(1) Operations Statement Data include the results of operations of acquisitions since the date of acquisition. Balance Sheet Data reflect acquisitions as of December 31, of the year of acquisition. See the notes to consolidated financial statements for detail on our acquisitions.
Health Plan membership decreased .9% over the prior year, excluding the new Medicare Part D business.
Medicare Part D revenues of $669.9 million and membership of 687,000.
Health Plan medical loss ratio of 78.9% improved 60 basis points over the prior year.
Selling, general and administrative expenses were 17.3% of operating revenues, a decrease of 60 basis points from the prior year.
Operating margin of 10.9% declined 110 basis points over the prior year.
We have established systems that monitor the availability, appropriateness and effectiveness of the patient care we provide. We collect utilization data in each of our markets that we use to analyze over-utilization or under-utilization of services and assist our health plans in arranging for appropriate care for their members and improving patient outcomes in a cost efficient manner. Medical directors also monitor the utilization of diagnostic services and encourage the use of outpatient surgery and testing where appropriate. Each health plan collects data showing each physician’s utilization profile for diagnostic tests, specialty referrals and hospitalization and presents such data to the health plan’s physicians. The medical directors monitor these results in an effort to ensure the use of medically, cost-effective appropriate services.
Managed care premiums are recorded as revenue in the month in which members are entitled to service. Premiums are based on both a per-subscriber contract rate and the number of subscribers in our records at the time of billing. Premium billings are generally sent to employers in the month preceding the month of coverage. Premium billings may be subsequently adjusted to reflect changes in membership as a result of retroactive terminations, additions, or other changes. Due to early timing of the premium billing, we are able to identify in the current month the retroactive adjustments for two subsequent months billings. Current period revenues are adjusted to reflect these retroactive adjustments.
Based on information received subsequent to generating premium billings, historical trends, bad debt write-offs and the collectibility of specific accounts, we estimate, on a monthly basis, the amount of bad debt and future membership retroactivity and adjust our revenue and allowances accordingly.
As of December 31, 2006, we maintained allowances for retroactive billing adjustments of approximately $20.1 million compared with approximately $20.6 million at December 31, 2005. We also maintained allowances for doubtful accounts of approximately $1.9 million and $3.6 million as of December 31, 2006 and 2005, 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.
We employ a team of actuaries that have used a set of reserve models that are based on a consistent methodology. Although the calculation is consistent, we adjust our estimates of medical utilization and components of medical cost trends to amounts we estimate to be appropriate. The medical liabilities are an accumulation of the results from many individual models, each calculated at the statutory level and representing different markets and/or products. These reserve models do not calculate separate amounts for reported but not paid and incurred but not reported, but rather a single estimate of medical claims liabilities. These reserve models make use of both historical claim payment patterns as well as emerging medical cost trends to project our best estimate of claim liabilities. Within these models, historical data of paid claims is formatted into claim triangles which compare claim incurred dates to the claim payment dates. This information is analyzed to create “completion factors” that represent the average percentage of total incurred claims that have been paid through a given date after being incurred. Completion factors are applied to claims paid through the financial statement date to estimate the ultimate claim expense incurred for the current period. Actuarial estimates of claim liabilities are then determined by subtracting the actual paid claims from the estimate of the ultimate incurred claims.
Actuarial standards of practice generally require the actuarial developed medical claims estimates to cover obligations under an assumption of moderately adverse conditions. Adverse conditions are situations in which the actual claims are expected to be higher than the otherwise estimated value of such claims. In many situations, the claims paid amount experienced will be less than the estimate that satisfies the actuarial standards of practice. Medical claims liabilities are recorded at an amount we estimate to be appropriate. Adjustments of prior years estimates may result in additional medical costs or, as we have experienced during the last several years, a reduction in medical costs in the period an adjustment was made. Our reserve models have historically developed favorably suggesting that the accrued liabilities calculated from the models were more than adequate to cover our ultimate liability for unpaid claims. We believe that this favorable development is a result of good communications between our health plans and our actuarial staff regarding medical utilization, mix of provider rates and other components of medical cost trend.
The Medicare Part D related subsidy liabilities identified in the table above represent subsidy amounts received from CMS for reinsurance and for cost sharing related to low income individuals. These subsidies are recorded in medical liabilities and we do not recognize premium revenue or claims expense for these subsidies. Following the final settlement in 2007 related to the 2006 plan year, any remaining balances from these subsidy payments will be refunded to CMS.
For the more recent incurred months, the percentage of claims paid to claims incurred in those months is generally low. As a result, the completion factor methodology is less reliable for such months. For that reason, incurred claims for recent months are not projected solely from historical completion and payment patterns. Instead, they are projected by estimating the claims expense for those months based upon recent claims expense levels and health care trend levels, or “trend factors.” As these months mature over time, the two estimates (completion factor and trend) are blended with completion factors being used exclusively for older months.
We believe that the amount of medical liabilities is adequate to cover our ultimate liability for unpaid claims as of December 31, 2006 however, actual claim payments and other items may differ from established estimates.
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 increases and not unfavorable changes in the credit ratings associated with these securities. These investments are not in high risk industries or sectors and we intend to hold these investments for a period of time sufficient to allow for a recovery in market value, which may be maturity.
Goodwill and other intangible assets that have indefinite lives are subject to a periodic assessment for impairment by applying a fair-value-based test. For our impairment analysis of the Health Plan segment goodwill, we used three approaches to identify the fair value of our goodwill and other intangible assets: a market approach, a market capitalization approach and an income approach. The market approach estimates a business’s fair value by analyzing the recent sales of similar companies. The market capitalization approach is based on the market value of our total shares outstanding. The income approach is based on the present value of expected future cash flows. The income approach involves estimating the present value of the company’s estimated future cash flows, and discounting these cash flows at a given rate of return. All three approaches were reviewed together for consistency and commonality.
Our remaining long-lived assets consist of property and equipment and other finite-lived intangible assets. These assets are depreciated or amortized over their estimated useful life, and are subject to impairment reviews. In accordance with Statement of Position (“SOP”) 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” the cost of internally developed software is capitalized and included in property and equipment. We capitalize costs incurred during the application development stage for the development of internal-use software. These costs primarily relate to payroll and payroll-related costs for employees along with costs incurred for external consultants who are directly associated with the internal-use software project. We periodically review long-lived assets whenever adverse events or changes in circumstances indicate the carrying value of the asset may not be recoverable. In assessing recoverability, we must make assumptions regarding estimated future cash flows and other factors to determine if an impairment loss may exist, and, if so, estimate fair value. We also must estimate and make assumptions regarding the useful life we assign to our long-lived assets. If these estimates or their related assumptions change in the future, we may be required to record impairment losses or change the useful life, including accelerating depreciation for these assets.
During the three years ended December 31, 2006, we completed two business combinations and a 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 twenty years.
The following table summarizes all business combinations and membership purchases for the three years ended December 31, 2006. The purchase price of each business combination includes the payment for net worth and estimated transition costs. The purchase price shown for recent acquisitions, in millions, is inclusive of all retroactive balance sheet settlements and transaction cost adjustments.
The following table presents our Health Plan membership as of December 31, 2006 and 2005 (in thousands) and the percentage change in membership between these dates.
Commercial insured membership decreased over the prior year end due to losses experienced in our Pennsylvania market and the expected loss of commercial insured members in our Louisiana operations during the first half of 2006, primarily due to Hurricane Katrina. Additionally, there were a few large groups changing from a risk product to a non-risk product. These losses were partially offset by gains in employer group business in other markets such as Delaware, Kansas and Georgia and also by growth in individual business across multiple markets.
Medicaid membership decreased over the prior year end due to changes in the eligibility requirements for Medicaid beneficiaries throughout the Missouri market as well as the state of North Carolina’s termination of its existing managed care program during the third quarter resulting in a loss of approximately 7,400 members.
The increase in non-risk membership was attributable to organic growth in various markets as well as a few large groups changing from a risk product to a non-risk product.
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, 2006 (in thousands, except earnings per share and membership data).
Managed care premium revenue increased as a result of new business related to our Medicare Part D products and as a result of rate increases that occurred throughout all markets. Medicare Part D business accounted for $669.9 million of managed care premium revenue in 2006 which excludes $32.6 million attributable to the estimated CMS risk-sharing payments that will be due to CMS upon the final settlement in 2007 for the 2006 plan year.
Additionally, we have quota share reinsurance arrangements with two of our Medicare Part D distribution partners. As a result of the quota sharing arrangements, we ceded Medicare Part D premium revenue to these partners of $65.8 million. This amount is excluded from the $669.9 million of reported Medicare Part D revenue. Before subtracting the quota share ceded revenue, the premium yield, per member per month, for Medicare Part D business would have been $8.88 higher than the $90.48 reported. When reviewing the premium yield for Medicare Part D business, adjusting for the ceded revenue is useful for comparisons to competitors that may not have similar ceding arrangements.
Management services revenue decreased partially as a result of declines in membership in the National Accounts and Federal Employees Health Benefit Plan sectors of the First Health segment. Additionally, the implementation of Medicare Part D resulted in a decline of First Health pharmacy administration fee based revenue compared to the prior year, although this decline is more than offset by the increased revenue from our new Medicare Part D business discussed above in the managed care premium revenue section. These decreases are partially offset by reporting a full year of First Health results in 2006. First Health was acquired on January 28, 2005 and therefore only results from January 28, 2005 through December 31, 2005 are included in our 2005 results of operations.
Other income increased as a result of a larger investment portfolio and a rise in interest rates during 2005 and 2006.
Our provision for income taxes increased almost exclusively due to an increase in earnings. The effective tax rate remained relatively flat at 37.5% in 2006 compared to 37.3% in 2005.
Other income increased as a result of a larger investment portfolio and a rise in short term rates during the year.
During the third quarter of 2006, we received approval to offer PFFS products in 43 states. The PFFS plans will be marketed under the brand name of Advantra Freedom. These plans include options with pharmacy benefits or stand alone medical benefits. In addition, there are benefit plans available at a zero premium option in most states.
Products will be underwritten by Coventry Health and Life Insurance Company, First Health Life and Health Insurance Company and Cambridge Life Insurance Company. We have established partnerships with Medicare Supplement insurance carriers and brokerage channels nationwide to provide Medicare Private Fee For Service to Medicare beneficiaries.
Our cash and investments, consisting of cash and cash equivalents and short-term and long-term investments, but excluding deposits of $56.4 million restricted under state regulations, increased $723.9 million to $2.7 billion at December 31, 2006 from $2.0 billion at December 31, 2005.
On February 8, 2007, the Company announced it has signed a definitive agreement to acquire Concentra, Inc.’s workers’ compensation managed care services businesses. The Company will acquire the Concentra businesses for $387.5 million in an all-cash transaction expected to close in 90 to 180 days, subject to closing conditions, regulatory and other customary approvals. We anticipate the funds for payment of the acquisition will be provided by existing cash, additional bank borrowings or a new bond offering.
Net cash from operating activities is primarily driven by net earnings and an increase in medical liabilities. The increase in medical liabilities was driven by the addition of approximately $363.5 million related to the Part D program. Total cash inflows from Medicare Part D totaled $348.6 million. This amount included a net receipt of claim reinsurance subsidies from CMS of approximately $234.7 million. Following the final settlement in 2007 related to the 2006 plan year, any remaining balances from reinsurance and other subsidy payments will be returned to CMS. Accounts payable and other liabilities increased primarily due to CMS risk sharing payment accruals, attributable largely to the Part D program; an increase in income taxes payable; and other normal operating activities. Accounts receivable decreased during the year as a result of strong collections. Offsetting these operating cash inflows was an increase in other receivables which was primarily a result of pharmacy rebate receivables recorded related to the Part D program.
Capital expenditures in 2006 of approximately $72.6 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 2007 of approximately $65-$70 million consist primarily of computer hardware, software and other equipment.
The majority of states in which we operate health plans have adopted a risk-based capital (“RBC”) policy that recommends the health plans maintain statutory reserves at or above the ‘Company Action Level’ which is currently equal to 200% of their RBC. We have adopted an internal policy to maintain all of our regulated subsidiaries’ statutory capital and surplus at or above 250% of their RBC and a level of 300% in aggregate (referred to below as “300% of RBC”). Some states in which our regulated subsidiaries operate require deposits to be maintained with the respective states’ departments of insurance. The table below summarizes our statutory reserve information, as of December 31, 2006 and 2005 (in millions, except percentage data).
As of December 31, 2006, we were contractually obligated to make the following payments within the next five years and thereafter (in thousands):
In the normal course of business, we have been named as a defendant in various legal actions such as actions seeking payments for claims denied by us, 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, 2006 may result in the assertion of additional claims. We maintain general liability, professional liability and employment practices liability insurances in amounts that we believe are appropriate, with varying deductibles for which we maintain reserves. The professional liability and employment practices liability insurances are carried through our captive subsidiary. Although the results of pending litigation are always uncertain, we do 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 our consolidated financial position or results of operations.
For 2007, we will offer a new Medicare Advantage PFFS plan in 43 states. Through the combined efforts of our various distribution channels, we expect to generate between 90,000 to 100,000 new PFFS members during 2007 with associated revenue of approximately $700 million.
To the Board of Directors and Stockholders of Coventry Health Care, Inc.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Coventry Health Care, Inc. and subsidiaries at December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
Coventry Health Care, Inc. (together with its subsidiaries, the “Company” or “Coventry”) is a national managed health care company based in Bethesda, Maryland operating health plans, insurance companies, network rental/managed care services companies, and workers’ compensation services companies. The Company provides a full range of risk and fee-based managed care products and services, including HMO, PPO, POS, Medicare Advantage, Medicare Prescription Drug Plans, Medicaid, Workers’ Compensation and Network Rental to a broad cross section of individuals, employer and government-funded groups, government agencies, and other insurance carriers and administrators in all 50 states as well as the District of Columbia and Puerto Rico.
Since the Company began operations in 1987 with the acquisition of the American Service Companies entities, including Coventry Health and Life Insurance Company (“CH&L”), the Company has grown substantially through acquisitions. See Note B to these consolidated financial statements for information on the Company’s most recent acquisitions.
Investments - The Company accounts for investments in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 115 - “Accounting for Certain Investments in Debt and Equity Securities” and in accordance with FASB Staff Position Number FAS 115-1, “The meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The Company invests primarily in fixed income securities and classifies all of its investments as available-for-sale. Investments are evaluated on an individual security basis at least quarterly to determine if declines in value are other-than-temporary. In making that determination, the Company considers all available evidence relating to the realizable value of a security. This evidence is reviewed at the individual security level and includes, but is not limited to, the following:
Business Combinations, Accounting for Goodwill and Other Intangibles - The Company accounts for business combinations, goodwill and other intangibles in accordance with SFAS No. 141 - “Business Combinations,” SFAS No. 142 - “Goodwill and Other Intangible Assets” and SFAS No. 144 - “Accounting for the Impairment or Disposal of Long-Lived Assets.” Acquired intangible assets are separately recognized upon meeting certain criteria. Such intangible assets include, but are not limited to, trade and service marks, non-compete agreements, customer lists and licenses. An intangible asset that is subject to amortization shall be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. Goodwill and other intangible assets that have indefinite lives are subject to a periodic assessment for impairment by applying a fair-value-based test. The Company considers multiple approaches to identifying the fair value of its goodwill and other intangible assets. Those approaches include the market approach, the market capitalization approach, the income approach and the cost approach. The market approach estimates a business’s fair value by analyzing the recent sales of similar companies. The market capitalization approach is based on market value of the Company’s total shares outstanding. The income approach is based on the present value of expected future cash flows. The cost approach is based on the cost to reconstruct or replace an asset with another of like utility. As impairment charges occur, write-down charges will be recorded in the period in which the impairment took place. See Note C to consolidated financial statements for disclosure related to intangible assets.
The following table shows the components of the change in medical liabilities for the years ended December 31, 2006, 2005 and 2004, respectively:
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 we do not recognize premium revenue or claims expense for these subsidies. Following the final settlement in 2007 related to the 2006 plan year, any remaining balances from these subsidy payments will be refunded to CMS.
Other Long-term Liabilities - Other long-term liabilities consist primarily of liabilities associated with the 401(k) Restoration and Deferred Compensation Plan and the deferred tax liabilities associated with both intangible assets and a limited partnership investment.
Comprehensive Income - Comprehensive income includes net income and the unrealized net gains and losses on investment securities. Other comprehensive income is net of reclassification adjustments to adjust for items currently included in net income, such as realized gains and losses on investment securities. The deferred tax benefit for unrealized holding losses arising from investment securities during the years ended December 31, 2006, 2005 and 2004 was $0.02 million, $6.9 million and $6.0 million, respectively. The deferred tax benefit for reclassification adjustments for loss included in net income on investment securities during the year ended December 31, 2006 was $0.2 million. The deferred tax provision for reclassification adjustments for gains included in net income on investment securities during the years ended December 31, 2005 and 2004 was $0.8 million and $0.2 million, respectively.
The Medicare Part D program, which gives beneficiaries access to prescription drug coverage, took effect January 1, 2006. Coventry has been awarded contracts by the Centers for Medicare & Medicaid Services (“CMS”) to offer various Medicare Part D plans on a nationwide basis, in accordance with guidelines put forth by the agency. Payments from CMS under these contracts include amounts for premiums, amounts for risk corridor adjustments and amounts for reinsurance and low-income cost subsidies.
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 our health care provider networks and health care management services, for which we do 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 we provide typically include health care provider network management, clinical management, pharmacy benefit management (“PBM”), bill review, claims repricing, fiscal agent services (generally for state entitlement programs), claims processing, utilization review and quality assurance.
During the three years ended December 31, 2006, the Company completed two business combinations and one membership purchase. The Company’s 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 twenty years.
The total purchase price, including estimated transition costs, for First Health of $1.7 billion was allocated to the assets, including identifiable intangible assets and liabilities based on estimated fair values. The estimated transition costs of $46.4 million include estimated costs for involuntary employee termination of $25.6 million, of which $24.8 million has been paid, estimated costs for exiting certain leased building space of $10.0 million, of which $5.6 million has been paid, and other transition cost accruals of which all has been paid. Deferred tax liabilities associated with the acquisition were $168.4 million. The following table lists the assigned value of the intangible assets as of the acquisition date (in millions) and the associated amortization period:
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, 2006.
Depreciation expense for the years ended December 31, 2006, 2005 and 2004 was $77.9 million, $55.1 million and $14.9 million, respectively. Included in the depreciation expense for the years ended December 31, 2006, 2005 and 2004 is $26.9 million, $13.1 million and $0, respectively, of expense for developed software. The increase in depreciation expense in 2005 was a result of the property and equipment obtained with the acquisition of First Health.
The amortized cost, gross unrealized gain or loss and estimated fair value of short-term and long-term investments by security type were as follows at December 31, 2006 and 2005 (in thousands):
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, 2006 was $54.1 million and is accounted for using the equity method. The Company’s proportionate share of the partnership’s income since the date of the acquisition was $6.7 and $4.6 million for the periods ended December 31, 2006 and 2005, respectively, and is included in other income. The Company 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).
Effective January 1, 2006, the Company adopted SFAS 123R using the modified prospective method. Under this method, the fair value of awards granted after the date of adoption and the unvested portion of previously granted awards outstanding at the date of adoption are included in operating expenses over the vesting period during which an employee provides service in exchange for the award. In accordance with the modified prospective method, prior period amounts presented herein have not been restated to reflect the adoption of SFAS 123R.
As a result of adopting SFAS 123R, the Company recorded $30.7 million of compensation expense related to stock options, or $18.8 million after-tax, in its statement of operations for the year ended December 31, 2006. As required in prior years under APB No. 25, the Company recognized forfeitures related to stock awards as they occurred. SFAS 123R requires an entity to estimate expected forfeitures at the grant date. As a result, the Company recorded a favorable $0.5 million ($0.3 million after tax) cumulative effect of a change in accounting principle upon the adoption of SFAS 123R as it relates to estimated forfeitures. This one time benefit applies to compensation cost recognized in prior periods for awards that are unvested on the adoption date and represents an estimate of the number of outstanding instruments upon adoption of SFAS 123R for which the requisite service is not expected to be rendered. The net increase of SFAS 123R for stock-based compensation expense reduced both basic and diluted earnings per share by $0.11 for year ended December 31, 2006. In accordance with SFAS 123R, the Company estimates forfeitures and is recognizing compensation expense only for those share-based awards that are expected to vest.
As of December 31, 2006, 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. In May 2006, the Stock Incentive Plan was amended to increase the number of shares authorized for issuance by an additional 9.0 million shares. Shares available for issuance under the Stock Incentive Plan were 9.9 million as of December 31, 2006.
Under the Stock Incentive Plan, the terms and conditions of option grants are established on an individual basis with the exercise price of the options being equal to not less than 100% of the fair value of the underlying stock at the date of grant. Options generally become exercisable after one year in 25% increments per year and expire ten years from the date of grant. At December 31, 2006, the Stock Incentive Plan had outstanding options representing 11.3 million shares of common stock.
The Company has elected to continue to use the Black-Scholes-Merton option pricing model and straight-line amortization of compensation expense over the requisite service period of the grant. The Company will reconsider use of the Black-Scholes-Merton model if additional information becomes available in the future that indicates another model would be more appropriate, or if grants issued in future periods have characteristics that cannot be reasonably estimated using this model.
The following table illustrates the effect on net earnings and earnings per common share (“EPS”) as if we had applied the fair value recognition provisions of SFAS 123 to stock-based compensation during the years ended December 31, 2005 and 2004 (in thousands, except per share amounts):
The effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2006 and 2005 are presented below (in thousands):
(1) Includes $59.4 million and $57.7 million classified as current assets at December 31, 2006 and 2005, respectively, and ($183.3) million and ($199.3) million classified as noncurrent liabilities at December 31, 2006 and 2005, respectively.
There is no valuation allowance for the 2006 and 2005 deferred tax assets as the Company believes that the realization of the deferred tax assets, including net operating losses, is more likely than not due to the future reversals of existing taxable temporary differences.
The Stock Incentive Plan is authorized to grant either incentive stock options or nonqualified stock options, stock appreciation rights, restricted stock and other stock-based awards at the discretion of the Compensation and Benefits Committee of the Board of Directors. Shares available for issuance under the Stock Incentive Plan were 9.9 million and 3.5 million as of December 31, 2006 and 2005, respectively. For more information regarding the Company’s stock-based compensation, please refer to Note F, Stock-Based Compensation.
As of December 31, 2006, the Company had one defined contribution retirement plan qualifying under the Internal Revenue Code Section 401(k): the Coventry Health Care, Inc. Retirement Savings Plan (the “Savings Plan”). All employees of Coventry Health Care, Inc. and employees of its subsidiaries 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.
Under the Savings Plan, participants may defer up to 75% of their eligible compensation, limited by the maximum compensation deferral amount permitted by applicable law. The Company makes matching contributions in the Company’s common stock equal to 100% of the participant’s contribution on the first 3% of the participant’s eligible compensation and equal to 50% of the participant’s contribution on the second 3% of the participant’s eligible compensation. Participants will vest in the Company’s matching contributions in 50% increments annually on their anniversary date over a period of two years of service with the Company. Effective January 1, 2006, the Savings Plan was amended to provide 100% vesting for all employer matching contributions made after January 1, 2006. The Savings Plan permits divestiture, whereby employees with three or more years of service were eligible to sell the employer match portion of the Coventry common stock in their accounts, during certain times of the year, and transfer the proceeds to other Coventry 401(k) funds of their choosing. All costs of the Savings Plan are funded by the Company and participants as they are incurred.
As of December 31, 2006, the Company was the sponsor of a 401(k) Restoration and Deferred Compensation Plan (“RESTORE”), currently known as the Coventry Health Care, Inc. 401(k) Restoration and Deferred Compensation Plan. Under the RESTORE, participants may defer up to 15% of their base salary and up to 100% of any bonus awarded. Effective January 1, 2006, the RESTORE was amended to enable participants to defer up to 75% of their base salary. The Company makes matching contributions equal to 100% of the participant’s contribution on the first 3% of the participant’s compensation and 50% of the participant’s contribution on the second 3% of the participant’s compensation. Participants vest in the Company’s matching contributions ratably over two years. All costs of the RESTORE are funded by the Company as they are incurred.
The cost, principally employer matching contributions, of the RESTORE charged to operations for 2006, 2005 and 2004 was $1.2 million, $1.1 million and $1.0 million, respectively.
As of December 31, 2005, the Company was the sponsor of two deferred compensation plans that were designed to promote the retention of key senior management and to recognize their strategic importance to the Company. During 2006, these plans were settled and paid out in cash and a new plan was created with similar design features. The fixed dollar and stock equivalent allocations charged to operations for these plans were $5.0 million, $15.6 million, and $11.6 million in 2006, 2005 and 2004, respectively, and the liability for these plans was $1.2 million and $37.0 million at December 31, 2006 and 2005, respectively.
The Company’s 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 2006, the Company received $297 million in dividends from its regulated subsidiaries.
The Company’s Board of Directors has approved a program to repurchase its outstanding common stock. Stock repurchases may be made from time to time at prevailing prices on the open market, by block purchase or in private transactions. In February 2006, our Board of Directors approved an increase to the share repurchase program in an amount equal to 5% of our outstanding common stock, thus increasing our repurchase authorization by 8.1 million shares. Under the share repurchase program, the Company purchased 4.6 million shares of the Company’s common stock during 2006, at an aggregate cost of $256.1 million, no shares were purchased in 2005 and 3.0 million shares during 2004, at an aggregate cost of $84.6 million. The total remaining common shares the Company is authorized to repurchase under this program is 6.2 million as of December 31, 2006. Excluded from these amounts are shares purchased in exchange for employee payroll taxes on vesting of restricted stock awards as these purchases are not part of the program.
The Company has two reportable segments: Health Plans and First Health. Each of these segments is managed separately and separate operating results are available that are evaluated by the chief operating decision maker. The Health Plans segment provides commercial, Medicare and Medicaid products to a cross section of employer groups and individuals. Commercial products include HMO, PPO and POS products. 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. The Company provides comprehensive health benefits to members participating in Medicare and Medicaid programs and receives premium payments from federal and state governments.
National Accounts - a variety of stand-alone managed care services and a portfolio of integrated health plan products to self-insured payors
Network Rental - national PPO network and other managed care products to national, regional and local third party administrators and insurance carriers
Medicaid/Public Sector - offers products and services more specialized to the needs of state governments as public sector health programs move toward more efficient utilization of health services. Product offerings include pharmacy benefit management, clinical management and fiscal intermediary services
The table below summarizes the Company’s reportable segments (in thousands). “Other” represents the elimination of fees charged between segments. First Health only includes results since the date of acquisition. Disclosure of total assets by reportable segment has not been disclosed, as they are not reported on a segment basis internally by the Company and are not reviewed by the Company’s chief operating decision maker:
On February 8, 2007, the Company announced it has signed a definitive agreement to acquire Concentra, Inc.’s workers’ compensation managed care services businesses. The Company will acquire the Concentra businesses for $387.5 million in an all-cash transaction expected to close in 90 to 180 days from that date, subject to closing conditions, regulatory and other customary approvals.