We own approximately 161,000 square feet of space in Las Vegas, Nevada. This includes a 134,000 square foot administrative building owned by HPN and SHL that is used as their Las Vegas headquarters and 27,000 square feet of space that houses our in-house print shop operations and information systems data center. Our Las Vegas headquarters serves as the home office and regional home office for our Nevada HMO and health insurance subsidiaries, respectively. We lease office and clinical space in Nevada totaling approximately 337,000 and 384,000 square feet, respectively, with the majority of the lease agreements running through January 2016. We lease a 2,155
We believe that current and planned clinical space will be adequate for our present needs. However, additional clinical space may be required if membership expands in southern Nevada. All of the properties described above are for the operations of our managed care and corporate operations segment. Our military health operations segment is winding down and no longer has any leased or owned property.
Commercial and Medicaid HMO membership increased 9.8% as a result of new accounts and in-case growth on commercial membership and continued growth in Medicaid membership.
Medical Premiums. The increase in medical premiums for 2006 reflects an 8.8% increase in commercial HMO member months (the number of months individuals are enrolled in a plan), which is attributed to in-case growth, movement from self-insured plans to our commercial products and other new accounts. HMO and HMO Point of Service premium rates for renewing commercial groups increased approximately 5.7% while the overall recorded per member per month revenue increase, including new and continuing business, was approximately 2.8%, net of changes in benefits.
In 2007, SHL will offer its stand-alone PDP in 30 states and the District of Columbia. We have engaged a national marketing partner for our PDP plans and we are using our established broker network in Nevada and Utah. Additionally, SHL will remain eligible as a PDP sponsor for its current auto-enrolled Medicare and Medicaid beneficiaries in California and Nevada, and for its current and 2007 auto-enrolled beneficiaries in Arizona, Colorado, Idaho, Oregon, Utah and Washington. SHL will no longer be a PDP sponsor for auto-enrolled beneficiaries in New Mexico and Texas. At December 31, 2006, we had approximately 19,500 auto-enrolled members in New Mexico and Texas. We will lose these auto-enrolled members, but we are still eligible to retain the CMS subsidized beneficiaries in New Mexico and Texas that are not auto-enrolled, although it is likely that these beneficiaries will select another PDP sponsor. At December 31, 2006, CMS subsidized beneficiaries in New Mexico and Texas that were not auto-enrolled totaled approximately 6,300 members.
enrolled in managed care programs, including the Social HMO, which has been administratively extended by CMS through 2007. For Social HMO members, the new methodology includes a frailty adjuster that uses measures of functional impairment to predict expenditures. CMS is transitioning to the new payment methodology on a graduated basis from 2004 through 2007 and we will be completely transitioned to the new methodology effective January 1, 2008. In 2005 and 2006, we were paid 70% and 50%, based on the previous payment methodology and 30% and 50%, based on the new methodology, respectively. For 2007, we will be paid 25%, based on the previous payment methodology and 75%,` based on the new methodology. For 2006, this transition towards the frailty adjusted risk methodology was favorable to our rate as a result of the unexpectedly high frailty adjuster we received for 2006 that caused our payment to be increased by 160 basis points compared to what our payment would have been if we had not continued the methodology transition. Including the effect of the revised Medicare Advantage bid process, changes in membership mix and the additional payments for the MA PDP, our net 2006 Medicare yield increase was approximately 4%. Based on the data we received in the first two months of 2007, we expect our net Medicare per-member-per-month yield to be relatively flat in 2007.
For 2008, we will be fully transitioned to a risk payment methodology which we believe will still have a frailty factor component through 2010 based on an advance notice CMS issued for comment on February 16, 2007. The notice stated that the frailty factor would continue to be a component of the risk score calculation for former Social HMO plans by using 75%, 50%, and 25% of the current frailty factor for the payments in 2008, 2009 and 2010, respectively. A final decision on this pending notice is expected to be made on April 2, 2007. Given the nature of this notice and other variable components of our annual payment calculation our 2008 payment per member may be less than our expected 2007 payment per member.
We have made CMS aware of the issues and they are in the process of researching the various issues. We expect these funds to be settled with CMS over the course of the next several quarters. Additionally, we have some membership discrepancies with some of the data received from CMS for 2006. We currently have approximately 1,600 Medicare members which we have been providing benefits for but for which we have not yet recorded revenue. Many of these members go back several months. We have submitted these members to CMS as part of the enrollment reconciliation process but we have not received validation or approval for these members from CMS. We believe that most, if not all, of these members will be validated and we will ultimately be paid by CMS over the next several months but we cannot be reasonably assured of that at this time. Until we receive confirmation from CMS that they are in fact our members and that we will be paid for them we do not believe that they meet the criteria for revenue recognition. As a result we have not recognized the revenue on these members during 2006.
Effective November 1, 2006, the DHCFP awarded a contract to Health Plan of Nevada, Inc. as one of two Medicaid managed care contractors in the state of Nevada. The new contract is effective until June 30, 2009. The new contract includes a provision that allows the DHCFP, at its sole option, to extend the contract for up to two additional years. The other Medicaid managed care contractor is new to the program and when the new contract became effective, the Medicaid members were given the option to select their plan and it appears that not only did we retain our existing members, but that many of the other members selected us over the new contractor as well. Since our current membership is estimated to be approximately 60% of the market share, the new contractor will get approximately 90% of new members that do not make an active selection based on the state Medicaid membership algorithm. Over time, this should keep the membership within a 60/40 band between the two contractors.
Continued medical premium revenue growth is principally dependent upon continued enrollment in our products and upon competitive and regulatory factors.
Professional Fees. The increase in professional fees primarily resulted from increased visits to our clinical subsidiaries, a new contract to provide pharmacy services to a skilled nursing facility, and a new contract to provide anesthesiology services to a local hospital, which started in the third quarter of 2005.
Medical Expenses. Our medical care ratio increased 80 basis points primarily due to the PDP, which had medical expenses of $160.3 million and has a higher medical care ratio than our other products. Our medical care ratio for the PDP was 81.3%, which accounted for 50 basis points of the increase. Medical premiums from the PDP are recognized as earned over the contract period; however, pharmacy and administrative costs are recognized as incurred with no allocation or annualized estimation of the impact of deductibles, the coverage gap or “donut hole,” prior to it being reached by the member, or reinsurance. This method of recognizing revenues and expenses results in a disproportionate amount of expense in the first part of each contract year when the plan is responsible for a larger portion of the drug cost.
The number of days in claims payable, which is the medical claims payable balance divided by the average medical expense per day, for 2006, was 62.8 compared to 48.6 for 2005. Pharmacy claims activity related to the PDP accounted for 11.2 days of this increase due to the timing of a year end claims run and amounts reserved under the state to plan reconciliation. The remaining increase was related to an increase in claims payable for provider disputes and timing of claims payments.
Our medical claims payable liability requires us to make significant estimates. Any changes to the estimates would be reflected in the year the adjustments are made. Included in medical expenses is favorable development on prior years’ estimates of $15.9 million and $13.3 million for the years ended December 31, 2006 and 2005, respectively. The favorable development is a result of claims being settled for amounts less than originally estimated. We also have amounts related to provider disputes in our claims payable that if settled for more than the amount recorded could have an adverse impact on our operating results, financial position and cash flows. For a further description of the estimate for our medical claims payable liability, see below in “Critical Accounting Policies and Estimates”.
We contract with hospitals, physicians and other independent providers of health care under capitated or discounted fee-for-service arrangements, including hospital per diems, to provide medical care services to members. We also have an extensive pharmacy network to provide pharmaceuticals to our members. Capitated providers are at risk for a portion of the cost of medical care services provided to our members in the relevant geographic areas; however, we are ultimately responsible for the provision of services to our members should the capitated provider be unable to provide the contracted services. We incurred capitation expenses with non-affiliated providers of $134.3 million and $128.3 million, or 10.4% and 12.6%, of our total medical expenses for 2006 and 2005, respectively. Also included in
The Las Vegas area has thirteen hospitals. Our contract with our 2006 primary Las Vegas area contracted hospital organization, which includes three hospitals − Sunrise Hospital and Medical Center, Mountain View Hospital and Southern Hills Hospital and Medical Center − owned by HCA, expired on December 31, 2006. We have contracts in place through at least the middle of 2008 with all of the other hospitals in southern Nevada. These contracts are based on a fixed per diem rate structure and in some circumstances are higher than the previous HCA contract rates. While we believe our efforts to move the majority of our HCA hospital days to other contracted hospitals will be successful, there will be emergency and other situations that will require us to use the HCA hospitals in 2007. In 2007, we may be required to pay full-billed charges for services rendered to our commercial members at an HCA hospital. Full-billed charges are substantially higher then our current commercial rates with our contracted hospitals. We will receive a significant discount to full-billed charges for services rendered to Medicare and Medicaid members at an HCA hospital because they will be required to bill us at the Medicare and Medicaid fee schedule. Currently, we cannot project the utilization of HCA hospitals in 2007; however, we believe there is sufficient hospital capacity in our Las Vegas area contracted hospitals to service all of our members. We do expect the loss of the HCA contract to have a material adverse impact on our medical loss ratio in 2007.
recorded per member per month revenue increase, including new and continuing business, was approximately 6.4%, excluding the impact of changes in benefits. We received a 1% increase in Medicaid rates for 2005.
Military Contract Revenues.The decrease in military contract revenue for the year is the result of SMHS completing its health care operations under the TRICARE contract on August 31, 2004.
SMHS completed the fifth year of a five-year contract in May 2003. SMHS then operated under a negotiated contract extension period, which ended August 31, 2004. The new contractor became operational in Region 1 on September 1, 2004 and the new contract superseded the remainder of our TRICARE Region 1 contract. On September 1, 2004, SMHS commenced a phase-out of operations at prices previously negotiated with the DoD. SMHS does not meet the definition of discontinued operations.
Investment and Other Revenues. We had an overall decrease in investment and other revenues of $2.4 million. We had a decrease of $9.4 million in administrative services revenue for the services we are providing relative to our sales agreement for the workers’ compensation insurance operations, beginning April 1, 2004. On March 31, 2004, we completed the sale of the workers’ compensation insurance operations. The purchaser engaged a third party claims administrator to administer claims for a period of fifteen years for which we are financially obligated for its contracted fees. In addition, we are required to perform certain transition and managed care services. Total revenue associated with these services for 2005 and 2004 was $2.7 million and $12.1 million, respectively. The cost to provide these services is reflected in our general and administrative expenses.
Medical Expenses. Our medical care ratio increased from 75.3% to 76.5%. The increase in our medical care ratio is due primarily to cost increases in excess of premium increases and benefit reductions. The number of days in claims payable, which is the medical claims payable balance divided by the average medical expense per day for the year, for 2005 was 48.6 compared to 49.8 for 2004. The decrease in days in claims payable is primarily attributable to the payment of previously accrued balances related to our Medicare supplement products and a continued decrease in the time required to make claim payments due primarily to system enhancements.
General and Administrative Expenses. G&A expenses decreased due to lower expenses to provide services and other adjustments relative to our sales agreement for the workers’ compensation insurance operations, offset by higher employee compensation related expenses, premium taxes, brokers’ fees and costs associated with marketing our new Medicare programs. As a percentage of medical premium revenue, G&A expenses were 13.4% for 2005, compared to 16.1% for 2004. Services related to our sales agreement for the workers’ compensation insurance operations, included in our G&A expenses, as a percentage of medical premium revenue, were 0.2% and 1.9% for 2005 and 2004, respectively.
Interest Expense. Interest expense increased due to interest expense related to a short sale of U.S. Treasury bonds and the prepaid interest paid for the conversion of $63.0 million of the Company’s senior convertible debentures and the associated write-off in deferred debenture-related costs.
in a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter exceeds 120% of the conversion price per share of our common stock; (ii) the debentures are called for redemption; (iii) there is an event of default with respect to the debentures; or (iv) specified corporate transactions have occurred. Beginning December 2003 and for each subsequent period, the market price of our common stock has exceeded 120% of the conversion price for at least 20 trading days in a period of 30 consecutive trading days. The conversion rate is subject to certain adjustments. This conversion rate represents a conversion price of $9.145 per share. Holders of the debentures may require us to repurchase all or a portion of their debentures on March 15 in 2008, 2013 and 2018 or upon certain corporate events including a change in control. In either case, we may choose to pay the purchase price of such debentures in cash or common stock or a combination of cash and common stock. We can redeem the debentures for cash beginning on or after March 20, 2008.
Purchase obligations include a $10.0 million investment commitment to purchase a limited partnership interest in a private equity group and purchase obligations totaling $984,000 that have a remaining commitment in excess of $100,000 at December 31, 2006.
In addition to changes in existing laws and regulations, we are subject to audits, investigations and enforcement actions. These include, but are not limited to, possible government actions relating to ERISA, the Federal Employees Health Benefit Plan, federal and state fraud and abuse laws and laws relating to utilization management and the delivery and payment of health care. In addition, our Medicare business is subject to Medicare regulations promulgated by CMS. Violation of government laws and regulations may result in an assessment of damages, civil or criminal fines or penalties, or other sanctions, including exclusion from participation in government programs. In addition, disclosure of any adverse investigation or audit results or sanctions could negatively affect our reputation in various markets and make it more difficult for us to sell our products and services and retain existing business.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (SFAS 158). SFAS 158 requires the recognition of the unfunded status of pension and other postretirement benefit plans on the balance sheet. SFAS 158 is effective for fiscal years ending after December 15, 2006. We have adopted SFAS 158 and it did not have a material impact on our year ended December 31, 2006 consolidated financial position or results of operations. See Note 9," Employee and Director Benefit Plans", in the Notes to Consolidated Financial Statements.
Medical Claims Payable. Our medical claims payable balance includes claims in process, a provision for the estimate of incurred but not reported (IBNR) claims and a provision for disputed claims obligations including provider disputes. Our most significant accounting estimate is for our reserves for IBNR claims. We make this estimate primarily using standard actuarial methodologies based upon historical data. These standard actuarial methodologies recognize, among other factors, contractual requirements, historical utilization trends, the interval between the date services are rendered and the date claims are paid, denied claims activity, disputed claims activity, benefit changes, expected health care cost inflation, seasonality patterns and changes in membership. In developing the IBNR claims estimate, we apply different estimation methods depending on the month for which incurred claims are being estimated. For example, we actuarially calculate completion factors using our analysis of claims payment patterns over the most recent six-to-twelve month period. The completion factor is an actuarial estimate, based upon historical experience, of the percentage of claims incurred during a given period that have been paid by us as of the date of estimation. We then apply the completion factors to the actual claims paid to date for each incurral month, except for the most recent months, to estimate the expected amount of ultimate incurred claims for each of these months. For the most recent incurred months, generally three months or less, the percentage of claims paid for claims incurred in those months is usually low. This makes the completion factor methodology less reliable for such months. For these recent months, we estimate our claims incurred by applying estimated per member per month
Reflects estimated potential changes in medical claims payable caused by changes in the completion factors for claims incurred in months prior to the most recent three months. Completion factors are not increased beyond 100%.
The “changes in prior periods’ estimates” of $15.9 million represents an estimate based on paid claim activity from January 1, 2006 to December 31, 2006. Medical claim liabilities are usually described as having a “short tail”, which means that they are generally paid within several months of the member receiving service from the provider. Approximately 69% of the “changes in prior periods’ estimates” incurred in 2006 relates to claims incurred in 2005, with the remaining 31% related to claims incurred in 2004 and prior. A portionof the change to claims incurred in 2004 and prior relate to final settlement of provider related dispute items settled in 2006.
The increase in the medical claims payable balance from December 31, 2005 to December 31, 2006 is primarily due to our new PDP program, an increase in amounts reserved for provider disputes, and other activities in the ordinary course of business. These activities include, but are not limited to, increases in membership, utilization and unit costs. The ratio of medical claims payable at the end of the period to the incurred medical expense for current period medical claims is 17.0% and 13.1% for 2006 and 2005, respectively.
loss contingencies when we believe it is both probable that a loss will be incurred and that the amount of the loss can be reasonably estimated. Our loss estimates are primarily based on an analysis of potential results, the stage of the dispute, consultation with outside legal counsel and any other relevant information presently available. The ultimate outcome of these loss contingencies cannot be predicted with certainty and it is difficult to measure the actual loss that may be incurred. Actual results may materially differ from our estimates and this difference would be reported in our current operations.
At December 31, 2006, we reevaluated the $15.0 million valuation allowance on the $62.0 million note receivable and considered the actuarial analyses at December 31, 2006. Based upon the analyses performed, it was determined no change to the valuation allowance was warranted at December 31, 2006.
The Company’s continuing operations include two reportable segments: the managed care and corporate operations segment and military health services operations segment. The Company’s prior third reportable segment, workers’ compensation operations, was classified as a discontinued operation and was sold on March 31, 2004. See Note 12 - "CII Financial, Inc. Discontinued Operations" for disclosure on and a description of the discontinued operations.
Reclassifications. Certain amounts in the consolidated financial statements for the years ended December 31, 2005 and 2004 have been reclassified to conform with the current year presentation.
Principles of Consolidation. All significant intercompany transactions and balances have been eliminated in consolidation. Sierra's consolidated subsidiaries include: Health Plan of Nevada, Inc. (“HPN”) and Texas Health Choice, L.C. (“TXHC”), which are licensed HMOs; Sierra Health and Life Insurance Company, Inc. (“SHL”), a health and life insurance company; Southwest Medical Associates, Inc. (“SMA”), a multi-specialty medical provider group; Sierra Military Health Services, LLC, and its subsidiary, (“SMHS”), a company that provided and administered managed care services to certain TRICARE eligible beneficiaries; CII Financial, Inc. ("CII"); administrative services companies; a home health care agency; a full service hospice agency; a home medical products subsidiary; and a company that provides and manages mental health and substance abuse services.
Payments from CMS for reinsurance and for cost sharing related to low income individuals (“Subsidies”) are recorded as a payable when received. This payable is reduced when reinsurance is utilized and Subsidies are provided by the Company. This activity is accumulated and when the net balance for each contract is negative, it is reclassed to a receivable. The payable or receivable is recorded in the Consolidated Balance Sheet in prepaid expenses and other current assets or accrued and other current liabilities depending on the net contract balance at the end of the reporting period. The Company had a $63.4 million receivable balance at December 31, 2006 for reinsurance and Subsidies related to our stand-alone PDP, which is included in prepaid and other current assets in the Consolidated Balance Sheet. A reconciliation of the final risk sharing, Subsidies, and reinsurance amounts is performed following the end of the contract year and is expected to be finalized by the third quarter of 2007.
During 2006, the PDP membership data submitted by CMS to plan sponsors contained many inaccuracies, which resulted in plan sponsors providing pharmacy benefits to members that ultimately were not their member. CMS created a formal program-wide reconciliation process (“Plan to Plan”) to reconcile the amounts owed from one plan sponsor to another. Phase I of the Plan to Plan has been implemented and the majority of the balances have been settled. The Company has recorded its best estimate of amounts related to the Plan to Plan. Also, because of confusion caused by the inaccurate membership data provided by CMS, many state agencies and some Medicaid managed care organizations paid for pharmacy benefits that ultimately were the responsibility of the Company. The Company has recorded its best estimate of amounts owed to state agencies and Medicaid managed care organizations.
interpretations of existing laws or regulations or disputed contract provisions that result in the Company having to provide new or extended benefits and changes in the Company’s health care delivery system or costs. The Company believes that the recorded liability for medical claims payable at December 31, 2006 is reasonable and adequate to cover future health care claim payments. Any subsequent changes in an estimate for a prior year would be reflected in that subsequent year’s operating results, financial position and cash flows.
Investments. Investments consist primarily of U.S. Government and its agencies’ securities, municipal bonds, corporate bonds, mortgage backed and other securities, trust deed mortgage notes and real estate joint ventures. All investments, other than trust deed mortgage notes and real estate joint ventures, have been designated as available-for-sale and are stated at fair value. Fair value is estimated primarily from published market values at the balance sheet date. All non-restricted available-for-sale investments are classified as current assets. These investments are available for use in the current operations regardless of contractual maturity dates. Restricted investments are classified as non-current assets. Realized gains and losses are calculated using the specific identification method and are included in investment and other revenues. Unrealized holding gains and losses on available-for-sale securities are included as a separate component of stockholders' equity, net of income tax effects, until realized. The Company does not believe any of its available-for-sale and restricted investments are other than temporarily impaired at December 31, 2006.
Trust deed mortgage notes and real estate joint ventures are stated at amortized cost and categorized as other investments. All other investments are classified as current assets if expected maturity is within one year of the balance sheet date. Otherwise, they are classified as long-term investments, and are included in other assets. The Company believes that no adjustments are required to its recorded amounts of investments in trust deed mortgage notes and real estate joint ventures at December 31, 2006.
Restricted Cash and Investments. Certain subsidiaries are required by state regulatory agencies to maintain deposits and must also meet net worth and reserve requirements. The Company believes its subsidiaries are in material compliance with the applicable minimum regulatory and capital requirements.
Goodwill. The goodwill balance at December 31, 2006, was $14.8 million, all of which is part of the managed care and corporate operations segment. During 2006, 2005 and 2004, the Company’s assessment of goodwill resulted in no impairment of goodwill.
Treasury Stock. Shares purchased and placed in treasury are valued at cost. Subsequent sales of treasury stock at amounts in excess of their cost are credited to additional paid-in capital. Sale of treasury stock at amounts below their cost are charged to additional paid-in capital to the extent it includes gains from previous sales and the remainder to retained earnings. Sales of treasury shares in 2006, 2005 and 2004, at amounts below their cost of $14.1 million, $10.8 million and $5.8 million, respectively, were charged to retained earnings, as the Company did not previously have gains in additional paid-in capital. Almost all issuance of treasury shares in 2006, 2005 and 2004 were in connection with the exercise of stock options.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities- Including an Amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 would create a fair value option of accounting for qualifying financial assets and liabilities under which an irrevocable election could be made at inception to measure such assets and liabilities initially and subsequently at fair value, with all changes in fair value reported in earnings. SFAS 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact that the adoption of SFAS 159 will have on its consolidated financial position, results of operations or cash flows.
Use of Estimates and Assumptions in the Preparation of Financial Statements. The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management must exercise its judgment, taking into consideration the facts and circumstances in selecting assumptions and other factors, in calculating its estimates. On an on-going basis, management re-evaluates its assumptions and the methods of calculating its estimates. Estimates and assumptions include, but are not limited to,
The Company entered into a short sale of U.S. Treasury Bonds during the first quarter of 2005. The short sale did not meet the accounting definition of a hedge. The position was adjusted to fair value at March 31, 2005 and a gain of $500,000 was included in investment and other revenues for the period. Interest income on the short position and the gain/loss on the position is included in investment and other revenues and the interest expense on the short position is included in interest expense. During the second quarter of 2005, the position was covered and the Company recognized a loss of $1.8 million for the transaction.
The following table summarizes the Company's available-for-sale investments at December 31, 2005:
The following table shows the fair value and unrealized losses, aggregated by investment category and length of time, that individual securities have been in a continuous unrealized loss position at December 31, 2006:
The unrealized losses in the Company’s investments in U.S. government and its agencies, municipal obligations,
The contractual maturities of available-for-sale debt securities at December 31, 2006 are shown below:
Of the cash and cash equivalents and current investments that total $382.8 million in the accompanying Consolidated Balance Sheet at December 31, 2006, $335.3 million is held by the Company’s regulated subsidiaries and is only available for use by them. Such amounts are available for transfer to Sierra from the regulated subsidiaries only to the extent that they can be remitted in accordance with terms of existing management agreements or by dividends, which are generally limited based on an entity’s level of statutory net income and statutory capital and surplus. The remainder is available to Sierra on an unrestricted basis.
Depreciation expense including capital leases from continuing operations in 2006, 2005 and 2004 was $16.6 million, $15.0 million and $17.1 million, respectively.
The tax effects of significant items comprising the net deferred tax assets of the Company’s continuing operations are as follows at December 31:
Amounts incurred related to prior years show that the liability at the beginning of each year was ultimately greater than the amount subsequently incurred. This favorable development has primarily been a result of claims being settled for amounts less than originally estimated.
The military contract expenses presented in the Consolidated Statements of Operations include the total incurred medical expenses presented above and the general and administrative expenses for SMHS. SMHS’ general and administrative expenses under the military contract totaled $138,000, $6.1 million and $117.6 million for the years ended December 31, 2006, 2005 and 2004, respectively. Amounts incurred related to prior years show that the liability at the beginning of each year was ultimately greater than the amount subsequently incurred. This favorable development was the result of claims being settled for amounts less than originally estimated. At December 31, 2006 and 2005, there were no remaining liabilities for the military health care payable as a result of a negotiated settlement
Sierra Debentures - In March 2003, the Company issued $115.0 million aggregate principal amount of its 2¼% senior convertible debentures due March 15, 2023. The debentures are not guaranteed by any of Sierra’s subsidiaries. The debentures pay interest, which is due semi-annually on March 15 and September 15 of each year. Each $1,000 principal amount of debentures is convertible, at the option of the holders, into 109.3494 shares of the Company’s common stock prior to March 15, 2023 if: (i) the market price of the Company’s common stock for at least 20 trading days in a period of 30 consecutive trading days ending on the last trading day of the preceding fiscal quarter exceeds 120% of the conversion price per share of the Company’s common stock; (ii) the debentures are called for redemption; (iii) there is an event of default with respect to the debentures; or (iv) specified corporate transactions have occurred. Beginning December 2003, and for each subsequent period, the market price of the Company’s common stock has exceeded 120% of the conversion price for at least 20 trading days in a period of 30 consecutive trading days. The conversion rate is subject to certain adjustments. This conversion rate represents a conversion price of $9.145 per share. Holders of the debentures may require the Company to repurchase all or a portion of their debentures on March 15 in 2008, 2013 and 2018 or upon certain corporate events including a change in control. In either case, the Company may choose to pay the purchase price of such debentures in cash or common stock or a combination of cash and common stock. The debentures can be redeemed by the Company for cash beginning on or after March 20, 2008.
The credit facility remains secured by guarantees by certain of the Company’s subsidiaries and a first priority perfected security interest in (i) all of the capital stock of each of the Company’s unregulated, material domestic subsidiaries
Scheduled maturities of the Company's long-term debt and future minimum payments under capital leases, together with the present value of the net minimum lease payments at December 31, 2006, are as follows:
value based method and recognition provisions of SFAS 123 to stock-based compensation for the years ended December 31, 2005 and 2004.
The computation of expected volatility is based on a combination of the Company’s historical and market-based implied volatility. The computation of average expected term is based on the Company’s historical exercise patterns. The risk-free interest rate for periods within the contractual life of the award is based on the U.S. Treasury yield curve in effect at the time of grant.
The aggregate intrinsic value in the table below represents the total pretax intrinsic value (the difference between the market price of the Company’s common stock on December 31, 2006 and the exercise price, multiplied by the number of shares) that would have been received by the option holders had all option holders exercised their options on December 31, 2006. This amount changes based on the market value of the Company’s common stock. The total intrinsic value of options exercised during 2006, 2005 and 2004 was $36.1 million, $99.2 million and $128.6 million, respectively.
The following table reflects the activity of the nonvested stock options for the year ended December 31, 2006:
As of December 31, 2006, the Company expects to recognize future total compensation cost of $3.3 million related to nonvested stock options over a weighted-average period of 12 months. The total fair value of vested stock options
The following table reflects the activity of the restricted stock unit plans for the year ended December 31, 2006:
(1) Does not include 406,000 shares that have vested but have not settled.
(3) Does not include 536,000 shares that have vested but have not settled.
As of December 31, 2006, the Company expects to recognize future total compensation cost of $3.3 million related to current nonvested Units over a weighted-average period of 1.8 years.
While the SERP is an unfunded plan, the Company is informally funding the plan through life insurance contracts on certain Company employees. The life insurance contracts had cash surrender values of $24.9 million and $20.4 million at December 31, 2006 and 2005, respectively.
Of the $10.4 million accumulated comprehensive loss recorded at December 31, 2006, the Company expects to recognize $1.2 million of prior service cost and $209,000 of net actuarial losses as net periodic benefit costs in 2007.
At December 31, 2006, expected future benefit payments related to the Company’s defined benefit plans were as follows:
The Company’s revolving credit facility, as amended, currently allows for unlimited stock repurchases based on meeting a certain covenant ratio. The Company has repurchased 585,000 shares for $21.1 million at an average cost of $36.04 subsequent to December 31, 2006 through February 23, 2007. As of February 23, 2007, $53.1 million was still
On March 31, 2004, the Company completed the sale of Cal Indemnity. Cal Indemnity's subsidiaries, which were included in the sale, were Commercial Casualty Insurance Company, Sierra Insurance Company of Texas, and CII Insurance Company.
The Company received $14.2 million in cash at the closing, which was subsequently reduced by $2.7 million based on
Specialty product revenues presented above were for the workers’ compensation insurance operations and consisted of net earned premiums. Specialty product expenses consisted of loss and loss adjustment expenses incurred and general and administrative expenses.
Beginning in 1999, a series of class action lawsuits were filed against many major firms in the health benefits business alleging an unlawful conspiracy to deny, diminish or delay payments to physicians. The Company has not been named as a defendant in these lawsuits. A multi-district litigation panel has consolidated some of these cases in the United States District Court for the Southern District of Florida, Miami Division. In the lead case, known as Shane, the amended complaint alleges multiple violations under the Racketeer Influenced and Corrupt Organizations Act ("RICO"). The suit seeks injunctive, compensatory and equitable relief as well as restitution, costs, fees and interest
The Company is subject to other various claims and litigation in the ordinary course of business. Such litigation includes, but is not limited to, claims of medical malpractice, claims for coverage or payment for medical services rendered to HMO and other members, and claims by providers for payment for medical services rendered to HMO and other members. Some litigation may also include claims for punitive or other damages that are not covered by insurance. These actions are in various stages of litigation and some may ultimately be brought to trial.
While the Company believes it is probable that a premium deficiency exists, the amount cannot be reasonably estimated based on the information currently available. In addition, there is not enough information at this time to develop a reasonable estimate of the range of the potential loss. In accordance with Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies”, no liability has been recorded in the December 31, 2006 consolidated financial statements.
The Company has a minority interest in a health care facility in Las Vegas, which is accounted for under the equity method. The Company made an initial capital contribution of $1.1 million and has subsequently increased the carrying amount of its investment by $3.2 million to reflect its share of the undistributed income of the health care facility. The Company made capitated payments of $32.8 million, $30.4 million and $28.4 million to the health care facility for services performed in the ordinary course of business during 2006, 2005 and 2004, respectively. Activities related to the minority interest are included in the Managed Care and Corporate Operations segment.
The Company incurred legal fees of $112,000, $212,000 and $7,000 in the years ended December 31, 2006, 2005 and 2004, respectively, with a Nevada law firm of which a non-employee Board of Director member is a shareholder. This Board member retired from the Company’s Board in May 2006.
SMHS completed the fifth year of a five-year contract in May 2003. SMHS then operated under a negotiated contract extension period, which ended August 31, 2004. The new contractor became operational on September 1, 2004 and the new contract superseded the remainder of the Company’s TRICARE Region 1 contract. On September 1, 2004, SMHS commenced a phase-out of operations at prices previously negotiated with the DoD. SMHS does not meet the definition of discontinued operations since the Company did not dispose of the operations before the phase-out was complete. The Company believes the remaining SMHS liabilities are adequate and that no revisions to the estimates at December 31, 2006 are necessary at this time.
The Company evaluates each segment's performance based on segment operating profit. The accounting policies of the operating segments are the same as those described in the summary of significant accounting policies. Information concerning the operations of the reportable segments is as follows: