As of December 31, 2012, we leased approximately 66,000 square feet of space for our corporate office in Bethesda, Maryland. We also leased approximately 1,926,000 aggregate square feet for office space, subsidiary operations and customer service centers for the various markets where our health plans and other subsidiaries operate, of which approximately 2.4% is subleased. Our leases expire at various dates from 2013 through 2022. We also own eight buildings throughout the country with approximately 643,000 square feet, which is used for administrative services related to our subsidiaries’ operations, of which approximately 3.5% is subleased. We believe that our facilities are adequate for our operations.
Unless noted as discontinued operations, Operating Data excludes First Health Services Corporation (“FHSC”) operating results for each year presented due to the sale of this business in July 2009. Balance Sheet Data does not exclude FHSC balances for 2008 as such amounts are immaterial.
Increased MA-CCP Star ratings, as publicly released by the Centers for Medicare & Medicaid Services (CMS) on October 13, 2012.
Selling, general and administrative expense as a percentage of total revenue was 14.7 %, compared to 16.5% in the prior year.
On November 21, 2012, our stockholders voted at the stockholder special meeting to approve the adoption of the Merger Agreement. Of the 104,941,398 shares voting at the special meeting of stockholders, more than 99% voted in favor of the adoption
Our selling, general and administrative expenses consist primarily of salaries and related costs for personnel involved in the administration of services we offer as well as commissions paid to brokers and agents who assist in the sale of our products. To a lesser extent, our selling, general and administrative expenses include other administrative and facility costs needed to provide these administrative services. We operate regional service centers that perform claims processing, premium billing and collection, enrollment and customer service functions. Our regional service centers enable us to take advantage of economies of scale, implement standardized management practices and capitalize on the benefits of our integrated information technology systems.
We receive premium payments from the Centers for Medicare and Medicaid Services (“CMS”) on a monthly basis for our Medicare membership to provide healthcare benefits to our Medicare members. Premiums are fixed (subject to retroactive risk adjustment) on an annual basis by contracts with CMS. Membership and category eligibility are periodically reconciled with CMS and can result in adjustments to revenue. CMS uses a risk adjustment model that incorporates the use of hierarchical condition category (“HCC”) codes to determine premium payments to health plans. We estimate risk adjustment revenues based on the individual member diagnosis data (risk scores) submitted to CMS. Changes in revenue from CMS resulting from the periodic changes in risk adjustment scores for our membership are recognized when the amounts become determinable and the collectibility is reasonably assured.
We contract with the United States Office of Personnel Management (“OPM”) and with various federal employee organizations to provide health insurance benefits under the Federal Employees Health Benefits Program (“FEHBP”). These contracts are subject to government regulatory oversight by the Office of the Inspector General (“OIG”) of OPM, which performs periodic audits of these benefit program activities to ensure that contractors meet their contractual obligations with OPM. For our managed care contracts, the OIG conducts periodic audits to, among other things, verify that premiums established under its contracts are in compliance with community rating requirements under the FEHBP. The OPM may seek premium refunds or institute other sanctions against health plans that participate in the managed care contract program. For our experience-rated plans, the OIG focuses on the appropriateness of contract charges, the effectiveness of claims processing, financial and cost accounting systems, and the adequacy of internal controls to ensure proper contract charges and benefit payments. The OIG may seek refunds of costs charged under these contracts or institute other sanctions against our health plans. These audits are generally a number of years in arrears. We estimate and record reserves for audit and other contract adjustments for both our managed care contracts and our experience rated plans based on appropriate guidelines and historical results. Any differences between actual results and estimates are recorded in the year the audits are finalized.
We employ a team of actuaries that have developed, refined and used the same set of reserve models over the past several years. These reserve models do not calculate separate amounts for reported but not paid and incurred but not reported, but rather a single estimate of medical claims liabilities. These reserve models make use of both historical claim payment patterns as well as emerging medical cost trends to project our best estimate of claim liabilities. Within these models, historical data of paid claims is formatted into claim triangles which compare claim incurred dates to the claim payment dates. This information is analyzed to create “completion factors” that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period.
favorably suggesting that the accrued liabilities calculated from the models were more than adequate to cover our ultimate liability for unpaid claims. We believe that this favorable development has been a result of good communications between our health plans and our actuarial staff regarding medical utilization, mix of provider rates and other components of medical cost trend.
The following table presents the components of the change in medical claims liabilities for the years ended December 31, 2012, 2011 and 2010, respectively (in thousands).
Acquisition balances represent medical liabilities of the acquired company as of the applicable acquisition date.
A regular element of our unpaid medical claim liability estimation process is the examination of actual results and, if appropriate, the modification of assumptions and inputs related to the process based upon past experience. Our reserve setting methodologies have taken these changes into consideration when determining the factors used in calculating our medical claims liabilities as of December 31, 2012 by choosing factors that reflect more recent experience.
We believe that the amount of medical liabilities is adequate to cover our ultimate liability for unpaid claims as of December 31, 2012. However, actual claim payments and other items may differ from established estimates.
the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future;
if we have decided to sell the security or it is more-likely-than-not that we will be required to sell the security before recovery of its amortized cost.
We use prices from independent pricing services and, when necessary, indicative (non-binding) quotes from independent brokers to measure the fair value of our investment securities. We utilize multiple independent pricing services and brokers to obtain fair values; however, we generally obtain one price/quote for each individual security. Broker quotes were not relied upon in determining fair value measurements.
Generally, we do not adjust prices received from pricing services or brokers unless it is evident from our verification procedures that the fair value measurement is not consistent with ASC Topic 820, “Fair Value Measurements and Disclosures.” Based upon our internal price verification procedures and review of fair value methodology documentation provided by independent pricing services, we have concluded that the fair values provided by pricing services and brokers are consistent with the guidance in ASC Topic 820.
The following table includes only our investments that were in an unrealized loss position at December 31, 2012. For these investments, the table shows the gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands).
Our municipal bond investments remain at an investment grade status based on their own merits (excluding monoline insurers). Although we do not rely on bond insurers exclusively to maintain our high level of investment credit quality, $217 million of our $1.3 billion total state and municipal bond holdings are insured through a monoline insurer. For our mortgage-backed and asset-backed securities, our holdings remain at investment grade with AA+ and AAA average credit quality ratings, respectively. The average credit quality ratings are based on the weighted average credit rating as provided by Standard & Poor’s. See Footnote F, Investments, to the consolidated financial statements for more information regarding investments, which is incorporated by reference.We participate in only the higher level investment tranches. For our asset-backed securities, we only participate in offerings that are over collateralized to further protect our principal investment.
The Company’s goodwill impairment analysis begins with an assessment of qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test. In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying value, we consider factors outlined in Accounting Standards Update (“ASU”) 2011-08, “Intangibles-Goodwill and Other (Topic 350),” including, but not limited to:
Macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital, fluctuations in foreign exchange rates, or other developments in equity and credit markets;
Industry and market considerations such as a deterioration in the environment in which we operate, an increased competitive environment, a decline in market-dependent multiples or metrics (consider in both absolute terms and relative to peers), a change in the market for our products or services, or a regulatory or political development;
If applicable, a sustained decrease in share price (consider in both absolute terms and relative to our peers).
For our quantitative impairment analysis we rely on both the income and market approaches. The income approach is based on the present value of expected future cash flows. The income approach involves estimating the present value of our estimated future cash flows utilizing a risk adjusted discount rate. The market approach estimates the Company’s fair value by comparing our Company to similar publicly traded entities and also by analyzing the recent sales of similar companies. The approaches are reviewed together for consistency and commonality.
In accordance with ASC Topic 350-30, “General Intangibles Other than Goodwill,” we test intangible assets not subject to amortization for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test consists of a comparison of the fair value of an intangible asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess. We have chosen October 1 as our annual impairment testing date. Our only intangible asset that is not subject to amortization is a trade name which we determined was not impaired based on the result of the October 1, 2012 analysis. The Company’s intangible impairment analysis was an assessment of qualitative factors to determine whether it is more likely than not that the fair value of the intangible asset is less than its carrying value. In evaluating whether it is more likely than not that the fair value of the intangible asset is less than its carrying value, we consider qualitative factors as outlined in ASU 2012-02, “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite - Lived Intangible Assets for Impairment,” similar to the qualitative assessment of goodwill, previously discussed.
We account for share-based compensation in accordance with the provisions of ASC Topic 718 “Compensation - Stock Compensation.” Under the fair value recognition provisions of ASC Topic 718, determining the appropriate fair value model and calculating the fair value of share-based payment awards require the input of subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. We believe that a blend of the implied volatility of our tradeable options and the historical volatility of our share price is a better indicator of expected volatility and future stock price trends than historical volatility alone. Therefore, the expected volatility was based on a blend of market-based implied volatility and the historical volatility of our stock. The assumptions used in calculating the fair value of share-based payment awards represent our best estimates. In addition, we are required to estimate the expected forfeiture rate and recognize expense only for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. See Note J, Stock-Based Compensation, to the consolidated financial statements for additional information on stock-based compensation, which is incorporated herein by reference.
The following table is provided to facilitate a discussion regarding the comparison of our consolidated results of continuing operations for each of the three years in the period ended December 31, 2012 (in thousands, except diluted earnings per share amounts). For additional financial information, see the consolidated financial statements and the accompanying notes, which is incorporated herein by reference.
Management services revenue increased over the prior year primarily due to certain groups moving from Commercial Risk to ASO products. The increase in management services revenue was partially offset by a slight decline in the Workers’ Compensation Division revenue due to the loss of a customer account.
Medical costs increased from the prior year primarily as a result of the new Medicaid contract with the Commonwealth of Kentucky, the acquisition of FHP and continued Medicare Part D membership growth. Medical costs also increased as a result of organic membership growth for the Medicare Advantage CCP and Medicaid products. This was partially offset by a decrease in Commercial membership, as noted above.
Total MLR increased 1.9% over the prior year, from 82.1% to 84.0%, as a result of the increased Medicare Part D and Medicaid MLR, which was partially offset by the Medicare Advantage RADV audit reserve releases during the current year. The overall MLR also increased due to a higher mix of Medicaid members, which operate at a higher MLR compared to our Commercial business.
Selling, general and administrative expense, in the aggregate, increased over the prior year primarily due to normal operating costs associated with the new Medicaid contract with the Commonwealth of Kentucky and the FHP acquisition; including, but not limited to, salaries and benefits, professional fees and premium taxes. The increase is also attributable to additional salaries and benefits associated with an increase in the number of full-time employees associated with the growth of the Medicare Part D products. The increases are partially offset by a general reduction in broker commissions and lower stock-based compensation expense. For more information regarding stock-based compensation, refer to Note J, Stock-Based Compensation, to the consolidated financial statements, which is incorporated herein by reference.
Accordingly, the current year depreciation and amortization expense includes a $7.7 million impairment charge of the intangibles associated with the non-renewal of this contract. The impairment charge related only to the intangibles assigned to the Kansas business acquired in the FHP acquisition and did not affect the intangibles assigned to the ongoing Missouri business, also acquired in the FHP acquisition. Additionally, a portion of the depreciation and amortization expense increase is a result of placing certain internally developed medical quality improvement software into service during the current year.
Interest expense in the current year was relatively consistent with the prior year. The slight increase over the prior year was due to the issuance of $600.0 million aggregate principal amount of our 5.450% Senior Notes due 2021 in the later part of the second quarter of 2011. This was partially offset by lower interest expense in 2012 associated with the repayment, at maturity, of the $233.9 million outstanding balance of our 5.875% Senior Notes in January 2012 and the repayment of our revolving Credit Facility in the second quarter of 2011.
Other income, net increased as income in the current year included larger realized gains on the sales of investments.
Managed care premium revenue increased primarily as a result of the acquisition of MHP, Inc. (“MHP”) in the fourth quarter of 2010. Revenue also increased as a result of organic membership growth and an increase in the average realized premium per member per month. The increase was also attributed to Medicaid Risk revenue due to new markets entered during August 2010 in the State of Nebraska and the launch of the new Kentucky Medicaid contract, effective November 1, 2011. These increases were partially offset by a decrease in Medicare Part D revenue as a result of the loss of membership resulting from the loss of auto assign regions and reduction in product offerings in 2011. The increases mentioned above were also partially offset by an accrual for the minimum medical loss ratio rebate for our Commercial business required by PPACA.
During the second quarter of 2010, a $278.0 million charge for a provider class action was recorded resulting from the Court of Appeal, Third Circuit for the State of Louisiana decision to affirm the trial court’s decision to grant summary judgment against a wholly-owned subsidiary of Coventry in provider class action litigation in Louisiana state court. On May 27, 2011, the court
entered an order of final approval of a settlement and, accordingly, we recorded a non-recurring pre-tax adjustment that increased earnings of $159.3 million in the second quarter of 2011.
The provision for income taxes increased due to an increase in earnings. The effective tax rate on continuing operations increased to 36.7% for 2011 as compared to 36.1% for 2010 due primarily to the proportion of our earnings in states with higher tax rates and by compliance with new health care reform regulations.
Our segment presentation for 2011 and 2010 has been reclassified to conform to the 2012 presentation. For additional information regarding our segments, refer to Note B, Segment Information, in the notes to the consolidated financial statements, which is incorporated herein by reference.
The following table is provided to facilitate a discussion regarding the comparison of our segment results of operations for the years ended December 31, 2012, 2011 and 2010.
The gross margin for this Division decreased primarily due to a decline in Commercial Risk membership and the resulting lower premium revenue. The Commercial Risk MLR was relatively consistent year-over-year.
Medicaid revenue increased primarily as a result of the new contract with the Commonwealth of Kentucky effective November 2011 and the acquisition of FHP effective January 1, 2012. Medicaid revenue also increased as a result of organic membership growth. The Medicare Advantage revenue increase is primarily a result of continued organic membership growth. Additionally, the Medicare Advantage revenue increase reflected the RADV audit reserve releases, as previously discussed.
The gross margin for this Division decreased primarily due to lower favorable prior year medical cost development and the accrual for the minimum MLR rebate for our Commercial business. The Commercial Risk MLR increased for the year primarily due to the accruals for the minimum MLR rebates as well as utilization beginning to return to normal levels.
Medicare Advantage revenue increased primarily due to the acquisition of MHP in October 2010, as well as a general increase in premiums per member per month. The increase in Medicaid Risk revenue is due to entering new markets which included the State of Nebraska in August 2010 and the Commonwealth of Kentucky in November 2011. The Medicaid risk premiums per member per month also increased as a result of a rate increase effective July 1, 2011, in Missouri, our largest Medicaid market, the implementation of the Kentucky contract (which has a higher than average premium per member per month) and due to a change in member mix in our Nebraska market.
The Government Programs division revenue increases were partially offset by a decrease in Medicare Part D revenue in 2011. The Medicare Part D revenue decrease was primarily due to lower Medicare Part D membership as a result of the loss of auto assign regions as well as a reduction in product offerings from five in 2010 to two in 2011. Including the effect of the CMS risk sharing premium adjustments as well as ceded revenue, the premiums increased to $88.80 in 2011, compared to $82.86 in 2010, primarily due to pharmacy cost trends and the loss of the lower priced premium products.
Workers’ Compensation division revenue increased primarily due to the growth of our pharmacy benefit management program, which was partially offset by a decline in volume and rates in our network products.
Our investment guidelines require our fixed income securities to be investment grade in order to provide liquidity to meet future payment obligations and minimize the risk to the principal. Our fixed income portfolio includes, among other investment categories, government and corporate securities and has an average credit quality rating of “AA-” and an effective duration of 4.06 years as of December 31, 2012. The average credit quality rating is based on the weighted average credit rating as provided by Standard & Poor’s. See Footnote F, Investments, to the consolidated financial statements for more information regarding investments, which is incorporated by reference. Typically, the amount and duration of our short-term assets are more than sufficient to pay for our short-term liabilities, and we do not anticipate that sales of our long-term investment portfolio will be necessary to fund our claims liabilities.
During the year ended December 31, 2012, the Board of Directors declared four quarterly cash dividends of $0.125 per share each, or $68.4 million in the aggregate. The cash dividend for the quarter ended December 31, 2012 was accrued in “accounts payable and other accrued liabilities” in the accompanying balance sheet at December 31, 2012, and subsequently paid on January 7, 2013. Declaration and payment of future quarterly dividends is at the discretion of the Board and may be adjusted as business needs or market conditions change. Additionally, the terms of the Merger Agreement restrict payment of future cash dividends other than our quarterly dividend consistent with past practice not to exceed $0.125 per share.
We have classified all of our investments as available-for-sale securities. Contractual maturities of the securities are disclosed in Note F, Investments, to the consolidated financial statements, which is incorporated herein by reference.
The demand for our products and services is subject to many economic fluctuations, risks and uncertainties that could materially affect the way we do business. See Part I, Item 1A, “Risk Factors,” in this Form 10-K for more information. Management believes that the combination of our ability to generate cash flows from operations, cash and investments on hand, and the excess funds held in certain of our regulated subsidiaries will be sufficient to fund continuing operations, capital expenditures, debt interest
Net cash from operating activities for the year ended December 31, 2012 was an inflow as a result of net earnings generated by our normal operations during the period, net of adjustments to earnings, and an increase in medical liabilities primarily related to the Medicare Part D and Kentucky Medicaid business. Offsetting these inflows is an increase in other receivables related to the settlement timing of current year subsidy and risk share receivables due from CMS for our Medicare business. The increase is a result of the growth in our Medicare Part D and Medicare Advantage businesses, that we expect to receive in 2013. Additionally, offsetting the inflows is a decrease in accounts payable and other accrued liabilities primarily as a result of payments in 2012 for the annual management incentive and performance compensation programs as well as payments in 2012 for the 2011 minimum medical loss ratio rebates.
Cash flows used for investing activities for the year ended December 31, 2012 decreased by $477.1 million from the corresponding 2011 period. This decrease is primarily due to lower investment purchases in 2012, partially offset by lower proceeds received from the sales of investments and larger payments for acquisitions in 2012.
Net cash from financing activities was an outflow, primarily due to share repurchases during the year ended December 31, 2012 and the repayment of the $233.9 million outstanding balance of our 5.875% Senior Notes.
In January 2012, at maturity, we repaid the $233.9 million outstanding balance of our 5.875% Senior Notes. On June 22, 2011, we entered into a five-year revolving credit facility agreement in the principal amount of $750.0 million. As of December 31, 2012, there were no amounts outstanding under this credit facility. For more information, refer to Note H, Debt, to the consolidated financial statements, which is incorporated herein by reference.
Cash flows used for financing activities for the year ended December 31, 2011 increased by $87.7 million from the corresponding 2010 period. The increase is primarily due to higher net borrowings in 2011 related to the issuance in 2011 of our Senior Notes due June 7, 2021 as well as higher share repurchases in 2011.
Our regulated HMO and insurance company subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends the parent may receive from our regulated entities. During 2012, we received $214.7 million in dividends from our regulated subsidiaries and we made $144.0 million in capital contributions to them.
Regulators will use the RBC results to determine if any regulatory actions are required. Regulatory actions that could take place, if any, range from requiring the subsidiary to file a financial action plan explaining how the plan will increase its statutory net worth to the approved levels, to the health plan being placed under regulatory control.
As of December 31, 2012, we were contractually obligated to make the following payments during the next five years and thereafter (in thousands):
In recent years, health care cost inflation has exceeded the general inflation rate. To reduce the effect of health care cost inflation on our business operations in which we assume underwriting risk, we have, where possible, increased premium rates and implemented cost control measures in our patient care management and provider contracting. We cannot be certain that we will be able to increase future premium rates at a rate that equals or exceeds the health care cost inflation rate or that our other cost control measures will be effective.
Medicare Part D - Due to a reduction in the Company's auto-assign footprint, Coventry's Medicare Part D membership is expected to decline by approximately 143,000 members, or 9% in the first quarter of 2013.
Tax Rate - We expect our effective tax rate to range from 39% to 41% for 2013, up from 37.92% for 2012. This increase is due primarily to Internal Revenue Code 162(m)(6), which limits the annual tax deduction for compensation paid by health insurers to individuals providing services, including employees, to $500,000 per individual, effective January 1, 2013.
Effective January 1, 2011, PPACA mandated minimum medical loss ratios for commercial health plans such that the percentage of health coverage premium revenue spent on health care medical costs and quality improvement expenses be at least 80% for individual and small group health coverage and 85% for large group coverage, with rebates to policyholders if the actual loss ratios fall below these minimums. In addition, beginning in 2014, PPACA requires Medicare Advantage plans to have a minimum medical loss ratio of 85% or refund the difference. If a Medicare Advantage plan's medical loss ratio is below 85% for three consecutive years, enrollment will be restricted. A plan's Medicare Advantage contract will be terminated if the plan is out of compliance for five consecutive years. On February 15, 2013, CMS released a proposed rule to implement these requirements for Medicare Advantage plans. Under the proposed rule, a plan's medical loss ratio would be reported on a per contract basis. The medical loss ratio would be determined based on the percentage of contract revenue spent on clinical services, prescription drugs, quality improving activities and direct benefits to beneficiaries in the form of reduced Part B premiums. The medical loss ratio requirement will require ongoing efforts to control administrative costs.
CMS recently released preliminary estimates of benchmark payment rates for calendar year 2014 for Medicare Advantage plans that would result in materially decreased payments to our Medicare Advantage plans. These estimates are preliminary and could change when the final rates are announced on April 1, 2013. If the final payment rates are lower than current rates, our results of operations and cash flows could be adversely affected.
reinsurance program, a temporary risk corridors program, and a permanent risk adjustment program. The transitional reinsurance program will be established in each state to help stabilize premiums for coverage in the individual market from 2014 through 2016 and will be funded on a per capita basis from all commercial lines of business including insured and self-funded arrangements. The aggregate contribution amounts for all states are expected to total $12 billion in 2014, $8 billion in 2015 and $5 billion in 2016 (subject to additional amounts required by states). The terms of the specific reinsurance programs to be used in each state are not yet known. The temporary risk corridors program permits the federal government and qualified health plans to share in profits or losses resulting from inaccurate rate setting from 2014 to 2016. Under the risk corridors program, qualified health plan issuers with allowable costs that are less than 97% of the plan's target amount will remit charges for a percentage of those savings to HHS (issuers with allowable costs greater than 103% of the plan's target amount will receive payments from HHS to offset a percentage of those losses). The risk adjustment program is intended to mitigate the affects of possible adverse selection and stabilize the premiums in the individual and small group markets as and after insurance market reforms are implemented. Under the risk adjustment program, funds from plans with relatively lower risk enrollees are transferred to plans with relatively higher risk enrollees.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Coventry Health Care, Inc.'s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2013 expressed an unqualified opinion thereon.
Coventry Health Care, Inc. (together with its subsidiaries, the “Company” or “Coventry”) is a diversified national managed health care company based in Bethesda, Maryland, dedicated to delivering high-quality health care solutions at an affordable price. The Company provides a full portfolio of risk and fee-based products including Medicare and Medicaid programs, group and individual health insurance, workers’ compensation solutions, and network rental services. With a presence in every state in the nation, Coventry’s products currently serve approximately 5 million individuals helping them receive the greatest possible value for their health care investment.
On August 19, 2012, the Company, Aetna Inc. (“Aetna”) and Jaguar Merger Subsidiary, Inc. (“Merger Sub”) entered into an Agreement and Plan of Merger, pursuant to which, subject to the satisfaction or waiver of certain conditions, Merger Sub will be merged with and into Coventry, with the Company surviving the merger as a wholly-owned subsidiary of Aetna (the “Merger”). A copy of the Agreement and Plan of Merger was filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on August 20, 2012. The Company subsequently entered into Amendment No. 1 and Amendment No. 2 to the Agreement and Plan of Merger, which were filed as Exhibits 2.1 to the Company’s Current Report on Form 8-K filed on October 23, 2012 and November 21, 2012, respectively. As used herein, the “Merger Agreement” means the Agreement and Plan of Merger, by and among Coventry, Aetna and Merger Sub, as amended. Under the terms of the Merger Agreement, the Company’s shareholders will receive $27.30 in cash, without interest, and 0.3885 of an Aetna common share for each share of Coventry common stock. The total transaction was estimated at approximately $7.3 billion, including the assumption of Coventry debt, based on the closing price of Aetna common shares on August 17, 2012.
Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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. Actual results could differ from those amounts.
Significant Customers - The Company’s health plan commercial risk products are diversified across a large customer base and no customer group comprises 10% or more of Coventry’s managed care premiums. The Company received 11.7%, 10.0% and 11.2% of its management services revenue from a single customer, Mail Handlers Benefit Plan (“MHBP”), for the years ended December 31, 2012, 2011 and 2010, respectively.
auto assign regions in 2012 as well as an increase in product offerings from two in 2011 to three in 2012. The decline in 2011 is primarily due to lower Medicare Part D membership as a result of the loss of auto assign regions as well as a reduction in product offerings from five in 2010 and two in 2011.
The Company also received 21.7%, 12.5% and 10.9% of its managed care premiums for the years ended December 31, 2012, 2011 and 2010, respectively, from state-sponsored Medicaid programs throughout its various health plan markets. The increase in 2012 is primarily as a result of the contract with the Commonwealth of Kentucky to provide services for the Commonwealth’s Medicaid program and the acquisition of Children’s Mercy’s Family Health Partners (“FHP”) with Medicaid membership in Kansas and Missouri. The Kentucky contract was awarded effective in the fourth quarter of 2011, and the acquisition of FHP was completed in the first quarter of 2012. The increase is also due to same-store growth in the Company’s Missouri market and expansion into new regions in the Company’s Nebraska, Pennsylvania and Virginia markets during the third quarter of 2012. In 2012, the Commonwealth of Kentucky and the State of Missouri accounted for 33.2%, and 23.8% of the Company’s Medicaid premiums, respectively.
Other Long-term Assets - Long-term assets primarily include assets associated with senior note issuance costs and reinsurance recoveries. The reinsurance recoveries were obtained with the acquisition of First Health Group Corporation (“FHGC”) and are related to certain life insurance receivables from a third party insurer for liabilities that have been ceded to that third party insurer.
The Company’s annual impairment test date is October 1 of each fiscal year. However, each year the Company could be required to evaluate the recoverability of goodwill and other indefinite lived intangible assets prior to the required annual assessment if there is any indication of a potential impairment. Those indications may include experiencing disruptions to business, unexpected significant declines in operating results, regulatory actions (such as health care reform) that may affect operating results, divestiture of a significant component of the business or a sustained decline in market capitalization. The Company has six reporting units: Health Plan Commercial, Health Plan Government, Network Rental, MHNet, Workers’ Compensation and Medicare Part D.
Industry and market considerations such as a deterioration in the environment in which the Company operates, an increased competitive environment, a decline in market-dependent multiples or metrics (considered in both absolute terms and relative to peers), a change in the market for the Company’s products or services, or a regulatory or political development;
If applicable, a sustained decrease in share price (considered in both absolute terms and relative to the Company’s peers).
the second step of the impairment test in order to determine the implied fair value of the reporting unit’s goodwill. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, the Company records an impairment charge equal to the difference. Impairment charges are recorded in the period incurred.
While the Company believes it has made reasonable estimates and assumptions, in its quantitative impairment analysis, to calculate the fair values of the reporting units and other intangible assets, it is possible a material change could occur. Under the income approach, the Company assumed certain growth rates, capital expenditures, discount rates and terminal growth rates in its calculations. If the assumptions used in the Company’s fair-value-based tests differ from actual results, the estimates underlying its goodwill impairment tests could be adversely affected.
See Note D, Goodwill and Other Intangible Assets, to the consolidated financial statements for disclosure related to these assets.
Medical Liabilities and Expense - Medical liabilities consist of actual claims reported but not paid and estimates of health care services incurred but not reported. The estimated claims incurred but not reported are based on historical data, current enrollment, health service utilization statistics and other related information. In determining medical liabilities, the Company employs standard actuarial reserve methods that are specific to each market’s membership, product characteristics, geographic territories and provider network. The Company also considers utilization frequency and unit costs of inpatient, outpatient, pharmacy and other medical expenses, as well as claim payment backlogs and the timing of provider reimbursements. The Company also establishes reserves, if required, for the probability that anticipated future health care costs and contract maintenance costs under the group of existing contracts will exceed anticipated future premiums and reinsurance recoveries on those contracts. For purposes of premium deficiency reserves, contracts are grouped in a manner consistent with the Company’s method of acquiring, servicing and measuring the profitability of such contracts. If established, the premium deficiency reserves would be expected to cover losses until the next policy renewal dates for the related policies. Once established, premium deficiency reserves are released straight-line over the remaining life of the contract. No premium deficiency reserves were established at December 31, 2012 or 2011. These accruals are continually monitored and reviewed, and as settlements are made or accruals adjusted, differences are reflected in current operations. Changes in assumptions for medical costs caused by changes in actual experience could cause these estimates to change in the near term.
Comprehensive Income - Comprehensive income includes net earnings and unrealized net gains and losses on investment securities. Other comprehensive income is net of reclassification adjustments to adjust for items currently included in net earnings, such as realized gains and losses on investment securities. The deferred tax provision for holding gains arising from investment securities during the years ended December 31, 2012, 2011 and 2010 was $21.1 million, $18.3 million, and $4.1 million, respectively. The deferred tax provision for reclassification adjustments for gains included in net earnings on investment securities during the years ended December 31, 2012, 2011 and 2010 was $15.6 million, $6.5 million, and $4.3 million, respectively.
Revenue Recognition - Managed care premiums are recorded as revenue in the month in which members are entitled to service. Premiums are based on a per subscriber contract rate and the subscribers in the Company’s records at the time of billing. Premium billings are generally sent to employers in the month preceding the month of coverage. Premium billings may be subsequently adjusted to reflect changes in membership as a result of retroactive terminations, additions or other changes. Payments received in advance of the period of coverage are recognized as deferred revenue. The Company also receives premium payments from CMS on a monthly basis for its Medicare membership. Membership and category eligibility are periodically reconciled with CMS and such reconciliations could result in adjustments to revenue. CMS uses a risk adjustment model to determine premium payments to health plans. This risk adjustment model apportions premiums paid to all health plans according to health severity based on diagnosis data provided to CMS. The Company estimates risk adjustment revenues based on the diagnosis data submitted
The Company also receives premium payments on a monthly basis from the state Medicaid programs with which the Company contracts for the Medicaid members for whom it provides health coverage. Membership and category eligibility are periodically reconciled with the state Medicaid programs and such reconciliations could result in adjustments to revenue. Premiums collected in advance are recorded as deferred revenue.
The Company has quota share arrangements on business with certain individual and employer groups with some of its Medicare distribution partners covering portions of the Company’s Medicare Part D and, previously, Medicare PFFS products. The Medicare PFFS products were not renewed for the 2010 plan year and, accordingly, the quota share arrangements were discontinued with a three year run out provision. As a result of the quota share arrangements, for the years ended December 31, 2012, 2011, and 2010, the Company ceded premium revenue of $45.3 million, $43.3 million and $49.8 million, respectively, and the associated medical costs to these partners. The ceded amounts are excluded from the Company’s results of operations. The Company is not relieved of its primary obligation to the policyholder under this ceding arrangement.
Earnings Per Common Share - Earnings per common share (“EPS”) is calculated under the two-class method under which all earnings (distributed and undistributed) are allocated to each class of common stock and participating securities based on their respective rights to receive dividends. Coventry grants restricted stock to certain employees under its stock-based compensation program, which entitles recipients to receive non-forfeitable cash dividends during the vesting period on a basis equivalent to the dividends paid to holders of common stock. Basic EPS is calculated using the weighted average number of common shares
Other Income, net - Other income, net includes interest income, net of fees, realized gains and losses on sales of investments and charges on the other-than-temporary impairment of investment securities.
In July 2012, the FASB issued ASU 2012-02, “Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” ASU 2012-02 permits an entity to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is “more likely than not” that the indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Codification Subtopic 350-30, Intangibles-Goodwill and Other, General Intangibles Other Than Goodwill. ASU 2012-02 was effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, with early adoption permitted. The Company adopted ASU 2012-02 effective January 1, 2012 for its 2012 annual impairment test. The adoption of ASU 2012-02 did not materially affect the Company’s financial position or results of operations and comprehensive income.
In September 2011, the FASB issued ASU 2011-08, “Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other. ASU 2011-08 was effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The Company adopted ASU 2011-08 effective January 1, 2012, and it did not materially affect the Company’s financial position or results of operations and comprehensive income.
In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards.” ASU 2011-04 requires additional fair value measurement disclosures, including: (a) quantitative information about the significant unobservable inputs used for Level 3 fair value measurements, a qualitative discussion about the sensitivity of the measurements to changes in the unobservable inputs, and a description of a company’s valuation process, (b) any transfers between Level 1 and 2, (c) information
about when the current use of a non-financial asset measured at fair value differs from its highest and best use, and (d) the hierarchy classification for items whose fair value is not recorded on the balance sheet but is disclosed in the notes. ASU 2011-04 was effective for fiscal periods beginning after December 15, 2011. The Company adopted these disclosure requirements effective January 1, 2012, as required. The adoption of ASU 2011-04 did not affect the Company’s financial position or results of operations and comprehensive income.
During the first quarter of 2012, the Company reorganized the executive management team to better align resources and provide continued focus on areas of future growth. As a result of this reorganization, the Company realigned its segments during the first quarter of 2012 to reflect the manner in which the chief operating decision maker reviews financial information. As a result, the Company has the following three reportable segments: Commercial Products, Government Programs and Workers’ Compensation. Each of these segments, which the Company also refers to as “Divisions,” is separately managed and provides separate operating results that are evaluated by the Company’s chief operating decision maker.
The Government Programs Division includes the Company’s Medicare Part D and traditional health plan based Medicare Advantage CCP and Medicaid products.
The Workers’ Compensation Division is comprised of fee-based, managed care services, such as provider network access, bill review, pharmacy benefit management, durable medical equipment and ancillary services, and care management services to underwriters and administrators of workers’ compensation insurance.
The tables below summarize the operating results of the Company’s reportable segments through the gross margin level, as that is the measure of profitability used by the chief operating decision maker to assess segment performance and make decisions regarding the allocation of resources. A reconciliation of gross margin to operating earnings at a consolidated level is also provided. Total assets by reportable segment are not disclosed as these assets are not reviewed separately by the Company’s chief operating decision maker. The dollar amounts in the segment tables are presented in thousands. The Company’s segment presentation for the prior years have been reclassified to conform to the 2012 presentation.
The following table summarizes the business combinations for the three years ended December 31, 2012. The purchase price, inclusive of all retroactive balance sheet settlements to date, is presented below (in millions):
Effective January 1, 2012, the Company completed its acquisition of FHP, a Medicaid health plan that was affiliated with Children’s Mercy Hospital in Kansas City serving approximately 210,000 Medicaid members in the Kansas and Missouri markets. The Company acquired FHP to expand its Medicaid footprint in the Missouri market.
On October 1, 2010, the Company completed its acquisition of MHP, a diversified health plan with approximately 90,000 commercial risk members, 60,000 commercial self-funded members and 30,000 Medicare Advantage CCP members throughout Missouri and northwest Arkansas. The Company acquired MHP to expand its footprint in the Missouri market.
As a result of the PHS and MHP acquisitions, the Company recorded $30.9 million of goodwill, none of which is expected to be deductible for tax purposes. As a result of the FHP acquisition, the Company recorded $42.7 million of goodwill, all of which is expected to be deductible for tax purposes.
The changes in the carrying amount of goodwill, by reporting segment, for the years ended December 31, 2012 and 2011 were as follows (in thousands):
The Company performed an impairment test of its unamortized other intangible asset (trade name) as of October 1, 2012, and determined that the asset was not impaired.
Other intangible asset amortization expense for the years ended December 31, 2012, 2011 and 2010 was $74.1 million, $64.4 million, and $64.1 million, respectively. For the years ending December 31, 2013, 2014, 2015, 2016, and 2017, the Company’s estimated intangible amortization expense is $66.1 million, $65.6 million, $32.2 million, $16.6 million and $13.3 million, respectively. For the years ended December 31, 2012 and 2011, the weighted-average amortization period is approximately 10 years for other intangible assets.
Depreciation expense for the years ended December 31, 2012, 2011 and 2010 was $78.7 million, $72.5 million and $76.6 million, respectively. Included in the depreciation expense for the years ended December 31, 2012, 2011 and 2010 was $25.3 million, $21.6 million and $25.2 million, respectively, of amortization expense for developed software. Property and equipment, net, includes $97.7 million and $85.1 million of internally developed software, net of accumulated depreciation as of December 31, 2012 and 2011, respectively.
The Company considers all of its investments as available-for-sale securities. Realized gains and losses on the sale of investments are determined on a specific identification basis.
The amortized cost, gross unrealized gain or loss and estimated fair value of short-term and long-term investments by security type were as follows at December 31, 2012 and 2011 (in thousands):
The Company acquired eight separate investments (tranches) in a limited liability company that invests in equipment leased to third parties, through its acquisition of First Health Group Corp. on January 28, 2005. The total investment as of December 31, 2012 was $23.7 million and is accounted for using the equity method. The Company’s proportionate share of the limited liability company’s income is included in other income in the Company’s statements of operations and comprehensive income. The Company has between a 20% and 25% interest in the limited liability company’s share of each individual tranche of the limited liability company (approximately 10% of the total limited liability company).
The amortized cost and estimated fair value of available for sale debt securities by contractual maturity were as follows at December 31, 2012 and 2011 (in thousands):
Investments with long-term option adjusted maturities, such as residential and commercial mortgage-backed securities, are included in the “Over 10 years” category. Actual maturities may differ due to call or prepayment rights.
The unrealized losses presented in this table do not meet the criteria for treatment as an other-than-temporary impairment. The unrealized losses are the result of interest rate movements. The Company has not decided to sell and it is not more-likely-than not that the Company will be required to sell before a recovery of the amortized cost basis of these securities.
The Company’s Level 2 securities primarily consist of government-sponsored enterprise securities, state and municipal bonds, mortgage-backed securities, asset-backed securities, corporate debt and money market funds. The Company determines the estimated fair value for its Level 2 securities using the following methods: quoted prices for similar assets/liabilities in active
For the Company’s Level 2 assets, the following inputs and valuation techniques were utilized in determining the fair value of its financial instruments:
The following table presents the fair value hierarchy for the Company’s financial assets measured at fair value on a recurring basis at December 31, 2012 and 2011 (in thousands):
Transfers between levels, if any, are recorded as of the end of the reporting period. During the years ended December 31, 2012 and December 31, 2011, there were no transfers between Level 1 and Level 2. During the year ended December 31, 2012, there were no transfers to (from) Level 3 and, accordingly, a table summarizing changes in fair value of the Company’s financial assets for that period is not presented. The following table provides a summary of changes in the fair value of the Company’s Level 3 financial assets for the year ended December 31, 2011 (in thousands):
The Company no longer relied upon broker quotes or other models involving unobservable inputs to value these securities, as there were sufficient observable inputs (e.g., trading activity) to validate the reported fair value. As a result, the Company transferred all securities from Level 3 to Level 2 during the year ended December 31, 2011.
The Company’s fair value of publicly-traded debt (senior notes) is based on Level 2 inputs, including quoted market prices for the same or a similar debt or, if no quoted market prices are available, on the current market observable rates estimated to be available to the Company for debt of similar terms and remaining maturities. The carrying value of the senior notes (including the long-term and current portions) was $1.59 billion at December 31, 2012 and $1.82 billion at December 31, 2011. The estimated fair value of the Company’s senior notes (including the long-term and current portions) was $1.81 billion at December 31, 2012 and $1.99 billion at December 31, 2011.
The carrying value of the revolving credit facility approximates the fair value due to the short maturity dates of the draws. The Company had no outstanding borrowings under its current credit facility at December 31, 2012 or 2011.
In January 2012, at maturity, the Company repaid the $233.9 million outstanding balance of its 5.875% Senior Notes.
As a result of corporate acquisitions and transactions, the Company has acquired entities that have sponsored other qualified plans. All qualified plans sponsored by the acquired subsidiaries of the Company have either terminated or merged with and into the Savings Plan. The cost of the Savings Plan, including the acquired plans, for 2012, 2011 and 2010 was approximately $31.2 million, $29.7 million and $27.4 million, respectively.
The Company is the sponsor of a 401(k) Restoration and Deferred Compensation Plan (“RESTORE”). Under RESTORE, participants may defer up to 75% of their base salary and up to 100% of any bonus awarded. The Company makes matching contributions equal to 100% of the participant’s contribution on the first 3% of the participant’s compensation and 50% of the participant’s contribution on the second 3% of the participant’s compensation. Participants vest in the Company’s matching contributions ratably over two years for the first two years of service and vest immediately for all subsequent years of service. All costs of RESTORE are funded by the Company as they are incurred.
The Company has one stock incentive plan, the Amended and Restated 2004 Incentive Plan (the “Incentive Plan”) under which shares of the Company’s common stock are authorized for issuance to key employees, consultants and directors in the form of stock options, restricted stock and other stock-based awards. The Incentive Plan includes a provision for accelerated vesting of equity awards in the event of a change of control of the Company. Shares available for issuance under the Incentive Plan were 4.5 million as of December 31, 2012.
The Company recorded compensation expense related to stock options of approximately $12.5 million, $15.6 million and $21.0 million, for the years ended December 31, 2012, 2011 and 2010, respectively. Cash received from stock option exercises was $87.7 million, $44.6 million and $15.5 million, for the years ended December 31, 2012, 2011 and 2010, respectively.
The following table summarizes restricted stock award activity for the year ended December 31, 2012:
Performance share units (“PSUs”) represent hypothetical shares of the Company’s common stock. The PSUs vest (if at all) based upon the achievement of certain performance goals and other criteria at various periods through 2015. The Company granted PSUs during the year ended December 31, 2012 but did not record compensation expense related to the PSUs as the performance goals for the two-year cumulative period have not been finalized for the 2013 targets, and therefore the measurement criteria has not been established for accounting purposes. The PSU performance goals are anticipated to be finalized in the first quarter of 2013. All PSUs that vest will be paid out in cash or stock based upon the price of the Company’s common stock. The PSUs will be classified as a liability by the Company.
The Company’s Board of Directors has approved a program to repurchase its outstanding common shares. Share repurchases may be made from time to time at prevailing prices on the open market, by block purchase, or in private transactions. The Company’s Board of Directors approved increases in November 2011 and March 2011 to the share repurchase program in amounts equal to 10% and 5% of the Company’s then outstanding common stock, thus increasing the Company’s repurchase authorization by 14.4 million and 7.5 million shares, respectively. Under the share repurchase program, the Company purchased 9.9 million shares and 10.7 million shares of its common stock, at an aggregate cost of $328.0 million and $327.7 million during 2012 and 2011, respectively. During 2010, the Company made no repurchases of its common stock. As of December 31, 2012, the total remaining common shares the Company is authorized to repurchase under this program is 6.5 million. Excluded from these amounts are shares purchased in connection with the vesting of restricted stock awards to satisfy employees’ minimum statutory tax withholding obligations as these purchases are not part of the program. The terms of the Merger Agreement prohibit share repurchases without Aetna’s consent, other than share repurchases made in connection with the exercise of stock options and the vesting of restricted stock or other equity awards.
During the year ended December 31, 2012, the Board of Directors declared and the Company paid the following cash dividends:
Earnings per share (“EPS”) is calculated under the two-class method under which all earnings (distributed and undistributed) are allocated to each class of common stock and participating securities based on their respective rights to receive dividends. Coventry grants restricted stock to certain employees under its stock-based compensation program, which entitles recipients to receive non-forfeitable cash dividends during the vesting period on a basis equivalent to the dividends paid to holders of common stock. The application of the two-class method resulted in an immaterial decrease of $0.05 and $0.03 to previously reported basic and diluted EPS, respectively, for the year ended December 31, 2011 and $0.04 and $0.03 to previously reported basic and diluted EPS, respectively, for the year ended December 31, 2010.
The following table presents the components of Other income, net for the years ended December 31, 2012, 2011 and 2010 (in millions):
A reconciliation of the total amounts of unrecognized tax benefits for the years ended December 31, 2012, 2011 and 2010 is as follows (in thousands):
The total amount of unrecognized tax benefits, as of December 31, 2012 and 2011 that, if recognized, would affect the effective tax rate was $34.4 million and $38.2 million, respectively. Further the Company is unaware of any positions for which it is
reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next twelve months.
Penalties and tax-related interest expense are reported as a component of income tax expense. As of December 31, 2012 and 2011, the total amount of income tax-related accrued interest and penalties, net of related tax benefit, recognized in the statement of financial position was $9.3 million and $10.4 million, respectively.
During the year ended December 31, 2012, the Company settled certain income tax examinations with various state and local tax authorities. Tax assessed as a result of these examinations was not material.
The Company operates in leased facilities with original lease terms of up to thirteen years with options for renewal. Total rent expense was $33.9 million, $33.3 million and $32.4 million for the years ended December 31, 2012, 2011 and 2010, respectively.
On February 25, 2008, the Company received a subpoena from the U.S. Attorney for the District of Maryland, Northern Division, requesting information regarding the operational process for confirming Medicare eligibility for its Workers’ Compensation Medicare set-aside product. Under federal law, insurance companies, when settling a workers’ compensation claim, are required to determine if the injured person is a Medicare beneficiary and if so, must set aside an appropriate amount of the settlement funds to insure that Medicare does not pay for any future medical costs of the injured person. During 2005 and 2006, certain employees working in the Medicare set-aside department accessed, without authorization, the Medicare beneficiary database to determine Medicare eligibility. In November of 2012, the Company entered into a civil monetary settlement agreement with the U.S. Attorney’s Office and paid a $3 million fine to settle and resolve this matter.
On September 3, 2009, a shareholder filed a putative securities class action against the Company and three of its current and former officers in the U.S. District Court for the District of Maryland. Subsequent to the filing of the complaint, three other shareholders and/or investor groups filed motions with the court for appointment as lead plaintiff and approval of selection of lead and liaison counsel. By agreement, the four shareholders submitted a stipulation to the court regarding appointment of lead plaintiff and approval of selection of lead and liaison counsel. In December 2009, the court approved the stipulation and ordered the lead plaintiff to file a consolidated and amended complaint. The purported class period was February 9, 2007 to October 22, 2008. The consolidated and amended complaint alleges that the Company’s public statements contained false, misleading and incomplete information regarding the Company’s profitability, particularly with respect to the profit margins for its Medicare Advantage Private-Fee-For-Service products. The Company filed a motion to dismiss the complaint. By Order, dated March 31, 2011, the court granted in part, and denied in part, the Company’s motion to dismiss the complaint. The Company filed a motion for reconsideration with respect to that part of the court’s March 31, 2011 Order which denied the Company’s motion to dismiss the complaint. The motion for reconsideration was denied but the court did rule that the class period was further restricted to April 25, 2008 to June 18, 2008. As a result of a court ordered mediation, the Company has entered into a settlement agreement with counsel for the plaintiffs and the class. The parties will be submitting a formal written settlement agreement to the court for preliminary approval. These lawsuits are a covered claim under the Company’s Directors and Officers Liability Policy (“D&O Policy”), and therefore, after exhaustion of the Company’s self-insured retention of $2.5 million, the settlement amount will be fully funded and paid under the D&O Policy. The Company has accrued an immaterial settlement amount in “accounts payable and other accrued liabilities” and an associated recovery amount from the D&O Policy in “other receivables, net” in the accompanying balance sheet.
On August 31, 2012, a putative stockholder class action lawsuit captioned Brennan v. Coventry Health Care, Inc. et al., C.A. No. 7826-CS, was filed in the Court of Chancery of the State of Delaware against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On September 14, 2012, a second putative stockholder class action lawsuit captioned Nashelsky v. Coventry Health Care, Inc. et al., C.A. No. 7868-CS, was filed in the Court of Chancery of the State of Delaware against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On September 27, 2012, and September 28, 2012, putative stockholder class action lawsuits captioned Employees’ Retirement System of the Government of the Virgin Islands v. Coventry Health Care, Inc. et al., C.A. No. 7905-CS and Farina v. Coventry Health Care, Inc. et al., C.A. No. 7909-CS, were filed in the Court of Chancery of the State of Delaware against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On October 1, 2012, an amended
Where available information indicates that it is probable that a loss has been incurred as of the date of the consolidated financial statements and the Company can reasonably estimate the amount of that loss, the Company accrues a liability of an estimated amount. In many proceedings, however, it is difficult to determine whether any loss is probable or reasonably possible. In addition, even where a loss is reasonably possible or an exposure to a loss exists in excess of the liability already accrued with respect to a previously identified loss contingency, it is not always possible to reasonably estimate the amount of the possible loss or range of loss.
There is significant judgment required in both the probability determination and as to whether an exposure to a loss can be reasonably estimated. No estimate of the possible loss, or range of loss, in excess of amounts accrued, if any, can be made at this time regarding the matters specifically described above due to the inherently unpredictable nature of legal proceedings. These matters can be affected by various factors; including, but not limited to, the procedural status of the dispute, the novel legal issues presented (including the legal basis for the majority of the alleged violations), the inherent difficulty in predicting regulatory judgments, fines and penalties, and the various remedies and levels of judicial review available to the Company in the event a judgment, fine or penalty is assessed. If one or more of these legal matters were resolved against the Company for amounts in excess of the Company’s expectations, the Company’s financial position or results of operations and comprehensive income could be materially adversely affected.
The Company’s financial instruments that are exposed to credit risk consist primarily of cash equivalents, investments in fixed income securities and accounts receivable. The Company invests its excess cash in state and municipal bonds, U.S. Treasury and agency securities, mortgage-backed securities, asset-backed securities, corporate debt and other securities. Investments in marketable securities are managed within guidelines established by the Board of Directors, which only allow for the purchase of investment-grade fixed income securities and limits exposure to any one issuer. The Company’s financial instruments are reported at fair value. There is some credit risk associated with these instruments.
The Company is a provider of health insurance coverage to the State of Illinois employees and their dependents. As of December 31, 2012, the Company has an outstanding premium receivable balance from the State of Illinois of approximately $32.2 million which represents seven months of health insurance premiums. As the receivable is from a governmental entity which has been making payments, the Company believes that the full receivable balance will ultimately be realized and therefore the Company has not reserved against the outstanding balance. The Company’s regulated subsidiaries are required to submit statutory-basis financial statements to state regulatory agencies. For those financial statements, in accordance with state regulations, this receivable is being treated as an admitted asset in its entirety.
The Company contracts with a pharmacy benefit management (“PBM”) vendor to manage the pharmacy benefits for its members and to provide rebate administration services on behalf of the Company. As of December 31, 2012, the Company had pharmacy rebate receivables of $305.4 million due from the PBM vendor resulting from the normal cycle of rebate processing, data submission and collection of rebates. The Company has credit risk due to the concentration of receivables with this single vendor although the Company does not consider the associated credit risk to be significant. The Company only records the pharmacy rebate receivables to the extent that the amounts are deemed probable of collection.
The National Association of Insurance Commissioners (“NAIC”) has proposed that states adopt risk-based capital (“RBC”) standards which are a method of measuring the minimum amount of capital appropriate for a managed care organization to support its overall business operations in consideration of its size and risk profile. The managed care organization’s RBC is calculated by applying factors to various assets, premiums and reserve items. The factor is higher for those items with greater underlying risk and lower for less risky items. The adequacy of a managed care organization’s actual capital can then be measured by a comparison to its RBC as determined by the formula. The Company’s health plans are required to submit an RBC report to the NAIC and their domiciled state’s department of insurance with their annual filing.
The Company believes that all subsidiaries which incur medical claims maintain more than adequate liquidity and capital resources to meet these short-term obligations as a matter of both Company policy and applicable department of insurance regulations.
The following is a summary of unaudited quarterly results of operations (in thousands, except per share data) for the years ended December 31, 2012 and 2011. Due to rounding of quarterly results, total amounts for each year may differ immaterially from the annual results.
During the quarter ended March 31, 2012, CMS announced which contract years are subject to the CMS RADV audits and other core areas of the audit methodology. As a result of these changes, the Company recorded a non-recurring pre-tax adjustment to earnings of $133.0 million during the first quarter of 2012. See Note A, Organization and Summary of Significant Accounting Policies, to the consolidated financial statements for additional information.
On May 27, 2011, the court entered an order of final approval of a settlement and, accordingly, the Company recorded a non-recurring pre-tax adjustment that increased earnings of $159.3 million in the second quarter of 2011.