Expanded geographic coverage in four new counties in Florida, effective October 1, 2008, and retained all existing counties for the Florida Healthy Kids program through a competitive bidding process;
Entered into an agreement to provide Medicaid managed care services to TANF and CHIP populations in Nevada beginning February 1, 2009;
Entered into an agreement to sell the rights to provide managed care services under our South Carolina subsidiary’s Medicaid contract; and
Additionally, recent actions by the Federal government, including the CHIP program expansion and the American Recovery and Reinvestment Act of 2009 that temporarily increased the FMAP match rate to state Medicaid programs, will have an impact on publicly sponsored healthcare programs; however it is too early to determine to what extent, if any, these actions will impact the programs in the states in which we operate. We can make no assurance that these actions will be favorable to our results of operations or financial condition in future periods.
Expenses relating to health benefits for the year ended December 31, 2008, increased $402.2 million, or 12.5%, to $3.6 billion compared to $3.2 billion for the year ended December 31, 2007. However, our HBR decreased to 81.4% for the year ended December 31, 2008 versus 83.1% for the prior year. The decrease in HBR was primarily as a result of retroactive premium rate adjustments in Tennessee and Georgia totaling approximately $45.9 million in addition to premium rate increases and yield increases resulting from membership mix changes in other markets.
Selling, general and administrative expenses (“SG&A”) increased $108.9 million, or 21.8%, for the year ended December 31, 2008 compared to 2007. Our SG&A ratio for the year ended December 31, 2008 was 13.5% compared to 12.6% for 2007. The increase in SG&A ratio was primarily a result of an increase in experience rebate expense in Texas due to favorable results in that market. The increase in SG&A expenses is a result of the increase in this expense as well as increases in salaries and benefits primarily due to wage rate increases, increase in employee healthcare benefit expenses and increased earnings-based compensation as a result of favorable operating performance in 2008.
The CoLTS program is designed to coordinate long-term care for individuals by bringing together a full range of healthcare services, from highly specialized hospital and institutional care to community-based support services that currently are fragmented and may not be easily available to those who need them. Populations enrolled in this program include: the Disabled and Elderly waiver program; Medicaid Personal Care Option program; residents of nursing facilities; dual eligible beneficiaries who have not yet accessed the system of long-term services in the state; and certain qualified individuals with brain injuries.
As a statewide mandatory program, CoLTS encompasses rural and Native American communities, as well as the State’s urban population. A joint endeavor by the New Mexico Department of Aging and Long-Term Care Services and the Department of Human Services, CoLTS is designed to empower individual consumers of healthcare and to produce long-term cost savings.
On February 1, 2009, our Nevada subsidiary, AMERIGROUP Nevada, Inc., began serving approximately 50,000 TANF and CHIP members under a contract to provide Medicaid managed care services through June 30, 2011. We are one of two organizations that together contract to provide managed care services to approximately 100,000 members across the Urban Washoe and Urban Clark county service areas.
We can make no assurance that our entry into these markets will be favorable to our results of operations or financial condition in future periods.
A significant portion of our current membership has resulted from acquisitions. We periodically evaluate acquisition opportunities to determine if they align with our business strategy. We continue to believe acquisitions can be an important part of our long-term growth strategy. We also have a disciplined approach to evaluating the operating performance of our existing markets to determine whether to exit or continue operating in each market. As a result, in the past we have and may in the future decide to exit certain markets if they do not align with our long-term business goals.
In November 2008, we entered into an agreement to sell substantially all of the assets of AMERIGROUP Community Care of South Carolina, Inc. This transaction is expected to close in the first quarter of 2009. AMERIGROUP Community Care of South Carolina, Inc., served approximately 16,000 members in South Carolina as of December 31, 2008.
Our ASO arrangement for the West Tennessee region terminated on October 31, 2008 pursuant to its terms. However, we have certain claims run-out and transition obligations that will continue into 2009. Additionally, we received a purchase price adjustment that reduced the purchase price by $1.5 million for early termination of the ASO contract which was recorded as an adjustment to goodwill. The resulting goodwill of $6.5 million, or $0.08 per diluted share net of the related income tax effect for the year ended December 31, 2008, was written off to selling,
general and administrative expenses. Additional costs recorded and to be recorded to discontinue operations in West Tennessee are not material.
On March 10, 2008, AMERIGROUP Maryland, Inc. d/b/a AMERIGROUP Community Care of the District of Columbia was notified that it was one of four successful bidders in the reprocurement of the District of Columbia’s Medicaid managed care business for the contract period beginning May 1, 2008. On April 2, 2008, AMERIGROUP Maryland, Inc. elected not to participate in the District’s new contract due to premium rate and programmatic concerns. Accordingly, its contract with the District of Columbia, as amended, terminated on June 30, 2008. As a result of exiting this market, we have written off acquired goodwill of $2.3 million or $0.03 per diluted share, net of the related income tax effect as of the year ended December 31, 2008. Additional costs recorded and to be recorded to discontinue operations are not material.
AMERIGROUP Texas, Inc. previously had an exclusive risk-sharing arrangement in the Fort Worth service area with Cook Children’s Health Care Network (“CCHCN”) and Cook Children’s Physician Network (“CCPN”), which includes Cook Children’s Medical Center (“CCMC”), that expired by its own terms as of August 31, 2005. Under this risk-sharing arrangement the parties had an obligation to perform annual reconciliations and settlements of the risk pool for each contract year. The contract with CCHCN prescribes reconciliation procedures all of which have been completed. CCHCN subsequently engaged external consultants to review all medical claim payments made for the 2005 contract year and the preliminary results challenged payments made on certain claims. The parties participated in voluntary non-binding mediation but were unable to resolve this matter. Following the conclusion of the mediation, on August 27, 2008, AMERIGROUP Texas, Inc. filed suit against CCHCN and CCPN in the District Court for the 153rd Judicial District in Tarrant County, Texas, case no. 153-232258-08, alleging breach of contract and seeking compensatory damages in the amount of $10.8 million plus pre- and post-judgment interest and attorney’s fees and costs. On October 3, 2008, CCHCN and CCPN filed a counterclaim against AMERIGROUP Texas, Inc. alleging breach of contract and seeking an amount to be determined at trial plus pre- and post-judgment interest and attorney’s fees and costs. A trial is set for September 14, 2009 and the parties are currently engaged in discovery.
payments are based upon eligibility lists produced by the government agencies with whom we contract. Errors in this eligibility determination on which we rely can result in positive and negative revenue adjustments to the extent this information is adjusted by the state. Adjustments to eligibility data received from these government agencies result from retroactive application of enrollment or disenrollment of members or classification changes of members between rate categories that were not known by us in previous months due to timing of the receipt of data or errors in processing by the government agencies. These changes, while common, are not generally large. Retroactive adjustments to revenue for corrections in eligibility data are recorded in the period in which the information becomes known. We estimate the amount of outstanding retroactivity each period and adjust premium revenue accordingly, if appropriate. Historically, the impact of these adjustments has represented less than 1% of annual revenue, which results in a negligible impact on annual earnings as changes in revenue are typically accompanied by corresponding changes in the related health benefits expense. We believe this historical experience represents what is reasonably likely to occur in future periods.
Reflects estimated potential changes in health benefits expenses and medical claims payable caused by changes in completion factors used in developing medical claims payable estimates for older periods, generally periods prior to the most recent three months.
Medical cost PMPM trend factors are the most significant factors we use in estimating our medical claims payable for the most recent three months. The following table illustrates the sensitivity of these factors and the estimated potential impact on our medical claims payable estimates for the most recent three months as of December 31, 2008:
In addition to incurred but not paid claims, the liability for medical claims payable includes reserves for premium deficiencies, if appropriate. Premium deficiencies are recognized when it is probable that expected claims and administrative expenses will exceed future premiums and investment income on existing medical insurance contracts. For purposes of premium deficiencies, contracts are grouped in a manner consistent with our method of acquiring, servicing and measuring the profitability of such contracts. We did not have any premium deficiency reserves at December 31, 2008.
The valuation of goodwill and intangible assets at acquisition requires assumptions regarding estimated discounted cash flows and market analyses. These assumptions contain uncertainties because they require management to use judgment in selecting the assumptions and applying the market analyses to the individual acquisitions. Additionally, impairment evaluations require management to use judgment to determine if impairment of goodwill and intangible assets is apparent. We have applied a consistent methodology in both the original valuation and subsequent impairment evaluations for all goodwill and intangible assets resulting from acquisitions occurring since the adoption of FASB Statement No. 142 Goodwill and Other Intangible Assets. We do not anticipate any changes to that methodology, nor has any impairment loss resulted from our analyses other than that recognized in connection with discontinued operations in West Tennessee and the District of Columbia as noted above. If the assumptions used to evaluate the value of goodwill and intangible assets change in the future, an impairment loss may be recorded and it could be material to our results of operations in the period in which the impairment loss occurs.
FASB Statement No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active
markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions. In October 2008, the FASB issued FASB Staff Position 157-3 (“FSP 157-3”), Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active, which clarifies the application of FASB Statement No. 157 in an inactive market and illustrates how an entity would determine fair value when the market for a financial asset is not active. The Company’s assumptions underlying our adoption of FASB Statement No. 157 were not materially impacted by the provisions of FSP 157-3. FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157 (“FSP 157-2”), delays the effective date of FASB Statement No. 157 until fiscal years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis which would include the following:
The following table sets forth selected operating ratios for the years ended December 31, 2008, 2007 and 2006. All ratios, with the exception of the health benefits ratio, are shown as a percentage of total revenues.
Summarized comparative financial information for the years ending December 31, 2008, 2007 and 2006 are as follows ($ in millions, except per share data) (totals in the table below may not equal the sum of individual line items as all line items have been rounded to the nearest decimal):
increases and yield increases resulting from changes in membership mix across many of our markets. Lastly, in 2008 both the Tennessee and Georgia markets benefited from retroactive premium rate adjustments related to operations in 2007 of approximately $35.5 million and $10.4 million, respectively.
Premium revenue for the year ended December 31, 2007 increased $1,076.4 million, or 38.5%. The increase was primarily due to entry into Tennessee, geographic expansion in Georgia and ABD expansion in San Antonio and Austin, Texas and the Southwest Region of Ohio. Additionally, our existing products and markets contributed further to revenue growth from premium rate increases and yield increases resulting from changes in membership mix. Total membership increased 30.0% to 1,711,000 as of December 31, 2007 from 1,316,000 as of December 31, 2006.
Other revenue of approximately $20.5 million and $4.6 million for the years ended December 31, 2008 and 2007, respectively, resulted primarily from our ASO contract in West Tennessee. This contract terminated on October 31, 2008 pursuant to its terms.
Expenses relating to health benefits for the year ended December 31, 2007 increased $950.1 million, or 41.9%. The HBR for the year ended December 31, 2007 was 83.1% compared to 81.1% in 2006. Our 2007 results compared to 2006 reflect an increase in the HBR primarily as a result of a higher proportion of our business in developing markets. These developing markets (which include Georgia, Tennessee, Ohio ABD, and Texas ABD as well as Maryland Medicare Advantage, all as of December 31, 2007) generally have a higher HBR than our mature markets due to the introduction of managed care into a previously unmanaged population and the associated start-up period required to identify and implement appropriate care management and disease management strategies for the population.
SG&A increased $108.9 million, or 21.8%, for the year ended December 31, 2008 compared to 2007. Our SG&A ratio for the year ended December 31, 2008 was 13.5% compared to 12.6% in 2007. The increase in SG&A ratio is primarily a result of an increase in experience rebate expense in Texas due to favorable results in that market. The increase in SG&A expenses was primarily due to:
an increase in salaries and benefits primarily due to wage rate increases, increases in employee healthcare benefit expenses, and increased earnings-based compensation as a result of favorable operating performance;
an increase in experience rebate expense in Texas due to favorable results in that market; and
an increase in experience rebate expense in Texas driven by two factors: an accrual of $7.4 million associated with the resolution of audit items on all open experience rebate reports for prior years; and the experience rebate expense associated with the favorable operational performance in the State.
Depreciation and amortization expense was $37.4 million, $31.6 million and $25.5 million for the years ended December 31, 2008, 2007 and 2006, respectively. The increase from 2007 to 2008 is a result of an increase in fixed assets and accelerated amortization of debt issuance costs due to significant principal payments in 2008. The increase from 2006 to 2007 was a result of greater depreciable assets, the write-off of debt issuance costs related to the termination of the Company’s previous $150.0 million credit agreement and an increase in amortization of debt issuance costs as a result of the new Credit Agreement entered into in March 2007.
Interest expense was $11.2 million, $12.3 million and $0.6 million for the years ended December 31, 2008, 2007 and 2006, respectively. The decrease in interest expense in 2008 compared to 2007 is a result of decreased interest rates compared to prior year and principal payments on outstanding borrowings under our Credit Agreement reducing the balance on which interest was paid. The Company entered into and borrowed under the Credit Agreement and issued 2.0% Convertible Senior Notes in 2007 causing the significant increase in interest expense in 2007 compared to 2006.
Income tax expense for 2008 and 2007 was $57.8 million and $70.1 million, respectively, with an effective tax rate of 814.7% in 2008 and 37.6% in 2007. The primary driver of the difference in the effective tax rate for the year ended December 31, 2008 versus the year ended December 31, 2007 is the fact that a portion of the settlement payment in connection with qui tam litigation is not deductible for income tax purposes. The estimated tax benefit related to the non-recurring qui tam litigation settlement payment was approximately $34.6 million.
Income tax expense for 2006 was $66.0 million with an effective tax rate of 38.1%. The decrease in effective tax rate from 2006 to 2007 is primarily a result of the decrease in the blended state income tax rate.
Net loss for 2008 was $50.7 million, or $0.96 per diluted share, compared to net income of $116.5 million, or $2.16 per diluted share in 2007. Net income for 2006 was $107.1 million or $2.02 per diluted share. Net income decreased from 2007 to 2008 primarily as a result of the one-time expense recorded in connection with the settlement of the qui tam litigation equal to $234.2 million or $199.6 million, net of the related tax benefit. The impact of this one-time expense was mitigated in part by a lower health benefits ratio due to retroactive premium adjustments.
Net income increased from 2006 to 2007 as a result of growth in total revenues (associated with geographic expansion, membership increases, premium rate increases and investment income increases) limiting the increase in HBR, and reducing SG&A as a percentage of revenues.
We manage our cash, investments and capital structure so we are able to meet the short- and long-term obligations of our business while maintaining financial flexibility and liquidity. We forecast, analyze and monitor our cash flows to enable prudent investment management and financing within the confines of our financial strategy.
Our primary sources of liquidity are cash and cash equivalents, short- and long-term investments, cash flows from operations and borrowings under our Credit Agreement. As of December 31, 2008, we had cash and cash equivalents of $763.3 million, short and long-term investments of $574.2 million and restricted investments on deposit for licensure of $95.0 million. Cash, cash equivalents, and investments which are unrestricted and unregulated totaled $309.8 million at December 31, 2008.
Our Credit Agreement provides both a secured term loan and a secured senior revolving credit facility. As of December 31, 2008, we had $44.3 million outstanding under the term loan portion of our Credit Agreement. The Credit Agreement terminates on March 15, 2012. During 2008, the Company paid $84.0 million in scheduled and voluntary principal payments of outstanding balances under the Credit Agreement. The Company elected to make voluntary payments of principal as a result of cash received from the release of restricted investments held as collateral in excess of the amount needed to fund the qui tam litigation settlement. Additionally, the Company purchased in the open-market and retired approximately $5.5 million of its outstanding principal on the term loan at approximately 88% of par resulting in a gain of $0.7 million for the year ended December 31, 2008. Our Credit Agreement also provides for up to $50.0 million of financing under a senior secured revolving credit facility. As of December 31, 2008, we had no outstanding borrowings under the senior secured revolving credit facility portion of
As of December 31, 2008, we had outstanding $260.0 million in aggregate principal amount of 2.0% Convertible Senior Notes due May 15, 2012. In May 2007, we filed an automatic shelf registration statement on Form S-3 with the SEC covering the resale of the 2.0% Convertible Senior Notes and common stock issuable upon conversion of the 2.0% Convertible Senior Notes. The 2.0% Convertible Senior Notes are governed by an Indenture dated as of March 28, 2007 (the “Indenture”). The 2.0% Convertible Senior Notes are senior unsecured obligations of the Company and rank equally with all of our existing and future senior debt and senior to all of our subordinated debt. The 2.0% Convertible Senior Notes are effectively subordinated to all existing and future liabilities of our subsidiaries and to any existing and future secured indebtedness, including the obligations under our Credit Agreement. The 2.0% Convertible Senior Notes bear interest at a rate of 2.0% per year, payable semiannually in arrears in cash on May 15 and November 15 of each year, beginning on May 15, 2007. The 2.0% Convertible Senior Notes mature on May 15, 2012, unless earlier repurchased or converted in accordance with the Indenture.
Concurrent with the issuance of the 2.0% Convertible Senior Notes, we purchased convertible note hedges covering, subject to customary anti-dilution adjustments, 6,112,964 shares of our common stock. The convertible note hedges allow us to receive shares of our common stock and/or cash equal to the amounts of common stock and/or cash related to the excess conversion value that we would pay to the holders of the Notes upon conversion. These convertible note hedges will terminate at the earlier of the maturity dates of the Notes or the first day on which none of the Notes remain outstanding due to conversion or otherwise.
On December 15, 2008, we filed a universal automatic shelf registration statement with the SEC which enables the Company to sell, in one or more public offerings, common stock, preferred stock and debt securities and other securities at prices and on terms to be determined at the time of the applicable offering. The shelf registration provides us with the flexibility to publicly offer and sell securities at times it believe market conditions make such an offering attractive. Because we are a well-known seasoned issuer, the shelf registration statement was effective upon filing. No securities have been issued under the shelf registration.
In 2008, our Board of Directors approved a stock repurchase program and authorized the repurchase of up to two million shares, subject to limits imposed by our Credit Agreement and otherwise. Pursuant to this share repurchase program, we repurchased 1,163,027 shares of our common stock and placed them into treasury during the year ended December 31, 2008 for a total cost of approximately $30.6 million. As of December 31, 2008, the Company’s share repurchase program had approximately 0.8 million shares remaining under the limit authorized to be repurchased. In February 2009, our Board of Directors authorized the repurchase of an additional three million shares under the program.
Cash from operations was $74.3 million for the year ended December 31, 2008 compared to $350.7 million for the year ended December 31, 2007. The decrease in cash from operations is primarily a result of a decrease in net income as a result of the qui tam litigation settlement recorded and paid in 2008. Additionally, cash flows from operations decreased due to a decrease in cash flows provided by changes in working capital of $122.7 million. This decrease was primarily a result of an increase in claims payable in 2007 as a result of the entry into Tennessee in 2007 with no comparable increase in 2008 and differences in the timing of tax payments year-over-year.
Our investment policies are designed to preserve capital, provide liquidity and maximize total return on invested assets. As of December 31, 2008, our investment portfolio consisted primarily of fixed-income securities. The weighted-average maturity is approximately eight months excluding our auction rate securities which are
discussed below. We utilize investment vehicles such as money market funds, commercial paper, municipal bonds, debt securities of government sponsored entities, corporate bonds, auction rate securities and U.S. Treasury instruments. The states in which we operate prescribe the types of instruments in which our subsidiaries may invest their funds. The weighted-average taxable equivalent yield on consolidated investments as of December 31, 2008 was approximately 2.13%. As of December 31, 2008, we had total cash and investments of $1.43 billion. Approximately 52% of our investment portfolio was invested in a diversified array of money market funds. Approximately 35% of our portfolio was invested in debt obligations of government sponsored entities, U.S. Treasuries, or FDIC-backed corporate bonds, all of which carried an AAA credit rating. Approximately 4% of our portfolio was invested in investment grade corporate bonds with a weighted average credit rating of AA and approximately 5% of our portfolio is in long-term municipal student loan corporation auction rate securities that carried a weighted average credit rating of AAA.
As of December 31, 2008, $71.6 million of our investments were comprised of municipal note investments with an auction reset feature (“auction rate securities”). These notes were issued by various state and local municipal entities for the purpose of financing student loans, public projects and other activities. All of these securities carry at least an A credit rating with the majority carrying a AAA credit rating. Liquidity for these auction rate securities was historically provided by an auction process which allowed holders to sell their notes and the interest rate was resets at pre-determined intervals, usually every 28 or 35 days. Since early 2008, auctions for these auction rate securities have failed and there is no assurance that auctions for these securities will succeed in the future. An auction failure means that the parties wishing to sell their securities could not be matched with an adequate volume of buyers. In the event that there is a failed auction the indenture governing the security requires the issuer to pay interest at a contractually defined rate. The securities for which auctions have failed will continue to accrue interest at the contractual rate and be auctioned every 28 or 35 days until the auction succeeds, the issuer calls the securities, or they mature. As a result, our ability to liquidate and fully recover the carrying value of our auction rate securities in the near term may be limited or not exist. As we cannot predict the timing of future successful auctions, if any, auction rate securities totaling $71.6 million are classified as long-term investments in our Consolidated Financial Statements as of December 31, 2008.
The following table summarizes our material contractual obligations, including both on- and off-balance sheet arrangements, and our commitments at December 31, 2008 (in thousands):
Long-term Obligations. Long-term obligations include amounts payable under our Credit Agreement which terminates March 12, 2012 and our 2.0% Convertible Senior Notes which mature May 15, 2012.
We have no investments, loans or any other known contractual arrangements with special-purpose entities, variable interest entities or financial partnerships. As of the year ended December 31, 2008, the Company has caused an irrevocable letter of credit to be issued under our Credit Agreement in the amount of $16.5 million for the benefit of the State of Georgia Department of Community Health in compliance with requirements of the Georgia Medicaid contract.
AMERIGROUP Corporation (the “Company”), a Delaware corporation, through its wholly-owned subsidiaries, is a multi-state managed healthcare company focused on serving people who receive healthcare benefits through publicly sponsored programs, including Medicaid, State Children’s Health Insurance Program (“CHIP”), Medicaid expansion and Medicare Advantage.
The Consolidated Financial Statements include the financial statements of AMERIGROUP Corporation and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Short and long-term investments and investments on deposit for licensure at December 31, 2008 and 2007 consist of commercial paper, money market funds, U.S. Treasury securities, corporate bonds, debt securities of government sponsored entities, municipal bonds and auction rate securities. We consider all investments with original maturities greater than three months but less than or equal to twelve months to be short-term investments. We classify our debt securities in one of three categories: trading, available-for-sale or held-to-maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those securities in which we have the ability and intent to hold the security until maturity. All other securities not included in trading or held-to-maturity are classified as available-for-sale. At December 31, 2008 and 2007, our auction rate securities are classified as either trading or available-for-sale. All other securities are classified as held-to-maturity.
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization expense on property and equipment is calculated on the straight-line method over the estimated useful lives of the assets. Property and equipment held under capital leases and leasehold improvements are amortized on the straight-line method over the shorter of the lease term or estimated useful life of the asset. Depreciation and amortization expense on property and equipment was $16,321, $16,372 and $13,714 for the years ended December 31, 2008, 2007 and 2006, respectively. The estimated useful lives are as follows:
Software is stated at cost less accumulated amortization in accordance with Statement of Position 98-1, Accounting for the Costs of Software Developed or Obtained for Internal Use. Software is amortized over its estimated useful life of three to ten years, using the straight-line method. Amortization expense on software was $14,255, $9,543 and $6,723 for the years ended December 31, 2008, 2007 and 2006, respectively.
We account for income taxes in accordance with the provisions of the FASB Statement No. 109, Accounting for Income Taxes. On a quarterly basis, we estimate our required tax liability based on enacted tax rates, estimates of book to tax differences in income, and projections of income that will be earned in each taxing jurisdiction. Deferred tax assets and liabilities representing the tax effect of temporary differences between financial reporting net income and taxable income are measured at the tax rates enacted at the time the deferred tax asset or liability is recorded.
After tax returns for the applicable year are filed, the estimated tax liability is adjusted to the actual liability per the filed Federal and state tax returns. Historically, we have not experienced significant differences between our estimates of tax liability and our actual tax liability.
In addition, we are periodically audited by Federal and state taxing authorities and these audits can result in proposed assessments. We believe that our tax positions comply with applicable tax law and, as such, will vigorously defend these positions on audit. We believe that we have adequately provided for any reasonable foreseeable outcome related to these matters. Although the ultimate resolution of these audits may require additional tax payments, we do not anticipate any material impact to earnings.
The qui tam litigation settlement payment had a significant impact on tax expense and the effective tax rate for 2008 due to the fact that a portion of the settlement payment is not deductible for income tax purposes. At December 31, 2008, the estimated tax benefit associated with the qui tam settlement payment was approximately $34,600. The Company has requested a pre-filing agreement with the Internal Revenue Service (“IRS”) regarding the tax treatment of the qui tam settlement. As the Company works to resolve this issue with the IRS, it is possible that there will be changes to the tax benefit associated with the qui tam settlement that will have a material impact on income tax expense and the effective tax rate in future accounting periods.
We record compensation expense related to share-based payments in accordance with FASB Statement No. 123 (revised 2004), Shared-Based Payment (“FASB Statement No. 123(R)”), whereby we are required to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. The fair value of employee share options and similar instruments is estimated using option-pricing models adjusted for the unique characteristics of those instruments. That cost is recognized over the period during which an employee is required to provide service in exchange for the award, which is generally quarterly over four years.
Accrued medical expenses for claims associated with the provision of services to our members (including hospital inpatient and outpatient services, physician services, pharmacy and other ancillary services) include amounts billed and not paid and an estimate of costs incurred for unbilled services provided. These estimates are principally based on historical payment patterns while taking into consideration variability in those patterns using actuarial techniques. In addition, claims processing costs are accrued based on an estimate of the costs necessary to process unpaid claims. Claims payable are reviewed and adjusted periodically and, as adjustments are made, differences are included in current operations.
The following table presents the components of the change in medical claims payable for the years ended December 31 (in thousands):
The remaining reduction in health benefits expenses incurred during the year, related to prior years, of approximately $23,500 and $37,800 for the years ended December 31, 2008 and 2007, respectively, resulted from obtaining more complete claims information for claims incurred for dates of service in the prior years. We refer to these amounts as net reserve development. Claims processing initiatives yielded increased claim payment recoveries and coordination of benefits in 2008 and 2007 related to prior year dates of services for both periods. These recoveries also caused our actuarial estimates to include faster completion factors than were originally established. The faster completion factors account for the remaining net favorable reserve development in each respective period.
Long-lived assets, such as property and equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows and the assets could not be used within the Company, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the consolidated balance sheets and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a group classified as held for sale would be presented separately in the appropriate asset and liability sections of the consolidated balance sheet. No impairment of long-lived assets was recorded in 2008, 2007 or 2006.
Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, we determine the fair value of a reporting unit and compare it to its carrying amount. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with FASB Statement No. 141, Business Combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. As a result of our exit from our West Tennessee and District of Columbia markets, we recorded an impairment loss of $8,808 during the year ended December 31, 2008 related to goodwill acquired in business combinations in those markets in prior years. No impairment of goodwill was recorded in 2007 or 2006.
Although the adoption of FASB Statement No. 157 did not materially impact our financial condition, results of operations, or cash flow, the Company is now required to provide additional disclosures as part of its financial statements.
We did not have any material transactions related to these types of nonfinancial assets and nonfinancial liabilities to which the provisions of FASB Statement No. 157 would apply during the year ended December 31, 2008. Additionally, the provisions of FASB Statement No. 157 were not applied to fair value measurements of nonfinancial assets and nonfinancial liabilities measured at fair value to determine the amount of goodwill impairment, if any.
to be allocated between a liability component and an equity component. The resulting debt discount will be amortized over the period the convertible debt is expected to be outstanding as additional non-cash interest expense. FSP APB 14-a is effective for fiscal years beginning after December 15, 2008, and is applied retrospectively to prior periods. FSP APB 14-a will change the accounting treatment for our $260,000 2.0% Convertible Senior Notes due May 15, 2012, which were issued effective March 28, 2007. The impact of this new accounting treatment will be significant to our results of operations and will result in an increase to non-cash interest expense beginning in 2009 for financial statements covering past and future periods. We estimate that our 2007, 2008 and 2009 earnings per diluted share will decrease by approximately $0.08, $0.11 and $0.12, respectively, as a result of the adoption of FSP APB 14-a.
withdrawal. The amortized cost, gross unrealized holding gains, gross unrealized holding losses and fair value for these held-to-maturity securities are summarized as follows at December 31, 2008 and 2007:
The following table shows the fair value of our available-for-sale and held-to-maturity investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2008:
On November 1, 2007, AMERIGROUP Tennessee, Inc. acquired the contract rights and substantially all of the assets of Memphis Managed Care Corporation (“MMCC”) including substantially all of the assets of Midsouth Health Solutions, Inc., a subsidiary of MMCC, for approximately $11,733. The purchase price was financed through available unregulated cash. The assets purchased consisted primarily of MMCC’s rights to provide administrative services to the State of Tennessee for its TennCare members in the West Tennessee region. Goodwill and other intangibles totaled $9,967, which included $1,923 of specifically identifiable intangibles allocated to the rights to the administrative services contract, the provider network and trademarks.
On March 10, 2008, AMERIGROUP Maryland, Inc. d/b/a AMERIGROUP Community Care of the District of Columbia was notified that it was one of four successful bidders in the reprocurement of the District of Columbia’s Medicaid managed care business for the contract period beginning May 1, 2008. On April 2, 2008, AMERIGROUP Maryland, Inc. elected not to participate in the District’s new contract due to premium rate and programmatic concerns. Accordingly, its contract with the District of Columbia, as amended, terminated on June 30, 2008. As a result of exiting this market, we have written off acquired goodwill of $2,264, or $0.03 per diluted share, net of the related income tax effect as of December 31, 2008. Additional costs recorded and to be recorded to discontinue operations are not expected to be material.
Goodwill and acquired intangible assets for the years ended December 31, 2008 and 2007 are as follows:
Amortization expense for the years ended December 31, 2008, 2007 and 2006 was $2,496, $2,279 and $4,541, respectively, and the estimated aggregate amortization expense for the five succeeding years is as follows:
The effective tax rate is based on expected taxable income, statutory tax rates, and estimated permanent book to tax differences. Income tax returns that we file are periodically audited by Federal or state authorities for compliance with applicable Federal and state tax laws. Our effective tax rate is computed taking into account changes in facts and circumstances, including progress of audits, developments in case law and other applicable authority, and emerging legislation. The increase in non-deductible expenses for 2008 compared to 2007 and 2006 is primarily attributable to a decrease in Federal tax exempt interest income and an increase in expenses that are not deductible for tax purposes.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007 are presented below:
To assess the recoverability of deferred tax assets, we consider whether it is more likely than not that deferred tax assets will be realized. In making this determination, we take into account the scheduled reversal of deferred tax liabilities and whether projected future taxable income is sufficient to permit deduction of the deferred tax assets. Based on the level of historical taxable income and projections for future taxable income, we believe it is more likely than not that we will fully realize the benefits of the gross deferred tax assets of $58,180. State net operating loss carryforwards that expire in 2027 through 2028 comprise $872 of the gross deferred tax assets.
The borrowings under the Credit Agreement accrue interest at our option at a percentage, per annum, equal to the adjusted Eurodollar rate plus 2.0% or the base rate plus 1.0%. The applicable interest rate was 2.50% at December 31, 2008. We are required to make payments of interest in arrears on each interest payment date (to be determined depending on interest period elections made by the Company) and at maturity of the loans, including final maturity thereof.
Borrowings under the Credit Agreement are secured by substantially all of our assets and the assets of our wholly-owned subsidiary, PHP Holdings, Inc., including the stock of each of our respective wholly-owned managed care subsidiaries, in each case, subject to carve-outs.
Also concurrent with the issuance of the 2.0% Convertible Senior Notes, we sold warrants to acquire 6,112,964 shares of our common stock at an exercise price of $53.77 per share. If the average price of our common stock during a defined period ending on or about the settlement date exceeds the exercise price of the warrants, the warrants will be settled, at our option, in cash or shares of our common stock.
the expected life of each award granted was calculated using the “simplified method” in accordance with Staff Accounting Bulletin No. 107 which uses the vesting period, generally quarterly over four years, and the option term, generally seven years, to calculate the expected life of the option;
The Company employs the simplified method to estimate the expected life of each award due to the significant volatility in the market price of our stock which has created exercise patterns that we do not believe are indicative of future activity.
Non-vested restricted stock includes grants with both service and performance condition based vesting. Service-based awards generally vest annually over a period of four years contingent only on the employees’ continued employment. Performance based shares contingently vest over a period of four years from the date of grant based upon the extent of achievement of certain operating goals relating to the Company’s earnings per share, with up to 25% vesting on the first anniversary of the grant date and up to an additional 25% vesting on each of the second, third and fourth anniversaries of the grant date. The shares in each of the respective four tranches vest in full if earnings per share for each of the four calendar years after the date of grant equals or exceeds 115% of earnings per share for the preceding calendar year, as adjusted for any changes in measurement methods; provided that 50% of each tranche will vest if earnings per share for the year is between 113.50% and 114.24% (inclusive) of adjusted earnings per share for the preceding year, and 75% of each tranche will vest if earnings per share for the year is between 114.25% and 114.99% (inclusive) of adjusted earnings per share for the preceding year. Performance based awards represent 11,759 shares of outstanding non-vested restricted stock awards.
The per share fair value of those purchase rights granted in each of the six month offering periods during 2008, 2007 and 2006 were as follows:
Potential common stock equivalents representing 909,668 shares for the year ended December 31, 2008 were not included in the computation of diluted net loss per share because of the net loss for the period. Including such shares would have been anti-dilutive. Additionally, potential common stock equivalents representing 2,442,139 shares with a weighted-average exercise price of $35.88 for the year ended December 31, 2008, were not included in the computation of diluted net loss per share because to do so would have been anti-dilutive. Potential common stock equivalents representing 1,531,368 shares with a weighted-average exercise price of $37.59 for the year ended December 31, 2007, were not included in the computation of diluted net income per share because to do so would have been anti- dilutive. Potential common stock equivalents representing 1,666,560 shares with a weighted-average exercise price of $39.55 for the year ended December 31, 2006, were not included in the computation of diluted net income per share because to do so would have been anti-dilutive.
The Company’s 2.0% Convertible Senior Notes due May 15, 2012 issued effective March 28, 2007 in an aggregate principle amount of $260,000, were not included as dilutive securities for the years ended December 31, 2008 and 2007 because the conversion price of $42.53 was greater than the average market price of shares of the Company’s common stock for each of those years; therefore, to do so would have been anti-dilutive. The Company’s warrants sold on March 28, 2007 and April 9, 2007 were not included as dilutive securities for the years ended December 31, 2008 and 2007 because the warrants’ exercise price of $53.77 was greater than the average market price of the Company’s common shares for each of those years; therefore, to do so would have been anti-dilutive.
Short-term investments, long-term investments, investments on deposit for licensure and forward contracts related to certain auction rate securities (included in other long-term assets): Fair values for these financial instruments are determined based on quoted market prices, discounted cash flow analyses or other type of valuation models (See Note 2(b)).
The estimated fair value of the borrowings under the Credit Agreement and the 2.0% Convertible Senior Notes is determined based upon quoted market prices. As of December 31, 2008, the fair value of the borrowings under the Credit Agreement and 2.0% Convertible Senior Notes was $38,901 and $222,300, respectively.
We are obligated under capital leases covering certain office equipment that expire at various dates during the next year. At December 31, 2008 and 2007, the gross amount of office equipment and related accumulated amortization recorded under capital leases was as follows:
We also lease office space under operating leases which expire at various dates through 2019. Future minimum payments by year and in the aggregate under all non-cancelable leases are as follows at December 31, 2008:
These leases have various escalations, abatements and tenant improvement allowances that have been included in the total cost of each lease and amortized on a straight-line basis. Total rent expense for all office space and office equipment under non-cancelable operating leases was $18,351, $15,846 and $12,576 in 2008, 2007 and 2006, respectively, and is included in selling, general and administrative expenses in the accompanying consolidated statements of operations.
Our employees have the option to participate in a deferred compensation plan sponsored by the Company. All full-time and most part-time employees of the Company and its subsidiaries may elect to participate in this plan. This plan is a defined contribution profit sharing plan under Section (401)k of the Internal Revenue Code. Participants may contribute a certain percentage of their compensation subject to maximum Federal and plan limits. We may elect to match a certain percentage of each employee’s contributions up to specified limits. For the years ended December 31, 2008, 2007 and 2006, the matching contributions under the plan were $3,649, $3,748, and $2,785, respectively.
On February 10, 2009, the Company and AMERIGROUP New Jersey, Inc. filed a Motion for Partial Dismissal of the Complaint and to Transfer Venue, seeking the dismissal of the tortious interference claims against both the Company and AMERIGROUP New Jersey, Inc., and the transfer of venue of the remaining cause of action in the Complaint from the Superior Court of New Jersey, Essex County, to the Superior Court of New Jersey, Middlesex County, the latter being the location of the executive offices of both AMERIGROUP New Jersey, Inc. and UHP.
The Company and AMERIGROUP New Jersey, Inc. believe that they have substantial defenses to these claims and will defend against them vigorously. While the results of this litigation cannot be predicted with certainty, we believe the final outcome of such litigation will not have a material adverse effect on the financial condition, results of operations or liquidity of the Company.