**UNITED STATES**

**SECURITIES 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, 2007**

**OR**

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

**Forthe transition period from             to**

**Commission file 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)

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

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

Large acceleratedfiler  o                     Acceleratedfiler  x                     Non-acceleratedfiler  o

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

Asof April 30, 2007, 59,442,873 shares of the registrant’s common stock wereissued and outstanding.

 

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**TABLEOF CONTENTS**

|              | ** ** | **Item** | ** ** | **Description** | ** ** | **Page**                                                                                    | ** ** |
|--------------|------------|----------|------------|-----------------|------------|---------------------------------------------------------------------------------------------|------------|
| PART 1  |       |     |       |            |       | Financial Information                                                                       |       |   |   |   |   |
|         |       |     | 1          |            |       | Financial  Statements (unaudited):                                                          |       |   |   |   |   |
|         |       |     |       |            |       | Consolidated Balance  Sheets                                                                |       |   | 4 |   |   |
|         |       |     |       |            |       | Consolidated  Statements of Operations—Three Months                                    |       |   | 5 |   |   |
|         |       |     |       |            |       | Consolidated  Statements of 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 |       |   | 30 |   |   |
|         |       |     | 3          |            |       | Quantitative  and Qualitative Disclosures About Market Risk                                 |       |   | 55 |   |   |
|         |       |     | 4          |            |       | Controls and  Procedures                                                                    |       |   | 56 |   |   |
| PART II |       |     |       |            |       | Other Information                                                                           |       |   | 57 |   |   |
|         |       |     | 1          |            |       | Legal Proceedings                                                                           |       |   | 57 |   |   |
|         |       |     | 1A         |            |       | Risk Factors                                                                                |       |   | 57 |   |   |
|         |       |     | 2          |            |       | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       |   | 58 |   |   |
|         |       |     | 3          |            |       | Defaults Upon  Senior Securities                                                            |       |   | 58 |   |   |
|         |       |     | 4          |            |       | Submission of  Matters to a Vote of Security Holders                                        |       |   | 58 |   |   |
|         |       |     | 5          |            |       | Other Information                                                                           |       |   | 58 |   |   |
|         |       |     | 6          |            |       | Exhibits                                                                                    |       |   | 58 |   |   |
|         |       |     |       |            |       | Signatures                                                                                  |       |   | 60 |   |   |

 

2

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

**DISCLOSUREREGARDING FORWARD LOOKING STATEMENTS**

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

Important factors that may cause actual results todiffer materially from forward-looking statements include, but are not limitedto, the risks and uncertainties set forth in this report in Item 1A “RiskFactors” and Item 2 “Management’s Discussion and Analysis of FinancialCondition and Results of Operations”, and Item 1 “Business”, Item 1A “RiskFactors” and Item 7 “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” in our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2006,as well as other reports thatwe file with the Securities and Exchange Commission. We assume no obligation toupdate or supplement any forward-looking statements that may become untruebecause of subsequent events, whether as a result of new information, futureevents or otherwise.

3

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**PART I**

**ITEM 1—FINANCIALSTATEMENTS (Unaudited)**

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

| ** **                                                                                                    | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                        |       |                     |       |                        |       |   |   |
| Investments (Note 5):                                                                                         |       |                     |       |                        |       |   |   |
| Fixed maturities  available for sale, at fair value (amortized cost: 2007, $1,153,659; 2006,  $1,110,323)     |       | $                        | 1,156,417  |                        |       | $ | 1,112,086 |   |   |
| Policy loans                                                                                                  |       | 21,978                   |       |                        | 22,032     |   |   |
| Other invested assets                                                                                         |       | 1,744                    |       |                        | 1,725      |   |   |
| Total investments                                                                                             |       | 1,180,139                |       |                        | 1,135,843  |   |   |
| Cash and cash  equivalents (Note 2)                                                                           |       | 925,914                  |       |                        | 542,130    |   |   |
| Accrued investment  income                                                                                    |       | 11,789                   |       |                        | 12,927     |   |   |
| Deferred policy  acquisition costs                                                                            |       | 251,377                  |       |                        | 262,144    |   |   |
| Amounts due from  reinsurers                                                                                  |       | 312,105                  |       |                        | 293,350    |   |   |
| Due and unpaid  premiums                                                                                      |       | 83,605                   |       |                        | 11,043     |   |   |
| Present value of  future profits and other amortizing intangible assets (Note 4)                              |       | 62,007                   |       |                        | 54,738     |   |   |
| Goodwill and other  indefinite lived intangible assets (Note 4)                                               |       | 79,648                   |       |                        | 71,332     |   |   |
| Income taxes  receivable                                                                                      |       | 749                      |       |                        | —     |   |   |
| Other Part D  receivables (Note 2)                                                                       |       | 78,259                   |       |                        | 85,871     |   |   |
| Advances to agents                                                                                            |       | 72,306                   |       |                        | 48,912     |   |   |
| Other assets                                                                                                  |       | 86,110                   |       |                        | 66,752     |   |   |
| Total assets                                                                                                  |       | $                        | 3,144,008  |                        |       | $ | 2,585,042 |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                     |       |                     |       |                        |       |   |   |
| LIABILITIES                                                                                                   |       |                     |       |                        |       |   |   |
| Policyholder  account balances (Note 2)                                                                       |       | $                        | 475,313    |                        |       | $ | 485,189 |   |   |
| Reserves for future  policy benefits                                                                          |       | 606,766                  |       |                        | 600,497    |   |   |
| Policy and  contract claims—life                                                                         |       | 12,760                   |       |                        | 12,901     |   |   |
| Policy and  contract claims—health                                                                       |       | 429,320                  |       |                        | 201,811    |   |   |
| Advance premium                                                                                               |       | 210,804                  |       |                        | 26,120     |   |   |
| CMS contract  deposits for amounts not at risk (Note 2)                                                       |       | 209,188                  |       |                        | 134,184    |   |   |
| Loan payable (Note  9)                                                                                        |       | 139,250                  |       |                        | 90,563     |   |   |
| Other long term  debt (Note 10)                                                                               |       | 125,000                  |       |                        | 75,000     |   |   |
| Amounts due to  reinsurers                                                                                    |       | 77,295                   |       |                        | 100,397    |   |   |
| Income taxes  payable                                                                                         |       | —                   |       |                        | 20,502     |   |   |
| Deferred income  tax liability                                                                                |       | 17,223                   |       |                        | 19,573     |   |   |
| Other Part D  liabilities                                                                                |       | 107,417                  |       |                        | 106,599    |   |   |
| Other liabilities                                                                                             |       | 100,231                  |       |                        | 87,797     |   |   |
| Total liabilities                                                                                             |       | 2,510,567                |       |                        | 1,961,133  |   |   |
| Commitments and contingencies (Note 12)                                                                       |       |                     |       |                        |       |   |   |
| STOCKHOLDERS’ EQUITY (Note 6)                                                                            |       |                     |       |                        |       |   |   |
| Common stock  (Authorized: 100 million shares, issued: 2007, 60.1 million shares; 2006,  59.9 million shares) |       | 601                      |       |                        | 599        |   |   |
| Additional paid-in  capital                                                                                   |       | 256,042                  |       |                        | 252,542    |   |   |
| Accumulated other  comprehensive income (Notes 6 and 13)                                                      |       | 2,258                    |       |                        | 1,883      |   |   |
| Retained earnings                                                                                             |       | 383,872                  |       |                        | 379,511    |   |   |
| Less: Treasury  stock (2007, 0.6 million shares; 2006, 0.7 million shares)                                    |       | (9,332                   | )          |                        | (10,626    | ) |   |
| Total stockholders’  equity                                                                              |       | 633,441                  |       |                        | 623,909    |   |   |
| Total liabilities and stockholders’ equity                                                               |       | $                        | 3,144,008  |                        |       | $ | 2,585,042 |   |   |

 

See notes to unaudited consolidated financial statements.

4

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**UNIVERSAL AMERICAN FINANCIAL CORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONSFor the Three Months Ended March 31, 2007 and 2006(In thousands, per share amounts in dollars)**

| ** **                                                                                        | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Revenues:                                                                                         |       |       |       |       |       |
| Direct premium and policyholder fees earned                                                       |       | $          | 795,631    |       | $          | 467,750 |   |
| Reinsurance premiums assumed                                                                      |       | 8,628      |       | 8,317      |       |
| Reinsurance premiums ceded                                                                        |       | (216,361   | )          | (183,993   | )          |
| Net premiums and  policyholder fees earned                                                        |       | 587,898    |       | 292,074    |       |
| Net investment income                                                                             |       | 22,362     |       | 17,347     |       |
| Fee and other income                                                                              |       | 6,255      |       | 6,240      |       |
| Net realized gains on investments                                                                 |       | 1,904      |       | (1         | )          |
| Total revenues                                                                                    |       | 618,419    |       | 315,660    |       |
| Benefits, Claims and  Expenses:                                                                   |       |       |       |       |       |
| Claims and other benefits                                                                         |       | 497,740    |       | 236,557    |       |
| Increase in reserves for future policy benefits                                                   |       | 3,251      |       | 4,805      |       |
| Interest credited to policyholders                                                                |       | 4,705      |       | 4,470      |       |
| Change in deferred acquisition costs                                                              |       | 10,334     |       | (4,079     | )          |
| Amortization of intangible assets (Note 4)                                                        |       | 2,109      |       | 2,368      |       |
| Commissions                                                                                       |       | 35,041     |       | 31,481     |       |
| Reinsurance commission and expense allowances                                                     |       | (18,190    | )          | (17,799    | )          |
| Interest expense                                                                                  |       | 3,439      |       | 3,042      |       |
| Other operating costs and expenses                                                                |       | 87,392     |       | 56,861     |       |
| Total benefits, claims and other deductions                                                       |       | 625,821    |       | 317,706    |       |
| Income (loss) from continuing operations, before  equity in earnings of unconsolidated subsidiary |       | (7,402     | )          | (2,046     | )          |
| Equity in earnings of unconsolidated subsidiary (Note  14)                                        |       | 13,203     |       | 9,807      |       |
| Income from continuing operations, before income  taxes                                           |       | 5,801      |       | 7,761      |       |
| Provision for income taxes                                                                        |       | 1,440      |       | 2,829      |       |
| **Income from continuing operations**                                                             | ** ** | **4,361**  | ** ** | **4,932**  | ** ** |
| Discontinued Operations  (Note 16):                                                               |       |       |       |       |       |
| Income from discontinued operations, net of income  taxes                                         |       | —     |       | 2,089      |       |
| **Net income**                                                                                    | ** ** | **$**      | **4,361**  | ** ** | **$**      | **7,021** | ** ** |
| **Earnings per common share:**                                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Basic:**                                                                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from continuing operations                                                                 |       | $          | 0.07       |       | $          | 0.08 |   |
| Income from discontinued operations                                                               |       | —     |       | 0.04       |       |
| **Net income**                                                                                    | ** ** | **$**      | **0.07**   | ** ** | **$**      | **0.12** | ** ** |
| **Diluted:**                                                                                      | ** ** | ** ** | ** ** | ** ** | ** ** |
| Income from continuing operations                                                                 |       | $          | 0.07       |       | $          | 0.08 |   |
| Income from discontinued operations                                                               |       | —     |       | 0.04       |       |
| **Net income**                                                                                    | ** ** | **$**      | **0.07**   | ** ** | **$**      | **0.12** | ** ** |
| **Weighted average shares  outstanding:**                                                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average shares outstanding                                                               |       | 59,968     |       | 59,056     |       |
| Less weighted average treasury shares                                                             |       | (667       | )          | (751       | )          |
| **Basic weighted shares outstanding**                                                             | ** ** | **59,301** | ** ** | **58,305** | ** ** |
| Effect of dilutive securities                                                                     |       | 1,328      |       | 1,611      |       |
| **Diluted  weighted shares outstanding**                                                          | ** ** | **60,629** | ** ** | **59,916** | ** ** |

** **

See notes to unaudited consolidated financial statements.

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**UNIVERSALAMERICAN FINANCIAL CORP. AND SUBSIDIARIE**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITYAND COMPREHENSIVE INCOME**

**For the ThreeMonths Ended March 31, 2007 and 2006(In thousands)**

| ** **                                        | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Retained  Earnings** | ** ** | **Treasury  Stock** | ** ** | **Total**  | ** ** |
|---------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|-----------------------------------------------|------------|------------------------|------------|---------------------|------------|------------|------------|
| **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 13)               |       |              | —     | ** **                       |       | —                                        |       |                   | (11,456    | )                   |       | —     |       | — |   | (11,456 | ) |
| Comprehensive loss                                |       |              | —     | ** **                       |       | —                                        |       |                   | —     |                |       | —     |       | — |   | (4,435 | ) |
| Issuance of  common stock (Note 6)                |       |              | 1          | ** **                       |       | 306                                           |       |                   | —     |                |       | —     |       | — |   | 307 |   |
| Stock-based  compensation (Note 7)                |       |              | —     | ** **                       |       | 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 |   |
| **2007**                                          |       |              |       | ** **                       |       |                                          |       |                   |       |                |       |       |       |   |   |   |   |
| Balance,  January 1, 2007                    |       |              | $          | 599                              | ** ** |                                          | $          | 252,542                |       |                | $          | 1,883      |       |   | $ | 379,511 |   | $ | (10,626 | ) | $ | 623,909 |   |
| Net income                                        |       |              | —     | ** **                       |       | —                                        |       |                   | —     |                |       | 4,361      |       | — |   | 4,361 |   |
| Other  comprehensive income (Note 13)             |       |              | —     | ** **                       |       | —                                        |       |                   | 375        |                |       | —     |       | — |   | 375 |   |
| Comprehensive  income                             |       |              | —     | ** **                       |       | —                                        |       |                   | —     |                |       | —     |       | — |   | 4,736 |   |
| Issuance of  common stock (Note 6)                |       |              | 2          | ** **                       |       | 1,966                                         |       |                   | —     |                |       | —     |       | — |   | 1,968 |   |
| Stock-based  compensation (Note 7)                |       |              | —     | ** **                       |       | 1,225                                         |       |                   | —     |                |       | —     |       | — |   | 1,225 |   |
| Treasury shares  purchased, at cost (Note 6) |       |              | —     | ** **                       |       | —                                        |       |                   | —     |                |       | —     |       | — |   | — |   |
| Treasury shares  reissued (Note 6)                |       |              | —     | ** **                       |       | 309                                           |       |                   | —     |                |       | —     |       | 1,294 |   | 1,603 |   |
| Balance, March 31,  2007                     |       |              | $          | 601                              | ** ** |                                          | $          | 256,042                |       |                | $          | 2,258      |       |   | $ | 383,872 |   | $ | (9,332 | ) | $ | 633,441 |   |

** **

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, 2007 and 2006(In thousands)**

| ** **                                                                                                            | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Cash flows from operating  activities:                                                                                |       |     |       |     |       |
| Net income                                                                                                            |       | $        | 4,361      |     | $          | 7,021 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities, net of  balances acquired or sold: |       |     |       |     |       |
| Income from  discontinued operations                                                                                  |       | —   |       | (2,089   | )          |
| Equity in  (earnings) loss of unconsolidated subsidiary                                                               |       | (13,203  | )          | (9,807   | )          |
| Distribution from  unconsolidated subsidiary                                                                          |       | 14,000   |       | —   |       |
| Deferred income  taxes                                                                                                |       | (5,829   | )          | (7,398   | )          |
| Realized gains on  investments                                                                                        |       | (1,904   | )          | 1        |       |
| Amortization of  present value of future profits and other intangibles                                                |       | 2,109    |       | 2,368    |       |
| Net amortization  of bond premium                                                                                     |       | 417      |       | 654      |       |
| Change in deferred  policy acquisition costs                                                                          |       | 10,334   |       | (4,079   | )          |
| Change in reserves  for future policy benefits                                                                        |       | 6,270    |       | 46,434   |       |
| Change in policy  and contract claims payable                                                                         |       | 224,450  |       | 5,421    |       |
| Change in reinsurance  balances                                                                                       |       | (42,206  | )          | (22,536  | )          |
| Change in advance  and due premium, net                                                                               |       | 112,084  |       | 43,763   |       |
| Change in income  taxes payable (receivable)                                                                          |       | 6,609    |       | 9,449    |       |
| Change in other Part D  receivables                                                                              |       | 7,612    |       | (43,814  | )          |
| Change in other Part D  liabilities                                                                              |       | 818      |       | 26,667   |       |
| Advances to  agents, net                                                                                              |       | (23,394  | )          |     |       |
| Other, net                                                                                                            |       | (7,205   | )          | 4,092    |       |
| Cash from  operating activities—continuing operations                                                            |       | 295,323  |       | 56,147   |       |
| Cash from  operating activities—discontinued operations                                                          |       | —   |       | 2,388    |       |
| Cash from operating  activities                                                                                       |       | 295,323  |       | 58,535   |       |
| Cash flows from investing  activities:                                                                                |       |     |       |     |       |
| Proceeds from sale  or redemption of fixed maturities                                                                 |       | 66,212   |       | 16,481   |       |
| Cost of fixed  maturities purchased                                                                                   |       | (113,434 | )          | (7,619   | )          |
| Proceeds from sale  of discontinued operations, net of cash sold (Note 16)                                            |       | 8,364    |       | —   |       |
| Taxes paid for  gain on sale of discontinued operations (Note 16)                                                     |       | (28,200  | )          | —   |       |
| Proceeds from sale  of subsidiary, net of cash sold (Note 17)                                                         |       | 5,102    |       | —   |       |
| Purchase of  business, net of cash acquired                                                                           |       | (17,722  | )          | (12,075  | )          |
| Other investing  activities                                                                                           |       | 4,355    |       | 77       |       |
| Cash from  investing activities—continuing operations                                                            |       | (75,323  | )          | (3,136   | )          |
| Cash from  investing activities—discontinued operations                                                          |       | —   |       | (1,954   | )          |
| Cash from (used  for) investing activities                                                                            |       | (75,323  | )          | (5,090   | )          |
| Cash flows from financing  activities:                                                                                |       |     |       |     |       |
| Net proceeds from  issuance of common stock                                                                           |       | 1,968    |       | 559      |       |
| Cost of treasury  stock purchases                                                                                     |       | —   |       | (7       | )          |
| Receipts from CMS  contract deposits                                                                                  |       | 248,759  |       | 270,397  |       |
| Withdrawals from  CMS contract deposits                                                                               |       | (173,755 | )          | (118,852 | )          |
| Deposits and interest  credited to policyholder account balances                                                      |       | 5,583    |       | 16,509   |       |
| Surrenders and  other withdrawals from policyholder account balances                                                  |       | (15,458  | )          | (11,335  | )          |
| New debt issued,  net of issue costs                                                                                  |       | 98,000   |       | —   |       |
| Principal  repayment on loan payable                                                                                  |       | (1,313   | )          | (1,313   | )          |
| Cash from  financing activities—continuing operations                                                            |       | 163,784  |       | 155,958  |       |
| Cash from  financing activities—discontinued operations                                                          |       | —   |       | —   |       |
| Cash used for  financing activities                                                                                   |       | 163,784  |       | 155,958  |       |
| Net increase  (decrease) in cash and cash equivalents                                                                 |       | 383,784  |       | 209,403  |       |
| Cash and cash  equivalents at beginning of year                                                                       |       | 542,130  |       | 138,899  |       |
| Cash and cash  equivalents at end of year                                                                             |       | 925,914  |       | 348,302  |       |
| Less cash and cash  equivalents of discontinued operations at end of period                                           |       | —   |       | (2,403   | )          |
| Cash and cash equivalents  of continuing operations at end of period                                                  |       | $        | 925,914    |     | $          | 345,899 |   |

 

See notes to unaudited consolidated financial statements.

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

**1.**                 *ORGANIZATION AND COMPANY BACKGROUND*

Universal American Financial Corp. (“we,” the “Company,”or “Universal American”) is a specialty health and life insurance holdingcompany with an emphasis on providing a broad array of health insurance andmanaged care products and services to the growing senior population. UniversalAmerican was incorporated in the State of New York in 1981. Collectively, ourinsurance company subsidiaries are licensed to sell life and accident andhealth insurance and annuities in all fifty states, the District of Columbia,and Puerto Rico. The principal insurance products currently sold by the Companyare Medicare Advantage private fee-for-service plans (“PFFS”), Medicareprescription drug benefit plans (“PDPs”), Medicare Supplement, fixed benefitaccident and sickness disability insurance and senior life insurance. TheCompany distributes these products through an independent general agency systemand a career agency system. The career agents sell for Pennsylvania LifeInsurance Company (“Pennsylvania Life”) and The Pyramid Life Insurance Company(“Pyramid Life”) while the independent general agents sell for American PioneerLife Insurance Company (“American Pioneer”), American Progressive Life & HealthInsurance Company of New York (“American Progressive”), Constitution LifeInsurance Company (“Constitution”), Marquette National Life Insurance Company (“Marquette”)and Union Bankers Insurance Company (“Union Bankers”).

In 2006, we began offering PDPs pursuant to Medicare Part D(“Part D”) through Pennsylvania Life and American Progressive, inconnection with a strategic alliance with PharmaCare Management Services, Inc.(“PharmaCare”), a third party pharmacy benefits manager (“PBM”) andwholly-owned subsidiary of CVS Corporation (“CVS”).

The Company operates Medicare Advantage health plansin Texas through SelectCare of Texas, L.L.C. and SelectCare HealthPlans, Inc.,in Oklahoma through SelectCare of Oklahoma, Inc. and GlobalHealth, Inc.(“GlobalHealth”), in Florida through American Pioneer HealthPlans, Inc. andin Wisconsin through Abri Health Plan, Inc. and our Medicare Advantage PFFSplans through American Progressive and Pyramid Life.

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.

On December 1, 2006,the Company completed the sale of Penncorp Life Insurance Company (“PennCorpLife Canada”), its Canadian subsidiary. Consequently, the Company has accountedfor the operations of PennCorp Life Canada as discontinued operations. All priorperiod amounts have been reclassified to conform to this presentation. See Note16—Discontinued Operations.

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

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

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wholly-owned subsidiary ofPhamaCare, for which it receives fees and other remuneration from our PDPs andPharmaCare. As noted above, the operations of PennCorp Life Canada are reportedas discontinued operations.

For the insurance subsidiaries, GAAP differs fromstatutory accounting practices prescribed or permitted by regulatoryauthorities. All material intercompany transactions and balances betweenUniversal American and its subsidiaries have been eliminated.

The interim financial information herein is unaudited,but in the opinion of management, includes all adjustments (including normal,recurring adjustments) necessary to present fairly the financial position andresults of operations for such periods. The results of operations for the threemonths ended March 31, 2007 and 2006 are not necessarily indicative of theresults to be expected for the full year. The accompanying consolidatedfinancial statements and notes should be read in conjunction with the Company’sAnnual Report on Form 10-K for the fiscal year ended December 31,2006.

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

***Supplemental Cash Flow Information:  ***Cashand cash equivalents include cash on deposit, money market funds, and shortterm investments that had an original maturity of three months or less from thetime of purchase. Included in cash and cash equivalents at March 31, 2007is $297 million relating to our PDPs that cannot be used for other lines ofbusiness or general corporate purposes. Supplemental cash flow information forinterest and income taxes paid for continuing and discontinued operations is asfollows:

| ** **                                                        | ** ** | **Three months ended  March 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                        | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                                        | ** ** | **(in thousands)**                          | ** ** |
| Supplemental cash  flow information from continuing operations:   |       |                                             |       |   |   |
| Cash paid for interest                                            |       | $                                                | 3,209      |   | $ | 3,061 |   |
| Cash paid for income taxes                                        |       | $                                                | 27,009     |   | $ | — |   |
| Supplemental cash  flow information from discontinued operations: |       |                                             |       |   |   |
| Cash paid for  income taxes                                       |       | $                                                | —     |   | $ | 2,311 |   |

*** ***

***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 for the fiscal year ended December 31,2006.

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

In general, prescription drug benefits under Part DPDPs may vary in terms of coverage levels and out-of-pocket costs forbeneficiary premiums, deductibles and co-insurance. However, all Part DPDPs 

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must offer either “standardcoverage” or its actuarial equivalent (with out-of-pocket threshold anddeductible amounts that do not exceed those of standard coverage). Thesedefined “standard” benefits represent the minimum level of benefits mandated byCongress. We also offer other PDPs containing benefits in excess of standardcoverage limits for an additional beneficiary premium.

Our PDPs receive monthly payments from CMS whichgenerally represents our bid amount for providing insurance coverage. Werecognize premium revenue for providing this insurance coverage during eachmonth in which members are entitled to benefits. Our CMS payments also includecatastrophic reinsurance allowances and Federal subsidies (CMS contractdeposits) for which we do not bear risk.

Part D premium revenue is subject to riskcorridor adjustment, which permits our PDPs and CMS to share the riskassociated with the ultimate costs of the Part D benefit. The riskcorridor adjustments may be positive or negative based upon the application ofrisk corridors that compare a plan’s actual prescription drug costs to theirtargeted costs, as reflected 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 CMSdefined “standard” benefit plan. We estimate and recognize an adjustment topremium revenues related to the risk corridor payment adjustment based uponprescription drug claims experience to date, net of manufacturer rebates andother Part D revenues, at the end of each reporting period. Accordingly,this estimate does not consider future prescription drug claims experience. Werecord a receivable for rebates due to us which is included in other Part Dreceivables.

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 arereimbursed by CMS through the reinsurance subsidy for PDPs offering thestandard coverage. Low-income cost subsidies represent reimbursements from CMSfor all or a portion of the deductible, the coinsurance and the co-paymentamounts for low-income beneficiaries. We account for these subsidies as a depositin our balance sheet and as a financing activity in our statement of cashflows. We do not recognize premium revenue or claims expense for thesesubsidies. Receipt and payment activity is accumulated at the contract leveland recorded in the balance sheet as a CMS contract deposit account asset orliability depending on the net contract balance at the end of the reportingperiod. A reconciliation and related settlement of CMS’s prospective subsidiesagainst actual prescription drug costs we paid will be made after the end ofthe year.

We recognize pharmacy benefit costs as incurred. Wehave subcontracted the pharmacy claims administration to PharmaCare. Certain ofour PDPs receive all or a portion of the rebates from drug manufacturers onprescriptions filled. A significant portion of these rebates are reflected as areduction in pharmacy benefit costs with the balance offset against thecatastrophic reinsurance claims reimbursed by CMS, for which we are not atrisk. Pharmacy benefit costs are based on rates as contracted with PharmaCare.

The PDPs sponsored by subsidiaries of UniversalAmerican are reinsured, on a 50% coinsurance funds withheld basis, toPharmaCare Re. Pennsylvania Life also assumes, on a 33.3% quota share basis,risks of an unaffiliated prescription drug plan. The contract for the 33.3%assumed business will be terminated as of December 31, 2007, however,under the termination provisions of the contract, Pennsylvania Life willreceive an amount equal to two years of the reinsurance profits generated by theblock of business.

We based our membership for Part D on enrollmentinformation provided by CMS which indicated that, as of March 31, 2007,approximately 490,400 members were enrolled in our PDPs for which we were paidby CMS. This includes approximately 466,500 members in our PDPs that weparticipate in on a 50% 

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basis and 23,900 membersin the unaffiliated PDP that we participate in on a 33.3% basis. Our revenuesand claims expense are based on earned premium and incurred pharmacy benefitsfor the reported enrolled membership. During 2006 and 2007, we also paid claimsfor individuals who ultimately were determined to be members of other plans. AtMarch 31, 2007, we have a receivable of $36.5 million for these claimswhich is included in other Part D receivables on the consolidated balancesheet. Membership information continues to be reconciled and refined by CMSwith respect to the enrollment of members among all plans participating in the Part Dprogram. Additionally, as of March 31, 2007, we have a liability of $30.4million, included in policy and contract claims—health on the consolidatedbalance sheet, for our estimate of claims paid by state Medicaid programs onbehalf of members of our PDPs. As a result of the continuing reconciliationprocess, it is likely that the membership data upon which we based our resultswill change, with a corresponding change in the financial results for thesegment. We are unable to precisely quantify the impact of any potential changeuntil the membership data is fully reconciled with CMS; however, we do notbelieve that any change from the amounts reported as of March 31, 2007 islikely to be material.

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

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

***Deferred***Acquisition Costs—*********In***September 2005,the American Institute of Certified Public Accountants issued Statement ofPosition 05-1, “Accounting by Insurance Enterprises for DeferredAcquisition Costs (“DAC”) in Connection with Modifications or Exchanges ofInsurance Contracts” (“SOP 05-1”). SOP 05-1 provides guidance onaccounting by insurance enterprises for DAC on internal replacements ofinsurance and investment contracts. An internal replacement is a modificationin product benefits, features, rights or coverages that occurs by the exchangeof a contract for a new contract, or by amendment, endorsement, or rider to acontract, or by the election of a feature or coverage within a contract.Modifications that result in a replacement contract that is substantiallychanged from the replaced contract should be accounted for as an extinguishmentof the replaced contract. Unamortized DAC, unearned revenue liabilities anddeferred sales inducements from the replaced contract must be written-off.Modifications that result in a contract that is substantially unchanged fromthe replaced contract should be accounted for as a continuation of the replacedcontract. SOP 05-1 is effective for internal replacements occurring infiscal years beginning after December 15, 2006, with earlier adoptionencouraged. Initial application of SOP 05-1 should be as of the beginningof the entity’s fiscal year. The Company adopted SOP 05-1 effective January 1,2007. Adoption of this statement did not have a material effect on the Company’sconsolidated financial statements.

***Income******Taxes—******In***June 2006,the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty inIncome Taxes-an Interpretation of FASB Statement 109” (“FIN 48”). FIN 48prescribes a comprehensive model for how a company should recognize, measure,present, and disclose in its financial statements uncertain tax positions thatthe company has taken or expects to take on a tax return. The interpretationrequires companies to recognize the tax benefits of uncertain tax positionsonly where the position is “more likely than not” to be sustained assumingexamination by tax authorities. The amount recognized would be the amount thatrepresents the largest amount of tax benefit that is greater than 50% likely ofbeing realized upon ultimate settlement with the taxing authority. A liabilitywould be recognized for any benefit claimed, or expected to be claimed, in atax return in excess of the benefit recorded in the financial statements, alongwith any interest and penalty (if applicable) on the excess. FIN 48 willrequire a tabular reconciliation of the change in the aggregate unrecognizedtax benefits claimed, or expected to be claimed, in tax returns and disclosurerelating to accrued interest and penalties for unrecognized tax benefits.Discussion will also be required for those uncertain tax positions where it isreasonably possible that the estimate of the tax benefit will changesignificantly in the next 12 months. FIN 48 is effective for 

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fiscal years beginningafter December 15, 2006. The adoption of FIN 48 did not have a materialeffect on the Company’s consolidated financial statements.

***Fair***Value—******InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“SFAS 157”). This statement defines fair value, establishes aframework for measuring fair value under accounting principles generallyaccepted in the United States, and enhances disclosures about fair valuemeasurements. SFAS 157 provides guidance on how to measure fair value whenrequired under existing accounting standards. The statement establishes a fairvalue hierarchy that prioritizes the inputs to valuation techniques used tomeasure fair value into three broad levels (“Level 1, 2 and 3”). Level 1 inputsare observable inputs that reflect quoted prices for identical assets orliabilities in active markets the Company has the ability to access at themeasurement date. Level 2 inputs are observable inputs, other than quotedprices included in Level 1, for the asset or liability. Level 3 inputs areunobservable inputs reflecting the reporting entity’s estimates of the assumptionsthat market participants would use in pricing the asset or liability (includingassumptions about risk). Quantitative and qualitative disclosures will focus onthe inputs used to measure fair value for both recurring and non-recurring fairvalue measurements and the effects of the measurements in the financialstatements. SFAS 157 is effective for fiscal years beginning after November 15,2007, with earlier application encouraged only in the initial quarter of anentity’s fiscal year. Adoption of this statement is expected to have an impacton the Company’s consolidated financial statements; however, the timing foradoption and impact has not yet been determined.

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

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**4.**                 *INTANGIBLE ASSETS*

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

| ** **                                    | ** ** | **Weighted**            | ** ** | ** **                   | ** ** | ** **                      | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                    | ** ** | **Average**             | ** ** | **March 31, 2007** | ** ** | **December 31, 2006** | ** ** |
| ** **                                    | ** ** | **Life  (Years)**       | ** ** | **Value  Assigned**          | ** ** | **Accumulated  Amortization**   | ** ** | **Value  Assigned** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                    | ** ** | **(In thousands)** | ** ** |
| Senior Health  Insurance:                     |       |                    |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Policies in force                             |       |                    | 9          |                         |       | $                               | 18,473     |   |   | $ | 10,596 |   |   | $ | 18,473 |   |   | $ | 9,786 |   |   |
| Distribution Channel                          |       |                    | 30         |                         |       | 22,055                          |       |   | 2,941 |   |   | 22,055 |   |   | 2,757 |   |   |
| Life  Insurance/Annuity—PVFP             |       |                    | 7          |                         |       | 4,127                           |       |   | 1,945 |   |   | 4,127 |   |   | 1,912 |   |   |
| Senior Managed  Care—Medicare Advantage: |       |                    |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Membership base                               |       |                    | 7          |                         |       | 23,413                          |       |   | 5,981 |   |   | 15,381 |   |   | 5,428 |   |   |
| Provider contracts                            |       |                    | 10         |                         |       | 15,539                          |       |   | 2,646 |   |   | 15,539 |   |   | 2,244 |   |   |
| Non-compete                                   |       |                    | 7          |                         |       | 1,346                           |       |   | 16 |   |   | — |   |   | — |   |   |
| Senior  Administrative Services               |       |                    |       |                         |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Administrative service contracts              |       |                    | 6          |                         |       | 7,671                           |       |   | 7,431 |   |   | 7,671 |   |   | 7,399 |   |   |
| Hospital network Contracts                    |       |                    | 10         |                         |       | 1,797                           |       |   | 858 |   |   | 1,797 |   |   | 779 |   |   |
| Total                                         |       |                    | 17         |                         |       | $                               | 94,421     |   |   | $ | 32,414 |   |   | $ | 85,043 |   |   | $ | 30,305 |   |   |

 

Thefollowing table shows the changes in the amortizing intangible assets:

| ** **                    | ** ** | **Three months  ended  March 31,** | ** ** |
|-------------------------------|------------|---------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| Balance,  beginning of year   |       | $                                                 | 54,738     |   | $ | 50,724 |   |
| Additions and adjustments     |       | 9,378                                             |       | 12,076 |   |
| Amortization, net of interest |       | (2,109                                            | )          | (2,368 | ) |
| Balance, end of year          |       | $                                                 | 62,007     |   | $ | 60,432 |   |

 

On March 1, 2007, the Company acquired HarmonyHealth, Inc. (“Harmony”), a provider-owned company that operatesGlobalHealth, a Medicare Advantage and Commercial managed care plan in OklahomaCity, Oklahoma for $18.2 million in cash, including direct costs of acquisitionof $0.2 million. Harmony was a majority-owned subsidiary of the Oklahoma CityClinic. Founded in 2002, GlobalHealth had approximately 3,800 MedicareAdvantage members with annualized revenue of approximately $37 million atthe date of acquisition. Under the terms of the agreement, the Oklahoma CityClinic has entered into a long-term agreement with Universal American toprovide healthcare services to GlobalHealth members. In addition, Oklahoma CityClinic will retain the risk for commercial business under a global capitationarrangement.

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Thetangible book value at the date of acquisition was $3.8 million. The excess ofpurchase price over the tangible book value was $17.7 million, gross ofdeferred taxes of $3.3 million, and was allocated as follows:

| **Description**                                          | ** ** | ** ** | ** ** | **Amount  (in millions)** | ** ** | **Weighted  Average Life  At Acquisition** | ** ** | **Amortization Basis** | ** ** |
|----------------------------------------------------------|------------|------------|------------|--------------------------------|------------|------------------------------------------------------|------------|-----------------------------|------------|
| Membership base acquired                                 |       |       | $          | 8.0                            |       |                                                 |       | 10                          |       |   | The  pattern of projected future cash flows for the   membership base acquired over the estimated   weighted average life of the membership base |   |
| Non-compete agreement                                    |       |       | 1.4        |                           |       |                                                 | 7          |                        |       | Straight  line over the length of the agreement |   |
| Goodwill                                                 |       |       | 8.3        |                           |       |                                                 | —     |                        |       | Non  amortizing |   |
| Total excess of  purchase price over tangible book value |       |       | $          | 17.7                           |       |                                                 |       |                        |       |   |   |   |

 

During the first quarter of 2006, Heritage acquired anadditional interest in the earnings of one of its risk pools, effective as ofJanuary 1, 2006, for $12.1 million. The purchase price was allocated tothe amortizing intangible asset—Provider Contracts and represents the presentvalue of the estimated future cash flows related to the additional interest,and will be amortized over ten years.

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

| 2007 remainder of  year |   | $      | 7,469  |   |
|-------------------------|--------|--------|--------|--------|
| 2008                    |   | 8,070  |   |
| 2009                    |   | 7,394  |   |
| 2010                    |   | 5,910  |   |
| 2011                    |   | 4,231  |   |
| 2012                    |   | 3,928  |   |
| Thereafter              |   | 25,005 |   |
|                    |   | $      | 62,007 |   |

 

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

| ** **                                                 | ** ** | **December 31,   2006** | ** ** | **Additions** | ** ** | **Adjustments** | ** ** | **March 31,   2007** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------|------------|---------------|------------|-----------------|------------|--------------------------------|------------|
| ** **                                                 | ** ** | **(In thousands)**           | ** ** |
| Senior Market Health  Insurance:                           |       |                              |       |          |       |            |       |                           |       |   |   |   |   |   |   |   |   |
| Goodwill                                                   |       |                              | $          | 3,893         |       |            |       | $                              | —     |   |   |   | $ | — |   |   |   | $ | 3,893 |   |   |
| Other                                                      |       |                              | 4,867      |          |       |            | —     |                           |       |   | — |   |   |   | 4,867 |   |   |
| Subtotal—Senior  Market Health Insurance              |       |                              | 8,760      |          |       |            | —     |                           |       |   | — |   |   |   | 8,760 |   |   |
| Senior Managed  Care—Medicare Advantage:              |       |                              |       |          |       |            |       |                           |       |   |   |   |   |   |   |   |   |
| Goodwill                                                   |       |                              | 53,052     |          |       |            | 8,316      |                           |       |   | — |   |   |   | 61,368 |   |   |
| Other                                                      |       |                              | 5,163      |          |       |            | —     |                           |       |   | — |   |   |   | 5,163 |   |   |
| Subtotal—Senior  Managed Care—Medicare Advantage |       |                              | 58,215     |          |       |            | 8,316      |                           |       |   | — |   |   |   | 66,531 |   |   |
| Senior  Administrative Services—Goodwill              |       |                              | 4,357      |          |       |            | —     |                           |       |   | — |   |   |   | 4,357 |   |   |
| Total                                                      |       |                              | $          | 71,332        |       |            |       | $                              | 8,316      |   |   |   | $ | — |   |   |   | $ | 79,648 |   |   |

 

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

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**5.**                 *INVESTMENTS*

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

| ** **                                                   | ** ** | **March 31, 2007** | ** ** |
|--------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                   | ** ** | ** **                   | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **Amortized**                | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| **Classification**                                           | ** ** | ** **                   | ** ** | **Cost** | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
| ** **                                                   | ** ** | **(In thousands)**      | ** ** |
| U.S. Treasury  securities and obligations of U.S. government |       | $                            | 144,826    |   |   | $ | 408 |   |   |   | $ | (618 | ) |   | $ | 144,616 |   |
| Corporate debt  securities                                   |       | 422,242                      |       |   | 7,721 |   |   |   | (3,948 | ) |   | 426,015 |   |
| Foreign debt  securities                                     |       | 34,302                       |       |   | 478 |   |   |   | (253 | ) |   | 34,527 |   |
| Mortgage-backed  and asset-backed securities                 |       | 552,289                      |       |   | 2,693 |   |   |   | (3,723 | ) |   | 551,259 |   |
|                                                         |       | $                            | 1,153,659  |   |   | $ | 11,300 |   |   |   | $ | (8,542 | ) |   | $ | 1,156,417 |   |
|                                                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| ** **                                                   | ** ** | **December 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 |       | $                               | 115,315    |   |   | $ | 308 |   |   |   | $ | (1,067 | ) |   | $ | 114,556 |   |
| Corporate debt  securities                                   |       | 431,455                         |       |   | 7,739 |   |   |   | (4,424 | ) |   | 434,770 |   |
| Foreign debt  securities                                     |       | 32,120                          |       |   | 427 |   |   |   | (359 | ) |   | 32,188 |   |
| Mortgage-backed  and asset-backed securities                 |       | 531,433                         |       |   | 2,904 |   |   |   | (3,765 | ) |   | 530,572 |   |
|                                                         |       | $                               | 1,110,323  |   |   | $ | 11,378 |   |   |   | $ | (9,615 | ) |   | $ | 1,112,086 |   |
|                                                              |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The amortized cost andfair value of fixed maturities at March 31, 2007 by contractual maturityare shown below. Expected maturities will differ from contractual maturitiesbecause borrowers may have the right to call or prepay obligations with orwithout call or prepayment penalties.

| ** **                            | ** ** | **Amortized**           | ** ** | **Fair**  | ** ** |
|---------------------------------------|------------|-------------------------|------------|-----------|------------|
| ** **                            | ** ** | **Cost**                | ** ** | **Value** | ** ** |
| ** **                            | ** ** | **(In thousands)** | ** ** |
| Due in 1 year or  less                |       | $                       | 79,921     |      | $          | 84,181 |   |
| Due after 1 year  through 5 years     |       | 287,296                 |       | 288,384   |       |
| Due after 5 years  through 10 years   |       | 167,978                 |       | 168,050   |       |
| Due after 10  years                   |       | 66,175                  |       | 64,543    |       |
| Mortgage and  asset-backed securities |       | 552,289                 |       | 551,259   |       |
|                                  |       | $                       | 1,153,659  |      | $          | 1,156,417 |   |

 

**6.**                 *STOCKHOLDERS’ EQUITY*

*Preferred Stock*

The Company has 2.0million authorized shares of preferred stock with no such shares issued oroutstanding at March 31, 2007 or at December 31, 2006.

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*Common Stock*

TheCompany has 100 million shares of common stock, par value $0.01 per share,authorized for issuance. Changes in the number of shares of common stock issuedwere as follows:

| **Three months ended March 31,**                                     | ** ** | ** ** | ** ** | **2007**   | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|----------|------------|
| Common stock  outstanding, beginning of year                                             |       | 59,890,500 |       | 59,042,685 |       |
| Stock options  exercised                                                                 |       | 139,288    |       | 47,283     |       |
| Agent stock award                                                                        |       | 2,543      |       | (639       | )          |
| Stock purchases  pursuant to agents’ stock purchase and deferred compensation plans |       | 21,043     |       | 1,200      |       |
| Common stock  outstanding, end of period                                                 |       | 60,053,374 |       | 59,090,529 |       |

 

*Treasury Stock*

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

| ** **                                          | ** ** | **For the three months ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2007**                                                               | ** ** | **2006** | ** ** |
| ** **                                          | ** ** | **Shares**                                                             | ** ** | **Amount** | ** ** | **Weighted  Average  Cost Per  Share** | ** ** | **Shares** | ** ** | **Amount** | ** ** | **Weighted  Average  Cost Per  Share** | ** ** |
| ** **                                          | ** ** | **(In thousands)**                                                | ** ** | **(In thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Treasury stock  beginning of year                   |       |                                                                   | 712,868    |   |   |   | $ | 10,626 |   |   |   | $ | 14.91 |   |   | 751,473 |   | $ | 11,240 |   |   | $ | 14.96 |   |   |
| Shares  repurchased                                 |       |                                                                   | —     |   |   |   | — |   |   |   | — |   |   | 513 |   | 8 |   |   | 14.85 |   |   |
| Shares  distributed in the form of employee bonuses |       |                                                                   | (86,823    | ) |   |   | (1,294 | ) |   |   | 18.47 |   |   | (1,156 | ) | (17 | ) |   | 15.08 |   |   |
| Treasury stock, end of  period                      |       |                                                                   | 626,045    |   |   |   | $ | 9,332 |   |   |   | $ | 14.91 |   |   | 750,830 |   | $ | 11,231 |   |   | $ | 14.96 |   |   |

 

*Additional Paid InCapital*

In connection with the1999 acquisition of Pennsylvania Life and related companies, Universal Americanprovided loans to certain members of management to purchase shares of commonstock. The loans totaled $1.0 million at inception and were accounted for as areduction of additional paid in capital in the financial statements. Through March 31,2007, $0.9 million has been repaid. Repayments are reported as an increase toadditional paid in capital. As of March 31, 2007, the outstanding balanceof these loans was $0.1 million.

*Accumulated OtherComprehensive Income*

Thecomponents of accumulated other comprehensive income are as follows:

| ** **                                    | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **(In thousands)**  | ** ** |
| Continuing  Operations:                       |       |                     |       |                        |       |   |   |   |   |
| Net unrealized appreciation  on  investments  |       |                     | $          | 2,765                       |       |   |   | $ | 1,769 |   |   |
| Deferred  acquisition cost adjustment         |       |                     | 462        |                        |       |   | 895 |   |   |
| Foreign currency  translation gains           |       |                     | 247        |                        |       |   | 233 |   |   |
| Deferred tax                                  |       |                     | (1,216     | )                           |       |   | (1,014 | ) |   |
| Total accumulated  other comprehensive income |       |                     | $          | 2,258                       |       |   |   | $ | 1,883 |   |   |

 

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

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

*Stock Option Awards*

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

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

| ** **                            | ** ** | **For options granted in:** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2007**                                   | ** ** | **Prior years** | ** ** |
| Risk free  interest rates             |       | 4.68% - 4.93%                    |       | 3.12% - 5.28% |   |
| Dividend yields                       |       | 0.0%                                       |       | 0.0% |   |
| Expected  volatility                  |       | 37.62%  - 39.60%                           |       | 40.00% - 47.23% |   |
| Expected lives of  options (in years) |       | 3.75 - 4.25                                |       | 3.0 - 9.0 |   |

 

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

Asummary of option activity for the three months ended March 31, 2007 and March 31,2006 is presented below:

| **Stock Options**             | ** ** | ** **              | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------|------------|-------------------------|------------|-------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **(in thousands)** | ** ** | ** **  | ** ** | **(in years)**                    | ** ** | **(in thousands)**                             | ** ** |
| Outstanding,  January 1, 2006 |       |                    | 4,823      |        |       |                                   | $          | 6.81                                                |       |                            |       | 5.2 |   |   |   |   |   |   |
| Granted                            |       |                    | 41         |        |       |                                   | 17.98      |                                                |       |                            |       |   |   |   |   |   |   |
| Exercised                          |       |                    | (47        | )           |       |                                   | 6.10       |                                                |       |                            |       |   |   |   |   |   |   |
| Forfeited or  expired              |       |                    | (25        | )           |       |                                   | 13.10      |                                                |       |                            |       |   |   |   |   |   |   |
| Outstanding,  March 31, 2006  |       |                    | 4,792      |        |       |                                   | $          | 6.82                                                |       |                            |       | 4.7 |   |   |   | $ | 42,107 |   |   |
| Exercisable,  March 31, 2006  |       |                    | 3,637      |        |       |                                   | $          | 6.04                                                |       |                            |       | 4.3 |   |   |   | $ | 34,544 |   |   |
| Outstanding, January 1, 2007  |       |                    | 4,325      |        |       |                                   | $          | 7.73                                                |       |                            |       | 4.0 |   |   |   |   |   |   |
| Granted                            |       |                    | 940        |        |       |                                   | 18.47      |                                                |       |                            |       |   |   |   |   |   |   |
| Exercised                          |       |                    | (139       | )           |       |                                   | 9.74       |                                                |       |                            |       |   |   |   |   |   |   |
| Forfeited or  expired              |       |                    | (56        | )           |       |                                   | 14.21      |                                                |       |                            |       |   |   |   |   |   |   |
| Outstanding,  March 31, 2007  |       |                    | 5,070      |        |       |                                   | $          | 9.59                                                |       |                            |       | 4.0 |   |   |   | $ | 49,636 |   |   |
| Exercisable,  March 31, 2007  |       |                    | 3,786      |        |       |                                   | $          | 7.16                                                |       |                            |       | 3.7 |   |   |   | $ | 46,262 |   |   |

 

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The weighted-average grant-date fair value was $6.92for options granted during the first three months of 2007 and was $4.72 foroptions granted during the first three months of 2006. The total intrinsicvalue of options exercised during the first three months of 2007 was $1.3million and the total intrinsic value of options exercised during the firstthree months of 2006 was $0.4 million.

As of March 31, 2007, the total compensation costrelated to non-vested awards not yet recognized was $7.8 million, which isexpected to be recognized over a weighted average period of 1.3 years.

Cash received from theexercise of stock options during the first three months of 2007 was $1.4million and cash received from the exercise of stock options during first threemonths of 2006 was $0.3 million. FAS 123-R also requires the benefits oftax deductions in excess of recognized compensation cost to be reported as afinancing cash flow, rather than as an operating cash flow as required underthe prior statement. The amount of financing cash flows recognized for suchexcess tax deductions was $0.3 million for the three months endedMarch 31, 2007 and was $0.3 million for the three months endedMarch 31, 2006.

*Employee StockAwards*

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

| ** **                                | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| **Non-vested Restricted Stock** | ** ** | ** **                                           | ** ** | **Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** | **Shares** | ** ** | **Weighted  Average  Grant-Date  Fair Value** | ** ** |
| ** **                                | ** ** | **(in thousands)**                              | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Non-vested at  beginning of year          |       |                                                 | 148        |   |   |   | $ | 13.60 |   |   |   | 157 |   |   |   | $ | 12.05 |   |   |
| Granted                                   |       |                                                 | 87         |   |   |   | 18.47 |   |   |   | — |   |   |   | — |   |   |
| Vested                                    |       |                                                 | (16        | ) |   |   | 15.88 |   |   |   | (18 | ) |   |   | 15.88 |   |   |
| Forfeited                                 |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Non-vested at end of  period              |       |                                                 | 219        |   |   |   | $ | 15.35 |   |   |   | 139 |   |   |   | $ | 11.55 |   |   |
|                                           |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The total fair value ofshares of restricted stock vested during the three months ended March 31,2007 was $0.3 million and the total fair value of shares of restricted stockvested during the three months ended March 31, 2006 was $0.3 million.

**8.**                 *STATUTORY FINANCIAL DATA*

The insurance subsidiaries are required to maintainminimum amounts of statutory capital and surplus as required by regulatoryauthorities. However, substantially more than such minimum amounts are neededto meet statutory and administrative requirements of adequate capital andsurplus to support the current level of our insurance subsidiaries’ operations.Each of the insurance subsidiaries’ statutory capital and surplus exceeds itsrespective minimum statutory requirement at levels we believe are sufficient tosupport their current levels of operation. Additionally, the NationalAssociation of Insurance Commissioners (“NAIC”) imposes regulatory risk-basedcapital (“RBC”) requirements on life insurance enterprises. At March 31,2006, all of our insurance subsidiaries maintained ratios of total adjustedcapital to RBC in excess of the “authorized control level”. The combinedstatutory capital and surplus, including 

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asset valuation reserve,of the insurance subsidiaries totaled $321.6 million at March 31, 2007 and$242.9 million at December 31, 2006. For the three months endedMarch 31, 2007, the insurance subsidiaries generated statutory net incomeof $10.2 million. For the three months ended March 31, 2006, the insurancesubsidiaries generated a statutory net income of $2.9 million.

Our health plan affiliatesare also required to maintain minimum amounts of capital and surplus, asrequired by regulatory authorities and are also subject to RBC requirements. AtMarch 31, 2007, the statutory capital and surplus of each of our healthplan affiliates exceeds its minimum requirement and its RBC is in excess of the“authorized control level”. The statutory capital and surplus for our healthplan affiliates was $52.5 million at March 31, 2007 and $44.0 million atDecember 31, 2006. Statutory net income for our health plan affiliates was$5.1 million for the three months ended March 31, 2007 and $3.1 millionfor the three months ended March 31, 2006.

**9.**                 *LOAN PAYABLE*

*Amended CreditAgreement*

In connection with the acquisition of Heritage onMay 28, 2004, the Company amended its then existing credit agreement byincreasing the facility to $120.0 million from $80.0 million (the “AmendedCredit Agreement”), including an increase in the term loan portion to $105.0million from $36.4 million (the balance outstanding at May 28, 2004) andmaintaining the $15.0 million revolving loan facility. None of the revolvingloan facility has been drawn as of March 31, 2007. Under the AmendedCredit Agreement, the spread over LIBOR was reduced to 225 basis points.Effective April 1, 2007, the interest rate on the term loan was 7.6%.Principal repayments are scheduled at $5.3 million per year over a five-yearperiod with a final payment of $80.1 million due upon maturity onMarch 31, 2009.

The Company made regularly scheduled principalpayments of $1.3 million during the three months ended March 31, 2007 and$1.3 million during the three months ended March 31, 2006, in connectionwith its credit facilities.

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

| 2007 (remainder  of the year) |   | $      | 3,937  |   |
|-------------------------------|--------|--------|--------|--------|
| 2008                          |   | 5,250  |   |
| 2009                          |   | 80,063 |   |
|                          |   | $      | 89,250 |   |

 

On January 18, 2007, the Company requested andreceived, from the administrative agent for the bank group an additionalshort-term revolving credit facility of $50.0 million. On March 13, 2007,the Company drew down all $50.0 million of the new short-term revolving creditfacility. This new short-term revolving credit facility has a maturity date ofSeptember 30, 2007 and bears interest at a spread of 75 basis points over LIBOR.The initial rate is 6.1%.

The Company paid interestof $1.7 million during the three months ended March 31, 2007 and $1.6million during the three months ended March 31, 2006, in connection withits credit facilities.

**10.**          *OTHER LONG 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 

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those activities necessaryor incidental thereto. In accordance with the adoption of FASB InterpretationNo. 46(R), “Consolidation of Variable Interest Entities,” the Company doesnot consolidate the trusts. In March, 2007 we issued $50 million of trustpreferred securities at a fixed interest rate of 7.7%. As of March 31, 2007,the Trusts have issued a combined $125.0 million in thirty year trust preferredsecurities.

The Company paid $1.5million in interest in connection with the Junior Subordinated Debt during thethree months ended March 31, 2007, and $1.4 million during the threemonths ended March 31, 2006.

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

EffectiveSeptember 4, 2003, the Company entered into a swap agreement whereby itpays a fixed rate of 6.7% on a $15.0 million notional amount relating to theDecember 2002 trust preferred securities issuance, in exchange for afloating rate of LIBOR plus 400 basis points, capped at 12.5%. The swapcontract expires in December 2007. Effective April 29, 2004, theCompany entered into a second swap agreement whereby it pays a fixed rate of6.98% on a $20.0 million notional amount relating to the October 2003trust preferred securities issuance, in exchange for a floating rate of LIBORplus 395 basis points, capped at 12.45%. The swap contract expires inOctober 2008. The combined fair value of the swaps was $1.0 million atMarch 31, 2007 and $1.2 million at December 31, 2006 and is includedin other assets. We had applied the “short-cut method” to determineeffectiveness and the swaps were initially designated as cash flow hedges, withchanges in their fair value recorded in accumulated other comprehensive income.In 2006, the SEC affirmed its interpretation that prohibits the use of the“short-cut method” for all fair value hedges of fixed-rate trust preferredsecurities, as well as cash flow hedges of the variable cash flows associatedwith variable-rate trust preferred securities, whenever the issuer has theability to defer interest payments at their election. As a result, these cashflow hedges are no longer deemed effective. In the fourth quarter of 2006, thefair value of the hedge was reversed out of accumulated other comprehensiveincome and reported in realized gains in our consolidated income statement. Anyfuture changes in the fair value will also be reported in realized gains.During the three months ended March 31, 2007, $0.2 million relating to thereduction in the fair value of the cash flow swap agreements was reported as arealized loss.

**12.**          *COMMITMENTS AND CONTINGENCIES*

***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,two of which have been consolidated.

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 Kemp Actionis a 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 unspecified damages underSection 10(b) and 20(a) of the Securities Exchange Act of 1934 based uponallegedly false statements by the Company and Richard A. Barasch, Robert A.Waegelein and Gary W. Bryant (hereinafter, the “Officer Defendants”) inpress releases, financial statements and analyst conferences during the classperiod.

Another purported class action was filed by WesternTrust Laborers-Employers Pension Trust (the “Western Trust Action”), a putativeclass member in the Kemp Action who has been appointed lead plaintiff in thataction, on February 2, 2006, in the United States District Court for theSouthern District of New York. The factual and legal allegations in the WesternTrust Action, which also purports to be a class 

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action, are similar tothose in the Kemp Action. By order dated May 1, 2006, the Kemp Action andthe Western Trust Action were consolidated.

On June 26, 2006, a consolidated amended classaction complaint was filed in the Kemp Action (the “Amended Complaint”), whichnow subsumes the Western Trust Action. The Amended Complaint asserts the samelegal claims as in the original Kemp and Western Trust Actions, but also namesan additional defendant and includes additional allegations. The additionaldefendant is William E. Wehner, a former director and former president of PennsylvaniaLife Insurance Company, a subsidiary of the Company. The Amended Complaintalleges that Mr. Wehner is liable for violations ofSections 10(b) and 20(a) of the Securities Exchange Act of 1934on grounds similar to those asserted against the Officer Defendants. Theadditional assertions are supposedly based in part upon information from sixformer employees and agents of the Company and its subsidiaries concerning,among other things, the Company’s medical loss ratio. Like the originalcomplaints in the Kemp and Western Trust Actions, the Amended Complaint seeksdamages in an unspecified amount. On August 14, 2006, defendants served amotion to dismiss the Amended Complaint in the Kemp Action. The lead plaintiffserved opposition papers to the motion on October 17, 2006. The motion wasargued before the Court on December 13, 2006, and, on January 10,2007, the complaint was dismissed without prejudice.  On March 29, 2007, lead plaintiff in theKemp Action served a second amended complaint, which carried forward most ofthe factual and legal assertions in the prior pleading and added certain newallegations from the alleged confidential witnesses referred to in the AmendedComplaint. The second amended complaint dropped the claim that defendant Mr. Wehnerdirectly violated Section 10(b) of the Securities Exchange Ace of1934, as amended. Defendants served a motion to dismiss the second amendedcomplaint on May 10, 2007.

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 Officer Defendants.

On July 19, 2006, the plaintiff in the GreenMeadows Action filed a Verified Amended Shareholder Derivative Complaint (the“GM Amended Complaint”). The GM Amended Complaint adds as new defendantsMr. Wehner, Capital Z Financial Services Fund II, L.P. (“Capital Z”) and threedirectors of the Company who are affiliated with Capital Z, namely Bradley E.Cooper, Robert A. Spass and Eric W. Leathers. Capital Z is the largestshareholder of the Company. The GM Amended Complaint carries forward the legalclaims asserted in the original complaint against the original defendants (withadditional allegations), and adds new claims (i) against the new directordefendants for alleged breach of fiduciary duty in connection with a secondaryoffering in June 2005 that included five million shares of the Company’scommon stock that had been owned by Capital Z and (ii) against Capital Zfor alleged unjust enrichment with respect to the proceeds Capital Z realizedfrom the sale of the five million shares it formerly owned in the secondary offering.On September 8, 2006, defendants served a motion to dismiss the GM AmendedComplaint. On October 26, 2006 (prior to the response date for plaintiff),the Court entered an order staying the case for 90 days. On January 22,2007 (prior to the expiration of the previous stay), the Court entered an orderstaying the case for an additional 120 days.

The second derivativeaction was filed by plaintiff Arthur Tsutsui (the “Tsutsui Action”) onDecember 30, 2005, in the Supreme Court for New York State, WestchesterCounty. The defendants in the Tsutsui Action are the three Officer Defendantsnamed in the other actions, as well as all of the directors sitting on theCompany’s Board of Directors as of the time the complaint was filed. TheTsutsui Action 

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allegesthat the same alleged misstatements that are the subject of the Kemp Actionconstituted a breach of fiduciary duty by the Officer Defendants and thedirectors that caused the Company to sustain damages. The Tsutsui Action alsoseeks recovery of any proceeds derived by the Officer Defendants from the saleof Company stock that was in breach of their fiduciary duties. Defendants inthe Tsutsui Action filed a motion to dismiss the complaint on June 9,2006. On August 17, 2006, the Court issued an order staying the case untilsuch time (i) as the Kemp Action is fully and finally resolved or settled,or (ii) the Green Meadows Action is fully and finally resolved, orshareholders in that case receive notice of a proposed settlement. Each of theOfficer Defendants denies the allegations and has indicated that he intends tovigorously defend against the allegations. Management believes that afterliability insurance recoveries, none of these actions will have a materialadverse effect on the Company.

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

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

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

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

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On January 11, 2007,the New York Supreme Court, Westchester County, signed an order consolidatingeach of the six actions in the Commercial Division of Westchester Court underthe caption, *In re Universal American Financial Corp.Buyout Offer Shareholder Litigation*(the “Consolidated Action”). Thedefendants named in the consolidation order included the Company,Mr. Barasch and the other sponsors of the offer, including Capital Z, aswell as eight other members of the Company’s board of directors. The court’sorder provided that the plaintiff would file a consolidated amended complaint,and the defendants’ time to respond would extend to 40 days thereafter. Theconsolidated amended complaint has not yet been filed. A status conference withthe court is scheduled in the Consolidated Action for May 25, 2007.

***Other Litigation***

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

**13.**          *OTHER COMPREHENSIVE INCOME*

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

| ** **                                                                              | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                                              | ** ** | **Before Tax  Amount**                          | ** ** | **Tax Expense  (Benefit)** | ** ** | **Net of Tax  Amount** | ** ** | **Before Tax  Amount** | ** ** | **Tax Expense  (Benefit)** | ** ** | **Net of Tax  Amount** | ** ** |
| ** **                                                                              | ** ** | **(In thousands)**                              | ** ** |
| ***From continuing operations:***                                                       |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net unrealized (loss) gain arising during  the year (net of deferred acquisition costs) |       |                                                 | $          | 468 |   |   |   | $ | 164 |   |   |   | $ | 304 |   |   |   | $ | (10,268 | ) |   |   | $ | (3,593 | ) |   | $ | (6,675 | ) |
| Reclassification adjustment for losses (gains) included in net income                   |       |                                                 | 95         |   |   |   | 33 |   |   |   | 62 |   |   |   | 1 |   |   |   | — |   |   | 1 |   |
| Net unrealized (loss) gain                                                              |       |                                                 | 563        |   |   |   | 197 |   |   |   | 366 |   |   |   | (10,267 | ) |   |   | (3,593 | ) |   | (6,674 | ) |
| Cash Flow Hedge                                                                         |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | 170 |   |   |   | 60 |   |   | 110 |   |
| Foreign currency translation adjustment                                                 |       |                                                 | 14         |   |   |   | 5 |   |   |   | 9 |   |   |   | (20 | ) |   |   | (7 | ) |   | (13 | ) |
| Other comprehensive (loss) income from continuing operations                            |       |                                                 | 577        |   |   |   | 202 |   |   |   | 375 |   |   |   | (10,117 | ) |   |   | (3,540 | ) |   | (6,577 | ) |
| ***From discontinued operations:***                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net unrealized gain arising during  the year (net of deferred acquisition costs)        |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | (7,239 | ) |   |   | (2,533 | ) |   | (4,706 | ) |
| Reclassification adjustment for gains  included in net income                           |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   | — |   |
| Net unrealized gain                                                                     |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | (7,239 | ) |   |   | (2,533 | ) |   | (4,706 | ) |
| Foreign currency translation adjustment                                                 |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | (266 | ) |   |   | (93 | ) |   | (173 | ) |
| Other comprehensive income from discontinued operations                                 |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |   | (7,505 | ) |   |   | (2,626 | ) |   | (4,879 | ) |
| Total  other comprehensive (loss) income                                                |       |                                                 | $          | 577 |   |   |   | $ | 202 |   |   |   | $ | 375 |   |   |   | $ | (17,622 | ) |   |   | $ | (6,166 | ) |   | $ | (11,456 | ) |

 

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**14.**          *UNCONSOLIDATED SUBSIDIARY*

During 2005, we entered into a strategic alliance withPharmaCare and created PDMS, which is 50% owned by Universal American and 50%owned by PharmaCare. PDMS principally performs marketing and risk managementservices on behalf of our PDPs and PharmaCare for which it receives fees andother 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.Our investment in PDMS was $5.1 million at March 31, 2007 and $6.0 millionat December 31, 2006. Our share in the income or loss of PDMS is includedin “equity in earnings of unconsolidated subsidiary.”  Our share in the net income of PDMS was $13.2million for the three months ended March 31, 2007 and was $9.8 million forthe three months ended March 31, 2006. PDMS made distributions to itsowners aggregating $28.0 million during the three months ended March 31,2007. Our share of these distributions was $14.0 million. No distributions weremade during the three months ended March 31, 2006.

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

| ** **                    | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                    | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **                    | ** ** | **(In thousands)** | ** ** |
| *Assets*                      |       |                    |       |                  |       |   |   |   |   |
| Cash and  investments         |       |                    | $          | 4,072                 |       |   |   | $ | 7,237 |   |   |
| Other                         |       |                    | 7,555      |                  |       |   | 10,234 |   |   |
| Total Assets                  |       |                    | $          | 11,627                |       |   |   | $ | 17,471 |   |   |
| *Liabilities and Equity*      |       |                    |       |                  |       |   |   |   |   |
| Accrued expenses  and other   |       |                    | $          | 1,307                 |       |   |   | $ | 5,558 |   |   |
| Equity                        |       |                    | 10,320     |                  |       |   | 11,913 |   |   |
| Total liabilities  and equity |       |                    | $          | 11,627                |       |   |   | $ | 17,471 |   |   |

 

| ** **     | ** ** | **Three months ended  March 31,** | ** ** |
|----------------|------------|--------------------------------------------------|------------|
| ** **     | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **     | ** ** | **(In thousands)**                          | ** ** |
| Total revenue  |       | $                                                | 27,146     |   | $ | 21,104 |   |
| Total expenses |       | 739                                              |       | 1,490 |   |
| Income         |       | $                                                | 26,407     |   | $ | 19,614 |   |

 

**15.**          *BUSINESSSEGMENT INFORMATION*

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

**Senior Managed Care—MedicareAdvantage—**The Senior ManagedCare—Medicare Advantage segment includes the operations of our initiatives inmanaged care for seniors. We operate various health plans, including SelectCareof Texas, that offer coverage to Medicare beneficiaries under a contract withCMS in Southeastern Texas, Oklahoma, Florida and Wisconsin. The health plansare sold by our career and independent agents and directly by employeerepresentatives. In connection with the health plans, we operate separateManagement Service Organizations (“MSO’s”) that manage that business andaffiliated Independent Physician Associations (“IPA’s”). We participate in thenet results derived from these affiliated IPA’s. Our Medicare Advantage privatefee-for-service plans, also under a contract with CMS, 

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**aresold by our career and independent agents. We currently market PFFS products in2,600 counties throughout 35 states.**

**Senior MarketHealth Insurance—**Thissegment consists of our Medicare Supplement business and other senior markethealth products distributed through our career agency sales force and throughour network of independent general agencies, as well as our MedicarePart D plans, including the equity in the income or loss of PDMS, thatbegan offering prescription drug coverage for seniors on January 1, 2006.The inclusion of the operating results from our Medicare Part D businesswith those of our Medicare Supplement business has resulted in an increase inthe level of seasonality in our reported results during a given calendar year.These businesses generally see higher claim experience in the early quarters ofthe year, with lower claims experience in the later quarters of the year,resulting in a pattern of increasing reported net income attributable to thosebusinesses.

**Specialty HealthInsurance**—This segment includes specialty health insuranceproducts, primarily fixed benefit accident and sickness disability insurancesold to the middle income self-employed market in the United States. Thissegment also includes certain products that we no longer sell such as long termcare and major medical insurance. This segment’s products are distributedprimarily by our career agents. The results for this segment for prior periodshave been restated to exclude the results for PennCorp Life, since it is nowclassified as discontinued operations.

**Life Insurance andAnnuity**—This segment includes all of the life insurance andannuity business sold in the United States. This segment’s products includesenior, traditional and universal life insurance and fixed annuities and aredistributed through both independent general agents and our career agencydistribution systems.

**SeniorAdministrative Services—**Oursenior administrative services subsidiary acts as a third party administratorand service provider of senior market insurance products and geriatric caremanagement for both affiliated and unaffiliated insurance companies. Theservices provided include policy underwriting and issuance, telephone andface-to-face verification, policyholder services agent licensing, commissionpayment, claims adjudication, case management, care assessment, referral tohealth care facilities and administration of our Part D prescription drugplans on behalf of our subsidiaries which commenced on January 1, 2006. In2007, we began administration for private-fee-for-service business.

**Corporate—**This segment reflects the activities of UniversalAmerican, including debt service, certain senior executive compensation, andcompliance with requirements resulting from our status as a public company.

Intersegment revenues and expenses are reported on a gross basis ineach of the operating segments but eliminated in the consolidated results.These intersegment revenues and expenses affect the amounts reported on theindividual financial statement line items, but are eliminated in consolidationand do not change income before taxes. The significant items eliminated includeintersegment revenue and expense relating to services performed by the SeniorAdministrative Services segment for our other segments and interest on notespayable or receivable between the Corporate segment and the operating segments.

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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,** | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                 | ** ** | **Revenue**                                          | ** ** | **Income  (Loss)  Before  Income  Taxes** | ** ** | **Revenue** | ** ** | **Income  (Loss)  Before  Income  Taxes** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                              | ** ** |
| Senior Managed  Care—Medicare Advantage               |       | $                                                    | 382,017    |   | $ | 5,992 |   | $ | 91,034 |   | $ | 9,232 |   |
| Senior Market  Health Insurance                            |       | 191,218                                              |       | (6,888 | ) | 178,790 |   | (860 | ) |
| Specialty Health  Insurance                                |       | 24,249                                               |       | 3,413 |   | 24,892 |   | 1,402 |   |
| Life Insurance  and Annuity                                |       | 25,345                                               |       | 3,297 |   | 25,041 |   | 1,042 |   |
| Senior  Administrative Services                            |       | 25,565                                               |       | 5,837 |   | 20,204 |   | 2,427 |   |
| Corporate                                                  |       | 653                                                  |       | (7,754 | ) | 135 |   | (5,481 | ) |
| Intersegment  revenues                                     |       | (19,329                                              | )          | — |   | (14,628 | ) | — |   |
| Adjustments to segment  amounts:                           |       |                                                 |       |   |   |   |   |   |   |
| Net realized gains (losses)(1)                             |       | 1,904                                                |       | 1,904 |   | (1 | ) | (1 | ) |
| Equity in (earnings) loss of unconsolidated  subsidiary(2) |       | (13,203                                              | )          | — |   | (9,807 | ) | — |   |
| Total—Continuing  Operations                          |       | $                                                    | 618,419    |   | $ | 5,801 |   | $ | 315,660 |   | $ | 7,761 |   |

----

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

(2)          We report the equity inthe earnings of unconsolidated subsidiary as revenue for our Senior MarketHealth Insurance segment for purposes of analyzing the ratio of net pharmacybenefits incurred because the amount is incorporated in the calculation of therisk corridor adjustment. For consolidated reporting, this amount is includedas a separate line in income from continuing operations.

Identifiableassets by segment are as follows:

| ** **                                   | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                   | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **                                   | ** ** | **(In thousands)** | ** ** |
| Senior Managed  Care—Medicare Advantage |       | $                       | 834,954    |                  |       | $ | 390,413 |   |   |
| Senior Market  Health Insurance              |       | 886,107                 |       |                  | 819,056    |   |   |
| Specialty Health  Insurance                  |       | 593,032                 |       |                  | 527,486    |   |   |
| Life Insurance  and Annuity                  |       | 721,210                 |       |                  | 731,003    |   |   |
| Senior  Administrative Services              |       | 29,811                  |       |                  | 31,326     |   |   |
| Corporate                                    |       | 945,806                 |       |                  | 816,908    |   |   |
| Intersegment  assets(1)                      |       | (866,912                | )          |                  | (731,150   | ) |   |
| Total Assets                                 |       | $                       | 3,144,008  |                  |       | $ | 2,585,042 |   |   |

----

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

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**16.**          *DISCONTINUED OPERATIONS*

On December 1, 2006, the Company completed thesale of UAFC (Canada) Inc., including PennCorp Life Canada. Pursuant to thePurchase Agreement, the Company sold all of the outstanding shares of UAFC(Canada) Inc., owner of the Company’s Canadian insurance subsidiary, PennCorpLife Canada, to a venture 70% owned by La Capitale and 30% owned by GMF, for anaggregate purchase price of approximately $131 million (CAD$146 million) incash, on the terms and conditions set forth in the Purchase Agreement (the“Sale”). The purchase price is comprised of $121.9 million (CAD$137.0 million) in cash, plus an amount equal to the balance of netearnings generated by PennCorp Life Canada during the period fromJanuary 1, 2006 through the closing date, December 1, 2006, equalapproximately $8.4 million (CAD $9.9 million). Universal American hasaccounted for the operations of PennCorp Life Canada as discontinued operationsbeginning in the third quarter of 2006. All prior period amounts have beenreclassified to conform to this presentation.

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

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

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

Summarizedfinancial information for our discontinued operations for the three monthsended March 31, 2007 and 2006 is presented below.

| ** **                           | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Total revenue                        |       |     | $          | —   |       |   | $ | 20,062 |   |
| Total expenses                       |       |     | —     |     |       | 16,766 |   |
| Income before  provision for taxes   |       |     | —     |     |       | 3,296 |   |
| Provision for income taxes           |       |     | —     |     |       | 1,207 |   |
| Income from discontinued  operations |       |     | $          | —   |       |   | $ | 2,089 |   |

 

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

| ** **                         | ** ** | **March 31,  2007** | ** ** | **December 1,  2006** | ** ** |
|------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                         | ** ** | **(In thousands)**  | ** ** |
| **Assets**                         | ** ** | ** **               |       |                       |       |   |   |   |   |
| Cash and  investments              |       |                     | $          | —                     |       |   |   | $ | 266,607 |   |   |
| Deferred policy  acquisition costs |       |                     | —     |                       |       |   | 33,942 |   |   |
| Other assets                       |       |                     | —     |                       |       |   | 19,025 |   |   |
| Total assets                       |       |                     | $          | —                     |       |   |   | $ | 319,574 |   |   |
| **Liabilities**                    |       |                     |       |                       |       |   |   |   |   |
| Policyholder  liabilities          |       |                     | $          | —                     |       |   |   | $ | 223,656 |   |   |
| Other liabilities                  |       |                     | —     |                       |       |   | 6,385 |   |   |
| Total liabilities                  |       |                     | $          | —                     |       |   |   | $ | 230,041 |   |   |

 

**17.**          *SALE OF SUBSIDIARY*

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

**18.**          *SUBSEQUENT EVENT*

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

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

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

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Purchase Agreement (the“Stage 1 Securities Purchase Agreement”) with the Equity Investors, UniversalAmerican will issue and sell to the Equity Investors in a private placement anaggregate of 30,473 shares of Series A Preferred Stock and 19,527 sharesof Series B Preferred Stock. Pursuant to a second Securities PurchaseAgreement (the “Stage 2 Securities Purchase Agreement”) with the Equity Investors,Universal American will issue and sell to the Equity Investors an aggregate of125,000 shares of Series B Preferred Stock (a portion of which may beissued to and purchased by an Equity Investor under the Stage 2 Purchase Agreement instead in the form ofSeries A Preferred Stock at the request of such Investor).

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

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

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

**Introduction**

The following discussionand analysis presents a review of the Company as of March 31, 2007 and itsresults of operations for the three months ended March 31, 2007, and 2006.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 endedDecember 31, 2006.

**Overview**

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

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

**Critical AccountingPolicies**

Our consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States (“GAAP”). The preparation of ourfinancial statements in conformity with GAAP requires us to make estimates andassumptions that affect the amounts of assets and liabilities and disclosuresof assets and liabilities reported by us at the date of the 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 future policy benefits and claim liabilities, deferred policyacquisition costs, goodwill, present value of future profits and other intangibleassets, the valuation of certain investments and deferred income taxes. Therehave been no changes in our critical accounting policies during the currentquarter.

***Policy related liabilities***

We calculate and maintain reserves for the estimatedfuture payment of claims to our policyholders using the same actuarialassumptions that we use in the pricing of our products. For our accident andhealth insurance business, we establish an active life reserve for expectedfuture policy benefits, plus a liability for due and unpaid claims and incurredbut not reported claims. Our net income depends upon the extent to which ouractual claims experience is consistent with the assumptions we used in settingour reserves and pricing our policies. If our assumptions with respect tofuture claims are incorrect, and our reserves are insufficient to cover ouractual losses and expenses, we would be required to increase our liabilitiesresulting in reduced net income and shareholders’ equity.

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

| ** **                                            | ** ** | **March 31, 2007**   | ** ** | **December 31, 2006** | ** ** |
|-------------------------------------------------------|------------|--------------------------------|------------|---------------------------------|------------|
| **Liability Type**                               | ** ** | ** **                     | ** ** | **Amount**                      | ** ** | **% of  Total  Policy  Liabilities** | ** ** | **Amount** | ** ** | **% of  Total  Policy  Liabilities** | ** ** |
| ** **                                            | ** ** | **($ in thousands)** | ** ** |
| Policyholder  Account Balances                        |       | $                              | 475,313    |                            |       | 31 | % |   | $ | 485,189 |   |   | 37 | % |   |
| Future Policy Benefit  Reserves:                      |       |                           |       |                            |       |   |   |   |   |   |   |   |   |
| Traditional life insurance                            |       | 193,156                        |       |                            | 13         | % |   | 189,243 |   |   | 14 | % |   |
| Accident and health                                   |       | 413,610                        |       |                            | 27         | % |   | 411,254 |   |   | 32 | % |   |
| Total Future  Policy Benefit Reserves                 |       | 606,766                        |       |                            | 40         | % |   | 600,497 |   |   | 46 | % |   |
| Policy and contract  claims—Accident and Health: |       |                           |       |                            |       |   |   |   |   |   |   |   |   |
| Due and Unpaid Claims                                 |       | 147,608                        |       |                            | 9          | % |   | 105,272 |   |   | 8 | % |   |
| Incurred but not reported claims (“IBNR”)   |       | 281,712                        |       |                            | 19         | % |   | 96,539 |   |   | 8 | % |   |
| Total Accident  and Health Claim Liabilities          |       | 429,320                        |       |                            | 28         | % |   | 201,811 |   |   | 16 | % |   |
| Policy and  contract claims—Life                 |       | 12,760                         |       |                            | 1          | % |   | 12,901 |   |   | 1 | % |   |
| Total Policy Liabilities                              |       | $                              | 1,524,159  |                            |       | 100 | % |   | $ | 1,300,398 |   |   | 100 | % |   |
|                                                       |            |                                |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

***Policyholder Account Balances***

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

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

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

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

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

For our fixed benefit accident and sickness and ourlong term care products, we establish a reserve for future policy benefits atthe time each policy is issued based on the present value of future benefitpayments less the present value of future premiums. (It should be noted that weno longer issue new long term care policies, however our current policies arerenewably annually at the discretion of the policyholder, as evidenced by thepolicyholder continuing to make premium payments.)  In establishing these reserves, we mustevaluate assumptions about mortality, morbidity, lapse rates and the rate atwhich new claims are submitted to us. We estimate the future policy benefitsreserve for these products using the above assumptions and actuarialprinciples. For long-duration insurance contracts, these original assumptionsare used throughout the life of the policy and generally are not subsequentlymodified.

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

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

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

| ** **                                                     | ** ** | **Direct and Assumed** | ** ** | ** **               | ** ** | ** **              | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|--------------------------|------------|-------------------------|------------|
| ** **                                                     | ** ** | ** **                       | ** ** | **% of  Total**     | ** ** | ** **              | ** ** | **% of  Total** | ** ** | **Net of Reserves Ceded to  Reinsurers** | ** ** |
| **Accident & Health Claims Liability** | ** ** | ** **                       | ** ** | **March 31,  2007** | ** ** | **Policy  Liabilities** | ** ** | **December 31,  2006** | ** ** | **Policy  Liabilities** | ** ** | **March 31,  2007** | ** ** | **December 31,  2006** | ** ** |
| ** **                                                     | ** ** | **($ In thousands)**   | ** ** |
| Due &  Unpaid Claims:                                 |       |                             |       |                     |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Medicare Part D                                           |       | $                                | 66,840     |                     |       | 4                       | %          |   |   | $ | 44,052 |   |   |   | 4 | % |   | $ | 33,702 |   |   | $ | 22,179 |   |   |
| Medicare Advantage—Health  Plans                          |       | 58,089                           |       |                     | 3          | %                       |       |   | 44,830 |   |   |   | 3 | % |   | 51,285 |   |   | 42,865 |   |   |
| Other—Specialty                                           |       | 22,680                           |       |                     | 2          | %                       |       |   | 16,390 |   |   |   | 1 | % |   | 9,307 |   |   | 4,000 |   |   |
| Total  Due & Unpaid Claims                            |       | 147,609                          |       |                     | 9          | %                       |       |   | 105,272 |   |   |   | 8 | % |   | 94,294 |   |   | 69,044 |   |   |
| IBNR:                                                          |       |                             |       |                     |       |                    |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Medicare Supplement                                            |       | 51,492                           |       |                     | 3          | %                       |       |   | 51,860 |   |   |   | 4 | % |   | 31,575 |   |   | 37,801 |   |   |
| Medicare Advantage—Private Fee-For-Service                |       | 223,007                          |       |                     | 15         | %                       |       |   | 32,985 |   |   |   | 3 | % |   | 223,007 |   |   | 32,985 |   |   |
| Other—Specialty                                           |       | 7,212                            |       |                     | 1          | %                       |       |   | 11,694 |   |   |   | 1 | % |   | 6,174 |   |   | 11,695 |   |   |
| Total IBNR                                                     |       | 281,711                          |       |                     | 19         | %                       |       |   | 96,539 |   |   |   | 8 | % |   | 260,756 |   |   | 82,481 |   |   |
| Total Accident and  Health Claim Liabilities                   |       | $                                | 429,320    |                     |       | 28                      | %          |   |   | $ | 201,811 |   |   |   | 16 | % |   | $ | 355,050 |   |   | $ | 151,525 |   |   |
|                                                                |            |                                  |            |                          |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

We develop our estimate for IBNR using actuarialmethodologies and assumptions, primarily based upon historical claim paymentand claim receipt patterns, as well as historical medical cost trends.Depending on the period for which incurred claims are estimated, we apply adifferent method in determining our estimate. For periods prior to the mostrecent three months, the key assumption used in estimating our IBNR is that thecompletion factor pattern remains consistent over a rolling 12-monthperiod after adjusting for known changes in claim inventory levels and knownchanges in claim payment processes. Completion factors result from thecalculation of the percentage of claims incurred during a given period thathave historically been adjudicated as of the reporting period. For the mostrecent three months, the incurred claims are estimated primarily from a trendanalysis based upon per member per month (“PMPM”) claims trends developed fromour historical experience in the preceding months, adjusted for known changesin estimates of recent hospital and drug utilization data, provider contractingchanges, changes in benefit levels, product mix, and seasonality.

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

Medical cost trends potentially are more volatile thanother segments of the economy. The drivers of medical cost trends includeincreases in the utilization of hospital facilities, physician services, prescriptiondrugs, and new medical technologies, as well as the inflationary effect on thecost per unit of each of these expense components. Other external factors suchas government-mandated benefits or other regulatory changes, increases inmedical services, an aging population, catastrophes, and epidemics also mayimpact medical cost trends. Internal factors such as claims processing cycletimes, changes in medical management practices and changes in providercontracts also may impact our ability to accurately predict estimates ofhistorical completion factors or medical cost trends. All of these factors areconsidered in estimating IBNR and in estimating the PMPM claims trend forpurposes of determining the reserve for the most recent three months. Additionally,we continually prepare and review follow-up studies to assess thereasonableness of the estimates generated by our process and methods over time.The results of these studies are also considered in determining the reserve forthe most recent three months. Each of these factors requires significantjudgment by management.

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

***Sensitivity Analysis***

Thefollowing table illustrates the sensitivity of our accident and health IBNRpayable at March 31, 2007 to certain reasonably possible changes to theestimated weighted average completion factors and health care cost trend rates.However, it is possible that the actual completion factors and health care costtrend rates will develop differently from our historical patterns and thereforecould be outside of the ranges illustrated below.

| Completion Factor(a):               | ** ** | **Claims Trend Factor(b):**                                        | ** ** |
|------------------------------------------|------------|------------------------------------------------------------------------------|------------|
| **(Decrease)  Increase  in Factor** | ** ** | **Increase  (Decrease) in  Net Accident  & Health  IBNR** | ** ** | **(Decrease)  Increase  in Factor** | ** ** | **(Decrease)  Increase in  Net Accident  & Health  IBNR** | ** ** |
| **($ in thousands)**           | ** ** |
|                                          | (3         | )%                                                                           |       |   | $ | 459 |   |   |   | (3 | )% |   |   | $ | (9,812 | ) |   |
|                                     | (2         | )%                                                                           |       |   | $ | 306 |   |   |   | (2 | )% |   |   | $ | (6,541 | ) |   |
|                                          | (1         | )%                                                                           |       |   | $ | 153 |   |   |   | (1 | )% |   |   | $ | (3,270 | ) |   |
|                                     | 1          | %                                                                            |       |   | $ | (152 | ) |   |   | 1 | % |   |   | $ | 3,279 |   |   |
|                                          | 2          | %                                                                            |       |   | $ | (305 | ) |   |   | 2 | % |   |   | $ | 6,558 |   |   |
|                                     | 3          | %                                                                            |       |   | $ | (458 | ) |   |   | 3 | % |   |   | $ | 9,837 |   |   |

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

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

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

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

***Deferred policy acquisition costs***

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

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

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

At January 1, 2005, prospective unlocking wastriggered due to the actual trend in premium rates of 11.6% exceeding theassumed trend of 10%. The balance of DAC for Medicare supplement business as ofJanuary 1, 2005 was approximately $81 million. The prospective unlockinghad the effect of slowing the future amortization of DAC, as compared to theanticipated amortization had the prospective unlocking not been triggered.Prospective unlocking also had the effect of slowing the future increase inbenefit reserves, as compared to the anticipated increase had the unlocking notbeen triggered.

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During the third quarter of 2006, the annual test forunlocking was performed and we determined that there were no significantchanges in the actual premium rate increase experience. Accordingly, there wasno prospective unlocking of assumptions for DAC for the Company’s Medicaresupplement business during 2006. However, based on current premium rate trends,we believe that it is likely that unlocking will be triggered during 2007. Thebalance of DAC for Medicare Supplement business as of March 31, 2007 wasapproximately $110.9 million. Should the unlocking be triggered in 2007, weanticipate the amortization subsequent to the unlocking will be slower in theinitial quarters subsequent to unlocking by between $0.3 million and $0.7million per quarter, and then it will increase.

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

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

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

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

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

 

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At least annually,management reviews the unamortized balances of present value of future profits,goodwill and other identified intangibles to determine whether events 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, 2007.

***Investment valuation***

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

We regularly evaluate theamortized cost of our investments compared to the fair value of thoseinvestments. Impairments of securities generally are recognized when a declinein fair value below the amortized cost basis is considered to beother-than-temporary. The evaluation is based on the intent and ability to holdthe security to recovery, and is considered on an individual security basis,not on a portfolio basis. Generally, we consider a decline in fair value to beother-than-temporary when the fair value of an individual security is belowamortized cost for an extended period and we do not believe that recovery infair value is probable. Impairment losses for certain mortgage-backed andasset-backed securities are recognized when an adverse change in the amount ortiming of estimated cash flows occurs, unless the adverse change is solely aresult of changes in estimated market interest rates and we intend to hold thesecurity until recovery. The cost basis for securities determined to beimpaired are reduced to their fair value, with the excess of the cost basisover the fair value recognized as a realized investment loss.

***Income taxes***

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

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

During the three monthsended March 31, 2007, we added approximately $0.6 million of valuationallowances on tax capital loss carryforwards, resulting from a portion of thetax capital loss that was generated from the sale of Peninsular during thatperiod. As of March 31, 2007 we have $0.8 million of valuation allowanceson tax capital loss carryforwards remaining.

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**SignificantTransactions and Initiatives**

***Medicare Advantage***

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

For 2007, we have expanded into new markets for ourMedicare HMO and PFFS plans. We currently offer our Medicare Advantagecoordinated care plans in 3 new markets; Florida, north Texas and Wisconsin.Through our insurance subsidiaries American Progressive and Pyramid Life, wecurrently offer our PFFS products in 35 states in 2007. We incurredapproximately $25 million of additional costs in order to execute theseexpansion initiatives during the third and fourth quarters of 2006. As of March 1,2007 our enrollment in PFFS plans has increased to approximately 146,000,representing approximately $1.2 billion of annualized premium.

On March 1, 2007, theCompany acquired Harmony Health, Inc. (“Harmony”), a provider-ownedcompany that operates GlobalHealth, Inc. (“GlobalHealth”), a MedicareAdvantage and Commercial managed care plan in Oklahoma City, Oklahoma for $18.2 millionin cash including direct costs of acquisition of $0.2 million. Harmony wasa majority-owned subsidiary of the Oklahoma City Clinic. Founded in 2002,GlobalHealth had approximately 3,800 Medicare Advantage members with annualizedrevenue of approximately $37 million at the date of acquisition. Under theterms of the agreement, the Oklahoma City Clinic has entered into a long-termagreement with Universal American to provide healthcare services toGlobalHealth members. In addition, the Oklahoma City Clinic will retain therisk for commercial business under a global capitation arrangement.

***Medicare Part D***

Effective January 1, 2006, private insurers werepermitted to sponsor insured stand-alone PDPs pursuant to Part D, whichwas established by the MMA. A portion of the premium for this insurance is paidby the Federal government, and the balance, if any, is paid by the individualswho enroll. The Federal government will also provide additional subsidies inthe form of premium support and coverage of the cost-sharing elements of theplan to certain low income Medicare beneficiaries. For the 2007 plan year, wehave been approved to offer, through our insurance subsidiaries, ourPrescription Pathway SMprescription drug plans in all 32 regions designated by CMS in which we bid,which excludes only Hawaii and Alaska. In addition, we are entitled to receiveauto assignment of dual eligibles and low income subsidy (“LIS”) beneficiarieswho are dually eligible for Medicare and Medicaid in 28 of the 32 CMS regions.These regions include all of the 26 regions for which we were eligible toreceive auto assignees in 2006, plus two new regions. We believe that this newprogram provides increased opportunities to offer a much needed coverage and tofurther serve our target markets.

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

***Medicare Supplement***

Medicare Supplement insurance reimburses thepolicyholder for certain expenses that are not covered by standard Medicarecoverage such as deductibles and co-pays. This coverage is designed for peoplewho want the freedom to choose providers who participate in the standardMedicare program and limit their 

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out of pocket costs to thefixed annual premiums they pay, as opposed to the more restrictive networksthat exist in Medicare Advantage healthplan markets and the co-payments anddeductibles that exist in PFFS and other health plans. We believe that themarket for Medicare supplement products will continue to be attractive,especially because many seniors may lose similar coverage that had previouslybeen offered to them as a retiree benefit by their former employers.

In the last 15 months,there has been increased competition from other Medicare Supplement carriers,as well as from Medicare Advantage plans, which has affected our production andpersistency of Medicare Supplement business. As a result, we continue toexperience higher levels of lapsation in our Medicare Supplement business. Thisexcess lapsation has accelerated the amortization of the deferred acquisitioncost and present value of future profits assets associated with the businessthat lapsed. We cannot give assurances that lapsation of our Medicare Supplementbusiness will decline, requiring faster amortization of the deferred costs.

**Results ofOperations**

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

**Operations—Consolidated Overview**

| ** **                                 | ** ** | **Three months ended  March 31,** | ** ** |
|--------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                 | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                 | ** ** | **(In thousands)**                          | ** ** |
| Senior Managed  Care-Medicare Advantage(1) |       | $                                                | 5,992      |   | $ | 9,232 |   |
| Senior Market  Health Insurance(1)         |       | (6,888                                           | )          | (860 | ) |
| Specialty Health  Insurance(1)(2)          |       | 3,413                                            |       | 1,402 |   |
| Life Insurance  and Annuity(1)             |       | 3,297                                            |       | 1,042 |   |
| Senior  Administrative Services(1)         |       | 5,837                                            |       | 2,427 |   |
| Corporate(1)                               |       | (7,754                                           | )          | (5,481 | ) |
| Net realized  gains on investments         |       | 1,904                                            |       | (1 | ) |
| Income before  income taxes(1)             |       | 5,801                                            |       | 7,761 |   |
| Income taxes, excluding capital gains      |       | 773                                              |       | 2,829 |   |
| Income taxes on  capital gains             |       | 667                                              |       | — |   |
| Total income taxes                         |       | 1,440                                            |       | 2,829 |   |
| **Income from continuing operations**      | ** ** | **4,361**                                        | ** ** | **4,932** | ** ** |
| Income from discontinued operations(2)     |       | —                                           |       | 2,089 |   |
| **Net income**                             | ** ** | **$**                                            | **4,361**  | ** ** | **$** | **7,021** | ** ** |
| **Earnings per common share (diluted):**   |       |                                             |       |   |   |
| Income from continuing operations          |       | $                                                | 0.07       |   | $ | 0.08 |   |
| Income from discontinued operations        |       | —                                           |       | 0.04 |   |
| **Net  income**                            | ** ** | **$**                                            | **0.07**   | ** ** | **$** | **0.12** | ** ** |

 

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

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

***Three months ended March 31, 2007 and 2006***

Net income for the three months ended March 31,2007 decreased to $4.4 million, or $0.07 per diluted share, compared to $7.0million, or $0.12 per diluted share for the first quarter of 2006. Income fromcontinuing operations, after taxes, was $4.4 million, or $0.07 per dilutedshare for the first quarter of 2007 compared to income from continuingoperations, after taxes, of $4.9 million, or $0.08 per diluted share for thefirst quarter of 2006. Income from continuing operations for 2007 includesrealized investment gains, net of tax, of $1.2 million, relating primarilyto the gain on the sale of Peninsular. Our effective tax rate for continuingoperations was 24.8% for the first quarter of 2007, and 36.4% for the firstquarter of 2006. The effective tax rate for the first quarter of 2007 includesa one-time benefit relating to state taxes of $0.7 million.

The first quarter of 2006 included income fromdiscontinued operations, after taxes of $2.1 million or $0.04 per diluted share

Our Senior Managed Care—Medicare Advantage segmentgenerated segment income of $6.0 million in the first quarter of 2007, adecrease of $3.2 million, compared to $9.2 million for the first quarter of2006, primarily due to higher medical loss ratios and expenses relating toinfrastructure expansion to support growth of our PFFS plans.

The Senior Market Health Insurance segment generated aloss of $6.9 million in the first quarter of 2007 compared to a loss of $0.9million for the first quarter of 2006. Results for our Medicare Supplementbusiness declined by $5.6 million compared to the first quarter of 2006primarily as a result of the continued effect of higher levels of lapsation ofour Medicare Supplement in force business, which resulted in acceleratedamortization of deferred acquisition costs. A significant portion of thelapsation was attributable to the 15,000 Medicare Supplement policyholders whoswitched to our PFFS coverage during the first quarter. Segment income for our Part Dbusiness decreased by $0.5 million, or 8% compared to the first quarter of2006.

Our Specialty Health Insurance segment incomeincreased by $2.0 million, or 143%, compared to the first quarter of 2006,primarily as a result of lower commissions and general expenses.

Segment income from our Life Insurance and Annuitysegment increased by $2.3 million, compared to the first quarter of 2006,primarily as a result of an increase in investment income and more favorablemortality.

Segment income for our Senior Administrative Servicessegment increased by $3.4 million, or 141%, to $5.8 million for the firstquarter of 2007, as compared to the same period of 2006. This increase isprimarily the result of the growth in business administered.

The loss from our Corporate segment increased by $2.3million, or 41%, for the three months ended March 31, 2007 compared to thethree months ended March 31, 2006. The increase was due primarily toincreases in other parent company expenses, stock-based compensation andinterest costs.

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

| ** **                                   | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                          | ** ** |
| Net premiums                                 |       | $                                                | 379,098    |   | $ | 89,958 |   |
| Net and other investment  income             |       | 2,919                                            |       | 1,076 |   |
| Total revenue                                |       | 382,017                                          |       | 91,034 |   |
| Medical expenses                             |       | 317,027                                          |       | 66,200 |   |
| Amortization of  intangible assets           |       | 971                                              |       | 870 |   |
| Commissions and general  expenses            |       | 58,027                                           |       | 14,732 |   |
| Total benefits, claims  and other deductions |       | 376,025                                          |       | 81,802 |   |
| Segment income                               |       | $                                                | 5,992      |   | $ | 9,232 |   |

 

Our Senior Managed Care—MedicareAdvantage segment includes the operations of our initiatives in managed carefor seniors. We operate various health plans that offer coverage to Medicarebeneficiaries, under contracts with CMS, in Southeastern Texas, Oklahoma,Florida, Wisconsin and North Texas. The health plans are sold by our career andindependent agents and directly by employee representatives. Our MedicareAdvantage PFFS plans, also under a contract with CMS, are sold by our careerand independent agents through American Progressive and Pyramid Life inapproximately 2,600 counties across 35 states.

***Three months ended March 31,2007 and 2006***

Our Senior Managed Care—MedicareAdvantage segment generated segment income of $6.0 million in the firstquarter of 2007, a decrease of $3.2 million, compared to $9.2 million for thefirst quarter of 2006, primarily due to higher medical loss ratios and expensesrelating to infrastructure expansion to support growth of our PFFS plans.

**Healthplans**

| ** **                                   | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                          | ** ** |
| Net premiums                                 |       | $                                                | 114,632    |   | $ | 73,672 |   |
| Net and other investment  income             |       | 1,673                                            |       | 1,005 |   |
| Total revenue                                |       | 116,305                                          |       | 74,677 |   |
| Medical expenses                             |       | 86,084                                           |       | 54,566 |   |
| Amortization of  intangible assets           |       | 971                                              |       | 870 |   |
| Commissions and general  expenses            |       | 22,529                                           |       | 12,603 |   |
| Total benefits, claims  and other deductions |       | 109,584                                          |       | 68,039 |   |
| Segment income                               |       | $                                                | 6,721      |   | $ | 6,638 |   |

 

***Three months ended March 31,2007 and 2006***

*Revenues.**  *Net premiums for the Healthplansincreased by $41.0 million, or 56%, compared to the first quarter of 2006.Approximately $38.3 million of the increase was due to growth in membership toapproximately 46,000 members from 28,000 in the first quarter of 2006. Additionaly,in connection with the acquisition of Harmony Health in March 2007, weacquired approximately 10,600 commercial members, representing approximately$2.8 million of the increase in revenues. This commercial business has beencapitated at an 89% medical loss ratio through an arrangement with the seller,the Oklahoma City Clinic. 

40

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Net investmentincome increased by $0.7 million, due primarily to growth in investedassets as a result of growth in business.

*Benefits, Claims andExpenses.**  *Medicalexpenses increased by $31.5 million, or 58%, compared to the first quarter of2006. Growth in membership added approximately $28.3 million and the HarmonyHealth commercial business added $2.5 million. The balance of $0.7 million wasdue to an increase in the loss ratio. Overall loss ratios for the healthplans,excluding the Harmony Health commercial business, increased to 74.7% for thefirst quarter of 2007, from 74.1% for the first quarter of 2006. Commissionsand general expenses increased by $9.9 million compared to the first quarter of2006, due primarily to the growth in business, as well as an increase incommissions, as more of the Medicare Advantage product is being sold by ouragents.

**Private Fee-for-Service**

| ** **                                   | ** ** | **Three months ended  March 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                   | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(In thousands)**                          | ** ** |
| Net premiums                                 |       | $                                                | 264,466    |   | $ | 16,286 |   |
| Net and other investment  income             |       | 1,246                                            |       | 71 |   |
| Total revenue                                |       | 265,712                                          |       | 16,357 |   |
| Medical expenses                             |       | 230,943                                          |       | 11,634 |   |
| Commissions and general  expenses            |       | 35,498                                           |       | 2,129 |   |
| Total benefits, claims  and other deductions |       | 266,441                                          |       | 13,763 |   |
| Segment (loss) income                        |       | $                                                | (729       | ) | $ | 2,594 |   |

 

***Three months ended March 31,2007 and 2006***

*Revenues.**  *Net premiums for the PFFS businessincreased by $248.2 million, or 1,524%, compared to the first quarter of 2006.Approximately $231.6 million of the increase was due to the growth inmembership to approximately 146,000 members from 10,000 in the first quarter of2006  The balance of the increase of$16.6 million was due to an increase in the average premium PMPM. Netinvestment income increased by $1.2 million, due primarily to the growthin invested assets as a result of the growth in business.

*Benefits, Claims andExpenses.**  *Medicalexpenses increased by $219.3 million, or 1,885%, compared to the first quarterof 2006. Growth in membership added approximately $177.3 million. The balanceof $42.0 million was due to an increase in the loss ratio. Overall loss ratiosincreased to 87.3% for the first quarter of 2007 from 71.4% for the firstquarter of 2006 primarily due to more competitively priced products. Commissionsand general expenses increased by $33.4 million compared to the first quarterof 2006, due primarily to the growth in business.

41

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**Segment Results—Senior Market Health Insurance**

| ** **                                           | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                         | ** ** |
| Premiums:                                            |       |                                            |       |   |   |
| Direct and assumed                                   |       | $                                               | 296,589    |   | $ | 274,035 |   |
| Ceded                                                |       | (121,315                                        | )          | (107,534 | ) |
| Net premiums                                         |       | 175,274                                         |       | 166,501 |   |
| Other Part D  income—PDMS                  |       | 13,203                                          |       | 9,807 |   |
| Net investment income                                |       | 2,783                                           |       | 1,970 |   |
| Other income                                         |       | (42                                             | )          | 512 |   |
| Total revenue                                        |       | 191,218                                         |       | 178,790 |   |
| Policyholder benefits                                |       | 156,901                                         |       | 145,578 |   |
| Change in deferred  acquisition costs                |       | 8,790                                           |       | (2,788 | ) |
| Amortization of  intangible assets                   |       | 992                                             |       | 1,295 |   |
| Commissions and general  expenses, net of allowances |       | 31,423                                          |       | 35,565 |   |
| Total benefits, claims  and other deductions         |       | 198,106                                         |       | 179,650 |   |
| Segment (loss) income                                |       | $                                               | (6,888     | ) | $ | (860 | ) |

 

Our Senior Market HealthInsurance segment historically has included our Medicare Supplement businessand other health insurance products designed for the senior market. On January 1,2006, we began covering prescription drug benefits in accordance with Medicare Part Das a stand-alone benefit to Medicare eligible beneficiaries under PDPs. Wereinsure 50% of the business of our PDPs to PharmaCare Re. The total resultsfor the segment are presented above. Results for our Medicare Supplementbusiness are separately presented below on a comparative basis. Additionally,we have also separately presented the results for our Part D business.

***Three months ended March 31, 2007 and 2006***

The Senior Market Health Insurance segment generated aloss of $6.9 million in the first quarter of 2007 compared to a loss of $0.9million for the first quarter of 2006. Results for our Medicare Supplementbusiness declined by $5.6 million compared to the first quarter of 2006primarily as a result of the continued effect of higher levels of lapsation ofour Medicare Supplement in force business, which resulted in acceleratedamortization of deferred acquisition costs. A significant portion of thelapsation was attributable to the 15,000 Medicare Supplement policyholders whoswitched to our PFFS coverage during the first quarter. Segment income for our Part Dbusiness decreased by $0.5 million, or 8% compared to the first quarter of2006.

42

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**Medicare Supplement**

| ** **                                           | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                         | ** ** |
| Premiums:                                            |       |                                            |       |   |   |
| Direct and assumed                                   |       | $                                               | 116,271    |   | $ | 139,220 |   |
| Ceded                                                |       | (32,444                                         | )          | (40,847 | ) |
| Net premiums                                         |       | 83,827                                          |       | 98,373 |   |
| Net investment  income                               |       | 1,547                                           |       | 1,488 |   |
| Other income                                         |       | (57                                             | )          | 495 |   |
| Total revenue                                        |       | 85,317                                          |       | 100,356 |   |
| Policyholder  benefits                               |       | 65,513                                          |       | 78,712 |   |
| Change in  deferred acquisition costs                |       | 8,790                                           |       | (2,788 | ) |
| Amortization of  intangible assets                   |       | 992                                             |       | 1,295 |   |
| Commissions and  general expenses, net of allowances |       | 21,898                                          |       | 29,438 |   |
| Total benefits, claims and other deductions          |       | 97,193                                          |       | 106,657 |   |
| Segment loss                                         |       | $                                               | (11,876    | ) | $ | (6,301 | ) |

 

***Three months ended March 31, 2007 and 2006***

*Revenues.**  *Net premiums for our Medicare Supplement businessdeclined by $14.5 million, compared to the first quarter of 2006, due to thecontinued effect of higher lapsation of our Medicare Supplement in forcebusiness, offset, in part by the effect of rate increases on the remaining inforce business. Approximately 15,000 Medicare Supplement policyholders switchedto our PFFS coverage during the first quarter of 2007. As a result we lostapproximately $30 million of Medicare Supplement premium revenues attributableto these policyholders, which was replaced with approximately $120 million ofMedicare Advantage PFFS revenue. The average annual premium increasedapproximately 10.0% compared to the first quarter of 2006.

*Benefits,Claims and Expenses.**  *Policyholderbenefits incurred declined by $13.2 million, or 17%, compared to the firstquarter of 2006. The reduction in business, as noted above, resulted in areduction in benefits of $11.6 million. The decrease in the loss ratio furtherreduced benefits by $1.5 million to benefits compared to the first quarter of2006. Overall loss ratios for our Medicare Supplement business decreased 180basis points to 78.2% for the first quarter of 2007 compared to 80.0% for thefirst quarter of 2006.

There was net amortization of deferred acquisitioncosts in the first quarter of 2007 compared to an increase in deferredacquisition costs in the first quarter of 2006, an increase to expense of $11.6million. Two factors contributed to the increase. First, amortization increasedby approximately $5.7 million, primarily as a result of higher levels oflapsation of our Medicare supplement business, compared to the first quarter of2006. Second, we incurred lower commissions and other acquisition costs as aresult of lower production, resulting in a decrease in the costs capitalized of$5.9 million.

43

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Commissionsand general expenses, net of reinsurance allowances, decreased by $7.5 million,or 26%, compared to the first quarter of 2006. The following table details thecomponents of commission and other operating expenses:

| ** **                                           | ** ** | **Three months ended  March 31,** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                          | ** ** |
| Commissions                                          |       | $                                                | 13,145     |   | $ | 18,710 |   |
| Other operating  costs                               |       | 13,921                                           |       | 18,560 |   |
| Reinsurance  allowances                              |       | (5,168                                           | )          | (7,832 | ) |
| Commissions and general  expenses, net of allowances |       | $                                                | 21,898     |   | $ | 29,438 |   |

 

The ratio of commissionsto gross premiums decreased to 11.3% for the first quarter of 2007, from 13.4%for the first quarter of 2006, as a result of lower overall commission ratesassociated with the continued growth of our in force renewal premium and lessnew business production that has higher commission rates. Other operating costsas a percentage of gross premiums were 12.0% for the first quarter of 2007,compared to 13.3% for the first quarter of 2006 as a result of loweracquisition expenses due to lower new business production and lower fixedcosts. Commission and expense allowances received from reinsurers as apercentage of the premiums ceded decreased to 15.9% for the first quarter of2007 from 19.2% for the first quarter of 2006, primarily due to the reductionin new business ceded and the effects of normal lower commission allowances onour aging base of ceded renewal business.

**Medicare Part D**

| ** **                                                 | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                         | ** ** |
| Direct and  assumed premium                                |       | $                                               | 134,083    |   | $ | 120,790 |   |
| Risk corridor  adjustment/government reinsurance           |       | 46,235                                          |       | 14,025 |   |
| Direct and  assumed premium after risk corridor adjustment |       | 180,318                                         |       | 134,815 |   |
| Ceded premiums                                             |       | (88,871                                         | )          | (66,687 | ) |
| Net premiums                                               |       | 91,447                                          |       | 68,128 |   |
| Other Part D  income (loss)—PDMS                 |       | 13,203                                          |       | 9,807 |   |
| Total Part D  revenue                                 |       | 104,650                                         |       | 77,935 |   |
| Net investment  and other income                           |       | 1,251                                           |       | 499 |   |
| Total revenue                                              |       | 105,901                                         |       | 78,434 |   |
| Pharmacy benefits                                          |       | 91,388                                          |       | 66,866 |   |
| Commissions and  general expenses, net of allowances       |       | 9,525                                           |       | 6,127 |   |
| Total benefits, claims and other deductions                |       | 100,913                                         |       | 72,993 |   |
| Segment income                                             |       | $                                               | 4,988      |   | $ | 5,441 |   |

 

***Three months ended March 31, 2007 and 2006***

Our PDP segment income decreased by $0.5 million, or8%, compared to the first quarter of 2006.

*General.**  *A discussion of the accounting for Part D isincluded in Notes 2 and 14 of the notes to the consolidated financialstatements in this Quarterly Report on Form 10-Q. Below we note certainvariances in operating results in our Part D business betweenMarch 31, 2007 and 2006. During the first quarter of 2006, the Part Dbusiness was in a start-up phase with CMS guidance continually being developedrequiring accounting for the business using certain estimates. As a result, thecomponents of the income statements between the two periods might not becomparable though the year. We believe the Part D 

44

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business income statementfor the year end December 31, 2006 appropriately reflects the results on acomparable basis on those reported in the first quarter of 2007.

*Membership.**  *A discussion of the accounting for Part D isincluded in Notes 2 and 14 of the notes to the consolidated financialstatements in this Quarterly Report on Form 10-Q. We based ourmembership for Part D on enrollment information provided by CMS whichindicated that, as of March 31, 2007, approximately 490,400 members wereenrolled in our PDPs for which we were paid by CMS, an increase of 34% over March 31,2006 membership levels. The 2007 membership includes approximately 466,500members in our PDPs that we participate in on a 50% basis with PharmaCare Reand 23,900 members in the unaffiliated PDP that we participate in on a 33.3%basis. The enrollment information provided by CMS for the first quarter of 2006indicated that, as of March 31, 2006, approximately 367,000 members wereenrolled in our PDPs for which we were paid by CMS, including approximately350,700 members in our PDPs that we participate in on a 50% basis and 16,300members in the unaffiliated PDP that we participate in on a 33.3% basis. Ourrevenues and claims expense are based on earned premium and incurred pharmacybenefits for the reported enrolled membership. The membership informationcontinues to be reconciled and refined by CMS with respect to the enrollment ofmembers among all plans participating in the Part D program. As a resultof the continuing reconciliation process, it is likely that the membership dataupon which we based our results will change, with a corresponding change in thefinancial results for the segment. We are unable to precisely quantify theimpact of any potential change until the membership data is fully reconciledwith CMS; however, we do not believe that any change from the amounts reportedas of March 31, 2007 is likely to be material.

*Revenues.**  *Direct and assumed premium increased by $13.3million, or 11% over the first quarter of 2006. This growth was driven by the34% increase in membership, partially offset by an 18% decrease in the averageper member per month premium due to more competitive pricing of our PDPproducts and consistent with a decrease of 13% in the 2007 National averagebenchmark bid over 2006. The government risk corridor adjustment increased by$32.2 million, due to the change in the distribution of members among ourvarious plans and a change in our benefit design. Other Part D revenue representsour equity in the earnings or loss of PDMS. We report this as revenue forsegment reporting purposes in analyzing the ratio of net pharmacy benefitsincurred because the amount is incorporated in the calculation of the riskcorridor adjustment. For consolidated reporting, this amount is included as aseparate line in income from continuing operations. See the reconciliation ofsegment revenues in Note 15 of the Notes to the Consolidated FinancialStatements in this Quarterly Report on Form 10-Q.

*Benefits, Claims andExpenses.**  *Pharmacybenefit increased by $24.5 million or 37% over the first quarter of 2006, dueto the increase in membership. The ratio of incurred prescription drug benefitsto net premium for the first quarter of 2007 was 99.9% compared to 98.1% forthe first quarter of 2006. Generally, PDP designs result in the sponsor sharingin a greater portion of the responsibility for total pharmacy costs in theearly stages of a member’s plan period and less in the later stages. Based onthe coverage provided by our PDPs, we anticipate that results for our Part Dbusiness will be seasonal, with higher benefit ratios in the first and secondquarters, decreasing in the third and fourth quarters. Changes in the benefitratios are partially offset as a result of the risk corridor adjustments. Commissionsand general expenses increased by $3.4 million, or 56% as a result of theincrease in the membership.

45

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**Segment Results—Specialty Health Insurance**

| ** **                                           | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                         | ** ** |
| Premiums:                                            |       |                                            |       |   |   |
| Direct and assumed                                   |       | $                                               | 99,662     |   | $ | 92,224 |   |
| Ceded                                                |       | (80,725                                         | )          | (71,984 | ) |
| Net premiums                                         |       | 18,937                                          |       | 20,240 |   |
| Net investment  income                               |       | 5,279                                           |       | 4,564 |   |
| Other income                                         |       | 33                                              |       | 88 |   |
| Total revenue                                        |       | 24,249                                          |       | 24,892 |   |
| Policyholder  benefits                               |       | 17,229                                          |       | 18,106 |   |
| Change in  deferred acquisition costs                |       | 294                                             |       | (541 | ) |
| Commissions and  general expenses, net of allowances |       | 3,313                                           |       | 5,925 |   |
| Total benefits, claims and other deductions          |       | 20,836                                          |       | 23,490 |   |
| Segment income                                       |       | $                                               | 3,413      |   | $ | 1,402 |   |

 

***Three months ended March 31, 2007 and 2006***

Our Specialty Health Insurance segment incomeincreased by $2.0 million, or 143%, compared to the first quarter of 2006,primarily as a result of lower commissions and general expenses.

*Revenues.**  *Both direct and assumed and ceded premium include anincrease of approximately $9.0 million, compared to the first quarter of 2006,as a result of the premiums relating to the PharmaCare Re reinsurance agreementfor the State of Connecticut employees. Net premiums declined by approximately$1.3 million, or 6%, compared to the first quarter of 2006, primarily as aresult of declines of $1.0 million in our U.S. fixed benefit accident andsickness line and $0.3 million in our long term care line.

Net investment income increased by approximately $0.7million, or 16%, compared to the first quarter of 2006. The increase is dueprimarily to investing cash that we had been accumulating in anticipation ofrising interest rates.

*Benefits,Claims and Expenses.**  *Policyholderbenefits incurred declined by $0.9 million, or 5%, compared to the firstquarter of 2006, primarily as a result in the decline in premium, offset inpart by an increase in the overall loss ratios for the segment to 91.0% for thefirst quarter of 2007 compared to 89.5% for the first quarter of 2006.

There was net amortization of deferred acquisitioncosts in the first quarter of 2007 compared to an increase in deferredacquisition costs in the first quarter of 2006, an increase to expense of $0.8million. This was primarily due to an increase in the amortization during thefirst quarter of 2007 as compared to the first quarter of 2006.

Commissions and generalexpenses decreased by $2.6 million, or 44%, compared to the first quarter of2006, primarily as a result of a reduction in commissions. Commissions declinedby $1.7 million and general expenses declined by approximately $0.8 million,primarily as a result of the reduction in new business and renewal premium,particularly lower commission rates on renewal premium.

46

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**Segment Results—Life Insurance and Annuity**

| ** **                                           | ** ** | **Three months ended March 31,** | ** ** |
|------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                           | ** ** | **(In thousands)**                         | ** ** |
| Premiums :                                           |       |                                            |       |   |   |
| Direct and assumed                                   |       | $ 19,240                                   |       | $ 19,197 |   |
| Ceded                                                |       | (4,657                                          | )          | (3,825 | ) |
| Net premiums                                         |       | 14,583                                          |       | 15,372 |   |
| Net investment  income                               |       | 10,683                                          |       | 9,582 |   |
| Other income                                         |       | 79                                              |       | 87 |   |
| Total revenue                                        |       | 25,345                                          |       | 25,041 |   |
| Policyholder  benefits                               |       | 9,832                                           |       | 11,320 |   |
| Interest credited  to policyholders                  |       | 4,705                                           |       | 4,470 |   |
| Change in  deferred acquisition costs                |       | 1,139                                           |       | (750 | ) |
| Amortization of  intangible assets                   |       | 33                                              |       | 76 |   |
| Commissions and  general expenses, net of allowances |       | 6,339                                           |       | 8,883 |   |
| Total benefits, claims and other deductions          |       | 22,048                                          |       | 23,999 |   |
| Segment income                                       |       | $ 3,297                                    |       | $ 1,042 |   |

 

***Three months ended March 3***1, 2007 and 2006

Segment income from our Life Insurance and Annuitysegment increased by $2.3 million, compared to the first quarter of 2006,primarily as a result of an increase in investment income and more favorablemortality.

*Revenues.**  *Net premiums for the segment decreased by $0.8million, or 5%, compared to the first quarter of 2006, primarily as a result ofthe decline of $0.7 million in our traditional life business due to the sale,in 2006, of our group life insurance business.

Since September 30, 2006, we are no longerissuing annuity product as we continue our focus more on providing healthinsurance alternatives to the growing senior market. Our agents sold $10.8million of fixed annuities during the first quarter of 2006. Annuity depositsare not considered premiums for reporting in accordance with generally acceptedaccounting principles.

Net investment income increased by approximately $1.1million, or 12%, compared to the first quarter of 2006, primarily as a resultof the increase in portfolio yields.

*Benefits, Claims andExpenses.**  *Policyholderbenefits incurred declined by $1.5 million, or 13%, compared to the firstquarter of 2006. The decline in business reduced policyholder benefits byapproximately $0.6 million and claim costs were lower by approximately $0.9million as a result of more favorable mortality in the first quarter of 2007compared to the first quarter of 2006. There was net amortization of deferredacquisition costs in the first quarter of 2007 compared to an increase indeferred acquisition costs in the first quarter of 2006, an increase to expenseof $1.9 million. This was primarily due to lower production of new lifeinsurance and annuity business during the first quarter of 2007, resulting in alower level of acquisition costs to capitalize as compared to the first quarterof 2006. Commissions and general expenses, net of allowances decreased by $2.5million, or 29%, compared to the first quarter of 2006, primarily due to thelower production levels of new life insurance an annuity business, as notedabove.

47

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**Segment Results—Senior Administrative Services**

| ** **                                       | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | **(In thousands)**                         | ** ** |
| Affiliated fee revenue                           |       |                                            |       |   |   |
| Medicare supplement                              |       | $ 6,455                                    |       | $ 7,722 |   |
| Part D                                      |       | 6,202                                           |       | 3,929 |   |
| Private Fee-for-service                          |       | 3,096                                           |       | — |   |
| Long term care                                   |       | 623                                             |       | 755 |   |
| Life insurance                                   |       | 474                                             |       | 541 |   |
| Other                                            |       | 1,979                                           |       | 781 |   |
| Total affiliated revenue                         |       | 18,829                                          |       | 13,728 |   |
| Unaffiliated fee revenue                         |       |                                            |       |   |   |
| Medicare Advantage                               |       | 2,479                                           |       | 1,771 |   |
| Medicare supplement                              |       | 1,555                                           |       | 1,857 |   |
| Long term care                                   |       | 1,872                                           |       | 2,027 |   |
| Non-insurance products                           |       | 391                                             |       | 280 |   |
| Part D                                      |       | 397                                             |       | 328 |   |
| Other                                            |       | 42                                              |       | 213 |   |
| Total unaffiliated revenue                       |       | 6,736                                           |       | 6,476 |   |
| Total revenue                                    |       | 25,565                                          |       | 20,204 |   |
| Amortization of  present value of future profits |       | 110                                             |       | 123 |   |
| General expenses                                 |       | 19,618                                          |       | 17,654 |   |
| Total expenses                                   |       | 19,728                                          |       | 17,777 |   |
| Segment income                                   |       | $ 5,837                                    |       | $ 2,427 |   |

 

Included in unaffiliatedrevenue are fees received to administer certain business of our insurancesubsidiaries that is 100% reinsured to an unaffiliated reinsurer, whichamounted to $0.7 million in the three months ended March 31, 2007 and$0.9 million for the three months ended March 31, 2006. These fees,together with the affiliated revenue, were eliminated in consolidation.

***Three months ended March 31, 2007 and 2006***

Segment income for our Senior Administrative Servicessegment increased by $3.4 million, or 141%, to $5.8 million for the firstquarter of 2007, as compared to the same period of 2006. This increase isprimarily the result of the growth in business administered.

Revenue increased by $5.4million, or 27%, during the first quarter of 2007 compared to the first quarterof 2006. Affiliated service fee revenue increased by $5.1 million primarily asa result the growth in fees for the administration of our Privatefee-for-service business as well as Part D prescription drug plans onbehalf of our insurance subsidiaries. The increase in other fees relates to theadministration of affiliated business that was previously performed by PennCorpLife Canada and was offset by the decline in fees for the administration of ourMedicare Supplement business. Unaffiliated service fee revenue increased by$0.3 million, due primarily to an increase in additional administrativeservices performed for unaffiliated clients for Medicare Advantage business,partially offset by a decrease in Medicare supplement business. Generalexpenses for the segment increased by $2.0 million, or 11%, primarilyattributed to the growth of the affiliated PFFS and Part D business.

48

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**Segment Results—Corporate**

| ** **                                         | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                                         | ** ** | **(In thousands)**                         | ** ** |
| Interest                                           |       | $ 3,439                                    |       | $ 3,042 |   |
| Amortization of  capitalized loan origination fees |       | 280                                             |       | 229 |   |
| Stock-based  compensation expense                  |       | 1,136                                           |       | 715 |   |
| Other parent  company expenses, net                |       | 2,899                                           |       | 1,495 |   |
| Segment loss                                       |       | $ 7,754                                    |       | $ 5,481 |   |

 

***Three months ended March 31, 2007 and 2006***

The loss from ourCorporate segment increased by $2.3 million, or 41%, for the three months endedMarch 31, 2007 compared to the three months ended March 31, 2006. Theincrease was due primarily to increases in other parent company expenses,stock-based compensation and interest costs. Other parent company expensesincreased as a result of costs associated with our Board of Director’s reviewof the proposed buyout offer, as well as an increase in management bonuses overthe prior year. The increase in stock-based compensation was due primarily tothe advance in the timing of the annual awards to February in 2007 from April in2006. Our combined outstanding debt was $264.3 million at March  31,2007 compared to $170.8 million at March 31, 2006. The weighted averageinterest rate on our loan payable increased to 7.5% for the three months ended March 31,2007 from 6.8% for the three months ended March 31, 2006. The weightedaverage interest rate on our other long term debt increased to 7.8% for thethree months ended March 31, 2007 from 7.6% for the three months ended March 31,2006. See “Liquidity and Capital Resources” for additional informationregarding our loan payable and other long term debt.

**Liquidity andCapital Resources**

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

We require cash at our parent company to meet ourobligations under our credit facility. We also require cash to pay theoperating expenses necessary to function as a holding company (applicableinsurance department regulations require us to bear our own expenses), and tomeet the costs of being a public company.

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

To provide the cash andcapital for our insurance company subsidiaries to support our growth andexpansion initiatives in Medicare Advantage, we have used the proceeds from thesale of our Canadian operations and, in March 2007, we drew down all $50million of our new short-term revolving credit facility. Additionally, in March 2007we issued $50 million of trust preferred securities. There can be no assuranceas to our continued ability to access funds though the capital markets tosupport our growth and expansion initiatives.

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*Amended CreditAgreement*

In connection with the acquisition of Heritage on May 28,2004, the Company its existing 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 31,2007. Under the Amended Credit Agreement, the spread over LIBOR was reduced to225 basis points from 275 basis points. Effective April 1, 2007, the interestrate on the term loan was 7.6%. Principal repayments are scheduled at $5.3million per year over a five-year period with a final payment of $80.1 milliondue upon maturity on March 31, 2009. The Company pays an annual commitmentfee of 50 basis points on the unutilized revolving loan facility. Please referto our 2006 Annual Report on Form 10-K for certain informationregarding the terms of the Amended Credit Agreement.

On January 18, 2007, the Company entered into anew short-term revolving credit facility of $50.0 million (the ‘RevolvingCredit Facility”). On March 13, 2007, the Company drew down all $50.0million of the Revolving Credit Facility. The Revolving Credit Facility has amaturity date of September 30, 2007 and bears interest at a spread of 75basis points over the three month LIBOR rate. The initial rate is 6.1%.

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

The Company made regularly scheduled principalpayments of $1.3 million during the three months ended March 31, 2007 and$1.3 million during the three months ended March 31, 2006 in connectionwith its credit facilities.

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

| 2007 (remainder  of the year) |   | $ 3,937  |   |
|-------------------------------|--------|---------------|--------|
| 2008                          |   | 5,250         |   |
| 2009                          |   | 80,063        |   |
|                          |   | $ 89,250 |   |

 

The Company paid interestof $1.7 million during the three months ended March 31, 2007 and $1.6million during the three months ended March 31, 2006 in connection withits credit facilities. Due to the variable interest rate for this CreditAgreement, the Company would be subject to higher interest costs if short-terminterest rates rise.

*Other Long TermDebt*

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

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

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

| **Maturity Date** | ** ** | ** **              | ** **     | **Amount Issued** | ** ** | **Term**                | ** ** | **Spread Over  LIBOR** | ** ** | **Rate as of  December 31, 2006** | ** ** |
|------------------------|------------|-------------------------|----------------|------------------------|------------|-------------------------|------------|-----------------------------|------------|-------------------------------------------------------|------------|
| ** **             | ** ** | **(In thousands)** | ** **     | ** **             | ** ** | **(Basis points)** | ** ** | ** **                  | ** ** |
| December 2032     |       |                    | $ 15,000  |                   |       | Fixed/Floating          |       |                        | 400        | (1)                                                   |       |   | 6.7 | % |   |
| March 2033        |       |                    | 10,000         |                   |       | Floating                |       |                        | 400        |                                                  |       |   | 9.4 | % |   |
| May 2033          |       |                    | 15,000         |                   |       | Floating                |       |                        | 420        |                                                  |       |   | 9.6 | % |   |
| May 2033          |       |                    | 15,000         |                   |       | Fixed/Floating          |       |                        | 410        | (2)                                                   |       |   | 7.4 | % |   |
| October 2033      |       |                    | 20,000         |                   |       | Fixed/Floating          |       |                        | 395        | (3)                                                   |       |   | 7.0 | % |   |
| March 2037        |       |                    | 50,000         |                   |       | Fixed/Floating          |       |                        | 275        | (4)                                                   |       |   | 7.7 | % |   |
|                   |       |                    | $ 125,000 |                   |       |                    |       |                        |       |                                                  |       |   |   |   |   |

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(1)          Effective September,2003, we entered into a swap agreement whereby it will pay a fixed rate of 6.7%in exchange for a floating rate of LIBOR plus 400 basis points. The swapcontract expires in December 2007.

(2)          The rate on this issueis fixed at 7.4% for the first five years. On May 15, 2008 it will beconverted to a floating rate equal to LIBOR plus 410 basis points.

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

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

We paid $1.5 million ininterest in connection with the Junior Subordinated Debt during the threemonths ended March 31, 2007, and $1.4 million during the three monthsended March 31, 2006.

*Shelf Registration*

On November 3, 2004, we filed a universal shelfregistration statement on Form S-3 with the U.S. Securities andExchange Commission (“SEC”), pursuant to which we may issue common stock,warrants and debt securities from time to time, up to an aggregate offering of$140 million. The registration statement also covers five 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 detailed descriptionof the use of proceeds will be included in any specific offering of securitiesin the prospectus supplement relating to the offering.

The aggregate amount thatremains available for offering under the shelf registration statement is $77.2million.

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*Sources of Liquidity to the Parent Company*

Weanticipate funding the obligations of the parent company and the capitalrequired to grow our business from the following distinct and uncorrelatedsources of cash flow within the organization:

·       theexpected cash flows of our senior administrative services company;

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

·       surplusnote principal and interest payments from American Exchange.

In addition, we haveaccess to $15.0 million under the revolving portion of our Amended CreditAgreement. Finally, we have the ability, from time to time, to access thecapital markets for additional capital. In March of 2007, we drew down all$50 million of the Revolving Credit Facility. Additionally, in March 2007 weissued $50 million of trust preferred securities. In addition, in connectionwith the May 8, 2007 announcement of the signing of definitive agreementsto acquire MemberHealth (see Note 18—Subsequent Event of the Notes to theConsolidated Financial Statements included in this Quarterly Report onForm 10-Q), we have signed stock purchase agreements with certainprivate equity investment funds to issue preferred securities totaling $350million at $20 per common equivalent share. We anticipate that $100 million of thesepreferred securities will be issued during the second quarter of 2007. Inconnection with the MemberHealth Transaction, the Company anticipatesrefinancing its Amended Credit Facility and Revolving Credit Facility with anew credit facility consisting of a $350 million term loan and a$150 million revolver. A portion of the proceeds from the refinancing willbe used to repay in full the outstanding amounts on the Amended Credit Facilityand Revolving Credit Facility. The early extinguishment of this debt willtrigger the immediate amortization of the related capitalized loan originationfees, resulting in a pre-tax expense of approximately $1 million. Therecan be no assurance as to our actual future cash flows, from the continuedavailability of dividends from our insurance company subsidiaries or fromaccess to the capital markets to support our growth and expansion initiatives.

*Senior AdministrativeServices Company.*   Liquidity for our SeniorAdministrative Services subsidiary is measured by its ability to pay operatingexpenses and pay dividends to our parent company. The primary source ofliquidity is fees collected from clients. We believe that the sources of cashfor our Senior Administrative Services company exceed scheduled uses of cashand results in amounts available to dividend to our parent holding company.

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

*Insurance Subsidiaries—SurplusNote, Dividends and Capital Contributions.**  *Cash generated by our insurance company subsidiarieswill be made available to our holding company, principally through periodicpayments of principal and interest on the surplus note owed to our holdingcompany by our subsidiary, American Exchange Life. As of March 31, 2007,the principal amount of the surplus note was $26.5 million. The note bearsinterest to our parent holding company at LIBOR plus 250 basis points. Weanticipate that the surplus note will be primarily serviced by dividends fromPennsylvania Life, a wholly owned subsidiary of American Exchange, bydistributions from PDMS, and by tax-sharing payments among the insurancecompanies that are wholly owned by American Exchange and file a consolidatedFederal income tax return. American Exchange made principal payments totaling$1.1 million during the three months ended March 31, 2007 and $1.0 millionduring the three months ended March 31, 2006. American 

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Exchange paidinterest on the surplus note of $0.6 million during the three months endedMarch 31, 2007 and $0.5 million during the three months ended March 31,2006.

Our parent holding companymade capital contributions to American Exchange amounting to $64.0 millionduring the first three months of 2007. American Exchange made capitalcontributions of $32.0 million to American Progressive and $32.0 million toPyramid during the first three months of 2007.

Our parent holding companymade capital contributions to American Exchange amounting to $3.5 millionduring the first three months of 2006. In January 2006, Pyramid Lifedeclared and paid a dividend in the amount of $10.8 million to PennsylvaniaLife. American Exchange made capital contributions of $2.5 million toConstitution during the first three months of 2006.

Dividend payments by ourU.S. insurance companies to our holding company or to intermediate subsidiariesare limited by, or subject to the approval of the insurance regulatoryauthorities of each insurance company’s state of domicile. Such dividendrequirements and approval processes vary significantly from state to state. PennsylvaniaLife is able to pay ordinary dividends of up to $21.9 million and Pyramid Lifeis be able to pay dividends of up to $2.7 million to American Exchange (theirdirect parent) in 2007 without the prior approval from the insurance departmentfor their respective states of domicile.

*Insurance Subsidiaries—Liquidity*

Liquidity for ourinsurance company subsidiaries is measured by their ability to pay scheduledcontractual benefits, pay operating expenses, fund investment commitments, andpay dividends to their parent company. The principal sources of cash for ourinsurance operations include scheduled and unscheduled principal and interestpayments on investments, premium payments, annuity deposits, and the sale ormaturity of investments. Both the sources and uses of cash are reasonablypredictable and we believe that these sources of cash for our insurance companysubsidiaries exceed scheduled uses of cash.

Liquidity is also affectedby unscheduled benefit payments including benefits under accident and healthinsurance policies, death benefits and interest-sensitive policy surrenders andwithdrawals.

Our accident and healthinsurance policies generally provide for fixed-benefit amounts and, in the caseof Medicare Supplement policies, for supplemental co-payments in accordancewith approved Medicare provider rates. Some of these benefits are subject tomedical-cost inflation and we have the capability to file for premium rateincreases to mitigate rising medical costs. Our health insurance business iswidely dispersed in the United States, which mitigates the risk of unexpectedincreases in claim payments due to epidemics and events of a catastrophicnature. These accident and health polices are not interest-sensitive andtherefore are not subject to unexpected policyholder redemptions due toinvestment yield changes.

Some of our life insuranceand annuity policies are interest-sensitive in nature. The amount of surrendersand withdrawals is affected by a variety of factors such as credited interestrates for similar products, general economic conditions and events in theindustry that affect policyholders’ confidence. Although the contractual termsof substantially all of our in force life insurance policies and annuities givethe holders the right to surrender the policies and annuities, we imposepenalties for early surrenders. As of March 31, 2007 we held reserves thatexceeded the underlying cash surrender values of our net retained in force lifeinsurance and annuities by $31.9 million. Our insurance subsidiaries, in ourview, have not experienced any material changes in surrender and withdrawalactivity in recent years.

Changes in interest ratesmay affect the incidence of policy surrenders and withdrawals. In addition tothe potential impact on liquidity, unanticipated surrenders and withdrawals ina changed interest rate environment could adversely affect earnings if we wererequired to sell investments at reduced values in order to meet liquiditydemands. We manage our asset and liability portfolios in order to minimize the 

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adverseearnings impact of changing market rates. We have segregated a portion of ourinvestment portfolio in order to match liabilities that are sensitive tointerest rate movements with fixed income securities containing similarcharacteristics to the related liabilities, most notably the expected durationand required interest spread. We believe that this asset/liability managementprocess adequately covers the expected payment of benefits related to theseliabilities.

At March 31, 2007,our insurance company subsidiaries held cash and cash equivalents totaling$587.6 million and fixed maturity securities that could readily be converted tocash with carrying values (and fair values) of $1.2 billion at March 31,2007. In addition, our insurance company subsidiaries have cash totalingapproximately $297.0 million for the operation of our PDPs that cannot be usedfor other lines of business or general corporate purposes.

The net yields on our cashand invested assets decreased to 4.7% for the three months ended March 31,2007, from 5.1% for the three months ended March 31, 2006. A portion ofthese securities are held to support the liabilities for policyholder accountbalances, which liabilities are subject to periodic adjustments to theircredited interest rates. The credited interest rates of the interest-sensitivepolicyholder account balances are determined by us based upon factors such asportfolio rates of return and prevailing market rates and typically follow thepattern of yields on the assets supporting these liabilities.

Our domestic insurancesubsidiaries are required to maintain minimum amounts of statutory capital andsurplus as required by regulatory authorities. However, substantially more thanthe statutory minimum amounts are needed to meet statutory and administrativerequirements of adequate capital and surplus to support the current level ofour insurance subsidiaries’ operations. Each of our insurance subsidiaries’statutory capital and surplus exceeds its respective minimum statutoryrequirement at levels we believe are sufficient to support their current levelsof operation. Additionally, the National Association of Insurance Commissioners(“NAIC”) imposes regulatory risk-based capital (“RBC”) requirements on lifeinsurance enterprises. At March 31, 2007, all of our insurancesubsidiaries maintained ratios of total adjusted capital to RBC in excess ofthe “authorized control level”. The combined statutory capital and surplus,including asset valuation reserve, of our U.S. insurance subsidiaries totaled $321.6million at March 31, 2007 and $242.9 million at December 31, 2006.For the three months ended March 31, 2007, our U.S. insurance subsidiariesgenerated a statutory net income of $10.2 million. For the three months ended March 31,2006, our U.S. insurance subsidiaries generated statutory net income of $2.9million.

Our health plan affiliatesare also required to maintain minimum amounts of capital and surplus, asrequired by regulatory authorities and are also subject to RBC requirements. AtMarch 31, 2007, the statutory capital and surplus of each of our healthplan affiliates exceeds its minimum requirement and its RBC is in excess of the“authorized control level”. The statutory capital and surplus for our healthplan affiliates was $52.5 million at March 31, 2007 and $44.0 million at December 31,2006. Statutory net income for our health plan affiliates was $5.1 million forthe three months ended March 31, 2007 and $3.1 million for the threemonths ended March 31, 2006.

*Investments*

Our investment policy isto balance the portfolio duration to achieve investment returns consistent withthe preservation of capital and maintenance of liquidity adequate to meetpayment of policy benefits and claims. We invest in assets permitted under theinsurance laws of the various states in which we operate. Such laws generallyprescribe the nature, quality of and limitations on various types ofinvestments that may be made. We do not currently have investments inpartnerships, special purpose entities, real estate, commodity contracts, orother derivative securities. We currently engage the services of threeinvestment advisors under the direction of the management of our insurancecompany subsidiaries and in accordance with guidelines adopted by theInvestment Committees of their respective boards of directors. Conning AssetManagement Company manages the portfolio of all of our United Statessubsidiaries, except for the portfolio of Pyramid Life, and certain floatingrate portfolios, which are 

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managedby Hyperion Capital. We invest primarily in fixed maturity securities of theU.S. Government and its agencies and in corporate fixed maturity securitieswith investment grade ratings of “BBB-” (Standard & Poor’sCorporation), “Baa3” (Moody’s Investor Service) or higher.

As of March 31, 2007,approximately 99% of our fixed maturity investments had investment graderatings from Standard & Poor’s Corporation or Moody’s InvestorService. There were no non-income producing fixed maturities as of March 31,2007. During the quarters ended March 31, 2007 and 2006, we did not writedown the value of any fixed maturity securities. A write-down of the value of afixed maturity security would represent our estimate of an other than temporarydecline in value and would be included in net realized gains and losses oninvestments in our consolidated statements of operations.

*Effects of Recently Issued and Pending AccountingPronouncements*

A summary of other recentand pending accounting pronouncements is provided in Note 2 of the consolidatedfinancial statements in the Annual Report on Form 10-K under thecaption “Future Adoption of Accounting Standards.”  We do not anticipate any material impact fromthe future adoption of the pending accounting pronouncements discussed in thatnote.

**ITEM3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

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

*Investment Interest Rate Sensitivity*

Our profitability could beaffected if we were required to liquidate fixed income securities duringperiods of rising and/or volatile interest rates. However, we attempt tomitigate our exposure to adverse interest rate movements through a combinationof active portfolio management and by staggering the maturities of our fixedincome investments to assure sufficient liquidity to meet our obligations andto address reinvestment risk considerations. Our insurance liabilitiesgenerally arise over relatively long periods of time, which typically permitsample time to prepare for their settlement.

Certain classes ofmortgage-backed securities are subject to significant prepayment risk due tothe fact that in periods of declining interest rates, individuals may refinancehigher rate mortgages to take advantage of the lower rates then available. Wemonitor and adjust our investment portfolio mix to mitigate this risk.

We regularly conductvarious analyses to gauge the financial impact of changes in interest rate onour financial condition. The ranges selected in these analyses reflect ourassessment as being reasonably possible over the succeeding twelve-monthperiod. The magnitude of changes modeled in the accompanying analyses shouldnot be construed as a prediction of future economic events, but rather, betreated as a simple illustration of the potential impact of such events on ourfinancial 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 31,2007, and with all other variables held constant. A 100 basis point increase inmarket interest rates would result in a pre-tax decrease in the market value ofour fixed income investments of $38.2 million and a 200 basis point increase inmarket interest rates would result in $78.9 million decrease. Similarly, a 100basis point decrease in market interest rates would result in a pre-taxincrease in the market value of our fixed income investments of $38.2 millionand a 200 basis point decrease in market interest rates would result in a $73.0million increase.

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*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, theCompany would be subject to higher interest costs if short-term interest ratesrise. We have attempted to mitigate our exposure to adverse interest ratemovements by fixing the rate on $65.0 million of the trust preferred securitiesfor a five year period through the contractual terms of the security atinception and an additional $35.0 million through the use of interest rateswaps.

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 with increases ordecreases in LIBOR of 100 and 200 basis points from their levels as of and forthe three months ended March 31, 2007, and with all other variables heldconstant. The following table summarizes the impact of changes in LIBOR.

| ** **                                                | ** ** | ** **             | ** ** | **Weighted**                              | ** ** | **Effect of Change in LIBOR on Pre-tax Income  for the three months ended March 31, 2007** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|-------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **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                                              |       |                   | 7.46       | %                                         |       |                                                                                                                                                             | $          | 100.6 |   |   |   | $ | 0.5 |   |   |   | $ | 0.3 |   |   |   | $ | (0.3 | ) |   |   | $ | (0.5 | ) |   |
| Other long term  debt                                     |       |                   | 9.48       | %                                         |       |                                                                                                                                                             | $          | 25.0 |   |   |   | 0.1 |   |   |   | 0.1 |   |   |   | (0.1 | ) |   |   | (0.1 | ) |   |
| Total                                                     |       |                   |       |                                      |       |                                                                                                                                                             |       |   |   |   | $ | 0.6 |   |   |   | $ | 0.4 |   |   |   | $ | (0.4 | ) |   |   | $ | (0.6 | ) |   |
|                                                           |            |                        |            |                                           |            |                                                                                                                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As noted above, we have fixed the interest rate on$100 million of our $264 million of total debt outstanding, leaving $164million of the debt exposed to rising interest rates. As of March 31, 2007we had approximately $629 million of cash and cash equivalents (excluding cashfor the operation of our PDPs) and $155 million in short duration floating rateinvestment securities. We anticipate that the net investment income on this$784 million will be positively impacted by rising interest rates and willmitigate the negative impact of rising interest rates on our debt.

The magnitude of changesreflected in the above analysis regarding interest rates should, in no manner,be construed as a prediction of future economic events, but rather as a simpleillustration of the potential impact of such 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.

**InherentLimitations on Effectiveness of Controls**

Our disclosure controls and procedures and ourinternal control over financial reporting may not prevent or detect all errorsand all fraud. A control system, no matter how well designed and operated, can 

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provide only reasonable,not absolute, 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 or deteriorationin the degree of compliance with policies or procedures.

**Evaluation ofEffectiveness of Controls**

An evaluation was carriedout under the supervision and with the participation of the Company’smanagement, including our Chief Executive Officer and Chief Financial Officer,of the effectiveness of our disclosure controls and procedures as of March 31,2007. Based on this evaluation, our Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective asof March 31, 2007, at a reasonable assurance level.

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

There were no changes inour internal control over financial reporting that occurred during the quarterended March 31, 2007 that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

**PART II**

**ITEM 1—LEGALPROCEEDINGS**

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

**ITEM 1A—RISKFACTORS**

In addition to the otherinformation set forth in this report, you should consider carefully the risksand uncertainties described under the caption “Part I—Item 1A. RiskFactors” in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2006, the occurrence of any of which could materiallyadversely affect our business, prospects, financial condition or results ofoperations. We also could be materially adversely affected by additional risksand uncertainties of which we are not currently aware, or which we currentlyconsider to be immaterial.

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**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,  2007—January 31, 2007   |       |       | —     |                                                |       |                                         | —     |                                                                                                                                   |       |                                                                                                                                | —     |   |   |   | 984,472 |   |   |
| February 1,  2007—February 28, 2007 |       |       | —     |                                                |       |                                         | —     |                                                                                                                                   |       |                                                                                                                                | —     |   |   |   | 984,472 |   |   |
| March 1,  2007—March 31, 2007       |       |       | —     |                                                |       |                                         | —     |                                                                                                                                   |       |                                                                                                                                | —     |   |   |   | 984,472 |   |   |
| Total                                              |       |       | —     |                                                |       |                                         |       |                                                                                                                                   |       |                                                                                                                                | —     |   |   |   |   |   |   |

 

**Recent Sales ofUnregistered Securities**

None.

**ITEM 3—DEFAULTSUPON SENIOR SECURITIES**

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

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

None.

**ITEM 5—OTHERINFORMATION**

Universal American haselected to postpone its previously announced Annual Meeting of Stockholders, asa result of the proposed MemberHealth Transaction. Universal American willnotify stockholders of the new meeting date, and the record date for suchmeeting, as soon as practicable.

**ITEM6—EXHIBITS**
| 3.1 |   | Restated  Certificate of Incorporation of Universal American Financial Corp. (filed as  Exhibit 3.1 to the Registrant’s Amendment No. 2 to the Registration  Statement on Form S-3 (File No. 333-62036) filed on  July 11, 2001, and incorporated by reference herein).                                                                                                                    |   |
|-----|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 3.2 |   | Amendment  No. 1 to the Restated Certificate of Incorporation of Universal American  Financial Corp. (filed as Exhibit 3 to the Registrant’s Quarterly Report  on Form 10-Q (File No. 0-11321) for the quarter ended  June 30, 2004, and incorporated by reference herein).                                                                                                                |   |
| 3.3 |   | Amended and  Restated By-Laws of Universal American Financial Corp. (filed as  Exhibit A to the Registrant’s Current Report on Form 8-K  (File No. 0-11321) dated August 13, 1999, and incorporated by  reference herein).                                                                                                                                                                      |   |
| 4.1 |   | Form of  Indenture dated as of December 2004 between Universal American Financial  Corp. and U.S. Bank National Association, as Trustee (filed as  Exhibit 4.01 to Amendment No. 1 to the Registrant’s Registration  Statement on Form S-3 (File No. 333-120190) filed with  the Securities and Exchange Commission on December 10, 2004, and  incorporated by reference herein) |   |

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| 4.2  |   | Form of  Indenture dated as of December 2004 between Universal American Financial  Corp. and U.S. Bank National Association, as Trustee (filed as  Exhibit 4.02 to Amendment No. 1 to the Registrant’s Registration  Statement on Form S-3 (File No. 333-120190) filed with  the Securities and Exchange Commission on December 10, 2004, and  incorporated by reference herein).                     |   |
|------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 4.3  |   | Shareholders  Agreement dated July 30, 1999, among the Company, Capital Z Financial  Services Fund II, L.P., UAFC, L.P., AAM Capital Partners, L.P., Chase Equity  Associates, L.P., Richard A. Barasch and others (filed as Exhibit A of  the Registrant’s Current Report on Form 8-K dated August 13,  1999, and incorporated by reference herein).                                                                |   |
| 4.4  |   | Registration  Rights Agreement, dated July 30, 1999, among the Company, Capital Z  Financial Services Fund II, L.P., Wand/Universal American Investments L.P.I.,  Wand/Universal American Investments L.P. II, Chase Equity Associates, L.P.,  Richard A. Barasch and others (filed as Exhibit A to the  Registrant’s Current Report on Form 8-K dated August 13,  1999, and incorporated by reference herein). |   |
| 10.1 | *      | Fourth Amendment  dated March 22, 2007, to Amended and Restated Credit Agreement dated as  of May 28, 2004 among the Company, the Banks party to the Credit  Agreement and Bank of America, N.A., as the Administrative Agent.                                                                                                                                                                                                      |   |
| 10.2 | *      | First Amendment  dated March 22, 2007, to Credit Agreement dated as of January 18,  2007, among the Company, one or more Lending Institutions, and Bank of  America, N.A., as the Administrative Agent and L/C Issuer.                                                                                                                                                                                                              |   |
| 11.1 | *      | Statement re  Computation of per share Earnings (contained in the Consolidated Statements  of Operations in this Report).                                                                                                                                                                                                                                                                                                                     |   |
| 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**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

|                   | **UNIVERSAL AMERICAN FINANCIAL CORP.**                                                |
|-------------------|---------------------------------------------------------------------------------------|
| May 10, 2007 | /s/ RICHARD A. BARASCH                                                                |   |
| ** **        | Richard A. Barasch                                                                    |
| *** ***      | Chief Executive Officer                                                               |
| May 10, 2007 | /s/ ROBERT A. WAEGELEIN                                                               |   |
| ** **        | Robert A. Waegelein                                                                   |
| *** ***      | Executive Vice President and  Chief Financial Officer  (Principal Accounting Officer) |

 

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