**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

**(Mark One)**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**Forthe quarterly period ended March 31, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

**Forthe transition periodfrom             to             **

**Commissionfile Number: 0-11321**

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**UNIVERSAL AMERICAN FINANCIAL CORP.**

(Exact name of registrantas specified in its charter)

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

 

**Six International 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 checkmarkwhether the registrant (1) has filed all reports required to be filed by Section 13or 15 (d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x   No o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

As of April 30, 2006, 58,398,558 shares of theregistrant’s common stock were issued 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  Stockholders’ Equity and Comprehensive   Income            |       | 6        |   |
|         |       |     |       | Consolidated Statements of  Cash Flows                                                      |       | 7        |   |
|         |       |     |       | Notes to Consolidated  Financial Statements                                                 |       | 8        |   |
|         |       | 2        |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operations |       | 24       |   |
|         |       | 3        |       | Quantitative and Qualitative  Disclosure of Market Risk                                     |       | 46       |   |
|         |       | 4        |       | Controls and Procedures                                                                     |       | 48       |   |
| PART II |       |     |       | Other  Information                                                                          |       |     |   |
|         |       | 1        |       | Legal Proceedings                                                                           |       | 50       |   |
|         |       | 1A       |       | Risk Factors                                                                                |       | 51       |   |
|         |       | 2        |       | Unregistered Sales of Equity  Securities and Use of Proceeds                                |       | 51       |   |
|         |       | 3        |       | Defaults Upon Senior  Securities                                                            |       | 51       |   |
|         |       | 4        |       | Submission of Matters to a  Vote of Security Holders                                        |       | 51       |   |
|         |       | 5        |       | Other Information                                                                           |       | 51       |   |
|         |       | 6        |       | Exhibits                                                                                    |       | 52       |   |
|         |       |     |       | Signatures                                                                                  |       | 53       |   |

 

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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 and certain oral statements made from time to time byrepresentatives of the Company may be considered “forward-looking statements”within the meaning of Section 21E of the Securities Exchange Act of 1934,as amended, and the Private Securities Litigation Reform Act of 1995. TheCompany intends such forward-looking statements to be covered by the safeharbor provisions for forward-looking statements contained in Section 21Eof the Exchange Act and the Private Securities Litigation Reform Act of 1995.Such forward-looking statements relate to, without limitation, the Company’sfuture economic performance, plans and objectives for future operations andprojections of revenue and other financial items. Forward-looking statementscan be identified by the use of words such as “prospects,” “outlook,” “believes,”“estimates,” “intends,” “may,” “will,” “should,” “anticipates,” “expects” or “plans,”or the negative or other variation of these or similar words, or by discussionof trends and conditions, strategy or risks and uncertainties. Forward-lookingstatements are inherently subject to risks, trends and uncertainties, many ofwhich are beyond the Company’s ability to control or predict with accuracy andsome of which the Company might not even anticipate. Although the Companybelieves that the expectations reflected in such forward-looking statements arebased upon reasonable assumptions at the time made, it can give no assurance thatits expectations will be achieved. Future events and actual results, financialand otherwise, may differ materially from the results discussed in theforward-looking statements. Readers are cautioned not to place undue relianceon these forward-looking statements.

Important factors that may cause actual results todiffer materially from forward-looking statements include, but are not limitedto, the risks and uncertainties set forth in our Annual Report on Form 10-Kin Item 1 “Business” and Item 1A “Risk Factors” and in this Quarterly Report onForm 10-Q in report Item 2 “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations”. The Company assumes noobligation to update and supplement any forward-looking statements that maybecome untrue because of subsequent events, whether as a result of newinformation, future events or otherwise.

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**PART I**

**ITEM 1—FINANCIALSTATEMENTS (Unaudited)**

**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In thousands)**

| ** **                                                                                                    | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                    | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| ASSETS                                                                                                        |       |                     |       |                        |       |   |   |   |   |
| Investments (Note 5):                                                                                         |       |                     |       |                        |       |   |   |   |   |
| Fixed maturities  available for sale, at fair value (amortized cost: 2006, $1,287,548; 2005,  $1,294,124)     |       |                     | $          | 1,316,228                   |       |   |   | $ | 1,344,775 |   |   |
| Policy loans                                                                                                  |       |                     | 23,598     |                        |       |   | 23,601 |   |   |
| Other invested  assets                                                                                        |       |                     | 1,658      |                        |       |   | 2,175 |   |   |
| Total investments                                                                                             |       |                     | 1,341,484  |                        |       |   | 1,370,551 |   |   |
| Cash and cash  equivalents                                                                                    |       |                     | 348,302    |                        |       |   | 138,899 |   |   |
| Accrued investment  income                                                                                    |       |                     | 12,576     |                        |       |   | 13,067 |   |   |
| Deferred policy  acquisition costs                                                                            |       |                     | 282,190    |                        |       |   | 272,542 |   |   |
| Amounts due from  reinsurers                                                                                  |       |                     | 273,191    |                        |       |   | 227,392 |   |   |
| Due and unpaid  premiums                                                                                      |       |                     | 23,141     |                        |       |   | 7,815 |   |   |
| Present value of  future profits and other amortizing intangible assets (Note 4)                         |       |                     | 60,432     |                        |       |   | 50,724 |   |   |
| Goodwill and other  indefinite lived intangible assets (Note 4)                                               |       |                     | 73,000     |                        |       |   | 73,000 |   |   |
| Income taxes  receivable                                                                                      |       |                     | —     |                        |       |   | 2,230 |   |   |
| Other assets                                                                                                  |       |                     | 136,290    |                        |       |   | 71,759 |   |   |
| Total assets                                                                                                  |       |                     | $          | 2,550,606                   |       |   |   | $ | 2,227,979 |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                     |       |                     |       |                        |       |   |   |   |   |
| LIABILITIES                                                                                                   |       |                     |       |                        |       |   |   |   |   |
| Policyholder  account balances                                                                                |       |                     | $          | 503,262                     |       |   |   | $ | 498,421 |   |   |
| Reserves for  future policy benefits                                                                          |       |                     | 790,528    |                        |       |   | 781,363 |   |   |
| Policy and  contract claims—life                                                                         |       |                     | 13,544     |                        |       |   | 14,525 |   |   |
| Policy and  contract claims—health                                                                       |       |                     | 163,043    |                        |       |   | 115,779 |   |   |
| Advance Premiums                                                                                              |       |                     | 77,585     |                        |       |   | 18,296 |   |   |
| CMS contract  deposits for amounts not at risk                                                                |       |                     | 151,545    |                        |       |   | — |   |   |
| Loan payable (Note  9)                                                                                        |       |                     | 94,500     |                        |       |   | 95,813 |   |   |
| Other long term  debt (Note 10)                                                                               |       |                     | 75,000     |                        |       |   | 75,000 |   |   |
| Amounts due to  reinsurers                                                                                    |       |                     | 29,887     |                        |       |   | 6,028 |   |   |
| Income taxes  payable                                                                                         |       |                     | 5,803      |                        |       |   | — |   |   |
| Deferred income  tax liability                                                                                |       |                     | 6,442      |                        |       |   | 20,072 |   |   |
| Other liabilities                                                                                             |       |                     | 110,626    |                        |       |   | 70,798 |   |   |
| Total liabilities                                                                                             |       |                     | 2,021,765  |                        |       |   | 1,696,095 |   |   |
| Commitments and contingencies (Note 12)                                                                       |       |                     |       |                        |       |   |   |   |   |
| STOCKHOLDERS’ EQUITY (Note 6)                                                                            |       |                     |       |                        |       |   |   |   |   |
| Common stock  (Authorized: 100 million shares, issued: 2006, 59.1 million shares; 2005,  59.0 million shares) |       |                     | 591        |                        |       |   | 590 |   |   |
| Additional paid-in  capital                                                                                   |       |                     | 243,815    |                        |       |   | 242,433 |   |   |
| Accumulated other  comprehensive income (Notes 6 and 14)                                                      |       |                     | 28,440     |                        |       |   | 39,896 |   |   |
| Retained earnings                                                                                             |       |                     | 267,226    |                        |       |   | 260,205 |   |   |
| Less: Treasury  stock (2006, 0.8 million shares; 2005, 0.8 million shares)                                    |       |                     | (11,231    | )                           |       |   | (11,240 | ) |   |
| Total  stockholders’ equity                                                                              |       |                     | 528,841    |                        |       |   | 531,884 |   |   |
| Total liabilities  and stockholders’ equity                                                              |       |                     | $          | 2,550,606                   |       |   |   | $ | 2,227,979 |   |   |

 

See notes to unaudited consolidated financial statements.

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**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSFor the Three Months Ended March 31, 2006 and 2005(Unaudited)(In thousands, per share amounts in dollars)**

| ** **                                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|
| Revenues:                                           |       |     |       |     |       |
| Direct premium and policyholder fees earned         |       | $        | 485,318    |     | $          | 253,344 |   |
| Reinsurance premiums assumed                        |       | 8,317    |       | 9,069    |       |
| Reinsurance premiums ceded                          |       | (184,329 | )          | (60,145  | )          |
| Net premiums and policyholder fees earned           |       | 309,306  |       | 202,268  |       |
| Net investment income                               |       | 20,129   |       | 16,681   |       |
| Net realized gains (losses) on investments          |       | (1       | )          | 1,073    |       |
| Fee and other income                                |       | 16,094   |       | 4,180    |       |
| Total revenues                                      |       | 345,528  |       | 224,202  |       |
| Benefits, Claims  and Expenses:                     |       |     |       |     |       |
| Claims and other benefits                           |       | 242,688  |       | 137,656  |       |
| Net increase in reserves for future policy benefits |       | 9,500    |       | 5,781    |       |
| Interest credited to policyholders                  |       | 4,470    |       | 4,545    |       |
| Increase in deferred acquisition costs              |       | (5,385   | )          | (15,687  | )          |
| Amortization of intangible assets (Note 4)          |       | 2,368    |       | 1,678    |       |
| Commissions                                         |       | 35,725   |       | 38,195   |       |
| Reinsurance commission and expense allowances       |       | (17,864  | )          | (14,408  | )          |
| Interest expense                                    |       | 3,042    |       | 2,511    |       |
| Other operating costs and expenses                  |       | 59,928   |       | 39,274   |       |
| Total benefits, claims and other deductions         |       | 334,472  |       | 199,545  |       |
| Income before taxes                                 |       | 11,056   |       | 24,657   |       |
| Income tax  expense                                 |       | 4,035    |       | 8,585    |       |
| Net income                                          |       | $        | 7,021      |     | $          | 16,072 |   |
| Earnings per common  share (Note 13):               |       |     |       |     |       |
| Basic                                               |       | $        | 0.12       |     | $          | 0.29 |   |
| Diluted                                             |       | $        | 0.12       |     | $          | 0.28 |   |

 

See notes to unaudited consolidated financial statements.

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**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY AND COMPREHENSIVE INCOMEFor the Three Months Ended March 31, 2006 and 2005(Unaudited)(In thousands)**

| ** **                                        | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **Total** | ** ** |
|---------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|-----------------------------------------------|------------|------------------------|------------|---------------------|------------|-----------|------------|
| **2005**                                          |       |              |       |                             |       |                                          |       |                   |       |                |       |      |       |   |   |   |   |
| Balance,  January 1, 2005                    |       |              | $          | 553                              |       |                                          | $          | 172,525                |       |                | $          | 40,983    |       |   | $ | 206,329 |   | $ | (969 | ) | $ | 419,421 |   |
| Net income                                        |       |              | —     |                             |       | —                                        |       |                   | —     |                |       | 16,072    |       | — |   | 16,072 |   |
| Other  comprehensive loss (Note 14)               |       |              | —     |                             |       | —                                        |       |                   | (8,313     | )                   |       | —    |       | — |   | (8,313 | ) |
| Comprehensive income                              |       |              |       |                             |       |                                          |       |                   |       |                |       |      |       |   |   | 7,759 |   |
| Issuance of common stock                          |       |              | 5          |                             |       | 3,156                                         |       |                   | —     |                |       | —    |       | — |   | 3,161 |   |
| Stock-based  compensation                         |       |              | —     |                             |       | 356                                           |       |                   | —     |                |       | —    |       | — |   | 356 |   |
| Repayments of  loans to officers                  |       |              | —     |                             |       | 20                                            |       |                   | —     |                |       | —    |       | — |   | 20 |   |
| Treasury shares  purchased, at cost (Note 6) |       |              | —     |                             |       | —                                        |       |                   | —     |                |       | —    |       | (11 | ) | (11 | ) |
| Treasury shares  reissued (Note 6)                |       |              | —     |                             |       | 593                                           |       |                   | —     |                |       | —    |       | 583 |   | 1,176 |   |
| Balance,  March 31, 2005                     |       |              | $          | 558                              |       |                                          | $          | 176,650                |       |                | $          | 32,670    |       |   | $ | 222,401 |   | $ | (397 | ) | $ | 431,882 |   |
| **2006**                                          |       |              |       |                             |       |                                          |       |                   |       |                |       |      |       |   |   |   |   |
| Balance,  January 1, 2006                    |       |              | $          | 590                              |       |                                          | $          | 242,433                |       |                | $          | 39,896    |       |   | $ | 260,205 |   | $ | (11,240 | ) | $ | 531,884 |   |
| Net income                                        |       |              | —     |                             |       | —                                        |       |                   | —     |                |       | 7,021     |       | — |   | 7,021 |   |
| Other  comprehensive loss (Note 14)               |       |              | —     |                             |       | —                                        |       |                   | (11,456    | )                   |       | —    |       | — |   | (11,456 | ) |
| Comprehensive loss                                |       |              |       |                             |       |                                          |       |                   |       |                |       |      |       |   |   | (4,435 | ) |
| Issuance of common stock                          |       |              | 1          |                             |       | 306                                           |       |                   | —     |                |       | —    |       | — |   | 307 |   |
| Stock-based  compensation                         |       |              | —     |                             |       | 1,075                                         |       |                   | —     |                |       | —    |       | — |   | 1,075 |   |
| Treasury shares  purchased, at cost (Note 6) |       |              | —     |                             |       | —                                        |       |                   | —     |                |       | —    |       | (8 | ) | (8 | ) |
| Treasury shares  reissued (Note 6)                |       |              | —     |                             |       | 1                                             |       |                   | —     |                |       | —    |       | 17 |   | 18 |   |
| Balance, March 31,  2006                     |       |              | $          | 591                              |       |                                          | $          | 243,815                |       |                | $          | 28,440    |       |   | $ | 267,226 |   | $ | (11,231 | ) | $ | 528,841 |   |

 

See notes to unaudited consolidated financial statements.

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**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSFor the Three Months Ended March 31, 2006 and 2005(Unaudited)(In thousands)**

| ** **                                                                                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating activities:                                                                        |       |     |       |     |       |
| Net income                                                                                                   |       | $        | 7,021      |     | $          | 16,072 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities, net of balances acquired: |       |     |       |     |       |
| Deferred income taxes                                                                                        |       | (7,465   | )          | 6,128    |       |
| Change in reserves for  future policy benefits                                                               |       | 10,183   |       | 540      |       |
| Change in policy and  contract claims                                                                        |       | 46,283   |       | 11,035   |       |
| Change in reinsurance  balances                                                                              |       | (22,658  | )          | (2,260   | )          |
| Change in deferred  policy acquisition costs                                                                 |       | (5,385   | )          | (15,687  | )          |
| Amortization of present  value of future profits and other intangibles                                       |       | 2,368    |       | 1,678    |       |
| Other amortization and  depreciation                                                                         |       | 1,774    |       | 960      |       |
| Net accretion of bond  discount                                                                              |       | (1,528   | )          | (988     | )          |
| Realized losses (gains)  on investments                                                                      |       | 1        |       | (1,073   | )          |
| Equity in the income of  unconsolidated subsidiary                                                           |       | (9,807   | )          | —   |       |
| Change in income taxes  payable                                                                              |       | 8,033    |       | 1,287    |       |
| Change in policy loans                                                                                       |       | 3        |       | 110      |       |
| Change in accrued  investment income                                                                         |       | 491      |       | (451     | )          |
| Other, net                                                                                                   |       | 29,220   |       | (5,983   | )          |
| Net cash provided by  operating activities                                                                   |       | 58,534   |       | 11,368   |       |
| Cash flows from investing activities:                                                                        |       |     |       |     |       |
| Proceeds from sale or  redemption of fixed maturities                                                        |       | 17,347   |       | 86,694   |       |
| Cost of fixed maturities  purchased                                                                          |       | (10,398  | )          | (146,420 | )          |
| Purchase of business                                                                                         |       | (12,075  | )          | —   |       |
| Other investing  activities                                                                                  |       | 37       |       | (902     | )          |
| Net cash used by  investing activities                                                                       |       | (5,089   | )          | (60,628  | )          |
| Cash flows from financing activities:                                                                        |       |     |       |     |       |
| Net proceeds from  issuance of common stock                                                                  |       | 559      |       | 2,173    |       |
| Cost of treasury stock  purchases                                                                            |       | (7       | )          | (11      | )          |
| Receipts from CMS  contract deposits                                                                         |       | 270,397  |       | —   |       |
| Withdrawals from CMS  contract deposits                                                                      |       | (118,852 | )          | —   |       |
| Change in policyholder  account balances                                                                     |       | 4,841    |       | 8,842    |       |
| Change in reinsurance on  policyholder account balances                                                      |       | 333      |       | (142     | )          |
| Principal repayment on  loan payable                                                                         |       | (1,313   | )          | (1,313   | )          |
| Net cash provided by  financing activities                                                                   |       | 155,958  |       | 9,549    |       |
| Net increase (decrease)  in cash and cash equivalents                                                        |       | 209,403  |       | (39,711  | )          |
| Cash and cash  equivalents at beginning of year                                                              |       | 138,899  |       | 181,257  |       |
| Cash and cash  equivalents at end of year                                                                    |       | $        | 348,302    |     | $          | 141,546 |   |
| Supplemental cash flow information:                                                                          |       |     |       |     |       |
| Cash paid for interest                                                                                       |       | $        | 3,061      |     | $          | 2,506 |   |
| Cash paid for income taxes                                                                                   |       | $        | 2,311      |     | $          | 1,207 |   |

 

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”, the “Company” or “Universal American”) is a specialtyhealth and life insurance holding company with an emphasis on providing a broadarray of health insurance and managed care products and services to the growingsenior population. Universal American was incorporated in the State of New Yorkin 1981. Collectively, our insurance company subsidiaries are licensed to selllife and accident & health insurance and annuities in all fiftystates, the District of Columbia, Puerto Rico and all the provinces of Canada.The principal insurance products currently sold by the Company are Medicare Supplementand Select, fixed benefit accident and sickness disability insurance, seniorlife insurance and fixed annuities. The Company distributes these productsthrough an independent general agency system and a career agency system. Thecareer agents focus on sales for Pennsylvania Life Insurance Company (“PennsylvaniaLife”), The Pyramid Life Insurance Company (“Pyramid Life”) and Penncorp LifeInsurance Company, a Canadian company (“Penncorp Life (Canada)”) while theindependent general agents sell for American Pioneer Life Insurance Company (“AmericanPioneer”), American Progressive Life & Health Insurance Company of NewYork (“American Progressive”), Constitution Life Insurance Company (“Constitution”),Marquette National Life Insurance Company (“Marquette”) and Union BankersInsurance Company (“Union Bankers”). Heritage Health Systems, Inc. (“Heritage”)operates Medicare Advantage plans in Houston and Beaumont Texas throughSelectCare of Texas, L.L.C., and in Oklahoma through SelectCare of Oklahoma, Inc.(formerly Eagle Life Insurance Company), and our Medicare Advantage privatefee-for-service plans. CHCS Services, Inc. (“CHCS”), the Company’sadministrative services company, acts as a service provider for both affiliatedand unaffiliated insurance companies for senior market insurance andnon-insurance programs. During 2005, we entered into a strategic alliance withPharmaCare Management Services, Inc. (“PharmaCare”), a wholly ownedsubsidiary of CVS Corporation (“CVS”), and created Part D ManagementServices, L.L.C. (“PDMS”). PDMS is 50% owned by Universal American and 50%owned by PharmaCare. We do not control PDMS and therefore PDMS is notconsolidated in our financial statements. PDMS principally performs marketingand risk management services on behalf of our PDPs and PharmaCare for which itreceives fees and other remuneration from our PDPs and PharmaCare. In 2006, webegan offering prescription drug benefit plans pursuant to Medicare Part D(“Part D”) through a strategic alliance with PharmaCare, a third partypharmacy benefits manager (“PBM”).

**2.   *SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES***

***Basis ofPresentation:***   The accompanyingconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States (“GAAP”) andconsolidate the accounts of Universal American Financial Corp. (“UniversalAmerican”) and its subsidiaries (collectively the “Company”), AmericanProgressive, American Pioneer, American Exchange Life Insurance Company (“AmericanExchange”), Pennsylvania Life, Peninsular Life Insurance Company (“Peninsular”),Union Bankers, Constitution, Marquette, Penncorp Life (Canada), Pyramid Life,Heritage and CHCS. For the insurance subsidiaries, GAAP differs from statutoryaccounting practices prescribed or permitted by regulatory authorities. Allmaterial intercompany transactions and balances between Universal American andits subsidiaries have been eliminated.

The interim financial information herein is unaudited,but in the opinion of management, includes all adjustments (consisting ofnormal, recurring adjustments) necessary to present fairly the financialposition and results of operations for such periods. The results of operationsfor the three months ended March 31, 2006 and 2005 are not necessarilyindicative of the results to be expected for the full year. The 

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accompanying consolidatedfinancial statements and notes should be read in conjunction with the Company’sAnnual Report on Form 10-K for the year ended December 31,2005.

***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.

***Significant Accounting Policies:  ***Fora description of significant accounting policies, see Note 2—Summary ofSignificant Accounting Policies in the notes to the Consolidated FinancialStatements included in the Company’s Annual Report on Form 10-K.

***Accounting forPrescription Drug Benefits under Medicare Part D***

On January 1, 2006, we began coveringprescription drug benefits in accordance with Medicare Part D as astand-alone benefit to Medicare eligible beneficiaries under Prescription DrugPlans (“PDPs”).

In general, pharmacy benefits under Medicare Part DPDPs may vary in terms of coverage levels and out-of-pocket costs forbeneficiary premiums, deductibles and co-insurance. However, all Part DPDPs must offer either “standard coverage” or its actuarial equivalent(with out-of-pocket threshold and deductible amounts that do not exceed thoseof standard coverage). These “defined standard” benefits represent the minimumlevel of benefits mandated by Congress. We also offer other PDPs containingbenefits in excess of the standard coverage limits for an additional beneficiarypremium.

The payment our PDPs receive monthly from the Centersfor Medicare and Medicaid Services, or CMS, generally represents our bid amountfor providing insurance coverage. We recognize premium revenue for providingthis insurance coverage for each month which members are entitled to service.However, our CMS payment includes subsidies and is subject to risk corridoradjustments in order for our PDPs and CMS to share the risk associated withfinancing the ultimate costs of the Part D benefit.

The amount of revenue payable to our PDPs by CMS issubject to adjustment, positive or negative, based upon the application of riskcorridors that compare a plan’s actual prescription drug costs as a percentageof revenues to the ratio targeted in their bids (“target amount’). Variancesexceeding, or below, certain thresholds may result in CMS making additionalpayments to us or requiring us to refund to CMS a portion of the payments wereceived. Actual prescription drug costs subject to risk sharing with CMS arelimited to the costs that are, or would have been, incurred under the CMS “definedstandard” benefit plan (“allowable risk corridor costs”). We estimate andrecognize an adjustment to premium revenues related to the risk corridorpayment adjustment based upon pharmacy claims experience to date as if theannual contract were to end at the end of each reporting period. Accordingly,this estimate does not consider future pharmacy claims experience.

Certain subsidies represent reimbursements from CMSfor claims we pay for which we assume little or no risk, including reinsurancepayments and low-income cost subsidies. A large percentage of claims paid abovethe out-of-pocket or catastrophic threshold for which we are not at risk areall reimbursed by CMS through the reinsurance subsidy for PDP plans offeringthe standard coverage. Low-income cost subsidies represent reimbursements fromCMS for all or a portion of the deductible, the coinsurance and the co-paymentamounts for low-income beneficiaries. We account for these subsidies as adeposit in our balance sheet and as a financing activity in our statement ofcash flows. We do not recognize premium revenue or 

9

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claims expense for thesesubsidies. Receipt and payment activity is accumulated at the contract leveland recorded to the balance sheet as a CMS contract deposit account asset orliability depending on the net contract balance at the end of the reportingperiod.

We recognize pharmacy benefit costs as incurred. Wehave subcontracted the pharmacy claims administration to PharmaCare, a thirdparty pharmacy benefit manager (“PBM”). Certain of our PDPs receive all ora portion of the rebates from drug companies on prescriptions filled. Theserebates are reflected as a reduction in pharmacy benefit costs. Pharmacybenefit costs are based on rates as contracted with PharmaCare.

We based our membership for Part D on March enrollmentinformation provided by CMS representing approximately 367,000 members enrolledin our PDPs for which we were paid by CMS. The membership information continuesto be reconciled and refined by CMS with respect to the allocation among allplans participating in the Part D program. As a result, it is likely thatthe membership data we based our results on for the first quarter willincrease, with a corresponding change in the financial results for the segment,however, we are unable to quantify the impact of this likely increase until themembership data is fully reconciled with CMS. Our claims expense is based onincurred pharmacy benefits for the reported enrolled membership.

During 2005, weentered into a strategic alliance with PharmaCare and created Part DManagement Services, L.L.C. (“PDMS”), which is 50% owned by Universal Americanand 50% owned by PharmaCare. PDMS principally performs marketing and riskmanagement services on behalf of our PDPs and PharmaCare for which it receives feesand other remuneration from our PDPs and PharmaCare. We do not control PDMS andtherefore PDMS is not consolidated in our financial statements. Our investmentin PDMS is accounted for on an equity basis and is included in other assets. AtMarch 31, 2006, our investment in the equity in PDMS was $10.1 million andat December 31, 2005, our share of the deficit of PDMS was $1.0 million. Ourshare in the net income of PDMS was $9.8 million for the three months ended March 31,2006 and is included in other income.

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

| ** **                   | ** ** | **March 31, 2006** | ** ** |
|------------------------------|------------|------------------------------|------------|
| ** **                   | ** ** | **(in thousands)**      | ** ** |
| *Assets*                     |       |                         |       |   |   |
| Cash and investments         |       |                         | $          | 13,444 |   |   |
| Other                        |       |                         | 7,502      |   |   |
| Total Assets                 |       |                         | $          | 20,946 |   |   |
| *Liabilities*                |       |                         |       |   |   |
| Accrued expenses and  other  |       |                         | $          | 793 |   |   |
| Equity                       |       |                         | 20,153     |   |   |
| Total liabilities and equity |       |                         | $          | 20,946 |   |   |

 

| ** **     | ** ** | **Three months  ended  March 31, 2006** | ** ** |
|----------------|------------|--------------------------------------------------------|------------|
| ** **     | ** ** | **(in thousands)**                                | ** ** |
| Total revenue  |       |                                                   | $          | 21,103 |   |   |
| Total expenses |       |                                                   | 1,490      |   |   |
| Net income     |       |                                                   | $          | 19,613 |   |   |

 

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

10

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**3.   *RECENT AND PENDING ACCOUNTING PRONOUNCEMENTS***

***Adoption of NewAccounting Pronouncements:***

***Accounting forStock-Based Compensation—******As of January 1, 2006, theCompany adopted***Financial Accounting Standards BoardStatement of Financial Accounting Standards No. 123-Revised, “Share-BasedPayment” (“FAS 123-R”) using the modified prospective method. FAS 123-Rrequires companies to recognize compensation costs for share-based payments toemployees and non-employee directors based on the grant date fair value of theaward and that this fair value be amortized over the grantees’ service period.The provisions of this standard require the fair value to be calculated using avaluation model (such as the Black-Scholes or binomial-lattice models). TheCompany has elected to use the Black-Scholes valuation model to value employeestock options, as it had done for its previous pro forma stock compensationdisclosures. Under the modified prospective method compensation cost isrecognized for the fair value of the unvested portion of existing arrangementsas of January 1, 2006, as well as the fair value for all new share-basedarrangements. Prior periods are not restated, as is allowed under the modifiedretrospective basis, but will continue to be disclosed on a pro forma basis inthe Notes to the Consolidated Financial Statements, as previously reported. SeeNote 7—Stock-Based Compensation for additional information.

***Other-Than-Temporary Impairment—******In*********November, 2005, the FinancialAccounting Standards Board issued FSP 115-1, “The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP115-1”). FSP 115-1 modifies certain existing guidance andestablishes a framework for the evaluation of whether an impairment of aninvestment is other-than-temporary. The evaluation is based on the intent andability to hold the security to maturity, and should be considered on an individualsecurity basis, not on a portfolio basis. FSP 115-1 also clarifies thatsubsequent to the recognition of an other-than-temporary impairment loss fordebt securities, an investor shall account for the security using the constanteffective yield method. FSP 115-1 is effective for reporting periodsbeginning after December 15, 2005, with earlier application permitted. Theadoption of FSP 115-1 did not have an effect on the Company’sconsolidated financial condition or results of operations. However, the frameworkprovided in FSP 115-1 could potentially result in the recognition ofunrealized losses, including those declines in value that are attributable tointerest rate movements, as other-than-temporary impairments, except thosedeemed to be minor in nature. As of March 31, 2006, the Company had $17.3million of total gross unrealized losses. The amount of impairments to berecognized, if any, will depend on market conditions and management’s intentand ability to hold securities with unrealized losses at the time of theimpairment evaluation.

***Future Adoption ofAccounting Standards:***

***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 adoptionencouraged. Initial application of SOP 05-1 should be as of the beginningof the entity’s fiscal year. The 

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Company expects toadopt SOP 05-1 effective January 1, 2007. Adoption of this statementis expected to have an effect on the Company’s consolidated financialstatements; however, the effect has not yet been determined.

**4.   *INTANGIBLE ASSETS***

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

| ** **                                         | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **Value  Assigned**          | ** ** | **Accumulated  Amortization**   | ** ** | **Value  Assigned** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                         | ** ** | **(In thousands)**      | ** ** |
| Senior Health Insurance:                           |       |                         |       |                            |       |   |   |   |   |   |   |   |   |
| Present value of future profits (“PVFP”) |       | $                            | 18,472     |                            |       | $ | 7,876 |   |   | $ | 18,472 |   |   | $ | 6,761 |   |   |
| Distribution Channel                               |       | 22,055                       |       |                            | 2,206      |   |   | 22,055 |   |   | 2,022 |   |   |
| Life Insurance and  Annuity—PVFP              |       | 4,127                        |       |                            | 1,653      |   |   | 4,127 |   |   | 1,577 |   |   |
| Senior Managed  Care—Medicare Advantage:      |       |                         |       |                            |       |   |   |   |   |   |   |   |   |
| PVFP—Healthplan membership                    |       | 15,381                       |       |                            | 4,025      |   |   | 15,381 |   |   | 3,558 |   |   |
| PVFP—IPA’s                               |       | 15,535                       |       |                            | 1,037      |   |   | 3,459 |   |   | 635 |   |   |
| Senior Administrative  Services                    |       |                         |       |                            |       |   |   |   |   |   |   |   |   |
| PVFP—Administrative service contracts         |       | 7,671                        |       |                            | 7,280      |   |   | 7,671 |   |   | 7,240 |   |   |
| PVFP—Override fees                            |       | 1,797                        |       |                            | 529        |   |   | 1,797 |   |   | 445 |   |   |
| Total                                              |       | $                            | 85,038     |                            |       | $ | 24,606 |   |   | $ | 72,962 |   |   | $ | 22,238 |   |   |

 

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

| ** **                    | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                    | ** ** | **(In thousands)**                          | ** ** |
| Balance,  beginning of year   |       | $                                                | 50,724     |   | $ | 60,804 |   |
| Additions                     |       | 12,076                                           |       | — |   |
| Amortization, net of interest |       | (2,368                                           | )          | (1,678 | ) |
| Balance, end of period        |       | $                                                | 60,432     |   | $ | 59,126 |   |

 

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 present value ofthe future profits, representing the value of the additional interest, and willbe amortized over ten years.

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

| 2006 (remainder  of year) |   | $      | 5,710  |   |
|---------------------------|--------|--------|--------|--------|
| 2007                      |   | 6,750  |   |
| 2008                      |   | 6,385  |   |
| 2009                      |   | 6,003  |   |
| 2010                      |   | 5,554  |   |
| Thereafter                |   | 30,030 |   |
|                      |   | $      | 60,432 |   |

 

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

| ** **                                   | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                                   | ** ** | **(In thousands)** | ** ** |
| Senior Market  Health Insurance              |       |                    | $          | 8,760                 | ** ** |   |   | $ | 8,760 | ** ** |   |
| Senior Managed  Care—Medicare Advantage |       |                    | 59,883     | ** **            |       |   | 59,883 | ** ** |   |
| Senior  Administrative Services              |       |                    | 4,357      | ** **            |       |   | 4,357 | ** ** |   |
| Total                                        |       |                    | $          | 73,000                | ** ** |   |   | $ | 73,000 | ** ** |   |

 

***5.***   INVESTMENTS

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

| ** **                                                   | ** ** | **March 31, 2006** | ** ** |
|--------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                   | ** ** | ** **                   | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **Amortized**                | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Classification**                                           | ** ** | ** **                   | ** ** | **Cost** | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**      | ** ** |
| U.S. Treasury  securities and obligations of U.S. government |       | $                            | 113,190    |   |   | $ | 58 |   |   |   | $ | (2,174 | ) |   | $ | 111,074 |   |
| Corporate debt  securities                                   |       | 446,970                      |       |   | 7,896 |   |   |   | (7,864 | ) |   | 447,002 |   |
| Foreign debt  securities(1)                                  |       | 223,032                      |       |   | 35,516 |   |   |   | (809 | ) |   | 257,739 |   |
| Mortgage-backed  and asset-backed securities                 |       | 504,356                      |       |   | 2,480 |   |   |   | (6,423 | ) |   | 500,413 |   |
|                                                         |       | $                            | 1,287,548  |   |   | $ | 45,950 |   |   |   | $ | (17,270 | ) |   | $ | 1,316,228 |   |
|                                                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                   | ** ** | **December 31, 2005** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Classification**                                           | ** ** | ** **                      | ** ** | **Cost** | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**         | ** ** |
| U.S. Treasury  securities and obligations of U.S. government |       | $                               | 112,857    |   |   | $ | 262 |   |   |   | $ | (1,258 | ) |   | $ | 111,861 |   |
| Corporate debt  securities                                   |       | 449,639                         |       |   | 12,956 |   |   |   | (3,786 | ) |   | 458,809 |   |
| Foreign debt  securities(1)                                  |       | 223,428                         |       |   | 42,949 |   |   |   | (209 | ) |   | 266,168 |   |
| Mortgage-backed  and asset-backed securities            |       | 508,200                         |       |   | 3,148 |   |   |   | (3,411 | ) |   | 507,937 |   |
|                                                         |       | $                               | 1,294,124  |   |   | $ | 59,315 |   |   |   | $ | (8,664 | ) |   | $ | 1,344,775 |   |
|                                                              |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Primarily Canadiandollar denominated bonds supporting our Canadian insurance reserves.

 

13

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Theamortized cost and fair value of fixed maturities at March 31, 2006 bycontractual maturity are shown below. Expected maturities will differ fromcontractual maturities because borrowers may have the right to call or prepayobligations with or without call or prepayment penalties.

| ** **                                   | ** ** | **Amortized**           | ** ** | **Fair**  | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-----------|------------|
| ** **                                   | ** ** | **Cost**                | ** ** | **Value** | ** ** |
| ** **                                   | ** ** | **(In thousands)** | ** ** |
| Due in 1 year or  less                       |       | $                       | 53,233     |      | $          | 54,289 |   |
| Due after 1 year  through 5 years            |       | 239,138                 |       | 239,917   |       |
| Due after 5 years  through 10 years          |       | 289,747                 |       | 294,200   |       |
| Due after 10 years                           |       | 201,204                 |       | 227,410   |       |
| Mortgage-backed  and asset-backed securities |       | 504,226                 |       | 500,412   |       |
|                                         |       | $                       | 1,287,548  |      | $          | 1,316,228 |   |

 

***6.  *STOCKHOLDERS’EQUITY**

*Preferred Stock*

The Company has 2.0million authorized shares of preferred stock with no such shares issued or outstandingat March 31, 2006 or December 31, 2005.

*Common Stock*

The par value of commonstock is $0.01 per share with 100 million shares authorized for issuance. Changesin the number of shares of common stock issued were as follows:

| ** **                                                                               | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                               | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Common stock  issued, beginning of year                                                  |       | 59,042,685                                       |       | 55,326,092 |   |
| Stock options  exercised                                                                 |       | 47,283                                           |       | 378,317 |   |
| Agent stock award                                                                        |       | (639                                             | )          | 60,002 |   |
| Stock purchases  pursuant to agents’ stock purchase and deferred compensation plans |       | 1,200                                            |       | 1,100 |   |
| Common stock issued, end  of period                                                      |       | 59,090,529                                       |       | 55,765,511 |   |

 

*Treasury Stock*

TheCompany currently has 1,000,255 shares available to purchase pursuant to sharerepurchase programs approved by our Board of Directors in November 2005 andDecember 2003. Changes in the number of shares of Treasury stock issuedwere as follows:

| ** **                                          | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                          | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                                          | ** ** | **Shares**                                           | ** ** | **Amount** | ** ** | **Weighted  Average  Cost Per  Share** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost Per  Share** | ** ** |
| ** **                                          | ** ** | ** **                                           | ** ** | **(In thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** | **(In thousands)** | ** ** | ** ** | ** ** |
| Treasury stock  beginning of year                   |       | 751,473                                              |       |   | $ | 11,240 |   |   |   | $ | 14.96 |   |   | 124,941 |   |   | $ | 969 |   |   |   | $ | 7.75 |   |   |
| Shares  repurchased                                 |       | 513                                                  |       |   | 8 |   |   |   | 14.85 |   |   | 750 |   |   | 11 |   |   |   | 15.11 |   |   |
| Shares  distributed in the form of employee bonuses |       | (1,156                                               | )          |   | (17 | ) |   |   | 15.08 |   |   | (74,771 | ) |   | (583 | ) |   |   | 15.72 |   |   |
| Treasury stock, end of  period                      |       | 750,830                                              |       |   | $ | 11,231 |   |   |   | $ | 14.96 |   |   | 50,920 |   |   | $ | 397 |   |   |   | $ | 7.81 |   |   |

 

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*Accumulated OtherComprehensive Income*

Thecomponents of accumulated other comprehensive income are as follows:

| ** **                                        | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | **(In thousands)**  | ** ** |
| Net unrealized appreciation  on  investments |       | $                        | 28,679     |                        |       | $ | 50,631 |   |   |
| Deferred  acquisition cost adjustment             |       | 3,181                    |       |                        | (1,265     | ) |   |
| Foreign currency  translation gains               |       | 10,183                   |       |                        | 10,469     |   |   |
| Fair value of  cash flow swap                     |       | 1,714                    |       |                        | 1,544      |   |   |
| Deferred tax on  the above                        |       | (15,317                  | )          |                        | (21,483    | ) |   |
| Accumulated other  comprehensive income           |       | $                        | 28,440     |                        |       | $ | 39,896 |   |   |

 

***7.  *STOCK-BASEDCOMPENSATION**

TheCompany has various stock-based incentive plans for its employees, non-employeedirectors and its agents. The Company issues new shares upon the exercise ofoptions. Detailed information for activity in the Company’s stock plans can befound in the financial statement section of our Annual Report on Form 10-Kin Note 8—Stock-Based Compensation. The Company adopted FAS 123-Rbeginning January 1, 2006, using the modified prospective method, andbegan recognizing compensation cost for share-based payments to employees andnon-employee directors based on the grant date fair value of the award, whichis amortized over the grantees’ service period. The Company has elected to usethe Black-Scholes valuation model to value employee stock options, as it haddone for its previous pro forma stock compensation disclosures. The adoption ofFAS 123-R did not have a material effect on the Company’s method ofcomputing compensation costs for options from that used to prepare the proforma disclosures in prior periods. The effect of the adoption of FAS 123-Ron selected line items is as follows

| **(In thousands, except per share amounts)** | ** ** | ** ** | ** ** | **Three months  ended  March 31,  2005** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|----------------------------------------------------|------------|
| Stock option  expense                                                 |       |       | $          | 715                                                |       |   |
| Income before  taxes                                                  |       |       | (715       | )                                                  |       |
| Income tax  (benefit)                                                 |       |       | (261       | )                                                  |       |
| Net income                                                            |       |       | (454       | )                                                  |       |
| Cash flows from  operations                                           |       |       | (253       | )                                                  |       |
| Cash flows from  financing                                            |       |       | 253        |                                               |       |
| Net income per share:                                                 |       |       |       |                                               |       |
| Basic                                                                 |       |       | $          | 0.01                                               |       |   |
| Diluted                                                               |       |       | $          | 0.01                                               |       |   |

 

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.

15

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Compensationcosts for share-based payments to employees and non-employee didrectors underthe fair value method prior to adoption of FAS 123-R is not reflected inthe financial statements of those periods. The following table illustrates theeffect on net income and earnings per share if the fair value based method hadbeen applied to those periods.

| **(In thousands, except per share amounts)**                                        | ** ** | ** ** | ** ** | **Three months  ended  March 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------------------------------------------------|------------|
| Reported net  income                                                                                         |       |       | $          | 16,072                                             |       |   |
| Add back:  Stock-based compensation expense included in reported net income, net of tax                      |       |       | 281        |                                               |       |
| Less: Stock-based  compensation expense determined under fair value based method for all awards,  net of tax |       |       | (614       | )                                                  |       |
| Pro forma net  income                                                                                        |       |       | $          | 15,739                                             |       |   |
| Net income per  share:                                                                                       |       |       |       |                                               |       |
| Basic, as reported                                                                                           |       |       | $          | 0.29                                               |       |   |
| Basic, pro forma                                                                                             |       |       | $          | 0.28                                               |       |   |
| Diluted, as reported                                                                                         |       |       | $          | 0.28                                               |       |   |
| Diluted, pro  forma                                                                                          |       |       | $          | 0.27                                               |       |   |

 

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

| Risk free  interest rates             |   | 3.12% - 6.68%   |   |
|---------------------------------------|--------|---------------------------|--------|
| Dividend yields                       |   | 0.0%                      |   |
| Expected  volatility                  |   | 40.00% - 48.64% |   |
| Expected lives of  options (in years) |   | 0 - 9.0%        |   |

 

A summary of optionactivity as of and for the three months ended March 31, 2006 is presentedbelow:

| ** **                        | ** ** | **Options  (in thousands)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value  (in thousands)** | ** ** |
|-----------------------------------|------------|----------------------------------|------------|----------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Outstanding at  beginning of year |       |                             | 4,823      |                                   |       |                                                                 | $          | 6.81                                                 |       |   |   | 5.2 |   |   |   |   |   |   |
| Granted                           |       |                             | 41         |                                   |       |                                                                 | 17.98      |                                                 |       |   |   |   |   |   |   |   |   |
| Exercised                         |       |                             | (47        | )                                      |       |                                                                 | 6.10       |                                                 |       |   |   |   |   |   |   |   |   |
| Forfeited or  expired             |       |                             | (25        | )                                      |       |                                                                 | 13.10      |                                                 |       |   |   |   |   |   |   |   |   |
| Outstanding at  end of period     |       |                             | 4,792      |                                   |       |                                                                 | $          | 6.82                                                 |       |   |   | 4.7 |   |   |   | $ | 42,107 |   |   |
| Exerciseable at end of  period    |       |                             | 3,637      |                                   |       |                                                                 | $          | 6.04                                                 |       |   |   | 4.3 |   |   |   | $ | 34,544 |   |   |

 

The weighted-average grant-date fair value of optionsgranted during the three months ended March 31, 2006 was $4.72 and was $6.11for options granted during the three months ended March 31, 2005. Thetotal intrinsic value of options exercised during the three months ended March 31,2006 was $0.4 million and was $3.7 million for options exercised duringthe three months ended March 31, 2005.

As of March 31, 2006, the total compensation costrelated to non-vested awards not yet recognized was $3.4 million, which isexpected to be recognized over a weighted average period of 1 year.

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Cash received from theexercise of stock options was $0.3 million in the first three months of 2006and was $2.2 million in the first three months of 2005. FAS 123-Ralso requires the benefits of tax deductions in excess of recognizedcompensation cost to be reported as a financing cash flow, rather than as anoperating cash flow as required under prior literature. The amount of financingcash flows recognized for such excess tax deductions were $0.3 million for thethree months ended March 31, 2006. The amount of operating cash flowsrecognized for such excess tax deductions were $1.0 million for the threemonths ended March 31, 2005.

***8.  *STATUTORYFINANCIAL DATA**

The insurance subsidiaries are required to maintainminimum amounts of statutory capital and surplus as required by regulatoryauthorities. However, substantially more than such minimum amounts are neededto meet statutory and administrative requirements of adequate capital andsurplus to support the current level of our insurance subsidiaries’ operations.Each of the life insurance subsidiaries’ statutory capital and surplus exceedsits respective minimum statutory requirement at levels we believe aresufficient to support their current levels of operation. Additionally, theNational Association of Insurance Commissioners (“NAIC”) imposes regulatoryrisk-based capital (“RBC”) requirements on life insurance enterprises. At March 31,2006, all of our life insurance subsidiaries maintained ratios of totaladjusted capital to RBC in excess of the “authorized control level”. Thecombined statutory capital and surplus, including asset valuation reserve, ofthe U.S. life insurance subsidiaries totaled $172.4 million at March 31,2006 and $158.4 million at December 31, 2005. For the three months ended March 31,2006, the insurance subsidiaries generated statutory net income of $2.9 millionand for the three months ended March 31, 2005, the insurance subsidiariesgenerated statutory net income of $0.1 million.

Our health plan affiliates are also required tomaintain minimum amounts of capital and surplus, as required by regulatoryauthorities and are also subject to RBC requirements. At March 31, 2006,the statutory capital and surplus of each of our health plan affiliates exceedsits minimum requirement and its RBC is in excess of the “authorized controllevel”. The statutory capital and surplus for our health plan affiliates was$27.7 million at March 31, 2006 and $23.0 million at December 31,2005. Statutory net income for our health plan affiliates was $3.1 million forthe three months ended March 31, 2006 and $2.6 million for the threemonths ended March 31, 2005.

Penncorp Life (Canada)reports to Canadian regulatory authorities based upon Canadian statutoryaccounting principles that vary in some respects from U.S. statutory accountingprinciples. Penncorp Life (Canada)’s net assets based upon Canadian statutoryaccounting principles were C$64.3 million (US$55.0 million) as of March 31,2006 and were C$62.3 million (US$53.6 million) as of December 31,2005. Penncorp Life (Canada) maintained a Minimum Continuing Capital andSurplus Requirement Ratio (“MCCSR”) in excess of the minimum requirement at March 31,2006. Net income for Penncorp Life (Canada) based on Canadian generallyaccepted accounting principles was C$2.0 million (US$1.7 million) for the threemonths ended March 31, 2006, C$1.9 million (US$1.6 million) for the threemonths ended March 31, 2005.

***9.  *LOANPAYABLE**

*Credit Facility, asAmended in May 2004*

In connection with the acquisition of Heritage on May 28,2004, the Company amended the Credit Agreement by increasing the facility to$120.0 million from $80.0 million (the “Amended Credit Agreement”), includingan increase in the term loan portion to $105.0 million from $36.4 million (thebalance outstanding at May 28, 2004) and maintaining the $15.0 millionrevolving loan facility. None of the revolving loan facility has been drawn asof March 31, 2006. Under the Amended Credit Agreement, the spread overLIBOR was reduced to 225 basis points. Effective April 1, 2006, theinterest rate on the term 

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loan was 7.2%. Principalrepayments are scheduled at $5.3 million per year over a five-year period witha final payment of $80.1 million due upon maturity on March 31, 2009.

The Company made regularly scheduled principalpayments of $1.3 million during the three months ended March 31, 2006 and$1.3 million during the three months ended March 31, 2005, in connectionwith its credit facilities. The Company paid interest of $1.6 million duringthe three months ended March 31, 2006 and $1.2 million during the threemonths ended March 31, 2005, in connection with its credit facilities.

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

| 2006 (remainder  of the year) |   | $      | 3,937  |   |
|-------------------------------|--------|--------|--------|--------|
| 2007                          |   | 5,250  |   |
| 2008                          |   | 5,250  |   |
| 2009                          |   | 80,063 |   |
|                          |   | $      | 94,500 |   |

 

***10.  *OTHERLONG TERM 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. The Trusts have issued a combined $75.0 million in thirty yeartrust preferred securities.

The Company paid $1.4million in interest in connection with the Junior Subordinated Debt during thethree months ended March 31, 2006, and $1.3 million during the threemonths ended March 31, 2005.

***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 swaps aredesignated and qualify as cash flow hedges, and changes in their fair value arerecorded in accumulated other comprehensive income. The combined fair value ofthe swaps was $1.7 million at March 31, 2006 and $1.5 million atDecember 31, 2005 and is included in other assets.

**12.   *COMMITMENTS AND CONTINGENCIES***

*SecuritiesClass Action and Derivative Litigation*

Five actions containing related factual allegationswere filed against the Company and certain of its officers and directorsbetween November 22, 2005 and February 2, 2006. One of these actionswas voluntarily withdrawn by plaintiffs, and four actions are now pending, twoof which have been consolidated.

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In the first action, Robert Kemp filed a purportedclass action complaint (the “Kemp Action”) on November 22, 2005, in theUnited States District Court for the Southern District of New York. The KempAction is a purported class action asserted on behalf of those shareholders ofthe Company who acquired the Company’s common stock between February 16,2005 and October 28, 2005. Plaintiffs in the Kemp Action seek unspecifieddamages under Section 10(b) and 20(a) of the Securities ExchangeAct of 1934 based upon allegedly false statements by the Company and Richard A.Barasch, Robert A. Waegelein and Gary W. Bryant (hereinafter, the “OfficerDefendants”) in press releases, financial statements and analyst conferencesduring the class period.

Another purported class action was filed by WesternTrust Laborers-Employers Pension Trust (the “Western Trust Action”), a putativeclass member in the Kemp Action who had filed a motion to be named as leadplaintiff in that action, on February 2, 2006, in the United States DistrictCourt for the Southern District of New York. The factual and legal allegationsin the Western Trust Action, which also purports to be a class action, aresimilar to those in the Kemp Action. By order dated May 1, 2006, the KempAction and the Western Trust Action were consolidated, and Western TrustLaborers-Employers Pension Trust was named lead plaintiff.

Two additional actions have been brought derivativelyby shareholders purporting to act on behalf of the Company, and not as classactions. One of these was filed by Green Meadows Partners LLP (the “GreenMeadows Action”) on December 13, 2005, in the United States District Courtfor the Southern District of New York, and has been assigned to the same judgepresiding over the Kemp Action and the Western Trust Action. In the GreenMeadows Action, plaintiffs seek contribution under Section 10(b) and 21Dof the Exchange Act on the ground that if the Company is found liable to haveviolated the securities laws in the Kemp Action, then the Officer Defendantsare liable for contribution. The Green Meadows Action also asserts three claimsunder state law for breach of fiduciary duty against the Officer Defendants.

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.

All of the cases are at apreliminary stage. In the consolidated class actions, the Court has adopted aschedule under which the lead plaintiff will file an amended consolidatedcomplaint by June 19, 2006, and defendants’ motion to dismiss thatcomplaint will be fully briefed and argued by December 13, 2006. The Courthas adopted a similar schedule in the Green Meadows Action. In the TsutsuiAction, the time for defendants initially to respond to the complaint has beenextended to June 2, 2006. Each of the Officer Defendants denies theallegations in the cases and has indicated that he intends to vigorously defendagainst the allegations. Management believes that after liability insurancerecoveries, none of these actions will have a material adverse effect on us.

*Other Litigation*

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

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**13.   *EARNINGS PER SHARE***

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

| ** **                                 | ** ** | **Three months ended March 31, 2006**                 | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Income**                                                                     | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                 | ** ** | ** (Numerator) **                                                    | ** ** | ** (Denominator) ** | ** ** | ** Amount ** | ** ** |
| ** **                                 | ** ** | **(In thousands, per share amounts in dollars)** | ** ** |
| Weighted average  common stock outstanding |       |                                                                           |       |   |   |   | 59,056 |   |   |   |   |   |   |
| Less: Weighted  average treasury shares    |       |                                                                           |       |   |   |   | (751 | ) |   |   |   |   |   |
| Basic earnings per share                   |       |                                                                           | $          | 7,021 |   |   |   | 58,305 |   |   |   | $ | 0.12 |   |   |
| Effect of dilutive securities              |       |                                                                           |       |   |   |   | 1,611 |   |   |   |   |   |   |
| Diluted EPS                                |       |                                                                           | $          | 7,021 |   |   |   | 59,916 |   |   |   | $ | 0.12 |   |   |

 

| ** **                                 | ** ** | **Three months ended March 31, 2005**                 | ** ** |
|--------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Income**                                                                     | ** ** | **Shares** | ** ** | **Per Share** | ** ** |
| ** **                                 | ** ** | ** (Numerator) **                                                    | ** ** | ** (Denominator) ** | ** ** | ** Amount ** | ** ** |
| ** **                                 | ** ** | **(In thousands, per share amounts in dollars)** | ** ** |
| Weighted average  common stock outstanding |       |                                                                           |       |   |   |   | 55,495 |   |   |   |   |   |   |
| Less: Weighted  average treasury shares    |       |                                                                           |       |   |   |   | (100 | ) |   |   |   |   |   |
| Basic earnings per share                   |       |                                                                           | $          | 16,072 |   |   |   | 55,395 |   |   |   | $ | 0.29 |   |   |
| Effect of dilutive securities              |       |                                                                           |       |   |   |   | 1,999 |   |   |   |   |   |   |
| Diluted EPS                                |       |                                                                           | $          | 16,072 |   |   |   | 57,394 |   |   |   | $ | 0.28 |   |   |

 

**14.   *OTHER COMPREHENSIVE INCOME***

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

| ** **                                                                            | ** ** | **Three months ended March 31, 2006** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **Before Tax  Amount**                                    | ** ** | **Tax Expense  (Benefit)** | ** ** | **Net of Tax  Amount** | ** ** |
| ** **                                                                            | ** ** | **(In thousands)**                                        | ** ** |
| Net unrealized loss arising during  the year (net of deferred acquisition costs) |       |                                                           | $          | (17,507 | ) |   |   | $ | (6,126 | ) |   | $ | (11,381 | ) |
| Reclassification adjustment for gains  included in net income                    |       |                                                           | 1          |   |   |   | — |   |   | 1 |   |
| Net unrealized loss                                                                   |       |                                                           | (17,506    | ) |   |   | (6,126 | ) |   | (11,380 | ) |
| Cash Flow Hedge                                                                       |       |                                                           | 170        |   |   |   | 60 |   |   | 110 |   |
| Foreign currency translation adjustment                                               |       |                                                           | (286       | ) |   |   | (100 | ) |   | (186 | ) |
| Other  comprehensive loss                                                             |       |                                                           | $          | (17,622 | ) |   |   | $ | (6,166 | ) |   | $ | (11,456 | ) |

 

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| ** **                                                                            | ** ** | **Three months ended March 31, 2005** | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                            | ** ** | **Before Tax  Amount**                                    | ** ** | **Tax Expense  (Benefit)** | ** ** | **Net of Tax  Amount** | ** ** |
| ** **                                                                            | ** ** | **(In thousands)**                                        | ** ** |
| Net unrealized loss arising during  the year (net of deferred acquisition costs) |       |                                                           | $          | (12,146 | ) |   |   | $ | (4,251 | ) |   |   | $ | (7,895 | ) |   |
| Reclassification adjustment for gains  included in net income                    |       |                                                           | (1,073     | ) |   |   | (376 | ) |   |   | (697 | ) |   |
| Net unrealized loss                                                                   |       |                                                           | (13,219    | ) |   |   | (4,627 | ) |   |   | (8,592 | ) |   |
| Cash Flow Hedge                                                                       |       |                                                           | 657        |   |   |   | 230 |   |   |   | 427 |   |   |
| Foreign currency translation adjustment                                               |       |                                                           | (227       | ) |   |   | (79 | ) |   |   | (148 | ) |   |
| Other  comprehensive loss                                                             |       |                                                           | $          | (12,789 | ) |   |   | $ | (4,476 | ) |   |   | $ | (8,313 | ) |   |

 

**15.  ***BUSINESS SEGMENT INFORMATION*

The Company’s principal business segments are based onproduct and include: Senior Managed Care—Medicare Advantage, Senior MarketHealth Insurance, Specialty Health Insurance, Life Insurance and Annuity andSenior Administrative Services. The Company also reports the activities of ourholding company in a separate segment. Reclassifications have been made toconform prior year amounts to the current year presentation. A description ofthese segments follows:

**Senior Managed Care—MedicareAdvantage—****The**Senior Managed Care—MedicareAdvantage segment includes the operations of our initiatives in managed carefor seniors. We operate various health plans, including SelectCare of Texas,that offer coverage to Medicare beneficiaries, under a contract with CMS, inSoutheastern Texas, Oklahoma and Florida. The health plans are sold by ourcareer agency sales force and directly by employee representatives. Inconnection with the health plans, we operate separate Management ServiceOrganizations (“MSO’s”) that manage that business and affiliated IndependentPhysician Associations (“IPA’s”). We participate in the net results derivedfrom these affiliated IPA’s. Our Medicare Advantage private fee-for-serviceplans, also under a contract with CMS, and are sold by our career andindependent agents. We currently market PFFS products in 459 countiesthroughout 15 states.

**SeniorMarket Health Insurance**—This segment consists of our MedicareSupplement business and other senior market health products distributed throughour career agency sales force and through our network of independent generalagencies, as well as our new Medicare Part D plans 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**—Thissegment includes specialty health insurance products, primarily fixed benefitaccident and sickness disability insurance sold to the middle incomeself-employed market in the United States and Canada. This segment alsoincludes certain products that we no longer sell such as long term care andmajor medical. This segment’s products are distributed primarily by our careeragents.

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

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**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, claims adjudication, case management, care assessment,referral to health care facilities and administration of our Part Dprescription drug plans on behalf of our subsidiaries which commenced on January 1, 2006.

**Corporate**—Thissegment reflects the activities of Universal American, including debt service,certain senior executive compensation, and compliance with requirementsresulting from our 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 March 31,** | ** ** |
|----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                   | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **Revenue**                                          | ** ** | **Income  (Loss)  Before  Income  Taxes** | ** ** | **Revenue** | ** ** | **Income  (Loss)  Before  Income  Taxes** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                              | ** ** |
| Senior Managed  Care—Medicare Advantage |       | $                                                    | 91,035     |   | $ | 9,232 |   | $ | 53,277 |   | $ | 7,041 |   |
| Senior Market  Health Insurance              |       | 178,790                                              |       | (860 | ) | 99,231 |   | 6,830 |   |
| Specialty Health  Insurance                  |       | 44,955                                               |       | 4,697 |   | 44,114 |   | 5,574 |   |
| Life Insurance  and Annuity                  |       | 25,041                                               |       | 1,042 |   | 22,833 |   | 4,040 |   |
| Senior  Administrative Services              |       | 20,204                                               |       | 2,427 |   | 14,908 |   | 3,615 |   |
| Corporate                                    |       | 135                                                  |       | (5,481 | ) | 51 |   | (3,516 | ) |
| Intersegment  revenues                       |       | (14,631                                              | )          | — |   | (11,285 | ) | — |   |
| Adjustments to  segment amounts:             |       |                                                 |       |   |   |   |   |   |   |
| Net realized (losses) gains(1)               |       | (1                                                   | )          | (1 | ) | 1,073 |   | 1,073 |   |
| Total                                        |       | $                                                    | 345,528    |   | $ | 11,056 |   | $ | 224,202 |   | $ | 24,657 |   |

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

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Identifiableassets by segment are as follows:

| ** **                                   | ** ** | **March 31,2006**  | ** ** | **December 31,2005** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|---------------------------|------------|
| ** **                                   | ** ** | **(In thousands)** | ** ** |
| Senior Managed  Care—Medicare Advantage |       |                    | $          | 202,183                   |       |   |   | $ | 167,664 |   |   |
| Senior Market  Health Insurance              |       |                    | 719,088    |                      |       |   | 440,661 |   |   |
| Specialty Health  Insurance                  |       |                    | 811,822    |                      |       |   | 795,768 |   |   |
| Life Insurance  and Annuity                  |       |                    | 769,810    |                      |       |   | 764,160 |   |   |
| Senior  Administrative Services              |       |                    | 27,417     |                      |       |   | 26,149 |   |   |
| Corporate                                    |       |                    | 704,187    |                      |       |   | 705,409 |   |   |
| Intersegment  assets(1)                      |       |                    | (683,901   | )                         |       |   | (671,832 | ) |   |
| Total Assets                                 |       |                    | $          | 2,550,606                 |       |   |   | $ | 2,227,979 |   |   |

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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.   *FOREIGN OPERATIONS***

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

| ** **    | ** ** | **Three months ended  March 31,** | ** ** |
|---------------|------------|--------------------------------------------------|------------|
| ** **    | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **    | ** ** | **(In thousands)**                          | ** ** |
| United States |       | $                                                | 325,467    |   | $ | 204,674 |   |
| Canada        |       | 20,062                                           |       | 18,455 |   |
| Total         |       | $                                                | 345,529    |   | $ | 223,129 |   |

 

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

| ** **  | ** ** | **March 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|-------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **  | ** ** | **(In thousands)**  | ** ** |
| Assets      |       |                     | $          | 277,259                     |       |   |   | $ | 277,695 |   |   |
| Liabilities |       |                     | $          | 214,334                     |       |   |   | $ | 212,270 |   |   |

 

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**ITEM 2—**MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION ANDRESULTS OF OPERATIONS

**Introduction**

The following discussionand analysis presents a review of the Company as of March 31, 2006 and itsresults of operations for the three months ended March 31, 2006, and 2005.The following analysis of our consolidated results of operations and financialcondition should be read in conjunction with the consolidated financialstatements 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 ended December 31,2005.

**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 21—Business Segment Information” in ourconsolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2005 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 financialstatements and the revenues and expenses reported during the reporting period.As additional information becomes available or actual amounts becomedeterminable, the recorded estimates may be revised and reflected in operatingresults. Actual results could differ from those estimates. Accounts that, inour judgment, are most critical to the preparation of our financial statementsinclude policy related liabilities, deferred policy acquisition costs,intangible assets, valuation of certain investments and deferred income taxes.There have been no changes in our critical accounting policies during thecurrent quarter.

***Policy related liabilities***

We calculate and maintainreserves for the estimated future payment of claims to our policyholders usingthe same actuarial assumptions that 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 unpaidclaims, claims in the course of settlement and incurred but not reportedclaims. Many factors can affect these reserves and liabilities, such aseconomic and social conditions, inflation, hospital and pharmaceutical costs,changes in doctrines of legal liability, premium rate increases and extracontractual damage awards. Therefore, the reserves and liabilities we establishare based on estimates, assumptions and prior years’ statistics. When weacquire other insurance companies or blocks of insurance, our assessment of theadequacy of acquired policy liabilities is subject to similar estimates and 

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assumptions.Establishing reserves involves inherent uncertainties, and it is possible thatactual claims could materially exceed our reserves and have a material adverseeffect on our results of operations and financial condition. Our net incomedepends significantly upon the extent to which our actual claims experience isconsistent with the assumptions we used in setting our reserves and pricing ourpolicies. If our assumptions with respect to future claims are incorrect, andour reserves are insufficient to cover our actual losses and expenses, we wouldbe required to increase our liabilities resulting in reduced net income andshareholders’ equity.

***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, “Accountingand Reporting by Insurance Enterprises for Certain Long-Duration Contracts andfor Realized Gains and Losses from the Sale of Investments”. For other life andhealth products, these costs are amortized in proportion to premium revenueusing the same assumptions used in estimating the liabilities for future policybenefits in accordance with FAS No. 60, “Accounting and Reporting byInsurance Enterprises.”  Amortization ofdeferred acquisition costs for Medicare Supplement policies is periodicallyadjusted for significant changes in benefit structures and differences inassumed premium rates on a prospective basis, consistent with assumptions usedin the related reserves for future policy benefits. During 2005, the Companydetermined that the historical actual approved rate increases and persistencywere higher than assumed levels. The prospective unlocking of these assumptionsresulted in a slower amortization of Medicare Supplement deferred acquisitioncosts.

The determination of expectedgross profits for interest-sensitive products is an inherently uncertainprocess that relies on assumptions including projected interest rates, thepersistency of the policies issued as well as anticipated benefits, commissionsand expenses. It is possible that the actual profits from the business may varymaterially from the assumptions used in the determination and amortization ofdeferred acquisition costs. Deferred policy acquisition costs are written offto the extent that it is determined that future policy premiums and investmentincome or 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 thein-force business acquired, discounted to reflect the present value of thosecash flows. The discount rate selected depends upon the general marketconditions at the time of the acquisition and the inherent risk in thetransaction. Purchase consideration in excess of the fair value of net assetsacquired, including the present value of future profits and other identifiedintangibles, for a specific acquisition, is allocated to goodwill. Allocationof purchase price is performed in the period in which the purchase isconsummated. Adjustments, if any, in subsequent periods relate to resolution ofpre-acquisition contingencies and refinements made to estimates of fair valuein connection with the preliminary allocation.

Amortization of present value of future profits isbased upon the pattern of the projected cash flows of the in-force businessacquired, over weighted average lives ranging from six to forty years. Otheridentified intangibles are amortized over their estimated lives.

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On a periodic basis,management reviews the unamortized balances of present value of future profits,goodwill and other identified intangibles to determine whether events orcircumstances indicate the carrying value of such assets is not recoverable, inwhich case an impairment charge would be recognized. Management believes thatno impairments of present value of future profits, goodwill or other identifiedintangibles existed as of March 31, 2006.

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

**SignificantTransactions and Initiatives**

***Medicare Opportunity***

We believe that attractivegrowth opportunities exist in providing a range of products, particularlyhealth insurance, to the growing senior market. At present, more than44 million Americans are eligible for Medicare, the Federal program thatoffers basic hospital and medical insurance to people over 65 years old pluscertain disabled people under the age of 65. The standard Medicare coverage doesnot cover prescription drugs except as required in the course of a coveredhospital stay. According to the U.S. 

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CensusBureau, more than 2 million Americans turn 65 in the United States eachyear, and this number is expected to grow as the so-called baby boomersbegin to turn 65. In addition, many large employers who traditionally providedmedical and prescription drug coverage to their retirees have begun to curtailthese benefits. Finally, the passage of the Medicare Modernization Act of 2003(the “MMA”) demonstrated the Federal government’s commitment to expand thehealthcare options available to Medicare beneficiaries through the expansion ofMedicare managed care plans (“Medicare Advantage”) and the authorization of asubsidized prescription drug insurance benefit pursuant to Part D (“Part D”).Taken together, these conditions present significant opportunities for us toincrease the sale of our products.

***Medicare Advantage***

As a result of the increased reimbursement rates fromthe Centers for Medicare and Medicaid Services (“CMS”), the Federal agency thatadministers the Medicare Advantage program, Medicare Advantage plans are ableto offer more attractive benefits including enhanced prescription drug coveragepursuant to Part D. Consequently, we believe that enrollment in MedicareAdvantage programs is likely to increase in the coming years.

We entered the MedicareAdvantage business in 2004 with the acquisition of Heritage Health Systems, Inc.which operates Medicare Advantage coordinated care plans in Southeastern Texas.Since 2005, we have expanded our service area to include 8 counties in Texas,10 counties in Oklahoma, and has begun to offer a coordinated care product in 3counties in Florida in 2006. In 2004, we began to offer Medicare Advantage privatefee-for-service (“PFFS”) plans in New York and Pennsylvania. As of January 2006,we are marketing PFFS plans in a total of 15 states.

***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, as opposed to the more restrictive networks that exist in MedicareAdvantage products. In the past ten years, we have become a successful providerof Medicare Supplement coverage as well as other products designed for thesenior market. We believe that the market for Medicare Supplement products willcontinue to be attractive, especially because many seniors may lose similarcoverage that had previously been offered to them as a retiree benefit by theirformer employers.

Recently, there has beenincreased competition from other Medicare Supplement carriers, as well as fromMedicare Advantage plans, which has affected our production and persistency ofMedicare Supplement business. As a result, we continue to experience higherthan expected lapsation in our Medicare Supplement business. This excesslapsation required us to accelerate 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.

***Medicare Part D***

Effective January 1,2006, private insurers were permitted to sponsor insured stand-aloneprescription drug benefit plans (“PDP’s”) pursuant to Part D, which wasestablished by the MMA. A portion of the premium for this insurance is paid bythe Federal government, and the balance, if any, is paid by the individuals whoenroll. The Federal government will also provide additional subsidies in theform of premium support and coverage of the cost-sharing elements of the planto certain low income Medicare beneficiaries. We have been approved to offerthese programs in 32 of the 34 regions that have been established for thisprogram.

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***Reinsurance—Connecticut State Employees***

During the third quarterof 2005, we began to provide an insured drug benefit for the employees of theState of Connecticut. This coverage is renewable annually by the State ofConnecticut. The risk is reinsured to PharmaCare’s wholly-owned reinsurancesubsidiary, PharmaCare Captive Re, Ltd. (“PharmaCare Re”), under a 100% quotashare contract. We receive an underwriting fee of two percent of premium.Annualized premium for this program is approximately $265 million. As aresult of this arrangement, both direct and ceded premium increased byapproximately $67.5 million for the three months ended March 31, 2006,with no impact on net premium.

**Results ofOperations—Consolidated Overview**

The inclusion of the operating results from ourMedicare Part D business with the those of our Medicare Supplementbusiness has resulted in an increase in the level of seasonality in ourreported results during a given calendar year. These businesses generally seehigher claim experience in the early quarters of the year, with lower claimsexperience in the later quarters of the year, resulting in a pattern ofincreasing reported net income over the calendar year attributable to those business.

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

| ** **                                      | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                      | ** ** | **(In thousands)**                          | ** ** |
| Senior Managed  Care-Medicare Advantage(1)      |       | $                                                | 9,232      |   | $ | 7,041 |   |
| Senior Market  Health Insurance(1)              |       | (860                                             | )          | 6,830 |   |
| Specialty Health  Insurance(1)                  |       | 4,697                                            |       | 5,574 |   |
| Life Insurance  and Annuity(1)                  |       | 1,042                                            |       | 4,040 |   |
| Senior  Administrative Services(1)              |       | 2,427                                            |       | 3,615 |   |
| Corporate(1)                                    |       | (5,481                                           | )          | (3,516 | ) |
| Realized (losses)  gains                        |       | (1                                               | )          | 1,073 |   |
| Income before  income taxes(1)                  |       | 11,056                                           |       | 24,657 |   |
| Income taxes, excluding realized (losses) gains |       | 4,035                                            |       | 8,209 |   |
| Income taxes on realized (losses) gains         |       | —                                           |       | 376 |   |
| Total income taxes                              |       | 4,035                                            |       | 8,585 |   |
| Net income                                      |       | $                                                | 7,021      |   | $ | 16,072 |   |
| Per Share Data  (Diluted):                      |       |                                             |       |   |   |
| Net income                                      |       | $                                                | 0.12       |   | $ | 0.28 |   |

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

***Three months ended March 31, 2006 and 2005***

Net income for the first quarter of 2006 declined to$7.0 million, or $0.12 per diluted share, compared to $16.1 million, or $0.28per diluted share for the first quarter of 2005. Net income for the firstquarter of 2006 was affected by higher claim costs in our Medicare Supplement,long term care and life businesses and increased lapsation of our MedicareSupplement in force business, which resulted in an acceleration of 

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the amortization of deferredacquisition costs and present value of future profits. These items are offset,in part, by the growth in our Senior Managed Care business and the income fromour new Part D business.

Net income for the first quarter of 2005 includesrealized investment gains, net of tax, of $0.7 million, or $0.01 per dilutedshare.

Our overall effective tax rate was 36.5% for the firstquarter of 2006, and 34.8% for the first quarter of 2005.

Our Senior Managed Care—Medicare Advantage segmentgenerated segment income of $9.2 million during the first quarter of 2006, anincrease of $2.2 million, compared to $7.0 million for the first quarter of2005, primarily due to the continued growth in membership in our MedicareAdvantage plans.

Our Senior Market Health Insurance segmenthistorically has included our Medicare Supplement business and other healthinsurance products designed for the senior market. On January 1, 2006, webegan covering prescription drug benefits in accordance with Medicare Part Das a stand-alone benefit to Medicare eligible beneficiaries under PDPs. TheSenior Market Health Insurance segment generated a loss of $0.9 million for thefirst quarter of 2006, compared to segment income of $6.8 million for the firstquarter of 2005. Results for our Medicare Supplement business declined by $13.1million, compared to the first quarter of 2005, as a result of increased lossratios and the continued effect of higher than expected lapsation of ourMedicare Supplement in force business, which resulted in an acceleration of theamortization of deferred acquisition costs and present value of future profits.This was offset, in part, by the segment income of $5.4 million generated byour Part D business.

Our Specialty Health Insurance segment income declinedby $0.9 million, or 16%, compared to the first quarter of 2005, primarily as aresult higher loss ratios in our long term care line of business, offset, inpart, by the underwriting fees earned on the reinsurance agreement withPharmaCare Captive Re Ltd. and the strengthening of the Canadian dollar.

Segment income from our Life Insurance and Annuitysegment decreased by $3.0 million, compared to the first quarter of 2005,primarily as an increase in claim costs and an increase in the amortization ofdeferred acquisition costs.

Segment income for our Senior Administrative Servicessegment decreased by $1.2 million, or 33%, to $2.4 million for the firstquarter of 2006, as compared to the same period of 2005. The decrease isprimarily as a result of the $1.8 million of extra expenses incurred in thissegment relating to our implementation of Part D, offset in part by growthin business administered.

The loss from ourCorporate segment increased by $2.0 million, or 56%, for the first quarter of2006 compared to the first quarter months of 2005. The increase was dueprimarily to the increase in stock-based compensation expense as a result ofthe adoption of FAS 123-R and higher interest cost as a result of anincrease in the weighted average interest rates, as compared to the firstquarter of 2005.

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

| ** **                                                                              | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| Net premiums                                                                            |       | $                                                | 89,959     |   | $ | 52,837 |   |
| Net and other  investment income                                                        |       | 1,076                                            |       | 440 |   |
| Total revenue                                                                           |       | 91,035                                           |       | 53,277 |   |
| Medical expenses                                                                        |       | 66,200                                           |       | 37,504 |   |
| Amortization of  intangible assets                                                      |       | 870                                              |       | 756 |   |
| Commissions and  general expenses                                                       |       | 14,733                                           |       | 7,976 |   |
| Total benefits, claims and other deductions                                             |       | 81,803                                           |       | 46,236 |   |
| Segment income                                                                          |       | 9,232                                            |       | 7,041 |   |
| Depreciation, amortization  and interest                                                |       | 934                                              |       | 890 |   |
| Earnings before  interest, taxes, depreciation and amortization (“EBITDA”)(1) |       | $                                                | 10,166     |   | $ | 7,931 |   |

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(1)          Inaddition to segment income, we also evaluate the results of our MedicareAdvantage segment based on earnings before interest, taxes, depreciation andamortization (“EBITDA”). EBITDA is a common alternative measure of performanceused by investors, financial analysts and rating agencies. It is also a measurethat is included in the fixed charge ratio required by the covenants for ouroutstanding bank debt. Accordingly, these groups use EBITDA, along with othermeasures, to estimate the value of a company and evaluate the Company’s abilityto meet its debt service requirements. While we consider EBITDA to be animportant measure of comparative operating performance, it should not beconstrued as an alternative to segment income or cash flows from operatingactivities (as determined in accordance with generally accepted accountingprinciples).

Our Senior Managed Care—MedicareAdvantage segment includes the operations of our initiatives in managed carefor seniors. We operate various health plans, including SelectCare of Texas,that offer coverage to Medicare beneficiaries, under a contract with CMS, inSoutheastern Texas, Oklahoma and Florida. The health plans are sold by ourcareer agency sales force and directly by employee representatives. Inconnection with the health plans, we operate separate Management ServiceOrganizations (“MSO’s”) that manage that business and affiliated IndependentPhysician Associations (“IPA’s”). We participate in the net results derivedfrom these affiliated IPA’s. Our Medicare Advantage PFFS plans, also under acontract with CMS, and are sold by our career and independent agents.

***Three months ended March 31,2006 and 2005***

*Revenues.*   Netpremiums for the Senior Managed Care segment increased by $37.1 million, or70%, compared to the first quarter of 2005. Approximately $34.4 million of theincrease was due to growth in membership and $6.7 million was from additional CMS revenue for the Part Dprescripton drug benefit. This was partially offset by the reduction in theaverage premium per member per month (“PMPM”) due to an increase in thepercentage of members in our PFFS plans which have a lower PMPM than our healthplans. Net investment income increased by $0.6 million, due primarily to growthin invested assets as a result of growth in business, as well as increasedyields.

*Benefits, Claims andExpenses.*   Medical expenses increased by $28.7million, or 77%, compared to the first quarter of 2005. Growth in membershipadded approximately $20.3 million and the additional pharmacy expenses fromproviding an enhanced Part D prescription drug benefit added $3.7 million.The balance of $4.7 million was due to an increase in the loss ratio. Overallloss ratios for the segment increased by 260 basis points to 73.6% for thefirst quarter of 2006 from 71.0% for the first quarter of 2005. Commissions andgeneral expenses increased by $6.8 million compared to the first quarter of2005, due 

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primarily to thegrowth in business, including marketing costs for new service areas and otherdevelopment activities.

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

| ** **               | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                             | ** ** | **2005** | ** ** |
| ** **               | ** ** | **Revenue**                                          | ** ** | **Segment Income** | ** ** | **Revenue** | ** ** | **Segment Income** | ** ** |
| ** **               | ** ** | **(In thousands)**                              | ** ** |
| Health Plans             |       | $                                                    | 74,142     |   |   | $ | 2,728 |   |   | $ | 49,667 |   |   | $ | 2,632 |   |   |
| Affiliated IPA’s    |       | 35,635                                               |       |   | 3,529 |   |   | 28,765 |   |   | 2,718 |   |   |
| MSO’s and Corporate |       | 10,398                                               |       |   | 381 |   |   | 7,690 |   |   | 1,684 |   |   |
| Private Fee-for Service  |       | 16,357                                               |       |   | 2,594 |   |   | 3,357 |   |   | 7 |   |   |
| Eliminations             |       | (45,497                                              | )          |   | — |   |   | (36,202 | ) |   | — |   |   |
| Total                    |       | $                                                    | 91,035     |   |   | $ | 9,232 |   |   | $ | 53,277 |   |   | $ | 7,041 |   |   |

 

Intra-segment revenues arereported on a gross basis in each of the above components of the MedicareAdvantage segment. These intra-segment revenues are eliminated in theconsolidation for the segment totals. The eliminations include premiumsreceived by the IPA’s from our health plans amounting to $35.4 million for 2006and $28.7 million for 2005 and management fees received by the MSO’s from thehealth plans and the IPA’s amounting to $10.1 million for 2006 and $7.5 millionfor 2005.

Our health plans receivepremiums primarily from CMS. As of March, 2006, there were 28,014 members inthese health plans. Membership is based on enrollment information provided byCMS, this enrollment information is subject to reconciliation with CMS. Thehealth plans make capitated risk payments to the IPA’s or other medical groups inthe Houston and Beaumont regions, two of which are affiliated IPA’s. Inaddition, the health plans retain the risk for certain other types of care,primarily out of area emergency and transplants. In August 2005, we beganenrolling members in a Medicare Advantage special needs program. Beginning January 1,2006, we began enrolling members in our Medicare Advantage coordinated careplan in South Florida. During the first quarter of 2006, the health plans hadrevenues of $74.1 million and reported a medical loss ratio of 83.7% versusrevenues of $49.7 million and a medical loss ratio of 81.4% in the firstquarter of 2005.

We participate in theprofits from the two affiliated IPA’s that receive capitated payments fromSelectCare of Texas. As of March 31, 2006, the affiliated IPA’s managedthe care for approximately 16,811 members. During the first quarter of 2006,the IPA’s earned $3.5 million on $35.6 million in revenues. For the firstquarter of 2005, the IPA’s earned $2.7 million on $28.8 million in revenues.

Our MSO’s providecomprehensive management services to our health plans and affiliated IPA’s aspart of long-term management agreements. Services provided include strategicplanning, provider network services, marketing, finance and accounting, enrollment,claims processing, information systems, utilization review, credentialing andquality management. For the first quarter of 2006, these MSO’s earned $0.4million of income on $10.4 million of fees collected. For the first quarter of2005, these MSO’s earned $1.7 million of income on $7.7 million of feescollected.

Startingin June 2004, we began enrolling members in our PFFS product, a MedicareAdvantage program that allows its members to have more flexibility in thedelivery of their health care services than other Medicare Advantage plans. Inaddition to premium received from CMS, we receive modest premium payments fromthe members. Beginning September 1, 2005, we expanded our PFFS productoffering to Medicare eligibles in 258 counties in seven new states. OnJanuary 1, 2006, we expanded the PFFS product to an additional 152counties in six states for a total service area of 459 counties in 15 states.As of March 31, 2006, we had 9,815 members enrolled in our PFFS plans.During the first quarter of 2006, we collected $16.4 million of premium fromCMS and the members, and reported a medical loss ratio of 71.4%. For the firstquarter of 2005, we collected $3.4 million of premium from CMS and the members,and reported a medical loss ratio of 75.0%.

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**Segment Results—Senior Market Health Insurance**

| ** **                                           | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                          | ** ** |
| **Total Segment**                               |       |                                             |       |   |   |
| **Premiums:**                                        |       |                                             |       |   |   |
| Direct and assumed                                   |       | $                                                | 274,035    |   | $ | 148,454 |   |
| Ceded                                                |       | (107,534                                         | )          | (50,592 | ) |
| Net premiums                                         |       | 166,501                                          |       | 97,862 |   |
| Other Part D  revenue                           |       | 9,807                                            |       | — |   |
| Net investment  income                               |       | 1,970                                            |       | 1,215 |   |
| Other income                                         |       | 512                                              |       | 154 |   |
| Total revenue                                        |       | 178,790                                          |       | 99,231 |   |
| Policyholder  benefits                               |       | 145,578                                          |       | 71,269 |   |
| Change in  deferred acquisition costs                |       | (2,788                                           | )          | (8,618 | ) |
| Amortization of  intangible assets                   |       | 1,295                                            |       | 706 |   |
| Commissions and  general expenses, net of allowances |       | 35,565                                           |       | 29,044 |   |
| Total benefits, claims and other deductions          |       | 179,650                                          |       | 92,401 |   |
| Segment (loss) income                                |       | $                                                | (860       | ) | $ | 6,830 |   |

 

***Three months ended March 31, 2006 and 2005***

Our Senior Market Health Insurance segmenthistorically has included our Medicare Supplement business and other healthinsurance products designed for the senior market. On January 1, 2006, webegan covering prescription drug benefits in accordance with Medicare Part Das a stand-alone benefit to Medicare eligible beneficiaries under PDPs. Thetotal results for the segment are presented above. Results for our MedicareSupplement business are separately presented below on a comparative basis. Additionally,we have also separately presented the results for our Part D business.

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TheSenior Market Health Insurance segment generated a loss of $0.9 million for thefirst quarter of 2006, compared to segment income of $6.8 million for the firstquarter of 2005. Results for our Medigap business declined by $13.1 million,compared to the first quarter of 2005, as a result of increased loss ratios andthe continued effect of higher than expected lapsation of our MedicareSupplement in force business, which resulted in an acceleration of theamortization of deferred acquisition costs and present value of future profits.This was offset, in part, by the segment income of $5.4 million generated byour Part D business. 

| ** **                                           | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                          | ** ** |
| **Medigap**                                          |       |                                             |       |   |   |
| Premiums:                                            |       |                                             |       |   |   |
| Direct and assumed                                   |       | $                                                | 139,220    |   | $ | 148,454 |   |
| Ceded                                                |       | (40,847                                          | )          | (50,592 | ) |
| Net premiums                                         |       | 98,373                                           |       | 97,862 |   |
| Net investment  income                               |       | 1,488                                            |       | 1,215 |   |
| Other income                                         |       | 495                                              |       | 154 |   |
| Total revenue                                        |       | 100,356                                          |       | 99,231 |   |
| Policyholder benefits                                |       | 78,712                                           |       | 71,269 |   |
| Change in  deferred acquisition costs                |       | (2,788                                           | )          | (8,618 | ) |
| Amortization of  intangible assets                   |       | 1,295                                            |       | 706 |   |
| Commissions and  general expenses, net of allowances |       | 29,438                                           |       | 29,044 |   |
| Total benefits, claims and other deductions          |       | 106,657                                          |       | 92,401 |   |
| Segment (loss) income                                |       | $                                                | (6,301     | ) | $ | 6,830 |   |

* *

*Revenues.**  *Net premiums for our Medigap business increased by$0.5 million, compared to 2004, due to increased retention of our MedicareSupplement business, rate increases and new sales, offset by policies thatlapsed during the period.

*Benefits,Claims and Expenses.**  *Policyholderbenefits incurred increased by $7.4 million, or 10%, compared to the firstquarter of 2005. Overall loss ratios for the first quarter of 2006 increased720 basis points to 80.0% for the first quarter of 2006 compared to 72.8% forthe first quarter of 2005. The loss ratio for the quarter ended March 31,2005, after consideration of certain adjustments made at the end of 2005 toincrease claim reserves, was 79.3%, or 70 basis points lower than the firstquarter of 2006. The increase in our Medicare Supplement loss ratio wasprimarily as a result of the increase in the Part B deductible.

The increase in deferred acquisition costs was $5.8million less for the first quarter of 2006, than the increase for the firstquarter of 2005. Two factors contributed to the decrease. First, we incurredlower commissions and other costs of acquisition as a result of lowerproduction, resulting in a decrease in the costs capitalized of $1.3 million. Second,amortization increased by approximately $4.5 million, primarily as a result ofhigher lapsation of our Medicare Supplement business, compared to the firstquarter of 2005. We began to experience higher than expected lapsation in ourMedicare Supplement business in the third quarter of 2005 that continued andworsened in the first quarter of 2006. We believe that there are a number offactors contributing to the lapsation, primarily competitive pressure fromMedicare Advantage products, as well as increased competition from otherMedicare Supplement carriers. This increase in lapsation required us toaccelerate the amortization of the deferred acquisition cost and present valueof future profits assets associated with the business that lapsed.

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The amortization of intangibles relates primarily tointangibles recorded from the acquisition of Pyramid Life, and increased by$0.6 million compared to the first quarter of 2005, due to the increase inlapsation of in force business noted above.

Commissionsand general expenses increased by $0.4 million, or 1%, compared to the firstquarter of 2005. The following table details the components of commission andother operating expenses:

| ** **                                           | ** ** | **2006**                | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                                           | ** ** | **(In thousands)** | ** ** |
| Commissions                                          |       | $                       | 18,710     |     | $          | 20,812 |   |
| Other operating  costs                               |       | 18,560                  |       | 18,311   |       |
| Reinsurance  allowances                              |       | (7,832                  | )          | (10,079  | )          |
| Commissions and general  expenses, net of allowances |       | $                       | 29,438     |     | $          | 29,044 |   |

 

Theratio of commissions to gross premiums decreased to 13.4% for the first quarterof 2006, from 14.0% for the first quarter of 2005, as a result of lower overallcommission rates associated with the continued growth of our in force renewalpremium and less new business production with its higher commission rates.Other operating costs as a percentage of gross premiums were 13.3% for thefirst quarter of 2006, compared to 12.3% for the first quarter of 2005.Commission and expense allowances received from reinsurers as a percentage ofthe premiums ceded decreased to 19.2% for the first quarter of 2006 from 19.9%for the first quarter of 2005, primarily due to the reduction in new businessceded and the effects of normal lower commission allowances on our aging baseof ceded renewal business.

| ** **                                           | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                          | ** ** |
| **Part D**                                      |       |                                             |       |   |   |   |   |
| Part D  Revenue                                 |       |                                             |       |   |   |   |   |
| CMS and Member premium                               |       | $                                                | 134,815    |   |   | $ | — |   |   |
| Ceded premiums                                       |       | (66,687                                          | )          |   | — |   |   |
| Net premiums                                         |       | 68,128                                           |       |   | — |   |   |
| Other Part D revenue                            |       | 9,807                                            |       |   | — |   |   |
| Total Part D  Revenue                           |       | 77,935                                           |       |   |   |   |   |
| Net investment  and other income                     |       | 499                                              |       |   | — |   |   |
| Total revenue                                        |       | 78,434                                           |       |   | — |   |   |
| Pharmacy benefits                                    |       | 66,866                                           |       |   | — |   |   |
| Commissions and  general expenses, net of allowances |       | 6,127                                            |       |   | — |   |   |
| Total benefits, claims and other deductions          |       | 72,993                                           |       |   | — |   |   |
| Segment income                                       |       | $                                                | 5,441      |   |   | $ | — |   |   |

 

A discussion of the accounting for Part D isincluded in “Note 2—Summary of Significant Accounting Policies” included in thenotes to the consolidated financial statements in this Form 10-Q. Webased our membership for Part D on March 2006 enrollment informationprovided by CMS representing approximately 367,000 members enrolled in our PDPsfor which we were paid by CMS. The membership information continues to bereconciled and refined by CMS with respect to the allocation among all plansparticipating in the Part D program. As a result, it is likely that themembership data we based our results on for the first quarter will increase,with a corresponding change in the financial results for the segment, however,we are unable to quantify the impact of this likely increase until themembership data is fully reconciled with CMS. The claims represent amountsbased on incurred claims for the reported enrolled membership.

34

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Other Part D revenue represents our equity in theearnings of PDMS, a strategic alliance we formed with PharmaCare. PDMSprincipally performs marketing and risk management services on behalf of ourPDPs and PharmaCare for which it receives fees and other remuneration from ourPDPs and PharmaCare.

The ratio of pharmacybenefits to Part D revenue for the first quarter of 2006 was 85.8%. Basedon the coverage provided by our PDPs, we anticipate that results for our Part Dbusiness will be seasonal, with higher benefit ratios in the first quarter,decreasing in each of the second, third and fourth quarters. However, changesin the benefit ratios are partially offset as a result of the risk corridoradjustments.

**Segment Results—Specialty Health Insurance**

| ** **                                           | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                          | ** ** |
| Premiums:                                            |       |                                             |       |   |   |
| Direct and assumed                                   |       | $                                                | 109,792    |   | $ | 43,109 |   |
| Ceded                                                |       | (72,319                                          | )          | (5,683 | ) |
| Net premiums                                         |       | 37,473                                           |       | 37,426 |   |
| Net investment  income                               |       | 7,347                                            |       | 6,389 |   |
| Other income                                         |       | 135                                              |       | 299 |   |
| Total revenue                                        |       | 44,955                                           |       | 44,114 |   |
| Policyholder  benefits                               |       | 28,932                                           |       | 25,382 |   |
| Change in  deferred acquisition costs                |       | (1,847                                           | )          | (1,969 | ) |
| Commissions and  general expenses, net of allowances |       | 13,173                                           |       | 15,127 |   |
| Total benefits, claims and other deductions          |       | 40,258                                           |       | 38,540 |   |
| Segment income                                       |       | $                                                | 4,697      |   | $ | 5,574 |   |

 

***Three months ended March 31, 2006 and 2005***

Our Specialty Health Insurance segment income declinedby $0.9 million, or 16%, compared to the first quarter of 2005, primarily as aresult higher loss ratios in our long term care line of business, offset, inpart, by the underwriting fees earned on the reinsurance arrangement withPharmaCare Re and the strengthening of the Canadian dollar. The operations ofPenncorp Life (Canada), which are included in our Specialty Health segmentresults, are transacted using the Canadian dollar as the functional currency.The Canadian dollar strengthened relative to the U.S. dollar during the firstquarter of 2006. The average conversion rate increased 6%, to C$0.8662 perU.S.$1.00 for the first quarter of 2006, from C$0.8157 per U.S.$1.00 for thefirst quarter of 2005. This strengthening added approximately $0.2 million ofpre-tax income to the Specialty Health segment results compared to the firstquarter of 2005. See discussion below under the heading “Quantitative andQualitative Disclosures about Market Risk” for additional information.

*Revenues.**  *Both direct and ceded premium for the SpecialtyHealth Insurance segment increased approximately $67.5 million, compared to thefirst quarter of 2005, in connection with the PharmaCare Re reinsuranceagreement discussed above. Net premiums were approximately the same as thefirst quarter of 2005. Canadian business accounted for approximately 46% of thenet premiums of this segment for the first quarter of 2006 and 43% of the netpremiums for the first quarter of 2005. The stronger Canadian dollar and increasedsales in Canada generated an increase in premiums of approximately $1.1million, which was offset by reductions of $0.8 million in our U.S. fixedbenefit accident and sickness line and $0.2 million in our long term care line.

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Net investment income increased by approximately $1.0million, or 15%, compared to the first quarter of 2005. The increase is dueprimarily to investing cash that we had been accumulating in anticipation ofrising interest rates.

*Benefits,Claims and Expenses.**  *Policyholderbenefits incurred increased by $3.6 million, or 14%, compared to the firstquarter of 2005, primarily as a result of higher loss ratios for our long termcare line. Long term care loss ratios increased to 153.3% for the first quarterof 2006 from 96.1% for the first quarter of 2005. Overall loss ratios for thesegment increased to 77.2% for the first quarter of 2006 compared to 67.8% forthe first quarter of 2005.

Commissions and generalexpenses decreased by $2.0 million, or 13%, compared to the first quarter of 2005,primarily as a result of the reinsurance allowance of $1.4 million for theunderwriting fees earned on the new reinsurance arrangement with PharmaCare Re.General expenses decreased by $0.7 million compared to the first quarter of2005 as a result of a decline in costs of acquisition as well as a reduction inoperating costs.

**Segment Results—Life Insurance and Annuity**

| ** **                                           | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                          | ** ** |
| **Premiums  :**                                      |       |                                             |       |   |   |
| Direct and assumed                                   |       | $                                                | 19,197     |   | $ | 17,978 |   |
| Ceded                                                |       | (3,825                                           | )          | (3,838 | ) |
| Net premiums                                         |       | 15,372                                           |       | 14,140 |   |
| Net investment  income                               |       | 9,582                                            |       | 8,689 |   |
| Other income                                         |       | 87                                               |       | 4 |   |
| Total revenue                                        |       | 25,041                                           |       | 22,833 |   |
| Policyholder  benefits                               |       | 11,320                                           |       | 8,988 |   |
| Interest credited  to policyholders                  |       | 4,470                                            |       | 4,545 |   |
| Change in  deferred acquisition costs                |       | (750                                             | )          | (5,100 | ) |
| Amortization of  intangible assets                   |       | 76                                               |       | 93 |   |
| Commissions and  general expenses, net of allowances |       | 8,883                                            |       | 10,267 |   |
| Total benefits, claims and other deductions          |       | 23,999                                           |       | 18,793 |   |
| Segment income                                       |       | $                                                | 1,042      |   | $ | 4,040 |   |

 

**Segment Results—LifeInsurance and Annuity**

***Three months ended March 3***1, 2006 and 2005

Segment income from our Life Insurance and Annuitysegment decreased by $3.0 million, compared to the first quarter of 2005,primarily as an increase in claim costs and an increase in the amortization ofdeferred acquisition costs.

Revenues.   Net premiums forthe segment increased by $1.2 million, or 9%, compared to the first quarter of2005. Approximately $1.1 million of the increase relates to the growth inrenewal premiums for our senior life product.

Our agents sold $10.8 million of fixed annuitiesduring the first quarter of 2006 and $15.5 million during the first quarter of2005. Annuity deposits are not considered premiums for reporting in accordancewith generally accepted accounting principles. The reduction in annuity saleswas the result of lower interest crediting rates offered and our reducedemphasis on this business as we continue our focus more on providing healthinsurance alternatives to the growing senior market.

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Net investment income increased by approximately $0.9million, or 10%, compared to the first quarter of 2005, primarily as a resultof the increase in policyholder account balances as well as an increase inportfolio yields.

*Benefits, Claims andExpenses.**  *Policyholderbenefits incurred increased by $2.3 million, or 26%, compared to the firstquarter of 2005. Claim costs were higher by approximately $1.5 million as aresult of worsening mortality and the increase in business added approximately$0.8 million to policyholder benefits during the first quarter of 2006, as comparedto the first quarter of 2005. The increase in deferred acquisition costs was$4.4 million less during the first quarter of 2006, as compared to the increaseduring the first quarter of 2005. This was primarily due to lower production ofnew life insurance and annuity business during the first quarter of 2006,resulting in a lower level of acquisition costs to capitalize, as well asincreased levels of amortization as compared to the first quarter of 2005 as aresult of higher lapsation and aging of the block of business. Commissions andgeneral expenses, net of allowances decreased by $1.4 million, or 14%, comparedto the first quarter of 2005, due to the lower production levels of new lifeinsurance an annuity business, as noted above.

**Segment Results—Senior Administrative Services**

| ** **                                                                              | ** ** | **Three months ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2006**                                         | ** ** | **2005** | ** ** |
| ** **                                                                              | ** ** | **(In thousands)**                          | ** ** |
| Affiliated Fee  Revenue                                                                 |       |                                             |       |   |   |
| Medicare Supplement                                                                     |       | $                                                | 7,722      |   | $ | 7,966 |   |
| Part D                                                                             |       | 3,929                                            |       | — |   |
| Long term care                                                                          |       | 755                                              |       | 596 |   |
| Life insurance                                                                          |       | 541                                              |       | 844 |   |
| Other                                                                                   |       | 781                                              |       | 797 |   |
| Total Affiliated Revenue                                                                |       | 13,728                                           |       | 10,203 |   |
| Unaffiliated Fee  Revenue                                                               |       |                                             |       |   |   |
| Medicare Supplement                                                                     |       | 1,857                                            |       | 2,034 |   |
| Long term care                                                                          |       | 2,027                                            |       | 2,023 |   |
| Non-insurance products                                                                  |       | 280                                              |       | 384 |   |
| Part D                                                                             |       | 328                                              |       | — |   |
| Other                                                                                   |       | 1,984                                            |       | 264 |   |
| Total Unaffiliated Revenue                                                              |       | 6,476                                            |       | 4,705 |   |
| Total revenue                                                                           |       | 20,204                                           |       | 14,908 |   |
| Amortization of  present value of future profits                                        |       | 123                                              |       | 119 |   |
| General expenses                                                                        |       | 17,654                                           |       | 11,174 |   |
| Total expenses                                                                          |       | 17,777                                           |       | 11,293 |   |
| Segment income                                                                          |       | 2,427                                            |       | 3,615 |   |
| Depreciation,  amortization and interest                                                |       | 811                                              |       | 532 |   |
| Earnings before  interest, taxes, depreciation and amortization (“EBITDA”)(1) |       | $                                                | 3,238      |   | $ | 4,147 |   |

----

(1)          In addition to segmentincome, we also evaluate the results of our Senior Administrative Servicessegment based on earnings before interest, taxes, depreciation and amortization(“EBITDA”). EBITDA is a common alternative measure of performance used byinvestors, financial analysts and rating agencies. It is also a measure that isincluded in the fixed charge ratio required by the covenants for ouroutstanding bank debt. Accordingly, these groups use EBITDA, along with othermeasures, to estimate the value of a company and evaluate the Company’s abilityto meet its debt service 

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requirements. While weconsider EBITDA to be an important measure of comparative operatingperformance, it should not be construed as an alternative to segment income orcash flows from operating activities (as determined in accordance withgenerally accepted accounting principles).

Included in unaffiliatedrevenue are fees received to administer certain business of our insurancesubsidiaries that is 100% reinsured to an unaffiliated reinsurer, whichamounted to $0.9 million for the three months ended March 31, 2006, and$1.1 million for the three months ended March 31, 2005. These fees,together with the affiliated revenue, were eliminated in consolidation.

***Three months ended March 31, 2006 and 2005***

Segment income for our Senior Administrative Servicessegment decreased by $1.2 million, or 33%, to $2.4 million for the firstquarter of 2006, as compared to the same period of 2005. The decrease isprimarily as a result of the $1.8 million of extra expenses incurred in thissegment relating to our implementation and roll-out of Part D, offset inpart by growth in business administered.

Service fee revenue increased by $5.3 million, or 36%,during the first quarter of 2006 compared to the first quarter of 2005.Affiliated service fee revenue increased by $3.5 million primarily as a resultof fees for the administration of our Part D prescription drug plans onbehalf of our subsidiaries which commenced on January 1, 2006, offset, inpart, by a decline in revenues for administration of affiliated life insurancebusiness.

Unaffiliated service feerevenue increased by $1.8 million, due primarily to an increase in fees for theadministration of agency services, including commission payments, forunaffiliated clients. General expenses for the segment increased by $6.5million, or 58%, due to growth in business administered, as well as the $1.8million of extra expenses relating to our implementation of  Part D.

**Segment Results—Corporate**

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

| ** **                                         | ** ** | **Three months ended  March 31,**         | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                         | ** ** | **    2006    ** | ** ** | **    2005    ** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                                  | ** ** |
| Interest                                           |       |                                                     | $          | 3,042 |   |   |   | $ | 2,511 |   |   |
| Amortization of  capitalized loan origination fees |       |                                                     | 229        |   |   |   | 217 |   |   |
| Stock-based  compensation expense                  |       |                                                     | 715        |   |   |   | 2 |   |   |
| Other parent  company expenses, net                |       |                                                     | 1,495      |   |   |   | 786 |   |   |
| Segment loss                                       |       |                                                     | $          | 5,481 |   |   |   | $ | 3,516 |   |   |

 

***Three months ended March 31, 2006 and 2005***

The loss from ourCorporate segment increased by $2.0 million, or 56%, for the first three monthsof 2006 compared to the first three months of 2005. The increase was dueprimarily to the increase in stock-based compensation expense as a result ofthe adoption of FAS 123-R and higher interest cost as a result of anincrease in the weighted average interest rates, as compared to the first threemonths of 2005. During the first three months of 2006, we recognized $0.7million of stock-based compensation expense relating to options vesting duringthe period. Our combined outstanding debt was $169.5 million at March 31,2006 compared to $174.8 million at March 31, 2005. The weighted averageinterest rate on our loan payable increased to 6.8% for the first three monthsof 2006 from 4.8% for the first three months of 2005. The weighted averageinterest rate on our other long term debt increased to 7.6% for the first threemonths of 2006 from 6.9% for the first three months of 2005. See “Liquidity andCapital Resources” for additional information regarding our loan payable andother long term debt.

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**Liquidity andCapital Resources**

Our capital is used primarily to support the retainedrisks and growth of our insurance company subsidiaries and health plan 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 ourcurrent cash position, the availability of our $15.0 million revolving creditfacility, the expected cash flows of our administrative service company andmanagement service organizations (acquired in the acquisition of Heritage) andthe surplus note interest and principal payments from American Exchange (asexplained below) can support our parent company obligations for the foreseeablefuture. However, there can be no assurance as to our actual future cash flowsor to the continued availability of dividends from our insurance companysubsidiaries.

*Credit Facility, asAmended in May 2004*

In connection with the acquisition of Heritage on May 28,2004, the Company amended the Credit Agreement by increasing the facility to$120 million from $80 million (the “Amended Credit Agreement”), including anincrease in the term loan portion to $105 million from $36.4 million (thebalance outstanding at May 28, 2004) and maintaining the $15 millionrevolving loan facility. None of the revolving loan facility was drawn as of March 31,2006. Under the Amended Credit Agreement, the spread over LIBOR was reduced to225 basis points from 275 basis points. Effective April 1, 2006, theinterest rate on the term loan was 7.2%. Principal repayments are scheduled at$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 incurred additional loan origination feesof approximately $2.1 million, which were capitalized and are being amortizedon a straight-line basis over the life of the Amended Credit Agreement alongwith the continued amortization of the origination fees incurred in connectionwith the Credit Agreement. The Company pays an annual commitment fee of 50basis points on the unutilized revolving loan facility.

The obligations of the Company under the Amended CreditFacility are guaranteed by our subsidiaries, CHCS Services Inc., WorldNetServices Corp., Quincy Coverage Corporation, Universal American FinancialServices, Inc., Heritage, HHS-HPN Network, Inc., Heritage HealthSystems of Texas, Inc., PSO Management of Texas, LLC, HHS Texas Management, Inc.and HHS Texas Management LP (collectively the “Guarantors”) and secured bysubstantially all of the assets of each of the Guarantors. In addition, assecurity for the performance by the Company of its obligations under theAmended Credit Facility, the Company, CHCS Services Inc., WorldNet ServicesCorp., Heritage and HHS Texas Management, Inc., have each pledged andassigned substantially all of their respective securities (but not more than65% of the issued and outstanding shares of voting stock of any foreignsubsidiary), all of their respective limited liability company and partnershipinterests, all of their respective rights, title and interest under any serviceor management contract entered into between or among any of their respectivesubsidiaries and all proceeds of any and all of the foregoing.

The Amended Credit Facility requires the Company andits subsidiaries to meet certain financial tests, including a minimum fixedcharge coverage ratio, a minimum risk based capital test and a minimumconsolidated net worth test. The Amended Credit Facility also containscovenants, which among other things, limit the incurrence of additionalindebtedness, dividends, capital expenditures, transactions with 

39

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affiliates, asset sales,acquisitions, mergers, prepayments of other indebtedness, liens andencumbrances and other matters customarily restricted in such agreements. TheAmended Credit Facility contains customary events of default, including, amongother things, payment defaults, breach of representations and warranties,covenant defaults, cross-acceleration, cross-defaults to certain otherindebtedness, certain events of bankruptcy and insolvency and judgmentdefaults. During the fourth quarter of 2005, the Company was in default with acovenant regarding limitations on treasury stock repurchases. The Companyrequested and received, from the administrative agent for the bank group, awaiver of the event of default and an amendment to the Amended Credit Facilityto increase the limitation for treasury stock purchases to $30.0 million in theaggregate after January 1, 2006.

We made regularly scheduled principal payments of $1.3million during the three months ended March 31, 2006 and $1.3 millionduring the three months ended March 31, 2005, in connection with ourcredit facilities. We paid interest of $1.6 million during the three monthsended March 31, 2006 and $1.2 million during the three months ended March 31,2005, in connection with our 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:

| 2006 (remainder  of the year) |   | $      | 3,937  |   |
|-------------------------------|--------|--------|--------|--------|
| 2007                          |   | 5,250  |   |
| 2008                          |   | 5,250  |   |
| 2009                          |   | 80,063 |   |
|                          |   | $      | 94,500 |   |

 

*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 FIN 46R, we have deconsolidated the trusts.

Separatesubsidiary trusts of our parent holding company (the “Trusts”) have issued acombined $75.0 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  March 31, 2006** | ** ** |
|------------------------|------------|-------------------------|------------|------------------------|------------|-------------------------|----------------|-----------------------------|------------|----------------------------------------------------|------------|
| ** **             | ** ** | **(In thousands)** | ** ** | ** **             | ** ** | **(Basis points)** | ** **     | ** **                  | ** ** |
| December 2032     |       |                    | $          | 15,000                 |       |                    | Fixed/Floating |                        |       | 400                                                | (1)        |   |   | 6.7 | % |   |
| March 2033        |       |                    | 10,000     |                   |       | Floating                |           |                        | 400        |                                               |       |   | 8.6 | % |   |
| May 2033          |       |                    | 15,000     |                   |       | Floating                |           |                        | 420        |                                               |       |   | 9.0 | % |   |
| May 2033          |       |                    | 15,000     |                   |       | Fixed/Floating          |           |                        | 410        | (2)                                                |       |   | 7.4 | % |   |
| October 2033      |       |                    | 20,000     |                   |       | Fixed/Floating          |           |                        | 395        | (3)                                                |       |   | 7.0 | % |   |
|                   |       |                    | $          | 75,000                 |       |                    |           |                        |       |                                               |       |   |   |   |   |   |

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(1)          Effective September,2003, 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.

The Trusts have the right to call the CapitalSecurities at par after five years from the date of issuance (which ranged fromDecember 2002 to October 2003).

The Capital Securities represent an undividedbeneficial interest in the Trusts’ assets, which consist solely of the JuniorSubordinated Debt. Holders of the Capital Securities have no voting rights. Ourparent holding company owns all of the common securities of the Trusts. Holdersof both the Capital Securities and the Junior Subordinated Debt are entitled toreceive cumulative cash distributions accruing from the date of issuance, andpayable quarterly in arrears at a floating rate equal to the three-month LIBORplus a spread. The floating rate resets quarterly and is limited to a maximumof 12.5% during the first sixty months. Due to the variable interest rate forthese securities, we may be subject to higher interest costs if short-terminterest rates rise. The Capital Securities are subject to mandatory redemptionupon repayment of the Junior Subordinated Debt at maturity or upon earlierredemption. The Junior Subordinated Debt is unsecured and ranks junior andsubordinate in right of payment to all present and future senior debt of ourparent holding company and is effectively subordinated to all existing andfuture obligations of the Company’s subsidiaries. Our parent holding companyhas the right to redeem the Junior Subordinated Debt after five years from thedate of issuance.

Our parent holding company has the right at any time,and from time to time, to defer payments of interest on the Junior SubordinatedDebt for a period not exceeding 20 consecutive quarters up to each debenture’smaturity date. During any such period, interest will continue to accrue and ourparent holding company may not declare or pay any cash dividends or distributionson, or purchase, our common stock nor make any principal, interest or premiumpayments on or repurchase any debt securities that rank equally with or juniorto the Junior Subordinated Debt. Our parent holding company has the right atany time to dissolve the Trusts and cause the Junior Subordinated Debt to bedistributed to the holders of the Capital Securities. We have guaranteed, on asubordinated basis, all of the Trusts’ obligations under the Capital Securitiesincluding payment of the redemption price and any accumulated and unpaiddistributions to the extent of available funds and upon dissolution, winding upor liquidation but only to the extent the Trusts have funds available to makesuch payments. The Capital Securities have not been and will not be registeredunder the Securities Act of 1933, as amended (the “Securities Act”), and willonly be offered and sold under an applicable exemption from registrationrequirements under the Securities Act.

We paid $1.4 million ininterest in connection with the Junior Subordinated Debt during the threemonths ended March 31, 2006, and $1.3 million during the three monthsended March 31, 2005.

*Lease Obligations*

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

| 2006 (remainder  of the year) |   | $      | 3,142  |   |
|-------------------------------|--------|--------|--------|--------|
| 2007                          |   | 4,151  |   |
| 2008                          |   | 4,011  |   |
| 2009                          |   | 3,619  |   |
| 2010 and  thereafter          |   | 10,220 |   |
| Totals                        |   | $      | 25,143 |   |

 

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In addition to the above,Pennsylvania Life and Penncorp Life (Canada) are the named lessees on 69 propertiesoccupied by Career Agents for use as field offices. The Career Agents reimbursePennsylvania Life and Penncorp Life (Canada) the actual rent for these fieldoffices. The total annual rent paid by the Company and reimbursed by the CareerAgents for these field offices during 2005 was approximately $1.7 million.

*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 million shares ofcommon stock that may be offered for sale by Capital Z Financial Services FundII, L.P. (“Capital Z”), our largest shareholder. The shelf registrationstatement 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 detaileddescription of the use of proceeds will be included in any specific offering ofsecurities in the prospectus supplement relating to the offering.

On June 22, 2005, we issued 2.0 million shares ofour common stock at a price of $23.61 per share, in connection with a publicoffering pursuant to the shelf registration. The issuance of these sharesgenerated proceeds to us of $44.2 million, net of underwriters discount andother issuance costs. Additionally, 5.0 million shares were sold byCapital Z Financial Services Fund II, L.P. and its affiliates (“Capital Z”),our largest shareholder, under the same shelf registration. On July 20,2005, the underwriters exercised their over-allotment option and we issued anadditional 660,000 shares of our common stock at $23.61 per share, generatingadditional net proceeds of $14.8 million. Following the offering, Capital Zowned 20.2 million shares, or 34.5% of our outstanding common stock.

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

*Sources of Liquidityto the Parent Company*

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

·       theexpected cash flows of our senior administrative services company;

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

·       dividendpayments received from Penncorp Life (Canada); and

·       surplusnote principal and interest payments from American Exchange.

In addition, we have access to the $15.0 millionavailable under the revolving portion of our credit facility. Finally, we havethe ability, from time to time, to access the capital markets for additionalcapital. There can be no assurance as to our actual future cash flows, from thecontinued availability of dividends from our insurance company subsidiaries orfrom access to the capital markets.

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The issues affecting the profitability of the Companyduring the third and fourth quarters of 2005, as discussed in the Managements’Discussion and Analysis, do not materially affect the sources of liquidity tothe Parent Company as discussed below. The increase in the Medicare Supplementloss ratios is confined to insurance companies that we do not look to forsignificant cash flow. The increased amortization of deferred acquisition costand present value of future profits is a non-cash item.

*SeniorAdministrative Services Company.*   Liquidity forour Senior Administrative Services subsidiary is measured by its ability to payoperating expenses and pay dividends to our parent company. The primary sourceof liquidity is fees collected from clients. We believe that the sources ofcash for our Senior Administrative Services company exceed scheduled uses ofcash and results in amounts available to dividend to our parent holdingcompany. We measure the ability of the Senior Administrative Services companyto pay dividends based on its earnings before interest, taxes, depreciation andamortization (“EBITDA”). EBITDA for our Senior Administrative Services segmentwas $3.2 million for the three months ended March 31, 2006, and $4.1million for the three months ended March 31, 2005.

*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 SCOT and services providedto the IPA’s. Dividend payments by SCOT to Heritage are subject to the approvalof the insurance regulatory authorities of the state of Texas, SCOT’s state ofdomicile. SCOT is not able to pay dividends during 2006 without prior approval.However, we believe that the sources of cash to our managed care holding companyexceed scheduled uses of cash which will result in funds available to dividendto our parent holding company. We measure the ability of the senior managedcare holding company to pay dividends based on its EBITDA. EBITDA for oursenior managed care holding company was $10.2 for the three months ended March 31,2006 and $7.9 million for the three months ended March 31, 2005.

*PenncorpLife (Canada) Dividends.**  *PenncorpLife (Canada) is a Canadian insurance company. Canadian law provides that alife insurer may pay a dividend after such dividend declaration has beenapproved by its board of directors and upon at least 10 days prior notificationto the Superintendent of Financial Institutions. Such a dividend is limited toretained net income (based on Canadian GAAP) for the preceding two years, plusnet income earned for the current year. In considering approval of a dividend,the board of directors must consider whether the payment of such dividend wouldbe in contravention of the Insurance Companies Act of Canada. During 2005,Penncorp Life (Canada) paid dividends of C$6.4 million (approximately US$5.4million) to Universal American. During 2005, Penncorp Life (Canada) becamesubject to a 5% withholding tax on dividends paid to Universal American. Thewithholding tax paid on the dividends from Penncorp Life (Canada) in 2005 wasC$0.2 million (approximately US$0.2 million). Due to limitations resulting fromthe timing of prior dividend payments by PennCorp (Canada), we do notanticipate that Penncorp (Canada) will be able to pay dividends in 2006,without prior approval.

*InsuranceSubsidiaries—Surplus Note, Dividends and Capital Contributions.*   Cash**generated by our insurance company subsidiaries will bemade available to our holding company, principally through periodic payments ofprincipal and interest on the surplus note owed to our holding company by oursubsidiary, American Exchange Life. As of March 31, 2006, the principalamount of the surplus note was $39.1 million. The note bears interest to ourparent holding company at LIBOR plus 325 basis points. We anticipate that thesurplus note will be primarily serviced by dividends from Pennsylvania Life, awholly owned subsidiary of American Exchange, and by tax-sharing payments amongthe insurance companies that are wholly owned by American Exchange and withwhich American Exchange files a consolidated Federal income tax return.American Exchange made principal payments of $1.0 million during the threemonths ended March 31, 2006, and $3.2 million during the three monthsended March 31, 2005. American Exchange paid interest on the surplus noteof $0.5 million during the three months ended March 31, 2006 and$0.4 million during the three months ended March 31, 2005.

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Our parent holding company made capital contributionsto American Exchange amounting to $3.5 million during the first threemonths of 2006. In January 2006, Pyramid Life declared and paid a dividendin the amount of $10.8 million to Pennsylvania Life. American Exchange madecapital contributions of $2.5 million to Constitution during the first threemonths 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.Pennsylvania Life is able to pay ordinary dividends of up to $9.8 million toAmerican Exchange during 2006, without prior approval.

*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 Supplement policies,for supplemental payments to Medicare provider rates. Some of these benefitsare subject to medical-cost inflation and we have the capability to file forpremium rate increases to mitigate rising medical costs. Our health insurancebusiness is widely dispersed in the United States and Canada, which mitigatesthe risk of unexpected increases in claim payments due to epidemics and eventsof a catastrophic nature. These accident and health polices are notinterest-sensitive and therefore are not subject to unexpected policyholderredemptions due to investment yield changes.

Some of our life insurance and annuity policies areinterest-sensitive in nature. The amount of surrenders and withdrawals isaffected by a variety of factors such as credited interest rates for similarproducts, general economic conditions and events in the industry that affectpolicyholders’ confidence. Although the contractual terms of substantially allof our in force life insurance policies and annuities give the holders theright to surrender the policies and annuities, we impose penalties for earlysurrenders. As of March 31, 2006 we held reserves that exceeded theunderlying cash surrender values of our net retained in force life insuranceand annuities by $35.0 million. Our insurance subsidiaries, in our view, havenot experienced any material changes in surrender and withdrawal activity inrecent years.

Changes in interest rates may affect the incidence ofpolicy surrenders and withdrawals. In addition to the potential impact on liquidity,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.

As of March 31, 2006, our insurance companysubsidiaries held cash and cash equivalents totaling $161.2 million, as well asfixed maturity securities that could readily be converted to cash with carryingvalues (and fair values) of $1.3 billion.

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The net yields on our cash and invested assetsincreased to 5.0% for the three months ended March 31, 2006, from 4.8% forthe three months ended March 31, 2005. A portion of these securities areheld to support the liabilities for policyholder account balances, which liabilitiesare subject to periodic adjustments to their credited interest rates. Thecredited interest rates of the interest-sensitive policyholder account balancesare determined by us based upon factors such as portfolio rates of return andprevailing market rates and typically follow the pattern of yields on theassets supporting these liabilities.

Our domestic insurance subsidiaries are required tomaintain minimum amounts of statutory capital and surplus as required byregulatory authorities. However, substantially more than the statutory minimumamounts are needed to meet statutory and administrative requirements ofadequate capital and surplus to support the current level of our insurancesubsidiaries’ operations. Each of our insurance subsidiaries’ statutory capitaland surplus exceeds its respective minimum statutory requirement at levels webelieve are sufficient to support their current levels of operation.Additionally, the National Association of Insurance Commissioners (“NAIC”)imposes regulatory risk-based capital (“RBC”) requirements on life insuranceenterprises. At March 31, 2006, all of our insurance subsidiariesmaintained ratios of total adjusted capital to RBC in excess of the “authorizedcontrol level”. The combined statutory capital and surplus, including assetvaluation reserve, of our U.S. insurance subsidiaries totaled $172.4 million atMarch 31, 2006, and $158.4 million at December 31, 2005. For thethree months ended March 31, 2006, our U.S. insurance subsidiariesgenerated statutory net income of $2.9 million. Our U.S. insurance companiesgenerated statutory net income of $0.1 million for the three months ended March 31,2005.

Our health plan affiliates are also required tomaintain minimum amounts of capital and surplus, as required by regulatoryauthorities and is also subject to RBC requirements. At March 31, 2006,the statutory capital and surplus of each of our health plan affiliates exceedsits minimum requirement and its RBC is in excess of the “authorized controllevel”. The statutory capital and surplus for our health plan affiliates was$27.7 million at March 31, 2006, and $23.0 million at December 31,2005. Statutory net income for our health plan affiliates was $3.1 million forthe three months ended March 31, 2006 and $2.6 million for the threemonths ended March 31, 2005.

Penncorp Life (Canada)reports to Canadian regulatory authorities based upon Canadian statutoryaccounting principles that vary in some respects from U.S. statutory accountingprinciples. Penncorp Life (Canada)’s net assets based upon Canadian statutoryaccounting principles were C$64.3 million (US$55.0 million) as of March 31,2006, and C$62.3 million (US$53.6 million) as of December 31, 2005. Netincome based on Canadian generally accepted accounting principles was C$2.0million (US$1.7 million) for the three months ended March 31, 2006 andC$1.9 million (US$1.6 million) for the three months ended March 31, 2005.Penncorp Life (Canada) maintained a Minimum Continuing Capital and SurplusRequirement Ratio (“MCCSR”) in excess of the minimum requirement at March 31,2006.

*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. MFCGlobal Investment Management manages our Canadian portfolio. We investprimarily in fixed maturity securities of the U.S. Government and its agenciesand in corporate 

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fixed maturity securitieswith investment grade ratings of “BBB-” (Standard & Poor’sCorporation), “Baa3” (Moody’s Investor Service) or higher.

As of March 31, 2006,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 March 31,2006. During the three months ended March 31, 2006 and 2005, we did notwrite down the value of any fixed maturity securities. These write-downs wouldrepresent our estimate of other than temporary declines in value and would beincluded in net realized gains on investments in our consolidated statements ofoperations.

*Effects of RecentlyIssued and Pending Accounting Pronouncements*

There was no materialimpact on our consolidated financial condition or results of operations as aresult of our adoption of the recently issued accounting pronouncements. We donot anticipate any material impact from the adoption of the recently issued orpending accounting pronouncements, other than the adoption of Statement ofFinancial Accounting Standards No. 123-Revised, “Share-Based Payment”(“FAS 123-R”). FAS 123-R was adopted effective January 1,2006, and requires all companies to recognize compensation costs forshare-based payments to employees based on the grant-date fair value of theaward for financial statements. Refer to Consolidated Financial Statements Note2—Recent and Pending Accounting Pronouncements and Note 8—Stock-basedCompensation.

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

In general, market riskrelates to changes in the value of financial instruments that arise fromadverse movements in interest rates, equity prices and foreign exchange rates.We are exposed principally to changes in interest rates that affect the marketprices of our fixed income securities as well as the cost of our variable ratedebt. Additionally, we are exposed to changes in the Canadian dollar thataffects the translation of the financial position and the results of operationsof our Canadian subsidiary from Canadian dollars to U.S. dollars.

*Investment InterestRate Sensitivity*

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

Certain classes of mortgage-backed securities aresubject to significant prepayment risk due to the fact that in periods ofdeclining interest rates, individuals may refinance higher rate mortgages totake 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 March 31,2006, and with all other variables held constant. A 100 basis point increase in

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marketinterest rates would result in a pre-tax decrease in the market value of ourfixed income investments of $65.1 million and a 200 basis point increase inmarket interest rates would result in $127.2 million decrease. Similarly,a 100 basis point decrease in market interest rates would result in a pre-taxincrease in the market value of our fixed income investments of $70.1 millionand a 200 basis point decrease in market interest rates would result in a$144.7 million increase.

*Debt*

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

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

Thesensitivity analysis of interest rate risk assumes scenarios increases ordecreases in LIBOR of 100 and 200 basis points from their levels as of and forthe three months ended March 31, 2006, and with all other variables heldconstant. The following table summarizes the impact of changes in LIBOR.
|                                                           | ** ** | ** **             | ** ** | ** **                                | ** ** | **Effect of Change in LIBOR on Pre-tax Income** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|-------------------------------------------|------------|------------------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | ** **             | ** ** | **Weighted**                              | ** ** | **for the three months ended March 31, 2006**   | ** ** |
| **Description of Floating Rate Debt** | ** ** | ** **             | ** ** | **Weighted  Average  Interest Rate** | ** ** | **Average  Balance  Outstanding**                                                  | ** ** | **200 Basis  Point  Decrease** | ** ** | **100 Basis  Point  Decrease** | ** ** | **100 Basis  Point  Increase** | ** ** | **200 Basis  Point  Increase** | ** ** |
| ** **                                                | ** ** | **(in millions)** | ** ** |
| Loan Payable                                              |       |                   | 6.78       | %                                         |       |                                                                               | $          | 95.8 |   |   |   | $ | 0.5 |   |   |   | $ | 0.2 |   |   |   | $ | (0.2 | ) |   |   | $ | (0.5 | ) |   |
| Other long term  debt                                     |       |                   | 8.69       | %                                         |       |                                                                               | $          | 25.0 |   |   |   | 0.1 |   |   |   | 0.1 |   |   |   | (0.1 | ) |   |   | (0.1 | ) |   |
| Total                                                     |       |                   |       |                                      |       |                                                                               |       |   |   |   | $ | 0.6 |   |   |   | $ | 0.3 |   |   |   | $ | (0.3 | ) |   |   | $ | (0.6 | ) |   |
|                                                           |            |                        |            |                                           |            |                                                                                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As noted above, we havefixed the interest rate on $50 million of our $170 million of total debtoutstanding, leaving $120 million of the debt exposed to rising interest rates.As of March 31, 2006 we had approximately $166 million of cash and cashequivalents and $147 million in short duration floating rate investmentsecurities. We anticipate that the net investment income on this $313 millionwill be positively impacted by rising interest rates and will mitigate thenegative impact of rising interest rates on our debt.

*Currency ExchangeRate Sensitivity*

Portions of our operations are transacted using theCanadian dollar as the functional currency. As of and for the three monthsended March 31, 2006, approximately 11% of our assets, 6% of our revenues,excluding realized gains, and 30% of our income before realized gains and taxeswere derived from our Canadian operations. As of and for the three months endedMarch 31, 2005, approximately 12% of our assets, 8% of our revenues,excluding realized gains, and 11% of our income before realized gains and taxeswere derived from our Canadian operations. Accordingly, our earnings andshareholder’s equity are affected by fluctuations in the value of the U.S.dollar as compared to the Canadian dollar. Although this risk is somewhatmitigated by the fact that both the assets and liabilities for our foreignoperations are denominated in Canadian dollars, we are still subject totranslation gains and losses.

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

A 10% strengthening of the U.S. dollar relative to theCanadian dollar, as compared to the actual average exchange rate for the threemonths ended March 31, 2006, would have resulted in a decrease in ourincome before realized gains and taxes of approximately $0.3 million for thethree months ended March 31, 2006 and a decrease in our shareholders’equity of approximately $5.7 million at March 31, 2006. A 10% weakening ofthe U.S. dollar relative to the Canadian dollar would have resulted in anincrease in our income before realized gains and taxes of approximately $0.4million for the three months ended March 31, 2006 and an increase inshareholders’ equity of approximately $7.0 million at March 31, 2006. Oursensitivity analysis of the effects of changes in foreign currency exchangerates does not factor in any potential change in sales levels, local prices orany other variables.

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

**ITEM 4—Controls andprocedures**

***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.

***Inherent Limitations on Effectiveness of Controls***

Our management, includingour Chief Executive Officer and Chief Financial Officer, does not expect thatour disclosure controls and procedures or our internal controls over financialreporting will prevent or detect all errors and all fraud. A control system, nomatter how well designed and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Thedesign of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Further, because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that misstatements due toerror or fraud will not occur or that all control issues and instances offraud, if any, within Universal American have been detected. These inherentlimitations include the realities that judgments in decision-making can befaulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons or bycollusion of two or more people. The design of any system of controls is basedin part on certain assumptions about the likelihood of future events, and therecan be no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions. Projections of any evaluation ofcontrols effectiveness to future periods are subject to risks. Over time,controls may become inadequate because of changes in conditions ordeterioration in the degree of compliance with policies or procedures.

***Evaluation of Effectiveness of Controls***

An evaluation was carriedout under the supervision and with the participation of the Company’smanagement, including its Chief Executive Officer and Chief Financial Officer,of the effectiveness of the Company’s disclosure controls and procedures as of March 31,2006. Based on this evaluation, the 

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Company’sChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of March 31, 2006, ata reasonable assurance level, to timely alerting management to materialinformation required to be included in the Company’s periodic filings with theSecurities and Exchange Commission.

***Remediation of Material Weaknesses***

Management had assessedour internal control over financial reporting as of December 31, 2005, theend of our fiscal year. Management based its assessment on criteria establishedin Internal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission. As disclosed in the Company’s AnnualReport on Form 10-K for the fiscal year ended December 31, 2005, inperforming its assessment of internal control over financial reporting,management determined that a material weakness existed in the Company’sinternal controls relating to the accounting for our Medicare Supplement claimreserves and the related amounts recoverable from reinsurers. Specifically, theCompany’s analysis and review controls were not sufficient to ensure that ourclaim reserves, amounts recoverable from reinsurers and net incurred claims forour Medicare Supplement business were appropriately stated. As a result of thisweakness, the Company’s internal controls did not detect the need foradjustments to the amounts initially recorded for these items. Based onadditional analysis and procedures performed, management made adjustments inthe fourth quarter of 2005 to its claim reserves and amounts recoverable fromreinsurers as of December 31, 2005 and the related incurred claims expensefor the year ended December 31, 2005 for our Medicare Supplement businessprior to the issuance of the consolidated financial statements as of December 31,2005.

Management is responsiblefor maintaining effective internal control processes over its financialstatement close and financial reporting processes. Management also is requiredto ensure that its finance and accounting personnel have the competence andtraining necessary for their assigned levels of responsibility, and thatsufficient staff is present to effectively perform all processes necessary tomaintaining a proper internal control environment. The Company believes it hastaken the necessary steps to remediate its material weakness by: (i) addingadditional analytical procedures to ensure the accuracy of claim reservesestimation methods; (ii) retaining independent consulting actuaries toreview the estimation of claim reserves and independently calculate claim reserveson a regular basis; and (iii) strengthening the management review of claimreserves trends and methods used to estimate Medicare Supplement claim reservesand amounts recoverable from reinsurers.

***Changes in Internal Control Over Financial Reporting***

During the quarter ended March 31, 2006,management implemented additional analysis and review controls, as noted above,relating to the accounting for our Medicare Supplement claim reserves and therelated amounts recoverable from reinsurers. Additionally, managementimplemented disclosure controls and procedures relating to the operationsassociated with Medicare Part D, which commenced January 1, 2006.Other than the above items, there were no changes in our internal control overfinancial reporting during the quarter ended March 31, 2006 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

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**PART II**

**ITEM 1—LEGALPROCEEDINGS**

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

Five actions containing related factual allegationswere filed against the Company and certain of its officers and directorsbetween November 22, 2005 and February 2, 2006. One of these actionswas voluntarily withdrawn by plaintiffs, and four actions are now pending, twoof which have been consolidated.

In the first action, Robert Kemp filed a purportedclass action complaint (the “Kemp Action”) on November 22, 2005, in the UnitedStates District Court for the Southern District of New York. The Kemp Action isa purported class action asserted on behalf of those shareholders of theCompany who acquired the Company’s common stock between February 16, 2005and October 28, 2005. Plaintiffs in the Kemp Action seek unspecifieddamages under Section 10(b) and 20(a) of the Securities ExchangeAct of 1934 based upon allegedly false statements by the Company and Richard A.Barasch, Robert A. Waegelein and Gary W. Bryant (hereinafter, the “OfficerDefendants”) in press releases, financial statements and analyst conferencesduring the class period.

Another purported class action was filed by WesternTrust Laborers-Employers Pension Trust (the “Western Trust Action”), a putativeclass member in the Kemp Action who had filed a motion to be named as leadplaintiff in that action, on February 2, 2006, in the United StatesDistrict Court for the Southern District of New York. The factual and legalallegations in the Western Trust Action, which also purports to be a classaction, are similar to those in the Kemp Action. By order dated May 1,2006, the Kemp Action and the Western Trust Action were consolidated, andWestern Trust Laborers-Employers Pension Trust was named lead plaintiff.

Two additional actions have been brought derivativelyby shareholders purporting to act on behalf of the Company, and not as classactions. One of these was filed by Green Meadows Partners LLP (the “GreenMeadows Action”) on December 13, 2005, in the United States District Courtfor the Southern District of New York, and has been assigned to the same judgepresiding over the Kemp Action and the Western Trust Action. In the GreenMeadows Action, plaintiffs seek contribution under Section 10(b) and21D of the Exchange Act on the ground that if the Company is found liable tohave violated the securities laws in the Kemp Action, then the OfficerDefendants are liable for contribution. The Green Meadows Action also assertsthree claims under state law for breach of fiduciary duty against the OfficerDefendants.

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.

All of the cases are at apreliminary stage. In the consolidated class actions, the Court has adopted aschedule under which the lead plaintiff will file an amended consolidatedcomplaint by June 19, 2006, and defendants’ motion to dismiss thatcomplaint will be fully briefed and argued by December 13, 2006. The Courthas adopted a similar schedule in the Green Meadows Action. In the TsutsuiAction, the time for defendants initially to respond to the complaint has beenextended to June 2, 2006. Each of the Officer Defendants denies theallegations in the cases and has indicated that he intends to vigorously defend

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againstthe allegations. Management believes that after liability insurance recoveries,none of these actions will have a material adverse effect on us.

***Other Litigation***

We have litigation in theordinary course of our business, including claims for medical, disability andlife insurance benefits, and in some cases, seeking punitive damages.Management believes that after liability insurance recoveries, none of theseactions will have a material adverse effect on us.

**ITEM 1A—RISKFACTORS**

Please refer to theCompany’s Annual Report on Form 10-K for the year ended December 31,2005 for disclosures with respect to the Company’s risk factors. There havebeen no material changes since year-end 2005 in the specified risk factorsdisclosed in the Company’s Annual Report on Form 10-K.

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

**Issuer purchases of Equity securities**

| **Period**                                         | ** ** | ** ** | ** ** | **Total Number  of Shares  Purchased(1)** | ** ** | **Average  Price Paid  Per Share** | ** ** | **Total Number of   Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number  of Shares That May  Yet Be Purchased  Under the Plans or  Programs** | ** ** |
|----------------------------------------------------|------------|------------|------------|-----------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 1,  2006—January 31, 2006   |       |       | —     |                                                |       |                                         | —     |                                                                                                                                   |       |                                                                                                                                | —     |   |   |   | 1,000,768 |   |   |
| February 1,  2006—February 28, 2006 |       |       | 60         |                                                |       |                                         | $          | 15.15                                                                                                                                  |       |                                                                                                                                |       | 60 |   |   |   | 1,000,708 |   |   |
| March 1,  2006—March 31, 2006       |       |       | 453        |                                                |       |                                         | $          | 14.81                                                                                                                                  |       |                                                                                                                                |       | 453 |   |   |   | 1,000,255 |   |   |
| Total                                              |       |       | 513        |                                                |       |                                         |       |                                                                                                                                   |       |                                                                                                                                | 513        |   |   |   |   |   |   |

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(1)          Allshares were purchased in private transactions.

**Recent Sales ofUnregistered Securities**

None.

**ITEM 3—DEFAULTSUPON SENIOR SECURITIES**

There were no defaultsupon senior securities during the first quarter of 2006.

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

There were no matterssubmitted by us to a vote of shareholders, through the solicitation of proxiesor otherwise, during the first quarter of 2006.

**ITEM 5—OTHERINFORMATION**

None.

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**ITEM6—EXHIBITS**
| 2.1   |   | Agreement and Plan of  Merger, dated as of March 9, 2004, among Universal American Financial  Corp., HHS Acquisition Corp., Heritage Health Systems, Inc. and Carlyle  Venture Partners, L.P., as the stockholder representative, incorporated by  reference to Form 8-K dated March 9, 2004.                                                                                  |
|-------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1   |   | Restated  Certificate of Incorporation of Universal American Financial Corp.  incorporated by reference to Exhibit 3.1 to the registrant’s Amendment  No. 2 to the Registration Statement (No. 333-62036) on  Form S-3 filed on July 11, 2001.                                                                                                                       |
| 3.2   |   | Amendment  No. 1 to the Restated Certificate of Incorporation of Universal American  Financial Corp., incorporated by reference to Exhibit 3 to Form 10-Q  (File No. 0-11321) for the quarter ended June 30, 2004, filed  with the SEC on August 9, 2004.                                                                                                            |
| 3.3   |   | Amended and  Restated By-Laws of Universal American Financial Corp., incorporated by  reference to Exhibit A to Form 8-K (File No. 0-11321)  dated August 13, 1999.                                                                                                                                                                                                            |
| 4.1   |   | Form of  Indenture dated as of December 2004 between Universal American Financial  Corp. and U.S. Bank National Association, as Trustee, incorporated by  reference to Exhibit 4.01 to Amendment No. 1 to the Company’s  Registration Statement on Form S-3 (File No. 333-120190)  filed with the Securities and Exchange Commission on December 10, 2004. |
| 4.2   |   | Form of  Indenture dated as of December 2004 between Universal American Financial  Corp. and U.S. Bank National Association, as Trustee, incorporated by  reference to Exhibit 4.02 to Amendment No. 1 to the Company’s Registration  Statement on Form S-3 (File No. 333-120190) filed with  the Securities and Exchange Commission on December 10, 2004. |
| 4.3   |   | Shareholders  Agreement dated July 30, 1999, among the Company, Capital Z Financial  Services Fund II, L.P., UAFC, L.P., AAM Capital Partners, L.P., Chase Equity  Associates, L.P., Richard A. Barasch and others, incorporated by reference to  Exhibit A of Form 8-K dated August 13, 1999.                                                                                 |
| 4.4   |   | Registration  Rights Agreement, dated July 30, 1999, among the Company, Capital Z  Financial Services Fund II, L.P., Wand/Universal American Investments L.P.I.,  Wand/Universal American Investments L.P. II, Chase Equity Associates, L.P.,  Richard A. Barasch and others, incorporated by reference to Exhibit A to  Form 8-K dated August 13, 1999.                  |
| 11.1* |   | Computation of  Per Share Earnings Data, (contained in Note 4 to the Consolidated Financial  Statements in this Report).                                                                                                                                                                                                                                                                           |
| 31.1* |   | Certification of  Chief Executive Officer, as required by Rule 13a-14(a) of the  Securities Exchange Act of 1934.                                                                                                                                                                                                                                                                        |
| 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.** |
|-------------------|-----------------------------------------|
| May 10, 2006 | /s/ RICHARD A. BARASCH                  |   |
|              | Richard A. Barasch                      |
|              | *Chief Executive Officer*               |
| May 10, 2006 | /s/ ROBERT A. WAEGELEIN                 |   |
|              | Robert A. Waegelein                     |
|              | *Executive Vice President and*          |
|              | *Chief Financial Officer*               |
|              | *(Principal Accounting Officer)*        |

 

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