Our executive offices are located in Rye Brook, New York. Marketing and professional staff for our U.S. insurance subsidiaries occupy space in Lake Mary, Florida and Solon, Ohio. Our Administrative Services operations occupy office space in Pensacola and Weston, Florida and Mississauga, Ontario, Canada. Our Medicare Advantage operations occupy office space in Houston, Beaumont and Dallas, Texas, as well as Oklahoma City, Oklahoma and Milwaukee, Wisconsin. We lease all of the approximately 452,000 square feet of office space that we occupy. Management considers its office facilities suitable and adequate for the current level of operations. In addition to the above, Pennsylvania Life is the named lessee on approximately 44 properties occupied by career agents for use as field offices. Rent for these field offices is reimbursed by the agents. Additional information regarding our lease obligations is included in Note 15-Commitments and Contingencies in our consolidated financial statements included in this Annual Report on Form 10-K.
statements and the notes to those consolidated financial statements as well as the discussion under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations."
The following discussion and analysis presents a review of the Company as of December 31, 2007 and its results of operations for the fiscal years ended December 31, 2007, 2006 and 2005.
•inter-segment revenue and expense relating to services performed by the Senior Administrative Services segment for our other segments, and
For our fixed benefit accident and sickness and our long term care products, we establish a reserve for future policy benefits at the time we issue each policy based on the present value of future benefit payments less the present value of future premiums. We ceased issuing new long term care 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.
We develop our estimate for IBNR using actuarial methodologies and assumptions, primarily based upon historical claim payment and claim receipt patterns, as well as historical medical cost trends. Depending on the period for which we are estimating incurred claims, we apply a different method in determining our estimate. For periods prior to the most recent three months, the key assumption used in estimating our IBNR is that the completion factor pattern, adjusted for known changes in claim inventory levels and claim payment processes, remains consistent over a certain rolling period. This period, ranging from 3 to 12 months, is dependent on the type of business valued. Completion factors result from the calculation of the percentage of claims incurred during a given period that have historically been adjudicated as of the reporting period. For the most recent three months, we estimate the incurred claims primarily from a trend analysis based upon per member per month, known as PMPM, claims trends developed from our historical experience in the preceding months, adjusted for known changes in estimates of recent hospital and drug utilization data, provider contracting changes, changes in benefit levels, product mix, and seasonality.
We use the completion factor method for the months of incurred claims prior to the most recent three months because the historical percentage of claims processed for those months is at a level sufficient to produce a consistently reliable result. Conversely, for the most recent three months of incurred claims, the volume of claims processed historically is not at a level sufficient to produce a reliable result, which therefore requires that we examine historical trend patterns as the primary method of evaluation. Due to the limited historical claims experience for PFFS, estimates for the most recent three months of incurred claims are based largely on our pricing assumptions for the product. The amounts above reflect the estimated potential medical and other expenses payable based upon assumptions used in determining the loss ratio for the pricing of our private fee-for-service products.
Our historical assumptions have not varied significantly from the actual amounts experienced to the extent that such variance resulted in a material adverse impact on reserves and net income. Activity in the accident and health policy and contract claim liability account is as follows:
During 2007, the claim reserve balances at December 31, 2006 ultimately settled during 2007 for $1.5 million less than originally estimated, representing 0.2% of the incurred claims recorded in 2006. During 2006, the claim reserve balances at December 31, 2005 ultimately settled during 2006 for $0.6 million less than originally estimated, representing 0.1% of the incurred claims recorded in 2005. During 2005, the claim reserve balances at December 31, 2004 ultimately settled during 2005 for $2.4 million more than originally estimated, representing 0.6% of the incurred claims recorded in 2004 and was primarily to higher than anticipated claims for the Medicare supplement business in the Traditional Insurance Segment.
In 2007, we acquired MemberHealth. The balances acquired line item represents the accident and health claim liabilities acquired in this transaction.
The following table illustrates the sensitivity of our accident and health IBNR payable at December 31, 2007 to identified reasonably possible changes to the estimated weighted average completion factors and health care cost trend rates. However, it is possible that the actual completion factors and health care cost trend rates will develop differently from our historical patterns and therefore could be outside of the ranges illustrated below.
(b)Reflects estimated potential changes in medical and other expenses payable, caused by changes in annualized claims trend used for the estimation of per member per month incurred claims for the most recent three months.
No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." The determination of expected gross profits for interest-sensitive products is an inherently uncertain process that relies on assumptions regarding:
It is possible that the actual profits from the business may vary materially from the assumptions used in the determination and amortization of DAC.
For other 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 FAS No. 60, "Accounting and Reporting by Insurance Enterprises." Under FAS No. 60, when a policy lapses, the remaining balance of DAC relating to that policy as of the date of the lapse is amortized. During 2007 and 2006, we experienced an increase in the amount of lapses on our Medicare supplement business, resulting in an increased level of DAC amortization.
We use a prospective unlocking approach to account for DAC for our Medicare supplement business. We use assumptions for future rate increases, persistency and benefit-design in the determination of DAC. Actual experience may vary from assumed trends, but we do not change these assumptions unless prospective unlocking is triggered. If prospective unlocking is triggered, we revise the assumptions to bring them in line with emerging experience. Annually, during our third fiscal quarter, we perform an analysis to determine whether prospective unlocking is triggered as a result of significant changes in the actual premium rate increase experience. At the point when prospective unlocking is triggered, we modify the DAC model prospectively with assumptions for all components. If and when prospective unlocking is triggered, there is not an immediate impact on the DAC balance. Rather, prospective unlocking affects the pattern of the future amortization of the DAC balance. Prospective unlocking also prospectively affects the reserves for future policy benefits for Medicare supplement business and accordingly, similar assumption revisions would occur.
We determined, based on our annual tests for potential unlocking of assumptions for DAC for our Medicare supplement business performed in the third quarters of 2007 and 2006, that there were no significant changes in the actual premium rate increase experience. Accordingly, we did not prospectively unlock the assumptions for DAC for our Medicare supplement business during 2007 or 2006. The balance of DAC for our Medicare supplement business as of December 31, 2007 was approximately $111.3 million.
We write off deferred policy acquisition costs to the extent that we determine that the present value of future policy premiums and investment income or the net present value of expected gross profits would not be adequate to recover the unamortized costs.
Business combinations accounted for as a purchase result in the allocation of the purchase consideration to the fair values of the assets and liabilities acquired, including the present value of future profits, establishing such fair values as the new accounting basis. The present value of future profits is based on an estimate of the cash flows of the in force business acquired, discounted to reflect
Set forth below are our amortization policies for each of the main categories of amortizing intangible assets:
The evaluation of impairment is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current period earnings. The risks and uncertainties include changes in general economic conditions, the issuer's financial condition or near term recovery prospects, the effects of changes in interest rates or credit spreads and the recovery period. The Company's accounting policy requires that a decline in the value of a security below its cost or amortized cost basis be assessed to determine if the decline is other-than-temporary. If the security is deemed to be other-than-temporarily impaired, a charge is recorded in net realized capital losses equal to the difference between the fair value and cost or amortized cost basis of the security. The fair value of the other-than-temporarily impaired investment becomes its new cost basis. The Company has a security monitoring process overseen by its Investment Committee, consisting of investment and accounting professionals that identify securities that, due to certain characteristics, as described below, are subjected to an enhanced analysis on a quarterly basis.
The Company reviews its fixed maturity securities at least quarterly to determine if an other-than-temporary impairment is present based on certain quantitative and qualitative factors. The primary factors considered in evaluating whether a decline in value is other-than-temporary include: (a) the length of time and the extent to which the fair value has been or is expected to be less than cost or amortized cost, (b) the financial condition, credit rating and near-term prospects of the issuer, (c) whether the debtor is current on contractually obligated interest and principal payments and (d) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery.
The Company holds securities with exposure to subprime residential mortgages. Subprime mortgage lending is the origination of residential mortgage loans to customers with weak credit profiles. The slowing U.S. housing market, greater use of mortgage products with low introductory interest rates (generally referred to as 'teaser rates'), and relaxed underwriting standards for some
As of December 31, 2007, the Company held subprime securities with par values of $147 million, an amortized cost of $106 million and a market value of $100 million representing approximately 6% of our cash and invested assets, with collateral comprising substantially of first lien mortgages. The majority of these securities are in senior or senior-mezzanine level tranches, which have preferential liquidation characteristics, and have an average S&P rating of AA+. None of these securities have experienced credit downgrades, although twelve securities with an amortized cost of approximately $47 million have been placed on negative credit watch. The following table presents the Company's exposure to subprime residential mortgages by vintage year.
We use the liability method to account for deferred income taxes. Under the liability method, we recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted tax rates that we expect to apply to taxable income in the years in which we expect to recover or settle those temporary differences. We recognize in income the effect on deferred tax assets and liabilities of a change in tax rates in the period that includes the enactment date of a change in tax rates.
As of December 31, 2007, we had $3.1 million of valuation allowances on tax capital loss carryforwards remaining.
In September 2007, CMS performed a routine triennial site survey of the integrated and non-integrated PFFS business of our American Progressive subsidiary covering the period from January 1, 2007 to June 30, 2007. Based on its findings, CMS made several corrective action recommendations for which we have created and implemented corrective action plans, known as CAPs. The CAPs have been submitted to CMS and are awaiting acceptance of them by CMS, whereupon the corrective action recommendations of CMS will be closed.
On March 1, 2007, we acquired Harmony Health, Inc., a provider-owned company that operates GlobalHealth, Inc. ("GlobalHealth"), a Medicare Advantage health plan and commercial managed care plan in Oklahoma City, OK, for $18.2 million in cash. Harmony was a majority-owned subsidiary of the Oklahoma City Clinic. Founded in 2002, GlobalHealth currently has approximately 5,500 Medicare
Advantage members with annualized revenue of approximately $52 million. Under the terms of the agreement, the Oklahoma City Clinic has entered into a long-term agreement with us to provide healthcare services to GlobalHealth members. In addition, the Oklahoma City Clinic has retained the risk for commercial business under a global capitation arrangement.
Effective January 1, 2006, private insurers were permitted to sponsor insured stand-alone PDPs pursuant to Part D, which was established by the MMA. The Federal government pays a portion of the premium for this insurance, and the individuals who enroll pay the balance, if any. The Federal government will also provide additional subsidies in the form of premium support and coverage of the cost-sharing elements of the plan to specified low income Medicare beneficiaries. For the 2007 plan year, we offered, through our insurance subsidiaries, our Prescription PathwaySM prescription drug plans in all 32 regions designated by CMS in which we bid. In addition, we received auto assignment of dual eligibles and low income subsidy beneficiaries who are dually eligible for Medicare and Medicaid in 28 of the 32 CMS regions. For the 2008 plan year we had a national plan bid below the benchmark in 30 regions. For bid below the benchmark we are eligible to receive auto and facilitated assignment of dual eligibles and other low income beneficiaries.
Through our strategic alliance with Caremark, we retain 50% of the Medicare Part D business of our PDPs, other than our MemberHealth PDPs described below. PharmaCare Re reinsures the remainder on a 50% quota share basis. Additionally, as part of the strategic alliance, we created PDMS, which is 50% owned by us and 50% owned by Caremark. PDMS principally performs marketing and risk management services on behalf of our PDPs, other than our MemberHealth PDPs and PharmaCare Re.
On September 21, 2007, we completed the acquisition of MemberHealth, Inc., a privately-held pharmacy benefits manager, or PBM, and sponsor of CommunityCCRxSM, a national Medicare Part D plan with more than 1.1 million members. Prior to the acquisition, MemberHealth was a leading national Medicare Part D sponsor, offering Medicare prescription drug plans in 50 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. MemberHealth has more than 60,000 pharmacies in its pharmacy network and covers 98 of the top 100 medications taken by Medicare beneficiaries.
the MemberHealth business. The maximum aggregate amount potentially payable under the performance-based earn-out is $150 million, payable in cash and our common stock. Subsequent to December 31, 2007, we determined that expected operating income for 2008 from the MemberHealth business will be less than previously forecast. We also learned after December 31, 2007 that MemberHealth incorrectly calculated its expected risk corridor receivable in its first quarter 2007 financial statements. In connection with these issues, we have concluded an agreement under which the sellers of MemberHealth are delivering back to us approximately $97 million of value. See Note 24-Subsequent Events of Notes to Consolidated Financial Statements included elsewhere in the annual Report on form 10K, for further information on these developments.
We expect the MemberHealth transaction to create significant strategic benefits, including the opportunity for us to build upon MemberHealth's successful pharmacy-centric business model through its ongoing alliance with the National Community Pharmacists Association, known as the NCPA and to introduce additional value-oriented health products and services into the market.
includes realized investment gains, net of tax, of $5.0 million, which reflects a benefit from a $1.9 million release of a tax valuation allowance relating to net capital loss carryforwards.
Our effective tax rate for continuing operations was 36.6% for 2007, and 34.8% for 2006, reflecting the release of the valuation allowance noted above.
Our Senior Managed Care-Medicare Advantage segment generated segment income of $52.7 million in 2007, an increase of $42.2 million compared to 2006, primarily due to growth in business due to our expansion of PFFS plan offerings from 500 counties in 15 states to 3,100 counties in 47 states.
Segment income for our Part D business increased by $54.0 million, to $49.2 million for 2006, compared to a loss of $4.8 million for 2005. The loss in 2005 was as due to the costs incurred to prepare for the launch of the Part D products beginning January 1, 2006.
Our Traditional Insurance segment income decreased by $7.0 million, or 16%, compared to 2005, primarily as a result of the continued effect of higher than expected lapsation of our Medicare supplement in force business, which resulted in an acceleration of the amortization of deferred acquisition costs, worsening morbidity in our long-term care lines, offset by a $1.5 million gain on the sale of our group life insurance business.
Our Senior Managed Care-Medicare Advantage segment generated segment income of $52.7 million in 2007, an increase of $42.2 million compared to 2006, primarily due to growth in
Revenues. Net premiums for our HMO's increased by $174.1 million, or 52%, compared to 2006, primarily due to growth in membership. Medicare membership increased to approximately 45,700 members at December 31, 2007 from approximately 35,400 at December 31, 2006. Additionally, in connection with the acquisition of Harmony Health in March 2007, we acquired approximately 10,600 commercial members which represent approximately $28.3 million of the increase in net premiums. The Harmony Health commercial business had a medical loss ratio of 87.4% for 2007. This commercial business is capitated through an arrangement with the seller, the Oklahoma City Clinic. Net investment income increased by $2.7 million, due primarily to growth in invested assets as a result of growth in business.
On January 1, 2006, we began providing prescription drug benefits in accordance with Medicare Part D as a stand-alone benefit to Medicare eligible beneficiaries under our Prescription PathwaySM PDPs. We reinsure 50% of the business of our Prescription PathwaySM PDPs to PharmaCare Re. Universal American and CVS Caremark have previously announced that their strategic alliance covering the Prescription PathwaySM Medicare Part D prescription drug plan program will end as of December 31, 2008, subject to regulatory approvals. Upon dissolving the strategic alliance, CVS Caremark and Universal American will each assume responsibility for the drug benefit of specified Prescription PathwaySM plan members to achieve an approximately equal distribution of the value of business that has been generated by the strategic alliance.
The results for MemberHealth and its Community CCRxSM PDP from September 21, 2007, the date of its acquisition by us, are also included and is for a period of the year that typically represents the highest operating results for prescription drug plans due to the seasonal nature of the benefits provided.
During the third quarter and fourth quarter of 2007, there were changes in estimates associated with our 2006 Medicare Part D reconciliations. These were mainly a result of additional submissions of prescription drug costs or 'PDE' data to CMS, and finalization of the 2006 membership adjustments between plans. This additional information impacted our estimates of certain subsidies from CMS and claims we pay for which we assume little or no risk, including reinsurance payments and low-income cost subsidies with the resulting impact on the risk corridor calculation for 2006. The net impact, after our 50% quota share reinsurance was $0.8 million and $0.9 million in the third and fourth quarter, respectively.
Revenues. Direct and assumed premium increased by $399.7 million, or 72%, compared to 2006. This growth resulted primarily from the MemberHealth which generated $398.2 million of direct and assumed premium since its acquisition. The change in the government risk corridor adjustment reduced revenue by an additional $44.7 million compared to 2006. The government risk corridor adjustment
Benefits, Claims and Expenses. Pharmacy benefits increased by $213.3 million, compared to 2006. The MemberHealth business generated $194.6 million of benefits since its acquisition, while benefits for our Prescription PathwaySM business increased by $18.7 million or 8.7% over 2006. During the second quarter of 2007, CMS clarified their guidance regarding the treatment of DIR relative to catastrophic reinsurance claims. Previously, only rebates were netted against the claim costs that were subject to the government's catastrophic reinsurance. Pursuant to the new guidance, other DIR must also be netted against those claim costs to determine the amount the government will cover. With respect to Prescription PathwaySM business, this increased claims costs, net of our 50% quota share reinsurance, by approximately $7.0 million, including $5.8 million relating to 2006. The increase in claims costs was partially offset by an increase in the risk corridor adjustment. The clarification of the CMS guidance added approximately $7.0 million, net of our 50% quota share reinsurance with respect to the Prescription PathwaySM business. Additionally, changes in estimates associated with our 2006 Medicare Part D reconciliations resulted in a reduction of benefits by $14.9 million, net of our 50% quota share, with the balance of the increase due to an increase in membership. The ratio of incurred prescription drug benefits to net premium for 2007 was 73.8% compared to 87.4% for 2006. Commissions and general expenses increased by $63.0 million, compared to 2006. MemberHealth added $56.0 million since its acquisition. The balance of the increase of $7.0 million relates to the growth in our Prescription PathwaySM business.
Membership. For Prescription PathwaySM, we based our membership on enrollment information provided by CMS which indicated that, as of December 31, 2006, approximately 432,000 members were enrolled, that we participate in on a 50% basis, for which we were paid by CMS. We also participate, on a 33.3% basis, in BCBS that had approximately 24,000 members at December 31, 2006.
Revenues. Direct and assumed premium were $551.3 million in 2006, the initial year of our Part D product. The government risk corridor adjustment reduced revenue by $69.1 million. Ceded premium represents the portion of premium reinsured with PharmaCare Re.
Other Part D income-PDMS increased by $50.2 million compared to 2005. The loss in 2005 was due to our share of the costs incurred at PDMS to prepare for the launch of the Prescription PathwaySM product beginning January 1, 2006.
Benefits, Claims and Expenses. Pharmacy benefits were $213.9 million in 2006. The ratio of incurred prescription drug benefits to net premium for 2006 was 87.4%. Commissions and general expenses increased by $30.2 million, compared to 2005 and a result of the commencement of operations for our Prescription PathwaySM product.
Our Traditional Insurance segment income decreased by $21.7 million, or 61%, compared to 2006. Results for our Medicare supplement business declined by $9.7 million compared to 2006 primarily as a result of a lower level of in force business as a result of the effect of higher levels of lapsation of our Medicare supplement in force business in 2007 and 2006 and an increase in our Medicare supplement medical loss ratio. A significant portion of the lapsation was attributable to Medicare supplement policyholders who switched to our PFFS coverage. Our Specialty Health Insurance income decreased by $6.3 million, or 62%, compared to 2006, primarily as the result of increased medical costs and an increase in the amortization of deferred costs in 2007 compared to 2006, partially offset by higher net investment income. Income from our Life Insurance and Annuity business declined by $4.1 million, compared to 2006, primarily as a result of higher commissions and general expenses.
Revenues. Net premium declined by $66.3 million, or 13% and was primarily caused by the continued effect of higher lapsation of our Medicare supplement in force products. Below is a summary of premium for the segment by major lines of business:
There was net amortization of deferred acquisition costs in 2007 compared to an increase in deferred acquisition costs in 2006, an increase to expense of $31.5 million. We incurred lower commissions and other acquisition costs during 2007 as a result of lower production, resulting in a decrease in the costs capitalized of $31.6 million compared to 2006. Amortization was flat compared to 2006, with excess amortization caused by higher levels of lapsation of our Medicare supplement products, due to many of these policyholders switching to our PFFS product. This was offset by a reduction in amortization on a smaller block of continuing business.
Net investment income increased by approximately $7.4 million, or 13%, compared to 2005, primarily as a result of an increase in portfolio yields.
Policyholder benefits incurred declined by $21.0 million, or 5%, compared to 2006. Overall loss ratios for the segment decreased to 73.4% for 2006 compared to 73.9% for 2005. The decline in benefits was principally caused by a reduction in Medicare supplement benefits by $24.8 million, as a result of a decline in the business, combined with a decrease in the Medicare supplement loss ratio that reduced benefits by $8.9 million compared to 2005.
Commission and expense allowances received from reinsurers as a percentage of the premiums ceded decreased to 10.1% for 2006 from 16.6% for 2005. The reinsurance allowance on the reinsurance agreement noted above is significantly lower than for other lines because there are no commissions related to that business. The reduction in new business ceded and the effects of normal lower commission allowances on our aging base of ceded renewal business also have the effect of reducing the ratio.
Segment income for our Senior Administrative Services segment increased by $8.3 million, or 52%, to $24.1 million for the year ended December 31, 2007, as compared to 2006. This increase is primarily the result of the growth in business administered.
Revenue increased by $21.9 million, or 26%, during 2007 compared to 2006. Affiliated service fee revenue increased by $21.6 million primarily as a result the growth in fees for the administration of our Medicare Advantage business as well as Part D prescription drug plans on behalf of our insurance subsidiaries. The increase in other fees relates to the administration of affiliated business that was previously performed by PennCorp Life Canada, which was sold. Revenue declined for the
Segment income for our Senior Administrative Services segment increased by $6.4 million, or 68%, to $15.8 million for the year ended December 31, 2006, as compared to 2005. This increase is primarily the result of new business administered.
The increase in interest cost of $7.7 million is due primarily to the increase in our debt outstanding, offset in part by a reduction in the interest rates charged on the debt, as compared to 2006. Our combined outstanding debt increased by $293.5 million to $459.1 million at December 31, 2007 from $165.6 million at December 31, 2006. The increase in the outstanding debt was due primarily to the refinancing of our credit facility in connection with the acquisition of MemberHealth in September 2007. The weighted average interest rate on our loan payable was 6.4% for 2007 compared to 7.3% for 2006. The weighted average interest rate on our other long term debt was 7.9% for 2007 compared to 7.8% for 2006. The early extinguishment of debt, in connection with the refinancing and the redemption of the trust preferred securities from Statutory Trust 1, resulted in the immediate amortization of the related capitalized loan origination fees, resulting in a pre-tax expense of approximately $1.3 million. See "Liquidity and Capital Resources" for additional information regarding our loan payable and other long term debt.
The increase in stock-based compensation resulted primarily from the awards, in 2007, to officers and other employees approved by the compensation committee. The increase in other parent company expenses was primarily due to outside legal costs in connection with the class action lawsuits and the proposed management buy-out.
Our combined outstanding debt was $165.6 million at December 31, 2006 compared to $170.8 million at December 31, 2005. The weighted average interest rate on our loan payable increased to 7.3% for 2006 from 5.5% for 2005. The weighted average interest rate on our other long term debt increased to 7.8% for 2006 from 7.2% for 2005. See "Liquidity and Capital Resources" for additional information regarding our loan payable and other long term debt.
(1)These obligations include contractual interest and the table reflects scheduled maturities for contractual obligations existing as of December 31, 2007.
the more than 5 Years column. The trust preferred securities generally have floating rate coupons. However, the coupon on $50 million of the trust preferred securities is fixed through its no call period and then converts to a floating rate. Additionally, we pay a fixed rate on $20 million of the trust preferred securities through the no call period through the use of a swap agreement. We did not project future changes in the base interest rates. For the purpose of this schedule, we applied the base rate in effect at December 31, 2007 to all future periods. Additionally, we assumed that, upon the expiration of the swap agreement and the fixed rate, the rate for the respective trust preferred securities adjusted to a variable rate using the current base rate.
We believe that our current cash position, the expected cash flows of our administrative service company and our senior managed care company, our PBM business in MemberHealth and the surplus note interest and principal payments from American Exchange can support our current parent company obligations. However, there can be no assurance as to our actual future cash flows or to the continued availability of dividends from our insurance company subsidiaries.
In connection with the MemberHealth transaction, as described in Note 23-Business Combinations to our Consolidated Financial Statements set forth above, the Company refinanced its Amended Credit Facility and Revolving Credit Facility with a new credit facility (the "2007 Credit Facility") consisting of a $350 million term loan and a $150 million revolver. A portion of the proceeds from the refinancing was used to repay in full the amounts outstanding on the Amended Credit Facility and Revolving Credit Facility. Interest under the 2007 Credit Facility is currently based on LIBOR plus a spread of 62.5 basis points. In addition, the Company currently pays a commitment fee on the unutilized revolving loan facility at an annualized rate of 10.0 basis points. In accordance with the credit agreement for the 2007 Credit Facility, the spread and fee are determined based on the Company's consolidated leverage ratio. Effective December 31, 2007, the interest rate on the term loan portion of the 2007 Credit Facility was 5.63%. The Company had not drawn on the revolving loan facility as of the date of this report. As a result of the value to be received pursuant to the settlement agreement discussed in Significant Transactions and Initiatives, and the occurrence of a breach of representation and warranty made by us in our 2007 credit agreement regarding historical MemberHealth financial statements, we will prepay $25 million of principal under the new facility in April 2008 pursuant to a waiver of that breach.
Principal repayments are scheduled to be made quarterly at the rate of $3.5 million per year over a five-year period and a final payment of $335.1 million due upon maturity in September, 2012. The
following table shows the schedule of principal payments remaining on the 2007 Credit Facility as of December 31, 2007, excluding the effect of the $25 million prepayment discussed above.
We made regularly scheduled principal payments of $3.5 million during the year ended December 31, 2007, $5.3 million during 2006 and $5.3 million during 2005, in connection with its credit facilities. We repaid the $87.9 million balance outstanding on our Amended Credit Facility in connection with the refinancing noted above.
We paid interest of $9.9 million during the year ended December 31, 2007, $6.9 million during 2006 and $5.5 million during 2005, in connection with our credit facilities. Due to the variable interest rate on the 2007 Credit Facility, for the portion not covered by the interest rate swaps would be subject to higher interest costs to the Company if short term interest rates rise.
accordance with the adoption of FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities," we do not consolidate the trusts.
In late March, 2007, we issued $50.0 million of trust preferred securities at a fixed interest rate of 7.7% pursuant to terms similar to our other trust preferred securities. On December 4, 2007, we exercised our option to redeem all $15.0 million of the trust preferred securities scheduled to mature December 2032.
Separate subsidiary trusts of our parent holding company (the "Trusts") have issued a combined $125.0 million in thirty year trust preferred securities, with $110 million currently outstanding as detailed in the following table:
(2)Effective April 29, 2004, we entered into a swap agreement whereby we will pay a fixed rate of 6.98% in exchange for a floating rate of LIBOR plus 395 basis points. The swap contract expires in October 2008.
We paid $8.7 million in interest in connection with the Junior Subordinated Debt during the year ended December 31, 2007, $5.8 million during 2006 and $5.3 million during 2005.
We are obligated under certain lease arrangements for our executive and administrative offices in New York, Florida, Indiana, Texas, Wisconsin, Oklahoma and Ontario, Canada. Rent expense was $6.0 million for the year ended December 31, 2007, $4.4 million for 2006 and $3.9 million for 2005. Annual minimum rental commitments, subject to escalation, under non-cancelable operating leases are as follows:
In addition to the above, Pennsylvania Life is the named lessee on 52 properties occupied by career agents for use as field offices. The career agents reimburse Pennsylvania Life the actual rent for these field offices. The total annual rent paid by the Company and reimbursed by the career agents for these field offices during 2007 was approximately $2.9 million.
On November 3, 2004, we filed a universal shelf registration statement on Form S-3 with the U.S. Securities and Exchange Commission or the SEC, pursuant to which we may issue common stock, warrants and debt securities from time to time, up to an aggregate offering of $140 million. The registration statement also covered five million shares of common stock that may be offered for sale by Capital Z Financial Services Fund II, L.P. ("Capital Z"), our largest shareholder. The SEC declared the shelf registration statement effective in December 2004. While this registration statement has expired, we could revive or extend it.
The aggregate amount that remains available for offering under the 2004 shelf registration statement is $77.2 million as of December 31, 2007.
Senior Administrative Services Company. Liquidity for our Senior Administrative Services subsidiary is measured by its ability to pay operating expenses and pay dividends to our parent company. The primary source of liquidity is fees collected from clients. We believe that the sources of cash for our Senior Administrative Services company exceed scheduled uses of cash and will result in amounts being available to pay dividends to our parent holding company.
Insurance Subsidiaries-Surplus Note, Dividends and Capital Contributions. Cash generated by our insurance company subsidiaries will be made available to our holding company, principally through periodic payments of principal and interest on the surplus note owed to our holding company by our subsidiary, American Exchange Life. As of December 31, 2007, the principal amount of the surplus note was $17.6 million. The note bears interest to our parent holding company at LIBOR plus 250 basis points. We anticipate that the surplus note will be primarily serviced by dividends from Pennsylvania Life, a wholly owned subsidiary of American Exchange and by distributions from PDMS, and by tax-sharing payments among the insurance companies that are wholly owned by American Exchange and file a consolidated Federal income tax return. American Exchange made principal payments totaling $10.0 million during the year ended December 31, 2007 and $12.5 million during the year ended December 31, 2006 and $8.4 million during the year ended December 31, 2005. American Exchange paid interest on the surplus note of $1.9 million during the year ended December 31, 2007 and $2.5 million during the year ended December 31, 2006 and $2.6 million during the year ended December 31, 2005.
On June 29, 2007 and December 31, 2007, Pyramid issued two $30.0 million surplus notes payable to our holding company. The notes are repayable through annual principal payments beginning March 29, 2009, based on a schedule, provided that capital and surplus are sufficient to maintain risk based capital levels of 450% or greater. The surplus notes can be pre-paid (with prior approval by the state of Kansas) to the extent that Pyramid's risk based capital levels exceed 450%. The notes bear interest to our parent holding company at fixed rates of 7.7% and 7.3%, respectively, for the term of the notes.
Dividend payments by our insurance companies to our holding company or to intermediate subsidiaries are limited by, or subject to the approval of the insurance regulatory authorities of each insurance company's state of domicile. Such dividend requirements and approval processes vary significantly from state to state. Pennsylvania Life is able to pay ordinary dividends of up to $51.1 million to American Exchange (its direct parent) and American Exchange is able to pay ordinary dividends of up to $26.1 million to Universal American in 2008 without the prior approval from the insurance department for their respective states of domicile.
Liquidity for our insurance company subsidiaries is measured by their ability to pay scheduled contractual benefits, pay operating expenses, fund investment commitments, and pay dividends to their parent company. The principal sources of cash for our insurance operations include scheduled and unscheduled principal and interest payments on investments, premium payments, annuity deposits, and the sale or maturity of investments. Both the sources and uses of cash are reasonably predictable and we believe that these sources of cash for our insurance company subsidiaries exceed scheduled uses of cash.
subsidiaries, in our view, have not experienced any material changes in surrender and withdrawal activity in recent years.
At December 31, 2007, we held cash and cash equivalents totaling $668 million and fixed maturity securities that could readily be converted to cash with carrying values and fair values of $1.1 billion
Our investment policy is to balance the portfolio duration to achieve investment returns consistent with the preservation of capital and maintenance of liquidity adequate to meet payment of policy benefits and claims. We invest in assets permitted under the insurance laws of the various states in which we operate. Such laws generally prescribe the nature, quality of and limitations on various types of investments that may be made. We do not currently have investments in partnerships, special purpose entities, real estate, commodity contracts, or other derivative securities. We currently engage
the services of two investment advisors under the direction of the management of our insurance company subsidiaries and in accordance with guidelines adopted by the Investment Committees of their respective boards of directors. Conning Asset Management Company manages the portfolio of all of our United States subsidiaries, except for the portfolios of Pyramid Life, SelectCare of Texas, L.L.C. and certain floating rate portfolios, which are managed by Hyperion Capital.
We invest primarily in fixed maturity securities of the U.S. Government and its agencies and in corporate fixed maturity securities with investment grade ratings of BBB- or higher by Standard & Poor's Corporation ("S&P") or Baa3 or higher by Moody's Investor Service ("Moody's"). As of December 31, 2007, approximately 98% of our fixed maturity investments had investment grade ratings from Standard & Poor's Corporation or Moody's Investor Service. There were no non-income producing fixed maturities as of December 31, 2007. As of December 31, 2007, we held securities with par values of approximately $147 million with exposure to Subprime mortgages. The market value of these securities was $100 million at December 31, 2007, representing approximately 6% of our cash and invested assets. The collateral for these securities is substantially all first lien mortgages. These securities have an average S&P rating of AA+ and none of these securities have experienced credit downgrades, although twelve securities we own with an amortized cost of approximately $47 million have been placed on negative watch by Moody's or S&P. During the fourth quarter of 2007, we recognized other than temporary impairment totaling $41.0 million in the value of certain of our securities with exposure to subprime mortgages.
At December 31, 2007, the Company (exclusive of American Exchange and its subsidiaries) had net operating loss carryforward of approximately $6.0 million that expires in 2025. The use of the net operating loss carryforward is limited to $1.6 million per year under the Internal Revenue Code.
The Company establishes valuation allowances based upon an analysis of projected taxable income and its ability to implement prudent and feasible tax planning strategies. The Company carried valuation allowances on its deferred tax assets of $3.1 million at December 31, 2007 and $0.2 million at December 31, 2006.
Our U.S. insurance company subsidiaries are taxed as life insurance companies as provided in the Internal Revenue Code. The Omnibus Budget Reconciliation Act of 1990 amended the Internal Revenue Code to require a portion of the expenses incurred in selling insurance products to be
The Jobs Creation Tax Act of 2004 (the "Jobs Act") contains a provision that places a two year moratorium on the imposition of tax on distributions from Policyholder Surplus Accounts ("PSA"), the Phase III tax. Additionally, the ordering rules were changed to allow for the first dollar of any distribution to reduce the PSA. At December 31, 2007 and 2006, we had $7.1 million in deferred tax liabilities for potential Phase III tax. In accordance with the Jobs Act, distributions during 2005 and 2006 from an insurance company that has a PSA will be treated as a distribution from its PSA account, however, the distribution will not be 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. Upon the confirmation of the elimination of the potential Phase III tax on the PSAs, the deferred tax liability will be released. Approximately $3.8 million will reduce goodwill related to the acquisition of Pyramid. The remaining $3.3 million will reduce deferred tax expense.