Our principal administrative, sales and marketing facilities are located at our headquarters in Tampa, Florida. We currently occupy approximately 377,000 square feet of office space in the Tampa facility under a lease whose term is scheduled to expire in various phases from 2011 through 2016. Our corporate headquarters in Tampa, Florida are used in all of our lines of business. We also lease office space for our health plans in Florida, New York, Illinois, Indiana, Connecticut, Georgia, Ohio, Louisiana, Hawaii, New Jersey, Missouri and Texas. We believe these facilities are suitable and provide the appropriate level of capacity for our current operations.
The following table sets forth our summary financial data. This information should be read in conjunction with our financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this 2007 Form 10-K. The data for the years ended December 31, 2004, 2005, 2006 and 2007, and as of December 31, 2006 and 2007 is derived from consolidated financial statements included elsewhere in this 2007 Form 10-K. The data for the year ended and as of December 31, 2003 is derived from audited financial statements not included in this 2007 Form 10-K.
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 2007 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 2007 Form 10-K.
As a result of the restatement, our previously issued financial statements for the Restatement Period have been adjusted to reflect a reduction in Premium revenues, Income before income taxes, Net income and EPS, and an increase in Other payables to government partners. In addition to the impact of the restatement, we also have concluded that certain refundable premiums should be classified as a return of premium revenue rather than as medical benefits expense in our consolidated statements of operations, and also should have been reflected in our consolidated balance sheets as Other payables to government partners rather than as Medical benefits payable. These reclassifications do not impact our previously reported Net income, EPS or Net cash provided by operations for the Restatement Period. For a discussion of the restatement, including the material adjustments to our previously issued financial statements, see “Explanatory Note,” Note 3 of the Notes to Consolidated Financial Statements, “Part II - Item 6 - Selected Financial Data” and this “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations.”
We have been delayed in filing this 2007 Form 10-K as a result of, among other matters, the restatement and investigations. Due to the substantial lapse in time between December 31, 2007 and the date of filing of this 2007, among other matters, among other reasons, Form 10-K, we were able to review substantially complete claims information that has become available due to the substantial lapse in time between December 31, 2007 and the date of filing of this 2007 Form 10-K. We have determined that the claims information that has become available provides additional evidence about conditions that existed with respect to medical benefits payable at the December 31, 2007 balance sheet date and has been considered in accordance with GAAP. Consequently, the amounts we recorded for medical benefits payable and medical benefits expense for the year ended December 31, 2007 are based on actual claims paid. The difference between our actual claims paid for this period and the amount that would have resulted from using our original actuarially determined estimate is approximately $92.9 million, or a decrease of 1.8% in the MBR. Thus, Medical benefits expense, medical benefits payable and the MBR for the year ended December 31, 2007 include the effect of using actual claims paid. Conversely, we anticipate that medical benefits expense and MBRs in 2008 will be unfavorably impacted because they will not have the off-setting benefit of the prior period development that otherwise would have been recorded in 2008 if we were filing timely.
As discussed in more detail below, the restatement, investigations and related matters have caused us to expend significant financial resources. As of December 31, 2008, we had spent a cumulative amount of approximately $124.1 million on administrative expenses associated with, or consequential to, the government and Special Committee investigations, including legal fees, accounting
fees, consulting fees, employee recruitment and retention costs and similar expenses. Approximately $21.1 million of these investigation related costs were incurred in 2007 and approximately $103.0 million were incurred in 2008. We expect to continue incurring significant additional costs in 2009 as a result of the federal and state investigations and pending civil actions, including administrative expenses and costs necessary to remediate our internal controls, improve our corporate governance and address other issues that may be identified through the restatement and remediation process.
As of September 30, 2008, our consolidated cash and cash equivalents were approximately $1,176.2 million. As of September 30, 2008, our consolidated investments were approximately $138.7 million. As of September 30, 2008, we had unregulated cash of approximately $89.5 million and unregulated investments of approximately $5.5 million. In addition, as of September 30, 2008, we had approximately $1,086.7 million in regulated cash and $133.2 million in regulated investments.
On December 31, 2008, three of our Florida regulated subsidiaries declared dividends to one of our non-regulated subsidiaries in the aggregate amount of $105.1 million, two of which were paid on December 31, 2008 and one of which was paid on January 2, 2009. The proceeds of such dividends are not reflected in our unregulated cash balances as of September 30, 2008.
We also have a number of other near-term obligations, including currently anticipated capital contributions to certain of our regulated subsidiaries, as well as significant costs associated with the government and Special Committee investigations, including legal, accounting and consulting fees, and employee recruitment and retention costs. For a detailed discussion of our financing needs, the financing challenges we face and the initiatives we are pursuing to increase our unregulated cash, see “Part II - Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”
As a result of economic uncertainty, many of the states in which we operate have experienced significant fiscal challenges, which are likely to result in budget deficits. In light of these budgetary challenges, the Medicaid segment premiums we receive likely will not keep pace with anticipated medical expense increases. While the economic downturn may increase the number of Medicaid recipients under current eligibility criteria, states may revise the eligibility criteria to reduce the number of people who are eligible for our plans. Furthermore, federal budgetary challenges or policy changes could result in rates that do not keep pace with anticipated medical expense increases, which could have a material adverse effect on our performance in the Medicaid or Medicare segments.
In addition, increasing market volatility and the tightening of the credit markets has significantly limited our ability to access external capital, which has, and is likely to continue to 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.
For instance, we are experiencing pressure on rates in Florida and Georgia, two states from which we derive a substantial portion of our revenue. We anticipate that 2008 reductions in premium rates in Florida will result in a loss of approximately $35.0 million of revenues in 2009. In addition to the 2008 rate reduction, in January 2009, the Florida legislature passed a 3% reduction to the State’s 2008-09 fiscal year budget for Medicaid prepaid health plans, effective March 1, 2009 through June 30, 2009. Although AHCA, which administers the Florida Medicaid program, has yet to determine how to implement the reductions and the budget is still subject to gubernatorial scrutiny, it is possible that AHCA will propose a substantial reduction to our Florida Medicaid premiums. These recent and possible future rate reductions will require us to evaluate our medical benefits and administrative expenses. In addition, effective January 1, 2009, Florida began prohibiting direct sales to Medicaid recipients for all plans participating in the Florida Medicaid program, which could result in further reductions in our Florida Medicaid membership and, as a result, a decrease in revenues. New legislation in Georgia related to payment of claims, eligibility determination and provider contracting, may negatively impact revenues and profits for the plan in 2009 and beyond. Further, continued economic slowdowns in Florida and Georgia could result in additional state actions that could adversely affect our revenues.
In January 2009, the new presidential administration took office. The new administration and recently elected U.S. Congress have indicated support for measures intended to expand the number of citizens covered by health insurance and other changes within the health care system. Although the ultimate impact of any such proposals remains uncertain, the costs of implementing some of these proposals could be financed, in part, by reductions in the payments made to health care providers under Medicare and other government programs. If such reductions are significant, our revenues and cash flows could be materially adversely affected.
In our Medicare segment, we are experiencing increased competition. As the result of the Part D bidding process for plan year 2009, we bid above the benchmark in 22 of the 34 regions. As a result, as of December 31, 2008, approximately 252,000 auto-assigned dual-eligible members were assigned away from our plans. In addition to this known membership loss, in 2009 we expect that a portion of the 153,000 low-income subsidized members who previously chose our plans will choose a new plan in 2009. We estimate that, based on these factors as well as new members choosing to enroll in our plans, new auto-assignment of members and other factors, our revenues generated from our PDP plans will decrease significantly for 2009. In addition, several changes to the Medicare program resulting from MIPPA that became effective in 2008 could increase competition for our existing and prospective members, which could adversely affect our revenues.
To achieve our business strategy, we continue to look for economically viable opportunities to expand our business within our existing markets, expand our current service territory and develop new product initiatives. We also are, however, evaluating various strategic alternatives, which may include entering new lines of business or markets, exiting existing lines of business or markets and/or disposing of assets depending on various factors, including changes in our business and regulatory environment, competitive position and financial resources. We also continue to rationalize our operations to make sure that our ongoing business is profitable. To the extent that we expand our current service territory or product offerings, we expect to generate additional revenues. On the other hand, if we decide to exit certain markets, as we did during 2008, our revenues could decrease.
We currently anticipate that our revenues and medical benefits expenses for 2008 and 2009 will be higher than in prior periods due to the changes in the numbers and demographic mix of membership principally occurring in our Medicare Advantage plans and Ohio Medicaid market, and, effective in 2009, in Hawaii. As the composition of our membership base continues to change as the result of programmatic, competitive, regulatory, benefit design, economic or other changes, we expect a corresponding change to our premium revenue, costs and margins which may have a material adverse effect on our cash flow, profitability and results of operations.
To the extent that our encounter data is inaccurate or incomplete, we may incur additional costs to collect or correct this data and could be exposed to regulatory risk for noncompliance. The accurate and timely reporting of encounter data is crucial to the success of our programs because more states are using encounter data to determine compliance with performance standards which are partly used by such states to set premium rates. As states increase their reliance on encounter data, our inability to obtain complete and accurate encounter data could significantly affect the premium rates we receive and how membership is assigned to us, which could have a material adverse effect on our results of operations, cash flows and our ability to bid for, and continue to participate in, certain programs.
For purposes of our Medicaid segment, we define our customer as the state and related governmental agencies that have common control over the contracts under which we operate in that particular state. In our Medicaid segment we have two customers from which we received 10% or more of our Medicaid segment premium revenue for 2006 and 2007: the State of Florida and the State of Georgia.
Medicare is a federal program that provides eligible persons age 65 and over and some disabled persons a variety of hospital, medical insurance and prescription drug benefits, and is administered and funded by CMS. For a more detailed description of our Medicare segment, please see “Item 1 - Business - Our Segments.” As of December 31, 2007, we had approximately 1,141,000 Medicare members. The following table summarizes our Medicare segment membership by line of business as of December 31, 2007, 2006, 2005 and 2004.
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. PFFS beneficiaries can join a 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 CCPs or PPOs can join a plan with Part D coverage or forego Part D coverage.
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. 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.
Medical benefits expense has two main components: direct medical expenses and medically-related administrative costs. Direct medical expenses include amounts paid to hospitals, physicians and providers of ancillary services, such as laboratory and pharmacy. Medically-related administrative costs include items such as case and disease management, utilization review services, quality assurance and on-call nurses. Medical benefits payable represents amounts for claims fully adjudicated awaiting payment disbursement and estimates for incurred, but not yet reported claims (“IBNR”).
The medical benefits payable estimate has been and continues to be the most significant estimate included in our financial statements. We historically have used and continue to use a consistent methodology for estimating our medical benefits expense and medical benefits payable. Our policy is to record management’s best estimate of medical benefits payable based on the experience and information available to us at the time. This estimate is determined utilizing standard actuarial methodologies based upon historical experience and key assumptions consisting of trend factors and completion factors using an assumption of moderately adverse conditions, which vary by business segment. These standard actuarial methodologies include using, among other factors, contractual requirements, historic utilization trends, the interval between the date services are rendered and the date claims are paid, denied claims activity, disputed claims activity, benefits changes, expected health care cost inflation, seasonality patterns, maturity of lines of business and changes in membership.
ultimate claims payment amounts; therefore, we may experience smaller differences between our original estimate of medical benefits payable and the actual claim amounts paid.
Many aspects of the managed care business are not predictable. These aspects include the incidences of illness or disease state (such as cardiac heart failure cases, cases of upper respiratory illness, the length and severity of the flu season, diabetes, the number of full-term versus premature births and the number of neonatal intensive care babies). Therefore, we must rely upon historical experience, as continually monitored, to reflect the ever-changing mix, needs and growth of our membership in our trend assumptions. Among the factors considered by management are changes in the level of benefits provided to members, seasonal variations in utilization, identified industry trends and changes in provider reimbursement arrangements, including changes in the percentage of reimbursements made on a capitation as opposed to a fee-for-service basis. These considerations are aggregated in the trend in medical benefits expense. Other external factors such as government-mandated benefits or other regulatory changes, catastrophes and epidemics may impact medical cost trends. Other internal factors such as system conversions and claims processing interruptions may impact our ability to accurately predict estimates of historical completion factors or medical cost trends. Medical cost trends potentially are more volatile than other segments of the economy. Management is required to use considerable judgment in the selection of medical benefits expense trends and other actuarial model inputs.
The following table provides a reconciliation of the total medical benefits payable balances as of December 31, 2007, 2006, 2005 and 2004:
During 2006, we acquired 100% of the stock of three companies through which we operate our Medicare PFFS business. The purchase price allocated to intangible assets consisted of state licenses in the amount of $4.3 million.
Comparison of Year Ended December 31, 2007 to Year Ended December 31, 2006
Medicaid. For the year ended December 31, 2007, Medicaid segment premium revenue increased $785.4 million, or 41.2%, to $2,691.8 million from $1,906.4 million for the same period in the prior year. The increase in Medicaid segment revenue was primarily due to increases in premium rates in certain markets and a full year of operating in Georgia in 2007 compared to seven months in 2006. Georgia premium revenue for 2007 totaled $1,086.8 million compared to $496.9 million in 2006. The increase also resulted from our entry into the Ohio market in 2007 in which we had revenues of approximately $161.0 million. This increase was partially offset by a decrease resulting from the aggregate membership in the Medicaid segment decreasing slightly by 13,000 members, or 1%, from 1,245,000 members at December 31, 2006 to 1,232,000 at December 31, 2007.
Medicare. For the year ended December 31, 2007, Medicare segment premium revenue increased $933.4 million, or 55.6%, to $2,613.1 million from $1,679.7 million for the same period in the prior year. Growth in premium revenue within the Medicare segment was primarily the result of our PFFS product launch and premium increases associated with the demographic mix of our Medicare Advantage membership. Membership within the Medicare segment grew by 128,000 members, or 12.6%, from 1,013,000 members at December 31, 2006 to 1,141,000 members at December 31, 2007, principally due to the new PFFS product.
* We believe that Medical Benefits Expense as adjusted for the year ended December 31, 2007, is a non-GAAP financial measure because it does not take into account the claims information that has become available as of the date of filing of this 2007 Form 10-K. The most directly comparable GAAP measure is Medical Benefits Expense, which has been determined based on the substantially complete claims information that has subsequently become available as of the date of filing this 2007 Form 10-K. Consequently, the amounts we recorded in accordance with GAAP for medical benefits expense for the year ended December 31, 2007 are based on actual claims paid. The difference between Medical Benefits Expense and Medical Benefits Expense as adjusted, is approximately $92.9 million, or a 1.8% decrease in the MBR. 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 is based on our actuarially-determined estimate, will better facilitate a year over year comparison of our Medical Benefits Expense.
* We believe that Medicare Medical Benefits Expense as adjusted for the year ended December 31, 2007, is a non-GAAP financial measure because it does not take into account the claims information that has become available as of the date of filing of this 2007 Form 10-K. The most directly comparable GAAP measure is Medicare Medical Benefits Expense, which has been determined based on the substantially complete claims information that has subsequently become available as of the date of filing this 2007 Form 10-K. Consequently, the amounts we recorded in accordance with GAAP for Medicare Medical Benefits Expense for the year ended December 31, 2007 are based on actual claims paid. The difference between Medicare Medical Benefits Expense and Medicare Medical Benefits Expense as adjusted, is approximately $53.4 million. Thus, our recorded amounts for Medicare 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 Medicare Medical Benefits Expense as adjusted for the year ended December 31, 2007, which is based on our actuarially determined estimate, will better facilitate a year over year comparison of our Medicare Medical Benefits Expense.
Selling, general and administrative expense. For the year ended December 31, 2007, selling, general and administrative expense increased $270.2 million, or 54.4%, to $766.6 million from $496.4 million for the same period in the prior year. Our selling, general and administrative expense to revenue ratio was 14.2% and 13.7% for the years ended December 31, 2007 and 2006, respectively. The increase in selling, general and administrative expense was primarily due to the costs related to the investigation, investments in information technology, investments in sales and marketing activities, and increased spending necessary to support and sustain our membership growth. Our SG&A expense to revenue ratio increased in 2007 as a result of recording a $50.0 million accrual for our potential liability in connection with the ultimate resolution of the investigation related matters discussed in Notes 3 and 11 to the Consolidated Financial Statements,
Comparison of Year Ended December 31, 2006 (Restated) to Year Ended December 31, 2005 (Restated)
Medicaid. For the year ended December 31, 2006, Medicaid medical benefits expense increased $462.6 million, or 42.3%, to $1,555.8 million from $1,093.2 million for the same period in the prior year. The increase in our Medicaid membership, principally as a result of our Georgia market, accounted for $439.1 million of the increase while increased health care costs and the demographic change in membership accounted for $23.5 million of the increase. For the year ended December 31, 2006, the Medicaid MBR was 81.6% compared to 81.3% for the same period in the prior year. This decline resulted from premium rate increases, changes in the health care utilization pattern of our members and the demographic mix of our members in our 2005 existing markets, partially off-set by the higher medical costs associated with our Georgia launch.
Medicare. For the year ended December 31, 2006, Medicare medical benefits expense increased $939.3 million, or 227.9%, to $1,351.5 million from $412.2 million for the same period in the prior year. The increase was primarily due to the growth in membership, principally as a result of our new PDP business, which accounted for $715.7 million of the increase. Increased health care costs and the demographic change in membership accounted for $223.6 million of the increase. For the year ended December 31, 2006, the Medicare MBR was 80.5% compared to 81.7% for the same period in the prior year.
Comparison of Year Ended December 31, 2005 (Restated) to Year Ended December 31, 2004 (Restated)
Premium revenue. For the year ended December 31, 2005, premium revenue increased $470.4 million, or 34.1%, to $1,848.3 million from $1,377.9 million for the same period in the prior year due to increases in premium revenue in both the Medicaid and Medicare segments, as discussed below. Total membership grew by 108,000 members, or 14.5%, from 747,000 at December 31, 2004 to 855,000 at December 31, 2005.
Medicaid. For the year ended December 31, 2005, Medicaid segment premium revenue increased $300.6 million, or 28.8%, to $1,343.8 million from $1,043.2 million for the same period in the prior year. The increase was primarily due to growth in Medicaid membership, which accounted for $151.2 million, the inclusion of Harmony revenue for the entire year, which accounted for $135.7 million, and increases in premium rates, which accounted for $13.7 million. Aggregate membership in the Medicaid segment grew by 85,000 members, or 12.1%, from 701,000 members at December 31, 2004 to 786,000 at December 31, 2005.
Medicaid. For the year ended December 31, 2005, Medicaid medical benefits expense increased $244.8 million, or 28.9%, to $1,093.2 million from $848.4 million for the same period in the prior year. The membership increase accounted for $167.8 million of the increase. The inclusion of Harmony for the entire year ended December 31, 2005 accounted for approximately $13.3 million of the increase. Increases in health care costs and membership growth accounted for $63.7 million of the year over year change.
Interest expense. Interest expense was $13.6 million and $10.2 million for the years ended December 31, 2005 and 2004, respectively. The increase primarily relates to the additional amount of debt outstanding for the full year of 2005 and higher borrowing costs due to the rising interest rate environment.
Income tax expense. Income tax expense for the year ended December 31, 2005 was $30.3 million with an effective tax rate of 39.0% as compared to $26.9 million with an effective tax rate of 38.8% for the same period in the prior year.
Net income. For the year ended December 31, 2005, net income was $47.4 million compared to $42.4 million for the same period in the prior year, representing an increase of 11.8%. The increase is due to increased revenues generated by our membership growth while maintaining a relatively consistent MBR.
The primary sources of cash for our non-regulated subsidiaries are management fees received from our regulated subsidiaries, investment income and cash received from debt or equity offerings. Our non-regulated subsidiaries’ primary uses of cash include
payment of administrative costs not charged to our regulated subsidiaries for corporate functions, including administrative services related to claims payment, member and provider services and information technology. Other primary uses include capital contributions made by our non-regulated subsidiaries to our regulated subsidiaries and repayment of debt. We refer collectively to the cash and investment balances available in our non-regulated subsidiaries as “unregulated cash” and “unregulated investments,” respectively. “Cash and cash equivalents,” which appears as a line item in our Consolidated Balance Sheet, is the sum of regulated cash and unregulated cash, and “Investments,” which also appears as a line item in our Consolidated Balance Sheet, is the sum of regulated investments and unregulated investments.
At December 31, 2007 and 2006, cash and cash equivalents were $1,008.4 million and $964.5 million, respectively. We also had short-term investments of $253.9 million and $126.4 million at December 31, 2007 and 2006, respectively. Of these short-term investments, $33.8 million and $30.9 million had maturities of 3 to 12 months as of December 31, 2007 and 2006, respectively. As of December 31, 2007 and 2006, 12.3% and 24.1% of our investments were invested in certificates of deposit with a weighted average maturity of 98 days and 133 days, respectively. The annualized tax equivalent portfolio yield for the years ended December 31, 2007 and 2006 was 5.0% and 4.2%, respectively.
On December 31, 2008, three of our Florida regulated subsidiaries declared dividends to one of our non-regulated subsidiaries in the aggregate amount of $105.1 million, two of which were paid on December 31, 2008 and one of which was paid on January 2, 2009. The proceeds from such dividends are not reflected in our unregulated cash balances as of September 30, 2008.
Our senior secured credit facility with Wachovia Bank, as Administrative Agent, and a syndicate of lenders, which has a term loan facility with an outstanding balance of approximately $152.8 million as of December 31, 2008, is currently in default and subject to acceleration by the lenders and, absent acceleration by the lenders, will become due and payable on May 13, 2009. Taking into account, among other things, the increase in our unregulated cash balances as a result of our receipt of the $105.1 million in dividends described above, we currently expect that we will be able to repay in full the outstanding balance under the credit facility when it becomes due. However, we cannot provide any assurances that adverse developments will not arise that impede our ability to repay in full the outstanding balance under the credit facility when it becomes due. In particular, the timing and amount of any potential resolution of pending investigations by the USAO, the Civil Division, the OIG and the State of Florida are uncertain and could materially and adversely affect our ability to meet our near-term obligations, including repayment of the outstanding balance under the credit facility. Also, our ability to repay in full the outstanding balance under the credit facility could be materially and adversely affected if, among other things, Florida regulators were to require certain of our intercompany loan arrangements which total approximately $50 million to be terminated. In addition, there may be other potential adverse developments that could impede our ability to repay in full the outstanding balance under the credit facility.
In addition to our senior secured credit facility, we have other significant near-term cash requirements, principally costs associated with the ongoing investigations. We have incurred, and continue to incur, significant costs associated with the government and Special Committee investigations, including legal, accounting and consulting fees, and employee recruitment and retention costs. As of December 31, 2008, we had spent a cumulative amount of approximately $124.1 million on administrative expenses associated with, or consequential to, the government and Special Committee investigations, including legal fees, accounting fees, consulting fees, employee recruitment and retention costs and similar expenses. Approximately $21.1 million of these investigation related costs were incurred in 2007 and approximately $103.0 million were incurred in 2008. We expect to continue to incur higher than normal costs due to the government and Special Committee investigations. As noted elsewhere we have accrued a liability in the amount of $50.0 million in our financial statements for the year ended December 31, 2007 in connection with the ultimate resolution of these investigations. However, the timing and amount of such costs is uncertain.
As of December 31, 2007, $204.7 million of our $253.9 million in short-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; they carry investment grade credit ratings. Subsequent to December 31, 2007, $198.0 million of the $204.7 million of auction rate securities that we held at the balance sheet date were either sold or had their interest rate reset through a successful auction. As of December 31, 2008, only $61.4 million of our investments were comprised of auction rate securities, as $143.3 million were settled at par subsequent to year-end. 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 January 22, 2009, auctions had failed for $61.4 million of our auction rate securities and there is no assurance that auctions on the remaining auction rate securities in our investment portfolio will continue to succeed. 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 short-term 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 not exist. These developments may result in the classification of some or all of these securities as long-term investments in our consolidated financial statements for the first quarter of 2008 or in other future periods. 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.
Each of our HMO subsidiaries is licensed in the markets in which it operates and is subject to the rules, regulations and oversight by the applicable state department of insurance (“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 capital structure, ownership, financial condition, certain intercompany transactions and business operations. From time to time, each of our plans is selected to undergo periodic examinations and reviews by the applicable state to review our operational and financial assertions.
For the years ended December 31, 2007, 2006, 2005 and 2004 our cash flows from operations are summarized as follows:
During 2005, investing activities consisted primarily of the investment of excess cash generated by operations totaling approximately $18.6 million in various short-term investment instruments. An additional $28.9 million was invested in capitalized assets, which included expansion costs related to our corporate headquarters in Tampa, and investments in technology needed in anticipation of our entry into the Georgia market and PDP product offerings. Additionally, $5.8 million was invested in restricted investment accounts to satisfy the requirements of various state statutes, and $4.9 million was paid in final settlement of the Harmony acquisition.
In 2006, financing activities consisted of proceeds from options exercised totaling $9.0 million and proceeds from our follow-on offering of $22.0 million, partially offset by payments on our credit agreement of $25.6 million.
Also included in financing activities are funds held for the benefit of others, which totaled approximately $113.7 million as of December 31, 2006. These funds are PDP member subsidies and represent pass-through payments from government partners and 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.
In 2004, cash from financing activities was primarily related to our public offerings, which generated net proceeds of $157.5 million. Additionally we obtained $159.2 million from the proceeds of a debt issuance. These proceeds were partially offset by payments made on previous debt facilities totaling approximately $108.8 million.
As discussed above, our senior secured credit facility with Wachovia Bank, as Administrative Agent, and a syndicate of lenders, which has a term loan facility with an outstanding balance of approximately $152.8 million as of December 31, 2008, is currently in default and subject to acceleration by the lenders and will, absent acceleration by the lenders, become due and payable on May 13, 2009. Our senior secured credit facility also included a revolving credit facility that expired in May 2008. Although we are not in payment default, we are in default of a number of covenants contained in the credit agreement, some of which cannot be cured prior to maturity of the senior secured credit facility (such as our entry into intercompany loan transactions that were not effected in compliance with the credit agreement). As of the date hereof, our payment obligations under the credit agreement have not been accelerated and the rate of interest has not been increased. However, we cannot provide any assurance that such obligations will not be accelerated or the rate of interest increased in the future or that the lenders will not exercise other remedies for default.
The term loan and credit facilities are secured by a pledge of substantially all of the assets or our non-regulated entities, which includes the stock of our operating subsidiaries directly held by our non-regulated entities. Interest is payable quarterly, currently at a
Subsequent to our year end, our credit ratings were downgraded. As of the date of this report, our credit ratings are as follows:
At December 31, 2007, we did not have any off-balance sheet financing arrangements except for operating leases as described in the table below.
(1) We are engaged in resolution discussions as to matters under review with the USAO, the Civil Division, the OIG and the State of Florida. Based on the current status of matters and all information known to us to date, we have accrued a liability in the amount of $50,000 in our financial statements for the year ended December 31, 2007 in connection with the ultimate resolution of these matters. However, we cannot provide any assurances regarding the likelihood, timing or terms and conditions of any potential negotiated resolution of pending investigations by the USAO, the Civil Division, the OIG or the State of Florida. Accordingly, the amount has been excluded from the table above.
As a result of our ongoing review of issues identified in the Special Committee investigation, we have determined that certain material weaknesses existed at the Company as of December 31, 2007. Specifically, we have determined that (a) former senior management set an inappropriate tone in connection with the Company’s efforts to comply with the regulatory requirements related to the AHCA contract and Healthy Kids contract that led to a deficiency in the design in our internal controls, and therefore a material weakness existed in a portion of the control environment and control activities components of our internal controls, and (b) former senior management’s failure to ensure effective communications regarding the AHCA contract and Healthy Kids contract with, among others, our Board and certain regulators resulted in a material weakness in the information and communication system. A detailed description of these material weaknesses is provided in “Part II - Item 9A - Controls and Procedures.”
In June 2006, the Financial Accounting Standards Board (the “FASB”) issued FASB Interpretation (“FIN”) No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. FIN 48 requires companies to determine whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. It also provides guidance on the recognition, measurement and classification of income tax uncertainties, along with any related interest and penalties. Previously recorded income tax benefits that no longer meet this standard are required to be charged to earnings in the period that such determination is made. FIN 48 also requires significant additional disclosures. FIN 48 was effective for fiscal years beginning after December 15, 2006. The Company adopted the new standard during the first quarter of 2007 as required. There was no cumulative effect of adopting FIN 48 for 2007.
In April 2008, the FASB issued FASB Staff Position FAS 142-3, Determination of the Useful Life of Intangible Assets (“FSP 142-3”). FSP 142-3 amends the factors to be considered in developing renewal and extension assumptions used to determine the useful life of a recognized intangible asset accounted for under FAS No. 142, Goodwill and Other Intangible Assets. FSP 142-3 is effective for the Company’s fiscal year 2009 and must be applied prospectively to intangible assets acquired after January 1, 2009. Early adoption is not permitted. The Company does not expect the adoption of FSP 142-3 will have a material impact on its Consolidated Financial Statements.
In March 2008, the FASB issued FAS No. 161, Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133” (“FAS 161”). FAS 161 amends and expands the disclosure requirements of FAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“FAS 133”), to require qualitative disclosure about objectives and strategies for using derivatives; quantitative disclosures about fair value amounts and gains and losses on derivative instruments; and disclosures about credit-risk-related contingent features in derivative agreements. FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The Company does not expect that the adoption of FAS 160 will have an impact on its Consolidated Financial Statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“FAS 159”). FAS 159 permits an entity to measure certain financial assets and financial liabilities at fair value. Under FAS 159, entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The pronouncement is effective for fiscal years beginning after November 15, 2007. The Company adopted the new standard during the first quarter of 2008 as required. The Company has evaluated the impact of FAS 159 and does not expect that the pronouncement will have a material impact on the Company’s consolidated financial statements.
In December 2007, the FASB issued FAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51” (“FAS 160”). FAS 160 requires that accounting and reporting for minority interests be recharacterized as noncontrolling interests and classified as a component of equity. The standard is effective for fiscal year 2009 and must be applied prospectively. The Company does not expect that the adoption of FAS 160 will have an impact on its consolidated financial statements.
In September 2006, the FASB issued FAS No. 157, Fair Value Measurements (“FAS 157”). FAS 157 defines fair value, establishes a framework for measuring fair value in GAAP and requires enhanced disclosures about fair value measurements. FAS 157 does not require any new fair value measurements. The pronouncement is effective for fiscal years beginning after November 15, 2007. The guidance in FAS 157 will be applied prospectively with the exception of: (i) block discounts of financial instruments, and (ii) certain financial and hybrid instruments measured at initial recognition under FAS 133, which are to be applied retrospectively as of the beginning of initial adoption (a limited form of retrospective application). The Company adopted the new
standard during the first quarter of 2008 as required. The Company has evaluated the impact of FAS 157 and does not expect that the pronouncement will have a material impact on the Company’s consolidated financial statements.