The following discussion and analysis provides information which management believes is relevant for an assessment and understanding of our consolidated financial condition and results of operations. The discussion should be read in conjunction with the Consolidated Financial Statements and related Notes thereto. The information contained below may be subject to risk factors. We urge you to review carefully the sections entitled “Forward-Looking Statements” in Part 1, Item 1 and “Risk Factors” in Part 1, Item 1A of this Annual Report on Form 10-K for a more complete discussion of forward looking statements and the risks associated with an investment in our securities.
HMO membership increased 1.5% as a result of new accounts and in-case growth on commercial membership and growth in Medicaid member months. This increase is net of the 11,000 commercial member terminations effective January 1, 2007, from three large employer groups that had been anticipated.
January 1, 2008. In 2006, we were paid 50% based on the previous payment methodology and 50% based on the new methodology. For 2007, we were paid 25% based on the previous payment methodology and 75% based on the new methodology. We received a higher than expected mid-year adjustment from CMS to the risk factor used to calculate a portion of our payment. This adjustment was retroactive to January 1, 2007. Our actual Medicare per member per month rate increased 5.1% in 2007.
For 2008, we will be fully transitioned to a risk payment methodology; however, we have been notified by CMS that there will continue to be a frailty factor component to our payment through 2010. The frailty factor will be a component of the risk score calculation for former Social HMO plans by using 75%, 50% and 25% of the current frailty factor for plan years 2008, 2009 and 2010, respectively. Even with the additional frailty factor component, we believe that with a full transition to a risk payment methodology, our per member payment in 2008 is expected to be less than our per member payment in 2007.
The “changes in prior periods’ estimates” of $31.4 million represents an estimate based on paid claim activity from January 1, 2007 to December 31, 2007. Medical claim liabilities are usually described as having a “short tail”, which means that they are generally paid within several months of the member receiving service from the provider. Approximately 90% of the “changes in prior periods’ estimates” in 2007 relates to claims incurred in 2006, with the remaining 10% related to claims incurred in 2005 and prior. A large portion of the “changes in prior period’s estimates” in 2007 relate to the final settlement of provider related dispute items recorded in 2006, but settled in 2007 for less than originally estimated.
The decrease in the medical claims payable balance from December 31, 2006 to December 31, 2007 is primarily due to the timing of the year end pharmacy claims run, amounts reserved under the state to plan reconciliation for our
Payments from CMS for reinsurance and for cost sharing related to low income individuals ("Subsidies") are recorded as a payable when received. This payable is reduced when reinsurance is utilized and Subsidies are provided by the Company. This activity is accumulated and when the net balance for each contract is negative, it is reclassed to a receivable. The payable or receivable is recorded in the Consolidated Balance Sheet in prepaid expenses and other current assets or accrued and other current liabilities depending on the net contract balance at the end of the reporting period. The Company had a $56.9 million and a $63.4 million receivable balance at December 31, 2007 and December 31, 2006, respectively, for reinsurance and Subsidies related to our stand-alone PDP. A reconciliation of the final risk sharing, Subsidies, and reinsurance amounts is usually performed in the third quarter following the plan year. The Company has received the reconciliation for the 2006 plan year and received a final payment in the fourth quarter of 2007.
Investment and Other Revenues. Investment income is recognized in the period earned. Realized gains and losses are
debentures pay interest, which is due semi-annually on March 15 and September 15 of each year. Each $1,000 principal amount of debentures is convertible, at the option of the holders, into 109.3494 shares of the Company’s common stock prior to March 15, 2023 if: (i) the market price of the Company’s common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter exceeds 120% of the conversion price per share of the Company’s common stock; (ii) the debentures are called for redemption; (iii) there is an event of default with respect to the debentures; or (iv) specified corporate transactions have occurred. Beginning December 2003, and for each subsequent period, the market price of the Company’s common stock has exceeded 120% of the conversion price for at least 20 trading days in a period of 30 consecutive trading days. The conversion rate is subject to certain adjustments. This conversion rate represents a conversion price of $9.145 per share. Holders of the debentures may require the Company to repurchase all or a portion of their debentures on March 15 in 2008, 2013 and 2018 or upon certain corporate events including a change in control. In either case, the Company may choose to pay the purchase price of such debentures in cash or common stock or a combination of cash and common stock. Notice was sent to debenture holders (“holders”) in January 2008 informing them of the Company's intent to redeem the debentures for cash on March 20, 2008. Due to the impending redemption, the debentures have been classified as a current liability in the Consolidated Balance Sheet at December 31, 2007. As of March 7, 2008 $17.7 million principal amount of debentures were redeemed for $84.4 million.
The fair value of debt at December 31, 2007 is estimated to be approximately $93.3 million based on the borrowing rates and market quotes of the convertible debentures currently available to the Company.
Supplemental Executive Retirement Plan (“SERP”) - The Company has a defined benefit retirement plan covering certain key employees. The Company is informally funding the benefits through the purchase of life insurance policies. Certain participant benefits are based on, among other things, the employee's average earnings of the three highest years over the five-year period prior to retirement or termination, and length of service. For other participants, benefits are set and defined by the plan and based on length of service. Any benefits attributable to service prior to the adoption of the plan are amortized over the estimated remaining service period for those employees participating in the plan. The Company expects to contribute $4.1 million to the plan in 2008 to fund expected benefit payments for 2008. The annual plan measurement date is December 31.
The Company had $12.2 million accumulated comprehensive loss recorded at December 31, 2007 related to unrecognized prior service cost and unrecognized net actuarial loss. Of this amount, the Company expects to recognize $1.2 million of prior service cost and $450,000 of net actuarial losses as net periodic benefit costs in 2008.