The following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected Financial Data” beginning on Page 47 and our combined and consolidated financial statements and related notes appearing elsewhere in this 2009 Form 10-K. The following discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause our actual results to differ materially from management’s expectations. Factors that could cause such differences include those set forth under “Risk Factors,” “Forward-Looking Statements,” “Business” and elsewhere in this 2009 Form 10-K.
As discussed above, we have resolved our previously disclosed matters under investigation by the USAO and the State of Florida but remain in resolution discussions as to matters under review with the Civil Division and the OIG. Any resolution of the ongoing investigations being conducted by these agencies could have a material adverse effect on our business, financial condition, results of operations, and cash flows. As previously disclosed, we have paid the USAO a total of $80.0 million pursuant to the terms of the DPA. Pursuant to the Consent and Final Judgment, we agreed to pay a penalty of $10.0 million to the SEC, of which $2.5 million remains to be paid during the first quarter of 2010. Based on the current status of matters and all information known to us to date, management estimates that we have a liability of approximately $60.0 million plus interest associated with the matters remaining under investigation. We anticipate these amounts will be payable in installments over a period of four to five years. In accordance with fair value accounting guidance, we discounted the liability and recorded it at its current fair value of approximately $55.9 million. This amount remains accrued in our Consolidated Balance Sheet as of December 31, 2009 within the short and long term portions of Amounts accrued related to investigation resolution line items. The final timing, terms and conditions of a resolution of these matters may differ from those currently anticipated, which may result in an adjustment to our recorded amounts. These adjustments may be material. We cannot provide an estimable range of additional amounts, if any, nor can we provide assurances regarding the timing, terms and conditions of any potential negotiated resolution of pending investigations by the Civil Division or the OIG.
In addition, increasing market volatility and the tightening of the credit markets have significantly limited our ability to access external capital, which may have an adverse effect on our ability to execute our business strategy. However, we continue to pursue financing alternatives to raise additional unregulated cash, including seeking dividends from certain of our regulated subsidiaries and accessing the public and private equity and debt markets.
Government funding continues to be a significant challenge to our business, particularly in light of the current economic conditions. Because the health care services we offer are through government-sponsored programs, our profitability is largely dependent on continued funding for government health care programs at or above current levels. Future Medicaid premium rate levels may be affected by continued government efforts to contain medical costs or state and federal budgetary constraints. Health care spending increases appear to be more limited than in the past as states continue to look at Medicaid programs as opportunities for budget savings, and some states may find it difficult to continue paying current rates to Medicaid health plans.
In particular, we are experiencing pressure on rates in Florida and Georgia, two states from which we derive a substantial portion of our revenue. In 2009, Florida implemented Medicaid rates that made it economically unfeasible for us to continue to provide services in certain counties and programs. As a result, we withdrew from the Medicaid reform programs effective July 1, 2009, which resulted in a loss of approximately 80,000 members. New or proposed legislation in Georgia related to payment of claims, program design, eligibility determination and provider contracting may negatively impact revenues and administrative expenses for the plan in 2010 and beyond. Further, continued economic slowdowns in Florida and Georgia, as well as other states, could result in additional state actions that could adversely affect our revenues.
We currently do not foresee large, one-time opportunities to expand our business, such as prior efforts like the launch of PDPs in 2006 and the privatization of Georgia Medicaid in 2006. We continue to focus our resources on strengthening compliance and operating capabilities. These factors, when combined with the rationalization of our operations and the operational challenges we face, will cause us to be unable to sustain the rapid growth we have achieved in the recent past.
We provide managed care services targeted exclusively to government-sponsored health care programs, focused on Medicaid and Medicare, including prescription drug plans and health plans for families, children, and the aged, blind and disabled. As of December 31, 2009, we served approximately 2,321,000 members. Most of our revenues are generated by premiums consisting of fixed monthly payments per member.
We did not renew our contracts to participate in the MA PFFS program in 2010 or beyond. Our MA PFFS business represents approximately 31.4% of our Medicare segment revenue and 16.5% of our total premium revenue for the year ended December 31, 2009; accordingly our exit of this line of business will cause our Medicare revenue and consolidated net income to decline in 2010. We anticipate that the withdrawal from the MA PFFS business may provide approximately $40.0 million to $60.0 million of excess capital in the insurance companies that underwrite this line of business, which we may be able to dividend to our unregulated subsidiaries. However, we currently believe we will not have the benefit of these dividends prior to 2011, if at all. Any dividend of surplus capital of our applicable insurance subsidiaries, including the timing and amount of any dividend, would be subject to a variety of factors, which could materially change the aforementioned timing and amount. Those factors include the ultimate financial performance of the MA PFFS business as well as the financial performance of other lines of business that operate in those insurance subsidiaries, approval from regulatory agencies and potential changes in regulatory capital requirements. For example, our current estimate of $40.0 million to $60.0 million has declined from previous estimates of $80.0 million to $100.0 million, because the financial performance of these insurance subsidiaries worsened during 2009.
The consolidated balance sheets, statements of operations, changes in stockholders’ equity and comprehensive income and cash flows include accounts of ours and all of our wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated.
We receive premiums from state and federal agencies for the members that are assigned to, or have selected, us to provide health care services under Medicaid and Medicare. The premiums we receive for each member varies according to the specific government program and may vary according to many other factors, including the member’s geographic location, age, gender, medical history or condition, or the services rendered to the member. The premiums we receive under each of our government benefit plans are generally determined at the beginning of the contract period. These premiums are subject to adjustment throughout the term of the contract, although such adjustments are typically made at the commencement of each new contract period. The premium payments we receive are based upon eligibility lists produced by the government. From time to time, our regulators require us to reimburse them for premiums we received based on an eligibility list that the regulator later discovers contains individuals who were not eligible for any government-sponsored program or are eligible for a different premium category or a different program. CMS employs a risk-adjustment model that apportions premiums paid to all Medicare plans according to the health status of each beneficiary enrolled. The CMS risk-adjustment model pays more for Medicare members with predictably higher costs. We collect claim and encounter data from providers, who we rely on to properly code and document this data, and submit the necessary diagnosis data and coding to CMS within the prescribed deadlines and CMS determines the final risk score based on its interpretation and acceptance of the data we provided. The claims and encounter data provided to determine the risk score are subject to subsequent audit by CMS. These audits may result in the refund of premiums to CMS that were previously received by us. While our experience to date has not resulted in a material refund, this refund could be significant in the future, which would reduce our premium revenue in the year that CMS requires repayment from us. See "Risk Factors - CMS’s risk adjustment payment system makes our revenue and results of operations difficult to predict and could result in material retroactive adjustments that have a material adverse effect on our results of operations” for additional risks associated with a current CMS audit of one of our plans. These periodic premium rate adjustments, risk-adjusted premiums and member eligibility determinations, adversely impact our ability to predict what our future revenues will be under each of our government contracts even when we believe membership will remain constant.
In general, members are required to use our network, except in cases of emergencies, transition of care or when network providers are unavailable to meet a member’s medical needs, and generally must receive a referral from their PCP in order to receive health care from a specialist, such as an orthopedic surgeon or neurologist. Members do not pay any premiums, deductibles or co-payments for most of our Medicaid plans.
Through our Medicare Advantage plans, we also cover a wide spectrum of medical services. We provide additional benefits not covered by Original Medicare, such as vision, dental and hearing services. Through these enhanced benefits, the out-of-pocket expenses incurred by our members are reduced, which allows our members to better manage their health care costs.
Depending on medical coverage type, a beneficiary has various options for accessing drug coverage. Beneficiaries enrolled in Original Medicare can either join a stand-alone PDP or forego Part D drug coverage. MA PFFS beneficiaries can join a MA PFFS plan that has Part D drug coverage or join a plan without such coverage and choose either to obtain a drug benefit from a stand-alone PDP or forego Part D drug coverage. Beneficiaries enrolled in MA CCPs can join a plan with Part D coverage or forego Part D coverage.
Our largest expense is the cost of medical benefits that we provide, which is based primarily on our arrangements with health care providers and utilization of health care services by our members. Our profitability depends on our ability to predict and effectively manage medical benefits expense relative to the primarily fixed premiums we receive. Our arrangements with providers primarily fall into two broad categories: capitation arrangements, pursuant to which we pay the capitated providers a fixed fee per member and fee-for-service as well as risk-sharing arrangements, pursuant to which the provider assumes a portion of the risk of the cost of the health care provided. Capitation payments represented 11.0%, 12.0% and 11.0% of our total medical benefits expense for the years ended December 31, 2009, 2008 and 2007, respectively. Other components of medical benefits expense are variable and require estimation and ongoing cost management.
One of our primary tools for measuring profitability is our MBR, the ratio of our medical benefits expense to the premiums we receive. Changes in the MBR from period to period result from, among other things, changes in Medicaid and Medicare funding, changes in the mix of Medicaid and Medicare membership, our ability to manage medical costs and changes in accounting estimates related to incurred but not reported claims (“IBNR”). Estimation of medical benefits expense and medical benefits payable is our most significant critical accounting estimate. See “Critical Accounting Policies” below. We use MBRs both to monitor our management of medical benefits expense and to make various business decisions, including what health care plans to offer, what geographic areas to enter or exit and the selection of health care providers. Although MBRs play an important role in our business strategy, we may, for example, be willing to enter into new geographical markets and/or enter into provider arrangements that might produce a less favorable MBR if those arrangements, such as capitation or risk-sharing, would likely lower our exposure to variability in medical costs and for other reasons.
Revenue recognition. Our Medicaid contracts with state governments are generally multi-year contracts subject to annual renewal provisions. Our Medicare Advantage and PDP contracts with CMS generally have terms of one year. We recognize premium revenues in the period in which we are obligated to provide services to our members. We estimate, on an ongoing basis, the amount of member billings that may not be fully collectible or that will be returned based on historical trends, anticipated or actual MBRs, and other factors. An allowance is established for the estimated amount that may not be collectible and a liability is established for premium expected to be returned. Historically, the allowance has not been significant relative to premium revenue. The payment we receive monthly from CMS for our PDP program generally represents our bid amount for providing prescription drug insurance coverage. We recognize premium revenue for providing this insurance coverage ratably over the term of our annual contract. Premiums collected in advance are deferred and reported as unearned premiums in the accompanying consolidated balance sheets and amounts that have not been received by the end of the period remain on the balance sheet classified as premium receivables.
Premium payments that we receive are based upon eligibility lists produced by our customers. From time to time, the states or CMS require us to reimburse them for premiums that we received based on an eligibility list that a state or CMS later discovers contains individuals who were not eligible for any government-sponsored program or are eligible for a different premium category, different program, or belong to a different plan other than ours. We record adjustments to revenues based on member retroactivity, if deemed material. These adjustments reflect changes in the number of and eligibility status of enrollees subsequent to when revenue was billed. We estimate the amount of outstanding retroactivity adjustments each period and adjust premium revenue accordingly; if appropriate, the estimates of retroactivity adjustments are based on historical trends, premiums billed, the volume of member and contract renewal activity and other information. Changes to member retroactivity adjustment estimates had a minimal impact on adjustments recorded during the periods presented. Our government contracts establish monthly rates per member, but may have additional amounts due to us based on items such as age, working status or medical history.
The CMS risk adjustment model pays more for Medicare members with predictably higher costs. Diagnosis data from inpatient and ambulatory treatment settings are used to calculate the risk adjusted premium payment to us. We collect claims and encounter data and submit the necessary diagnosis data to CMS within prescribed deadlines. We estimate risk adjustments to revenues based upon the diagnosis data submitted to CMS and ultimately accepted by CMS, and record such adjustments in our results of operations. However, due to the variability of the assumptions that we use in our estimates, the actual results may differ from the amounts that management estimated. If our estimates are materially incorrect, it may have an adverse effect on our results of operations in future periods. Historically, we have not experienced significant differences between the amounts that we have recorded and the revenues that we actually received. The claims and encounter data submitted to CMS to determine our risk-adjusted premium are subject to audit by CMS subsequent to the annual settlement.
In developing our estimates, we apply different estimation methods depending on the month for which incurred claims are being estimated. For the more recent months, which constitute the majority of the amount of the medical benefits payable, we estimate claims incurred by applying observed trend factors to the PMPM costs for prior months, which costs have been estimated using completion factors, in order to estimate the PMPM costs for the most recent months. We validate our estimates of the most recent PMPM costs by comparing the most recent months’ utilization levels to the utilization levels in prior months and actuarial techniques that incorporate a historical analysis of claim payments, including trends in cost of care provided and timeliness of submission and processing of claims.
The following table provides a reconciliation of the total medical benefits payable balances as of December 31, 2009, 2008 and 2007:
Changes in medical benefits payable estimates are primarily the result of obtaining more complete claims information and medical expense trend data over time. Differences in our financial statements between actual experience and estimates used to establish the liability, which we refer to as prior period developments, are recorded in the period when such differences become known, and have the effect of increasing or decreasing the reported medical benefits expense and resulting MBR in such periods.
Medical benefits payable recorded at December 31, 2008, 2007 and 2006 developed favorably by approximately $121.1 million, $8.0 million and $100.2 million in 2009, 2008 and 2007, respectively. These prior period developments were primarily attributable to the release of the provision for moderately adverse conditions, which is included as part of the assumptions, and favorable variances between actual experience and key assumptions relating to trend factors and completion factors for claims incurred in prior years. The release of the provision for moderately adverse conditions was substantially offset by the provision for moderately adverse conditions established for claims incurred in the current year. Accordingly, the change in the amount of the incurred claims related to prior years in the Medical benefits payable does not directly correspond to an increase in net income recognized during the period.
Medicare. For the year ended December 31, 2009, Medicare segment premium revenue increased $118.5 million, or 3.4%, to $3,610.5 million from $3,492.0 million for the same period in the prior year. The increase in Medicare segment revenue is primarily due to a change in the demographic mix of our members, partially offset by a loss in PDP membership of approximately 239,000 members. Aggregate membership within the Medicare segment declined by 260,000 members, or 21.1%, from 1,232,000 members at December 31, 2008 to 972,000 members at December 31, 2009.
Medical benefits expense. For the year ended December 31, 2009, total medical benefits expense increased $332.3 million, or 6.0%, to $5,862.5 million from $5,530.2 million for the same period in the prior year due to membership increases, primarily in our Medicaid segment, partially offset by our loss in PDP membership. The change in the demographic mix of our members and overall increased utilization patterns and costs of our members accounted for the majority of the remaining change. Our MBR was 85.4% for the year ended December 31, 2009 compared to 85.3% for the same period in the prior year.
Medical Benefits Expense as adjusted for the year ended December 31, 2008 is a non-GAAP financial measure because it reflects the favorable development that otherwise would have been recognized in the year ended December 31, 2008 if we had timely filed our 2007 Form 10-K. Due to the delay in filing our 2007 Form 10-K, we were able to review substantially complete claims information that had become available due to the substantial lapse in time between December 31, 2007 and the date we filed our 2007 Form 10-K; therefore, the favorable development was reported in 2007 instead of 2008 as it otherwise would have been. The most directly comparable GAAP measure is Medical Benefits Expense, which has been determined based on the actuarially determined methods. Thus, our recorded amounts for Medical Benefits Expense and MBR for the year ended December 31, 2008 is approximately $92.9 million higher than it otherwise would have been if we had filed our 2007 Form 10-K on time, which resulted in an unfavorable impact on MBR. Consequently, we believe that Medical Benefits Expense as adjusted for the year ended December 31, 2008 will better facilitate a year over year comparison of our Medical Benefits Expense.
Medicaid. For the year ended December 31, 2009, Medicaid medical benefits expense increased $273.2 million, or 10.8%, to $2,810.6 million from $2,537.4 million for the same period in the prior year. Our Medicaid MBR was 86.3% for the year ended December 31, 2009 compared to 84.8% for the same period in the prior year. The Medicaid segment medical benefits expense for the year ended December 31, 2009, increased $312.7 million, or 12.5%, to approximately $2,810.6 million from approximately $2,497.9 million, as adjusted, for the same period in the prior year. This increase was due to the growth in membership primarily in the Hawaii ABD program. The changes in the utilization patterns of our members in our other markets accounted for the remaining change. The Medicaid MBR for the twelve months ended December 31, 2009, was 86.3% compared to 83.5% as adjusted for the same period in the prior year. The increase in MBR is primarily the result of higher costs associated with the Hawaii business as well as premium rate increases during the past year that were below our medical cost trend, or in some cases, rate decreases.
Medicaid Medical Benefits Expense as adjusted for the year ended December 31, 2008 is a non-GAAP financial measure because it reflects the favorable development that otherwise would have been recognized in year ended December 31, 2008 if we had timely filed our 2007 Form 10-K. Due to the delay in filing our 2007 Form 10-K, we were able to review substantially complete claims information that had become available due to the substantial lapse in time between December 31, 2007 and the date we filed our 2007 Form 10-K; therefore, the favorable development was reported in 2007 instead of 2008 as it otherwise would have been. The most directly comparable GAAP measure is Medicaid Medical Benefits Expense, which has been determined based on the actuarially determined methods. Thus, our recorded amounts for Medicaid Medical Benefits Expense and MBR for the year ended December 31, 2008 is approximately $39.5 million higher than it otherwise would have been if we had filed our 2007 Form 10-K on time, which resulted in an unfavorable impact on MBR. Consequently, we believe that Medicaid Medical Benefits Expense as adjusted for the year ended December 31, 2008 will better facilitate a year over year comparison of our Medical Benefits Expense.
Selling, general and administrative expense. For the year ended December 31, 2009, selling, general and administrative (“SG&A”) expenses decreased approximately $40.5 million, or 4.3%, to $892.9 million from $933.4 million for the same period in the prior year. The reduction in SG&A expense was primarily driven by decreased legal, professional and retention expenses consequential to the governmental and Company investigations of $61.7 million for the twelve months ended December 31, 2009, as well as lower sales and marketing costs
Medicaid. For the year ended December 31, 2008, Medicaid segment premium revenue increased $299.3 million, or 11.1%, to $2,991.1 million from $2,691.8 million for the same period in the prior year. The increase in Medicaid segment revenue was primarily due to increases in membership, as well as premium rate increases in certain of our markets. Medicaid membership grew from 1,232,000 members at December 31, 2007 to 1,300,000 at December 31, 2008.
the amounts we recorded in accordance with GAAP for medical benefits expense for year ended December 31, 2007 were based on actual claims paid. The difference between Medical Benefits Expense and Medical Benefits Expense as adjusted is approximately $92.9 million. Thus, our recorded amounts for Medical Benefits Expense and MBR for the year ended December 31, 2007 both include the effect of using actual claims paid. Consequently, we believe that Medical Benefits Expense as adjusted for the year ended December 31, 2007, which was based on our actuarially determined estimate, will better facilitate a year over year comparison of our Medical Benefits Expense.
For the year ended December 31, 2008, Medicaid medical benefits expense as adjusted increased $321.7 million, or 14.8%, to $2,497.9 million from $2,176.2 million for the same period in the prior year. Membership growth in our Medicaid segment accounted for $212.9 million of the increase, partially offset by the decrease in medical benefits expense resulting from our Connecticut Medicaid withdrawal totaling approximately $62.8 million. The remaining change is attributed to the demographic mix of our members and overall increased utilization patterns and costs. Absent the adjustment that was recorded in 2007 for the favorable medical benefits development, our MBR would have been 83.5% and 80.8% for the years ended December 31, 2008 and 2007, respectively.
Interest expense. Interest expense decreased $2.2 million, or 15.7%, to $11.8 million for the year ended December 31, 2008 from $14.0 million for the same period in the prior year. The decrease relates to the reduced amount of debt outstanding and the lower cost of borrowing given the lower interest rate environment in 2008 versus higher interest rates in 2007.
At December 31, 2009 and 2008, cash and cash equivalents were $1,158.1 million and $1,181.9 million, respectively. We also had short-term investments of $62.7 million and $70.1 million at December 31, 2009 and 2008, respectively. Of these short-term investments, $58.9 million and $66.2 million had maturities of three to 12 months as of December 31, 2009 and 2008, respectively. As of December 31, 2009 and 2008, 93.9% and 94.4% of our investments were invested in certificates of deposit with a weighted average maturity of 40 days and 98 days, respectively. The annualized tax equivalent portfolio yield for the years ended December 31, 2009 and 2008 was 0.6% and 2.4%, respectively.
We are pursuing alternatives to raise additional unregulated cash. Some of these initiatives include, but are not limited to, consideration of obtaining dividends from certain of our regulated subsidiaries to the extent that we are able to access any available excess capital and accessing the credit markets. However, we cannot provide any assurances that we will obtain applicable state regulatory approvals for dividends to our non-regulated subsidiaries by our regulated subsidiaries. In addition to dividends, our strategies include accessing the public and private debt and equity markets and potentially selling assets.
As of December 31, 2009, all of our long-term investments were comprised of municipal note investments with an auction reset feature (“auction rate securities”). These notes are issued by various state and local municipal entities for the purpose of financing student loans, public projects and other activities, which carry investment grade credit ratings. Liquidity for these auction rate securities is typically provided by an auction process which allows holders to sell their notes and resets the applicable interest rate at pre-determined intervals, usually every seven, 14, 28 or 35 days. As of the date of this Form 10-K, auctions have failed for $57.0 million of our auction rate securities and there is no assurance that auctions on the remaining auction rate securities in our investment portfolio will succeed in the future. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction the indenture governing the security requires the issuer to pay interest at a contractually defined rate that is generally above market rates for other types of similar instruments. The securities for which auctions have failed will continue to accrue interest at the contractual rate and be auctioned every seven, 14, 28 or 35 days until the auction succeeds, the issuer calls the securities, or they mature. As a result, our ability to liquidate and fully recover the carrying value of our remaining auction rate securities in the near term may be limited or non-existent. In addition, while all of our auction rate securities currently carry investment grade ratings, if the issuers are unable to successfully close future auctions and their credit ratings deteriorate, we may in the future be required to record an impairment charge on these investments.
We believe we will be able to liquidate our auction rate securities without significant loss, and we currently believe these securities are not impaired, primarily due to government guarantees or municipal bond insurance; however, it could take until the final maturity of the underlying securities to realize our investments’ recorded value. The final maturity of the underlying securities could be as long as 30 years. The weighted-average life of the underlying securities for our auction rate securities portfolio is 21 years. We currently have the ability and intent to hold our auction rate securities until market stability is restored with respect to these securities.
We have expended significant financial resources in connection with the ongoing investigations and related matters. Since the inception of the investigations through December 31, 2009, we have incurred approximately $165.4 million for administrative expenses associated with, or consequential to, these governmental and Company investigations for legal fees, accounting fees, consulting fees, employee recruitment and retention costs and other similar expenses. Approximately $8.4 million and $41.3 million were incurred in the three months and year ended December 31, 2009, respectively. In addition, we have paid $87.5 million to resolve matters with certain government agencies, of which $52.3 million was paid during 2009. We currently estimate that we will pay approximately $60.0 million in installments over a period of four to five years to resolve matters with the Civil Division and the OIG. The final timing, terms and conditions of a civil resolution may differ from those current anticipated, which may results in an adjustment to our recorded amounts. These adjustments may be material.
We may be required to pay significant damages or other amounts in the event of an adverse judgment or settlement of the shareholder actions against us. A substantial amount of these costs will not be covered by, or may exceed the limits of, our insurance. We are unable to provide an estimate or range of amounts that we may pay, if any, to resolve the outstanding shareholder actions. If we were required to pay a significant amount to resolves these matters, it could have a material adverse effect on our business, financial condition and cash flows.
Each of our HMO and insurance company subsidiaries is licensed in the markets in which it operates and is subject to the rules, regulations and oversight by the applicable state DOI in the areas of licensing and solvency. Each of our health and prescription drug plans is required to report regularly on its operational and financial performance to the appropriate regulatory agency in the state in which it is licensed, which describes our HMO’s and insurance companies’ capital structure, ownership, financial condition, certain intercompany transactions and business operations. From time to time, each of our subsidiaries is selected to undergo periodic examinations and reviews by the applicable state to review our operational and financial assertions.
Each of our HMO and insurance subsidiaries must maintain a minimum statutory net worth in an amount determined by statute or regulation and we may only invest in types of investments approved by the state. The minimum statutory net worth requirements differ by state and are generally based on a percentage of annualized premium revenue, a percentage of annualized health care costs, a percentage of certain liabilities, a statutory minimum, or RBC requirements. The RBC requirements are based on guidelines established by the NAIC and are administered by the states. As of December 31, 2009, our Connecticut, Georgia, Illinois, Indiana, Louisiana, Missouri, Ohio, Texas and PFFS operations are subject to RBC requirements. The RBC requirements may be modified as each state legislature deems appropriate for that state. The RBC formula, based on asset risk, underwriting risk, credit risk, business risk and other factors, generates the authorized company action level, or CAL, which represents the amount of net worth believed to be required to support the regulated entity’s business.
For states in which the RBC requirements have been adopted, the regulated entity typically must maintain a minimum of the greater of the required CAL or the minimum statutory net worth requirement calculated pursuant to pre-RBC guidelines. In addition to the foregoing requirements, our regulated subsidiaries are subject to restrictions on their ability to make dividend payments, loans and other transfers of cash.
The statutory framework for our regulated subsidiaries’ minimum net worth may change over time. For instance, RBC requirements may be adopted by more of the states in which we operate. These subsidiaries are also subject to their state regulators’ overall oversight powers. For example, New York enacted regulations that increase the reserve requirement by 150% over an eight-year period. In addition, regulators could require our subsidiaries to maintain minimum levels of statutory net worth in excess of the amount required under the applicable state laws if the regulators determine that maintaining such additional statutory net worth is in the best interest of our members. For example, our Ohio HMO is required to maintain required statutory capital at an RBC level of 150% of CAL. Moreover, as we expand our plan offerings in new states or pursue new business opportunities, we may be required to make additional statutory capital contributions. At December 31, 2009, our consolidated RBC ratio for these states is estimated to be over 333% which is in excess of the required CAL of 223%. However, two of our subsidiaries were individually below the required CAL at December 31, 2009. These two subsidiaries underwrote our PFFS product and one also underwrote our products in Hawaii. As we are no longer offering PFFS plans, the amount of RBC required is substantially reduced in 2010 and we anticipate that these two subsidiaries will be in compliance in 2010.
Overview of Cash Flow Activities - For the years ended December 31, 2009, 2008 and 2007 our cash flows from operations are summarized as follows:
In 2007, financing activities consisted of net proceeds from options exercised totaling $12.8 million, and the incremental tax benefit from options exercised of $23.1 million. Also included in financing activities are funds held for the benefit of others, which used approximately $81.9 million of cash as of December 31, 2007. These funds, which represent PDP member subsidies and pass-through payments from government partners, are not accounted for in our results of operations since they represent pass-through payments from our government partners to fund deductibles, co-payments and other member benefits for certain of our members.
(1) We have resolved our matters under investigation by the USAO and the State of Florida but remain in resolution discussions as to matters under review with the Civil Division and the OIG. Pursuant to the Consent and Final Judgment, we agreed to pay a penalty of $10.0 million to the SEC, of which $2.5 million remains to be paid. Based on the current status of matters and all information known to us to date, management estimates that we have a liability of approximately $60.0 million plus interest associated with the matters remaining under investigation. We anticipate these amounts will be payable in installments over a period of four to five years. In accordance with fair value accounting guidance, we discounted the liability and recorded it at its current fair value of approximately $55.9 million. This amount is accrued in our Consolidated Balance Sheet as of December 31, 2009 within the short and long term portions of Amounts accrued related to investigation resolution line items. The final timing, terms and conditions of a resolution of these matters may differ from those currently anticipated, which may result in a material adjustment to our recorded amounts. We cannot provide an estimable range of additional amounts, if any, nor can we provide assurances regarding the timing, terms and conditions of any potential negotiated resolution of pending investigations by the Civil Division or the OIG. In addition, putative class action complaints were filed against us, as well as certain of our past and present officers and directors in October and November 2007, alleging, among other things, numerous violations of securities laws. At this time, neither we nor any of our subsidiaries can predict the probable outcome of these claims. In addition, derivative actions, by their nature, do not seek to recover damages from the companies on whose behalf the plaintiff shareholders are purporting to act.
In January 2010, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance related to improving disclosures about fair value measurements. This standard requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair value measurements and information on purchases, sales, issuances and settlements on a gross basis in the reconciliation of Level 3 fair value measurements. This standard is effective for annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual periods beginning after December 15, 2010. The adoption will not have a material impact on our financial statements in 2010.
In May 2009, the FASB issued authoritative guidance that provides general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The guidance sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements. The guidance also sets forth the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements. Furthermore, this guidance identifies the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. We adopted this guidance as required in the second quarter of 2009.
In April 2009, the FASB issued authoritative guidance on the recognition and presentation of other-than-temporary impairments (“OTTI”) modifying previous OTTI guidance for debt securities through increased consistency in the timing of impairment recognition and enhanced disclosures related to the credit and noncredit components of impaired debt securities that are not expected to be sold. In addition, increased disclosures are required for both debt and equity securities regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. We adopted this guidance during the second quarter of 2009, as required. The adoption did not have a material impact on our financial statements.
In April 2009, the FASB issued authoritative guidance in regard to (1) determining fair value when the volume and level of activity for the asset or liability has significantly decreased and (2) identifying transactions that are considered not orderly. This guidance specifically clarifies the methodology used to determine fair value when there is no active market or where the price inputs being used represent distressed sales. The guidance also reaffirms the objective of a fair value measurement, which is to reflect how much an asset would be sold for in an orderly transaction. It also reaffirms the need to use judgment to determine if a formerly active market has become inactive, as well as to determine fair values when markets have become inactive. This guidance was adopted and applied prospectively during the second quarter of 2009, as required. The adoption did not have a material impact on our financial statements.