(2) All historical common share data have been adjusted for a 3-for-2 stock split in the form of a stock dividend paid on October 17, 2005 to stockholders of record on October 3, 2005.
We are a national managed health care company based in Bethesda, Maryland operating health plans, insurance companies, network rental / managed care services companies, and workers’ compensation services companies. We provide a full range of risk and fee-based managed care products and services, including health maintenance organization (“HMO”), preferred provider organization (“PPO”), point of service (“POS”), Medicare Advantage, Medicare Prescription Drug Plans, Medicaid, Workers’ Compensation and Network Rental to a broad cross section of individuals, employer and government-funded groups, government agencies, and other insurance carriers and administrators in all 50 states as well as the District of Columbia and Puerto Rico.
Revenue increased 24.5% over the prior year. Health Plan only revenue increased 9.3% over the prior year.
Health Plan medical loss ratio of 79.5% improved 100 basis points over the prior year.
Selling, general and administrative expenses were 17.9% of operating revenues, Health Plan only selling, general and administrative expense was 11.4%, a 10 basis point improvement over the prior year.
Cash flows from operations were $804.5 million, a 77.2% improvement over the prior year.
During the three years ended December 31, 2005, we experienced substantial growth in operating revenues due in part to membership increases from health plan acquisitions and more recently, as a result of the acquisition of First Health Group (“First Health”). We generally seek acquisitions that we believe have a manageable regulatory and business climate and have the ability to add value to our company. Additionally, membership growth was achieved organically through marketing efforts, geographic expansion and increased product offerings. Our ability to introduce products quickly to each market has helped us to expand our customer base. In particular, we have been able to add a large variety of lower cost products, which has proven attractive to customers.
Managed care premiums are recorded as revenue in the month in which members are entitled to service. Premiums are based on both a per subscriber contract rate and the number of subscribers in our records at the time of billing. Premium billings are generally sent to employers in the month preceding the month of coverage. Premium billings may be subsequently adjusted to reflect changes in membership as a result of retroactive terminations, additions, or other changes. Due to early timing of the premium billing, we are able to identify in the current month the retroactive adjustments for two subsequent months billings. Current period revenues are adjusted to reflect these retroactive adjustments.
We believe that the amount of medical liabilities is adequate to cover our ultimate liability for unpaid claims as of December 31, 2005; however, actual claim payments and other items may differ from established estimates.
For our impairment analysis of the First Health segment goodwill and indefinite lived intangible asset, we engaged an independent business valuation firm to assist us in our analysis. For the First Health goodwill impairment analysis, we relied primarily on the income approach and secondarily on the market approach. For the First Health indefinite lived asset, we relied on two separate variations of the income approach. Each approach was reviewed together for consistency and commonality.
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, the estimates underlying our goodwill impairment tests could be adversely affected. Any impairment charges that may result will be recorded in the period in which the impairment is identified. We have not incurred an impairment charge related to goodwill or indefinite lived intangibles. See Note C to the consolidated financial statements for additional disclosure related to intangible assets.
Our remaining long-lived assets consist of property and equipment and other finite-lived intangible assets. These assets are depreciated or amortized over their estimated useful life, and are subject to impairment reviews. In accordance with Statement of Position (“SOP”) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, the cost of internally developed software is capitalized and included in property and equipment. We capitalize 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. We periodically review long-lived 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. We also must estimate and make assumptions regarding the useful life we assign to our long-lived assets. If these estimates or their related assumptions change in the future, we may be required to record impairment losses or change the useful life, including accelerating depreciation for these assets.
As permitted by SFAS No. 123, the Company accounted for share-based payments to employees using APB No. 25’s intrinsic value method through December 31, 2005 and, as such, has recognized no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have an effect on its results of operations, although it will have no material effect on its overall financial position. The effect of adoption of SFAS No. 123(R) will depend on the value and levels of share-based payments granted in the future. However, assuming share-based payments are granted in 2006 at values and levels granted in 2005, the Company expects the diluted earnings per share effect of adopting SFAS No. 123(R) to be a $0.13 to $0.14 reduction for the full year of 2006.
SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While the Company can not estimate what those amounts will be in the future (as it is dependent upon, among other things, when employees exercise stock options), the amounts of operating cash flows that were recognized in prior periods for such excess tax benefits were $38.0 million, $21.4 million, and $18.5 million in 2005, 2004 and 2003, respectively.
The following table summarizes all business combinations and membership purchases for the three years ended December 31, 2005. The purchase price of each business combination includes the payment for net worth and estimated transition costs. The purchase price shown for recent acquisitions, in millions, is inclusive of all retroactive balance sheet settlements and transaction cost adjustments.
Commercial insured membership increased over the prior year end due to strong sales and retention, especially in the third and fourth quarters. These membership gains were partially offset by the loss, during the first quarter of 2005, of a large commercial insured account to an administrative services only (“ASO”) bid and a large existing group in the Kansas market that changed from a risk product to a non-risk product effective January 1, 2005. On August 29, 2005, Hurricane Katrina caused significant destruction and flooding in Southern Louisiana, most notably in the greater New Orleans area. As a result of its effects, we lost 11,000 commercial insured members in our Louisiana operations in the fourth quarter of 2005 and expect additional losses of membership in 2006.
The following table is provided to facilitate a more meaningful discussion regarding the comparison of our operations for each of the three years in the period ended December 31, 2005 (in thousands, except EPS and membership).
Managed care premium revenue increased as a result of rate increases that occurred throughout all markets and as a result of acquisitions. Commercial yields (premium per member per month) increased as a result of rate increases on renewals. Medicare yields increased as a result of the rate increases on January 1, 2005 from the annual Adjusted Community Rating filings. Medicaid yields increased as a result of a rate increase of 6.5% effective January 1, 2005 in Missouri, our largest Medicaid market, and as a result of the OmniCare acquisition which has a higher yield than our historical Medicaid membership. The acquisition of OmniCare effective October 1, 2004 and First Health effective January 28, 2005 accounted for $151.9 million of the increase in managed care premium revenue over the prior year. The First Health acquisition closed January 28, 2005 and, therefore, only results from January 28, 2005 through December 31, 2005 are included in our results of operations.
Selling, general and administrative expenses increased primarily due to normal operating costs of First Health, which accounted for $523.7 million of the increase in selling, general and administrative expense. Additional increases include an increase in salary expense, Medicare Part D implementation costs and a full twelve months of normal operating costs of OmniCare. Salary expenses, excluding acquisitions, have increased due to annual compensation increases and additional amortization expense related to restricted shares of common stock granted in 2004 and 2005. However, Health Plan selling, general and administrative expenses as a percentage of revenue have improved as a result of continuing revenue growth and success in controlling administrative costs.
Management services revenue increased due to the increase in non-risk membership influenced by three large groups changing from a risk product to a non-risk product effective January 1, 2004, as well as from additional organic membership obtained in the Missouri market.
Selling, general and administrative expense increased primarily due to normal operating costs of recent acquisitions, an increase in broker commissions and an increase in salary expenses. Broker commissions, excluding acquisitions, have increased due to the growth in both organic membership and in premium rates. Salary expenses, excluding acquisitions, have increased due to annual compensation increases, additional amortization expense related to restricted shares of common stock granted in 2003 and 2004, and incremental compensation expense related to our organic membership growth. Selling, general and administrative expenses as a percentage of revenue have improved as a result of continuing revenue growth and success in controlling customer service costs.
The Medicare Part D program, which gives beneficiaries access to prescription drug coverage, took effect January 1, 2006. Coventry has been awarded contracts by the CMS to offer various Medicare Part D plans on a nationwide basis, in accordance with guidelines put forth by the agency.
Coventry submitted bids as a national prescription drug plan sponsor in all 34 CMS established regions. The bids are designed to provide solutions for individuals, employer groups and low income populations. Our primary retail distribution strategy for the Medicare Part D program is through distribution alliances with other insurers and retail operations.
During the third quarter of 2005, we received approval to offer Part D Prescription Drug Plans (“PDP”) in all 34 regions. We also qualified in all 13 regions where we sought to participate in the auto assignment of low income beneficiaries. The PDP plans will be marketed under the brand names of Advantra Rx and First Health Premier and include options with first dollar coverage (no deductible). Products will be underwritten by Coventry Health and Life Insurance Company, First Health Life and Health Insurance Company and Cambridge Life Insurance Company. We have established partnerships with Medicare Supplement insurance carriers and brokerage channels nationwide to provide Medicare Part D prescription drug products to Medicare beneficiaries.
We have incurred approximately $12.4 million in selling, general and administrative expenses in 2005 preparing for the implementation of this program.
Our investment guidelines emphasize investment grade fixed income instruments in order to provide liquidity to meet future payment obligations and minimize the risk to the principal. The fixed income portfolio includes government and corporate securities with an average quality rating of “AA+” and an average contractual duration of 2.2 years, as of December 31, 2005. Typically, the amount and duration of our short-term assets are more than sufficient to pay for our short-term liabilities, and we do not anticipate that sales of our long-term investment portfolio will be necessary to fund our claims liabilities.
Our total cash and investments, consisting of cash and cash equivalents and short-term and long-term investments, but excluding deposits of $49.4 million restricted under state regulations, increased $308.9 million to $2.0 billion at December 31, 2005 from $1.7 billion at December 31, 2004.
Net cash from operating activities is primarily driven by net earnings. For the year ended December 31, 2005, operating cash flow was positively affected by an increase in medical liabilities and an increase in accounts payable and other accrued liabilities. Medical liabilities have increased due primarily to an increase in medical claims incurred but not reported in certain markets and an increase in capitation payable amounts owed related to our Pennsylvania Medicaid product. Accounts payable and other liabilities increased as a result of an increase in taxes payable, an increase in interest payable and an increase in deferred compensation liabilities. Cash flow from operating activities has improved over the prior year as a result of higher earnings and a larger increase in accounts payable and other accrued liabilities.
The senior notes and credit facilities require compliance with specified financial ratios and contain certain covenants and restrictions regarding incurring additional debt, limiting dividends or other restricted payments, and restricting sales of assets above a certain threshold and consolidations or mergers in the context of a change of control. We have complied with all ratios and covenants under the senior notes and credit facilities.
Capital expenditures in 2005 of approximately $71.4 million consist primarily of computer hardware, software and related costs associated with the development and implementation of improved operational and communication systems and Medicare Part D infrastructure.
Our Board of Directors has approved a program to repurchase our outstanding common stock. Stock repurchases may be made from time to time at prevailing prices on the open market, by block purchase or in private transactions. As a part of this program, no shares of common stock were purchased in 2003, 3.0 million shares during the first quarter of 2004 at an aggregate cost of $84.6 million and no shares were purchased in 2005. As of December 31, 2005, the total remaining common shares we are authorized to repurchase under the program is approximately 2.6 million. Excluded from these amounts are shares purchased in exchange for employee payroll taxes on vesting of restricted stock awards as these purchases are not part of the program. In February 2006, our Board of Directors approved an increase to the repurchase authorization in an amount equal to 5% of our outstanding common stock thus increasing our repurchase authorization by 8.1 million shares.
The National Association of Insurance Commissioners (“NAIC”) has proposed that states adopt risk-based capital (“RBC”) standards that, if adopted, would generally require higher minimum capitalization requirements for HMOs and other risk-bearing health care entities. RBC is a method of measuring the minimum amount of capital appropriate for a managed care organization to support its overall business operations in consideration of its size and risk profile. The managed care organization’s RBC is calculated by applying factors to various assets, premiums and reserve items. The factor is higher for those items with greater underlying risk and lower for less risky items. The adequacy of a managed care organization’s actual capital can then be measured by a comparison to its RBC as determined by the formula. Our health plans are required to submit an RBC report to the NAIC and their domiciled state’s department of insurance with their annual filing.
The increase in capital and surplus for our regulated subsidiaries is a result of income, the inclusion of regulated subsidiaries acquired with First Health and capital contributions offset by dividends paid to the parent company. The increase in statutory deposits is a result of the inclusion of deposits held by the regulated subsidiaries acquired with First Health.
As of December 31, 2005, we were contractually obligated to make the following payments within the next five years and thereafter (in thousands):
The trial court has certified various subclasses of plaintiffs. The defendants filed an appeal of that certification order to the 11th Circuit Court of Appeals. The Court of Appeals has overturned the class certification order as to the plaintiffs’ state law claims but affirmed the certification with respect to the plaintiffs’ federal law claims. The U.S. Supreme Court has denied the defendants’ petition to review the 11th Circuit’s class certification decision. As a result of the class certification decision, the only causes of action remaining in the lawsuit are the claims of (1) conspiracy to violate RICO and (2) aiding and abetting violations of RICO. Seven defendants have entered into settlement agreements with the plaintiffs which have received final approval from the trial court. The claims against one defendant have been dismissed. Two defendants remain, including the Company. The trial of this lawsuit is tentatively scheduled to start September 18, 2006. The Shane lawsuit has triggered the filing of copycat class action complaints by other health care providers such as chiropractors, podiatrists, acupuncturists and other licensed health care professionals. Each of these actions has been transferred to the MDL and have been designated as “tag-along” actions. The court has entered an order which stays all proceedings in the tag-along actions until all pre-trial proceedings in the Shane action have been concluded. Although we can not predict the outcome, management believes that the Shane lawsuit and the tag-along actions will not have a material adverse effect on its financial position or its results of operations. Management also believes that the claims asserted in these lawsuits are without merit and we intend to defend our position.
Although the provisions of any legislation adopted at the state or federal level can not be accurately predicted at this time, management believes that the ultimate outcome of currently proposed legislation should not have a material adverse effect on the results of our operations in the short-term. Nevertheless, it is possible that future legislation or regulation could have a significant effect on our operations.
In recent years, health care cost inflation has exceeded the general inflation rate. To reduce the effect of health care cost inflation on our business operations we have, where possible, increased premium rates and implemented cost control measures in our patient care management and provider contracting. We can not be certain that we will be able to increase future premium rates at a rate that equals or exceeds the health care cost inflation rate or that our other cost control measures will be effective.
Our health plans operate in highly competitive markets, but in the aggregate we believe that the pricing environment is generally rational in our existing markets, thus creating the opportunity for reasonable price increases. We will continue to obtain adequate premium increases for our commercial business and expect premium rates to continue to rise at a rate equal to or greater than medical trend in 2006. Management believes that existing markets have potential for premium growth for our commercial and governmental products.
We expect the new Medicare Part D program to contribute $0.08 to our 2006 full year earnings per diluted share. We estimate a loss of $0.08 in the first quarter of 2006, a smaller loss in the second quarter of 2006, and increasing profits in the third and fourth quarters of 2006 to get to the total $0.08 gain for the full year of 2006. This incremental contribution to earnings per share excludes the effect of the expected losses of First Health fee based revenue of $31 million and associated earnings per share reductions of $.06 relating to the termination of dual eligible administration and senior pharmacy discount card business as a result of the implementation of the Medicare Part D program.
Additionally, we will begin to incur expense effective January 1, 2006 related to the adoption of SFAS 123(R). We estimate the effect of the adoption of SFAS 123(R) to reduce earnings by $0.03 per diluted share in the first quarter of 2006 and by $0.13 to $0.14 per diluted share for the year ending December 31, 2006.
See Part I, Item 1A, “Risk Factors” which is incorporated herein by reference.
We have audited the accompanying consolidated balance sheets of Coventry Health Care, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
Coventry Health Care, Inc. (together with its subsidiaries, the “Company” or “Coventry”) is a national managed health care company based in Bethesda, Maryland operating health plans, insurance companies, network rental / managed care services companies, and workers’ compensation services companies. The Company provides a full range of risk and fee-based managed care products and services, including HMO, PPO, POS, Medicare Advantage, Medicare Prescription Drug Plans, Medicaid, Workers’ Compensation and Network Rental to a broad cross section of individuals, employer and government-funded groups, government agencies, and other insurance carriers and administrators in all 50 states as well as the District of Columbia and Puerto Rico.
Stock Split - On August 31, 2005, the Company’s Board of Directors approved a three-for-two stock split of the Company’s common stock. The stock split, in the form of a stock dividend, was distributed October 17, 2005 for stockholders of record on October 3, 2005. The stock split is reflected retroactively in the Company’s consolidated financial statements and notes thereto for all periods presented.
Long-term Assets - Long-term assets primarily include assets associated with the Supplemental Executive Retirement Plan (“SERP”), senior note issuance costs and reinsurance recoveries. The reinsurance recoveries were obtained with the acquisition of First Health Group Corp. (“First Health”) and are related to certain life insurance receivables from a third party insurer for liabilities that have been ceded to that third party insurer.
(1) Acquisition balances represent medical liabilities of the acquired company as of the applicable acquisition date.
Other Long-term Liabilities - Other long-term liabilities consist primarily of liabilities associated with the SERP and the deferred tax liabilities associated with intangible assets and a limited partnership investment.
Comprehensive Income - Comprehensive income includes net income and the unrealized net gains and losses on investment securities. Other comprehensive income is net of reclassification adjustments to adjust for items currently included in net income, such as realized gains and losses on investment securities. The deferred tax benefit for unrealized holding losses arising from investment securities during the years ended December 31, 2005, 2004 and 2003 was $6.9 million, $6.0 million and $1.0 million, respectively. The deferred tax benefit for reclassification adjustments for gains included in net income on investment securities during the years ended December 31, 2005, 2004 and 2003 was $0.8 million, $0.2 million and $0.02 million, respectively.
As permitted by SFAS No. 123, the Company accounted for share-based payments to employees using APB No. 25’s intrinsic value method through December 31, 2005 and, as such, has recognized no compensation cost for employee stock options. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have an effect on its results of operations, although it will have no material effect on its overall financial position. The effect of adoption of SFAS No. 123(R) will depend on the value and levels of share-based payments granted in the future. However, assuming share-based payments are granted in 2006 at values and levels granted in 2005, the Company expects the earnings per share effect of adopting SFAS No. 123(R) to be a $0.13 to $0.14 reduction for the full year of 2006.
The acquisition was accounted for using the purchase method of accounting and, accordingly, the operating results of First Health have been included in the Company’s consolidated financial statements since January 28, 2005, the date of acquisition. The following unaudited pro forma condensed consolidated results of operations assumes the First Health acquisition occurred on January 1, 2005 and 2004 (in millions, except per share data):
Goodwill and other intangible assets consist of costs in excess of the fair value of the net tangible assets of subsidiaries or operations acquired through December 31, 2005.
Depreciation expense for the years ended December 31, 2005, 2004 and 2003 was $55.1 million, $14.9 million and $15.6 million, respectively. Included in the depreciation expense for the year ended December 31, 2005 is $13.1 million of expense for developed software. The increase in property and equipment and the related depreciation expense is a result of the property and equipment obtained with the acquisition of First Health.
The unrealized loss reflected on each category of the Company’s investments is almost exclusively the result of interest rate increases subsequent to the purchase of the investments and not deteriorating credit quality. The Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity. As a result, the Company does not consider those investments to be other-than-temporarily impaired at December 31, 2005. At December 31, 2005, the number of investment positions in an unrealized loss position was approximately 1,200.
Includes $57.7 million and $37.4 million classified as current assets at December 31, 2005 and 2004, respectively, and ($204.5) million and $28.2 million classified as noncurrent (liabilities) assets at December 31, 2005 and 2004, respectively.
As of December 31, 2005, the Company had one stock incentive plan, the Amended and Restated 2004 Stock Incentive Plan (the “Stock Incentive Plan”) under which shares of the Company’s common stock were authorized for issuance to key employees, consultants and directors in the form of stock options, restricted stock and other stock-based awards.
Transactions with respect to stock options granted under the Stock Incentive Plan for the three years ended December 31, 2005 were as follows (shares in thousands):
The weighted-average grant date fair values for options granted in 2005, 2004 and 2003 were $14.96, $13.38 and $7.13, respectively.
The Company’s Employee Stock Purchase Plan, implemented in 1994, allows substantially all employees who meet length of service requirements to set aside a portion of their salary for the purchase of the Company’s common stock. At the end of each plan year, the Company issues the stock to participating employees at an issue price equal to 85% of the lower of the stock price at the end of the plan year or the average stock price, as defined in the plan. The Company issued 86,800, 38,900 and 38,600 shares in 2005, 2004 and 2003, respectively. Effective January 1, 2006, the Company terminated the Employee Stock Purchase Plan.
As of December 31, 2005, the Company had three defined contribution retirement plans qualifying under the Internal Revenue Code Section 401(k): the Coventry Health Care, Inc. Retirement Savings Plan (the “Savings Plan”), the First Health Group Corp Retirement Savings Plan (the “First Health Plan”) and the First Health Priority Services, Inc 401(k) Plan (the “Priority Services Plan”). The Mid-America Health Partners Inc. 401(k) and Investment Plan, which terminated on December 1, 2002, distributed all of the remaining assets to participants on December 28, 2005. All employees of Coventry Health Care, Inc. and employees of its subsidiaries (except First Health and First Health Priority Services, who maintained separate plans as described below) can elect to participate in the Savings Plan. T. Rowe Price is the custodial trustee of all Savings Plan assets, participant loans and the Coventry Health Care, Inc. common stock in the Savings Plan.
Immediately upon participation in the Savings Plan, all participant account balances included in the assets of the former qualified retirement plan were rolled over into the Savings Plan and employees were permitted to commence participation in the Savings Plan. All employees of Altius were eligible to participate in the Savings Plan effective January 1, 2004. The Altius SaveMore 401(k) Plan (the “Altius Plan”) was frozen effective December 31, 2003 and the Plan assets were merged with and into the Savings Plan on February 2, 2004. No contributions were made to the Altius Plan after December 31, 2003. The Altius Plan assets were held by Reliance Trust Company, the funding agent of the assets held under the terms of the Plan and Trust. All participants in the Altius Plan were 100% vested in employer matching contributions as of September 1, 2003. All costs of the Altius Plan were funded by the Company and participants as they were incurred.
The First Health Plan was frozen effective December 31, 2005, and assets were merged with and into the Savings Plan on January 1, 2006. All First Health employees were eligible for the Savings Plan effective January 1, 2006. No contributions were made to the First Health Plan after December 31, 2005. During the 2005 plan year, employees of First Health Group Corp were eligible to participate in the First Health Plan upon attainment of age 21 and 3 months of service. T. Rowe Price is the custodial trustee of all First Health Plan assets, participant loans and the Coventry Health Care, Inc. common stock in the First Health Plan. Under the First Health Plan, participants were able to defer up to 100% of their eligible compensation, limited by the maximum compensation deferral amount permitted by applicable law. First Health Group Corp made discretionary matching contributions to the First Health Plan in cash equal to 85% of each participant’s contribution not to exceed 6% of eligible compensation. The First Health Plan had multiple three and five year graded vesting schedules that applied for all employer matching contributions made through December 31, 2005. All employer matching contributions made after January 1, 2006 in the Savings Plan are 100% vested. All costs of the First Health Plan were funded by First Health Group Corp as incurred.
The Priority Services Plan was frozen effective December 31, 2005, and assets were merged with and into the Savings Plan on February 1, 2006. No contributions were made to the Priority Services Plan after December 31, 2005. All Priority Services employees were eligible for the Savings Plan effective January 1, 2006. During the 2005 plan year, employees of First Health Priority Services were eligible to participate in the Priority Services Plan upon attainment of age 21 and 1 year of service. Nationwide Financial was custodial trustee of all Priority Services Plan assets until February 1, 2006 when the Priority Services Plan assets merged with and into the Savings Plan assets held at T. Rowe Price. Under the Priority Services Plan, participants were able to defer up to 100% of their eligible compensation, limited by the maximum compensation deferral amount permitted by applicable law. The Priority Services Plan had a six year graded vesting schedule that applied for all employer matching contributions made through December 31, 2005. All employer matching contributions made after January 1, 2006 in the Savings Plan are 100% vested. All costs of the Priority Services Plan were funded by First Health Group Corp as incurred.
As of December 31, 2005, the Company was the sponsor of a Supplemental Executive Retirement Plan (the “SERP”), currently known as the Coventry Health Care, Inc. Supplemental Executive Retirement Plan. Under the SERP, participants may defer up to 15% of their base salary and up to 100% of any bonus awarded. Effective January 1, 2006, the SERP was amended to enable participants to defer up to 75% of their base salary. The Company makes matching contributions equal to 100% of the participant’s contribution on the first 3% of the participant’s compensation and 50% of the participant’s contribution on the second 3% of the participant’s compensation. Participants vest in the Company’s matching contributions ratably over two years. All costs of the SERP are funded by the Company as they are incurred.
The Company’s outstanding debt was as follows at December 31, 2005 and 2004 (in thousands):
In August 2003, the Company repurchased a portion of its senior notes with a face value of $4.5 million and a weighted average premium of 8.9%. The Company recorded a loss on the repurchase in accordance with SFAS No. 145 which requires gains and losses on extinguishments of debt to be classified as income or loss from continuing operations. The loss of $0.5 million was included as additional senior notes interest expense. The carrying value of the senior notes is equal to the face value and the fair value is based on the quoted market prices. As of December 31, 2005 and 2004, the fair value was $180.5 million and $185.2 million, respectively.
As of December 31, 2005, the Company is contractually obligated to make the following minimum lease payments within the next five years and thereafter (in thousands):
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 premium to cover all the medical costs provided to the globally capitated members. Under some capitated arrangements, physicians may also receive additional compensation from risk sharing and other incentive arrangements. Global 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. In addition to global capitation arrangements, the Company has capitation arrangements for ancillary services, such as mental health care. The Company is ultimately responsible for the coverage of its members pursuant to the customer agreements. To the extent that the respective provider organization faces financial difficulties or otherwise is unable to perform its obligations under the capitation arrangements, the Company will 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 arrangements. Medical costs associated with capitation arrangements made up approximately 6.5%, 7.1%, and 9.9% of the Company’s total medical costs for the years ended December 31, 2005, 2004 and 2003, respectively. Membership associated with global capitation arrangements was approximately 116,000, 127,000 and 145,000 as of December 31, 2005, 2004 and 2003, 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, 2005. The Company has a risk of incurring losses if such allowances are not adequate.
The increase in capital and surplus for the Company’s regulated subsidiaries is a result of income and the inclusion of regulated subsidiaries acquired with First Health offset by dividends paid to the parent company. The increase in statutory deposits is a result of the inclusion of deposits held by the regulated subsidiaries acquired with First Health.
Excluding funds held by entities subject to regulation, the Company had cash and investments of approximately $347.2 million and $383.1 million at December 31, 2005 and December 31, 2004, respectively. The decrease in non regulated cash and investments is a result of cash and investments used related to the First Health acquisition and debt repayment offset by dividends received from subsidiaries mentioned above. During the year ended December 31, 2005, Coventry made capital contributions of approximately $8.1 million to the Company’s HMO subsidiaries.
As of December 31, 2005, the Company’s Board of Directors has approved a program to repurchase its outstanding common stock. Stock repurchases may be made from time to time at prevailing prices on the open market, by block purchase or in private transactions. As a part of this program, no shares of common stock were purchased by the Company in 2003, 3.0 million shares during 2004 at an aggregate cost of $84.6 million and no shares were purchased in 2005. The total remaining common shares the Company is authorized to repurchase under the program is approximately 2.6 million as of December 31, 2005. Excluded from these amounts are shares purchased in exchange for employee payroll taxes on vesting of restricted stock awards as these purchases are not part of the program. In February 2006, our Board of Directors approved an increase to the repurchase authorization in an amount equal to 5% of our outstanding common stock thus increasing our repurchase authorization by 8.1 million shares.
• National Accounts - a variety of stand-alone managed care services and a portfolio of integrated health plan products to self-insured payors
The table below summarizes the Company’s reportable segments (in thousands). “Other” represents the elimination of fees charged between segments. In the near term, depreciation and amortization is separately identifiable to each segment and is included in the total operating expenses for each segment in the table below. However, we expect our information technology and customer service departments in each segment to consolidate, and thereafter depreciation and amortization related to their operations will become no longer separately identifiable by segment. First Health only includes results since the date of acquisition. Disclosure of total assets by reportable segment has not been disclosed, as they are not reported on a segment basis internally by the Company and are not reviewed by the Company’s chief operating decision maker:
First Health operations are aligned into two sectors. The Company believes identifying the revenue from each of these sectors is useful in understanding the Company’s results of operations. Revenue from the Company’s First Health sectors since the date of acquisition is as follows (in thousands):
The following is a summary of unaudited quarterly results of operations (in thousands, except per share data) for the years ended December 31, 2005 and 2004. Due to rounding of quarterly results, total amounts for each year may differ immaterially from the annual results.