We own approximately 161,000 square feet of space in Las Vegas, Nevada. This includes a 134,000 square foot administrative building owned by HPN and SHL that is used as their Las Vegas headquarters and 27,000 square feet of space that houses our in-house print shop operations and information systems data center. Our Las Vegas headquarters serves as the home office and regional home office for our Nevada HMO and health insurance subsidiaries, respectively. We lease clinical and office space in Nevada totaling approximately 378,000 and 349,000 square feet, respectively, with the majority of the lease agreements running through January 2016. We lease a 2,155 square foot sales office in Utah. We also own several parcels of land in Las Vegas.
We believe that current and planned clinical space will be adequate for our present needs. However, additional clinical space may be required if membership expands in southern Nevada. All of the properties described above are for the operations of our managed care and corporate operations segment. Our military health operations segment is no longer operating and no longer has any leased or owned property.
Omitted pursuant to the reduced disclosure format permitted by General Instruction I(2) of Form 10-K.
We are a managed health care organization that provides and administers the delivery of comprehensive health care programs with an emphasis on quality care and cost management. Our strategy has been to develop and offer a portfolio of managed health care products to government agencies, employer groups, and individuals. We derive revenues primarily from our health maintenance organization (HMO) and managed indemnity plans. To a lesser extent, we also derive revenues from professional fees (consisting primarily of fees for providing health care services to non-members, co-payment fees received from members and ancillary products), and investment and other revenue (including fees for workers' compensation third party administration, utilization management services and ancillary products).
On February 25, 2008, pursuant to the Merger Agreement, Merger Sub merged with and into Sierra, with Sierra continuing after the merger as a wholly owned subsidiary of UnitedHealth Group. Pursuant to the Merger Agreement, each issued and outstanding share of our common stock (other than shares owned by UnitedHealth
Group or Merger Sub, whose shares were cancelled) has been converted into the right to receive $43.50 in cash, on the terms specified in the Merger Agreement.
General and administrative (G&A) expenses as a percentage of medical premiums increased to 13.0% in 2007 from 12.7% in 2006. Total G&A expenses increased 15.0% primarily due to costs associated with our merger with UnitedHealth Group, increases in premium taxes and brokers' fees, G&A costs related to our new enhanced PDP product and impairment charges related to our investments in trust deed mortgage notes and joint ventures. See General and Administrative Expenses below for more details.
premium rates for renewing commercial groups increased approximately 5.2% while the overall recorded per member per month revenue increase, including new and continuing business, was approximately 3.8%, net of changes in benefits.
On January 1, 2006, we began offering the Basic Plan in eight regions covering Arizona, California, Colorado, Idaho, Nevada, New Mexico, Oregon, Texas, Utah and Washington. We had also been selected as a PDP sponsor in the same states for auto-enrolled CMS subsidized beneficiaries. The Basic Plan covers a wide variety of preferred generic and brand name prescription drugs that are distributed through most major retail pharmacy chains and a large number of independent pharmacies.
In 2007, we expanded our offering of our Basic Plan to 30 states and the District of Columbia. We engaged a national marketing partner for our Basic Plan and we are using our established broker network in Nevada and Utah. Additionally, our Basic Plan remained eligible as a PDP sponsor for our existing 2006 auto-enrolled Centers for Medicare and Medicaid Services (CMS) subsidized beneficiaries in California and Nevada, and for our existing 2006 and new 2007 auto-enrolled CMS subsidized beneficiaries in Arizona, Colorado, Idaho, Oregon, Utah and Washington. Our Basic Plan was no longer a PDP sponsor for auto-enrolled beneficiaries in New Mexico and Texas. At December 31, 2007, we had 148,900 beneficiaries enrolled in our Basic Plan, the majority of which were auto-enrolled CMS subsidized beneficiaries.
In 2007, for the first time, we offered an Enhanced Plan, which provided brand name and generic prescription drug benefits through the coverage gap or "donut hole", in 30 states and the District of Columbia. We incurred a pre-tax operating loss of $67.9 million related to the Enhanced Plan. See Medical Expenses below for more details. At December 31, 2007, we had 43,600 members enrolled in our Enhanced Plan. We did not submit a bid to CMS for an Enhanced Plan in 2008 and therefore, we are not offering this plan for 2008.
In 2007, we offered Local and Regional Medicare Advantage PPO (MAPPO) plans and for the first time, we offered a Medicare Advantage Private Fee-For-Service (MAPFFS) plan. This plan is available in 28 states and the District of Columbia. The MAPFFS plan does not include Medicare Part D prescription drug coverage but does provide hospital and physician coverage. Members pay a monthly premium, co-payments and coinsurance, with reasonable out-of-pocket maximum amounts. Members also have unlimited network access. At December 31, 2007, we had 2,100 and 400 members enrolled in our Regional and Local MAPPO plans, respectively. At December 31, 2007, we had 1,000 members enrolled in our MAPFFS plan. In 2008, we will continue to offer our Local and Regional MAPPO plans as well as our MAPFFS plan.
We contract with the Division of Healthcare Financing and Policy of the state of Nevada (DHCFP) to provide health care coverage to certain Medicaid eligible individuals. To enroll in our Medicaid program, an individual must be eligible for the Temporary Assistance for Needy Families or the Children's Health Assurance Program categories of the state's Medicaid program. At December 31, 2007, we had approximately 44,800 members enrolled in this program. We also contract with the DHCFP to provide health care coverage to the Nevada Check Up program, which covers certain uninsured children who do not qualify for Medicaid. At December 31, 2007, we had approximately 16,000 members enrolled in this program. We receive a monthly fee for each Medicaid and Nevada Check Up member enrolled by the state's Managed Care Division and we also receive a per case fee for each Medicaid and Nevada Check Up eligible newborn delivery. In the first quarter, we received a 1.0% rate increase retroactive to January 1, 2007 and did not receive any further rate increases for 2007. We expect approximately a 5% rate increase in March 2008 that will be retroactive to January 1, 2008.
Continued medical premium revenue growth is principally dependent upon continued enrollment in our products and
Professional Fees. The increase in professional fees primarily resulted from increased visits to our clinical subsidiaries.
Our medical claims payable liability requires us to make significant estimates. Any changes to the estimates would be reflected in the year the adjustments are made. Included in medical expenses is favorable development on prior years’ estimates of $31.4 million and $15.9 million for the years ended December 31, 2006 and 2005, respectively. The favorable development is a result of claims being settled for amounts less than originally estimated. We also have amounts related to provider disputes in our claims payable that if settled for more than the amount recorded could have an adverse impact on our operating results, financial position and cash flows. For a further description of the estimate for our medical claims payable liability, see below in “Critical Accounting Policies and Estimates”.
Interest Expense. Interest expense decreased due to a decrease in long-term debt. At December 31, 2007, we had no balance outstanding on our credit facility and we had a lower average balance outstanding in 2007 compared to 2006.
Provision for Income Taxes. Our effective tax rate is higher than the statutory tax rate primarily due to increases in our liability for uncertain tax positions offset by tax-preferred investment income. See Note 6, "Income Taxes", in the Notes to Consolidated Financial Statements for further discussion of our income taxes.
Our effective tax rate is based on actual or expected income, statutory tax rates and tax planning opportunities available to us. We use significant estimates and judgments in determining our effective tax rate. We are occasionally audited by federal, state or local jurisdictions regarding compliance with federal, state and local tax laws and the recognition of income and deductibility of expenses. Tax assessments may not arise until several years after tax returns are filed. While there is an element of uncertainty in predicting the outcome of tax audits, we believe that the recorded tax assets and liabilities are appropriately stated based on our analyses of probable outcomes, including interest and other potential adjustments. Our tax assets and liabilities are adjusted based on the most current facts and circumstances, including the progress of audits, case law, emerging legislation and interpretations; any adjustments are included in the effective tax rate in the current period.
Pursuant to an existing contract with the Division of Healthcare Financing and Policy of the state of Nevada (DHCFP), we provide health care coverage to certain Medicaid eligible individuals and uninsured children who do not qualify for Medicaid. At December 31, 2006, we had approximately 44,300 members enrolled in our HMO Medicaid risk program. To enroll in this program, an individual must be eligible for the Temporary Assistance for Needy Families or the Children's Health Assurance Program categories of the state’s Medicaid program. At December 31, 2006, we also had approximately 16,200 Nevada Check Up members. Nevada Check Up is the state’s Children's Health Insurance Program, which covers certain uninsured children who do not qualify for Medicaid. We receive a monthly fee for each Medicaid and Nevada Check Up member enrolled by the state's Managed Care Division and we also receive a per case fee for each Medicaid and Nevada Check Up eligible newborn delivery. We received a 0.9% decrease on January 1, 2006, due in large part to our mix of Medicaid members; however, we received a 2.6% rate increase on July 1, 2006.
Investment and Other Revenue. Higher average invested balances and an increase in yield during 2006 primarily contributed to the increase in investment and other revenues.
have amounts related to provider disputes in our claims payable that if settled for more than the amount recorded could have an adverse impact on our operating results, financial position and cash flows. For a further description of the estimate for our medical claims payable liability, see below in “Critical Accounting Policies and Estimates”.
We contract with hospitals, physicians and other independent providers of health care under capitated or discounted fee-for-service arrangements, including hospital per diems, to provide medical care services to members. We also have an extensive pharmacy network to provide pharmaceuticals to our members. Capitated providers are at risk for a portion of the cost of medical care services provided to our members in the relevant geographic areas; however, we are ultimately responsible for the provision of services to our members should the capitated provider be unable to provide the contracted services. We incurred capitation expenses with non-affiliated providers of $134.3 million and $128.3 million, or 10.4% and 12.6%, of our total medical expenses for 2006 and 2005, respectively. Also included in medical expenses are the operating expenses of the Company’s medical provider subsidiaries and certain claims-related administrative expenses, which accounted for 28.4% and 32.9% of our total medical expenses for 2006 and 2005, respectively.
Net cash used for investing activities during 2007 included capital expenditures associated with the continued implementation of new computer systems, leasehold improvements on facilities, furniture and equipment and other capital purchases to support our growth. The net cash change in investments for the period was a decrease in investments, as investments were sold to fund operations.
In March 2003, we issued $115.0 million aggregate principal amount of 2.25% Senior Convertible Debentures Due 2023. The 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
On March 3, 2003, we entered into a revolving credit facility. Effective June 26, 2006, the current facility was amended to extend the maturity from December 31, 2009 to June 26, 2011, increase the availability from $140.0 million to $250.0 million and reduce the drawn and undrawn fees. As of December 31, 2007, the incremental borrowing rate was LIBOR plus .60%. At December 31, 2007, we had no outstanding balance on this facility. In connection with our merger with UnitedHealth Group, the facility was terminated on February 25, 2008.
From January 1, 2007 through December 31, 2007, we purchased 585,000 shares of our common stock in the open market for $21.1 million at an average cost per share of $36.04. Since the repurchase program began in early 2003 and through December 31, 2007, we purchased, in the open market or through negotiated transactions, 29.2 million shares, adjusted for the two for one stock split effective December 30, 2005, for $651.9 million at an average cost per share of $22.29. On January 25, 2007, our Board of Directors authorized an additional $50.0 million in share repurchases. At December 31, 2007, $53.1 million was still available under the Board of Directors' authorized plan. The repurchase program has no stated expiration date. Effective March 11, 2007, we halted our repurchase program as a result of the merger with UnitedHealth Group.
Of the $95.6 million in cash and cash equivalents held at December 31, 2007, $67.0 million was designated for use only by the regulated subsidiaries. Amounts are available for transfer to the parent company from the HMO and insurance subsidiaries only to the extent that they can be remitted in accordance with the terms of existing management agreements and by dividends. The parent company will not receive dividends from its regulated subsidiaries if such dividend payment would cause a violation of statutory net worth and reserve requirements.
Our contractual obligations and commitments at December 31, 2007 are summarized in the table below. The amounts presented include all future payments associated with each obligation including interest expense.
On January 24, 2008, Sierra notified Wells Fargo Bank, N.A., as trustee under the Indenture dated as of March 3, 2003 governing our 2.25% Senior Convertible Debentures Due 2023, that all outstanding debentures will be redeemed by Sierra on March 20, 2008 in accordance with the terms of the Indenture. Outstanding debentures may be converted into $4,756.70 in cash for each $1,000 principal amount of debentures so converted until March 19, 2008. Due to the impending redemption, the debentures have been classified as a current liability in the Consolidated Balance Sheet at December 31, 2007. See Note 8 - "Long-Term Debt" in the Notes to Consolidated Financial Statements for additional information related to our senior convertible debentures.
Purchase obligations include a $7.6 million investment commitment to purchase a limited partnership interest in a private equity group and purchase obligations totaling $230,000 that have a remaining commitment in excess of $100,000 at December 31, 2007.
The FIN 48 obligations shown in the table above represents uncertain tax positions recorded in accordance with FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109”. The years for which the uncertain tax positions will reverse have been estimated in scheduling the obligations within the table. Included in the unrecognized tax positions above are potential penalties of $2.6 million and interest of $3.2 million.
During 2007, we incurred expenditures related primarily to the purchase of computer hardware and software, leasehold improvements on facilities, furniture and equipment and other normal capital requirements. Our short-term liquidity needs will be primarily for the capital items noted above along with normal operating items. We expect to spend $15 to $25 million in capital expenditures in 2008. We believe that our existing working capital and operating cash flow should be sufficient to fund our capital expenditures and liquidity needs on a short and long-term basis. Additionally, subject to unanticipated cash requirements, we believe that our existing working capital and operating cash flow should enable us to meet our liquidity needs on a long-term basis.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities- Including an Amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 would create a fair value option of accounting for qualifying financial assets and liabilities under which an irrevocable election could be made at inception to measure such assets and liabilities initially and subsequently at fair value, with all changes in fair value reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. We do not believe the adoption of SFAS 159 will have a material impact on our consolidated financial position, results of operations or cash flows.
In December 2007, the FASB issued Statement of Financial Accounting Standards No.141 (Revised 2007), “Business Combinations” (SFAS 141R) which replaces SFAS No. 141, “Business Combinations”. SFAS 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any noncontrolling interest in the acquiree and the goodwill acquired. The statement also establishes disclosure requirements that will enable users to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for our fiscal year 2009 and must be applied prospectively to all new acquisitions closing on or after January 1, 2009. Early adoption of this standard is not permitted. We do not believe the adoption of SFAS 141R will have a material impact on our consolidated financial position, results of operations or cash flows.
Our consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States. In preparing these financial statements, we are required to make judgments, assumptions and estimates, which we believe are reasonable and prudent based on currently available facts and circumstances. These judgments, assumptions and estimates affect certain of our revenues and expenses and their related balance sheet accounts and disclosure of our contingent assets and liabilities. We base our assumptions and estimates primarily on historical experience and trends and factor in known and projected trends. On an on-going basis, we reevaluate our selection of assumptions and the method of calculating our estimates. Actual results, however, may materially differ from our calculated estimates and this difference would be reported in our current operations. The following discusses our most critical accounting policies and estimates, which have been reviewed by the Audit Committee of our Board of Directors.
between the date services are rendered and the date claims are paid, denied claims activity, disputed claims activity, benefit changes, expected health care cost inflation, seasonality patterns and changes in membership. In developing the IBNR claims estimate, we apply different estimation methods depending on the month for which incurred claims are being estimated. For example, we actuarially calculate completion factors using our analysis of claims payment patterns over the most recent six-to-twelve month period. The completion factor is an actuarial estimate, based upon historical experience, of the percentage of claims incurred during a given period that have been paid by us as of the date of estimation. We then apply the completion factors to the actual claims paid to date for each incurral month, except for the most recent months, to estimate the expected amount of ultimate incurred claims for each of these months. For the most recent incurred months, generally three months or less, the percentage of claims paid for claims incurred in those months is usually low. This makes the completion factor methodology less reliable for such months. For these recent months, we estimate our claims incurred by applying estimated per member per month (PMPM) costs to the current membership. The estimated PMPM costs are derived from historical paid claims (with completion factors as described above), trend assumptions and current utilization reports. This methodology is consistently applied from period to period.
PDP at December 31, 2006 that were settled during 2007, and the settlement of certain provider disputes. The ratio of medical claims payable at the end of the period to the incurred medical expense for current period medical claims is 12.9% and 17.0% for 2007 and 2006, respectively.
Our provision for provider disputes is based on a separate evaluation of each dispute. We recognize a liability for such loss contingencies when we believe it is both probable that a loss will be incurred and that the amount of the loss can be reasonably estimated. Our loss estimates are primarily based on an analysis of potential results, the stage of the dispute, consultation with outside legal counsel and any other relevant information presently available. The ultimate outcome of these loss contingencies cannot be predicted with certainty and it is difficult to measure the actual loss that may be incurred. Actual results may materially differ from our estimates and this difference would be reported in our current operations.
The determination of loss development requires an actuarial evaluation of Cal Indemnity’s or its successor’s loss reserves. Projecting loss and ALAE reserves have a significant degree of inherent uncertainty when related to their subsequent payments. It is not only possible but also probable that the projected reserves will differ from their related subsequent developments. Underlying causes for this uncertainty include, but are not limited to, uncertainty in development patterns, unanticipated inflationary trends affecting the cost of services covered by the insurance contract, adverse legal outcomes and new interpretations of laws or regulations or of disputed contract provisions that result in having to provide new or extended benefits. This uncertainty can result in both adverse as well as favorable development of actual subsequent activity when compared to the reserve established. Our sold workers’ compensation insurance subsidiaries had net adverse loss development occur in each of the past years 1999 to 2004 ranging from $8.7 million to $24.0 million.
In making actuarial loss projections, there is no single “right” way or method. An actuary must exercise a significant amount of his or her judgment in selecting loss development factors and even a small change in one loss
development factor can have a large impact when it is applied over several accident years. This can result in significant differences between one actuary’s best estimate of the projected loss reserves and another actuary’s best estimate of those same loss reserves. In addition, actuarial projections will change with the passage of time as new or additional information is obtained or experienced. However, as the number of open claims diminishes, the range of difference between actuarial projections should also diminish.
It should be noted that in January 2007, we received a confirmation request from the acquiring company’s auditors, which stated that they are carrying their note payable to Sierra at an amount that is lower than our receivable balance. As noted above, there is no single correct actuarial method to project workers’ compensation insurance reserves. While we believe that our actuary’s analyses are reasonable and appropriate, there is no assurance that an independent arbitrator will agree with our actuary’s findings when the note is settled in 2010.
We have audited the accompanying consolidated balance sheets of Sierra Health Services, Inc. and subsidiaries (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. Our audits also included the financial statement schedules included in Item 15 (a)(2). These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules based on our audits.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sierra Health Services, Inc. and subsidiaries as of December 31, 2007 and 2006, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
On January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standard No. 123(R), Share-Based Payment, and on December 31, 2006, the Company adopted the provisions of Statement of Financial Accounting Standard No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans. Also, as discussed in Note 6 to the consolidated financial statements, on January 1, 2007, the Company adopted the provisions of FASB Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes.
As discussed in Note 3 to the consolidated financial statements on February 25, 2008, the Company completed a merger with UnitedHealth Group Incorporated, a Minnesota corporation. As a result of the merger, the Company became a wholly owned subsidiary of UnitedHealth Group Incorporated.
Business. The consolidated financial statements include the accounts of Sierra Health Services, Inc. and its subsidiaries (collectively referred to as “Sierra” or the “Company”). Sierra is a managed health care organization that provides and administers the delivery of comprehensive health care programs with an emphasis on quality care and cost management. Sierra’s broad range of managed health care services are provided through its health maintenance organization (“HMO”), managed indemnity plans, third-party administrative services programs for employer-funded health benefit plans and medical management programs. Ancillary products and services that complement the Company's managed health care product lines are also offered.
Medicare Part D Prescription Drug Program (“PDP”). The Company contracted with CMS to offer a basic stand-alone PDP plan ("Basic Plan") to eligible Medicare beneficiaries effective January 1, 2006. In 2006, the Company offered the Basic Plan in eight regions covering Arizona, California, Colorado, Idaho, Nevada, New Mexico, Oregon,
The Company recognizes premium revenue as earned over the contract period; however, pharmacy and administrative costs are required to be recognized as incurred with no allocation or annualized estimation of the impact of deductibles, the coverage gap or "donut hole," prior to it being reached by the member, or reinsurance. This method of recognizing revenues and expenses results in a disproportionate amount of expense in the first part of each contract year when the plan is responsible for a larger portion of the drug cost.
CMS shares in the risk of certain pharmacy costs related to the basic benefits covered in both of the Company’s stand-alone plans and its Medicare Advantage PDP. The Company recognizes a risk sharing receivable or payable based on the year-to-date activity. The risk sharing receivable or payable is accumulated for each contract and 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 $2.2 million and $11.8 million risk sharing payable balances related to its Medicare Advantage PDP at December 31, 2007 and December 31, 2006, respectively, which is included in accrued and other current liabilities in the Consolidated Balance Sheet.
Medical Expenses. Health care expenses are recorded in the period when services are provided to enrolled members, including estimates for provider costs, which have been incurred at the balance sheet date but not yet reported to the Company. The Company uses a variety of standard actuarial projection methods to make these estimates and must use judgments in selecting development factors and assumed trends. In making projections, the Company considers medical cost utilization and trends, changes in internal processes, the average interval between the date services are rendered and the date claims are received and/or paid, denied claims activity, disputed claims activity, seasonality patterns and changes in membership. Assumptions could be affected by the timing of the receipt of claims, the timing of processing claims and unanticipated changes, such as adverse legal outcomes, legislative or regulatory changes, new interpretations of existing laws or regulations or disputed contract provisions that result in the Company having to provide new or extended benefits and changes in the Company’s health care delivery system or costs. The Company believes that the recorded liability of $200.3 million for medical claims payable at December 31, 2007 is reasonable and adequate to cover future health care claim payments. Any subsequent changes in an estimate for a prior year would be reflected in that subsequent year’s operating results, financial position and cash flows.
Investments. Investments consist primarily of U.S. Government and its agencies’ securities, municipal bonds, corporate bonds, mortgage backed and other securities, trust deed mortgage notes and joint ventures. All investments, other than trust deed mortgage notes and real estate joint ventures, have been designated as available-for-sale and are stated at fair value. Fair value is estimated primarily from published market values at the balance sheet date. All non-restricted available-for-sale investments are classified as current assets. These investments are available for use in the current operations regardless of contractual maturity dates. Restricted investments are classified as non-current assets. Realized gains and losses are calculated using the specific identification method and are included in investment and other revenues. Unrealized holding gains and losses on available-for-sale securities are included as a separate component of stockholders' equity, net of income tax effects, until realized. The Company does not believe any of its available-for-sale and restricted investments are other than temporarily impaired at December 31, 2007.
Reinsurance Recoverable. In the normal course of business, the Company seeks to reduce the effects of catastrophic and other events that may cause unfavorable underwriting results by reinsuring certain levels of risk with other reinsurers. Reinsurance receivable for ceded paid claims is recorded in accordance with the terms of the agreements.
The Company is covered under medical reinsurance agreements that provide coverage between 70% and 90% of hospital and other costs in excess of $350,000 and $200,000 per case for its commercial HMO and managed indemnity plans, respectively, and up to a maximum of $2.0 million per member per lifetime for both plans. The Company’s retentions for hospital expenses were increased to $400,000 and $350,000 for commercial HMO and managed indemnity plans, respectively, on July 1, 2007. Additionally, the Nevada Medicaid Program has stop-loss insurance that reimburses the Company for 75% of hospital costs in excess of $100,000 per individual. Reinsurance premiums of $1.7 million, $2.1 million and $1.8 million, net of reinsurance recoveries of $2.5 million, $3.2 million and $4.0 million, are included in medical expenses for 2007, 2006 and 2005, respectively.
Concentration of Credit Risk. The Company's financial instruments that are exposed to credit risk consist primarily of cash equivalents, investments and accounts receivable. The Company maintains cash and cash equivalents and investments with various financial institutions. These financial institutions are located in many different regions and Company policy is designed to limit exposure with any one institution. The Company’s investments in trust deed mortgage notes are with numerous independent borrowers and are secured by real estate in several states. The loan to value ratios for these investments were typically based on appraisals or other market data obtained at the time of loan origination; however, the current deterioration of the real estate market has caused the value of the underlying assets of several of the Company’s trust deed mortgage notes to significantly decrease. Several of the Company’s trust deed mortgage notes are in default and in various stages of foreclosure. The Company has evaluated each trust deed mortgage note to determine if impairment exists. All trust deed mortgage notes determined to be impaired have been
Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising the Company's customer base and their dispersion across many different industries. The Company’s customers are primarily located in the various states in which the Company is licensed and operates, although they are principally located in Nevada. The Company also has receivables from its reinsurers. Reinsurance contracts do not relieve the Company from its obligations to enrollees or policyholders. Failure of reinsurers to honor their obligations would result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. All reinsurers with whom the Company has reinsurance contracts are rated A or better by A.M. Best Company (3rd highest out of 16).
Recently Issued Accounting Standards. In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" ("SFAS 157"). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies only to other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company does not believe the adoption of SFAS 157 will have a material impact on its consolidated financial position, results of operations, or cash flows.
In December 2007, the FASB issued Statement of Financial Accounting Standards No.160, “Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51” (SFAS 160). SFAS 160 requires that accounting and reporting for minority interests be recharacterized as noncontrolling interests and classified as a component of equity. The Company does not believe the adoption of SFAS 160 will have a material impact on its consolidated financial position, results of operations or cash flows.
Use of Estimates and Assumptions in the Preparation of Financial Statements. The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management must exercise its judgment, taking into consideration the facts and circumstances in selecting assumptions and other factors, in calculating its estimates. On an on-going basis, management re-evaluates its assumptions and the methods of calculating its estimates. Estimates and assumptions include, but are not limited to, medical expenses and reserves, military revenue and expenses, legal reserves, fair values of investments, amounts receivable or payable under government contracts, deferred income taxes, goodwill, asset allowances, accrued
liabilities, malpractice reserves and amounts collectable from notes receivable. Actual results may materially differ from estimates.
The remaining investments have been categorized as available-for-sale and are stated at their fair value. Fair value is estimated primarily from published market values at the balance sheet date. Gross realized gains on investments, for
The unrealized losses in the Company’s investments in U.S. government and its agencies, municipal obligations, mortgage backed securities and corporate bonds are due to interest rate increases. It is expected that the securities would not be realized at a price less than the amortized cost of the Company’s investment. Based on the immaterial severity of the impairments and the ability and intent of the Company to hold these investments until recovery of fair value, which may be maturity, the investments were not considered to be other than temporarily impaired at December 31, 2007.
The contractual maturities, which exclude preferred stock, of available-for-sale debt securities at December 31, 2007 are shown below:
Of the cash and cash equivalents and current investments that total $318.9 million in the accompanying Consolidated Balance Sheet at December 31, 2007, $256.2 million is held by the Company’s regulated subsidiaries and is only available for use by them. Such amounts are available for transfer to Sierra from the regulated subsidiaries only to the extent that they can be remitted in accordance with terms of existing management agreements or by dividends, which are generally limited based on an entity’s level of statutory net income and statutory capital and surplus. The remainder is available to Sierra on an unrestricted basis.
Included in loss carryforwards and credits is the unrealized capital loss on the sale of Cal Indemnity of $43.1 million. There is no tax benefit for the capital loss due to the nature of the contingent note receivable associated with the sale of Cal Indemnity. This loss will not be realized for tax purposes until December 31, 2009. The Company cannot be assured that it can generate sufficient capital gains during the applicable carry-over periods to recognize the tax benefit of this capital loss. During 2007 and 2006, the Company generated approximately $1.6 million and $700,000, respectively, of capital gains which has resulted in a reduction of the valuation allowance of $550,000 and $240,000, respectively. Otherwise, the remaining unrealized capital loss has a full valuation allowance at December 31, 2007 and December 31, 2006. Also, the Company had approximately $700,000 of regular state tax operating loss carryforwards in both the years 2007 and 2006. The net operating loss carryforwards can be used to reduce future state taxable income until they expire in the years ending in 2008 through 2013. The Company does not expect to derive any benefit from these state operating loss carryforwards, and a full valuation allowance has been established. Deferred tax liabilities of $360,000 at December 31, 2006, are included in other liabilities.
The Company classifies interest and penalties associated with uncertain income tax positions as income taxes within its consolidated financial statements. During the year ended December 31, 2007, the Company recognized approximately $1.3 million and $1.1 million in interest and penalties expense, respectively. The Company had approximately $3.2 million and $2.6 million of interest and penalties, respectively, accrued at December 31, 2007.
During 2005, the Company received offers and entered into five separate and privately negotiated transactions with holders pursuant to which the holders converted an aggregate of $63.0 million of debentures they owned into approximately 6.9 million shares of Sierra common stock in accordance with the indenture governing the debentures. During 2006, a holder converted $500,000 in debentures for approximately 54,000 shares of common stock and the Company entered into a privately negotiated transaction with a holder pursuant to which the holder converted $8.0 million in debentures for approximately 875,000 shares of common stock in accordance with the indenture governing the debentures. During 2007, the Company entered into a privately negotiated transaction with a holder pursuant to which the holder converted $21.7 million in debentures for approximately 2.4 million shares of common stock in accordance with the indenture governing the debentures. As a result of these transactions, the Company expensed prepaid interest of $601,000, $176,000 and $1.5 million in 2007, 2006 and 2005, respectively, and deferred financing costs of $176,000, $91,000 and $1.2 million in 2007, 2006 and 2005, respectively.
The revolving credit facility's covenants limited the Company’s ability to dispose of assets, incur indebtedness, incur other liens, make investments, loans or advances, make acquisitions, engage in mergers or consolidations, make capital expenditures and otherwise restrict certain corporate activities. The Company’s ability to pay dividends, repurchase its common stock and prepay other debt was unlimited provided that the Company was able to exceed a certain required leverage ratio after such transaction or any borrowing incurred as a result of such transaction. In addition, the Company was required to comply with specified financial ratios as set forth in the credit agreement.
with the present value of the net minimum lease payments at December 31, 2007, are as follows:
Stock-Based Compensation - The Company's employee stock plan and non-employee director stock plan provide common stock-based awards to employees and to non-employee directors. The plans provide for the granting of restricted stock units, options, and other stock-based awards. At December 31, 2007, the employee plan and the non-employee director plan permit the granting of share options and shares of up to 4.0 million and 221,000 shares, respectively, of common stock. Shares are issued using either treasury shares, or newly issued shares of common stock. A committee appointed by the Board of Directors grants awards. Awards become exercisable at such times and in such increments as set by the committee.
For the years ended December 31, 2007, 2006 and 2005 net cash proceeds realized from stock option exercises and purchases under the Company’s Employee Stock Purchase Plan (“Purchase Plan”) were $6.7 million, $14.5 million and $22.3 million, respectively and the actual tax benefit realized from stock option exercises and purchases under the Purchase Plan were $5.4 million, $10.1 million and $25.7 million respectively.
Before January 1, 2006, the Company accounted for its stock-based compensation using the intrinsic value method prescribed by APB 25. Accordingly, no compensation cost was recognized for the Company’s employee stock plans except for those expenses associated with restricted stock units and certain stock options in which the Company had agreed to accelerate the vesting.
The aggregate intrinsic value in the table below represents the total pretax intrinsic value (the difference between the market price of the Company’s common stock on December 31, 2007 and the exercise price, multiplied by the number of shares) that would have been received by the option holders had all option holders exercised their options on December 31, 2007. This amount changes based on the market value of the Company’s common stock. The total intrinsic value of options exercised during 2007, 2006 and 2005 was $14.7 million, $36.1 million and $99.2 million, respectively.
Excludes 164,000 and 140,000 shares at January 1, 2007 and December 31, 2007, respectively, which vested in 2005, but are not exercisable until 2008.
In January 2006, the Company issued 4,000 non-performance based Units to each of the six non-employee Directors. The Units vest on the fourth anniversary of the grant date or earlier based on the occurrence of certain events. The fair value of the transaction was based on the number of Units issued and the Company's common stock price on the date of grant, which was $38.49. Total expense associated with the Units during 2007 and 2006 was $192,000 and $336,000, respectively which represents the fair value of vested Units during the year.
(3)Does not include 296,000 shares that have vested but have not settled.
Executive Split Dollar Life Insurance Plan - The Company has split dollar life insurance agreements with certain officers and key executives (selected and approved by the Sierra Board of Directors). The premiums paid by the Company will be reimbursed upon the occurrence of certain events as specified in the contract. No premiums have been paid under these policies since July 2002.
While the SERP is an unfunded plan, the Company is informally funding the plan through life insurance contracts on certain Company employees. The life insurance contracts had cash surrender values of $26.3 million and $24.9 million at December 31, 2007 and 2006, respectively.
Rent expense totaled $18.9 million, $19.0 million and $19.8 million for the years ended December 31, 2007, 2006 and 2005, respectively.
Litigation and Legal Matters. Although the Company has not been sued, Sierra was identified in discovery submissions in pending class action litigation against major managed care companies as having allegedly participated in an unlawful conspiracy to improperly deny, diminish or delay payments to physicians. In Re: Managed Care Litigation, MDL No. 1334 (S.D.Fl.).
Beginning in 1999, a series of class action lawsuits were filed against many major firms in the health benefits business alleging an unlawful conspiracy to deny, diminish or delay payments to physicians. The Company has not been named
Subsequent lower court rulings have further resolved which of the plaintiffs' claims are subject to arbitration. In 2004, the Court of Appeals for the Eleventh Circuit upheld a district court ruling certifying a plaintiff class in the Shane case. In February 2005, the district court determined to bifurcate the case, holding a trial phase limited to liability issues, and a second, if necessary, regarding damages. The plaintiffs have appealed this decision.
On June 4, 2007, the Company and the defendants reached an agreement in principle to settle the lawsuit. As part of the settlement, the defendants deny all allegations of wrongdoing, and the Company agreed to make certain additional
The Company incurred legal fees of $57,000, $112,000 and $212,000 in the years ended December 31, 2007, 2006 and 2005, respectively, with a Nevada law firm of which a non-employee Board of Director member is a shareholder. This Board member retired from the Company’s Board in May 2006.
Information". The Company believes the only remaining reportable segment is the managed care and corporate operations segment. This segment's required financial information is represented in the accompanying consolidated financial statements.