Our executive offices are located in Rye Brook, New York. Marketing and professional staff for our U.S. insurance subsidiaries occupy space in Lake Mary, Florida and Solon, Ohio. Our Administrative Services operations occupy office space in Pensacola and Weston, Florida. Our Medicare Advantage operations occupy office space in Houston, Beaumont and Dallas, Texas, as well as Oklahoma City, Oklahoma and Milwaukee, Wisconsin. Our Part D operations occupy space in Solon, Ohio and Pensacola, Florida. We lease over 450,000 square feet of office space. Management considers its office facilities suitable and adequate for the current level of operations. In addition to the above, Pennsylvania Life is the named lessee on over 40 properties occupied by career agents for use as field offices. Rent for these field offices is reimbursed by the agents. Additional information regarding our lease obligations is included in Note 17-Commitments and Contingencies in our consolidated financial statements included in this Annual Report on Form 10-K.
The table below provides selected financial data and other operating information as of and for the five fiscal years ended December 31, 2008. We derived the selected financial data presented below for the five fiscal years ended December 31, 2008 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 statements and the notes to those consolidated financial statements as well as the discussion under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations."
We report inter-segment revenues and expenses on a gross basis in each of the operating segments but eliminate them in the consolidated results. These inter-segment revenues and expenses affect the amounts reported on the individual financial statement line items, but we eliminate them in consolidation and they do not change income before taxes. The significant items eliminated are
•interest on notes payable or receivable between the Corporate segment and the other operating segments.
differ materially from these estimates. We periodically evaluate our estimates, and as additional information becomes available or actual amounts become determinable, we may revise the recorded estimates and reflect them in operating results. We believe that the following accounting policies are critical, as they involve the most significant judgments and estimates used in the preparation of our consolidated financial statements:
The following table presents a summary of our policy-related liabilities by category:
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
We use the completion factor method for the months of incurred claims prior to the most recent three months because the historical percentage of claims processed for those months is at a level sufficient to produce a consistently reliable result. Conversely, for the most recent three months of incurred claims, the volume of claims processed historically is not at a level sufficient to produce a reliable result, which therefore requires that we examine historical trend patterns as the primary method of evaluation. Because cumulative claims payment development often fluctuates widely close to the incurral date of claims, estimates for the most recent three months of incurred claims are based largely on our pricing assumptions for the product. The amounts above reflect the estimated potential medical and other expenses payable based upon assumptions used in determining the loss ratio for the pricing of our PFFS products.
The claim reserve balances at December 31, 2007 ultimately settled during 2008 for $44.8 million less than originally estimated, representing 2.4% of the incurred claims recorded in 2007. The majority of the favorable development of 2007 claim reserves resulted from our Senior Managed Care-Medicare Advantage segment, including $35.2 million relating to our PFFS business and $6.9 million relating to our HMO business. The actual claims trends were lower than the original estimate of trend factors as a result of:
•limited historical information from which to base trend rate estimates at December 31, 2007, due to the rapid growth in our PFFS product in new geographic areas.
Additionally, our original estimate of the completion factors used to establish reserves at December 31, 2007, which were based upon historical patterns, were lower than the actual pattern that emerged during 2008. The actual patterns reflect a shortening of the cycle time associated with provider claim submissions and changes in claim payment and recovery patterns associated with continued enhancements made in our claims processing functions for our PFFS product.
We have adjusted for the favorable historical trend and completion factor experience together with our knowledge of recent events that may impact current trends and completion factors when establishing our reserves at December 31, 2008. However, based on our historical experience, it is reasonably likely that our actual trend and completion factors may vary from the factors used in our December 31, 2008 estimates. Any future variances are expected to be within the ranges presented in our sensitivity analysis table.
The liability for unpaid claims, which also reflects IBNR, reflects 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 periodically review amortizing intangible assets whenever adverse events or changes in circumstances indicate the carrying value of the asset may not be recoverable. In assessing recoverability, we must make assumptions regarding estimated future cash flows and other factors to determine if an impairment loss may exist, and, if so, estimate fair value. If these estimates or their related assumptions change in the future, we may be required to record impairment losses for these assets. There were no impairment losses relating to our amortizing intangible assets during 2008.
(2)Change in goodwill was due to impairment. See discussion below. The goodwill impairment test follows a two step process as defined in SFAS 142. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. This allocation is similar to a purchase price allocation performed in purchase accounting. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss shall be recognized in an amount equal to that excess.
The fair value for the majority of our fixed maturity and equity securities is determined by market prices supplied by third party pricing services. 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 prepayment 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 Part I, Item 3, Quantitative and Qualitative Disclosures About Market Risk, for a discussion regarding the interest rate sensitivity of our investment portfolio.
SFAS No. 157, Fair Value Measurements, known as SFAS 157, requires all publicly-traded companies in the U.S. to classify their assets based on the certainty with which fair values can be calculated into three asset categories: Level 1, Level 2 and Level 3. Level 1 assets are the easiest to value accurately based on standard market-based prices and Level 3 are the most difficult. We have analyzed the third party pricing services valuation methodologies and related inputs, and have also evaluated the various types of securities in our investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Based on the results of this evaluation and investment class analysis, we classified most securities that had prices provided by third party pricing services into Level 2 because the inputs used in pricing the securities are market observable.
Due to a general lack of transparency in the process that brokers use to develop prices, we classify most securities that have prices that are based on broker's prices as Level 3. We also classify internal model priced securities, primarily consisting of private placement asset-backed securities, as Level 3 because this model pricing reflects significant non-observable inputs. We classify private placement equity securities as Level 3 due to the lack of observable inputs.
Our accounting policy requires that we assess a decline in the value of a security below its cost or amortized cost basis to determine if the decline is other-than-temporary. If we deem the security to be other-than-temporarily impaired, we record a charge in net realized capital losses equal to the difference between the fair value and cost or amortized cost basis of the security. The fair value of the other-than-temporarily impaired investment becomes its new cost basis. We have a security monitoring process overseen by our Investment Committee, consisting of investment and accounting professionals that identify securities that, due to specified characteristics, as described below, we subject to an enhanced analysis on a quarterly basis.
Each quarter, during this analysis, we assert our intent and ability to retain until recovery those securities we judge to be temporarily impaired. Once identified, we restrict trading on these securities 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 are the deterioration in the issuer's creditworthiness, a change in regulatory requirements or a major business combination or major disposition.
We hold securities with exposure to subprime residential mortgages. Subprime mortgage lending is the origination of residential mortgage loans to customers with weak credit profiles. The slowing U.S. housing market, greater use of mortgage products with low introductory interest rates, generally referred to as "teaser rates," and relaxed underwriting standards for some originators of subprime loans have led to higher delinquency and loss rates, especially with regard to securities issued in 2006 and 2007 that are collateralized by interests in mortgages originated in 2006 and 2007. These factors combined with heightened capital constraints on financial institutions have caused a significant reduction in market liquidity and repricing of risk, which has led to a decrease in the market valuation of these securities sector wide.
We continuously review our subprime holdings stressing multiple variables, such as cash flows, prepayment speeds, default rates and loss severity, and 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 21 out of a total of 32 holdings to varying degrees. We expect delinquency and loss rates in the subprime mortgage sector to continue to increase in the near term but at a decreasing rate. 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. We utilize third party pricing services to provide or estimate market prices. The major inputs used by third party
The following table summarizes, on a pre-tax basis, our other-than-temporary impairments recorded since the subprime deterioration began last year:
We continue to review the estimated fair values indicated by pricing provided by the third party pricing services. However, we cannot give assurance that there will be no further impairments on these securities, until the market as a whole stabilizes. However, we believe that we will recover principal and interest greater than the market prices currently indicate on the subprime and other structured securities.
Medicare is a federal program that provides persons age 65 and over and some disabled persons under the age of 65 hospital and medical insurance benefits. Hospitalization benefits are provided under Part A, without the payment of any premium, for up to 90 days per incident of illness plus a lifetime reserve aggregating 60 days. Eligible beneficiaries are required to pay an annually adjusted premium to the federal government to be eligible for physician care and other services under Part B. Beneficiaries eligible for Part A and Part B coverage under traditional Medicare are still required to pay out-of-pocket deductibles and coinsurance. Prescription drug benefits are provided under Part D. The Centers for Medicare and Medicaid Services, known as CMS, an agency of the United States Department of Health and Human Services, administers the Medicare program. We contract with CMS under the Medicare Advantage program to provide a comprehensive array of health insurance benefits including wellness programs to Medicare eligible persons under HMO, PPO, PFFS and stand-alone Part D plans in exchange for contractual payments received from CMS, usually a fixed payment per member per month.
We analyze the membership for our Medicare Part D, HMO, PFFS and PPO plans in our administrative system and reconcile to the enrollment provided by CMS. Our revenues and claims expense are based on the enrollment information provided by CMS. 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. Additionally, the monthly payments from CMS include adjustments to reflect changes in membership as a result of retroactive terminations, additions or other changes. Current period revenues are adjusted to reflect retroactive changes in membership.
The remaining 280,000 will continue under our Prescriba RxSM PDP, our successor to Prescription PathwaySM, under which we will participate on a 100% basis in the plan. In connection with our acquisition of MemberHealth on September 21, 2007, we began providing Part D benefits through Community CCRx PDP. Our Medicare contracts with CMS renew annually.
Our PDPs receive monthly payments from CMS and members which generally represent our bid amount for providing insurance coverage. The payments from CMS reflect the health status of the beneficiary and risk sharing provisions, as discussed below. We recognize premium revenue for providing this insurance coverage during each month in which members are entitled to benefits.
Our CMS payment is subject to risk sharing through the Medicare Part D risk corridor provisions. The risk corridor provisions permit our PDPs and CMS to share the risk associated with the ultimate costs of the Part D benefit. The risk corridor provisions compare a plan's actual prescription drug costs, known as actual allowable costs, to their targeted costs, as reflected in their bids ("target amount') and could result in positive or negative adjustments to the CMS payment, that are reported through premium revenues. Variances exceeding, or below, thresholds may result in CMS making additional payments to us, or requiring us to refund to CMS a portion of the payments we received. Actual allowable costs subject to risk sharing with CMS are limited to the costs that are, or would have been, incurred under the CMS defined "standard" benefit plan. We estimate and recognize an adjustment to premium revenues related to the risk corridor payment, at the contract level, based upon prescription drug claims experience to date, net of manufacturer rebates and other Part D revenues, at the end of each reporting period. Accordingly, this estimate does not consider future prescription drug claims experience. We record a receivable or payable in the consolidated balance sheets based on the expected settlement. The estimate of the settlement associated with risk corridor provisions requires us to consider factors that may not be certain, including, among others, member eligibility differences with CMS.
In order to allow plans offering enhanced benefits the maximum flexibility in designing alternative prescription drug coverage, CMS provided a demonstration payment option in lieu of the reinsurance subsidy for plans offering enhanced coverage, or coverage beyond CMS's defined standard benefits. The demonstration payment option is an arrangement in which CMS pays a capitation amount to a plan for assuming the government's portion of prescription drug costs in the catastrophic layer of coverage. The capitation amount represents a fixed monthly amount per member to provide prescription drug coverage in the catastrophic layer. We chose the demonstration payment option for all of our enhanced benefit plans. This capitation amount, derived from our annual bid submissions, is recorded as premium revenue. The variance between the capitation amount and actual drug costs in the catastrophic layer is subject to risk sharing as part of the risk corridor settlement.
Settlement of the reinsurance and low-income cost subsidies as well as the risk corridor payment is based on a reconciliation made by CMS approximately 9 months after the close of each calendar year. This reconciliation process requires us to submit claims data necessary for CMS to administer the program. In October 2008, we received the reconciliation settlement data from CMS for the 2007 Plan year. These amounts were settled on a preliminary basis in the fourth quarter. However, the Company has requested a reopening of the 2007 Plan year. The Company does not expect any reopening to have a material impact on the consolidated financial statements. In October 2007, we received the reconciliation settlement data from CMS for the 2006 Plan year. These amounts were settled on a preliminary basis in the fourth quarter of 2007. However, CMS reopened the 2006 Plan year which resulted in the settlement of additional amounts for that Plan year in June 2008. The reopening did not have a material impact on the consolidated financial statements.
At December 31, 2008, the remaining balance due from CMS for both plans for the 2008 Plan year was approximately $547 million, including approximately $529 million for reinsurance and low-income cost subsidies and $18 million for the risk corridor. At December 31, 2008, the total due from CMS for both plans for the 2007 Plan year was approximately $103 million, including approximately $86 million for reinsurance and low-income cost subsidies and $17 million for the risk corridor. The Company received payment of $80 million for a reopening of the 2007 Plan year on January 2, 2009 and continues to work with CMS to settle the remaining amounts for the 2007 Plan year. At December 31, 2007, the total due from CMS from both plans for the 2007 Plan year was approximately $451 million, including approximately $406 million for reinsurance and low-income cost subsidies and $45 million for the risk corridor. At December 31, 2007, the remaining balance due to CMS from both plans for the 2006 Plan year was approximately $23 million, including approximately $12 million for reinsurance and low-income cost subsidies and $11 million for the risk corridor.
Through our insurance subsidiaries American Progressive, Pyramid Life and Marquette we offered our PFFS products in 47 states in 2008, up from 35 states at December 31, 2007. As of December 31, 2008, our enrollment in PFFS plans has decreased to approximately 186,200 members, compared with 190,000 members at December 31, 2007.
In late 2007, we began efforts to cultivate provider relationships to establish Medicare Advantage preferred provider organizations, known as PPOs. In December 2007, we advised CMS of our intent to market PPO products and received approval from CMS to launch PPO plans in 9 states, across 15 markets. Marketing for these PPO plans began on October 1, 2008. We continue to cultivate provider relationships across additional states and markets, with the anticipation of filing several more markets with CMS in first quarter 2009 for the 2010 benefit year.
Effective January 1, 2006, private insurers were permitted to sponsor insured stand-alone PDPs pursuant to Part D, which was established by the Medicare Modernization Act. The federal government
Subsequent to December 31, 2007, we determined that expected operating income for 2008 from the MemberHealth business, which we acquired in September 2007, will be less than previously forecast. The reason for the decline in expected income is that premium payments to MemberHealth will be lower than anticipated based upon the bids submitted to, and later accepted by CMS from
MemberHealth in June 2007 for its 2008 Part D plans. The premium payments are lower primarily as a result of incorrect information concerning the risk scores in the MemberHealth bids. In accounting for the issue relating to the 2008 bids, we recorded an acquisition liability of $39.2 million for the below-market contract that we are amortizing into income over the contract period, January 1, 2008 to December 31, 2008. We reflected this amortization in direct premium and policyholder fees earned in the consolidated statements of operations. See Note 3 of notes to consolidated financial statements for further discussion.
We also discovered after December 31, 2007 that MemberHealth incorrectly calculated its expected risk corridor receivable in its first quarter 2007 financial statements, resulting in an overstatement of their pre-tax income for the first quarter of 2007 of approximately $26 million. We adjusted the pro forma financial information in our financial statements for the year ended December 31, 2007 included in our filed Annual report on Form 10-K, to reflect the impact of this error, through an adjustment to purchase GAAP accounting, which reduced receivables and increased goodwill by $23 million, the after-tax amount of the misstatement.
During the third quarter of 2008, we performed the final purchase accounting for the MemberHealth acquisition, adjusting the purchase price allocation to reflect the final values. The adjustments posted increased goodwill by $7.9 million, primarily as a result of two significant items, the final 2007 CMS risk score adjustment and the 2007 final CMS prescription drug event reconciliation, as discussed below.
The final 2007 plan year reconciliation could not be completed until CMS finalized the membership eligibility data, the prescription drug event data, the plan to plan membership reconciliation and the risk score adjustments. CMS finalized the risk score adjustment in July 2008, the prescription drug event data submission deadline was July 31, 2008, CMS completed the Phase III or final plan to plan membership reconciliation in September 2008 and we received the final reconciliation for the 2007 Plan year in October 2008. After the receipt of this finalized information, we reconciled the amount due to CMS. We performed the reconciliation for the pre-acquisition and post-acquisition periods to capture the portion of the adjustment impacting the opening purchase GAAP balance sheet. Based on the reconciliation, we determined that the CMS receivable as of the date of acquisition was overstated by approximately $10.3 million, and that the receivable relating to post-acquisition activity was understated by approximately $2.0 million. We recorded the pre-acquisition amount, net of
After giving effect to the settlement and the final allocation adjustments discussed above, the excess of the purchase price over the fair value of net tangible assets acquired, adjusted for deferred income taxes, was approximately $607.6 million.
We expect the MemberHealth transaction to create significant strategic benefits, including the opportunity for us to build upon MemberHealth's successful pharmacy-centric business model through its ongoing alliance with the National Community Pharmacists Association, known as the NCPA, and to introduce additional value-oriented health products and services into the market.
To fund the cash required to close the transaction and to provide us with capital to support our organic growth, investment funds operated by Lee Equity Partners, LLC, Perry Capital, LLC, Union Square Partners Management, LLC, the successor to Capital Z Management, LLC, and Welsh, Carson, Anderson & Stowe X, L.P., acquired shares of our Series A and Series B preferred stock valued at $20 per equivalent share of our common stock. These funds invested a total of approximately $350 million, of which they funded $100 million in the second quarter of 2007, and the remainder effective September 21, 2007. The preferred stock is convertible into shares of our common stock and does not bear a dividend. See Note 8-Stockholders' Equity to the consolidated financial statements included elsewhere in this annual report on Form 10-K, for additional information regarding the preferred stock. We did not register the preferred stock under the Securities Act of 1933, as amended, and it may not be subsequently offered or sold by investors in the United States absent registration or an applicable exemption from the registration requirement.
(1)We evaluate the results of operations of our segments based on income before realized gains and income taxes. We believe that realized gains and losses are not indicative of overall operating trends. This differs from generally accepted accounting principles, which reflects 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 2008 was $95.1 million, or $1.08 per diluted share, compared to $84.1million, or $1.18 per diluted share for 2007. Net income for 2008 reflects realized investment losses, net of tax, of $38.8 million, or $0.44 per diluted shares, relating primarily to the recognition of other-than-temporary impairment of some of our securities with exposure to subprime mortgages, other structured securities and corporate securities . Income from continuing operations for 2007 reflects 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 some of our securities with exposure to subprime mortgages.
Our Medicare Part D income increased by $10.6 million, compared to the year ended December 31, 2007. We acquired MemberHealth on September 21, 2007 and our results for the year ended December 31, 2008 reflect income of $89.4 million on MemberHealth's business, which is an increase of $26.1 million over the prior year period. This was partially offset by a decrease in year to date earnings on Prescription PathwaySM business of $15.5 million compared with the prior year period, primarily as a result of increases in prescription drug costs and the impact of the government risk corridor.
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. In connection with issues that arose in 2008 with respect to the MemberHealth transaction, in March 2008, we concluded a settlement agreement under which the sellers of MemberHealth delivered to us 2,027,071 shares of our common stock.
Our senior managed care-Medicare Advantage segment generated segment income of $52.7 million in 2007, an increase of $42.2 million compared to 2006, resulting primarily from growth in business due to our expansion of PFFS plan offerings from 500 counties in 15 states to 3,100 counties in 47 states.
Our traditional insurance segment income decreased by $21.7 million, or 61%, compared to 2006. Results for our Medicare supplement business declined by $9.7 million compared to 2006 primarily as a result of a lower level of in force business as a result of the effect of higher levels of lapsation of our Medicare supplement in force business in 2007 and 2006 and an increase in our Medicare supplement medical loss ratio. A significant portion of the lapsation was attributable to Medicare supplement policyholders who switched to our PFFS coverage. Our specialty health insurance income decreased by $6.3 million, or 62%, compared to 2006, primarily as the result of increased medical costs and an increase in the amortization of deferred costs in 2007 compared to 2006, partially offset by higher net investment income. Income from our life insurance and annuity business declined by $4.1 million, compared to 2006, primarily as a result of higher commissions and general expenses.
Our Senior Managed Care-Medicare Advantage segment generated segment income before taxes of $94.6 million in the year ended December 31, 2008, an increase of $41.9 million compared to 2007, primarily due to growth in HMO and PFFS member months, $35.2 million of net positive 2007 development in our PFFS business, $6.9 million of net positive 2007 development in our HMO business and improved PFFS and HMO medical loss ratios, partially offset by false claims of $18.9 million submitted by fictitious providers in our PFFS business, lower investment income due to declining short term interest rates and $12.3 million of start-up costs mainly associated with the establishment of our PPO networks.
Benefits, Claims and Expenses. Medical expenses increased by $112.0 million, or 28%, compared to 2007. Growth in Medicare membership added approximately $104.7 million and growth in commercial business added $11.8 million which was offset by $4.4 million due to a decrease in utilization of member benefits. The member benefit ratio for the HMOs decreased to 76.3% for 2008, from 77.6% for 2007, as a result of $6.9 million of positive prior period reserve development, a $4.1 million 2007 risk score adjustment recorded during the year and a decrease in utilization of member benefits. Commissions and general expenses, while increasing $16.0 million compared to 2007,
Expenses. Commissions and general expenses amounted to $12.3 million in 2008 due to the costs of establishing provider networks in preparation for our initial launch of PPO plans in 2009.
On September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held pharmacy benefits manager, or PBM, and sponsor of Community CCRxSM, a national Medicare Part D plan with 1.2 million members. Prior to the acquisition, MemberHealth was a leading national Medicare Part D sponsor, offering Medicare prescription drug plans in 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. MemberHealth, Inc. had more than 60,000 pharmacies in its pharmacy network and covered 98 of the top 100 medications taken by Medicare beneficiaries.
Other Part D income-PDMS represents our equity in the earnings 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 reported to CMS. As discussed above and at Note 21 of the notes to the consolidated financial statements, this strategic alliance was terminated, effective December 31, 2008. For consolidated reporting, we reflect this amount as a separate line following income from continuing operations. See the reconciliation of segment revenues in Note 22 of the notes to the consolidated financial statements in this quarterly report on Form 10-K.
Revenues. Direct and assumed premium after risk corridor adjustment increased by $1,261.1 million, or 151%, compared to the prior year period. This growth resulted primarily from the inclusion of a full year of business for MemberHealth which generated $1,542.8 million of direct and assumed premium for the year ended December 31, 2008 compared to $398.2 million in the three months after acquisition in 2007. The MemberHealth premium reflects $39.2 million of amortization of the below market contract liability recorded in connection with the MemberHealth acquisition. The change in the government risk corridor adjustment increased revenue by an additional $122.8 million compared to the year ended December 31, 2007. The government risk corridor adjustment from MemberHealth for the year ended December 31, 2008 was an increase in revenues of $13.3 million, which was an increase of $93.4 million over the prior year as we acquired MemberHealth on September 21, 2007. The government risk corridor adjustment from our Prescription PathwaySM business decreased revenue $1.4 million for the year ended December 31, 2008 compared to a decrease of $33.4 million for the same period in 2007. The 2008 revenues reflect a $3.9 million reduction related to the final 2007 CMS PDE reconciliation for Prescription PathwaySM business.
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 participated, 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 reflects approximately 1,164,000 members enrolled in our Community CCRxSM PDP.
During the third and fourth quarters of 2007, there were changes in estimates associated with our 2006 Medicare Part D reconciliations. These were mainly a result of additional submissions of prescription drug event or 'PDE' data to CMS, and finalization of the 2006 membership adjustments between plans. This additional information affected our estimates of selected subsidies from CMS and claims we pay for which we assume little or no risk, including reinsurance payments and low-income cost subsidies with a resulting impact on the risk corridor calculation for 2006. The net impact, after our 50% quota share reinsurance from PharmacareRe, was $0.8 million and $0.9 million in the third and fourth quarter, respectively.
Benefits, Claims and Expenses. Pharmacy benefits increased by $213.3 million compared to 2006. The MemberHealth business generated $194.6 million of benefits since its acquisition, while benefits for our Prescription PathwaySM business increased by $18.7 million or 8.7% over 2006. During the second quarter of 2007, CMS clarified their guidance regarding the treatment of DIR relative to catastrophic reinsurance claims. Previously, only rebates were netted against the claim costs that were subject to the government's catastrophic reinsurance. Pursuant to the new guidance, other DIR must also be netted against those claim costs to determine the amount the government will cover. With respect to Prescription PathwaySM business, this increased claims costs, net of our 50% quota share reinsurance, by approximately $7.0 million, including $5.8 million relating to 2006. The increase in claims costs was partially offset by an increase in the risk corridor adjustment. The clarification of the CMS guidance added approximately $7.0 million, net of our 50% quota share reinsurance with respect to the Prescription PathwaySM business. Additionally, changes in estimates associated with our 2006 Medicare Part D reconciliations resulted in a reduction of benefits by $14.9 million, net of our 50% quota share, with the balance of the increase due to an increase in membership. The ratio of incurred prescription drug benefits to net premium for 2007 was 73.8% compared to 87.4% for 2006. Commissions and general expenses increased by $63.0 million, compared to 2006. MemberHealth added $56.0 million since its acquisition. The balance of the increase of $7.0 million relates to the growth in our Prescription PathwaySM business.
Our Traditional Insurance segment income before taxes decreased by $9.3 million compared to 2007, due to $3.9 million impairment of goodwill and lower earnings on specialty health and life insurance and annuity businesses, partially offset by increased earnings on Medicare supplement business. The declines were primarily due to lower investment income. The overall loss ratio for the segment was 76.8% for 2008, compared with 75.3% for last year. Individual loss ratios for 2008 were 75.2% for Medicare supplement, compared with 73.4% for last year, due to higher skilled nursing facility claims and aging of the business; 91.7% for specialty health, compared with 90.1% for last year and 65.8% for life and annuity, compared with 67.1% for last year.
Revenues. Net premium declined by $66.3 million or 13%, and was primarily caused by the continued effect of higher lapsation of our Medicare supplement in force products. Below is a summary of premium for the segment by major lines of business:
Benefits, Claims and Expenses. Policyholder benefits incurred declined by $40.4 million, or 11%, compared to 2006. Overall loss ratios for the segment increased to 75.3% for 2007 compared to 73.4% for 2006. The decline in benefits was principally caused by a reduction in Medicare supplement benefits of $41.5 million as a result of a decline in the business partially offset by an increase in the Medicare supplement loss ratio that increased benefits by $2.8 million compared to 2006.
The ratio of commissions to gross premiums decreased to 9.4% for 2007, from 10.9% for 2006, as a 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 9.2% for 2007, compared to 10.4% for 2006 as a result of lower acquisition expenses due to lower new business production and lower fixed costs. Commission and expense allowances received from reinsurers as a percentage of the premiums ceded decreased to 8.4% for 2007 from 10.1% for 2006, primarily due to the reduction in new business ceded and the effects of normal lower commission allowances on our aging base of ceded renewal business.
Unaffiliated revenue reflects fees received to administer selected business of our insurance subsidiaries that is 100% reinsured to an unaffiliated reinsurer. These fees amounted to $2.3 million, $2.8 million and $3.2 million for the years ended December 31, 2008, 2007 and 2006, respectively. In 2007 we performed administrative functions for the affiliated PFFS line that the affiliated entities performed directly in 2008. We eliminated these fees, together with the affiliated revenue, in consolidation.
Segment income before taxes for our Senior Administrative Services segment decreased by $2.1 million, or 9%, to $22.0 million for the year ended December 31, 2008, as compared to 2007. This decrease is primarily the result of reduced levels of unaffiliated service fee revenues.
The increase in stock-based compensation resulted primarily from option awards, in the second half of 2007 and the first half of 2008, to officers and other employees approved by the compensation committee.
(1)These obligations include contractual interest and the table reflects scheduled maturities for contractual obligations existing as of December 31, 2008.
(3)Reflects scheduled amortization through final maturity in 2012. The loan payable is floating rate debt, although we pay a fixed rate on $250 million through the use 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, 2008 to all future periods.
(4)Reflects minimum obligations on our data center outsourcing contract, as well as our outsourced administrative service contracts for portions of our HMO business, See "Outsourcing Arrangements" in Part 1, Item 1 of this annual report on Form 10-K. The amount of service provided under the contract and the levels of business administered affect our actual monthly payments; 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.
significantly from the estimates above. We anticipate that our liabilities for policyholder account balances and reserves for future policy benefits totaling $1.4 billion, along with future net premiums, investment income and recoveries from our reinsurers, will be sufficient to fund future policy benefit payments. In addition, we anticipate that our policy and contract claims liability totaling $741.0 million, along with recoveries from our reinsurers, will be sufficient to fund these claim liability payments.
To provide the cash and capital for our insurance company subsidiaries to support our growth and expansion initiatives in Medicare Advantage, we have used the proceeds from the sale of our Canadian operations and proceeds from the issuance of debt, equity and trust preferred securities. There can be no assurance as to our continued ability to access funds though the capital markets to support our growth and expansion initiatives.
Our Heritage and MemberHealth subsidiaries have guaranteed our obligations under the new credit facility. In addition, when a "rating condition" exists whereby we are either no longer rated by S&P or our rating falls below BBB-, this facility is secured by a pledge of substantially all of the equity interests of each of our Heritage Health Systems, American Exchange and MemberHealth subsidiaries. In March 2008, S&P reduced our rating to BB+, which constituted a rating condition that triggered this added security requirement.
Our new credit facility requires us and our subsidiaries to meet specified financial tests requiring that we maintain a minimum consolidated leverage ratio and a minimum risk-based capital. Our new credit facility also contains covenants, which among other things, under specified conditions, limit
Under the terms of the new credit facility, we must make principal repayments quarterly at the rate of $3.5 million per year over a five-year period and a final payment of $308.4 million due upon maturity in September, 2012. The following table shows the schedule of principal payments remaining on the new credit facility as of December 31, 2008:
On January 18, 2007, we requested and received, from the administrative agent for the lenders under the amended credit facility and revolving credit facility, an additional short-term revolving credit facility of $50.0 million. On March 13, 2007, we drew all $50.0 million of the new short-term revolving credit facility. This new short-term revolving credit facility had a maturity date of September 30, 2007 and bore interest at a spread of 75 basis points over the LIBOR rate. The initial rate was 6.1%. On July 18, 2007, we repaid the $50.0 million balance on this revolving credit facility, including accrued interest of $0.3 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 accordance with the adoption of FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities," we do not consolidate the trusts.
In March, 2007, we issued $50.0 million of trust preferred securities at a fixed interest rate of 7.7% pursuant to terms similar to our other trust preferred securities. On December 4, 2007, we exercised our option to redeem all $15.0 million of the trust preferred securities scheduled to mature December 2032.
(1)The rate on this issue is fixed at 7.4% for the first five years. On May 15, 2008 the rate converted to a floating rate equal to LIBOR plus 410 basis points.
We are obligated under lease arrangements for our executive and administrative offices in New York, Florida, Indiana, Texas, Wisconsin, Oklahoma, Ohio and Washington, D.C. Rent expense was $7.1 million for the year ended December 31, 2008, $5.8 million for 2007 and $4.4 million for 2006. Annual minimum rental commitments, subject to escalation, under non-cancelable operating leases (in thousands) are as follows:
In addition to the above, Pennsylvania Life is the named lessee on 43 properties occupied by career agents for use as field offices. The career agents reimburse Pennsylvania Life the actual rent for these field offices. The total annual rent paid by the Company and reimbursed by the career agents for these field offices during 2008 was approximately $4.0 million.
On November 3, 2004, we filed a universal shelf registration statement on Form S-3 with the U.S. Securities and Exchange Commission or the SEC, pursuant to which we may issue common stock, warrants and debt securities from time to time, up to an aggregate offering of $140 million. The registration statement also covered five million shares of common stock that may be offered for sale by Capital Z Financial Services Fund II, L.P., known as Capital Z, then our largest shareholder. The SEC declared the shelf registration statement effective in December 2004.
of proceeds of any specific offering of securities in the prospectus supplement relating to any particular offering.
The aggregate amount that remains available for offering under the 2004 shelf registration statement is $77.2 million as of December 31, 2008.
We anticipate funding the obligations of the parent company and the capital required to grow our business from the following distinct and uncorrelated sources of cash flow within the organization:
Insurance Subsidiaries-Surplus Note, Dividends and Capital Contributions. Cash generated by our insurance company subsidiaries will be made available to our holding company, principally through periodic payments of principal and interest on the surplus note owed to our holding company by our subsidiary, American Exchange. As of December 31, 2008, the principal amount of the surplus note was $5.6 million. The note bears interest to our parent holding company at LIBOR plus 250 basis points. We anticipate that the surplus note will be primarily serviced by dividends from PDMS. American Exchange made principal payments totaling $12.0 million during the year ended December 31, 2008 and $10.0 million during the year ended December 31, 2007 and $12.5 million during the year ended December 31, 2006. American Exchange paid interest on the surplus note of $0.6 million during the year ended December 31, 2008 and $1.9 million during the year ended December 31, 2007 and $2.5 million during the year ended December 31, 2006.
On June 29, 2007 and December 31, 2007, Pyramid issued two $30.0 million surplus notes payable to our holding company. The notes are repayable through annual principal payments beginning March 29, 2009, based on a schedule, provided that capital and surplus are sufficient to maintain risk-based capital levels of 450% or greater. At December 31, 2008, Pyramid's risk-based capital ratio was below 450%. The surplus notes can be pre-paid (with prior approval by the state of Kansas) to the extent that Pyramid's risk-based capital levels exceed 450%. The notes bear interest to our parent holding company at fixed rates of 7.7% and 7.3%, respectively, for the term of the notes.
Our parent holding company made capital contributions to American Exchange amounting to $81.0 million during 2007. American Exchange made capital contributions of $44.0 million to American Progressive, $32.0 million to Pyramid and $5.0 million to Marquette during 2007. In December 2007, Pennsylvania Life declared and paid a dividend in the amount of $21.0 million to American Exchange. American Exchange made a capital contribution of $20.0 million to Pyramid.
Effective January 1, 2009 the NAIC has adopted SSAP No. 98, Treatment of Cash Flows When Quantifying Changes in Valuation and Impairments. SSAP No. 98 effectively changes the impairment trigger from an undiscounted cash flow basis test to a discounted test. In addition, SSAP No. 98 changes the method of valuing the new cost basis of the impaired security from an undiscounted cash flow basis to a fair value basis. Had we adopted SSAP No. 98 on December 31, 2008, we would have recognized an additional $69.3 million of realized losses, pre-tax, for other-than-temporary impairments of investments on a statutory basis, however, the actual impairment recorded will depend upon conditions at the measurement date.
We evaluate the financial condition of our reinsurers and monitor concentrations of credit risk to minimize our exposure to significant losses from reinsurer insolvencies. We are obligated to pay claims in the event that a reinsurer to whom we have ceded an insured claim fails to meet its obligations under the reinsurance agreement. As of December 31, 2008, all of our primary reinsurers were rated "A" or better by A.M. Best, except for PharmaCare Re, which is unrated. We have secured a letter of credit from PharmaCare Re that we believe will adequately support the risks ceded. We do not know of
We file a consolidated life-nonlife return for Federal income tax purposes that reflects all US subsidiaries, as well as Heritage and its subsidiaries and American Exchange and its subsidiaries. At December 31, 2008, the Company had a net operating loss carryforward of approximately $4.4 million that expires in 2025. The use of the net operating loss carryforward is limited to $1.6 million per year under the Internal Revenue Code.
released a deferred tax valuation allowance of $10.4 million that had been recorded in the first quarter of 2008 in connection with other-than-temporary impairments taken in that period.
During 2005, the Company incurred creditable foreign taxes related to dividends from PennCorp Life Canada, its defined previously Canadian subsidiary, generating a foreign tax credit carryforward, for which a deferred tax asset of approximately $0.8 million was established. A valuation allowance for the entire amount was established because the Company lacked sufficient foreign source income to realize the benefit for the foreign tax credit. As foreign source income was generated in 2006, the valuation allowance related to the foreign tax credit carryforward was released.
A summary of 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 captions "Recently Adopted Accounting Standards" and "Future Adoption of Accounting Standards." We do not anticipate any material impact from the future adoption of the pending accounting pronouncements discussed in that note.