Revenues from continuing operations, excluding Medicare Advantage Private-Fee-For-Service (“PFFS”), increased 5.5% from the prior year.
Health Plan Commercial Group Risk membership growth of 223,000 from the prior year-end, an increase of 15.7%.
Debt to capital ratio of 27.6%, a decrease of 8.3% from the prior year.
Income from continuing operations of $438.6 million, an increase of 39.1% from 2009 income from continuing operations.
Diluted EPS from continuing operations of $2.97, an increase of 38.8% from 2009 diluted EPS from continuing operations.
We maintain provider networks that furnish health care services through contractual arrangements with physicians, hospitals and other health care providers. Prescription drug benefits are provided through a formulary comprised of an extensive list of drugs. Drug prices are negotiated at discounted rates through a national network of pharmacies. Drug costs for our risk products are included in medical costs.
We have capitation arrangements for certain ancillary heath care services, such as laboratory services and, in some cases, physician and radiology services. A small percentage of our membership is covered by global capitation arrangements. Under the typical arrangement, the provider receives a fixed percentage of premium to cover costs of all medical care or of the specified ancillary services provided to the capitated members. Under some capitated and professional capitation arrangements, physicians may also receive additional compensation from risk sharing and other incentive arrangements. Capitation arrangements limit our exposure to the risk of increasing medical costs but expose us to risk as to the adequacy of the financial and medical care resources of the provider organization. We are ultimately responsible for the coverage of our members pursuant to the customer agreements. To the extent a provider organization faces financial difficulties or otherwise is unable to perform its obligations under the capitation arrangements, we will be required to perform such obligations. Consequently, we may have to incur costs in excess of the amounts we would otherwise have to pay under the original global or ancillary capitation through our contracted network arrangements. Medical costs associated with capitation arrangements made up approximately 6.4% of our total medical costs for the year ended December 31, 2010.
We have established systems to monitor the availability, appropriateness and effectiveness of the patient care we provide. We collect utilization data in each of our markets that we use to analyze over-utilization or under-utilization of services and assist our health plans in arranging for appropriate care for their members and improving patient outcomes in a cost efficient manner. Medical directors also monitor the utilization of diagnostic services and encourage the use of outpatient surgery and testing where appropriate. Each health plan collects data showing each physician’s utilization profile for diagnostic tests, specialty referrals and hospitalization and presents such data to the health plan’s physicians. The medical directors monitor these results in an effort to ensure the use of medically appropriate, cost-effective services.
We consider the accounting policies described below critical in preparing our consolidated financial statements. Critical accounting policies are ones that require difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. The judgments and uncertainties affecting the application of these policies include significant estimates and assumptions made by us using information available at the time the estimates are made. Actual results could differ materially from those estimates.
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 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 benefits payments. The OIG may seek refunds of costs charged under these contracts or institute other sanctions against 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.
The following table presents the components of the change in medical claims liabilities for the years ended December 31, 2010, 2009 and 2008, respectively (in thousands).
Acquisition Balances represent medical liabilities of the acquired company as of the applicable acquisition date.
The significant favorable factors driving the overall 2010 favorable prior year development for the PFFS product include:
The change in Medicare Part D related subsidy liabilities identified in the table above represents subsidy amounts received from CMS for reinsurance and for cost sharing related to low-income individuals. These subsidies are recorded in medical liabilities and we do not recognize premium revenue or claims expense for these subsidies.
Changes in the completion factors, trend factors and utilization factors can have a significant effect on the claim liability. The following example (in thousands, except percentages) provides the estimated effect to our December 31, 2010 unpaid claims liability assuming hypothetical changes in the completion, trend and inpatient day factors. While we believe the selection of factors and ranges provided are reasonable, certain factors and actual results may differ.
We account for investments in accordance with Accounting Standards Codification (“ASC”) Topic 320 “Investments - Debt and Equity Securities.” We invest primarily in fixed income securities and classify all of our investments as available-for-sale. Investments are evaluated on an individual security basis at least quarterly to determine if declines in value are other-than-temporary. In making that determination, we consider all available evidence relating to the realizable value of a security. This evidence includes, but is not limited to, the following:
We use prices from independent pricing services and, to a lesser extent, 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.
Generally, we do not adjust prices received from pricing services or brokers unless it is evident from our verification procedures the fair value measurement is not consistent with ASC Topic 820. 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 goodwill impairment test compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. For our impairment analysis we relied 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 were reviewed together for consistency and commonality.
In accordance with ASC 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, 2010 analysis.
See Note E, Goodwill and Other Intangible Assets, to the consolidated financial statements for additional disclosure related to our goodwill and other intangible assets which is incorporated herein by reference.
See Note A, Organization and Summary of Significant Accounting Policies, to the consolidated financial statements for information and disclosures related to new accounting standards which is incorporated herein by reference.
The decrease in Medicare Part D of 55,000 members is the result of a reduction in the number of low-income regions in which we have contracts, from 29 in 2009 to 21 in 2010, which was offset by growth in our other Medicare Part D products.
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, 2010 (in thousands, except diluted earnings per share amounts):
Medical costs decreased from the prior year primarily as a result of not renewing our PFFS product. Partially offsetting this decrease was an increase in medical costs as a result of the acquisitions of PHS and MHP in 2010. Total medical costs as a percentage of premium revenue, “medical loss ratio” or “MLR,” decreased 6.0% over the prior year to 79.4% from 85.4% as a result of the change in the mix of business resulting from the exit of the PFFS product, which had a higher MLR of 92.0%. Additionally, we experienced lower than expected medical trend levels in 2010 which resulted in improved MLR percentages in all lines of business.
Depreciation and amortization expense was lower during the current year primarily due to the prior year including a write down in value of certain long-lived assets as well as certain assets becoming fully depreciated.
Interest expense decreased during the current year due to the lower average debt balance outstanding compared to the prior year.
The provision for income taxes increased from the prior year due to the increase in earnings. The effective tax rate on continuing operations decreased to 36.1% as compared to 37.5% for the prior year due primarily to the proportion of our earnings in states with lower tax rates.
Managed care premium revenue increased primarily as a result of higher membership in our Medicare business in Part D, PFFS, and CCP as a result of successful enrollment for 2009. The revenue increases were also a result of increased individual membership. Partially offsetting this increase was lower revenue for our Commercial Risk business due to membership declines.
Medical costs increased primarily as a result of the increase in Medicare membership, as discussed above. MLR increased over the prior year as a result of a change in our mix of business primarily related to Medicare Advantage, Part D, and Commercial Risk.
Cost of sales increased due to the growth of the pharmacy benefit management program revenues in the Workers’ Compensation Division.
Selling, general and administrative expense increased primarily due to the costs associated with the growth in the Medicare business, including higher wage expense, an increase in broker commission costs and other member related costs due to the higher Medicare membership. Additionally there was higher wage expense related to annual incentive compensation accruals in the current year, while such types of incentive payments were not earned and accrued in 2008; new executive hires in the current year; and severance expense related to terminated employees in 2009. Selling, general and administrative expense as a percentage of revenue improved as a result of expenses being controlled at a rate lower than the increase in revenue.
Other income, net increased for the current year due to a charge of $33.5 million for the other-than-temporary impairment of investment securities recorded in 2008. This other-than-temporary impairment loss did not reoccur in 2009. Additionally, other income, net increased due to gains of $8.4 million on the repurchase of outstanding senior notes during 2009. Partially offsetting the increases was a $39 million current year interest income decrease resulting from lower interest rates on the large percentage of the portfolio invested in Treasury instruments and money market funds.
(1) Revenue PMPM excludes the effect of revenue ceded to external parties.
The increase in Medicare Advantage CCP revenue was attributable to the acquisition of MHP as well as the increase in organic membership associated with that product. The Medicare Advantage premium per member per month increased in 2010 as a result of the exit from the PFFS product which had a lower premium rate than the Medicare Advantage CCP product. The PFFS premium yield was lower than the Medicare Advantage CCP premium rate since PFFS typically did not include a pharmacy benefit. The increase in Medicaid revenue was attributable to commencing operations during 2010 in the Nebraska and Pennsylvania markets. The Medicaid premium per member per month decreased in 2010 as a result of program benefit changes in Missouri, our largest Medicaid market. Effective October 1, 2009, the pharmacy benefit was removed from the program and thus was no longer included in the Missouri Medicaid rate payment.
Gross margin increased for the year, primarily due to the improved medical loss ratios for the Health Plan Commercial Risk and Medicare Advantage CCP products. The Commercial Risk MLR decreased from the prior year primarily due to the lower than expected utilization trends and more benign flu season than 2009. The Medicare Advantage CCP MLR decrease resulted from lower than expected utilization trends and demographic changes within the product. Partially offsetting these increases in gross margin was a decrease in gross margin resulting from our exit from the PFFS product.
Revenue in the Workers’ Compensation Division decreased slightly from the prior year period primarily due to a decline in volume in our network and clinical programs, partially offset by the growth of our pharmacy benefit management program.
Health Plan and Medical Services revenue increased over the prior year primarily due to membership growth in the Medicare PFFS products, coupled with an increase in the average realized premium yield PMPM for the product. After deducting revenue ceded to third parties, the Medicare Advantage risk premium yield PMPM for the year increased to $798.16 in 2009 from $742.07 in 2008. The increase is a result of a smaller portion of our Medicare PFFS business in 2009 being ceded to external parties through quota share arrangements. When reviewing the premium yield for Medicare Advantage business, we believe that adjusting for the ceded revenue is useful for comparisons to competitors that may not have similar ceding arrangements. Additionally, the Medicare Advantage risk premium yields have increased as a result of higher risk scores.
Specialized Managed Care Division revenue experienced a significant increase over the prior year due to the large increase in membership for the Medicare Part D product. Medicare Part D premium yields for 2009, excluding the effect of CMS risk sharing premium adjustments and revenue ceded to external parties, decreased compared to 2008, primarily due to the mix of products sold in 2009. The majority of the Medicare Part D growth was in the lower cost, leaner benefit plans, which have a lower premium. Including the effect of the CMS risk sharing premium adjustments as well as the ceded revenue, the premium yields were $80.98 for 2009 compared to $78.84 in 2008. The increase is a result of a smaller portion of our Medicare Part D business in 2009 being ceded to external parties through quota share arrangements.
The gross margin for the Specialized Managed Care Division improved for 2009 primarily as a result of increased Part D membership during the current periods, offset by an increase in the Part D MLR due to higher than anticipated pharmacy costs in one product.
Revenue in the Workers’ Compensation Division increased in 2009 primarily due to the growth of our pharmacy benefit management program. The increase was partially offset by lower revenue in the Division’s other business lines as a result of lower claim volume.
The nature of a majority of our operations is such that cash receipts from premium revenues are typically received up to two months prior to the expected cash payment for related medical costs. Premium revenues are typically received at the beginning of the month in which they are earned, and the corresponding incurred medical expenses are paid in a future time period, typically 15 to 60 days after the date such medical services are rendered. The lag between premium receipts and claims payments creates positive cash flow and overall cash growth. As a result, we typically hold approximately one to two months of “float.” In addition, accumulated earnings provide further positive cash flow.
Our cash and investments, consisting of cash, cash equivalents, short-term investments, and long-term investments, but excluding deposits of $79.9 million restricted under state regulations, increased $195.2 million to $4.0 billion at December 31, 2010 from $3.8 billion at December 31, 2009.
Our net cash from operating activities in 2010 was $609.6 million lower than the 2009 period as the current year period reflects the medical claim payments associated with the PFFS product run out. During 2009, we experienced large positive cash flows from operating activities primarily due to membership growth across the Medicare products.
Net cash from investing activities for the year ended December 31, 2010 was an inflow due to proceeds received from investment maturities and sales during the period, partially offset by investment purchases and the payment for our acquisitions of PHS and MHP, net of cash acquired.
We did not make any debt repayments during 2010. Refer to Note K, Debt, to the consolidated financial statements for more information regarding our debt.
The increase in capital and surplus for our regulated subsidiaries primarily resulted from net earnings and capital contributions made by the parent company and the acquisitions of PHS and MHP, partially offset by dividends paid to the parent company.
The table above does not reflect the timing of cash payments related to income taxes or legal contingencies. Refer to Note I, Income Taxes, and Note L, Commitments and Contingencies, to the consolidated financial statements for additional information related to our income taxes, operating leases and other contingencies.
We have typically paid 90% to 95% of medical claims within six months of the date incurred and approximately 99% of medical claims within nine months of the date incurred. Accordingly, we believe medical claims liabilities are short-term in nature and therefore do not meet the listed criteria for classification as contractual obligations and have been excluded from the table above. As of December 31, 2010, we had $136.3 million of unrecognized tax benefits. The above table excludes these amounts due to uncertainty of timing and amounts regarding future payments.
For our Health Plan based Medicare Advantage CCP product, we are forecasting membership to be flat to slightly down for 2011 as compared to 2010 results. We expect the 2011 Medicare Advantage MLR to be consistent with our Medicare bids in the mid 80%s, an increase from the 2010 MLR of 82.0%.
For our Health Plan based Medicaid business, we are forecasting 2011 membership to grow in the mid single digits as compared to 2010 with a MLR in the high 80%s.
Workers Compensation Division - We believe our Workers Compensation Division will grow slightly compared to 2010 with continued focus on the supporting administrative cost structure.
Regarding our balance sheet and liquidity, we ended the year with approximately $850 million in free cash at the parent level. We have a net balance owing on our revolving line of credit of $380 million. As usual, our first priority with our free cash will be to support the regulatory capital needs of our subsidiaries and to maintain liquidity.
Regarding our effective tax rate, we expect it will range from 36% to 37% for the full year of 2011.
Significant Customers - The Company’s health plan commercial business is diversified across a large customer base and no customer group comprises 10% or more of Coventry’s managed care premiums. The Company received 35.6%, 50.7% and 38.1% of its managed care premiums for the years ended December 31, 2010, 2009 and 2008, respectively, from the federal Medicare program throughout its various health plan markets and from national Medicare Part D and Medicare Advantage Private-Fee-For-Service (“PFFS”) products. The decline in 2010 is primarily a result of the Company’s non-renewal of the Medicare PFFS product effective January 1, 2010. The Company also received 10.9%, 8.4% and 10.3% of its managed care premiums for the years ended December 31, 2010, 2009 and 2008, respectively, from state-sponsored Medicaid programs throughout its various health plan markets. For the years ended December 31, 2010, 2009 and 2008, the State of Missouri accounted for almost half of the Company’s Medicaid premiums. Additionally, the Company received 11.2%, 11.3% and 10.7% of its management services revenue from a single customer, Mail Handlers Benefit Plan (“MHBP”), for the years ended December 31, 2010, 2009 and 2008, respectively.
For debt securities, if the Company intends to either sell or determine that it will more-likely-than-not be required to sell a debt security before recovery of the entire amortized cost basis or maturity of the debt security, the Company recognizes the entire impairment in earnings. If the Company does not intend to sell the debt security and the Company determines that it will not more-likely-than-not be required to sell the debt security but it does not expect to recover the entire amortized cost basis, the impairment is bifurcated into the amount attributed to the credit loss, which is recognized in earnings, and all other cases, which are recognized in other comprehensive income. Realized gains and losses on the sale of investments are determined on a specific identification basis.
Investments with original maturities in excess of three months and less than one year are classified as short-term investments and generally consist of corporate bonds, U.S. Treasury notes and commercial paper. Long-term investments have original maturities in excess of one year and primarily consist of fixed income securities.
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 Corp. (“First Health”) and are related to certain life insurance receivables from a third party insurer for liabilities that have been ceded to that third party insurer.
Other acquired intangible assets are separately recognized upon meeting certain criteria. Such intangible assets include, but are not limited to, trade and service marks, health provider contracts, customer lists and licenses. An intangible asset that is subject to amortization is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The Company amortizes other acquired intangible assets with finite lives using the straight-line method over the estimated economic lives of the assets, ranging from three to 20 years.
Prior year reported medical costs in the current year as a percentage of prior year reported medical costs.
The change in Medicare Part D related subsidy liabilities identified in the table above represent subsidy amounts received from Centers for Medicare & Medicaid Services (“CMS”) for reinsurance and for cost sharing related to low-income individuals. These subsidies are recorded in medical liabilities and the Company does do not recognize premium revenue or claims expense for these subsidies.
The CMS risk sharing receivables are included in other receivables while the CMS risk sharing payables are included in accounts payable and other accrued liabilities. The reinsurance and low-income subsidy receivables are included in other receivables while the reinsurance and low-income subsidy payables are included in medical liabilities.
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 two year run out provision. As a result of the quota share arrangements, for the years ended December 31, 2010, 2009, and 2008, the Company ceded premium revenue of $49.8 million, $416.5 million and $574.1 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.
The Company enters into performance guarantees with employer groups where it pledges to meet certain standards. These standards vary widely and could involve customer service, member satisfaction, claims processing, claims accuracy and telephone response time, among others. The Company also enters into financial guarantees which can take various forms including, among others, achieving an annual aggregate savings threshold, achieving a targeted level of savings per-member per-month, or achieving overall network penetration in defined demographic markets. For each guarantee, the Company estimates and records performance based revenue after considering the relevant contractual terms and the data available for the performance based revenue calculation. Pro-rata performance based revenue is recognized on an interim basis taking into account the ultimate rights and obligations of the parties upon termination of the contracts.
Other Income, net - Other income, net includes interest income, net of fees, gains on the repayment of debt, realized gains and losses on sales of investments and charges on the other-than-temporary impairment of investment securities.
In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements.” ASU 2010-06 requires the disclosure of additional information about transfers in and out of Level 1 and Level 2 of the fair value hierarchy, requires the separate presentation (gross basis) of information about purchases, sales, issuances, and settlements of financial instruments in the roll forward of activity in fair value measurements using significant unobservable inputs (Level 3), and requires expanded disclosures regarding the determination of fair value measurements. The Company adopted the new disclosure provisions during the first quarter of 2010, except for the gross disclosures regarding purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which are required for the Company beginning with its filing on Form 10-Q for the quarter ended March 31, 2011. The adoption of ASU 2010-06 did not affect the Company’s financial position or results of operations.
The Company has the following three reportable segments: Health Plan and Medical Services, Specialized Managed Care and Workers’ Compensation. Each of these reportable 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 Health Plan and Medical Services Division is primarily comprised of the Company’s traditional health plan commercial risk, Medicare Advantage and Medicaid businesses and products. Additionally, through this Division the Company contracts with various federal employee organizations to provide health insurance benefits under the Federal Employees Health Benefits Program (“FEHBP”) and offers managed care and administrative products to businesses that self-insure the health care benefits of their employees. This Division also contains the dental services business. The Company did not renew its Medicare PFFS products effective for the 2010 plan year. Prior to the non-renewal, PFFS was part of this Division.
During the three years ended December 31, 2010, the Company completed four business combinations. These business combinations were accounted for using the acquisition method of accounting and therefore the operating results of each acquisition have been included in the Company’s consolidated financial statements since the date of their acquisition. The purchase price for each business combination was allocated to the assets, including the identifiable intangible assets and liabilities based on estimated fair values. The excess of the purchase price over the net identifiable assets acquired was allocated to goodwill.
On February 1, 2010, the Company completed its acquisition of PHS, a commercial health plan based in Wichita, Kansas serving approximately 100,000 commercial group risk members and 20,000 commercial self-funded members. The acquisition of PHS strengthens Coventry’s presence in the Kansas market. As part of the acquisition, the Company recognized a liability for potential contingent earn-outs that are attributed to certain performance measures by PHS. At December 31, 2010, the liability was not significant.
The PHS and MHP acquisitions are not material to the Company’s consolidated financial statements, individually or in the aggregate. As a result of the PHS and MHP acquisitions the Company recorded $21.9 million of goodwill as of December 31, 2010, none of which is expected to be deductible for tax purposes.
On July 31, 2009, the Company completed the sale of its fee-based Medicaid services subsidiary FHSC for $117.5 million in cash, which included adjustments for changes in working capital. FHSC was a component of the Company’s business operations within its Specialized Managed Care operating segment. In accordance with ASC 205-20 “Discontinued Operations,” FHSC’s operations and disposal costs are presented as (loss) income from discontinued operations, net of tax in the Company’s consolidated statements of operations.
The following table presents select FHSC discontinued operations information (in thousands):
The table below shows the carrying amounts of the major classes of assets and liabilities of FHSC as of December 31, 2008 that were included as part of the disposal group on the July 31, 2009 sale (in thousands):
In 2009, we recorded a $5.5 million impairment charge to our customer list balances primarily as a result of lower than expected customer retention levels. The impairment charges, which are included in the line item depreciation and amortization in the Company’s consolidated statements of operations, related to components of its Health Plan and Medical Services operating segment and its Specialized Managed Care operating segment, respectively. The fair values were based on present value calculations which are Level 3 in the fair value hierarchy.
Depreciation expense for the years ended December 31, 2010, 2009 and 2008 was $76.6 million, $80.8 million and $84.6 million, respectively. Included in the depreciation expense for the years ended December 31, 2010, 2009 and 2008 was $25.2 million, $25.4 million and $29.9 million, respectively, of amortization expense for developed software.
Includes investments in entities accounted for under the equity method of accounting and therefore are presented at their carrying value.
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 on January 28, 2005. The total investment as of December 31, 2010 was $27.0 million and is accounted for using the equity method. The Company’s proportionate share of the partnership’s income is included in other income in the Company’s statements of operations. The Company has between a 20% and 25% interest in the limited partners’ share of each individual tranche of the partnership (approximately 10% of the total partnership). The Company determined that events and changes in circumstances have occurred indicating that the carrying value might not be fully recoverable. Accordingly, the investment was evaluated to determine fair value. As a result of this evaluation, the Company recorded an impairment charge of $5.0 million and $2.5 million for the year ended December 31, 2010 and 2009, respectively.
The Company’s Level 3 securities primarily consist of corporate financial holdings and mortgage-backed and asset-backed securities that were thinly traded due to market volatility and lack of liquidity. The Company determines the estimated fair value for its Level 3 securities using unobservable inputs that cannot be corroborated by observable market data including, but not limited to, broker quotes, default rates, benchmark yields, credit spreads and prepayment speeds.
During the year ended December 31, 2010, there were no transfers between Level 1 and Level 2. The following table provides a summary of changes in the fair value of the Company’s Level 3 financial assets for the years ended December 31, 2010 and 2009 (in thousands):
(1) During 2010, one investment previously classified as Level 3 was reclassified to Level 2 because observable market data became available to price this security.
The Company has one stock incentive plan, the Amended and Restated 2004 Stock Incentive Plan (the “Stock 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. Shares available for issuance under the Stock Incentive Plan were 5.7 million as of December 31, 2010.
The Company continues to use the Black-Scholes-Merton option pricing model and amortizes compensation expense over the requisite service period of the grant. The methodology used in 2010 to derive the assumptions used in the valuation model is consistent with that used in prior years. The following average values and weighted-average assumptions were used for option grants.
The Company recorded compensation expense related to stock options of approximately $21.0 million, $30.6 million and $35.3 million, for the years ended December 31, 2010, 2009 and 2008, respectively. Cash received from stock option exercises was $15.5 million, $1.2 million and $7.2 million, for the years ended December 31, 2010, 2009 and 2008, respectively.
The following table summarizes stock option activity for the year ended December 31, 2010:
Under the Stock Incentive Plan, restricted stock awards generally vest in 25% increments per year. The fair value of restricted stock awards is based on the market price of our common stock on the date of grant and is amortized over various vesting periods through 2014. Restricted stock awards may also include a performance measure that must be met for the restricted stock award to vest.
A reconciliation of the total amounts of unrecognized tax benefits for the years ended December 31, 2010, 2009 and 2008 is as follows (in thousands):
The total amount of unrecognized tax benefits, as of December 31, 2010 and 2009 that, if recognized, would affect the effective tax rate was $43.3 million and $40.4 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.
For the years ended December 31, 2010, 2009 and 2008, the total amount of income tax-related accrued interest and penalties, net of related tax benefit, recognized in the statement of operations was $4.0 million, $2.8 million and $2.4 million, respectively.
During the year ended December 31, 2010, 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. During the year ended December 31, 2009, the Internal Revenue Service (“IRS”) completed its examination of the income tax returns for the Company for the years ended December 31, 2005 and 2006. Tax assessed as a result of this examination was not material. First Health Group Corporation (“FHGC”) is also subject to ongoing examinations by certain state tax authorities for pre-acquisition years. The Company believes that adequate accruals have been provided for all FHGC open tax years.
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 2010, 2009 and 2008 was approximately $27.4 million, $30.3 million and $31.5 million, respectively.
During 2009, the Company repaid a total of $68.9 million principal of outstanding senior notes for payments of $59.9 million, resulting in a gain of $8.4 million. These gains were net of the write off of deferred financing costs. The funds for the repayments were provided by cash from operations.
Loans under the credit facilities bear interest at a margin or spread in excess of either (1) the one-, two-, three-, six-, nine-, or twelve- month rate for Eurodollar deposits (the “Eurodollar Rate”) or (2) the greater of the federal funds rate plus 0.5% or the base rate of the Administrative Agent (“Base Rate”), as selected by the Company. The margin or spread depends on the Company’s non-credit-enhanced long-term senior unsecured debt ratings and varies from 0.350% to 1.000% for Eurodollar Rate advances and from 0.000% to 0.500% for Base Rate advances.
As of December 31, 2010, the aggregate maturities of debt based on their contractual terms, gross of unamortized discount, are as follows (in thousands):
As of December 31, 2010, the Company is contractually obligated to make the following minimum lease payments, including arrangements that may be noncancelable and may include escalation clauses, within the next five years and thereafter (in thousands):
In the normal course of business, the Company has been named as a defendant in various legal actions such as actions seeking payments for claims denied by the Company, medical malpractice actions, employment related claims and other various claims seeking monetary damages. The claims are in various stages of proceedings and some may ultimately be brought to trial. Incidents occurring through December 31, 2010 may result in the assertion of additional claims. The Company maintains general liability, professional liability and employment practices liability insurances in amounts that it believes are appropriate, with varying deductibles for which it maintains reserves. The professional errors and omissions liability and employment practices liability insurances are carried through its captive subsidiary. Although the results of pending litigation are always uncertain, the Company does not believe the results of such actions currently threatened or pending, including those described below, will individually or in the aggregate, have a material adverse effect on its consolidated financial position or results of operations.
Four providers who have contracts with FHGC filed a state court class action lawsuit against FHGC and certain payors alleging that FHGC violated Louisiana’s Any Willing Provider Act (the “Act”), which requires a payor accessing a preferred provider network contract to give a one time notice 30 days before that payor uses the discounted rate in the preferred provider network contract to pay the provider for services rendered to a member insured under that payor’s health benefit plan. These provider plaintiffs allege that the Act applies to medical bills for treatment rendered to injured workers and that the Act requires point of service written notice in the form of a benefit identification card. If a payor is found to have violated the Act’s notice provision, the court may assess up to $2,000 in damages for each instance when the provider was not given proper notice that a discounted rate would be used to pay for the services rendered. In response to the state court class action, FHGC and certain payors filed a suit in federal court against the same four provider plaintiffs in the state court class action seeking a declaratory judgment that FHGC’s contracts are valid and enforceable, that its contracts are not subject to the Act since that Act does not apply to medical services rendered to injured workers and that FHGC is exempt from the notice requirements of the Act because it has contracted directly with each provider in its network. The federal district court ruled in favor of FHGC and declared that its contracts are not subject to the Act, that FHGC was exempt from the Act’s notice provision because it contracted directly with the providers, and that FHGC’s contracts were valid and enforceable, i.e., the four provider plaintiffs were required to accept the discounted rate in accordance with the terms of their written contracts with FHGC.
Despite the federal court’s decision, the provider plaintiffs continued to pursue their state court class action against FHGC and filed a motion for partial summary judgment seeking damages of $2,000 for each provider visit where the provider was not given a benefit identification card at the time the service was performed. In response to the motion for partial summary judgment filed in the state court action, FHGC obtained an order from the federal court which enjoined, barred and prevented any of the four provider plaintiffs or their counsel from pursuing any claim against FHGC before any court or tribunal arising under the Act. Despite the issuance of this federal court injunction, the provider plaintiffs and their counsel pursued their motion for partial summary judgment in the state court action. Before the state court held a hearing on the motion for partial summary judgment, FHGC moved to decertify the class on the basis that the four named provider plaintiffs had been enjoined by the federal court from pursuing their claims against FHGC. The state court denied the motion to decertify the class but did enter an order permitting FHGC to file an immediate appeal of the state court’s denial of the motion. Even though FHGC had filed its appeal and there were no class representatives since all four named plaintiffs had been enjoined from pursuing their claims against FHGC, the state court held a hearing and granted the plaintiffs’ motion for partial summary judgment. The amount of the partial summary judgment was $262 million. FHGC appealed both the partial summary judgment order and the denial of class decertification order to the state’s intermediate appellate court. Both appeals were denied by the intermediate appellate court. FHGC has filed an application for a writ of appeal with the Louisiana Supreme Court with respect to the class decertification order and the partial summary judgment order. The decision to grant or deny the application for a writ of appeal is at the discretion of the Louisiana Supreme Court. The Louisiana Supreme Court has not yet issued a decision on either of these applications. FHGC also filed a motion with the federal court to enforce the federal court’s prior judgments and for sanctions against the provider plaintiffs for violating those judgments which barred and enjoined them from pursuing their claims against FHGC in the state courts. That motion also sought to enjoin the state courts from proceeding in order to protect and effectuate the federal court’s judgments. FHGC’s motion was denied by the federal court.
In exchange for the settlement payment by FHGC, class members will release FHGC and all of its affiliates and clients for any claims relating in any way to re-pricing, payment for, or reimbursement of a workers’ compensation bill, including but not limited to claims under the Act. Plaintiffs have also agreed to a notice procedure that FHGC may follow in the future to comply with the Act. As noted, the Memorandum of Understanding is contingent upon the execution of a definitive settlement agreement acceptable to FHGC. Under Louisiana law, once the parties have executed such a settlement agreement, they must apply to the court for approval of the settlement following a court-supervised process of notice to the class and an opportunity for the class to be heard about the fairness of the settlement or exclude themselves from the settlement.
On October 13, 2009, two former employees and participants in the Coventry Health Care Retirement Savings Plan filed a putative ERISA class action lawsuit against the Company and several of its current and former officers, directors and employees in the U.S. District Court for the District of Maryland. Plaintiffs allege that defendants breached their fiduciary duties under ERISA by offering and maintaining Company stock in the Plan after it allegedly became imprudent to do so and by allegedly failing to provide complete and accurate information about the Company’s financial condition to plan participants in SEC filings and public statements. Three similar actions by different plaintiffs were later filed in the same court and were consolidated on December 9, 2009. A consolidated complaint has not yet been filed. The Company intends to vigorously defend against the allegations in the consolidated lawsuit and has filed a motion to dismiss the complaint which is pending before the court. Although it cannot predict the outcome, the Company believes this lawsuit will not have a material adverse effect on its financial position or results of operations.
There were several lawsuits filed against our Florida health plan by non-participating providers seeking to be paid their full billed charges for services rendered to Florida members. The Florida health plan reimburses non-participating providers at rates which are usual and customary for similar services in the same geographical area. The Company has settled these lawsuits for amounts that did not have a material adverse effect on its financial position or results of operations.
As of December 31, 2010, the Company has an outstanding premium receivable balance from the State of Illinois of approximately $50.1 million which represents four months of health insurance premiums. As the receivable is from a governmental entity which has been making payments, including accrued interest on late payments, we believe that the full receivable balance will ultimately be realized and therefore we have 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.
Concentration of credit risk with respect to receivables is limited due to the large number of customers comprising the Company’s customer base and their breakdown among geographical locations. The Company believes the allowance for doubtful accounts adequately provides for estimated losses as of December 31, 2010. The Company has a risk of incurring losses if such allowances are not adequate.
The Company contracts with a pharmacy benefit management (“PBM”) vendor to manage our pharmacy benefits for our members and to provide rebate administration services on behalf of the Company. As of December 31, 2010, the Company had pharmacy rebate receivables of $310.7 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 majority of states in which the Company operates health plans have adopted a RBC policy that recommends the health plans maintain statutory reserves at or above the “Company Action Level,” which is currently equal to 200% of their RBC. Some states in which the Company’s regulated subsidiaries operate require deposits to be maintained with the respective states’ departments of insurance. The table below summarizes the Company’s statutory reserve information as of December 31, 2010 and 2009 (in millions, except percentage data).
Other income, net for the years ended December 31, 2010, 2009 and 2008 includes interest income, net of fees, of approximately $70.8 million, $65.5 million and $104.6 million, respectively. Other income, net includes gains of $8.4 million and $4.6 million on the repayment of outstanding debt for the years ended December 31, 2009 and 2008, respectively. Other income, net included a gain on disposal of investments of $11.0 million and $11.6 million for the years ended December 31, 2010 and 2009, respectively. For the year ended December 31, 2008, other income, net included a charge of $33.5 million for the other-than-temporary impairment of investment securities. As discussed in Note G, Investments and Fair Value Measurements, to the consolidated financial statements, the Company recorded an impairment charge, related to the Company’s equity method investments, of $5.0 million and $2.5 million for the years ended December 31, 2010 and 2009, respectively.
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. As a part of this program, the Company made no purchases of common stock during 2010. The Company purchased 1.5 million shares of its common stock during 2009 at an aggregate cost of $30.0 million and 7.3 million shares of its common stock during 2008 at an aggregate cost of $318.0 million. As of December 31, 2010, the total remaining common shares the Company is authorized to repurchase under this program is 5.2 million. Excluded from these amounts are shares purchased in exchange for employee payroll taxes on vesting of restricted stock awards as these purchases are not part of the program.
The following is a summary of unaudited quarterly results of operations (in thousands, except per share data) for the years ended December 31, 2010 and 2009. Due to rounding of quarterly results, total amounts for each year may differ immaterially from the annual results.
As a result of the Louisiana appellate court’s decision on July 1, 2010 to affirm the state trial court’s summary judgment order, the company recorded a $278 million pre-tax charge to earnings and a corresponding accrued liability during the quarter ended June 30, 2010. See Note L, Commitments and Contingencies, to the consolidated financial statements for additional information.
Allen F. Wise, Chief Executive Officer and Director of the Company, owns a majority interest in Health Risk Partners (“HRP”), an organization that has entered into a written contract with the Company to provide various services relating to the Company’s Medicare line of business. The contract was negotiated and entered into on an arms-length basis. Two other Directors of the Company own minority interests in HRP. Specifically, HRP provides operational consulting, data processing, data reporting, and chart review/coding services, premium reconciliation, and hierarchical condition categories (“HCC”) revenue compliance related to the Company’s Medicare business. For the years ended December 31, 2010, 2009 and 2008, the Company incurred expenses of approximately $15.4 million, $12.2 million and $1.1 million, respectively, to HRP for services rendered under the contract. At December 31, 2010 and 2009, the Company had accrued amounts to HRP of approximately $1.8 million and $4.6 million. These amounts are recognized within accounts payable and other accrued liabilities in the Company’s consolidated balance sheets.