The table below provides selected financial data and other operating information as of and for the five fiscal years ended December 31, 2007. We derived the selected financial data presented below for the five fiscal years ended December 31, 2007 from our audited financial statements. We have prepared the following data, other than statutory data, in conformity with generally accepted accounting principles. You should read this selected financial data together with our consolidated financial
(1)Includes the results of MemberHealth since its acquisition on September 21, 2007.
(2)Prior period amounts have been adjusted to reflect the operations of our Canadian subsidiary as discontinued operations.
(4)Includes the results of Pyramid Life, Inc. since its acquisition on March 31, 2003.
(3)Includes the results of Heritage Health Systems, Inc. since its acquisition on May 28, 2004.
As a result of the MemberHealth acquisition and Medicare Advantage expansion previously discussed, we have modified the way we manage and report our business. Our Senior Managed Care-Medicare Advantage segment remains unchanged and we continue to provide separate information on the results of our PFFS and HMO businesses. We have split Part D from Senior Market Health and formed a new segment to include both our Prescription PathwaySM product and MemberHealth's Part D product. We have combined the remaining former Senior Market Health segment, primarily Medicare supplement, with the former Specialty Health and Life & Annuity segments to form a new combined segment, Traditional Insurance. The Senior Administrative Services segment remains unchanged and we continue to report the corporate activities of our holding company in a separate segment. We have made reclassifications to conform prior year amounts to the current year presentation. See "Note 20-Business Segment Information" in our consolidated financial statements included in this Annual Report on Form 10-K for a description of our segments.
Our consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles, known as GAAP. The preparation of our financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts of assets and liabilities and disclosures of assets and liabilities reported by us at the date of the financial statements and the revenues and expenses reported during the reporting period. As additional information becomes available or actual amounts become determinable, we may revise the recorded estimates and reflect them in operating results. Actual results could differ from those estimates. The accounts that, in our judgment, are most critical to the preparation of our financial statements are:
There have been no changes in our critical accounting policies during 2007.
We calculate and maintain reserves for the estimated future payment of claims to our policyholders using actuarial assumptions that are consistent with actuarial assumptions we use in the pricing of our products. For our accident and health insurance business, we establish an active life reserve for expected future policy benefits, plus a liability for due and unpaid claims and incurred but not reported claims. Our net income depends upon the extent to which our actual claims experience is consistent with the assumptions we used in setting our reserves and pricing our policies. If our assumptions with respect to future claims are incorrect, and our reserves are insufficient to cover our actual losses and expenses, we would be required to increase our liabilities, resulting in reduced net income and shareholders' equity.
A summary of the liabilities by category is presented in the following table:
Policyholder account balances represent the balance that accrues to the benefit of the policyholder, otherwise known as the account value, as of the financial statement date. Account values increase to reflect additional deposits received and interest credited based on the account value. Account values decline to reflect surrenders and other withdrawals, including withdrawals relating to the cost of insurance and expense charges. We review the interest crediting rates periodically and adjust (with certain minimum levels below which the crediting rate cannot fall) as deemed necessary.
The liability for future policy benefits represents the present value of estimated future benefits to be paid to or on behalf of policyholders, less the future value of net premiums. We calculate this amount based on actuarially recognized methods using morbidity and mortality tables, which we modify to reflect the Company's actual experience when appropriate.
The Policy and Contract Claims liability for our Accident and Health Policies include a liability for unpaid claims, including claims in the course of settlement, as well as a liability for incurred but not yet reported claims, known as IBNR. Our IBNR, by major product grouping is as follows:
(a)Reflects estimated potential changes in medical and other expenses payable, caused by changes in completion factors for incurred months prior to the most recent three months.
The liability for unpaid claims, including IBNR, includes estimates of amounts to fully settle known reported claims as well as claims related to insured events that we estimate have been incurred, but have not yet been reported to us.
We refer to these costs as deferred acquisition costs or DAC. For interest-sensitive life and annuity products, we amortize these costs in relation to the present value of expected gross profits on the policies arising principally from investment, mortality and expense margins in accordance with FAS
the present value of those cash flows. The discount rate selected depends upon the general market conditions at the time of the acquisition and the inherent risk in the transaction. We allocate purchase consideration in excess of the fair value of net assets acquired, including the present value of future profits and other identified intangibles, for a specific acquisition, to goodwill. We perform the allocation of purchase price in the period in which we consummate the purchase. Adjustments, if any, in subsequent periods relate to resolution of pre-acquisition contingencies, tax matters and refinements made to estimates of fair value in connection with the preliminary allocation.
The fair value for fixed maturity securities is largely determined by third party pricing service market prices. Typical inputs used by third party pricing services include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows and prepayments speeds. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing for mortgage-backed and asset-backed securities are
estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates. See Item 7A, Quantitative and Qualititative Disclosures About Market Risk, for a discussion regarding the interest rate sensitivity of our investment portfolio.
The Company regularly evaluates the amortized cost of its investments compared to the fair value of those investments. Impairments of securities are generally recognized when a decline in fair value below the amortized cost basis is considered to be other-than-temporary. The evaluation includes on the intent and ability to hold the security to recovery, and is considered on an individual security basis, not on a portfolio basis. Impairment losses for certain mortgage-backed and asset-backed securities are recognized when an adverse change in the amount or timing of estimated cash flows occurs, unless the adverse change is solely a result of changes in estimated market interest rates. Impairment losses are also recognized when declines in fair values based on quoted prices are determined to be other than temporary.
Each quarter, during this analysis, the Company asserts its intent and ability to retain until recovery those securities judged to be temporarily impaired. Once identified, trading on these securities is restricted unless approved by members of the Investment Committee. The Investment Committee will only authorize the sale of these securities based on criteria that relate to events that could not have been foreseen. Examples of the criteria include, but are not limited to, the deterioration in the issuer's creditworthiness, a change in regulatory requirements or a major business combination or major disposition.
The Company continuously reviews its subprime holdings stressing multiple variables, including cash flows, prepayment speeds, default rates and loss severity, comparing current base case loss expectations to the loss required to incur a principal loss, or breakpoint. This breakpoint currently exceeds the base case loss expectation for all holdings to varying degrees. The Company expects delinquency and loss rates in the subprime mortgage sector to continue to increase in the near term. Those securities with a greater variance between the breakpoint and base case can withstand this further deterioration. However, holdings where the base case is closer to the breakpoint, principally holdings from the 2006 and 2007 vintage years, are more likely to incur a principal loss. The Company has recognized an other than temporary impairment on certain 2006 and 2007 vintage year holdings, resulting in a pre-tax realized loss on investment of $41 million. Eleven of the fourteen securities requiring an other than temporary impairment are on negative credit watch. The Company utilizes a third party pricing service to provide market prices. The major inputs used by third party pricing services include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows and prepayments speeds. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price, as has been the case with the Company's subprime holdings recently. The Company continues to review the estimated fair values indicated by pricing provided by the third party pricing service and anticipates that there will be further impairments on these securities in the first quarter, as prices have continued to decline since December 31, 2007. However, the Company believes that it will recover principal and interest greater than the market prices currently indicate.
We establish valuation allowances on our deferred tax assets for amounts that we determine will not be recoverable based upon our analysis of projected taxable income and our ability to implement prudent and feasible tax planning strategies. We recognize increases in these valuation allowances as deferred tax expense. We reflect portions of the valuation allowances subsequently determined to be no longer necessary as deferred tax benefits. To the extent that valuation allowances were established in conjunction with acquisitions, we first apply changes in those allowances to increasing or decreasing the goodwill, but not below zero, or other intangibles related to the acquisition and then apply those changes as an increase or decrease in income tax expense.
We entered the Medicare Advantage business in 2004 with the acquisition of Heritage Health Systems, Inc. which operates Medicare Advantage coordinated care plans in southeastern Texas and began offering new PFFS plans in 2 states. We have continued to increase our marketing of Medicare Advantage plans.
For 2007, we have expanded into new markets for our Medicare HMO and PFFS plans. We offered our Medicare Advantage coordinated care plans in 4 new markets; Florida, Oklahoma, north Texas and Wisconsin. As of December 31, 2007 our enrollment in HMO has increased to approximately 46,000 members. The Company elected not to renew its Medicare Advantage contract in Florida for 2008, and as of January 1, 2008 the Company has no membership in Florida.
Through our insurance subsidiaries American Progressive and Pyramid Life, we currently offer our PFFS products in 35 states in 2007. As of December 31, 2007 our enrollment in PFFS plans has increased to approximately 190,000 members.
Universal American and CVS Caremark have previously announced that their strategic alliance covering the Prescription PathwaySM Medicare Part D prescription drug plan program will end as of December 31, 2008, subject to regulatory approvals. Upon dissolving the strategic alliance, CVS Caremark and Universal American will each assume responsibility for the drug benefit of specified Prescription PathwaySM plan members to achieve an approximately equal distribution of the value of business that has been generated by the strategic alliance.
We also participate, on a 33.3% basis, in an unaffiliated plan with Arkansas Blue Cross and Blue Shield, known as BCBS, and PharmaCare Re. The contract for this participation terminated as of January 1, 2008, however, under the termination provisions of the contract, we will receive an amount equal to two years of the reinsurance profits generated by the block of business.
In July 2007, CMS performed a financial audit of our Marquette subsidiary Part D Prescription PathwaySM business from the period January 1, 2006 to December 31, 2006. We received a report from CMS on January 2, 2008 with no significant findings.
In connection with the MemberHealth transaction, we refinanced our Amended Credit Facility and Revolving Credit Facility with a new credit facility consisting of a $350 million term loan and a $150 million revolver. See Note 12-Loan Payable to the consolidated financial statements included elsewhere in this annual report on Form 10K, for further information about our credit facility. We used a portion of the proceeds from the refinancing to repay in full the outstanding amounts on the Amended Credit Facility and Revolving Credit Facility. The early extinguishment of this debt triggered the immediate amortization of the related capitalized loan origination fees, resulting in a pre-tax expense of approximately $0.9 million. As a result of the value to be received pursuant to the settlement agreement discussed above, and the occurrence of a breach of representation and warranty made by us in our 2007 Credit Agreement regarding historical MemberHealth financial statements, we will prepay $25 million of principal under the new facility in April 2008 pursuant to a waiver of that breach.
Medicare supplement insurance reimburses the policyholder for deductibles, co-pays and other specified expenses that are not covered by standard Medicare coverage. This coverage is designed for people who want the freedom to choose providers who participate in the standard Medicare program and limit their out of pocket costs to the fixed annual premiums they pay, as opposed to the more restrictive networks that exist in Medicare Advantage HMO markets or the co-payments and deductibles that exist in PFFS plans. We believe that the market for Medicare supplement products will continue to be attractive, especially because many seniors may lose similar coverage that had previously been offered to them as a retiree benefit by their former employers.
In the last two years, there has been increased competition from other Medicare supplement carriers, as well as from Medicare Advantage plans, which has affected our production and persistency of Medicare supplement business. As a result, we continue to experience higher than expected lapsation in our Medicare supplement business. This excess lapsation has accelerated the amortization of the deferred acquisition cost and present value of future profits assets associated with the lapsed business. We cannot give assurances that lapsation of our Medicare supplement business will decline, and continued excess lapsation will require continued accelerated amortization of the deferred costs.
On December 1, 2006, we completed the sale of our Canadian operations for approximately $131 million cash. The sale resulted in an after-tax realized gain of approximately $48 million and generated approximately $96 million of after tax proceeds. As a result, we have reported our Canadian Subsidiary as discontinued operations. See Note 21-Discontinued Operations in our consolidated financial statements included in this Annual Report on Form 10-K for a more detailed description of the sale.
The following table reflects income (loss) from each of our segments and contains a reconciliation to reported net income:
(1)We evaluate the results of operations of our segments based on income before realized gains and income taxes. Management believes that realized gains and losses are not indicative of overall operating trends. This differs from generally accepted accounting principles, which includes the effect of realized gains in the determination of net income. The schedule above reconciles our segment income to net income in accordance with generally accepted accounting principles.
Net income for 2007 was $84.1 million, or $1.18 per diluted share, compared to $119.3 million, or $1.99 per diluted share for 2006. Income from continuing operations increased by 37% compared to income from continuing operations of $61.1 million, or $1.02 per diluted share, for 2006. Income from continuing operations for 2007 includes realized investment losses, net of tax, of $26.1 million, or $0.37 per diluted shares, relating primarily to the recognition of other than temporary impairment of certain of our securities with exposure to subprime mortgages. Income from continuing operations for 2006
Results for 2007 include MemberHealth from September 21, 2007, the date of its acquisition by us, which generated incremental revenues of $318.3 million and pre-tax income of $63.3 million. In connection with the acquisition and related refinancing, we issued 31.7 million common equivalent shares of equity securities and incurred a pre-tax expense of $0.6 million, after-tax, related to the immediate amortization of the remaining capitalized loan fees on the debt that we refinanced
Net income for 2006 included income from discontinued operations, after taxes, including the gain on the sale of PennCorp Life, was $58.2 million or $0.97 per diluted share.
Our Medicare Part D income increased by $67.7 million, or 138%, compared to 2006. This includes $63.3 million on MemberHealth's business since September 21, 2007, the date of acquisition, a period of the year that typically represents the highest operating results for prescription drug plans due to the seasonal nature of the benefits provided.
Net income for 2006 increased to $119.3 million, or $1.99 per diluted share, compared to $53.9 million, or $0.91 per diluted share for 2005. Income from continuing operations, after taxes, was $61.1 million, or $1.02 per diluted share for 2006 compared to income from continuing operations, after taxes, of $43.8 million, or $0.74 per diluted share for 2005. Income from continuing operations for 2006 includes realized investment gains, net of tax, of $5.0 million, which reflects a benefit from a $1.9 million release of a tax valuation allowance relating to net capital loss carryforwards. Realized investment gains, net of tax, included in income from continuing operations for 2005 were $4.9 million, which reflects a benefit from a $1.7 million release of a tax valuation allowance relating to net capital loss carryforwards. Our effective tax rate for continuing operations was 34.8% for 2006, and 34.1% for 2005, reflecting the release of the valuation allowance noted above.
Income from discontinued operations, after taxes, including the gain on sale of PennCorp Life Insurance Company ("PennCorp Life Canada") was $58.2 million or $0.97 per diluted share, for 2006, compared to $10.1 million, or $0.17 per diluted share, for 2005.
Segment income for our Senior Administrative Services segment increased by $6.4 million, or 68%, to $15.8 million for 2006, as compared to 2005. This increase is primarily the result of new business administered.
The loss from our Corporate segment increased by $8.5 million, or 61%, for 2006 compared to 2005. The increase was due primarily to the increase in stock-based compensation expense as a result of the adoption of FAS 123-R, costs of due diligence and higher interest cost.
Our Senior Managed Care-Medicare Advantage segment includes the operations of our private fee-for-service business, known as PFFS, and our coordinated care plans which we refer to as HMO's, that offer coverage to Medicare beneficiaries in southeastern Texas, North Texas, Oklahoma and Wisconsin. These businesses provide managed care for seniors under a contract with CMS. PFFS is currently sold by our career and independent agents through American Progressive and Pyramid Life and Marquette in approximately 3,100 counties across 47 states. The HMO products are sold by our career and independent agents and directly by employee representatives.
business due to our expansion of PFFS plan offerings from 500 counties in 15 states in 2006 to 3,100 counties in 47 states in 2007.
Our Senior Managed Care-Medicare Advantage segment generated segment income of $10.5 million during 2006, a decrease of $17.3 million compared to 2005, primarily due to expenses of approximately $24.9 million incurred in 2006 relating to expansion initiatives for our Medicare Advantage plans, offset in part by the continued growth in HMO membership.
Membership. A discussion of the accounting for Medicare Advantage policies, including PFFS, is included in Note 2 of the notes to the consolidated financial statements in this Annual on Form 10-K. There are timing differences between the addition of members to our administrative system and the approval, or accretion, of the member by CMS before we are paid for that member by CMS. We analyze the membership in our administrative system and the enrollment provided by CMS. Due to the significant growth of the business and the limited historical experience, we recognize these timing delays and that CMS may not approve any individual enrollee. Accordingly, the results for our PFFS business are based on membership that is less than the level included in our administrative system. In the succeeding quarters, we analyze the member information used in our consolidated financial statements and adjust our membership based on members subsequently approved by CMS. Although we are unable to precisely quantify the impact of any potential member change from that used in our consolidated financial results, we do not believe that any change from the amounts reported as of December 31, 2007 is likely to be material.
Revenues. Net premiums for the PFFS business increased by $1.3 billion compared to 2006, primarily due to growth in membership. Membership increased to approximately 190,000 as of December 31, 2007 from approximately 18,000 as of December 31, 2006. Net investment income increased by $14.4 million, due primarily to growth in invested assets as a result of growth in business.
Revenues. Net premiums for the PFFS business increased by $89.3 million compared to 2005, primarily due to growth in membership. Membership increased to approximately 18,000 as of
December 31, 2006 from approximately 5,000 as of December 31, 2005. Net investment income increased by $0.8 million, due primarily to growth in invested assets as a result of growth in business.
Benefits, Claims and Expenses. Medical expenses increased by $149.5 million, or 61%, compared to 2006. Growth in Medicare membership added approximately $106.8 million and the Harmony Health commercial business added $24.7 million. Of the remaining $18.0 million balance, $9.1 million was due to an increase in the medical loss ratio due to a change in the mix of business for new markets, and $8.9 million was due to increase of utilization of member benefits. The medical loss ratio for the HMO's increased to 77.6% for 2007, from 73.3% for 2006, as a result of entering new markets, a change in the mix of business, as described previously, and an increase in utilization of member benefits and provider compensation. The medical loss ratio for 2007 includes the commercial business from the acquisition of Harmony Health. Excluding the commercial business, the loss ratio for the HMO's was 77.1%. Commissions and general expenses increased by $17.9 million compared to 2006, due primarily to the growth in business and an increase in commissions as more of the Medicare Advantage product is being sold by our agents.
Revenues. Net premiums for our HMO's increased by $117.4 million, or 54%, compared to 2005, primarily due to growth in membership. Membership increased to approximately 35,400 members at December 31, 2006 from approximately 24,900 at December 31, 2005. Pursuant to the MMA, we began
to receive incremental revenue from CMS for the Part D prescription drug benefit in 2006. For 2006, our HMO's received $28.0 million from CMS for the Part D prescription drug benefit Net investment income increased by $2.3 million, due primarily to growth in invested assets as a result of growth in business.
We also participate, on a 33.3% basis, in an unaffiliated plan with Arkansas Blue Cross and Blue Shield ("BCBS') and PharmaCare Re. The contract for this participation terminated as of January 1, 2008 and the business was assumed by BCBS. Under the termination provisions of the contract, we will receive an amount equal to two years of the estimated future profits generated by the block of business.
A discussion of the accounting for Part D is included in Notes 2 and 19 of the notes to the consolidated financial statements in this Annual Report on Form 10-K. Our revenues and claims expense are based on earned premium and incurred pharmacy benefits for the reported enrolled membership. The membership information is subject to reconciliation and refinement with CMS with respect to the allocation among all plans participating in the Part D program and is an on-going process. As a result of the on-going reconciliation process, it is likely that the membership data upon which we based our results will change, with a corresponding change in the financial results for the segment. We are unable to precisely quantify the impact of any potential change until the membership data for specific time periods is fully reconciled with CMS, however, based upon our past experience, we do not believe that the effect of any change from the amounts reported as of December 31, 2007 is likely to be material.
Other Part D income (loss)-PDMS represents our equity in the earnings or loss of PDMS. We report this as revenue for segment reporting purposes in analyzing the ratio of net pharmacy benefits incurred because the amount is incorporated in the calculation of the risk corridor adjustment. For consolidated reporting, this amount is included as a separate line following income from continuing operations. See the reconciliation of segment revenues in Note 21 of the notes to the consolidated financial statements in this Annual Report on Form 10-K.
Our Medicare Part D income increased by $67.7 million, or 138%, compared to 2006. This includes $63.3 million on MemberHealth's business since the date of acquisition on September 21, 2007 and is for a period of the year that typically represents the highest operating results for prescription drug plans due to the seasonal nature of the benefits provided.
Membership. At December 31, 2007, our total membership for Medicare Part D was 1,669,000 members compared to 456,000 members at December 31, 2006, an increase of 1,213,000 members principally attributable to our acquisition of MemberHealth. For Prescription PathwaySM, we based our membership on enrollment information provided by CMS which indicated that, as of December 31, 2007, approximately 480,000 members were enrolled, that we participate in on a 50% basis, for which we were paid by CMS. This represents an increase of 11% over the December 31, 2006 membership of approximately 432,000. We also participate, on a 33.3% basis, in BCBS that had approximately 25,000 members at December 31, 2007, and 24,000 at December 31, 2006. As a result of our acquisition of MemberHealth, our Part D membership as of December 31, 2007, also includes approximately 1,164,000 members enrolled in our Community CCRxSM PDP.
Commissions and general expenses, net of reinsurance allowances, decreased by $31.0 million, or 19%, compared to 2006. The following table details the components of commission and other operating expenses:
Our Traditional Insurance segment income decreased by $7.0 million, or 16%, compared to 2005, primarily as a result of the continued effect of higher than expected lapsation of our Medicare supplement in force products, which resulted in an acceleration of the amortization of deferred acquisition costs, and worsening morbidity in our long-term care products, offset by a $1.5 million gain on the sale of our group life insurance business.
Commissions and general expenses, net of reinsurance allowances, decreased by $23.9 million, or 13%, compared to 2005. The following table details the components of commission and other operating expenses:
The ratio of commissions to gross premiums decreased to 10.9% for 2006, from 15.0% for 2005, as a result the $160.5 million increase in premium received in 2006 related to the PharmaCare Re reinsurance agreement for the State of Connecticut employees for which there are no commissions. Excluding this increase in premiums, the ratio for 2006 would have been 13.4%. The decrease in the ratio is the result of lower overall commission rates associated with the continued growth of our in force renewal premium and less new business production that has higher commission rates. Other operating costs as a percentage of gross premiums were 10.4% for 2006, compared to 12.6% for 2005. Excluding the increase in premiums noted above, the ratio for 2006 would have been 12.5%.
Included in unaffiliated revenue are fees received to administer certain business of our insurance subsidiaries that is 100% reinsured to an unaffiliated reinsurer, which amounted to $2.8 million in the year ended December 31, 2007, $3.2 million for 2006 and $4.1 million for 2005. These fees, together with the affiliated revenue, were eliminated in consolidation. In 2007 we performed certain administrative functions for the affiliated Private fee-for-service line of business that will be performed directly by the affiliated entities. The fees were eliminated in consolidation.
administration of our Medicare supplement business due primarily to a reduction in the force policies. Unaffiliated service fee revenue increased by $0.32 million, due primarily to an increase in administrative services performed for unaffiliated Medicare Advantage clients that more than offset a reduction in services performed for unaffiliated Medicare supplement and long term care business. General expenses for the segment increased by $13.7 million, or 20%, primarily attributed to the growth of the affiliated Medicare Advantage and Part D business as well as the integration of the Canadian operations.
The loss from our Corporate segment increased by $8.5 million, or 61%, for the year ended December 31, 2006 compared to 2005. The increase was due primarily to the increase in stock-based compensation expense as a result of the adoption of FAS 123-R, costs of due diligence and higher interest cost. During 2006, we recognized $2.6 million of stock-based compensation expense relating to options vesting during the period. We also incurred $0.7 million of costs associated with due diligence for a potential acquisition that we determined we will not pursue at this time and we incurred $0.6 million of costs associated with our board of directors' review of the proposed buyout offer. Additionally, certain of the companies acquired in July 1999 had post-retirement benefit plans in place prior to their acquisition and Universal American maintained the liability for the expected cost of such plans. In October 2000, participants were notified of the termination of the plans in accordance with their terms. The liability has been reduced as, and to the extent that, it becomes certain that we will incur no liabilities for the plans as a result of the termination. During the fourth quarter of 2006, $0.6 million of the liability was released, compared to a release of $1.8 million in 2005.
Our contractual obligations as of December 31, 2007, are shown below.
(2)Trust preferred securities all have scheduled maturities of 30 years from the dates of issue; however they are all callable by us five years from the date of issuance. For the purpose of this schedule, we have assumed that the securities will be redeemed at their scheduled maturities, not the call date. Accordingly, the obligation for repayment of principal relating to these is included in
(3)Includes scheduled amortization through final maturity in 2012. The loan payable is floating rate debt, however, we pay a fixed rate on $250 million through the uses of swap agreements. We did not project future changes in the base interest rates. For the purpose of this schedule, we applied the rate in effect at December 31, 2007 to all future periods. As a result of the value to be received pursuant to the settlement agreement discussed in Significant Transactions and Initiatives, we will prepay $25 million of principal under the new facility in April 2008 pursuant to a waiver.
(4)Includes minimum obligations on our data center outsourcing contract, as well as our outsourced administrative service contracts for certain portions of our HMO business (See Outsourcing Arrangements in Part 1, Item 1 of this Annual Report on Form 10-K). Our actual monthly payments are affected by the amount of service provided under the contract and the levels of business administered and currently the actual payments exceed the minimums stated in the contracts. Therefore our actual payments will exceed the amounts presented in the above schedule based upon future usage and premium amounts.
Our obligations under the 2007 Credit Facility are guaranteed by our subsidiaries, Heritage Health Systems, Inc. and MemberHealth LLC and if, and only if, a rating condition exists whereby the Company is either no longer rated by S&P or such rating falls below BBB-, this facility would be secured by substantially all of the assets of each of the Guarantors. In March 2008, S&P placed a rating of BB+ on the Company that triggered this added security requirement.
The 2007 Credit Facility requires us and our subsidiaries to meet certain financial tests, including a minimum consolidated leverage ratio and a minimum risk based capital test. The 2007 Credit Facility also contains covenants, which among other things, under certain conditions, limit the incurrence of liens or additional indebtedness; investments; fundamental changes such as mergers, dissolution, consolidation, disposition of assets; restricted payments such as dividends by the Company; changing the nature of our business; transactions with affiliates; limitations on dividends by subsidiaries and other burdensome arrangements; use of proceeds; amendments of organization documents; prepayments of other indebtedness; restricted subsidiaries and other matters customarily restricted in such agreements. The 2007 Credit Facility contains customary events of default, including, among other things, payment defaults, breach of covenants or representations and warranties; cross-defaults to certain other indebtedness; certain events of bankruptcy and insolvency; judgment defaults and change of control.
We incurred additional loan origination fees of approximately $4.7 million, which were capitalized and are being amortized on a straight-line basis, which does not differ significantly from the effective yield basis, over the life of the 2007 Credit Facility. The early extinguishment of the Amended Credit Facility triggered the immediate amortization of the related capitalized loan origination fees, resulting in a pre-tax expense of approximately $0.9 million.
We have formed statutory business trusts, which exist for the exclusive purpose of issuing trust preferred securities representing undivided beneficial interests in the assets of the trust, investing the gross proceeds of the trust preferred securities in junior subordinated deferrable interest debentures of our parent holding company and engaging in only those activities necessary or incidental thereto. In
(1)The rate on this issue is fixed at 7.4% for the first five years. On May 15, 2008 the rate will convert to a floating rate equal to LIBOR plus 410 basis points.
Our parent holding company has the right at any time, and from time to time, to defer payments of interest on the Junior Subordinated Debt for a period not exceeding 20 consecutive quarters up to each debenture's maturity date. During any such period, interest will continue to accrue and our parent holding company may not declare or pay any cash dividends or distributions on, or purchase, our common stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank equally with or junior to the Junior Subordinated Debt. Our parent holding company has the right at any time to dissolve the Trusts and cause the Junior Subordinated Debt to be distributed to the holders of the Capital Securities. We have guaranteed, on a subordinated basis, all of the Trusts' obligations under the Capital Securities including payment of the redemption price and any accumulated and unpaid distributions to the extent of available funds and upon dissolution, winding up or liquidation but only to the extent the Trusts have funds available to make such payments. The Capital Securities have not been and will not be registered under the Securities Act of 1933, as amended, and will only be offered and sold under an applicable exemption from registration requirements under the Securities Act.
If revived or extended, the shelf registration statement or a successor registration statement would enable us to raise funds from the offering of any individual security covered by the shelf registration statement, as well as any combination thereof, through one or more methods of distribution, subject to market conditions and our capital needs. The terms of any offering pursuant to this or a successor registration statement will be established at the time of the offering. We plan to use the proceeds from any future offering under the registration statement or a successor registration statement for general corporate purposes, such as working capital, capital expenditures, investments in subsidiaries, acquisitions and refinancing of debt. We will include a more detailed description of the use of proceeds of any specific offering of securities in the prospectus supplement relating to any particular offering.
•surplus note principal and interest payments from American Exchange and Pyramid.
In addition, we have access to funds under existing credit facilities. We have $150.0 million available under the revolving portion of our 2007 Credit Facility. In March of 2007, we drew down all $50 million available under our then-existing short-term Revolving Credit Facility to finance capital needs at our insurance company subsidiaries to support the growth of our business. We then repaid the entire $50.0 million balance on July 18, 2007, when it was determined that it was not immediately needed, using cash received in our May 2007 equity raise.
We also have the ability, from time to time, to access the capital markets for additional capital. In March 2007, we issued $50 million of trust preferred securities. In addition, in connection with the May 8, 2007 announcement of the signing of definitive agreements to acquire MemberHealth (see Note 23-Business Combinations of the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K), we have issued preferred stock for aggregate proceeds of $350 million, at $20 per common equivalent share, to four private equity investment fund groups. We issued $100 million of preferred stock during the second quarter of 2007 and the balance in September 2007. There can be no assurance as to our actual future cash flows from the continued availability of dividends from our insurance company subsidiaries or from access to the capital markets to support our growth and expansion initiatives.
our managed care holding company exceed scheduled uses of cash which will result in funds being available to pay dividends to our parent holding company.
PBM Subsidiary. Liquidity for our PBM subsidiary is measured by its ability to pay operating expenses and pay dividends to our parent company. The primary source of liquidity is fees collected from clients. We believe that the sources of cash for our PBM subsidiary exceed scheduled uses of cash and results in amounts available to dividend to our parent holding company.
Our parent holding company made cash capital contributions to American Exchange amounting to $43.5 million during 2006. During May 2006, our parent holding company contributed its interest in PDMS to American Exchange. On the date of the contribution, our interest in PDMS was $4.1 million. In January 2006, Pyramid Life declared and paid a dividend in the amount of $10.8 million to Pennsylvania Life. In December 2006, American Pioneer declared and paid a dividend in the amount of $9.4 million to American Exchange. American Exchange made capital contributions of $16.0 million to American Progressive, $4.5 million to American Pioneer and $4.3 million to Constitution during the year ended December 31, 2006.
Our accident and health insurance policies generally provide for fixed-benefit amounts and, in the case of Medicare supplement policies, for supplemental co-payments in accordance with approved Medicare provider rates. Some of these benefits are subject to medical-cost inflation and we have the capability to file for premium rate increases to mitigate rising medical costs. Prescription drug benefits under Part D PDPs may vary in terms of coverage levels and out-of-pocket costs for beneficiary premiums, deductibles and co-insurance. However, all Part D PDPs must offer either "standard coverage" or its actuarial equivalent (with out-of-pocket threshold and deductible amounts that do not exceed those of standard coverage). These defined "standard" benefits represent the minimum level of benefits mandated by Congress. We also offer other PDPs containing benefits in excess of standard coverage limits for an additional beneficiary premium. Our PDPs receive monthly payments from CMS which generally represent our bid amount for providing insurance coverage. Due to the nature of the benefit design, where the PDP is covering the initial deductibles, Part D benefit costs will exceed these monthly CMS payments resulting in negative cash flows in the early part of the year. As deductibles are reached and benefit costs are shared with the plan members, the resulting cash flows match more evenly and eventually turn positive, where monthly plan receipts exceed the benefit costs in the latter part of the year. The Part D benefit costs are subject to risk corridor adjustment, which permits our PDPs and CMS to share the risk associated with the ultimate costs of the Part D benefit. However, the cash settlement for the risk corridor adjustment does not occur until the following year. Our Medicare Advantage policies provide benefits to Medicare enrollees as specified in our contracts with CMS, with premiums received from CMS and, depending on the individual product, from the enrollee. Our health insurance business is widely dispersed in the United States, which mitigates the risk of unexpected increases in claim payments due to epidemics and events of a catastrophic nature. These accident and health polices are not interest-sensitive and therefore are not subject to unexpected policyholder redemptions due to investment yield changes.
Some of our life insurance and annuity policies are interest-sensitive in nature. The amount of surrenders and withdrawals is affected by a variety of factors such as credited interest rates for similar products, general economic conditions and events in the industry that affect policyholders' confidence. Although the contractual terms of substantially all of our in force life insurance policies and annuities give the holders the right to surrender the policies and annuities, we impose penalties for early surrenders. As of December 31, 2007 we held reserves that exceeded the underlying cash surrender values of our net retained in force life insurance and annuities by $25 million. Our insurance
The net yields on our cash and invested assets increased to 5.4% for the year ended December 31, 2007, from 5.1% for 2006 and 5.0% for 2005. A portion of these securities are held to support the liabilities for policyholder account balances, which liabilities are subject to periodic adjustments to their credited interest rates. The credited interest rates of the interest-sensitive policyholder account balances are determined by us based upon factors such as portfolio rates of return and prevailing market rates and typically follow the pattern of yields on the assets supporting these liabilities.
Our domestic insurance subsidiaries are required to maintain minimum amounts of statutory capital and surplus as required by regulatory authorities. However, substantially more than the statutory minimum amounts are needed to meet statutory and administrative requirements of adequate capital and surplus to support the current level of our insurance subsidiaries' operations. Each of our insurance subsidiaries' statutory capital and surplus exceeds its respective minimum statutory requirement at levels we believe are sufficient to support their current levels of operation. Additionally, the National Association of Insurance Commissioners ("NAIC") imposes regulatory risk-based capital ("RBC") requirements on life insurance enterprises. At December 31, 2007, all of our insurance subsidiaries maintained ratios of total adjusted capital to RBC in excess of the "authorized control level". The combined statutory capital and surplus, including asset valuation reserve, of our U.S. insurance subsidiaries totaled $486.1 million at December 31, 2007 and $242.9 million at December 31, 2006. Our U.S. insurance subsidiaries generated statutory net income of $114.6 million for the year ended December 31, 2007 and $29.3 million for 2006. For the year ended December 31, 2005, our U.S. insurance subsidiaries generated a statutory net loss of $1.8 million.
Our HMO affiliates are also required by regulatory authorities to maintain minimum amounts of capital and surplus and are also subject to RBC requirements. At December 31, 2007, the statutory capital and surplus of each of our HMO affiliates exceeds its minimum requirement and its RBC is in excess of the "authorized control level." The statutory capital and surplus for our HMO affiliates was $64.3 million at December 31, 2007 and $44.0 million at December 31, 2006. Statutory net income for our HMO affiliates was $15.3 million for the year ended December 31, 2007, $17.3 million for 2006, and $9.6 million for 2005.
We did not write down the value of any fixed maturity securities during the years ended December 31, 2006 or 2005. A write-down of the value of a fixed maturity security would represent our estimate of an other than temporary decline in value and would be included in net realized gains and losses on investments in our consolidated statements of operations.
We file a consolidated return for Federal income tax purposes that includes all of the non-life insurance company subsidiaries, as well as Heritage and its subsidiaries. American Exchange and its subsidiaries are not currently included. American Exchange and its subsidiaries file a separate consolidated Federal return.
In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109 ("FIN 48") that provides criteria for recognition, measurement, presentation and disclosure of uncertain tax positions. The Company adopted FIN 48 on January 1, 2007. The Company has no material uncertain tax positions and no cumulative adjustment was required or recorded as a result of the implementation of FIN 48. The Company recognizes accrued interest and penalties related to uncertain tax positions in income tax expense when incurred. No material interest and penalties related to uncertain tax positions were accrued at December 31, 2007.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"). This statement defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States, and enhances disclosures about fair value measurements. SFAS 157 provides guidance on how to measure fair value when required under existing accounting standards. The statement establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels ("Level 1, 2 and 3"). Level 1 inputs are observable inputs that reflect quoted prices for identical assets or liabilities in active markets the Company has the ability to access at the measurement date. Level 2 inputs are observable inputs, other than quoted prices included in Level 1, for the asset or liability. Level 3 inputs are unobservable inputs reflecting the reporting entity's estimates of the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Quantitative and qualitative disclosures will focus on the inputs used to measure fair value for both recurring and non-recurring fair value measurements and the effects of the measurements in the financial statements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with earlier application encouraged only in the initial quarter of an entity's fiscal year. Adoption of this statement is not expected to have a material impact on the Company's consolidated financial statements. A summary of other recent and pending accounting pronouncements is provided in Note 2 of the consolidated financial statements in the Annual Report on Form 10-K under the caption "Future Adoption of Accounting Standards." We