The following discussion should be read in conjunction with the accompanying audited consolidated financial statements and notes thereto. The organization of our Management’s Discussion and Analysis of Financial Condition and Results of Operations is as follows.
As of December 31, 2007, we maintained allowances for retroactive billing adjustments of approximately $29.7 million compared with approximately $20.1 million at December 31, 2006. We also maintained allowances for doubtful accounts of approximately $3.4 million and $1.9 million as of December 31, 2007 and 2006, respectively. The calculation for these allowances is based on a percentage of the gross accounts receivable with the allowance percentage increasing for the older receivables.
The following table presents the components of the change in medical claims liabilities for the years ended December 31, 2007, 2006 and 2005, respectively (in thousands).
A regular element of our unpaid medical claim liability estimation process is the examination of actual results and, if appropriate, the modification of assumptions and inputs related to the process based upon past experience. Our reserve setting methodologies have taken these changes into consideration when determining the factors used in calculating our medical claims liabilities as of December 31, 2007 by choosing factors that reflect more recent experience.
We believe that the amount of medical liabilities is adequate to cover our ultimate liability for unpaid claims as of December 31, 2007. However, actual claim payments and other items may differ from established estimates.
adverse financial conditions of a specific issuer, monoline bond issuer, segment, industry, region or other variables;
The following table includes only our investments in an unrealized loss position at December 31, 2007. For those investments, the table shows the gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands).
The securities presented in this table do not meet the criteria for an other-than-temporarily impaired investment. The unrealized loss is almost exclusively the result of interest rate movements. We intend to hold these investments for a period of time sufficient to allow for a recovery in market value, which may be maturity.
Under the income approach, we assumed certain growth rates, capital expenditures, discount rates and terminal growth rates in our calculations. If the assumptions used in our fair-value-based tests differ from actual results, the estimates underlying our goodwill impairment tests could be adversely affected. 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.
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of SFAS No. 157 to have a material effect on our consolidated financial statements.
During the three years ended December 31, 2007, we completed five business combinations and one membership purchase. These business combinations are all accounted for using the purchase method of accounting and, accordingly, the operating results of each acquisition have been included in our consolidated financial statements since their effective date of acquisition. The purchase price for each business combination was allocated to the assets, including the identifiable intangible assets, and liabilities based on estimated fair values. The excess of the purchase price over the net identifiable assets acquired was allocated to goodwill. The purchase price of our membership purchases is allocated to identifiable intangible assets and is being amortized over a useful life of ten to fifteen years.
The following table summarizes all business combinations and membership purchases for the three years ended December 31, 2007. The purchase price of each business combination includes the payment for net worth and estimated transition costs. The purchase price, inclusive of all retroactive balance sheet settlements to date and transition cost adjustments, is presented below (millions):
(1) “Commercial Group Risk” membership includes our health plan commercial group business and a small group PPO insurance block which was previously imbedded within our First Health segment.
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, 2007 (in thousands, except earnings per share and percentage data).
Management services revenue increased compared to the prior year as a result of the acquisition of Concentra and Mutual described above. This increase was partially offset by membership losses in our Commercial Division’s National Accounts business.
Selling, general and administrative expense increased primarily due to operating costs associated with our recent acquisitions of Concentra, Mutual and Vista, as well as costs related to our new Medicare PFFS business in 2007. The increase in total selling, general and administrative expense was also attributable to increased salary and benefit expense as we position ourselves for future growth initiatives and as we incur normal annual compensation increases.
Depreciation and amortization increased as a result of the expense associated with the fixed assets and identifiable intangible assets acquired with the recent acquisitions, as well as a result of an increase in property and equipment over the past twelve months.
Medical costs increased as a result of new business related to our Medicare Part D products and as a result of medical trend. Medicare Part D medical costs totaled $565.9 million. Excluding Medicare Part D business, medical costs from our health plans as a percentage of premium revenue declined 0.6% in 2006 compared with 2005. The decline is primarily a result of premium increases and better than expected cost trends. The better than expected cost trends were primarily attributed to lower inpatient and outpatient utilization and the uncertainties at the prior year-end regarding our Louisiana operations and the effects from Hurricane Katrina. Days in total medical claims liabilities decreased slightly from the prior year due primarily to faster claim receipts and continually improved processing cycle times.
Depreciation and amortization increased as a result of reporting a full year of First Health results in 2006 and as a result of an increase in property and equipment during 2005 and 2006, primarily computer equipment and software related to our First Health business.
In an effort to further integrate the First Health business acquired in January of 2005, we realigned in 2007 into new operating units, which are based on the product sold and the customer type. Our new organizational structure, effective January 1, 2007, capitalizes on existing synergies and brings enhanced focus on areas of growth opportunities. As a result of the new organizational structure, our reportable segments changed. Each of our three new segments is managed separately and separate operating results are available that are evaluated by the chief operating decision maker. The Commercial Business Division is comprised of all of our commercial employer-focused businesses including the traditional health plan group risk and ASO products as well as the National Accounts, FEHBP, and Network Rental businesses. The Individual Consumer & Government Division contains the individual consumer products and all Medicare and Medicaid products. The Specialty Division includes our workers’ compensation services businesses.
Commercial group risk premium revenue increased from 2006 as a result of the acquisitions of Mutual and Vista, which accounted for $196.7 million in revenue. The increase was also a result of an increase in average premium yields per member per month in our commercial group risk business. Commercial premium yields increased as a result of rate increases that occurred throughout all markets. This increase was partially offset by membership declines in our same store commercial group risk business. However, a portion of those members changed from our risk products to our non-risk products. Commercial management services revenue declined in 2007 due to membership losses in our national accounts non-risk business, partially offset by an increase in our commercial health plan ASO membership.
The gross margin decreased as a result of the decline in commercial management services revenue discussed above and the increase in the Health Plan Commercial medical loss ratio in 2007 compared to 2006. The year-to-year increase in the medical loss ratio is a result of the inclusion of the acquired Mutual of Omaha and Vista businesses in 2007, as well as the low medical loss ratio experienced by our Louisiana health plan in 2006, which was driven by the unique circumstances that existed in the Louisiana market at that time, the effects due to Hurricane Katrina.
Specialty revenue and operating expenses increased primarily as a result of the acquisition of Concentra during the second quarter of 2007.
The nature of a majority of our operations is such that cash receipts from premium revenues are typically received up to two months prior to the expected cash payment for related medical costs. Premium revenues are typically received at the beginning of the month in which they are earned, and the corresponding incurred medical expenses are paid in a future time period, typically 15 to 60 days after the date such medical services are rendered. The lag between premium receipts and claims payments creates positive cash flow and overall cash growth. As a result, we typically hold approximately two months of “float.” In addition, accumulated earnings provide further positive cash flow. In addition to ample current liquidity, our long-term investment portfolio is available for further liquidity needs.
The demand for our products and services is subject to many economic fluctuations, risks and uncertainties that could materially affect the way we do business. See Part I, Item 1A, “Risk Factors,” in this Form 10-K for more information. Management believes that the combination of our ability to generate cash flows from operations, cash and investments on hand and the excess funds held in certain of our regulated subsidiaries will be sufficient to fund continuing operations, capital expenditures, debt interest costs, debt principal repayments and any other reasonably likely future cash requirements.
Capital expenditures in 2007 of approximately $61.3 million consist primarily of computer hardware, software and related costs associated with the development and implementation of improved operational and communication systems. Projected capital expenditures in 2008 of approximately $65-$75 million consist primarily of computer hardware, software and other equipment.
Proceeds from the issuance of debt include approximately $789.1 million of new Senior Notes, net of any discounts and payments made for debt issuance costs. These proceeds also include an amended and restated credit agreement providing for an $850 million credit facility, of which $365.0 million was drawn in 2007. In addition to cash on hand, the proceeds were partially used to retire both the $170.5 million of 2002 Senior Notes and our $90 million term loan, which included a $10 million scheduled repayment, and to fund the previously mentioned acquisitions. The details of these transactions are as follows:
On February 15, 2007, we redeemed all $170.5 million of our remaining outstanding 8.125% Senior Notes due February 15, 2012. We redeemed the notes at a redemption price equal to 104.1% of the principal amount plus interest accrued on the redemption date. As a result of the redemption, we recognized $6.9 million of interest expense for the premium paid on redemption and wrote off $2.2 million of deferred financing costs related to these Senior Notes. The funds for payment of the redemption price were provided by cash on hand.
On March 20, 2007, we completed the sale of $400 million aggregate principal amount of its 5.95% Senior Notes due March 15, 2017 (the “10-year Notes”) at the issue price of 99.63% per Note. The 10-year Notes were offered and we sold pursuant to its automatic shelf registration statement and are now registered with the Securities and Exchange Commission. As of December 31, 2007, the fair value was $390.5 million.
On July 11, 2007, we executed an Amended and Restated Credit Agreement (the “Credit Facility”). The Credit Facility provides for a five-year revolving credit facility in the principal amount of $850.0 million, with us having the ability to request an increase in the facility amount up to an aggregate principal amount not to exceed $1.0 billion. The obligations under the Credit Facility are our general unsecured obligations. We drew $80.0 million under the Credit Facility to pay off our remaining $80.0 million balance on our five-year term loan that was originally entered into during 2005 and drew an additional $285.0 million to help fund the Vista acquisition payment.
Our senior notes dated January 28, 2005 and credit facilities require compliance with a leverage ratio. All of our senior notes and credit facility contain certain covenants and restrictions regarding additional debt, dividends or other restricted payments, transactions with affiliates, disposing of assets and in some cases provide for debt repayment upon consolidations or mergers. As of December 31, 2007, we were in compliance with applicable covenants under the senior notes and credit facility.
Our regulated HMO and insurance company subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends the parent may receive from our regulated entities. During 2007, we received $421.6 million in dividends from our regulated subsidiaries and paid $71.9 million in capital contributions.
Excluding funds held by entities subject to regulation and excluding our equity method investments, we had cash and investments of approximately $436.2 million and $563.1 million at December 31, 2007 and December 31, 2006, respectively. The decrease was primarily due to payments made for the Concentra, Mutual of Omaha and Vista acquisitions and payments for share repurchases. These payments were partially offset by the proceeds from the sale of our Senior Notes, dividends received from our regulated subsidiaries, and additional borrowings on our credit facility.
As of December 31, 2007, we were contractually obligated to make the following payments within the next five years and thereafter (in thousands):
(a) Interest payable on credit facities has been estimated based on interest rates as of February 2008 and assumes no additional changes in the principal amount.
Refer to Note J to our consolidated financial statements for disclosure related to our operating leases.
See Legal Proceedings in Note J, “Commitments and Contingencies” which is incorporated herein by reference.
As a managed health care company, we are subject to extensive government regulation of our products and services. The laws and regulations affecting our industry generally give state and federal regulatory authorities broad discretion in their exercise of supervisory, regulatory and administrative powers. These laws and regulations are intended primarily for the benefit of the members of the health plans. Managed care laws and regulations vary significantly from jurisdiction to jurisdiction and changes are frequently considered and implemented. Likewise, interpretations of these laws and regulations are also subject to change.
Given the results of sales activity through February, 2008, we expect to add 100,000 net Medicare Advantage members during 2008 from both individual and group sales.
We expect to grow our commercial risk membership 1% to 2% for the full year. As with the first quarter of 2007, we expect that our commercial risk membership will decrease in the first quarter of 2008. However, based on our strong underlying small group results, and the large group pipeline, we expect membership to grow in each of the remaining quarters. Regarding the MLR for our “same store” commercial group business, we expect it to remain relatively flat in 2008 at approximately 78%, with the expected 2008 reported commercial group MLR, including the annualization impact of 2007 acquisitions, to be in the mid to high 78%’s.
We expect individual membership to grow to 150,000 members by the end of 2008. This would essentially double our non-Vista organic membership from our 2007 results.
Regarding use of cash, we remain committed to share repurchase as well as evaluating acquisition opportunities. We closed on an acquisition of a small behavioral health company during February 2008. This acquisition will have an immaterial effect on our consolidated revenue and results for the year. We expect to gain the benefits of in-sourcing our behavioral health business in all of our markets over the next several years.
We are also pursuing a range of solutions for both group life and dental products, and expect to move forward in these areas in 2008 as well. Any effect of these initiatives on revenue or earnings for 2008 is expected to be immaterial.
As discussed in Note F to the consolidated financial statements, on January 1, 2006, Coventry Health Care, Inc. changed the method of accounting for stock-based compensation in accordance with guidance provided in Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment.” As discussed in Note G to the consolidated financial statements, Coventry Health Care, Inc. adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” effective January 1, 2007.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Coventry Health Care, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2008 expressed an unqualified opinion thereon.
Basis of Presentation - The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and include the accounts of the Company and its subsidiaries, all of which are 100% owned. All inter-company transactions have been eliminated.
Significant Customers - The Company’s commercial business is diversified across a large customer base and there are no commercial groups that make up 10% or more of Coventry’s managed care premiums. The Company received 33.1%, 21.6% and 11.8% of its managed care premiums for the years ended December 31, 2007, 2006 and 2005, respectively, from the federal Medicare program throughout its various markets. The Company also received 10.7%, 11.1% and 13.2% of its managed care premiums for the years ended December 31, 2007, 2006 and 2005, respectively, from its state-sponsored Medicaid programs throughout its various markets. For the years ended December 31, 2007, 2006 and 2005, the State of Missouri accounted for almost half the Company’s Medicaid premiums. These revenues from the Medicare and Medicaid Programs are included in the Individual Consumer & Government Business division. The Company received 14.7%, 19.3% and 22.1% of its management services revenue from a single customer, Mail Handlers Benefit Plan, for the years ended December 31, 2007, 2006 and 2005, respectively and is included in the Commercial Business division.
Property and Equipment - Property, equipment and leasehold improvements are recorded at cost. 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. The Company capitalizes costs incurred during the application development stage for the development of internal-use software. These costs primarily relate to payroll and payroll-related costs for employees along with costs incurred for external consultants who are directly associated with the internal-use software project. Depreciation is computed using the straight-line method over the estimated lives of the related assets or, if shorter, over the terms of the respective leases.
The Medicare Part D related subsidy liabilities identified in the table above represent subsidy amounts received from the Centers for Medicare and Medicaid Services (“CMS”) for reinsurance and for cost sharing related to low income individuals. These subsidies are recorded in medical liabilities and the Company does not recognize premium revenue or claims expense for these subsidies. Following the final settlement of each contract plan year, any remaining balances from these subsidy payments are refunded to CMS.
The Company recognizes premium revenue ratably over the contract period for providing insurance coverage. Regarding the CMS risk corridor provision, an estimated risk sharing receivable or payable is recognized based on activity-to-date. Activity for CMS risk sharing is accumulated at the contract level and recorded within the consolidated balance sheet in other receivables or other accrued liabilities depending on the net contract balance at the end of the reporting period with corresponding adjustments to premium revenue. Costs for covered prescription drugs are expensed as incurred.
Subsidy amounts received for reinsurance and for cost sharing related to low income individuals are recorded in medical liabilities and will offset medical costs when paid. The Company does not recognize premium revenue or claims expense for these subsidies as the Company does not incur any risk with this part of the program.
The Company has quota share arrangements on certain individual and employer groups with two of its Medicare distribution partners covering portions of the Company’s Medicare Part D and Medicare Private Fee for Service businesses. As a result of the quota share sharing arrangements, the Company ceded premium revenue of $250.2 million and the associated medical costs to these partners. The ceded amounts are excluded from the Company’s results of operations. The Company is not relieved of its primary obligation to the policyholder under this ceding arrangement.
Management services revenue is generally a fixed administrative fee, provided on a predetermined contractual basis or on a percentage-of-savings basis, for access to the Company’s health care provider networks and health care management services, for which it does not assume underwriting risk. Percentage of savings revenue is determined using the difference between charges billed by contracted medical providers and the contracted reimbursement rates for the services billed and is recognized based on claims processed. The management services the Company provides typically include health care provider network management, clinical management, pharmacy benefit management, bill review, claims repricing, fiscal agent services (generally for state entitlement programs), claims processing, utilization review and quality assurance.
Contract Acquisition Costs - Costs related to the acquisition of customer contracts, such as commissions paid to outside brokers, are paid on a monthly basis and expensed as incurred. Regarding the Company’s Medicare Advantage business, it advances fund commissions and defer amortization of these costs to the period in which revenue associated with the acquired customer is earned, which is generally not more than one year.
In May 2007, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (“FSP”) FIN 48-1 Definition of Settlement in FASB Interpretation No. 48 (FSP FIN 48-1). FSP FIN 48-1 provides guidance on how to determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. FSP FIN 48-1 is effective retroactively to January 1, 2007. The implementation of this standard did not have a material impact on the Company’s consolidated financial position or results of operations.
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption of SFAS No. 157 to have a material effect on the Company’s consolidated financial statements.
During the three years ended December 31, 2007, the Company completed five business combinations and one membership purchase. These business combinations are all accounted for using the purchase method of accounting and, accordingly, the operating results of each acquisition have been included in the Company’s consolidated financial statements since their effective date of acquisition. The purchase price for each business combination was allocated to the assets, including the identifiable intangible assets, and liabilities based on estimated fair values. The excess of the purchase price over the net identifiable assets acquired was allocated to goodwill. The purchase price of the Company’s membership purchases is allocated to identifiable intangible assets and is being amortized over a useful life of ten to fifteen years.
The following table summarizes all business combinations and membership purchases for the three years ended December 31, 2007. The purchase price of each business combination includes the payment for net worth and estimated transition costs. The purchase price, inclusive of all retroactive balance sheet settlements to date and transition cost adjustments, is presented below (in millions):
As a result of these acquisitions made during the year ended December 31, 2007, the Company recorded $952.8 million of goodwill, of which, $289.1 million is expected to be deductible for tax purposes. The allocation of the purchase price is preliminary and is based upon information that was available to management at the time the consolidated financial statements were prepared. Accordingly, the allocation may change. The following table lists the assigned value of the intangible assets as of the acquisition date (in millions) and the associated amortization period:
The following unaudited pro-forma consolidated results of operations assumes the acquisitions made during the year ended December 31, 2007 occurred on January 1, 2007 and 2006 (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, 2007.
Gross investment gains of $1.7 million and gross investment losses of $0.5 million were realized on sales of investments for the year ended December 31, 2007. This compares to gross investment gains of $0.2 million and gross investment losses of $0.7 million on these sales for the year ended December 31, 2006, and gross investment gains of $3.0 million and gross investment losses of $1.1 million on these sales for the year ended December 31, 2005.
The unrealized loss reflected on each category of the Company’s investments is almost exclusively the result of interest rate movements subsequent to the purchase of the investments. 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, 2007.
Through its acquisition of First Health on January 28, 2005, the Company acquired eight separate investments (tranches) in a limited liability company that invests in equipment that is leased to third parties. The total investment as of December 31, 2007 was $51.9 million and is accounted for using the equity method. Coventry’s proportionate share of the partnership’s income since the date of the acquisition was $4.5, $6.7 and $4.6 million for the periods ended December 31, 2007, 2006 and 2005, respectively, and is included in other income. Coventry has between a 20% and 25% interest in the limited partners share of each individual tranche of the partnership (approximately 10% of the total partnership).
As of December 31, 2007, 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. Shares available for issuance under the Stock Incentive Plan were 7.0 million as of December 31, 2007.
The Company awarded 0.7 million shares of restricted stock in the twelve months ended December 31, 2007. The value of the restricted shares is amortized over various vesting periods through 2011. The Company recorded compensation expense related to restricted stock grants, including restricted stock granted in prior periods, of approximately $28.1 million, $25.0 million and $21.9 million for the years ended December 31, 2007, 2006 and 2005, respectively. The total unrecognized compensation cost (net of expected forfeitures) related to the restricted stock was $44.7 million at December 31, 2007, and is expected to be recognized over a weighted average period of 2.3 years. The weighted-average fair value of restricted stock granted was $ 59.42, $50.75 and $47.74 per share for the years ended December 31, 2007, 2006 and 2005, respectively. The total fair value of shares vested during the years ended December 31, 2007, 2006 and 2005 was $39.2 million, $36.1 million and $42.7 million, respectively.
The following table illustrates the effect on net earnings and earnings per common share (“EPS”) as if the Company had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the year ended December 31, 2005 (in thousands, except per share amounts):
At December 31, 2007, the Company had approximately $71.7 million of federal and $135.2 million of state tax net operating loss carryforwards. The Federal net operating losses were acquired through various acquisitions. The net operating loss carryforwards can be used to reduce future taxable income, and expire over varying periods through the year 2026.
The effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2007 and 2006 are presented below (in thousands):
(1) Includes $119.9 million and $59.4 million classified as current assets at December 31, 2007 and 2006, respectively, and ($229.0) million and ($183.3) million classified as noncurrent assets (liabilities) at December 31, 2007 and 2006, respectively.
The total amount of unrecognized tax benefits, as of December 31, 2007, that if recognized would affect the effective tax rate was $17.1 million. Further, the Company is unaware of any positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next twelve months.
During the year ended December 31, 2006, the Internal Revenue Service (“IRS”) completed its examination of the income tax returns of First Health Group Corporation (“FHGC”) for all years through 2003, except that the year ended December 31, 2003 remains open as a result of a claim filed related to the Research & Development Credit. As of December 31, 2007, the IRS was in the process of examining FHGC’s income tax returns for the year ended December 31, 2004 and the short year ended January 28, 2005, the date of FHGC’s merger with the Company. As of December 31, 2007, the IRS had begun an examination of the Company’s income tax returns for the years ended December 31, 2005 and December 31, 2006. Additionally, the Company settled certain income tax examinations with various state tax authorities. Tax assessed as a result of these examinations, if any, was not material. FHGC is also subject to ongoing examinations by state tax authorities for pre-acquisition years. The Company believes that adequate accruals have been provided for all FHGC open tax years, and the Company expects these accruals to be reclassified against goodwill upon settlement with the taxing authorities or upon the closing of the statute of limitations.
As of December 31, 2007, 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. For more information regarding the Company’s stock-based compensation, please refer to Note F, Stock-Based Compensation.
As of December 31, 2007, the Company sponsored two defined contribution retirement plans qualifying under the Internal Revenue Code Section 401(k): the Coventry Health Care, Inc. Retirement Savings Plan (the “Savings Plan”), and the Coventry Health Care Workers Compensation, Inc. 401(k) and Profit Sharing (the “Workers Compensation Plan”). All employees of Coventry Health Care, Inc. and employees of its subsidiaries (excluding employees of Coventry Workers Compensation, Inc. who were eligible for the Workers Compensation Plan 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. Fidelity Investments was the custodial trustee of all Workers Compensation Plan assets and participant loans until December 31, 2007. T. Rowe Price became the custodial trustee of the Workers Compensation Plan assets and participant loans on January 1, 2008 when the Workers Compensation Plan assets merged with and into the Savings Plan.
Under the Workers Compensation Plan, participants could defer up to 25% of their eligible compensation, limited by the maximum compensation deferral amount permitted by applicable law. The Company will make a discretionary employer matching contributions for the 2007 plan year. Participants are 100% vested in the Company’s matching contributions. All costs of the Workers Compensation Plan are funded by the Company and participants as they are incurred.
The cost, principally employer matching contributions, of the RESTORE charged to operations for 2007, 2006 and 2005 was $1.8 million, $1.2 million and $1.1 million, respectively.
As of December 31, 2007, the Company was the sponsor of a deferred compensation plan that is designed to promote the retention of key senior management and to recognize their strategic importance to the Company. During 2006, two similarly designed plans were settled and paid out. The fixed dollar and stock equivalent allocations charged to operations for these plans were $2.9 million, $5.0 million, and $15.6 million in 2007, 2006 and 2005, respectively, and the liability for these plans was $4.2 million and $1.2 million at December 31, 2007 and 2006, respectively.
On February 15, 2007, the Company redeemed all $170.5 million of its remaining outstanding 8.125% Senior Notes due February 15, 2012 originally sold on February 1, 2002. The Company redeemed the notes at a redemption price equal to 104.1% of the principal amount plus interest accrued on the redemption date. As a result of the redemption, the Company recognized $6.9 million of interest expense for the premium paid on redemption and wrote off $2.2 million of deferred financing costs related to the senior notes. The funds for payment of the redemption price were provided by cash on hand.
On March 20, 2007, the Company completed the sale of $400 million aggregate principal amount of its 5.95% Senior Notes due March 15, 2017 (the “10-year Notes”) at the issue price of 99.63% per Note. The 10-year Notes are senior unsecured obligations of Coventry and rank equally with all of its other senior unsecured indebtedness. As of December 31, 2007, the fair value was $390.5 million.
The Company’s senior notes dated January 28, 2005 and credit facilities require compliance with a leverage ratio. All of its senior notes and credit facility contain certain covenants and restrictions regarding additional debt, dividends or other restricted payments, transactions with affiliates, disposing of assets and in some cases provide for debt repayment upon consolidations or mergers. As of December 31, 2007, the Company was in compliance with the applicable covenants under the senior notes and credit facility.
As of December 31, 2007, the aggregate maturities of debt based on their contractual terms, are as follows (in thousands):
In the normal course of business, the Company has been named as a defendant in various legal actions such as actions seeking payments for claims denied by the Company, medical malpractice actions, employment related claims and other various claims seeking monetary damages. The claims are in various stages of proceedings and some may ultimately be brought to trial. Incidents occurring through December 31, 2007 may result in the assertion of additional claims. The Company maintains general liability, professional liability and employment practices liability insurances in amounts that it believes are appropriate, with varying deductibles for which it maintains reserves. The professional liability and employment practices liability insurances are carried through its captive subsidiary. Although the results of pending litigation are always uncertain, the Company does not believe the results of such actions currently threatened or pending, including those described below, will individually or in the aggregate, have a material adverse effect on its consolidated financial position or results of operations.
The Company is a defendant in the provider track of the In Re: Managed Care Litigation filed in the United States District Court for the Southern District of Florida, Miami Division, Multi-District Litigation (“MDL”), No. 1334, in the action captioned, Charles B. Shane., et al., vs. Humana, Inc., et al. This lawsuit was filed by a group of physicians as a class action against Coventry and nine other companies in the managed care industry. The plaintiffs alleged violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”), conspiracy to violate RICO and aiding and abetting a scheme to violate RICO. In addition to these federal law claims, the complaint included state law claims for breach of contract, violations of various state prompt payment laws and equitable claims for unjust enrichment and quantum meruit. The trial court dismissed several of the state law claims and ordered all physicians who had an arbitration provision in their provider contracts to submit their direct RICO claims and their remaining state law claims to arbitration. As a consequence of this ruling, the plaintiffs who had arbitration provisions voluntarily dismissed their claims that were subject to arbitration. In its order, the trial court also held that the plaintiffs’ claims of (1) conspiracy to violate RICO and (2) aiding and abetting violations of RICO were not subject to arbitration. The trial court then certified various subclasses of plaintiffs with respect to these two federal law claims.
The Company’s regulated HMO and insurance company subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends the parent may receive from its regulated entities. During 2007, the Company received $421.6 million in dividends from its regulated subsidiaries and paid $71.9 million in capital contributions.
(b) As mentioned above, the State of Florida does not have a RBC requirement for its regulated HMOs. Accordingly, the statutory reserve information provided, for Vista, is based on the actual statutory minimum capital required by the State of Florida.
Excluding funds held by entities subject to regulation and excluding the Company’s equity investments, the Company had cash and investments of approximately $436.2 million and $563.1 million at December 31, 2007 and 2006, respectively. The decrease was primarily due to payments made for the Concentra, Mutual of Omaha and Vista acquisitions and payments made for share repurchases. These payments were partially offset by the proceeds from the sale of the Company’s Senior Notes, dividends received from the Company’s regulated subsidiaries, and additional borrowings on the Company’s credit facility.
Through an effort to further integrate the First Health business acquired on January 28, 2005, the Company in 2007 has realigned into new operating units which are based on the product sold. The Company’s new organizational structure, effective January 1, 2007, capitalizes on existing synergies and brings enhanced focus on areas of growth opportunities. As a result of the new organizational structure, the Company’s reportable segments have changed. The Company has three reportable segments: Commercial, Individual Consumer & Government, and Specialty. Each of the Company’s three new segments is managed separately and separate operating results are available that are evaluated by the chief operating decision maker. The Commercial Business Division is comprised of all of the Company’s commercial employer-focused businesses, including the traditional health plan group risk and ASO products as well as the National Accounts, Federal Employees Health Benefit Plans, and Network Rental businesses. The Individual Consumer & Government Division contains the Company’s individual consumer products and all Medicare and Medicaid products. The Specialty Division includes the Company’s workers’ compensation services businesses.
The Commercial Business Division provides commercial HMO, PPO and POS products to a cross section of employer groups of all sizes through its health plans. HMO products provide comprehensive health care benefits to members primarily through a primary care physician. PPO and POS products permit members to participate in managed care but allow them the flexibility to utilize out-of-network providers in exchange for increased out-of-pocket costs. Additionally, the Commercial Business Division provides network rental services and other managed care products through a national PPO network to national, regional and local third party administrators and insurance carriers.
The Specialty Business Division currently provides workers’ compensation managed care services on a fee-based basis, including access to the Company’s provider network, pharmacy benefits management, field case management, telephonic case management, independent medical exam and bill review capabilities. This division includes the workers’ compensation managed care services businesses acquired from Concentra on April 2, 2007. See Note B to the Consolidated Financial Statements for additional information related to the Concentra acquisition.
The table below summarizes the operating results of the Company’s reportable segments (in thousands). Total operating expenses for the Commercial and Individual Consumer & Government Divisions are not segregated internally and, as a result, are aggregated. “Other” represents the elimination of fees charged among segments. Disclosure of total assets by reportable segment has not been included as such assets are not reported on a segment basis internally by the Company and are not reviewed separately by the Company’s chief operating decision maker.
During December 2007, the Company signed a definitive agreement to acquire MHNet, a behavioral health company. The transaction closed on February 13, 2008.