revenue                         |       |                                           |       |                                          |       |   |   |   |   |
| Medicare Advantage                               |       | 2,587                                          |       | 2,302                                         |       | 5,066 |   | 4,073 |   |
| Medicare supplement                              |       | 1,461                                          |       | 1,734                                         |       | 3,016 |   | 3,591 |   |
| Long term care                                   |       | 1,720                                          |       | 1,963                                         |       | 3,592 |   | 3,990 |   |
| Non-insurance products                           |       | 416                                            |       | 365                                           |       | 807 |   | 644 |   |
| Part D                                      |       | 399                                            |       | 402                                           |       | 796 |   | 730 |   |
| Other                                            |       | 41                                             |       | 183                                           |       | 82 |   | 397 |   |
| Total unaffiliated  revenue                      |       | 6,624                                          |       | 6,949                                         |       | 13,359 |   | 13,425 |   |
| Total revenue                                    |       | 26,295                                         |       | 21,758                                        |       | 51,860 |   | 41,962 |   |
| Amortization of present  value of future profits |       | 110                                            |       | 123                                           |       | 220 |   | 246 |   |
| General expenses                                 |       | 20,695                                         |       | 16,860                                        |       | 40,313 |   | 34,514 |   |
| Total expenses                                   |       | 20,805                                         |       | 16,983                                        |       | 40,533 |   | 34,760 |   |
| Segment income                                   |       | $                                              | 5,490      |                                          | $          | 4,775 |   | $ | 11,327 |   | $ | 7,202 |   |

 

Included in unaffiliatedrevenue are fees received to administer certain business of our insurancesubsidiaries that is 100% reinsured to an unaffiliated reinsurer. These feesamounted to $0.6 million and $0.8 million for the three months endedJune 30, 2007 and 2006, respectively and $1.3 million and $1.7 millionfor the six months ended June 30, 2007 and 2006, respectively. These fees,together with the affiliated revenue, were eliminated in consolidation.

***Three months ended June 30, 2007 and 2006***

Segment income for our Senior Administrative Servicessegment increased by $0.7 million, or 15%, to $5.5 million for thesecond quarter of 2007, as compared to the same period of 2006. This increaseis primarily the result of the growth in business administered.

Revenue increased by $4.5 million,or 21%, during the second quarter of 2007 compared to the second quarter of2006. Affiliated service fee revenue increased by $4.9 million primarilyas a result the growth in fees for the administration of our Privatefee-for-service business as well as Part D prescription drug plans onbehalf of our insurance subsidiaries. The increase in other fees relates to theadministration of affiliated business that was previously performed by PennCorpLife Canada and was offset by the decline in fees for the administration of ourMedicare Supplement business. Unaffiliated service fee revenue decreased by$0.3 million, due primarily to a reduction in services performed forunaffiliated Medicare supplement and Long term care business, partially offsetby an increase in additional administrative services performed for unaffiliatedclients for Medicare Advantage business. General expenses for the segmentincreased by $3.8 million, or 23%, primarily attributed to the growth ofthe affiliated PFFS and Part D business.

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***Six months ended June 30, 2006 and 2007***

Segment income for our Senior Administrative Servicessegment increased by $4.1 million, or 57%, to $11.3 million for thefirst six months of 2007, as compared to the same period of 2006. This increaseis primarily the result of the growth in business administered.

Revenue increased by $9.9 million,or 24%, during the first six months of 2007 compared to the first six months of2006. Affiliated service fee revenue increased by $10.0 million primarilyas a result the growth in fees for the administration of our Privatefee-for-service business as well as Part D prescription drug plans onbehalf of our insurance subsidiaries. The increase in other fees relates to theadministration of affiliated business that was previously performed by PennCorpLife Canada and was offset by the decline in fees for the administration of ourMedicare Supplement business. Unaffiliated service fee revenue decreased by$0.1 million, due primarily to a reduction in services performed forunaffiliated Medicare supplement and Long term care business, partially offsetby an increase in additional administrative services performed for unaffiliatedclients for Medicare Advantage business. General expenses for the segmentincreased by $5.8 million, or 17%, primarily attributed to the growth ofthe affiliated PFFS and Part D business.

**Segment Results—Corporate**

| ** **                                         | ** ** | **Three months ended June 30,** | ** ** | **Six months ended  June  30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                       | ** ** | **2006**                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                        | ** ** |
| Interest                                           |       | $                                              | 4,924      |                                                | $          | 3,186 |   | $ | 8,363 |   | $ | 6,228 |   |
| Amortization of  capitalized loan origination fees |       | 288                                            |       | 229                                                 |       | 568 |   | 458 |   |
| Stock-based compensation  expense                  |       | 971                                            |       | 780                                                 |       | 2,107 |   | 1,495 |   |
| Other parent company  expenses, net of revenues    |       | 1,459                                          |       | 2,193                                               |       | 4,359 |   | 3,688 |   |
| Segment loss                                       |       | $                                              | 7,642      |                                                | $          | 6,388 |   | $ | 15,397 |   | $ | 11,869 |   |

 

***Three months ended June 30, 2007 and 2006***

The loss from ourCorporate segment increased by $1.3 million, or 20%, for the three monthsended June 30, 2007 compared to the three months ended June 30, 2006.The increase was due primarily to the increase in interest costs, offset by anincrease in net investment income. Our combined outstanding debt increased by$94.7 million to $262.9 million at June 30, 2007 from $168.2 millionat June 30, 2006. The weighted average interest rate on our loan payablewas 7.1% for the three months ended June 30, 2007 compared to 7.2% for thethree months ended June 30, 2006. The weighted average interest rate onour other long term debt was 7.8% for each of the three months endedJune 30, 2007 and 2006. See “Liquidity and Capital Resources” foradditional information regarding our loan payable and other long term debt. Revenuesat the Corporate segment, primarily net investment income, increased to $1.3 millionfor the three months ended June 30, 2007 from $0.1 million for thethree months ended June 30, 2006 as a result of the capital raised fromthe issuance of debt and equity during 2007, that was retained at the parentcompany during the period and not yet used to fund the capital needs of theinsurance subsidiaries.

***Six months ended June 30, 2007 and 2006***

The loss from ourCorporate segment increased by $3.5 million, or 30%, for the six monthsended June 30, 2007 compared to the six months ended June 30, 2006.The increase was due primarily to increases in interest costs, other parentcompany expenses, and stock-based compensation. The increase in interest costswas due primarily to the increase in the outstanding debt, as noted above. See“Liquidity and Capital Resources” for additional information regarding our loanpayable and other long term debt. Other parent company expenses increased as aresult of costs associated with our Board of Director’s review of the proposedbuyout offer, as well as an increase in management bonuses over the prior year.The increase 

58

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instock-based compensation was due primarily to the advance in the timing of theannual awards to February in 2007 from April in 2006.

**Liquidity andCapital 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. We also require cash to pay theoperating expenses necessary to function as a holding company (applicableinsurance department regulations require us to bear our own expenses), and tomeet the costs of being a public company.

We believe that our current cash position, theexpected cash flows of our administrative service company and our seniormanaged care company, and the surplus note interest and principal payments fromAmerican Exchange can support our current parent company obligations. However,there can be no assurance as to our actual future cash flows or to thecontinued availability of dividends from our insurance company subsidiaries.

To provide the cash andcapital for our insurance company subsidiaries to support our growth andexpansion initiatives in Medicare Advantage, we have used the proceeds from thesale of our Canadian operations and, in March 2007, we issued $50 millionof trust preferred securities. There can be no assurance as to our continuedability to access funds though the capital markets to support our growth andexpansion initiatives.

*Amended CreditAgreement*

In connection with the acquisition of Heritage onMay 28, 2004, the Company amended its existing credit agreement byincreasing the facility to $120 million from $80 million (the“Amended Credit Agreement”), including an increase in the term loan portion to$105 million from $36.4 million (the balance outstanding atMay 28, 2004) and maintaining the $15 million revolving loanfacility. None of the revolving loan facility was drawn as of June 30,2007. Under the Amended Credit Agreement, the spread over LIBOR was reduced to225 basis points from 275 basis points. Effective July 1, 2007, theinterest rate on the term loan was 7.6%. Principal repayments are scheduled at$5.3 million per year over a five-year period with a final payment of$80.1 million due upon maturity on March 31, 2009. The Company paysan annual commitment fee of 50 basis points on the unutilized revolving loanfacility. Please refer to our 2006 Annual Report on Form 10-K forcertain information regarding the terms of the Amended Credit Agreement.

On March 22, 2007, the Company requested andreceived an amendment to each of the Amended Credit Facility and the RevolvingCredit Facility incorporating the issuance of an additional series of trustpreferred securities and raising the mandatory payment threshold.

The Company made regularly scheduled principalpayments of $2.6 million during the six months ended June 30, 2007and $2.6 million during the six months ended June 30, 2006 inconnection with its credit facilities.

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

| 2007 (remainder of the  year) |   | $      | 2,625  |   |
|-------------------------------|--------|--------|--------|--------|
| 2008                          |   | 5,250  |   |
| 2009                          |   | 80,063 |   |
|                          |   | $      | 87,938 |   |

 

On January 18, 2007, the Company entered into anew short-term revolving credit facility of $50.0 million (the ‘RevolvingCredit Facility”). On March 13, 2007, the Company drew down all $50.0 millionof the Revolving Credit Facility. The Revolving Credit Facility has a maturitydate of September 30, 2007 and bears interest at a spread of 75 basispoints over the three month LIBOR rate. The initial rate was 6.1%. OnJuly 18, 2007, the Company fully paid off the $50.0 million balanceon this revolving credit facility, including accrued interest of $0.3 million.

The Company paid interestof $4.2 million during the six months ended June 30, 2007 and $3.4 millionduring the six months ended June 30, 2006 in connection with its creditfacilities. Due to the variable interest rate for this Credit Agreement, theCompany would be subject to higher interest costs if short-term interest ratesrise.

*Other Long TermDebt*

We formed statutory business trusts, which exist forthe exclusive purpose of issuing trust preferred securities representingundivided beneficial interests in the assets of the trust, investing the grossproceeds of the trust preferred securities in junior subordinated deferrableinterest debentures of our parent holding company (the “Junior SubordinatedDebt”) and engaging in only those activities necessary or incidental thereto.In accordance with the adoption of FASB Interpretation No. 46(R),“Consolidation of Variable Interest Entities,” the Company does not consolidatethe trusts.

We issued $50.0 million of trust preferredsecurities in late March 2007 at a fixed interest rate of 7.7% pursuant toterms similar to our other trust preferred securities. Please refer to our 2006Annual Report onf Form 10-K and Current Report on Form 8-Kdated March 22, 2007 for certain information regarding the terms of theJunior Subordinated Debt.

Separatesubsidiary trusts of our parent holding company (the “Trusts”) have issued acombined $125.0 million in thirty year trust preferred securities (the “CapitalSecurities”) as detailed in the following table:

| **Maturity Date** | ** ** | ** **              | ** ** | **Amount Issued** | ** ** | **Term**                | ** **     | **Spread Over  LIBOR** | ** ** | **Rate as of  June 30, 2007** | ** ** |
|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|----------------|-----------------------------|------------|---------------------------------------------------|------------|
| ** **             | ** ** | **(In thousands)** | ** ** | ** **             | ** ** | **(Basis points)** | ** **     | ** **                  | ** ** |
| December 2032     |       |                    | $          | 15,000                 |       |                    | Fixed/Floating |                        |       | 400                                               | (1)        |   |   | 6.7 | % |   |
| March 2033        |       |                    | 10,000     |                   |       | Floating                |           |                        | 400        |                                              |       |   | 9.4 | % |   |
| May 2033          |       |                    | 15,000     |                   |       | Floating                |           |                        | 420        |                                              |       |   | 9.6 | % |   |
| May 2033          |       |                    | 15,000     |                   |       | Fixed/Floating          |           |                        | 410        | (2)                                               |       |   | 7.4 | % |   |
| October 2033      |       |                    | 20,000     |                   |       | Fixed/Floating          |           |                        | 395        | (3)                                               |       |   | 7.0 | % |   |
| March 2037        |       |                    | 50,000     |                   |       | Fixed/Floating          |           |                        | 275        | (4)                                               |       |   | 7.7 | % |   |
|                   |       |                    | $          | 125,000                |       |                    |           |                        |       |                                              |       |   |   |   |   |   |

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(1)          Effective September,2003, we entered into a swap agreement whereby it will pay a fixed rate of 6.7%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. On May 15, 2008 it will beconverted to a floating rate equal to LIBOR plus 410 basis points.

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(3)          Effective April 29,2004, we entered into a swap agreement whereby it will pay a fixed rate of6.98% in exchange for a floating rate of LIBOR plus 395 basis points. The swapcontract expires in October 2008.

(4)          The rate on this issueis fixed at 7.7% for the first five years. On March 23, 2012, it will beconverted to a floating rate equal to LIBOR plus 275 basis points.

We paid $3.8 millionin interest in connection with the Junior Subordinated Debt during the threemonths ended June 30, 2007, and $2.8 million during the three monthsended June 30, 2006.

*Shelf Registration*

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 millionshares of common stock that may be offered for sale by Capital Z FinancialServices Fund II, L.P. (“Capital Z”), our largest shareholder.The shelf registration statement was 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.The terms of any offering pursuant to this shelf will be established at thetime of the offering. We plan to use the proceeds from any future offeringunder the registration statement for general corporate purposes, including, butnot limited to, working capital, capital expenditures, investments insubsidiaries, acquisitions and refinancing of debt. A more detailed descriptionof the use of proceeds will be included in any specific offering of securitiesin the prospectus supplement relating to the offering.

The aggregateamount that remains available for offering under the shelf registrationstatement is $77.2 million.

*Sources ofLiquidity to the Parent Company*

We anticipatefunding the obligations of the parent company and the capital required to growour business from the following distinct and uncorrelated sources of cash flowwithin the organization:

·       theexpected cash flows of our senior administrative services company;

·       theexpected cash flows of our senior managed care company; and

·       surplusnote principal and interest payments from American Exchange and Pyramid.

In addition, we have access to funds under existingcredit facilities. We have $15.0 million available under the revolving portionof our Amended Credit Agreement. In March of 2007, we drew down all $50million available under our short-term Revolving Credit Facility inanticipation of our capital needs to support the growth of our business,however, we repaid the entire $50.0 million balance on July 18, 2007, whenit was determined that it was not immediately needed.

We also have the ability, from time to time, to accessthe capital markets for additional capital. In March 2007 we issued $50million of trust preferred securities. In addition, in connection with the May 8,2007 announcement of the signing of definitive agreements to acquireMemberHealth (see Note 18—Subsequent Event of the Notes to the ConsolidatedFinancial Statements included in this Quarterly Report on Form 10-Q),we have signed stock purchase agreements with certain private equity investmentfunds to issue preferred securities totaling $350 million at $20 per commonequivalent share. We issued $100 million of these preferred securities duringthe second quarter of 2007. There can be no assurance as to our actual futurecash flows, from the continued availability of dividends from our insurancecompany subsidiaries or from access to the capital markets to support ourgrowth and expansion initiatives.

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*SeniorAdministrative 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.

*SeniorManaged Care Company.**  *Liquidityfor our managed care company is measured by its ability to pay operatingexpenses and pay dividends to our parent company. The primary source ofliquidity is management fees for administration of our healthplan affiliatesand services provided to the IPA’s. Dividend payments by our healthplanaffiliates to Heritage are subject to the approval of the insurance regulatoryauthorities of our healthplan affiliates’s respective state of domicile. SCOTis not able to pay dividends during 2007 without prior approval. However, webelieve that the sources of cash to our managed care holding company exceedscheduled uses of cash which will result in funds available to dividend to ourparent holding company.

*InsuranceSubsidiaries—Surplus Note, Dividends and Capital Contributions.**  *Cash generated by our insurance company subsidiarieswill be made available to our holding company, principally through periodicpayments of principal and interest on the surplus note owed to our holdingcompany by our subsidiary, American Exchange Life. As of June 30, 2007,the principal amount of the surplus note was $22.5 million. The note bearsinterest to our parent holding company at LIBOR plus 250 basis points. Weanticipate that the surplus note will be primarily serviced by dividends fromPennsylvania Life, a wholly owned subsidiary of American Exchange, bydistributions from PDMS, and by tax-sharing payments among the insurancecompanies that are wholly owned by American Exchange and file a consolidatedFederal income tax return. American Exchange made principal payments totaling$5.0 million during the six months ended June 30, 2007 and $7.5 millionduring the six months ended June 30, 2006. American Exchange paid intereston the surplus note of $1.1 million during the six months ended June 30,2007 and $1.4 million during the six months ended June 30, 2006.

On June 29, 2007, Pyramid issued a $30.0 millionsurplus note payable to our holding company. The note is repayable throughannual principal payments beginning March 29, 2009, based on a schedule,provided that capital and surplus are sufficient to maintain risk based capitallevels of 450% or greater. The surplus note can be pre-paid to the extent thatPyramid’s risk based capital levels exceed 450%. The note bears interest to ourparent holding company at a fixed rate of 7.7% for the term of the note.

Our parent holding company made capital contributionsto American Exchange amounting to $64.0 million during the first six months of2007. American Exchange made capital contributions of $32.0 million to AmericanProgressive and $32.0 million to Pyramid during the first six months of 2007.

Our parent holding company made capital contributionsto American Exchange amounting to $3.5 million during the first six months of2006. During May, 2006, our parent holding company also contributed itsinterest in PDMS to American Exchange. On the date of the contribution, ourinterest in PDMS was $4.1 million. In January 2006, Pyramid Life declaredand paid a dividend in the amount of $10.8 million to Pennsylvania Life.American Exchange made capital contributions of $2.5 million to Constitutionduring the first six months of 2006.

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 $21.9 million and Pyramid Lifeis be able to pay dividends of up to $2.7 million to American Exchange (theirdirect parent) in 2007 without the prior approval from the insurance departmentfor their respective states of domicile.

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*InsuranceSubsidiaries—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.Both the sources and uses of cash are reasonably predictable and we believethat these sources of cash for our insurance company subsidiaries exceedscheduled uses 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 accident and health insurance policies generallyprovide for fixed-benefit amounts and, in the case of Medicare Supplementpolicies, for supplemental co-payments in accordance with approved Medicareprovider rates. Some of these benefits are subject to medical-cost inflationand we have the capability to file for premium rate increases to mitigaterising medical costs. Our health insurance business is widely dispersed in theUnited States, which mitigates the risk of unexpected increases in claimpayments due to epidemics and events of a catastrophic nature. These accidentand health polices are not interest-sensitive and therefore are not subject tounexpected policyholder redemptions 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 June 30, 2007 we held reserves that exceeded theunderlying cash surrender values of our net retained in force life insuranceand annuities by $30 million. Our insurance subsidiaries, in our view, have notexperienced any material changes in surrender and withdrawal activity in recentyears.

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 rate environmentcould adversely affect earnings if we were required to sell investments atreduced values in order to meet liquidity demands. We manage our asset andliability portfolios in order to minimize the adverse earnings impact ofchanging market rates. We have segregated a portion of our investment portfolioin order to match liabilities that are sensitive to interest rate movementswith fixed income securities containing similar characteristics to the relatedliabilities, most notably the expected duration and required interest spread.We believe that this asset/liability management process adequately covers theexpected payment of benefits related to these liabilities.

At June 30, 2007, we held cash and cashequivalents totaling $807 million and fixed maturity securities that couldreadily be converted to cash with carrying values (and fair values) of $1.2billion. In addition, our insurance company subsidiaries have cash totalingapproximately $226 million for the operation of our PDPs that cannot be usedfor other lines of business or general corporate purposes.

The net yields on our cash and invested assets was5.1% for the six months ended June 30, 2007, and for the six months ended June 30,2006. A portion of these securities are held to support the liabilities forpolicyholder account balances, which liabilities are subject to periodicadjustments to their credited interest rates. The credited interest rates ofthe interest-sensitive policyholder account balances are determined by us basedupon factors such as portfolio rates of return and prevailing market rates andtypically follow the pattern of yields on the assets supporting theseliabilities.

Our domestic insurance subsidiaries are required tomaintain minimum amounts of statutory capital and surplus as required byregulatory authorities. However, substantially more than the statutory minimum 

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amounts are needed to meetstatutory and administrative requirements of adequate capital and surplus tosupport the current level of our insurance subsidiaries’ operations. Each ofour insurance subsidiaries’ statutory capital and surplus exceeds itsrespective minimum statutory requirement at levels we believe are sufficient tosupport their current levels of operation. Additionally, the National Associationof Insurance Commissioners (“NAIC”) imposes regulatory risk-based capital (“RBC”)requirements on life insurance enterprises. At June 30, 2007, all of ourinsurance subsidiaries maintained ratios of total adjusted capital to RBC inexcess of the “authorized control level”. The combined statutory capital andsurplus, including asset valuation reserve, of our U.S. insurance subsidiariestotaled $372.6 million at June 30, 2007 and $242.9 million at December 31,2006. For the six months ended June 30, 2007, our U.S. insurancesubsidiaries generated a statutory net income of $38.8 million. For the sixmonths ended June 30, 2006, our U.S. insurance subsidiaries generatedstatutory net income of $9.2 million.

Our health plan affiliatesare also required to maintain minimum amounts of capital and surplus, asrequired by regulatory authorities and are also subject to RBC requirements. AtJune 30, 2007, the statutory capital and surplus of each of our healthplan affiliates exceeds its minimum requirement and its RBC is in excess of the“authorized control level”. The statutory capital and surplus for our healthplan affiliates was $57.3 million at June 30, 2007 and $44.0 million at December 31,2006. Statutory net income for our health plan affiliates was $9.0 millionfor the six months ended June 30, 2007 and $7.7 million for the six monthsended June 30, 2006.

*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 purposeentities, real estate, commodity contracts, or other derivative securities. Wecurrently engage the services of three investment advisors under the directionof the management of our insurance company subsidiaries 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. Weinvest primarily in fixed maturity securities of the U.S. Government and itsagencies and in corporate fixed maturity securities with investment graderatings of “BBB-” (Standard & Poor’s Corporation), “Baa3” (Moody’sInvestor Service) or higher. As of June 30, 2007, we held approximately$163 million of securities with exposure to sub-prime mortgages, representingapproximately 7% of our cash and invested assets. Approximately $13 million ofthese securities were sold during July, 2007. The collateral for thesesecurities are substantially all first lien mortgages. These securities have anaverage S&P rating of AA+ and none of these securities have experiencedcredit downgrades.

As of June 30, 2007,approximately 99% of our fixed maturity investments had investment graderatings from Standard & Poor’s Corporation or Moody’s InvestorService. There were no non-income producing fixed maturities as of June 30,2007. During the six months ended June 30, 2007 and 2006, we did not writedown the value of any fixed maturity securities. A write-down of the value of afixed maturity security would represent our estimate of an other than temporarydecline in value and would be included in net realized gains and losses oninvestments in our consolidated statements of operations.

*Effects of RecentlyIssued and Pending Accounting Pronouncements*

A summary of other recentand pending accounting pronouncements is provided in Note 2 of the consolidatedfinancial statements in the Annual Report on Form 10-K under thecaption “Future 

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Adoptionof Accounting Standards.”  We do notanticipate any material impact from the future adoption of the pendingaccounting pronouncements discussed in that note.

**ITEM 3—QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

In general, market risk towhich we are subject relates to changes in interest rates that affect themarket prices of our fixed income securities as well as the cost of ourvariable rate debt. We no longer have any material exposure to changes in thecurrency exchange rate for the Canadian dollar as a result of the sale of ourCanadian subsidiary.

*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 advantage of the lower rates then available. We monitor and adjust ourinvestment portfolio mix to mitigate 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 June 30, 2007,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 $44 million and a 200 basis point increase inmarket interest rates would result in $89 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 $44 million anda 200 basis point decrease in market interest rates would result in a $85million 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 $65.0 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.

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The sensitivity analysis of interest rate risk assumesscenarios with increases or decreases in LIBOR of 100 and 200 basis points fromtheir levels as of and for the six months ended June 30, 2007, and withall other variables held constant. The following table summarizes the impact ofchanges in LIBOR.

| ** **                                                | ** ** | ** **             | ** ** | ** **                                | ** ** | **Effect of Change in LIBOR on Pre-tax  Income for the six months ended June30, 2007** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|-------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|
| **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                                              |       |                   | 7.27       | %                                         |       |                                                                                                                      | $          | 120.0 |   |   |   | $ | 1.2 |   |   |   | $ | 0.6 |   |   |   | $ | (0.6 | ) |   |   | $ | (1.2 | ) |   |
| Other long term  debt                                     |       |                   | 9.53       | %                                         |       |                                                                                                                      | $          | 25.0 |   |   |   | 0.3 |   |   |   | 0.1 |   |   |   | (0.1 | ) |   |   | (0.3 | ) |   |
| Total                                                     |       |                   |       |                                      |       |                                                                                                                      |       |   |   |   | $ | 1.5 |   |   |   | $ | 0.77 |   |   |   | $ | (0.7 | ) |   |   | $ | (1.5 | ) |   |
|                                                           |            |                        |            |                                           |            |                                                                                                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As noted above, we have fixed the interest rate on$100 million of our $263 million of total debt outstanding, leaving $163million of the debt exposed to rising interest rates. As of June 30, 2007we had approximately $807 million of cash and cash equivalents (excluding cashfor the operation of our PDPs). We anticipate that the net investment incomefrom our cash and cash equivalents will be positively impacted by risinginterest rates and will mitigate the negative impact of rising interest rateson our debt.

The magnitude of changes reflected in the aboveanalysis regarding interest rates should, in no manner, be construed as aprediction of future economic events, but rather as a simple illustration ofthe potential impact of such events on our financial results.

On July 18, 2007, wefully paid off the $50.0 million balance on our short term revolving creditfacility, that is include in the Loan Payable in the analysis above. Additionally,it is likely that we will refinance our loan payable in connection with theMemberHealth Transaction. See Note 18—Pending Acquisition included in the Notesto Consolidated Financial Statements in Part I, Item 1 of this quarterlyreport on Form 10-Q for additional information on this transaction.

**ITEM 4—CONTROLS AND PROCEDURES**

***Disclosure Controls and Procedures***

The Company maintainsdisclosure controls and procedures that are designed to ensure that informationrequired to be disclosed in the reports that we file or submit under theExchange Act, is recorded, processed, summarized and reported within the timeperiods specified in the SEC’s rules and forms, and that such informationis accumulated and communicated to management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosures.

**InherentLimitations on Effectiveness of Controls**

Our disclosure controlsand procedures and our internal control over financial reporting may notprevent or detect all errors and all fraud. A control system, no matter howwell designed and operated, can provide only reasonable, not absolute,assurance that the objectives of the control system are met. The design of acontrol system must reflect the fact that there are resource constraints, andthe benefits of controls must be considered relative to their costs. Further,because of the inherent limitations in all control systems, no evaluation ofcontrols can provide absolute assurance that misstatements due to error orfraud will not occur or that all control issues and instances of fraud, if any,within Universal American have been detected. These inherent limitationsinclude the realities that judgments in decision-making can be faulty and thatbreakdowns can occur because of simple error or mistake. Controls can also becircumvented by the individual acts of some persons or by collusion of two ormore people. The design of 

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anysystem of controls is based in part on certain assumptions about the likelihoodof future events, and there can be no assurance that any design will succeed inachieving its stated goals under all potential future conditions. Projectionsof any evaluation of controls effectiveness to future periods are subject torisks. Over time, controls may become inadequate because of changes inconditions or deterioration in the degree of compliance with policies orprocedures.

**Evaluation ofEffectiveness of Controls**

An evaluation was carriedout under the supervision and with the participation of the Company’smanagement, including our Chief Executive Officer and Chief Financial Officer,of the effectiveness of our disclosure controls and procedures as of June 30,2007. Based on this evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof June 30, 2007, at a reasonable assurance level.

**Changes in InternalControl Over Financial Reporting**

There were no changes in our internal control overfinancial reporting that occurred during the quarter ended June 30, 2007that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

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**PART II**

**ITEM 1—LEGALPROCEEDINGS**

Please see Note 12—Commitmentsand Contingencies of the Notes to the Consolidated Financial Statements in Part I-Item 1 of this Form 10-Q, which is incorporated into this Part II—Item1—Legal Proceedings by reference, for information relating to litigationaffecting the Company.

**ITEM 1A—RISKFACTORS**

In addition to the otherinformation set forth in this report, you should consider carefully the risksand uncertainties described in the Current Report on Form 8-K dated August 8,2007 and under the caption “Part I- Item 1A. Risk Factors” in our AnnualReport on Form 10-K for the fiscal year ended December 31,2006, the occurrence of any of which could materially adversely affect ourbusiness, prospects, financial condition or results of operations. We alsocould be materially adversely affected by additional risks and uncertainties ofwhich we are not currently aware, or which we currently consider to beimmaterial.

**ITEM 2—UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

**Issuer purchases of Equity securities**

| **Period**                                   | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number of   Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number  of Shares That May  Yet Be Purchased  Under the Plans or  Programs** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| April 1,  2007–April 30, 2007 |       |                                             | —     |                                         |       |                                                                                                                                   | —     |                                                                                                                                |       |   | — |   |   |   | 984,472 |   |   |
| May 1, 2007–May 31,  2007     |       |                                             | —     |                                         |       |                                                                                                                                   | —     |                                                                                                                                |       |   | — |   |   |   | 984,472 |   |   |
| June 1, 2007–June 30,  2007   |       |                                             | —     |                                         |       |                                                                                                                                   | —     |                                                                                                                                |       |   | — |   |   |   | 984,472 |   |   |
| Total                                        |       |                                             | —     |                                         |       |                                                                                                                                   |       |                                                                                                                                |       |   | — |   |   |   |   |   |   |

 

**Recent Sales ofUnregistered Securities**

None, except as previouslydisclosed on Forms 8-K.

**ITEM 3—DEFAULTSUPON SENIOR SECURITIES**

There were no defaultsupon senior securities during the second quarter of 2007.

**ITEM 4—SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

**ITEM 5—OTHER INFORMATION**

Universal American hadelected to postpone its previously announced Annual Meeting of Stockholders, asa result of the proposed MemberHealth Transaction. The Annual Meeting ofStockholders is now scheduled for Thursday, August 26, 2007.

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**ITEM6—EXHIBITS**
|  2.1 |   | Agreement and Plan of Merger and Reorganization  (filed as Exhibit 2.1 to the Registrant’s Current Report on Form 8-K  (File No. 0-11321) dated May 7, 2007, and incorporated by  reference herein).                                                                                                                                                                                                            |
|-----------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|  3.1 |   | Restated Certificate of Incorporation of Universal  American Financial Corp. (filed as Exhibit 3.1 to the Registrant’s Amendment  No. 2 to the Registration Statement on Form S-3 (File  No. 333-62036) filed on July 11, 2001, and incorporated by  reference herein).                                                                                                                                    |
|  3.2 |   | Amendment No. 1 to  the Restated Certificate of Incorporation of Universal American Financial  Corp. (filed as Exhibit 3 to the Registrant’s Quarterly Report on  Form 10-Q (File No. 0-11321) for the quarter ended  June 30, 2004, and incorporated by reference herein).                                                                                                                                |
|  3.3 |   | Amended and Restated By-Laws  of Universal American Financial Corp. (filed as Exhibit A to the Registrant’s  Current Report on Form 8-K (File No. 0-11321) dated  August 13, 1999, and incorporated by reference herein).                                                                                                                                                                                       |
|  3.4 |   | Certificate of Amendment  to Universal American’s Certificate of Incorporation for the Series A  Preferred Stock (filed as Exhibit 3.1 to the Registrant’s Current Report  on Form 8-K (File No. 0-11321) dated May 7, 2007,  and incorporated by reference herein).                                                                                                                                  |
|  3.5 |   | Certificate of Amendment  to Universal American’s Certificate of Incorporation for the Series B  Preferred Stock (filed as Exhibit 3.2 to the Registrant’s Current Report  on Form 8-K (File No. 0-11321) dated May 7, 2007,  and incorporated by reference herein).                                                                                                                                  |
|  4.1 |   | Form of Indenture  dated as of December 2004 between Universal American Financial Corp. and  U.S. Bank National Association, as Trustee (filed as Exhibit 4.01 to  Amendment No. 1 to the Registrant’s Registration Statement on  Form S-3 (File No. 333-120190) filed with the  Securities and Exchange Commission on December 10, 2004, and  incorporated by reference herein).                |
|  4.2 |   | Form of Indenture  dated as of December 2004 between Universal American Financial Corp. and  U.S. Bank National Association, as Trustee (filed as Exhibit 4.02 to  Amendment No. 1 to the Registrant’s Registration Statement on  Form S-3 (File No. 333-120190) filed with the  Securities and Exchange Commission on December 10, 2004, and  incorporated by reference herein).                |
|  4.3 |   | 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 (filed as Exhibit A of  the Registrant’s Current Report on Form 8-K dated August 13,  1999, and incorporated by reference herein).                                                           |
|  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 (filed as Exhibit A to the Registrant’s Current  Report on Form 8-K dated August 13, 1999, and incorporated by  reference herein). |
|  4.5 |   | Guarantee Agreement,  dated as of March 22, 2007, by Universal American Financial Corp., as  Guarantor, and Wilmington Trust Company, as Trustee (filed as Exhibit 4.3  to the Registrant’s Current Report on Form 8-K dated  March 22, 2007, and incorporated herein by reference).                                                                                                                            |

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|  4.6 |   | Indenture, dated as of  March 22, 2007, between Universal American Financial Corp. and  Wilmington Trust Company, as Trustee, relating to Fixed/Floating Rate Junior  Subordinated Debentures Due 2037 (filed as Exhibit 4.1 to the  Registrant’s Current Report on Form 8-K dated March 22, 2007,  and incorporated herein by reference).                   |
|-----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.1      |   | Employment Agreement  dated July 30, 1999, between Registrant and Richard A. Barasch (filed as  Exhibit D to the Registrant’s Current Report on Form 8-K/A  dated March 14, 2001 and incorporated by reference herein).                                                                                                                                      |
| 10.2      |   | Employment Agreement  dated July 30, 1999, between Registrant and Gary Bryant (filed as  Exhibit E to the Registrant’s Current Report on Form 8-K/A  dated March 14, 2001 and incorporated by reference herein).                                                                                                                                             |
| 10.3      |   | Employment Agreement  dated July 30, 1999, between Registrant and Robert Waegelein (filed as  Exhibit E to the Registrant’s Current Report on Form 8-K/A  dated March 14, 2001 and incorporated by reference herein).                                                                                                                                        |
| 10.4      |   | Employment Letter dated  June 17, 2002, between the Company and Jason Israel (filed as  Exhibit 10.17 to the Registrant’s Current Report on Form 8-K  dated January 18, 2007, and incorporated herein by reference).                                                                                                                                         |
| 10.5      |   | Employment Agreement  dated March 9, 2004, by and among the Company, Heritage Health  Systems, Inc. and Theodore M. Carpenter, Jr. (filed as  Exhibit 10.18 to the Registrant’s Current Report on Form 8-K  dated January 18, 2007, and incorporated herein by reference).                                                                         |
| 10.6      |   | 1998 Incentive  Compensation Plan (filed as Annex A to the Registrant’s Definitive Proxy  Statement filed on Form 14A dated April 29, 1998, and incorporated  herein by reference).                                                                                                                                                                                    |
| 10.7      |   | Amendment No. 1 to  Universal American Financial Corp. 1998 Incentive Compensation Plan (filed as  Exhibit 10.1 to the Registrant’s Registration Statement on Form S-3  (Registration No. 333-120190) filed on November 3, 2004, and  incorporated herein by reference).                                                                                |
| 10.8      |   | Agent Equity Plan for  Agents of Penn Union Companies (filed as Amendment 1 to the Registrant’s  Registration Statement on Form S-2, dated July 13, 2000, and  incorporated herein by reference).                                                                                                                                                                      |
| 10.9      |   | Agent Equity Plan for  Regional Managers and Sub Managers of Penn Union Companies (filed as  Amendment 1 to the Registrant’s Registration Statement on Form S-2,  dated July 13, 2000, and incorporated herein by reference).                                                                                                                                          |
| 10.10     |   | Agreement dated as of  July 6, 2000, by and between ALICOMP, a division of ALICARE, Inc.  and Universal American Financial Corp., as amended (filed as  Exhibit 10.1 to the Registrant’s Form 10-Q/A (Amendment  No. 1) for the period ended September 30, 2003, dated  December 23, 2003, and incorporated herein by reference).             |
| 10.11     |   | Amended and Restated Credit  Agreement dated as of May 28, 2004, among the Company, various lending  institutions and Bank of America, N.A., as the Administrative Agent, the  Collateral Agent and the L/C Issuer, (filed as Exhibit 10.1 to the  Registrant’s Current Report on Form 8-K dated May 28, 2004,  and incorporated herein by reference).       |
| 10.12     |   | First Amendment to  Amended and Restated Credit Agreement dated as of June 2, 2005 among the  Company, the Banks party to the Credit Agreement and Bank of America, N.A.,  as the Administrative Agent (filed as Exhibit 10.12 to the Registrant’s  Annual Report on Form 10-K for the year ended December 31,  2005, and incorporated herein by reference). |

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| 10.13 |   | Waiver and Second  Amendment to Amended and Restated Credit Agreement dated as of  December 30, 2005 among the Company, the Banks party to the Credit  Agreement and Bank of America, N.A., as the Administrative Agent (filed as  Exhibit 10.13 to the Registrant’s Annual Report on Form 10-K  for the year ended December 31, 2005, and incorporated herein by reference).                                                                                                        |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.14 |   | Waiver and Third  Amendment to Amended and Restated Credit Agreement dated as of  November 29, 2006, among the Company, the Banks party to the Credit  Agreement and Bank of America, N.A., as the Administrative Agent (filed as  Exhibit 10.2 to the Registrant’s Current Report on Form 8-K  dated January 18, 2007, and incorporated herein by reference).                                                                                                                       |
| 10.15 |   | Credit Agreement dated  as of January 18, 2007, among the Company, one or more Lending  Institutions, and Bank of America, N.A., as the Administrative Agent and L/C  Issuer (filed as Exhibit 10.1 to the Registrant’s Current Report on  Form 8-K dated January 18, 2007, and incorporated herein by  reference).                                                                                                                                                                  |
| 10.16 |   | Addendum II for Item 1A  to agreement dated as of July 6, 2000, by and between ALICOMP, a  division of ALICARE, Inc. and Universal American Financial Corp. (filed  as Exhibit 10.13 to the Registrant’s Annual Report on Form 10-K  for the year ended December 31, 2004, and incorporated herein by  reference).                                                                                                                                                              |
| 10.17 |   | Quota Share Reinsurance  Agreement, dated June 30, 2005, among the Company and PharmaCare Captive  Re, Ltd. (filed as Exhibit 10.1 to the Registrant’s Quarterly Report on  Form 10-Q for the quarter ended September 30, 2005, and  incorporated herein by reference).                                                                                                                                                                                                              |
| 10.18 |   | Fourth Amendment dated  March 22, 2007, to Amended and Restated Credit Agreement dated as of  May 28, 2004 among the Company, the Banks party to the Credit Agreement  and Bank of America, N.A., as the Administrative Agent (filed as  Exhibit 10.1 to the Registrant’s Quarterly Report on Form 10-Q  for the quarter ended March 31, 2007, and incorporated herein by  reference).                                                                                          |
| 10.19 |   | First Amendment dated  March 22, 2007, to Credit Agreement dated as of January 18, 2007,  among the Company, one or more Lending Institutions, and Bank of America,  N.A., as the Administrative Agent and L/C Issuer (filed as Exhibit 10.2  to the Registrant’s Quarterly Report on Form 10-Q for the quarter  ended March 31, 2007, and incorporated herein by reference).                                                                                                   |
| 10.20 |   | Stage 1 securities  purchase agreement dated May 7, 2007 among Lee-Universal Holdings, LLC,  Welsh, Carson, Anderson & Stowe X, L.P., Union Square Universal  Partners, L.P., Perry Partners, L.P., Perry Partners  International, Inc., Perry Commitment Fund, L.P. and Perry Commitment  Master Fund, L.P. (filed as Exhibit 10.1 to the Registrant’s Current  Report on Form 8-K (File No. 0-11321) dated May 7,  2007, and incorporated by reference herein). |
| 10.21 |   | Stage 2 securities  purchase agreement dated May 7, 2007 among Lee-Universal Holdings, LLC,  Welsh, Carson, Anderson & Stowe X, L.P., Union Square Universal  Partners, L.P., Perry Partners, L.P., Perry Partners  International, Inc., Perry Commitment Fund, L.P. and Perry Commitment  Master Fund, L.P. (filed as Exhibit 10.2 to the Registrant’s Current  Report on Form 8-K (File No. 0-11321) dated May 7,  2007, and incorporated by reference herein). |
| 10.22 |   | Fifth Amendment to  Amended and Restated Credit Agreement dated as of May 7, 2007, among  Universal American Financial Corp., the Banks party to the Amended and Restated  Credit Agreement, and Bank of America, N.A., as Administrative Agent (filed  as Exhibit 10.2 to the Registrant’s Current Report on Form 8-K  (File No. 0-11321) dated May 15, 2007, and incorporated by  reference herein).                                                                          |

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| 10.23 |   | Second Amendment to  Credit Agreement dated as of May 7, 2007, among Universal American  Financial Corp., the Banks party to the Credit Agreement, and Bank of  America, N.A., as Administrative Agent (filed as Exhibit 10.2 to the  Registrant’s Current Report on Form 8-K (File No. 0-11321)  dated May 15, 2007, and incorporated by reference herein). |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.24 |   | Fourth Amendment dated  March 22, 2007, to Amended and Restated Credit Agreement dated as of  May 28, 2004 among the Company, the Banks party to the Credit Agreement  and Bank of America, N.A., as the Administrative Agent.                                                                                                                                                   |
| 10.25 |   | First Amendment dated  March 22, 2007, to Credit Agreement dated as of January 18, 2007,  among the Company, one or more Lending Institutions, and Bank of America,  N.A., as the Administrative Agent and L/C Issuer.                                                                                                                                                           |
| 11.1* |   | Statement re Computation  of per share Earnings (contained in the Consolidated Statements of Operations  in this Report).                                                                                                                                                                                                                                                                  |
| 23.1  |   | Consent of Dechert LLP  (filed as Exhibit 23.1 to the Registrant’s Form S-4, dated  July 17, 2007, and incorporated herein by reference).                                                                                                                                                                                                                              |
| 23.2  |   | Consents of  Ernst & Young LLP and Grant Thornton LLP (filed as Exhibit 23.2  to the Registrant’s Form S-4, dated July 17, 2007, and  incorporated herein by reference).                                                                                                                                                                                      |
| 24.1  |   | Powers of Attorney  (filed as Exhibit 24.1 to the Registrant’s Form S-4, dated  July 17, 2007, and incorporated herein by reference).                                                                                                                                                                                                                                  |
| 31.1* |   | Certification of Chief  Executive Officer, as required by Rule 13a-14(a) of the  Securities Exchange Act of 1934.                                                                                                                                                                                                                                                                |
| 31.2* |   | Certification of Chief  Financial Officer, as required by Rule 13a-14(a) of the  Securities Exchange Act of 1934.                                                                                                                                                                                                                                                                |
| 32.1* |   | Certification of the  Chief Executive Officer and Chief Financial Officer, as required by  Rule 13a-14(b) of the Securities Exchange Act of 1934 and 18  U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                   |

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*                    Filed orfurnished herewith.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                     | ** ** | **UNIVERSAL AMERICAN FINANCIAL CORP.**               |
|---------------------|------------|------------------------------------------------------|
| August 9, 2007 |       | /s/ RICHARD A. BARASCH                               |
|                |       | Richard A. Barasch                                   |
|                |       | Chief Executive Officer                              |
| August 9, 2007 |       | /s/ ROBERT A. WAEGELEIN                              |
|                |       | Robert A. Waegelein                                  |
|                |       | Executive Vice President and Chief Financial Officer |
|                |       | (Principal Accounting Officer)                       |

 

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