Our executive offices are located in White Plains, New York, with regional offices for various administrative and operations staff in Lake Mary, Florida, Houston, Texas, Brookfield, Wisconsin, Columbia, Maryland, Mechanicsburg, Pennsylvania and Hato Rey, Puerto Rico. Our Medicare Advantage operations occupy office space in Houston, Texas, Dallas, Texas, and Oklahoma City, Oklahoma. In addition, we maintain other smaller, local offices to support Medicaid contracts, as well as a number of mental health clinics under our Medicaid contracts in Hawaii and Puerto Rico. We lease a total of approximately 592,000 square feet of office space. Management considers its office facilities suitable and adequate for the current level of operations. Additional information regarding our lease obligations is included in Note 24-Commitments and Contingencies in the Notes to Consolidated Financial Statements included in this Annual Report on Form 10-K.
(1)The financial data for 2008 to 2011 has been adjusted for the following items:
•Change in accounting principle-the retrospective adoption of ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. (see Note 4-Recently Issued and Pending Accounting Pronouncements for additional detail);
For additional information see Note 2-Basis of Presentation-Adjustments to Financial Statements in the Notes to consolidated financial statements.
2008-Net income from continuing operations for the year ended December 31, 2008 increased by $3.9 million, or $0.04 per diluted share; including an increase of $4.0 million related to the implementation of ASU 2010-26 and a decrease of $0.1 million related to the correction. There was no impact to net income from discontinued operations. Stockholders' equity at December 31, 2008 decreased by $50.0 million, with decreases of $38.6 million related to the implementation of ASU 2010-26 and $11.4 million related to the correction.
The following discussion and analysis presents a review of our financial condition as of December 31, 2012 and our results of operations for the years ended December 31, 2012, 2011 and 2010. As used in this report, except as otherwise indicated, references to the "Company, "we," "our," and "us" are to (i) Universal American Corp., a Delaware corporation (formerly known as Universal American Spin Corp., "Universal American") and its subsidiaries following the closing of the Part D Transaction on April 29, 2011 and (ii) Universal American Corp, a New York corporation (now known as Caremark Ulysses Holding Corp., "Old Universal American") and its subsidiaries prior to the closing of the Part D Transaction on April 29, 2011.
•Continue to build our Medicare Advantage business and expand our Healthy Collaboration® model.
•Acquire and develop additional capabilities to participate in the growing Medicaid market, especially the dual eligible and long-term care sectors.
We have partnered with primary-care provider groups, hospitals, integrated delivery systems, and a variety of other health care providers to form 31 ACOs which have been approved by the CMS for
Due to the Medicaid expansion provisions under the Affordable Care Act, CMS projects that Medicaid expenditures will increase from approximately $450 billion in 2012 to approximately $900 billion by 2020. In addition, as part of the Affordable Care Act, approximately 20 million additional people are expected to qualify for Medicaid beginning in 2014.
Our Healthy Collaboration® strategy sets out a model of improving the quality of care to our members on a cost-efficient basis through an active partnership with our providers. We believe we can improve medical outcomes through a series of collaborative initiatives with our health care providers including clinically sound benefit design (where applicable), medical management, care coordination, population health management , long term supportive services and integrated care management systems. Our goal is to create mutually beneficial and interdependent collaborative arrangements with our providers. We believe provider compensation arrangements should not only help providers to be paid for complex care coordination, but also help align their interests with our objective of improving clinical outcomes and controlling unnecessary cost.
The Affordable Care Act enacted significant changes to various aspects of the U.S. health insurance industry. There are many important provisions of the legislation that will require additional guidance and clarification in form of regulations and interpretations in order to fully understand the impact of the legislation on our overall business, which we expect to occur over the next several years.
Certain significant provisions of the Affordable Care Act that will impact our business include, among others, establishment of ACO's, reduced Medicare Advantage reimbursement rates, implementation of quality bonus for Star Ratings, stipulated minimum medical loss ratios, non-deductible federal premium taxes assessed to health insurers and coding intensity adjustments with mandatory minimums. The health care reform legislation is discussed more fully in the "Risk Factors" section of this report.
On November 1, 2012, our Board of Directors approved the payment of a special cash dividend of $1.00 per share to each holder of our outstanding common stock. This special cash dividend was paid on November 19, 2012 to shareholders of record as of November 12, 2012. The cumulative dividend payment was $88.2 million. In addition, pursuant to the terms of our 2011 Omnibus Equity Award Plan, the exercise price on outstanding stock options was reduced by the amount of the dividend, $1.00 per share. We also established a liability for the dividends related to unvested restricted stock, which will be paid out as the restricted stock vests. For further discussion, see Note 22, Other Operational Disclosures-Special Dividends in the Notes to consolidated financial statements.
A portion of this special cash dividend is a return of capital for Federal tax purposes and is not currently taxable. The return of capital portion reduces the holder's basis in their Universal American Corp. common stock. The breakdown is as follows:
The following table reflects income from each of our segments and contains a reconciliation to reported net income (loss):
•Change in accounting principle-the retrospective adoption of ASU 2010-26, Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. (see Note 4-Recently Issued and Pending Accounting Pronouncements in the Notes to consolidated financial statements for additional detail);
Discontinued operations include the results of operations related to our Medicare Part D business and related corporate items that were transferred to CVS Caremark in connection with the closing of the Part D Transaction on April 29, 2011. See Note 1-Organization and Company Background and 23-Discontinued Operations in the Notes to consolidated financial statements for further information. We had a loss from discontinued operations of $50.9 million or $0.63 per diluted share for the year ended December 31, 2011, which represented the four months of operations prior to closing of the Part D Transaction as well as $10.7 million after-tax of transaction expenses. The benefits design of the Part D business results in significant seasonality in financial results, resulting in losses in the early part of the year, followed by profits in the latter part of the year.
Income from continuing operations for the year ended December 31, 2011 was $2.7 million, or $0.03 per diluted share, compared to $87.6 million, or $1.11 per diluted share for the year ended December 31, 2010. These amounts include realized investment gains, net of taxes, of $0.5 million, or $0.01 per diluted share and $4.3 million, or $0.05 per diluted share in 2011 and 2010, respectively.
The loss before income taxes from our Corporate & Other segment increased by $51.1 million for the year ended December 31, 2011 compared to 2010. This was primarily due to charges in 2011 for restructuring costs of $22.0 million, $15.6 million related to impairment of an intangible asset related to our Career distribution channels that were closed in the fourth quarter of 2011 and an $8.6 million
charge to stock-based compensation expense related to accelerated vesting of equity awards in connection with the Part D Transaction.
Net premiums. Net premiums for the Senior Managed Care-Medicare Advantage segment decreased by $340.9 million compared to the year ended December 31, 2011, primarily due to the decline in membership.
Net premiums. Net premiums for the Senior Managed Care-Medicare Advantage segment decreased by $1,195.6 million compared to the year ended December 31, 2010, primarily due to the decreased membership, resulting in lower member months in all plans.
Our Traditional Insurance segment generated income before taxes of $15.7 million for 2011, an increase of $13.6 million compared to 2010. The increase in earnings is driven by increased net investment income, primarily due to a change in the mix of assets caused by the sale of our Part D business and investing of our cash and cash equivalents into higher yielding fixed maturity securities, as well as a decrease in net amortization of deferred acquisition costs and general expenses. This improvement was partially offset by the continued decline of our insurance-in-force, particularly in the Senior Market and Specialty Health lines.
The loss before income taxes from our Corporate & Other segment decreased by $29.5 million for the year ended December 31, 2012 compared to 2011. This was primarily due to 2011 charges of $22.0 million for restructuring costs, $15.6 million related to impairment of an intangible asset related to our Career distribution channels that were closed in the fourth quarter of 2011 and an $8.6 million charge to stock-based compensation expense related to accelerated vesting of equity awards in connection with the Part D Transaction, partially offset by $21.7 million of start-up and operating costs relating to the development of our ACO business and higher debt service costs incurred in 2012.
Stock-based compensation expense declined $12.5 million primarily as a result of $8.6 million incurred in 2011 related to the accelerated vesting of equity awards in connection with the Part D Transaction and the Medicare Advantage and Traditional segments being charged for the stock-based compensation expense of their employees for the first time in 2012, which amounted to $2.4 million.
Other parent company expenses, net of revenues, decreased $5.5 million as compared to 2011 primarily due to insurance recoveries in 2012 related to litigation settled in prior years and reimbursement from CVS Caremark for certain services provided under a transition services agreement in connection with the Part D Transaction, partially offset by $3.7 million of costs incurred in connection with the acquisition of APS Healthcare. 2011 included $4.8 million related to the settlement of the HHS-OIG Wisconsin investigation and $1.8 million of transaction costs incurred in connection with the APS Healthcare acquisition.
Intangible asset impairment of $15.6 million represents the write-off of an intangible asset related to our acquisition of a Career agency sales force. As a result of our closure of our Career Agency operations, we reviewed the recoverability of that asset and determined that its carrying value was greater than its fair value.
to the CMS sanctions restricting our ability to sell Medicare Advantage products as well as favorable expense variances primarily related to lower staffing-related costs.
Our contractual obligations as of December 31, 2012, are shown below.
(3)Our obligations for policy related liabilities represent those payments we expect to make on death, disability and health insurance claims and policy surrenders, net of amounts recovered from reinsurers. These projected values contain assumptions for future policy persistency, mortality and morbidity comparable with our historical experience. The distribution of payments for policy and contract claims reflects assumptions as to the timing of policyholders reporting claims for prior periods and the amounts of those claims. Actual amounts and timing of both future policy benefits and policy and contract claims may differ significantly from the estimates above. We anticipate that our reserves for policy liabilities and policy and contract claims, along with future net premiums, investment income and recoveries from our reinsurers will be sufficient to fund our policy related obligations. On our consolidated balance sheets in Part II, Item 8 of this annual report on Form 10-K, we report our policy related liabilities gross of amounts recoverable from reinsurers, which are reported as assets. We are obligated to pay claims in the event that a reinsurer fails to meet its obligations under the reinsurance agreements. However, as of December 31, 2012, all of our primary reinsurers were rated "A-"(Excellent) or better by A.M. Best with the exception of
one reinsurer. For that reinsurer, which is not rated, a trust containing assets at 106% of policy reserve levels is maintained. We are not aware of any instances where any of our reinsurers have been unable to pay any policy claims on reinsured business. Therefore, we have presented our obligations in the table above net of amounts recoverable from reinsurers. Our obligations for policy related liabilities before amounts recovered from reinsurers amount to $1.7 billion.
Sources and Uses of Liquidity to the Parent Company, Universal American Corp. We require cash at our parent company to support the operations and growth of our insurance, HMO and other subsidiaries, fund new business opportunities through acquisitions or otherwise, and pay the operating expenses necessary to function as a holding company, as applicable insurance department regulations require us to bear our own expenses.
•payment of dividends to shareholders and holders of our mandatorily redeemable preferred stock;
•payment of debt principal, interest and fees required under our 2012 Credit Facility; and
As December 31, 2012, we had approximately $59 million of cash and investments in our parent company and unregulated subsidiaries.
In 2007, our wholly-owned subsidiary, The Pyramid Life Insurance Company issued $60.0 million of surplus notes payable to our parent company, bearing interest at an average fixed rate of 7.5%. On March 29, 2012, after receiving regulatory approval, the parent company received $80.2 million in cash from Pyramid, representing payment in full on the surplus notes, including $20.2 million of interest.
Capital contributions to and dividends from our Insurance and HMO subsidiaries are made through their respective holding companies. We did not make any capital contributions to our insurance subsidiaries during the year ended of 2012. During 2012, our insurance companies paid $28.4 million of dividends to their holding company. During 2012, we made capital contributions of $1.7 million to our HMO subsidiaries and our HMO subsidiary, SelectCare of Texas, paid $23.9 million of dividends to its holding company.
APS Healthcare. The primary sources of liquidity for APS Healthcare are fees from its customers, including health plans, state agencies and related organizations for performing a range of healthcare services. The primary uses of liquidity are the payments for salaries and expenses associated with providing these services. We believe the sources of cash for APS Healthcare will exceed scheduled uses of cash and result in amounts available to dividend to our parent company. APS Healthcare's Puerto Rico subsidiary is required to maintain minimum statutory equity as required by regulatory authorities and currently exceeds its minimum requirement at levels we believe are sufficient to support its current level of operations.
Cash and cash equivalents and short-term investments represent approximately 6% of our total cash and invested assets at December 31, 2012 and 5% at December 31, 2011. In the aggregate, approximately 37% of our cash and invested assets at December 31, 2012 are held in securities backed by the U.S. government or its agencies, as compared with 34% at December 31, 2011. The average credit quality of our total investment portfolio was AA- at December 31, 2012 and 2011.
The average book yield of our total investment portfolio decreased to 3.3% at December 31, 2012, from 3.7% at December 31, 2011. The overall decrease in yield is primarily due to our higher yielding assets maturing and the proceeds being reinvested in lower yielding securities in this low interest rate environment.
capital stock of the Company's material subsidiaries and are also guaranteed by certain of our subsidiaries.
We calculate and maintain reserves for the estimated future payment of claims to our policyholders using actuarial assumptions that are consistent with actuarial assumptions we use in the pricing of our products. For our accident and health insurance business, we establish an active life reserve for expected future policy benefits, plus a liability for due and unpaid claims and incurred but not reported claims, known as IBNR. Benefit expenses are recognized in the period in which services are provided or claims are incurred and include an estimate of the cost of services and IBNR claims. Our net income depends upon the extent to which our actual claims experience is consistent with the assumptions we used in setting our reserves and pricing our policies. If our assumptions with respect to future claims are incorrect, and our reserves are insufficient to cover our actual losses and expenses, we would be required to increase our liabilities, resulting in reduced net income and stockholders' equity.
policies, although our current policies are renewable annually at the discretion of the policyholder, as evidenced by the policyholder continuing to make premium payments. In establishing these reserves, we must evaluate assumptions about mortality, morbidity, lapse rates and the rate at which new claims are submitted to us. We estimate the future policy benefits reserve for these products using the above assumptions and actuarial principles. For long-duration insurance contracts, we use these original assumptions throughout the life of the policy and generally do not subsequently modify them.
The policy and contract claims liability for our health policies include a liability for unpaid claims, including claims in the course of settlement, as well as a liability for IBNR claims. Our liability for policy and contract claims-health by major product grouping is as follows:
The claim reserve balances at December 31, 2011 settled during 2012 for $0.6 million less than originally estimated. This prior year development represents less than 0.1% of the incurred claims recorded in 2011.
The claim reserve balances at December 31, 2010 settled during 2011 for $8.4 million less than originally estimated. This prior year development represents less than 0.5% of the incurred claims recorded in 2010.
The following table illustrates the sensitivity of our health IBNR payable at December 31, 2012 to identified reasonably possible changes to the estimated weighted average completion factors and healthcare cost trend rates. However, it is possible that the actual completion factors and healthcare cost trend rates will develop differently from our historical patterns and therefore could be outside of the ranges illustrated below.
•incremental direct costs of a successful contract acquisition, such an non-level commissions, and
We refer to these costs as deferred acquisition costs or DAC. For our net retained traditional life and health products, we amortize DAC in proportion to premium revenue using the same assumptions used in estimating the liabilities for future policy benefits in accordance with ASC 944, Financial
Services-Insurance. Under ASC 944, any unamortized DAC relating to lapsed policies must be amortized as of the date of the lapse.
In accordance with ASC 350, Intangibles and Other, 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. During our review of recoverability in the fourth quarter of 2011, we determined that the undiscounted cash flows from our acquired agency intangible asset were less than its carrying value of $15.6 million indicating that it was no longer fully recoverable and we
We estimate the fair values of our reporting units using discounted cash flows, which include assumptions about a wide variety of internal and external factors. Significant assumptions used in the impairment analysis include financial projections of cash flow (including significant assumptions about operations and target capital requirements), long-term growth rates for determining terminal value, and discount rates. Forecasts and long-term growth rates used for our reporting units are consistent with, and use inputs from, our internal long-term business plan and strategy. During our forecasting process, we assess revenue trends, medical cost trends, operating cost levels and target capital levels. Significant factors affecting these trends include changes in membership, premium yield, medical cost trends, and the impact and expectations of regulatory environments. Additional macro- economic assumptions around unemployment, GDP growth, interest rates, and inflation are also evaluated and incorporated.
We performed our annual goodwill assessment for our individual reporting units as of October 1, 2012. Based on this "Step 1" assessment, we determined, that our estimated fair value of our Senior Managed Care-Medicare Advantage reporting unit was in excess of its carrying value by 29% and that our estimated fair value of APS Healthcare was in excess of its carrying value by 1%. APS Healthcare was acquired on March 2, 2012 (see Note 5-Business Combinations in the Notes to consolidated financial statements). We do not have goodwill assigned to any other reporting units.
During each quarter, we perform a review of certain key components of our valuation of our reporting units, including the operating performance of the reporting units compared to plan (which was the primary basis for the prospective financial information included in our goodwill impairment test as of October 1, 2012), our weighted average cost of capital and our stock price and market capitalization. Based on our review of these items through the reporting date, we believe that our estimate of fair value for each of our reporting units remains reasonable.
variance tolerances. Exceptions to the rules are monitored, investigated and challenged, as needed. We review and test the security pricing procedures used to value our fixed maturity portfolio on an ongoing basis. Our procedures include review of the investment valuation policy and understanding of the procedures used to obtain investment valuations and review of pricing controls at our investment advisor, including their Statements on Standards for Attestation Engagements 16 controls review report. We also test the prices provided by the advisor monthly by comparing the data to another independent pricing source and monitoring the change in prices from month to month and upon sale of the security. Significant changes or variances are investigated and explained. To date, we have modified one price provided by the advisor.
The following table presents the fair value of the asset sectors within the ASC 820 Level 3 securities:
We regularly evaluate the amortized cost of our investments compared to the fair value of those investments. We generally recognize impairments of securities when we consider a decline in fair value below the amortized cost basis to be other-than-temporary. The evaluation includes the intent and ability to hold the security to recovery, and we consider it on an individual security basis, not on a
portfolio basis. We generally recognize impairment losses for mortgage-backed and asset-backed securities when an adverse change in the amount or timing of estimated cash flows occurs, unless the adverse change is solely a result of changes in estimated market interest rates. We also recognized impairment losses when we determine declines in fair values based on quoted prices to be other than temporary.
As of December 31, 2012, we held subprime securities with par values of $20.6 million, an amortized cost of $20.6 million and a fair value of $15.4 million representing approximately 1.0% of our cash and invested assets, with collateral comprised substantially of first lien mortgages in senior or senior mezzanine level tranches, with an average Standard & Poor's rating of A.
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. Based on the analysis of the remaining subprime holdings at December 31, 2012, we do not believe these holdings are other-than-temporarily impaired.
provided through private HMO, PPO and PFFS plans. An individual must have Medicare Part A and Part B in order to join a Medicare Advantage Plan.
Membership. We analyze the membership for our Medicare HMO, PPO, Network PFFS and Non-network PFFS, or Rural, plans in our administrative system and reconcile to the enrollment provided by CMS. There are timing differences between the addition of a member to our administrative system and the approval, or accretion, of the member by CMS. Additionally, the monthly payments from CMS include adjustments to reflect changes in the status of membership as a result of retroactive terminations, additions, whether CMS is secondary to other insurance coverage or other changes. Current period membership, net premium, CMS subsidies and claims expense are adjusted to reflect retroactive changes in membership.
Low-Income Premium Subsidy. For qualifying low-income status, or LIS, members of our Plans with Part D benefits, CMS pays us for some or all of the LIS member's monthly premium. The CMS payment is dependent upon a member's income level which is determined by the Social Security Administration. Low-income premium is recognized over the contract period and reported as premium revenue.
We carried valuation allowances on deferred tax assets of $5.8 million at December 31, 2012 and $1.9 million at December 31, 2011, primarily related to foreign tax credit carryforwards that we acquired in connection with our purchase of APS Healthcare in 2012 and various state net operating loss carryforwards.
from an insurance company that had a PSA that was treated as a distribution from its PSA account; however, the distribution was not subject to Federal income tax. We received the approval of the Insurance Departments of the respective companies for the transactions that could trigger the elimination of the potential tax and made such distributions during 2006. During 2010 we released the deferred tax liabilities previously established for the potential Phase III tax on the PSAs and reduced deferred tax expense.
At December 31, 2012, we had unrecognized tax benefits of $5.2 million, net of federal income tax, primarily related to refund claims filed in various state jurisdictions during 2010 and various pre-acquisition benefits related to APS. During 2012 and 2011 we recognized $8.9 million and $3.9 million, respectively, of refund claims filed in 2010. We recognize interest and penalties related to unrecognized state tax benefits in federal and state tax expense. During the years ended December 31, 2012, we recognized $0.6 million of interest expense and penalties. During the years ended December 31, 2011 and 2010, we recognized no such interest expense and penalties.