Balance Sheet Data includes acquisition balances as of December 31 of the year of acquisition. Operating data includes results of operations of acquisitions from the date of the respective acquisition. See the notes to the consolidated financial statements for information about our acquisitions.
We are a diversified national managed health care company based in Bethesda, Maryland, dedicated to delivering high-quality health care solutions at an affordable price. Coventry provides a full portfolio of risk and fee-based products including Medicare and Medicaid programs, group and individual health insurance, workers’ compensation solutions, and network rental services. Through our Commercial Products, Government Programs, and Workers’ Compensation reportable segments, which we also refer to as “Divisions,” we provide a full range of risk and fee-based managed care products and services to a broad cross section of individuals, employer and government-funded groups, government agencies, and other insurance carriers and administrators.
On August 20, 2012, announced that Coventry and Aetna entered into a definitive agreement pursuant to which Aetna will acquire Coventry in a transaction valued at $7.3 billion, including the assumption of Coventry debt.
Operating revenues of $14.1 billion, an increase of 15.8% from the prior year.
Total membership of 5,362,000, an increase of 597,000 members from the prior year, driven by growth across the Company’s Government Programs business in Medicare Advantage Coordinated Care Plans (“Medicare Advantage CCP”), Medicare Part D, and Medicaid.
Debt to capital ratio of 25.1%, a decrease of 3.6% from the prior year.
On August 19, 2012, we, Aetna Inc. (“Aetna”) and Jaguar Merger Subsidiary, Inc. (“Merger Sub”) entered into an Agreement and Plan of Merger, pursuant to which, subject to the satisfaction or waiver of certain conditions, Merger Sub will be merged with and into us, with the Company surviving the merger as a wholly-owned subsidiary of Aetna (the “Merger”). A copy of the Agreement and Plan of Merger was filed as Exhibit 2.1 to our Current Report on Form 8-K on August 20, 2012. We subsequently entered into Amendment No. 1 and Amendment No. 2 to the Agreement and Plan of Merger, which were filed as Exhibit 2.1 to our Current Reports on Form 8-K filed on October 23, 2012 and November 13, 2012, respectively. As used herein, the “Merger Agreement” means the Agreement and Plan of Merger, by and among Coventry, Aetna and Merger Sub, as amended. Under the terms of the Merger Agreement, our shareholders will receive $27.30 in cash, without interest, and 0.3885 of an Aetna common share for each share of our common stock. The total transaction was estimated at $7.3 billion, including the assumption of our debt, based on the closing price of Aetna common shares on August 17, 2012.
of the Merger Agreement, which represented approximately 78% of our total outstanding shares of common stock as of the October 15, 2012 record date.
The consummation of the Merger is subject to customary closing conditions, including, among others, the absence of certain legal impediments to the consummation of the Merger, the receipt of specified governmental consents and approvals, the early termination or expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, and, subject to certain exceptions, the accuracy of representations and warranties made by us and Aetna, respectively, and compliance by us and Aetna with their respective obligations under the Merger Agreement. The Merger is not expected to close until mid-2013.
We have capitation arrangements for certain ancillary health care services, such as laboratory services and, in some cases, physician and radiology services. A small percentage of our membership is covered by global capitation arrangements. Under the typical arrangement, the provider receives a fixed percentage of premiums to cover costs of all medical care or of the specified ancillary services provided to the capitated members. Under some professional or other capitation arrangements, physicians may also receive additional compensation from risk sharing and other incentive arrangements. Capitation arrangements limit our exposure to the risk of increasing medical costs but expose us to risk as to the adequacy of the financial and medical care resources of the provider organization. We are ultimately responsible for the coverage of our members pursuant to the customer agreements. To the extent a provider organization faces financial difficulties or otherwise is unable to perform its obligations under the capitation arrangements, we may be required to perform such obligations. Consequently, we may have to incur costs in excess of the amounts we would otherwise have to pay under the original global or ancillary capitation through our contracted network arrangements. Medical costs associated with capitation arrangements made up approximately 9.0% of our total medical costs for the year ended December 31, 2012.
We have established systems to monitor the availability, appropriateness and effectiveness of the patient care provided to our members by our network providers. We collect utilization data in each of our markets that we use to analyze over-utilization or under-utilization of services and assist our health plans in arranging for appropriate care for their members and improving patient outcomes in a cost efficient manner. Medical directors also monitor the utilization of diagnostic services. Each health plan collects data showing each physician’s utilization profile for diagnostic tests, specialty referrals and hospitalization and presents such data to the health plan’s physicians. The medical directors monitor these results in an effort to ensure the use of medically appropriate, cost-effective services.
We incur cost of sales expense for prescription drugs provided by our workers’ compensation pharmacy benefit manager, durable medical equipment and for the independent medical examinations performed by physicians on injured workers. These costs are associated with fee-based products.
We generate cash through operations. As a profitable company in an industry that is not capital equipment intensive, we have generally not needed to use external financing to fund operations. Our primary use of cash is to pay medical claims. Any excess cash has been historically used for acquisitions, repayment of debt, dividends to shareholders, and common stock repurchases.
As of December 31, 2012, we maintained allowances for retroactive billing adjustments of approximately $17.5 million, compared with approximately $19.7 million at December 31, 2011. We also maintained allowances for doubtful accounts of approximately $3.3 million and $4.7 million as of December 31, 2012 and 2011, respectively. The decrease from the prior year is primarily due to fewer Commercial risk members in 2012. The calculation for these allowances is based on a percentage of the gross accounts receivable with the allowance percentage increasing for older receivables.
CMS periodically performs audits and may seek return of premium payments made to us if risk adjustment factors are not properly supported by underlying medical record data. We estimate and may record reserves for CMS audits, when necessary, based on information available at the time the estimates are made. The judgments and uncertainties affecting the application of these policies include, among other things, significant estimates related to the amount of HCC revenue subject to audit, anticipated error rates, sample methodologies, confidence intervals, enrollee selection, and payment error extrapolation methodology. Certain of the Company’s health plans may be selected for audit. Although we may establish reserves for our exposure to the risk adjustment data validation (“RADV”) audits, actual results could differ materially from those estimates.
Actuarial standards of practice generally require the actuarially developed medical claims estimates to cover obligations under an assumption of moderately adverse conditions. Adverse conditions are situations in which the actual claims are expected to be higher than the otherwise estimated value of such claims. In many situations, the claims paid amount experienced will be less than the estimate that satisfies the actuarial standards of practice. Medical claims liabilities are recorded at an amount we estimate to be appropriate. Adjustments of prior years’ estimates may result in additional medical costs or, as we experienced during the last several years, a reduction in medical costs in the period an adjustment was made. Our reserve models have historically developed
The negative medical cost amounts noted as “prior year development” are favorable adjustments for claim estimates being settled for amounts less than originally anticipated. As noted above, these favorable developments from original estimates occur due to changes in medical utilization, mix of provider rates and other components of medical cost trends. Medical claim liabilities are generally paid within several months of the member receiving service from the provider. Accordingly, the 2012 prior year development relates almost entirely to claims incurred in calendar year 2011.
The significant favorable / (unfavorable) factors driving the overall favorable prior year development for 2012 include:
Prior year development experienced in 2012 was more favorable compared to amounts experienced in 2011. The higher 2012 favorable development is primarily due to lower than expected medical cost trends for Commercial Risk and Medicare Advantage business at the end of 2011.
Changes in the completion factors, trend factors and utilization factors can have a significant effect on the claim liability. The following example (in thousands, except percentages) provides the estimated effect to our December 31, 2012 unpaid claims liability assuming hypothetical changes in the completion, trend, and inpatient day factors. While we believe the selection of factors and ranges provided are reasonable, certain factors and actual results may differ.
We also establish premium deficiency reserves, if required, for the probability that anticipated future health care costs and contract maintenance costs under our existing provider contracts will exceed anticipated future premiums and reinsurance recoveries, if any, on those contracts. For purposes of premium deficiency reserves, contracts are grouped in a manner consistent with our method of acquiring, servicing and measuring the profitability of such contracts. If established, the premium deficiency reserves would be expected to cover losses until the next policy renewal dates for the related policies. Once established, premium deficiency reserves are released straight-line over the remaining life of the contract. No premium deficiency reserves were established at December 31, 2012 or 2011.
The unrealized losses presented in this table do not meet the criteria for an other-than-temporary impairment. The unrealized losses are the result of interest rate movements. We do not intend to sell and it is not more-likely-than-not that we will be required to sell before a recovery of the amortized cost basis of these securities.
Goodwill is subject to an annual assessment and periodic assessments if other indicators are present for impairment by applying a fair-value-based test. We performed a goodwill impairment analysis at the reporting unit level, as of October 1, our annual impairment test date, and determined that there were no impairments. However, each year we could be required to evaluate the recoverability of goodwill and other indefinite lived intangible assets prior to the required annual assessment if there is any indication of a potential impairment. Those indications may include experiencing disruptions to business, unexpected significant declines in operating results, regulatory actions (such as state exchanges resulting from health care reform) that may affect operating results, divestiture of a significant component of the business or a sustained decline in market capitalization.
Overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results of relevant prior periods;
While we believe we have made reasonable estimates and assumptions, in our quantitative impairment analysis, to calculate the fair values of the reporting units and other intangible assets, it is possible a material change could occur. Under the income approach, we assumed certain growth rates, capital expenditures, discount rates and terminal growth rates in our calculations. If the assumptions used in our fair-value-based tests differ from actual results, the estimates underlying our goodwill impairment tests could be adversely affected.
See Note A, Organization, Summary of Significant Accounting Policies and Significant Events, and Note D, Goodwill and Other Intangible Assets, to the consolidated financial statements for additional disclosure related to our goodwill and other intangible assets, which is incorporated herein by reference.
Also in accordance with ASC Topic 350-30 we review intangible assets that are subject to amortization for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. An impairment loss shall be recognized if the carrying amount of an intangible asset is not recoverable and its carrying amount exceeds its fair value. Our intangible assets that are subject to amortization consist of our customer lists, licenses and provider networks.
During the second quarter of 2012, we were notified of the non-renewal of the State of Kansas Medicaid contract, which we acquired in connection with the acquisition of Children’s Mercy’s Family Health Partners (“FHP”). Accordingly, the current year depreciation and amortization expense includes a $7.7 million impairment charge of the intangibles associated with the non-renewal of this contract. The impairment charge related only to the intangibles assigned to the Kansas business acquired in the FHP acquisition and did not affect the intangibles assigned to the ongoing Missouri business, also acquired in the FHP acquisition. See Note D, Goodwill and Other Intangible Assets, to the consolidated financial statements for additional disclosure related to our goodwill and other intangible assets, which is incorporated herein by reference.
Medicaid Risk membership increased 282,000 compared to December 31, 2011, primarily as a result of the acquisition of FHP, with Medicaid membership in Kansas and Missouri, which was completed in the first quarter of 2012. The Medicaid Risk membership increase is also due to same-store growth in our Missouri market as competitors exited that market, and expansion into new regions in our Nebraska, Pennsylvania and Virginia markets during the third quarter of 2012. This Medicaid Risk membership growth was partially offset by declines in the Kentucky market due to attrition during the open enrollment period in the fourth quarter of 2012. The decrease in Health Plan Commercial Risk membership was due to attrition, in-group changes and certain groups moving from Commercial Risk to Administrative Services Only (“ASO”) products primarily in our Missouri, Florida, Illinois and Pennsylvania markets. This Commercial Risk membership decline was partially offset by continued same-store membership growth in our Georgia market. The increase in Medicare Part D membership of 435,000 reflects the addition of eight auto assign regions in the first quarter of 2012 as well as an increase in product offerings from two in 2011 to three in 2012.
Managed care premium revenue increased from the prior year primarily as a result of the new Medicaid contract with the Commonwealth of Kentucky and the acquisition of FHP. The increase is also due to the growth of Medicare Part D revenue as a result of the addition of eight auto assign regions as well as an increase in Medicare Part D product offerings.
resulting in an increase in operating earnings of $133.0 million. Medicare Advantage revenue also increased as a result of organic membership growth.
Managed care premium revenue also increased from the prior year as a result of minimum medical loss ratio rebate accrual reductions of $36.3 million related to the 2011 plan year based on new guidance on capitated medical contracts issued in 2012 and as a result of increases in the average Commercial realized premium per member per month (“PMPM”). The total managed care premium revenue increases were offset by Commercial membership declines.
The overall Medicaid MLR increased in the current year, from 89.4% to 94.1%, primarily due to higher medical costs associated with the Kentucky Medicaid contract with an MLR of 109.4% in the current year. The MLR associated with Kentucky Medicaid was high primarily due to higher utilization and unit costs, especially in regions with high cost provider systems. Additionally, the Kentucky Medicaid MLR was high due to high utilization in pharmacy and mental health, along with program changes made by the Commonwealth of Kentucky after the initial databook was created, as well as delays by the Commonwealth of Kentucky in the full implementation of risk adjusted revenue. The higher costs are also related to transitioning a highly unmanaged Medicaid population to a managed care environment. Many initiatives to improve care and reduce medical costs including the introduction of member co-pays and changes made to the provider network, along with receiving our previously contracted 5.3% rate increase in October 2012, continue to show progress as seen by the reduction in the Kentucky year to date MLR throughout 2012 from 120.9% as of March 31, 2012 to 109.4% as of December 31, 2012. The Kentucky Medicaid MLR for the fourth quarter of 2012 was 96.7%.
Selling, general and administrative expense, as a percentage of revenue, decreased 1.8% from the prior year primarily as a result of managing headcount and associated costs while continuing to grow operating revenues.
During 2010, the Court of Appeal, Third Circuit for the State of Louisiana entered a decision to affirm the trial court’s decision to grant summary judgment against a wholly-owned subsidiary of Coventry in provider class action litigation in Louisiana state court. On May 27, 2011, a Louisiana state court entered an order of final approval of a provider class action settlement and, accordingly, the Company recorded a non-recurring pretax adjustment that increased earnings of $159.3 million in the second quarter of 2011.
Depreciation and amortization expense was higher during the current year primarily due to the intangible asset impairment associated with the non-renewal of the State of Kansas Medicaid contract. During the second quarter of 2012, we were notified of the non-renewal of the State of Kansas Medicaid contract, which we acquired in connection with the acquisition of FHP.
Medical costs increased as a result of the acquisition of MHP, new Medicaid Risk markets entered during 2011 and 2010, and organic membership growth and medical trends. This was partially offset by the decrease in Medicare Part D membership resulting from the loss of auto assign regions and reduction in product offerings in 2011. The overall total medical costs as a percentage of premium revenue, MLR, increased 2.7% over the prior year to 82.1% from 79.4%. The increase is primarily as a result of the minimum MLR mandates previously described as well as the MLR increases for the Medicare Advantage and Medicaid products, as described in the segment results of operations discussion that follows below. The MLR increase was partially offset by a lower MLR for the Medicare Part D business as a result of improved performance in our basic benefit product in 2011.
Selling, general and administrative expense increased primarily due to the addition of normal operating costs associated with MHP including, but not limited to, salaries and benefits, professional fees and premium taxes. The increase is also due to start-up costs associated with the implementation of the Kentucky Medicaid contract and increased marketing expenses associated with the rollout of expanded Medicare products for 2012. The increase is partially offset by lower legal fees in 2011 as 2010 included incremental legal fees related to the provider class action in Louisiana that were not incurred in 2011. Selling, general and administrative expense as a percentage of operating revenues decreased as a result of the growth in operating revenues in 2011.
Depreciation and amortization expense was lower primarily due to certain assets becoming fully depreciated.
Other income, net increased as income included more realized gains on the sales of investments compared to 2010.
We reorganized the executive management team to better align resources and provide continued focus on areas of future growth. As a result of this reorganization, we realigned our segments during the first quarter of 2012 to reflect the manner in which the chief operating decision maker reviews financial information. As a result, our reportable segments have changed to the following three reportable segments: Commercial Products, Government Programs and Workers’ Compensation.
The year ended December 31, 2012 includes the effect of the RADV reserve release.
Commercial Risk revenue decreased due to lower membership as a result of attrition, in-group changes and certain groups moving from Commercial Risk to ASO products. This decrease was partially offset by minimum medical loss ratio rebate accrual reductions in the current year related to the 2011 plan year of $36.3 million and an increase in the average realized premium PMPM due to renewal rate increases.
Medicare Part D revenue increased due to membership growth as a result of the addition of eight auto assign regions as well as an increase in product offerings from two in 2011 to three in 2012. Including the effect of the CMS risk sharing premium adjustments as well as ceded revenue, the premiums decreased to $83.85 PMPM in 2012, compared to $88.80 PMPM in 2011, primarily due to the addition of a new lower priced premium preferred network product in 2012.
The gross margin increased for the Government Programs Division, primarily driven by the Medicare Advantage RADV audit reserve releases in 2012 as well as increased membership and premium PMPM increases for Medicare Advantage and Medicaid Risk. These increases were offset by a higher Medicaid Risk MLR. The higher Medicaid Risk MLR was driven by high medical costs associated with the Kentucky business. As previously mentioned, the higher costs are related to transitioning a highly unmanaged Medicaid population to a managed care environment. Many initiatives to improve care and reduce medical costs including the introduction of member co-pays and changes made to the provider network, along with receiving our previously contracted 5.3% rate increase in October 2012, continue to show progress as seen by the reduction in the Kentucky incurred year to date MLR throughout 2012 from 120.9% as of March 31, 2012 to 109.4% as of December 31, 2012. The Kentucky Medicaid MLR for the fourth quarter of 2012 was 96.7%.
The Workers’ Compensation Division revenue and gross margin decreased in part due to the loss of a customer account. The revenue decrease is partially offset by increased revenue in our clinical and durable medical equipment programs as a result of higher volumes and service items, respectively.
The gross margin for this Division decreased for 2012 primarily due to lower favorable prior year medical cost development and a decrease in the Medicare PFFS gross margin. The Medicare PFFS product was not renewed effective January 1, 2010. The Medicare PFFS product experienced much more favorable incurred but not reported reserve development during 2010 than in 2011. Additionally, the decrease in gross margin was driven by the Medicare Part D membership losses. These decreases were offset by membership growth in 2011 due to the acquisition of MHP, as well as organic growth in existing markets. The Medicare Advantage MLR and Medicaid MLR increased due to utilization beginning to return to normal levels. Additionally, the Medicaid MLR increased due to higher initial medical costs associated with the new Kentucky business. This is partially offset by improved MLR on the Medicare Part D product. The Medicare Part D MLR was lower as a result of improved performance in our basic benefit product in 2011.
Our cash and investments, consisting of cash, cash equivalents, short-term investments, and long-term investments, but excluding deposits of $71.1 million at December 31, 2012 and $74.0 million at December 31, 2011 that are restricted under state regulations, decreased by $200 million to $4.1 billion at December 31, 2012 from $4.3 billion at December 31, 2011.
costs, debt principal repayments and any other reasonably likely future cash requirements. In addition, our long-term investment portfolio is available for further liquidity needs including satisfaction of policy holder benefits.
Our net cash from operating activities in 2012 increased $69.5 million from 2011. The increase was a result of $150.5 million payment to settle the provider class action litigation in Louisiana paid in the prior year and not repeated in 2012, the timing of prior year subsidy receivables for our Medicare business received from CMS and the receipt of additional deferred revenue in 2012. Partially offsetting these increased inflows was a decrease in accounts payable and other accrued liabilities as a result of payments in 2012 for the 2011 minimum medical loss ratio rebates, higher payments for the annual management incentive and performance compensation programs and adjusted net earnings.
Our net cash from operating activities in 2011 increased $128.9 million from 2010. The increase was primarily a result of the unusually low cash flows due to payments of medical claims liabilities associated with run out of the Medicare PFFS product. The nature of our business is such that premium revenues are generally received in advance of the expected cash payment for the related medical costs. This results in strong cash inflows upon the implementation of a benefit program and cash outflows upon the termination. Partially offsetting these increased inflows in 2011 are the increase in subsidy receivables during 2011 for our Medicare Part D business due from CMS, which we subsequently collected in 2012, and $150.5 million paid to settle the provider class action litigation in Louisiana.
Capital expenditures in 2012 of approximately $89.1 million consisted primarily of computer hardware, software and related costs associated with the development and implementation of improved operational systems. Projected capital expenditures in 2013 of approximately $95 to $105 million consist primarily of computer hardware, software and other equipment.
Net cash from investing activities for the year ended December 31, 2012 was an outflow primarily due to a large amount of investment purchases during the period. This outflow was partially offset by the proceeds received from the sales and maturities of investments.
Cash flows used for investing activities for the year ended December 31, 2011 increased by $751.7 million from the corresponding 2010 period. This increase is primarily due to high investment purchases in 2011, partially offset by higher proceeds received from the sales of investments and fewer payments for acquisitions.
share repurchases without Aenta’s consent, other than share repurchases made in connection with the exercise of stock options and the vesting of restricted stock or other equity awards.
Cash flows used for financing activities for the year ended December 31, 2012 increased by $451.4 million from the corresponding 2011 period. The increase is primarily due to higher net borrowings in 2011 related to the issuance in 2011 of our Senior Notes due June 7, 2021 as well as dividends paid in 2012, which did not occur in 2011.
The majority of states in which we operate health plans have adopted a RBC policy that recommends the health plans maintain statutory reserves at or above the “Company Action Level,” which is currently equal to 200% of their RBC. Statutory-based capital and surplus of our regulated subsidiaries was approximately $2.3 billion and $1.9 billion at December 31, 2012 and 2011, respectively. As of December 31, 2012 and 2011, all of our regulated subsidiaries exceeded the minimum RBC, capital and solvency requirements of the applicable state regulators. The increase in capital and surplus for our regulated subsidiaries primarily resulted from net earnings and, to a lesser extent, capital contributions made by the parent company, partially offset by dividends paid to the parent company.
Some states in which our regulated subsidiaries operate require deposits to be maintained with the respective states’ departments of insurance. Statutory deposits held by our regulated subsidiaries was $71.1 million and $74.0 million at December 31, 2012 and 2011, respectively.
Excluding funds held by entities subject to regulation and excluding our equity method investments, we had cash and investments of approximately $1.2 billion and $1.4 billion at December 31, 2012 and 2011, respectively. The decrease primarily resulted from share repurchases, repayment of our 5.875% Senior Notes in January 2012 at maturity, capital contributions made by the parent to regulated subsidiaries, cash paid for the FHP acquisition and cash dividend payments. This decrease was partially offset by dividends received from our regulated subsidiaries and earnings generated by our non-regulated entities.
The table above does not reflect the timing of cash payments related to income taxes or legal contingencies. As of December 31, 2012, we had $87.5 million of unrecognized tax benefits. The above table excludes these amounts due to uncertainty of timing and amounts regarding future payments.
On June 22, 2011, we entered into a five-year revolving credit facility agreement in the principal amount of $750.0 million. As of December 31, 2012, there were no amounts outstanding under this credit facility. For additional information, refer to Note H, Debt, to the consolidated financial statements, which are incorporated herein by reference.
We have typically paid 90% to 95% of medical claims within six months of the date incurred and approximately 99% of medical claims within nine months of the date incurred. We believe medical claims liabilities are short-term in nature and therefore do not meet the listed criteria for classification as contractual obligations and, accordingly, have been excluded from the table above. For additional information related to our income taxes, operating leases and other contingencies refer to Note N, Income Taxes, and Note O, Commitments and Contingencies, to the consolidated financial statements, which is incorporated herein by reference.
The full effect of any current or future legislation provisions adopted at the state or federal level cannot be accurately predicted at this time. See “Government Regulation” under Part I, Item 1, “Business,” for additional discussion of government regulation that affects our businesses.
Medicaid - On February 11, 2013, the Company announced in its Current Report on Form 8-K, that it has agreed to an amendment with the Commonwealth of Kentucky such that existing rates for each of the contract years remaining under the initial term of the contract were increased by 7%, effective January 1, 2013. In addition, the Commonwealth agreed to accelerate the effective date for the scheduled 2.3% rate increase for the last year of the contract’s initial term from October 1, 2013 to July 1, 2013. The Company’s Medicaid contract with the State of Kansas ended effective January 1, 2013, which represented 151,000 members as of December 31, 2012. As a result of these items, the Company is expecting a sequential improvement in full year MLR results.
In addition, PPACA provides for significant new taxes, including an industry user tax paid by health insurance companies beginning in 2014. The amount of the annual tax for the industry is approximately $8 billion in 2014, $11 billion in 2015 and 2016, $14 billion in 2017 and $14 billion in 2018. For 2019 and beyond, the amount will be equal to the annual tax for the preceding year increased by the rate of premium growth for the preceding year. The annual tax will be allocated based on the ratio of an entity's net premiums written during the preceding calendar year to the total health insurance industry's net premiums written for any U.S. health risk-based products during the preceding calendar year, subject to certain exceptions. This tax will first be paid and expensed in 2014.
PPACA provides for the establishment and operation of state health insurance exchanges by January 1, 2014. Through the state health insurance exchanges there are three programs designed to stabilize the health insurance markets including a transitional
See Part I, Item 1A, “Risk Factors,” in this Form 10-K for more information regarding PPACA.
We have audited the accompanying consolidated balance sheets of Coventry Health Care, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Coventry Health Care, Inc. at December 31, 2012 and 2011, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
On November 21, 2012, the Company’s stockholders voted at the stockholder special meeting to approve the adoption of the Merger Agreement. Of the 104,941,398 shares voting at the special meeting of stockholders, more than 99% voted in favor of the adoption of the Merger Agreement, which represented approximately 78% of the Company’s total outstanding shares of common stock as of the October 15, 2012 record date.
The consummation of the Merger is subject to customary closing conditions, including, among others, the absence of certain legal impediments to the consummation of the Merger, the receipt of specified governmental consents and approvals, the early termination or expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, and, subject to certain exceptions, the accuracy of representations and warranties made by Coventry and Aetna, respectively, and compliance by Coventry and Aetna with their respective obligations under the Merger Agreement. The Merger is not expected to close until mid-2013.
The Company received 34.2%, 32.7% and 35.6% of its managed care premiums for the years ended December 31, 2012, 2011 and 2010, respectively, from the federal Medicare program throughout its various health plan markets and from national Medicare Part D products. The increase in 2012 is primarily due to higher Medicare Part D membership as a result of the addition of eight
Investments - The Company accounts for investments in accordance with the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Topic 320-10, “Accounting for Certain Investments in Debt and Equity Securities,” ASC Topic 320-10, “Accounting for Debt Securities After an Other-than-Temporary Impairment,” and Accounting Standards Update (“ASU”) 2010-6, “Improving Disclosures about Fair Value Measurements.” The Company invests primarily in fixed income securities and classifies all of its investments as available-for-sale. Investments are evaluated on an individual security basis at least quarterly to determine if declines in value are other-than-temporary. In making that determination, the Company considers all available evidence relating to the realizable value of a security. This evidence is reviewed at the individual security level and includes, but is not limited to, the following:
Other Receivables - Other receivables include pharmacy rebate receivables of $305.4 million and $280.5 million at December 31, 2012 and 2011, respectively. Other receivables also include Medicare Part D program related risk share and subsidy receivables (discussed below under “Revenue Recognition”), Medicare risk adjuster receivables, Office of Personnel Management (“OPM”) receivables, interest receivables, and any other receivables that do not relate to premiums. The increase in other receivables during 2012 primarily resulted from the net Medicare Part D subsidy receivables (risk share, reinsurance subsidy, low-income subsidy and coverage gap subsidy) related to the 2012 plan year that we expect to collect when the plan year is settled in 2013. This increase was partially offset by the 2011 plan year settlement collected in 2012.
Other Current Assets - Other Current Assets primarily include deferred tax assets and also include prepaid expenses. See Note N, Income Taxes, to the consolidated financial statements for additional information.
Property and Equipment - Property, equipment and leasehold improvements are recorded at cost. Depreciation is computed using the straight-line method over the shorter of the estimated lives of the related assets or over the term of the respective leases, if applicable. The estimated useful lives of the Company’s property and equipment are between three to thirty years. In accordance with ASC 350-40, “Internal-Use Software,” the cost of internally developed software is capitalized and included in property and equipment. The Company capitalizes costs incurred during the application development stage for the development of internal-use software. These costs primarily relate to payroll and payroll-related costs for employees along with costs incurred for external consultants who are directly associated with the internal-use software project. See Note E, Property and Equipment, to the consolidated financial statements for additional information.
Business Combinations, Accounting for Goodwill and Other Intangibles - The Company accounts for Business Combinations in accordance with ASC Topic 805-10, “Business Combinations” and accounts for goodwill and other intangibles in accordance with ASC Topic 350-10, “Intangibles - Goodwill and Other” and ASU 2011-8, “Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” Goodwill and other intangible assets that have indefinite lives are subject to a periodic assessment for impairment. ASU 2011-08 permits an entity to first assess qualitative factors to determine whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in Topic 350, Intangibles-Goodwill and Other.
The Company performed a goodwill impairment analysis at the reporting unit level and determined that there were no impairments. The Company believes that the fair value of its reporting units are substantially in excess of their carrying values and not at risk of failing step one of the quantitative impairment test in the near term. The Company’s goodwill impairment analysis begins with an assessment of qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying value as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test. In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying value, the Company considers factors outlined in ASU2011-08, “Intangibles-Goodwill and Other (Topic 350),” including, but not limited to:
Cost factors such as increases in raw materials, labor, or other costs that have a negative effect on earnings and cash flows;
Other relevant entity-specific events such as changes in management, key personnel, strategy, or customers; contemplation of bankruptcy; or litigation;
Events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than-not expectation of selling or disposing all, or a portion, of a reporting unit, the testing for recoverability of a significant asset group within a reporting unit, or recognition of a goodwill impairment loss in the financial statements of a subsidiary that is a component of a reporting unit; and
If the Company determines that it is more likely than not that the fair value of the reporting unit is less than its carrying value, then the two-step quantitative goodwill impairment test is performed. The goodwill quantitative impairment test, if necessary, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired and no further testing is performed. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then the Company must perform
For the quantitative impairment analysis, the Company relies on both the income and market approaches. The income approach is based on the present value of expected future cash flows. The income approach involves estimating the present value of our estimated future cash flows utilizing a risk adjusted discount rate. The market approach estimates the Company’s fair value by comparing Coventry to similar publicly traded entities and also by analyzing the recent sales of similar companies. The approaches are reviewed together for consistency and commonality.
The fair value of the indefinite-lived intangible asset is estimated and compared to the carrying value. The Company estimates the fair value of the indefinite-lived intangible asset using an income approach. The income approach is based on the present value of expected future cash flows. The income approach involves estimating the present value of the Company’s estimated future cash flows utilizing a risk adjusted discount rate. Under the income approach, the Company assumed certain growth rates, capital expenditures, discount rates and terminal growth rates in its calculations. The Company recognizes an impairment loss when the estimated fair value of the indefinite-lived intangible asset is less than the carrying value.
Other acquired intangible assets are separately recognized upon meeting certain criteria. Such intangible assets include, but are not limited to, trade and service marks, provider contracts, customer lists and licenses. An intangible asset that is subject to amortization is tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The Company amortizes other acquired intangible assets with finite lives using the straight-line method over the estimated economic lives of the assets, ranging from three to twenty years.
The following table presents the components of the change in medical claims liabilities for the years ended December 31, 2012, 2011 and 2010, respectively (dollars in thousands).
Other Long-term Liabilities - Other long-term liabilities consist primarily of deferred tax liabilities, liability for unrecognized tax benefits and liabilities associated with the 401(k) Restoration and Deferred Compensation Plan. See Note I, Employee Benefit Plans to the consolidated financial statements for more information.
to CMS. Changes in revenue from CMS resulting from the periodic changes in risk adjustments scores for the Company’s membership are recognized when the amounts become determinable and the collectibility is reasonably assured.
The table below summarizes the CMS receivables and payables, for all contract years, at December 31, 2012 and 2011, respectively (in thousands).
Revenue for pharmacy benefit management services for the Workers’ Compensation business is derived on a pre-negotiated amount per pharmacy claim which includes the cost of the pharmaceutical. Revenue and a corresponding cost of sales to a third-party vendor related to the sale of pharmaceuticals is recorded when a pharmacy transaction is processed by the Company. No pharmacy rebate revenue is collected or recorded related to the Company’s Workers’ Compensation business.
CMS periodically performs audits and may seek return of premium payments made to the Company if risk adjustment factors are not properly supported by medical record data. The Company estimates and records reserves for CMS audits based on information available at the time the estimates are made. The judgements and uncertainties affecting the application of these policies include, among other things, significant estimates related to the amount of hierarchical condition category (“HCC”) revenue subject to audit, anticipated error rates, sample methodologies, confidence intervals, enrollee selection, and payment error extrapolation methodology. During the year ended December 31, 2012, CMS released a “Notice of Final Payment Error Calculation Methodology for Part C Medicare Advantage Risk Adjustment Data Validation (“RADV”) Contract-Level Audits.” Most importantly, CMS announced which contract years are subject to the CMS RADV audits and other core areas of the audit methodology. As a result of this notice, the Company released RADV reserves, for contract years 2007 through 2011, resulting in an increase in operating earnings of $133.0 million during the year ended December 31, 2012, all of which occurred in the first quarter of 2012.
Effective in 2011, as required by the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, “PPACA”), commercial health plans with medical loss ratios (“MLR”) on fully insured products that fall below certain targets are required to rebate ratable portions of their premiums annually. The mandated minimum MLR targets (as calculated under the definitions in PPACA and related regulations), for health plans such that the percentage of health coverage premium revenue spent on health care medical costs and quality improvement expenses, are set at 85% for large employer groups, 80% for small employer groups and 80% for individuals, subject to state-specific exceptions. The potential for and size of the rebates are measured by regulated subsidiary, state and market segment (individual, small group and large group). Accordingly, in the current year, the Company has recorded a rebate estimate in the “accounts payable and other accrued liabilities” line in the accompanying balance sheet and as contra-revenue in “managed care premiums” in the accompanying statements of operations and comprehensive income. The Company estimates the rebate liability based on judgments and estimated information, including utilization, unit cost trends, quality improvement costs, and product pricing, features and benefits. If actual experience varies from the Company’s estimates or future regulatory guidance differs from its current judgments, the actual rebate liability could differ from the Company’s estimates.
Contract Acquisition Costs - Costs related to the acquisition of customer contracts, such as commissions paid to outside brokers, are paid on a monthly basis and expensed as incurred. For the Medicare Advantage Coordinated Care Plans (“Medicare Advantage CCP”) business, the Company advances commissions and defers amortization of these costs to the period in which revenue associated with the acquired customer is earned, which is generally not more than one year, and are recorded in the “other current assets” line in the accompanying balance sheet.
Income Taxes - The Company files a consolidated federal tax return for the Company and its subsidiaries. The Company accounts for income taxes in accordance with ASC Topic 740, “Income Taxes.” The deferred tax assets and/or liabilities are determined by multiplying the differences between the financial reporting and tax reporting bases for assets and liabilities by the enacted tax rates expected to be in effect when such differences are recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The realization of total deferred tax assets is contingent upon the generation of future taxable income in the tax jurisdictions in which the deferred tax assets are located. Taxable income includes the effect of the reversal of deferred tax liabilities. Valuation allowances are provided to reduce such deferred tax assets to amounts more-likely-than-not to be ultimately realized.
outstanding during the period. Diluted EPS assumes the exercise of all options. Options issued under the stock-based compensation program that have an antidilutive effect are excluded from the computation of diluted EPS. Potential common stock equivalents to purchase 5.6 million, 6.5 million and 10.0 million shares for the years ended December 31, 2012, 2011 and 2010, respectively, were excluded from the computation of diluted earnings per common share because the potential common stock equivalents were antidilutive.
In July 2011, the FASB issued ASU 2011-06, “Other Expenses (Topic 720): Fees Paid to the Federal Government by Health Insurers.” ASU 2011-06 addresses the timing, recognition and classification of the annual health insurance industry assessment fee imposed on health insurers by the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, “PPACA”). The mandatory annual fee of health insurers will be imposed for each calendar year beginning on or after January 1, 2014. This update requires that the liability for the fee be estimated and recorded in full once the entity provides qualifying health insurance in the applicable calendar year in which the fee is payable with a corresponding deferred cost that is amortized to expense using a straight-line method of allocation unless another method better allocates the fee over the calendar year that it is payable. Although the federally mandated annual fee will be material, the adoption of ASU 2011-06 is not expected to materially affect the Company’s financial position or results of operations and comprehensive income.
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU 2011-05 allows an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in one continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. Also, reclassification adjustments between comprehensive income and net income must be presented on the face of the financial statements or the accompanying footnotes. ASU 2011-05 was effective for fiscal years and interim periods beginning after December 15, 2011, with early adoption permitted. The Company adopted ASU 2011-05 effective January 1, 2012 by presenting one continuous statement of comprehensive income. Other than a change in presentation, the adoption of ASU 2011-05 did not affect the Company’s financial position or results of operations and comprehensive income.
The Commercial Products Division is primarily comprised of the Company’s traditional health plan based Commercial and Individual Risk business. Additionally, through this Division the Company contracts with various federal employee organizations to provide health insurance benefits under the Federal Employees Health Benefits Program (“FEHBP”) and offers administrative services only products to businesses that self-insure their health benefits managed care. This Division also contains the dental services, network rental and behavioral health benefits products.
During the three years ended December 31, 2012, the Company completed three business combinations. These business combinations were accounted for using the acquisition method of accounting and therefore the operating results of each acquisition have been included in the Company’s consolidated financial statements since the date of their acquisition. The purchase price for each business combination was allocated to the assets, including the identifiable intangible assets and liabilities based on estimated fair values. The excess of the purchase price over the net identifiable assets acquired was allocated to goodwill.
The PHS, MHP and FHP acquisitions are not material to the Company’s consolidated financial statements, individually or in the aggregate.
On February 1, 2010, the Company completed its acquisition of PHS, a commercial health plan based in Wichita, Kansas serving approximately 100,000 commercial group risk members and 20,000 commercial self-funded members. The acquisition of PHS strengthened Coventry’s presence in the Kansas market. As part of the acquisition, the Company recognized a liability for potential contingent earn-outs that are attributed to certain performance measures by PHS. At December 31, 2012 and 2011, the liability was not significant.
The Company completed its 2012 annual impairment test of goodwill in accordance with ASC Topic 350 and determined that there were no impairments. The Company believes that the fair value of its reporting units are substantially in excess of their carrying values and not at risk of failing step one of the quantitative impairment test in the near term. In performing its impairment analysis the Company identified its reporting units in accordance with the provisions of ASC Topic 350 and ASC Topic 280, “Segment Reporting.”
During the second quarter of 2012, the Company was notified of the non-renewal of the State of Kansas Medicaid contract, which the Company acquired in connection with the acquisition of FHP. As a result of the non-renewal of the Kansas Medicaid contract, there are no future cash flows expected related to the associated intangibles; therefore, the fair value of those intangibles was written down to zero. Accordingly, depreciation and amortization expense for the twelve months ended December 31, 2012 includes a $7.7 million impairment charge of the intangibles associated with the non-renewal of this contract. The impairment charge related only to the intangibles assigned to the Kansas business acquired in the FHP acquisition and did not affect the intangibles assigned to the ongoing Missouri business, also acquired in the FHP acquisition.
Includes Agency pass-through securities, with the timely payment of principal and interest guaranteed.
Gross investment gains of $41.5 million and gross investment losses of $1.1 million were realized on sales of investments for the year ended December 31, 2012. This compares to gross investment gains of $17.4 million and gross investment losses of $0.4 million realized on sales of investments for the year ended December 31, 2011, and gross investment gains of $15.5 million and gross investment losses of $4.5 million realized on sales for the year ended December 31, 2010. The Company’s realized gains and losses are recorded in other income, net in the Company’s consolidated statements of operations and comprehensive income.
ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value and requires a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value based on the quality and reliability of the inputs or assumptions used in fair value measurements.
markets, quoted prices for identical or similar assets in non-active markets (few transactions, limited information, non-current prices and high variability over time), inputs other than quoted prices that are observable for the asset/liability (e.g., interest rates, yield curves, volatilities and default rates, among others), and inputs that are derived principally from or corroborated by other observable market data.
The Company no longer has Level 3 securities. During the quarter ended March 31, 2011, the Company transferred all Level 3 securities to Level 2. Prior to March 31, 2011, the Company’s Level 3 securities primarily consisted of corporate financial holdings, mortgage-backed securities and asset-backed securities that were thinly traded due to market volatility and lack of liquidity. The Company determined the estimated fair value for its Level 3 securities using unobservable inputs that could not be corroborated by observable market data; including, but not limited to, broker quotes, default rates, benchmark yields, credit spreads and prepayment speeds. The transfer from Level 3 to Level 2 resulted from increased trading activity of these securities and, therefore, a transition from unobservable inputs to inputs corroborated by observable market data or transactions.
During 2011, the Company completed the sale of $600.0 million aggregate principal amount of its 5.45% Senior Notes due 2021 (the “2021 Notes”) at the issue price of 99.800% per note. The 2021 Notes are senior unsecured obligations of Coventry and rank equally with all of its other senior unsecured indebtedness.
The Company’s senior notes and Credit Facility contain certain covenants and restrictions regarding, among other things, liens, asset dispositions and consolidations or mergers. Additionally, the Company’s Credit Facility requires compliance with a leverage ratio of 3 to 1 and limits subsidiary debt. As of December 31, 2012, the Company was in compliance with the applicable covenants and restrictions under its senior notes and Credit Facility.
As of December 31, 2012, the aggregate maturities of debt based on their contractual terms, gross of unamortized discount, were as follows (in thousands):
Under the Savings Plan, participants may defer up to 75% of their eligible compensation, limited by the maximum compensation deferral amount permitted by applicable law. The Company makes matching contributions in the Company’s common stock equal to 100% of the participant’s contribution on the first 3% of the participant’s eligible compensation and equal to 50% of the participant’s contribution on the second 3% of the participant’s eligible compensation. Beginning August 3, 2012, the Company’s matching contributions are invested in the participant’s account in the same investments as their before-tax contributions rather than the Company’s common stock fund. Participants vest immediately in all safe harbor matching contributions. The Savings Plan permits all participants, regardless of service, to sell the employer match portion of the Coventry common stock in their accounts during certain times of the year and transfer the proceeds to other Coventry 401(k) funds of their choosing. All costs of the Savings Plan are funded by the Company and participants as they are incurred.
Under the Incentive Plan, the terms and conditions of option grants are established on an individual basis with the exercise price of the options being equal to but not less than the fair value of the underlying stock at the date of grant. Options generally become exercisable in 33% increments per year and expire ten years from the date of grant.
The Company continues to use the Black-Scholes-Merton option pricing model and amortizes compensation expense over the requisite service period of the grant. The methodology used in 2012 to derive the assumptions used in the valuation model is consistent with that used in prior years. Beginning in March 2012, the Company declared its first quarterly cash dividend and, as a result, the expected dividend yield has changed. See Note K, Stockholders’ Equity, for more information regarding dividends. The expected dividend yields are based on the per share dividend declared by the Company’s Board of Directors.
The following average values and weighted-average assumptions were used for option grants.
The total intrinsic value of options exercised was $46.3 million, $20.9 million, and $11.3 million for the years ended December 31, 2012, 2011 and 2010, respectively. The tax benefit realized from stock option exercises was $18.1 million, $7.7 million and $4.1 million, for the years ended December 31, 2012, 2011 and 2010, respectively. As of December 31, 2012, there was $16.6 million of total unrecognized compensation cost (net of expected forfeitures) related to nonvested stock option grants which is expected to be recognized over a weighted-average period of 1.9 years.
Under the Incentive Plan, restricted stock awards generally vest in 25% increments per year. The fair value of restricted stock awards is based on the market price of the Company’s common stock on the date of grant and is amortized over various vesting periods through 2016. Restricted stock awards may also include a performance measure that must be met for the restricted stock award to vest.
Beginning in 2012, the Company issued Restricted Share Units (“RSUs”) which represent hypothetical shares of the Company’s common stock. The holders of RSUs have no rights as stockholders with respect to the shares of the Company’s common stock to which the awards relate. Some of the RSUs require the achievement of certain performance goals and other criteria in order to vest. The RSUs vest (if at all) at various periods through 2016 and all RSUs that vest will be paid out in cash based upon the price of the Company’s stock. The Company recorded compensation expense of $7.2 million related to the RSUs for the year ended December 31, 2012. The RSUs are classified as a liability by the Company. The related liability was $7.2 million and accrued in “accounts payable and other accrued liabilities” in the accompanying balance sheet at December 31, 2012.
The cash dividend for the quarter ended December 31, 2012 was accrued in “accounts payable and other accrued liabilities” in the accompanying balance sheet at December 31, 2012, and subsequently paid on January 7, 2013. Declaration and payment of future quarterly dividends is at the discretion of the Board of Directors and may be adjusted as business needs or market conditions change. Additionally, the terms of the Merger Agreement restrict payment of future cash dividends other than the Company’s quarterly dividend consistent with past practice not to exceed $0.125 per share.
Basic EPS is calculated using the weighted average number of common shares outstanding during the period. Diluted EPS assumes the exercise of all options. Options issued under the stock-based compensation program that have an antidilutive effect are excluded from the computation of diluted EPS. Potential common stock equivalents to purchase 5.6 million, 6.5 million and 10.0 million common shares for the year ended December 31, 2012, 2011 and 2010, respectively, were excluded from the computation of diluted earnings per common share because the potential common stock equivalents were antidilutive.
The table below provides the reconciliation of the earnings and number of shares used in our calculations of basic and diluted earnings per share (in thousands, except for per share data).
The effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2012 and 2011 are presented below (in thousands):
Includes $132.5 million and $181.8 million classified as other current assets at December 31, 2012 and 2011, respectively, and $187.3 million and $154.2 million classified as other long-term liabilities at December 31, 2012 and 2011, respectively.
At December 31, 2012, the Company had approximately $93.5 million of federal and $224.7 million of state tax net operating loss carryforwards. The Federal net operating losses were primarily acquired through various acquisitions and are subject to limitation under Internal Revenue Code Section 382. The net operating loss carryforwards can be used to reduce future taxable income and expire over varying periods through the year 2032. A valuation allowance of approximately $2.3 million and $4.2 million has been recorded as of December 31, 2012 and 2011, respectively, for certain net operating loss deferred tax assets as the Company believes it is not more-likely-than-not that these deferred tax assets will be realized before expiration of the net operating losses.
For the years ended December 31, 2012, 2011 and 2010, the total amount of income tax-related accrued interest and penalties, net of related tax benefit, recognized in the statement of operations was $2.8 million, $3.3 million and $4.0 million, respectively.
The Company is regularly audited by federal, state and local tax authorities, and from time to time these audits result in proposed assessments. Tax years 2009-2011 remain open to examination by these tax jurisdictions. The Company believes appropriate provisions for all outstanding issues have been made for all jurisdictions and all open years.
As of December 31, 2012, the Company is contractually obligated to make the following minimum lease payments, including arrangements that may be noncancelable and may include escalation clauses, within the next five years and thereafter (in thousands):
On August 23, 2012, a putative stockholder class action lawsuit captioned Coyne v. Wise et al., C.A. No. 367380, was filed in the Circuit Court for Montgomery County, Maryland, against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On August 27, 2012, a second putative stockholder class action lawsuit captioned O’Brien v. Coventry Health Care, Inc. et al., C.A. 367577, was filed in the Circuit Court for Montgomery County, Maryland, against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On September 5, 2012, a third putative stockholder class action lawsuit captioned Preze v. Coventry Health Care, Inc. et al., C.A. 367942, was filed in the Circuit Court for Montgomery County, Maryland, against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. These three (3) actions have been consolidated. The complaints allege, among other things, that the individual defendants breached their fiduciary duties owed to Coventry’s public stockholders in connection with the Merger because the merger consideration and certain other terms in the Merger Agreement are unfair. The complaints further allege that Aetna and Merger Sub aided and abetted these alleged breaches of fiduciary duty. In addition, the complaints allege that the proposed Merger improperly favors Aetna and that certain provisions of the Merger Agreement unduly restrict Coventry’s ability to negotiate with other potential bidders. Among other remedies, the complaints seek injunctive relief prohibiting the defendants from completing the proposed Merger or, in the event that an injunction is not awarded, unspecified money damages, costs and attorneys’ fees. In November 2012, the court, in response to a motion filed by the Company, entered an order which stayed all three (3) actions for 90 days. On February 13, 2013, the plaintiffs in each of the 3 lawsuits filed a Notice of Voluntary Dismissal of their lawsuits based on the settlement of the shareholder suits filed in Delaware. The Company believes these lawsuits are without merit and will vigorously contest and defend against the allegations in these complaints.
complaint was filed in the Brennan v. Coventry Health Care, Inc. action. The complaints generally allege that, among other things, the individual defendants breached their fiduciary duties owed to the public stockholders of Coventry in connection with the Merger because the merger consideration and certain other terms in the merger agreement are unfair. The complaints further allege that Aetna and Merger Sub aided and abetted these alleged breaches of fiduciary duty. In addition, the complaints generally allege that certain provisions of the Merger Agreement unduly restrict Coventry’s ability to negotiate with other potential bidders and that the Merger Agreement lacks adequate safeguards on behalf of Coventry’s stockholders against the decline in the value of the stock component of the merger consideration. The complaints in the Employees’ Retirement System of the Government of the Virgin Islands, and Farina actions and the amended complaint in the Brennan action also generally allege that Aetna’s Registration Statement on Form S-4 filed on September 21, 2012, contained various deficiencies. Among other remedies, the complaints generally seek injunctive relief prohibiting the defendants from completing the proposed Merger, rescissionary and other types of damages and costs and attorneys’ fees.
On October 4, 2012, the Court of Chancery of the State of Delaware entered an order consolidating the four Delaware actions under the caption In re Coventry Health Care, Inc. Shareholder Litigation, Consolidated C.A. No. 7905-CS, appointing the Employees’ Retirement System of the Government of the Virgin Islands, the General Retirement System of the City of Detroit, and the Police and Fire Retirement System of the City of Detroit as Co-Lead Plaintiffs. On October 5, 2012, plaintiffs in the consolidated Delaware action filed a motion for expedited proceedings, and on October 10, 2012, plaintiffs in the consolidated Delaware action filed a motion to preliminarily enjoin the defendants from taking any action to consummate the Merger. The parties have since reached agreement on the schedule for those proceedings, which was entered by order of the Court on October 12, 2012. Pursuant to that scheduling order, a hearing on plaintiffs’ preliminary injunction motion was scheduled for November 20, 2012. On November 12, 2012, the Company and all named defendants entered into a Memorandum of Understanding (“MOU”) with the plaintiffs and their respective counsel which set forth an agreement in principle providing for the settlement of the In re Coventry Health Care, Inc. Shareholder Litigation. In consideration for the full settlement and dismissal with prejudice of the Shareholder Litigation and releases, the defendants agreed to (1) include additional disclosures in the definitive prospectus/proxy statement; (2) amend the Merger Agreement to reduce the Termination Fee payable by the Company upon termination of the Merger Agreement from $167,500,000 to $100,000,000; (3) amend the Merger Agreement to reduce the period during which the Company is required to discuss and negotiate with Aetna before making an Adverse Recommendation Change relating to a Superior Proposal from five calendar days to two calendar days; and (4) pay any attorneys’ fees and expenses awarded by the court. The MOU requires the parties to negotiate and execute a Stipulation of Settlement for submission to the court to obtain final court approval of the settlement and dismissal of the Shareholder Litigation.
The Company operates in a regulatory environment that may require the Company to participate in assessments under state insurance guaranty association laws. The Company’s exposure to guaranty fund assessments is based on its share of business it writes in the relevant jurisdictions for certain obligations of insolvent insurance companies to policyholders and claimants. An assessment could have a material adverse effect on the Company’s financial position and results of operations and comprehensive income.
The Company has capitation arrangements for certain ancillary health care services, such as laboratory services and, in some cases, physician and radiology services. A small percentage of the Company’s membership is covered by global capitation
arrangements. Under the typical arrangement, the provider receives a fixed percentage of premiums to cover costs of all medical care or of the specified ancillary services provided to the capitated members. Under some capitated and professional capitation arrangements, physicians may also receive additional compensation from risk sharing and other incentive arrangements. Capitation arrangements limit the Company’s exposure to the risk of increasing medical costs, but expose the Company to risk as to the adequacy of the financial and medical care resources of the provider organization. The Company is ultimately responsible for the coverage of its members pursuant to the customer agreements. To the extent that a provider organization faces financial difficulties or otherwise is unable to perform its obligations under the capitation arrangements, the Company may be required to perform such obligations. Consequently, the Company may have to incur costs in excess of the amounts it would otherwise have to pay under the original global or ancillary capitation through contracted network arrangements. Medical costs associated with capitation arrangements made up approximately 9.0%, 8.2% and 6.4% of the Company’s total medical costs for the years ended December 31, 2012, 2011 and 2010, respectively.
Concentration of credit risk with respect to receivables is limited due to the large number of customers comprising the Company’s customer base and their breakdown among geographical locations. The Company believes the allowance for doubtful accounts adequately provides for estimated losses as of December 31, 2012. The Company has a risk of incurring losses if such allowances are not adequate.
The Company’s regulated health maintenance organizations (“HMO”) and insurance company subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends the parent may receive from its regulated entities. During 2012, the Company received $214.7 million in dividends from its regulated subsidiaries and paid $144.0 million in capital contributions to these subsidiaries.
The majority of states in which the Company operates health plans have adopted a RBC policy that recommends the health plans maintain statutory reserves at or above the “Company Action Level,” which is currently equal to 200% of their RBC. Statutory-based capital and surplus of the Company’s regulated subsidiaries was approximately $2.3 billion and $1.9 billion at December 31, 2012 and 2011, respectively. As of December 31, 2012 and 2011, all of the Company’s regulated subsidiaries exceeded the minimum RBC, capital and solvency requirements of the applicable state regulators. The increase in capital and surplus for the Company’s regulated subsidiaries primarily resulted from net earnings and, to a lesser extent, capital contributions made by the parent company, partially offset by dividends paid to the parent company.
Some states in which the Company’s regulated subsidiaries operate require deposits to be maintained with the respective states’ departments of insurance. Statutory deposits held by the Company’s regulated subsidiaries was $71.1 million and $74.0 million at December 31, 2012 and 2011, respectively.
Excluding funds held by entities subject to regulation and excluding the equity method investments, the Company had cash and investments of approximately $1.2 billion and $1.4 billion at December 31, 2012 and 2011, respectively. The decrease primarily resulted from share repurchases, repayment of the Company 5.875% Senior Notes in January 2012 at maturity, capital contributions made by the parent to regulated subsidiaries, cash paid for the FHP acquisition and cash dividend payments. This decrease was partially offset by dividends received from the Company’s regulated subsidiaries and earnings generated by the Company’s non-regulated entities.
Mr. Daniel N. Mendelson, a director of the Company, is the Chief Executive Officer and majority owner of Avalere Health Inc. Avalere Health LLC, a wholly owned subsidiary of Avalere Health Inc., is a healthcare policy and strategic advisory firm that provides syndicated research and market information products for clients in the healthcare industry, government and the not-for-profit sector. During 2012, 2011 and 2010, the Company paid $0.2 million each year to Avalere Health LLC for these services. Consistent with the Company’s Related Person Transactions Policy, disinterested members of the Board considered the transaction and determined that the services provided would be beneficial to the Company and the amounts to be paid were immaterial to both Avalere Health, Inc. and the Company and that the terms of the contract with Avalere Health, Inc. are fair and competitive with market rates for such services.
During 2012, Mr. Joseph R. Swedish was a director of the Company and the President and Chief Executive Officer of Trinity Health, a not-for-profit, integrated health care delivery system which operates hospitals and other health care facilities in ten states. Trinity Health has entered into market based provider contracts with subsidiaries of the Company in these ten states. During 2012, 2011 and 2010, the Company paid approximately $17.5 million, $14.4 million and $18.9 million respectively to Trinity Health for health care services provided to its members. Consistent with the Company’s Related Person Transactions Policy, disinterested members of the Board’s Nominating/Corporate Governance Committee as well as disinterested members of the entire Board determined that the level of reimbursement paid to Trinity Health for services provided to its members were market based and that the total amount paid was immaterial to both Trinity Health and the Company. Since Trinity Health is a not-for-profit organization, Mr. Swedish derives no additional income as a result of the transaction between Trinity Health and the Company.
On February 11, 2013, in its Current Report on Form 8-K, the Company announced that it and the Commonwealth of Kentucky (the “Commonwealth”) agreed to an amendment to the Company's Kentucky Medicaid contract that addresses the impact on Coventry of program changes subsequent to the effective date of the contract, specifically the smoking cessation program and outpatient reimbursements and concerns Coventry had raised over risk adjustment implementation. The amendment, among other things, increased existing rates for each of the contract years remaining under the initial term of the contract by 7%, effective January 1, 2013. In addition, the Commonwealth agreed to accelerate the effective date for the scheduled rate increase for the last year of the contract's initial term from October 1, 2013 to July 1, 2013. Subject to certain conditions, the Commonwealth also agreed to offer the Company the opportunity for contract renewal at rates no less than those in place at the end of the existing term. The parties also agreed to certain operational changes for improved member services and provider relations.