Statements and in the Notes to Consolidated Financial Statements as well as the discussion under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations."
(1)Reflects the inclusion of MemberHealth since its acquisition on September 21, 2007.
- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
•2010 diluted earnings per share of $2.38, compared with $1.73 in 2009.
•Membership in our Medicare Advantage Plans increased 19% year-over-year, including 45% growth in our Network-based (HMO and PPO) Plans.
•Reduced our aggregate outstanding indebtedness by $81 million to $233 million at December 31, 2010 as compared to $314 million at December 31, 2009.
•Other-than-temporary impairment of investment securities declined to $0.8 million, compared to $17.4 million of OTTI recorded in 2009.
As a result of the passage of the Medicare Improvements for Patients and Providers Act of 2008, known as MIPPA, the PFFS product is no longer available as of January 1, 2011, except in areas that meet approved CMS network access requirements or in certain designated rural areas. We have developed products meeting CMS network access requirements in selected core markets to enable the retention of our PFFS membership in these areas. These businesses provide managed care for persons with Medicare under contracts with CMS.
As a result of the network requirements of MIPPA, we were required to terminate approximately 60,000 members as of January 1, 2011. Further, due to lapsation and the limited ability to add new members during the 2011 Annual Election Period as a result of the CMS sanctions, membership declined by an additional 48,000, resulting in membership of approximately 178,000 as of January 1, 2011.
On July 28, 2010, the Board of Directors of the Company approved the payment of a special cash dividend of $2.00 per share to each holder of the Company's outstanding common stock and Series A Preferred Stock. This special cash dividend was paid on August 19, 2010 to the shareholders of record as of the close of business on August 5, 2010. On the payment date, as required under the terms of the 2007 Credit Facility, we made an additional principal payment on our term loan equal to 50% of the dividend payment. The cumulative dividend payment was $156.0 million and the principal payment was $78.0 million. In addition, pursuant to the terms of our 1998 Incentive Compensation Plan, we were required to reduce the exercise price on unexercised options by the amount of the dividend, $2.00 per share. We also established a liability for the dividends related to unvested restricted stock and performance shares. These dividends will be paid out as the restricted stock and performance shares vest. This dividend payable liability was $3.3 million at December 31, 2010. As these dividends are paid out, we will also make additional principal payments on our term loan at the rate of 50% of dividends paid.
•inter-segment revenue and expense relating to services performed by the former Senior Administrative Services segment (now reported as part of Corporate & Other since the sale of CHCS in April 2010) for our other segments,
Net income for the year ended December 31, 2010 was $187.7 million, or $2.38 per diluted share, compared to net income of $140.3 million, or $1.73 per diluted share for the year ended December 31, 2009. The net income for the year ended December 31, 2010 includes realized investment gains, net of taxes, of $3.2 million, or $0.04 per diluted share. Net income for the year ended December 31, 2009 includes realized investment losses, net of taxes, of $16.2 million, or $0.20 per diluted share, relating primarily to the recognition of other-than-temporary impairments on investments. For the year ended December 31, 2010, our effective tax rate was 31.6%, compared with 34.6% for the same period of 2009. The decline in the effective rate for the year ended December 31, 2010 is due to the recording of $14.4 million of non-recurring tax benefits during the year, compared with $5.5 million in 2009. The 2010 benefit resulted primarily from the impact of tax law changes on our insurance companies and benefits that were recognized upon the completion of examinations by the Internal Revenue Service primarily attributable to the pre-acquisition tax returns of MemberHealth, Inc. The 2009 benefit resulted from the settlement of the Internal Revenue Service examination of 2005 primarily related to the treatment of a controlled foreign corporation sold in 2006. Absent these non-recurring benefits, the effective rate would have been 36.8% and 37.2% for the years ended December 31, 2010 and 2009, respectively.
The loss before income taxes from our Corporate & Other segment increased by $12.7 million, or 24%, for the year ended December 31, 2010 compared to 2009. This was primarily due to the $7.8 million decline in net income-Senior Administrative Services as a result of the sale of CHCS
effective April 1, 2010. In addition, we recorded $4.0 million of expenses related to the Part D transaction. During 2010 and 2009 we recorded charges related to the realignment of our distribution channels amounting to $15.0 million and $13.6 million, respectively.
Net income for the year ended December 31, 2009 was $140.3 million, or $1.73 per diluted share, compared to net income of $95.1 million, or $1.08 per diluted share for the year ended December 31, 2008. The net income for the year ended December 31, 2009 includes realized investment losses, net of taxes, of $16.2 million, or $0.20 per diluted share, relating primarily to the recognition of other-than-temporary impairments on investments. Net income for the year ended December 31, 2008 includes realized investment losses, net of taxes, of $38.8 million, or $0.44 per diluted share, also related primarily to the recognition of other-than-temporary impairments on investments. For the year ended December 31, 2009, our effective tax rate was 34.6%, compared with 37.2% for the same period of 2008. The decline in the effective rate for the year ended December 31, 2009 is due to the recording of $5.5 million of non-recurring tax benefits during the third quarter of 2009. This benefit resulted from the settlement of the Internal Revenue Service examination of 2005 primarily related to the treatment of a controlled foreign corporation sold in 2006. Absent this non-recurring benefit, the effective rate would have been 37.2% for the year ended December 31, 2009.
The loss before income taxes from our Corporate & Other segment increased by $37.1 million for the year ended December 31, 2009 compared to 2008. This was due primarily to a $13.6 million charge related to the proposed closing and restructuring of certain career sales offices in 2009, $13.5 million lower profitability of the former Senior Administrative Services segment, a significant non-recurring
Our Senior Managed Care-Medicare Advantage segment includes the operations of our Medicare coordinated care Plans including PPOs and HMOs as well as our PFFS business, which provides coverage to Medicare beneficiaries in 45 states. Our HMOs offer coverage to Medicare beneficiaries primarily in Southeastern Texas and the area surrounding Dallas/Ft. Worth, 15 counties in Oklahoma and 4 counties in Wisconsin. In January 2010, we expanded our PPO products to 114 counties in 17 states.
Revenues. Net premiums for the Senior Managed Care-Medicare Advantage segment increased by $539.2 million compared to the year ended December 31, 2009, primarily due to an increase in premium resulting from the growth in membership in all products partially offset by lower premium per member primarily in PFFS. Total member months in our Medicare Advantage Plans for the year ended December 31, 2010 increased by approximately 23% from prior year with gains in all products.
Medical expenses. Medical expenses increased by $482.0 million compared to the year ended December 31, 2010, as a result of the higher level of net premiums and an increase in member months over 2010. The medical expense ratio increased to 83.6% for the year ended December 31, 2010 from 82.4% for the year ended December 31, 2009 as a result of the items discussed above.
Commissions and general expenses. Commissions and general expenses for the year ended December 31, 2010 increased $47.0 million compared to the year ended December 31, 2009, primarily as the result of the increased level of membership and higher expenses to support the continued investment in the development of provider networks for our expansion in PPO and network based PFFS markets. However, the ratio of commissions and general expenses to net premiums decreased to 12.4% for the year ended December 31, 2010 from 13.1% in 2009 primarily due to increased efficiencies and scale.
Commissions and general expenses. In the second quarter of 2009 we recorded a $3.5 million restructuring charge related to the in-sourcing of billing and enrollment for our health plan business. Commissions and general expenses increased by $22.6 million compared to the year ended December 31, 2008 primarily as the result of an increase in expenses to support the continued investment in the development of provider networks for our expansion PPO markets. However, the ratio of commissions and general expenses to premiums decreased to 13.1% for the year ended December 31, 2009 from 13.3% in 2008 primarily due to increased efficiencies.
Other Part D income-PDMS represents our equity in the earnings of PDMS-see "Unconsolidated Subs" in Note 24-Other Operational Disclosures in the Notes to Consolidated Financial Statements. We report this as revenue for segment reporting purposes because the amount is incorporated in the calculation of the risk corridor adjustment. For consolidated reporting, we reflect this amount as a separate line following income from operations. See the reconciliation of segment revenues in Note 26 of the Notes to Consolidated Financial Statements in this Annual Report on Form 10-K. Our strategic alliance with CVS Caremark was terminated effective December 31, 2008. Upon termination of this strategic alliance, CVS Caremark and Universal American were each assigned responsibility for the drug benefit of specific Prescription PathwaySM Plan members in a manner to achieve an approximately equal distribution of the value of business that had been generated by the strategic alliance. Universal American has continued to operate PDPs derived from this business under the name PrescribaRx. Effective January 1, 2009, PDMS no longer managed the strategic alliance and
did not earn revenue or incur expenses related to the 2009 Medicare PDP year. PDMS was dissolved in December 2009.
In 2008, the Prescription PathwaySM business was reinsured on a 50% coinsurance basis with PharmaCare Re, a subsidiary of CVS Caremark, and we retained a 50% share in that business. There was no reinsurance for the PrescribaRx business in 2009 or 2010, and therefore we retained 100%.
Positive prior year development for the year ended December 31, 2010 was $9.5 million, compared with $0.5 million of positive prior year development for the year ended December 31, 2009. Prior year development for the year ended December 31, 2010 was primarily attributable to the 2006 and 2007 plan years, and the majority of this development was recorded in the fourth quarter of 2010. In December 2010, CMS announced that the 2006 and 2007 plan years will be re-opened and settled based upon PDE submitted to CMS through January 30, 2011. Part D segment income for the year ended December 31, 2010 reflects amounts that Part D expects to collect when the 2006 and 2007 plan years are re-opened and settled.
Membership. At December 31, 2010, total membership for Medicare Part D, based on enrollment information provided by CMS, was approximately 1,897,000 members, an increase of 200,000 members, or 11.8%, compared to net retained membership of 1,697,000 members at December 31, 2009.
Net Premiums. Net premiums, excluding risk corridor for the year ended December 31, 2010, increased by $195.0 million, or 9.7%, versus the year ended December 31, 2009. The increase in net premiums, excluding risk corridor was primarily attributable to growth in net retained membership by 200,000 members, and was partially offset by decreases in member premium rates and risk-adjusted direct subsidy rates paid by CMS. The decrease in member premium rates was attributable to the 2010 plan year bidding strategy which contributed to the growth in membership. In addition, a larger portion of our 2010 membership enrolled in standard plans which have lower member premium rates than enhanced plans. Risk-adjusted direct subsidy rates decreased as a result of an improvement in our members' health status in 2010, as determined by CMS. Risk-adjusted rates are determined by CMS based upon the member's health status and are described in further detail in Note 3 in the Notes to Consolidated Financial Statements. In addition, net premiums, excluding risk corridor for the year ended December 31, 2010 included risk adjustment revenue totaling $13.9 million for our 2009 membership and for the year ended December 31, 2009 included risk adjustment revenue totaling $12.3 million for our 2008 membership.
Pharmacy Benefits. Pharmacy benefits for the year ended December 31, 2010, increased by $211.1 million, or 13.3%, compared to the year ended December 31, 2009, and the ratio of pharmacy benefits to net premium, after risk corridor adjustment, was 82.3% and 80.1% for the years ended December 31, 2010 and 2009, respectively. Pharmacy benefits increased as a percentage of net premiums due to the combination of lower member premium and direct subsidy rates (previously described), and higher drug costs. Higher drug costs were attributable to price increases imposed by pharmaceutical manufacturers which are customary and were consistent with historical experience. These increases were partially offset by a lower utilization of drugs by our members, which is consistent with the aforementioned improvement in our members' health status, and lower net negative prior year development. Pharmacy benefits for the year ended December 31, 2010 included $0.4 million of net negative prior year development compared with $14.2 million of net negative prior year development during the year ended December 31, 2009. Negative prior year development for the year ended December 31, 2009 is further described under "Years ended December 31, 2009 and 2008", below.
Commissions and general expenses. Commissions and general expenses for the year ended December 31, 2010 decreased by $14.9 million, or 7.4%, versus the year ended December 31, 2009. This decrease was attributable to our continuing efforts to reduce general expenses, as well as the restructuring of the Part D call center and other member services which were completed during 2009. The ratio of commissions and general expenses to net premium, excluding risk corridor improved to 8.5% for the year ended December 31, 2010 from 10.1% for the year ended December 31, 2009. This improvement was attributable to continued operating efficiencies and increased scale.
Caremark. Net investment and other income decreased by $17.9 million principally as a result of a decrease in revenue earned by MemberHealth for third party services performed in 2008 that were discontinued in 2009.
Our Traditional Insurance segment consists of three major lines of business. Senior Market includes Medicare supplement, senior dental and hospital indemnity products. Specialty Health includes disability, specified disease, hospital, surgical and long-term care products. Life Insurance and Annuities includes whole life, universal life and annuity products.
Results for our Traditional Insurance segment improved by $21.7 million compared to the year ended December 31, 2009. The improvement primarily results from an overall decrease in the
The net amortization of deferred acquisition costs decreased $2.1 million, or 27.5%. This was primarily caused by the elimination of the deferred acquisition costs and the related amortization on the life insurance and annuity business reinsured to Commonwealth.
Commissions and general expenses, net of allowances, decreased by $16.6 million compared to the year ended December 31, 2009. The lower level of commissions is associated with the continued aging of our in-force renewal premium which pays lower commissions as the duration of the policies increase. Other operating costs decreased $19.8 million for the year ended December 31, 2010, compared to the prior year. This is primarily due to cost reductions implemented to align with the lower levels of business in-force as well as savings associated with the outsourcing of certain administrative services previously provided by our CHCS subsidiary that was sold during the second quarter of 2010. Allowances received from reinsurers decreased $10.7 million for the year ended December 31, 2010 from the same period in the prior year. This is primarily due to the fact that, as of the fourth quarter of 2009, Commonwealth began performing the administration for the majority of the life insurance and annuity business. We therefore no longer receive the related expense allowances from third party reinsurers and allowances paid by Commonwealth to reimburse costs incurred from the effective date of the transaction until the administration of the blocks was transferred to them.
The sale of CHCS during the second quarter of 2010 (for further discussion, see "Sale of CHCS" in Note 24 in the Notes to Consolidated Financial Statements), eliminated substantially all of the business operations of our former Senior Administrative Services segment. As a result, beginning with the June 30, 2010 quarterly report on Form 10-Q, we began to report current and historical results of
The increase in stock-based compensation expense of $0.6 million resulted primarily from new equity awards granted in the last quarter of 2009 and the first three quarters of 2010 to directors, officers and other employees approved by the compensation committee, partially offset by a $2.0 million true up of our forfeiture rate estimate related to options that terminate non-vested that was made during 2010.
Net income-Senior Administrative Services declined by $7.8 million. $5.7 million was the result of the sale of CHCS which was effective April 1, 2010. The remaining $2.1 million variance was due to lower profitability of CHCS prior to its sale, due to anticipated reductions in service fee revenues, along with a corresponding decrease in general expenses.
Other parent company expenses, net of revenues, increased $24.7 million. In 2009, primarily in relation to a management decision to close or restructure under-performing field offices in connection
(2)Trust preferred securities all have scheduled maturities of 30 years from the dates of issue; however they are all callable by us five years from the date of issuance. For the purpose of this schedule, we have assumed that the securities will be redeemed at their scheduled maturities, not the call date. Accordingly, the obligation for repayment of principal relating to these is included in the More than 5 Years column. The trust preferred securities generally have floating rate interest rates. However, the interest rate on $50 million of the trust preferred securities is fixed through its no call period and then converts to a floating rate. We did not project future changes in the base interest rates. For the purpose of this schedule, we applied the base rate in effect at December 31, 2010 to all future periods. Additionally, we assumed that, upon the expiration of the fixed rate, the rate for the respective trust preferred security adjusted to a variable rate using the current base rate.
(5)Our obligations for policy related liabilities represent those payments we expect to make on death, disability and health insurance claims and policy surrenders, net of amounts recovered from reinsurers. These projected values contain assumptions for future policy persistency, mortality and morbidity comparable with our historical experience. The distribution of payments for policy and contract claims reflects assumptions as to the timing of policyholders reporting claims for prior periods and the amounts of those claims. Actual amounts and timing of both future policy benefits and policy and contract claims may differ significantly from the estimates above. We anticipate that our reserves for policy liabilities and policy and contract claims, along with future net premiums, investment income and recoveries from our reinsurers, will be sufficient to fund our policy related obligations. On our consolidated balance sheets in Part II, Item 8 of this annual report on Form 10-K, we report our policy related liabilities gross of amounts recoverable from reinsurers, which are reported as assets. We are obligated to pay claims in the event that a reinsurer fails to meet its obligations under the reinsurance agreements. However, as of December 31, 2010, all of our primary reinsurers were rated "A-" (Excellent) or better by A.M. Best with the exception of one reinsurer. For that reinsurer, which is not rated, a trust containing assets at 106% of policy reserve levels is maintained. We are not aware of any instances where any of our reinsurers have been unable to pay any policy claims on reinsured business. Therefore, we have presented our obligations in the table above net of amounts recoverable from reinsurers. Our obligations for policy related liabilities before amounts recovered from reinsurers amount to $1.8 billion.
Sources and Uses of Liquidity to the Parent Company, Universal American Corp.
We require cash at our parent company to support the growth of our insurance and HMO subsidiaries, meet our obligations under our credit facility, fund potential growth through acquisitions of other companies or blocks of business, and pay the operating expenses necessary to function as a holding company, as applicable insurance department regulations require us to bear our own expenses.
Our insurance subsidiaries are required to maintain minimum amounts of statutory capital and surplus as required by regulatory authorities and each currently exceeds its respective minimum requirement at levels we believe are sufficient to support their current levels of operation. Our HMO subsidiaries are also required by regulatory authorities to maintain minimum amounts of capital and surplus and each currently exceeds this minimum requirement.
At December 31, 2010, we held cash and cash equivalents and fixed maturity securities that could readily be converted to cash totaling $1.4 billion at our insurance companies and HMO subsidiaries. We believe that this level of liquidity is sufficient to meet our policy obligations and pay expenses.
Capital contributions to and dividends from our insurance subsidiaries are made through our holding company, UAC Holding, Inc. ("UACH"). UACH did not make capital contributions to the insurance subsidiaries during 2010. In May 2010, two of our wholly-owned subsidiaries, Pennsylvania Life Insurance Company and American Progressive Life & Health Insurance Company of New York, declared and paid to UACH a dividend of $119 million and $12 million, respectively. We used these dividends and other cash to pay a special cash dividend to our shareholders, and pay down debt in August 2010. (see "Special Dividend" in Note 24-Other Operational Disclosures in the Notes to Consolidated Financial Statements).
In November 2009, we amended the 2007 Credit Facility (the "November 2009 Amendment") which provided us with the ability to make $75 million of restricted payments, in addition to the $125 million provided for in the original agreement for a total of $200 million, in exchange for prepayments of Term Loan principal and increases in borrowing spreads and fees. In July 2010, we further amended the 2007 Credit Facility (the "July 2010 Amendment") which provided us with the ability to make an additional $100 million of restricted payments, for a total of $300 million, in
In 2003 and 2007, we formed statutory business trusts, in order to issue a combined $125.0 million in thirty year trust preferred securities, with $110 million currently outstanding. $60 million of these securities have floating interest rates based on LIBOR and are currently at an average rate of 4.35%. The remaining $50 million is fixed at 7.68% until March 2012. We made interest payments on the trust preferred securities totaling $6.5 million during 2010.
We invest primarily in fixed maturity securities of the U.S. Government and its agencies, mortgage-backed and other high quality asset-backed securities, fixed maturity securities issued by state and local municipalities, and in corporate fixed maturity securities with investment grade ratings of BBB- or higher by S&P or Baa3 or higher by Moody's Investor Service. As of December 31, 2010, approximately 99% of our fixed maturity investments had investment grade ratings from S&P or Moody's.
use in estimating our IBNR is that the completion factor pattern, adjusted for known changes in claim inventory levels and claim payment processes, remains consistent over a specified rolling period. This period, ranging from 3 to 12 months, is dependent on the type of business with respect to which we are estimating reserves or liabilities. Completion factors result from the calculation of the percentage of claims incurred during a given period that have historically been adjudicated as of the reporting period. For the most recent three months, we estimate the incurred claims primarily from a trend analysis based upon per member per month, known as PMPM, claims trends developed from our historical experience in the preceding months, adjusted for known changes in estimates of recent hospital and drug utilization data, provider contracting changes, changes in benefit levels, product mix, and seasonality.
The following table presents the components of the change in our liability for policy and contract claims-health:
The claim reserve balances at December 31, 2009 settled during 2010 for $1.1 million less than originally estimated, representing less than 0.1% of the incurred claims recorded in 2009.
The claim reserve balances at December 31, 2008 settled during 2009 for $3.6 million more than originally estimated, representing less than 0.1% of the incurred claims recorded in 2008.
The following table illustrates the sensitivity of our health IBNR payable at December 31, 2010 to identified reasonably possible changes to the estimated weighted average completion factors and health care cost trend rates. However, it is possible that the actual completion factors and health care cost
We refer to these costs as deferred acquisition costs or DAC. For our net retained traditional life and health products, we amortize DAC in proportion to premium revenue using the same assumptions used in estimating the liabilities for future policy benefits in accordance with ASC 944. Under ASC 944, any unamortized DAC relating to lapsed policies must be amortized as of the date of the lapse.
We test for the recoverability of DAC at least annually. To the extent that we determine that the present value of future policy premiums and investment income or the net present value of expected gross profits would not be adequate to recover the unamortized costs, we would write off the excess deferred policy acquisition costs. Based on our review of DAC recoverability as of October 1, 2010, we determined that DAC was recoverable.
In accordance with ASC 350, Intangibles and Other, we periodically review amortizing intangible assets whenever adverse events or changes in circumstances indicate the carrying value of the asset may not be recoverable. In assessing recoverability, we must make assumptions regarding estimated future cash flows and other factors to determine if an impairment loss may exist, and, if so, estimate fair value. If these estimates or their related assumptions change in the future, we may be required to record impairment losses for these assets. Based on our review of recoverability, we determined there were no impairments of our amortizing intangible assets during 2010, 2009 or 2008.
We operate a diversified set of health care businesses focused on the senior market. Our business model has been designed to address a multitude of market sectors. Our businesses participate in the U.S. health care economy, which comprises a significant portion of the gross domestic product and which has grown consistently for many years. We expect overall spending on health care in the U.S. to continue to rise in the future, due to inflation, medical technology and pharmaceutical advancement, demographic trends in the U.S. population and national interest in health and well-being. The rate of market growth may be affected by a variety of factors, including macro-economic conditions and enacted health care reforms, which could also impact our results of operations.
In the first quarter of 2010, the Health Reform Legislation was signed into law. HHS, the DOL and the Treasury Department have issued regulations (or proposed regulations) on a number of aspects of Health Reform Legislation, but we await final rules and interim guidance on other key aspects of the legislation, all of which have a variety of effective dates. The Health Reform Legislation and the related federal and state regulations establishes minimum medical loss ratios for health plans with fully insured products, mandates consumer discounts on brand name and generic prescription drugs for seniors in the coverage gap, freezes or reduces Medicare payment rates, and establishes an annual
Our revenues are also impacted by U.S. monetary and fiscal policy as it effects interest rates, which impacts the interest income earned on our investments and therefore our operating profitability. In response to current economic conditions, the U.S. Federal Reserve has maintained the target federal funds rate to a range of zero to 25 basis points. If the current economic environment continues for a prolonged period, the funding for various health care government programs in which we participate may be decreased or we may be subject to new or higher taxes or assessments. Government funding pressure, coupled with recessionary economic conditions, will impact the financial positions of hospitals, physicians and other care providers and could therefore increase medical cost trends experienced by our businesses.
It is difficult to predict the outcome of the Health Reform Legislation, pending the final rules and interim guidance on key aspects of the legislation. For additional discussions regarding our risks related to health care reforms, economic conditions and related risk factors, see "Item 1A. Risk Factors" in Part I of this Annual Report on Form 10-K.
ASC 820, Fair Value Measurements and Disclosures, requires companies in the U.S. to classify their assets based on the certainty with which fair values can be calculated into three asset categories: Level 1, Level 2 and Level 3. Level 1 assets are the easiest to value accurately based on standard market-based prices and Level 3 are the most difficult. We have analyzed the third party pricing services valuation methodologies and related inputs, and have also evaluated the various types of securities in our investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Based on the results of this evaluation and investment class analysis, we classified most securities that had prices provided by third party pricing services into Level 2 because the inputs used in pricing the securities are market observable.
The following table presents the fair value of the asset sectors within the ASC 820 Level 3 securities as of December 31, 2010:
The evaluation of impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether we should recognize declines in the fair value of investments in current period earnings. The principal risks and uncertainties are
The following table presents our exposure to subprime residential mortgages by vintage year.
securities with a greater variance between the breakpoint and base case can withstand this further deterioration. Based on the analysis of the remaining subprime holdings at December 31, 2010, we do not believe these holdings are other-than-temporarily impaired.
We analyze the membership for our Medicare HMO, PPO, PFFS and stand-alone Part D Plans in our administrative system and reconcile to the enrollment provided by CMS. There are timing differences between the addition of a member to our administrative system and the approval, or accretion, of the member by CMS. Additionally, the monthly payments from CMS include adjustments to reflect changes in the status of membership as a result of retroactive terminations, additions, whether CMS is secondary to other insurance coverage or other changes. Current period membership, net premium, CMS subsidies and claims expense are adjusted to reflect retroactive changes in membership.
For members of our PFFS Plans with Part D benefits, CMS makes prospective monthly catastrophic reinsurance payments to the Plans based on estimated average reinsurance payments to other Medicare Advantage-Prescription Drug (MA-PD) Plans that provide Part D benefits. Based upon the current guidelines from CMS, PFFS Plans are at risk for the variance between their actual expense and the CMS payments. As a result, we do not follow deposit accounting for these payments.
CMS Risk Corridor Provisions for the Part D benefits of our HMO and PPO Plans -Premiums from CMS for members of our HMO and PPO Plans with Part D benefits, are subject to risk sharing through the risk corridor provisions. The CMS risk corridor calculation compares the target amount of prescription drug costs (limited to costs under the standard coverage as defined by CMS) less rebates in our annual Plan bid (target amount) to actual experience. Variances of more than 5% above the target amount will result in CMS making additional payments to us, and variances of more than 5% below the target amount will require us to refund to CMS a portion of the premiums we received. Risk corridor payments due to or from CMS are estimated throughout the year and are recognized as adjustments to premium revenues and due and unpaid premiums. This estimate requires us to consider factors that may not be certain, including: membership, risk scores, prescription drug events, or PDEs, and rebates. After the close of the annual Plan year, CMS reconciles actual experience to the target amount and any differences are settled between CMS and the Plan.
Revenue Adjustments-The monthly CMS Direct Premium Subsidy is based upon the members' health status, which is determined by CMS, as more fully described above under "Medicare Risk Adjustment Provisions." We do not have access to diagnosis data with respect to our stand-alone PDP members and therefore, we cannot anticipate changes in our members' risk scores. Changes in CMS premiums related to risk-score adjustments for our stand-alone PDP membership are recognized when the amounts become determinable and collectability is reasonably assured, which occurs when we are notified by CMS of such adjustments. Although such adjustments have not been considered to be material in the past, future adjustments could be material.
Member Premium-We receive a monthly premium from members based on the Plan year bid we submitted to CMS. The member premium, which is fixed for the entire Plan year, is recognized over the contract period and reported as premium revenue.
Low-Income Premium Subsidy-For qualifying low-income status, or LIS, members, CMS pays us for some or all of the LIS member's monthly premium. The CMS payment is dependent upon a member's income level which is determined by the Social Security Administration. Low-income premium is recognized over the contract period and reported as premium revenue.
Low-Income Cost Sharing Subsidy-For qualifying LIS members, CMS will reimburse Plans for all or a portion of the LIS member's deductible, coinsurance and co-payment amounts above the out of pocket threshold for low income beneficiaries. Low-income cost sharing subsidies are paid by CMS prospectively as a fixed amount per member per month, and are determined based upon the Plan year bid we submitted to CMS. After the close of the annual Plan year, CMS reconciles actual experience to low-income cost sharing subsidies paid to the Plan and any differences are settled between CMS and the Plan. See "Deposit Accounting" below for a description of the accounting for low-income cost sharing subsidies.
CMS Risk Corridor-Premiums from CMS are subject to risk sharing through the Medicare Part D risk corridor provisions. The CMS risk corridor calculation compares the target amount of prescription drug costs (limited to costs under the standard coverage as defined by CMS) less rebates in our annual Plan bid to actual experience. Variances of more than 5% above the target amount will result in CMS making additional payments to us, and variances of more than 5% below the target amount will require us to refund to CMS a portion of the premiums we received. Risk corridor payments due to or from CMS are estimated throughout the year and are recognized as adjustments to premium revenues and due and unpaid premiums. This estimate requires us to consider factors that may not be certain, including: membership, risk scores, prescription drug events, or PDEs, and rebates. After the close of the annual Plan year, CMS reconciles actual experience to the target amount and any differences are settled between CMS and the Plan.
Income Taxes: We use the liability method of accounting for income taxes. Under this method, we recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted tax rates that we expect to apply to taxable income in the years in which we expect those temporary differences to be recovered or
settled. We recognize the effect on deferred tax assets and liabilities of a change in tax rates in income in the period that includes the enactment date of a change in tax rates.
The Jobs Creation Tax Act of 2004, known as the Jobs Act, contains a provision that placed a two year moratorium on the imposition of tax on distributions from Policyholder Surplus Accounts ("PSAs"), the Phase III tax. Additionally, the ordering rules were changed to allow for the first dollar of any distribution to reduce the PSA. In accordance with the Jobs Act, distributions during 2005 and 2006 from an insurance company that had a PSA was treated as a distribution from its PSA account; however, the distribution was not subject to Federal income tax. We received the approval of the Insurance Departments of the respective companies for the transactions that could trigger the elimination of the potential tax and made such distributions during 2006. During 2010 we released the deferred tax liabilities previously established for the potential Phase III tax on the PSAs and reduced deferred tax expense.
interest and penalties related to unrecognized tax benefits in federal and state tax expense. During the year ended December 31, 2010, we recognized no such interest expense and penalties.
A summary of recent and pending accounting pronouncements is provided in Note 4 of the Consolidated Financial Statements in the Annual Report on Form 10-K under the caption "Recently Issued and Pending Accounting Pronouncements." We do not anticipate any material impact from the future adoption of the pending accounting pronouncements discussed in that note.