Our executive offices are located in Rye Brook, New York. Marketing and professional staff for our U.S. insurance subsidiaries occupy space in Rye Brook, New York, Lake Mary, Florida and Solon, Ohio. Our Medicare Advantage operations occupy office space in Houston, Beaumont and Dallas, Texas, as well as Oklahoma City, Oklahoma and Milwaukee, Wisconsin. Our Part D operations occupy space in Solon, Ohio and Pensacola, Florida. We lease over 376,000 square feet of office space. Management considers its office facilities suitable and adequate for the current level of operations. In addition to the above, Pennsylvania Life is the named lessee on over 20 properties occupied by career agents for use as field offices. Rent for these field offices is reimbursed by the agents. Additional information regarding our lease obligations is included in Note 25-Commitments and Contingencies in our consolidated financial statements included in this Annual Report on Form 10-K.
The following discussion and analysis presents a review of the Company as of December 31, 2010 and its results of operations for the fiscal years ended December 31, 2010, 2009 and 2008.
•Declared and paid a special cash dividend of $2.00 per common share.
•On December 30, 2010, entered into a definitive agreement to sell our Medicare Part D business to CVS Caremark for $1.25 billion in cash, subject to adjustment.
•Our 2011 Part D Plan bid under the benchmark in 29 of the 34 regions. We also maintained all of our currently eligible auto-assigned regions, with the exception of Nevada, which represented approximately 6,700 members.
•Recorded charge of $12.6 million, after tax, or $0.16 per share related to the realignment of our distribution channels and costs incurred in connection with the Part D transaction.
The following table presents our membership in Medicare Advantage and Part D products as of December 31, 2010 and 2009.
In March 2010, President Obama signed into law The Patient Protection and Affordable Care Act and The Health Care and Education Reconciliation Act of 2010 (which we collectively refer to as the "Affordable Care Act") which enacts significant changes to various aspects of the U.S. health insurance industry. There are many important provisions of the legislation that will require additional guidance and clarification in form of regulations and interpretations in order to fully understand the impact of the legislation on our overall business, which we expect to occur over the next several years. In Certain aspects of the Affordable Care Act are currently being challenged in the judicial system. In addition, Congress may withhold the funding necessary to implement the new reforms or attempt to replace the legislation with amended provisions or repeal it altogether.
Certain significant provisions of the Affordable Care Act that will impact our business include, among others, reduced Medicare Advantage reimbursement rates, gradual closing of the coverage gap, or "donut hole" on Medicare Part D, implementation of quality bonus for Star Ratings, stipulated minimum medical loss ratios, shortened annual enrollment period, non-deductible federal premium taxes assessed to health insurers, coding intensity adjustments with mandatory minimums and a limitation on the federal tax deductibility of compensation earned by individuals. The Health Care Reform Legislation is discussed more fully under "Regulation" and Item 1A. Risk Factors.
On November 19, 2010, the Centers for Medicare and Medicaid Services ("CMS") notified us that we were suspended from marketing to and enrolling new members in our Medicare Advantage plans, effective December 5, 2010. According to CMS, the suspension relates primarily to agent oversight and market conduct issues and will remain in effect until CMS is satisfied that we have corrected the issues and they are not likely to recur. The suspension does not affect current members in our Medicare Advantage plans, nor does it affect the marketing, enrollment or membership in our stand-alone Medicare Prescription Drug plans. We are working diligently to resolve these issues with CMS as quickly as possible.
For the 2010 plan year, we offered through our insurance subsidiaries, one or both of our Community CCRxSM and PrescribaRxSM prescription drug plans in all 34 regions designated by CMS, and one or both of our plans bid under the benchmark in 30 of the 34 regions. For the 2011 Plan year, based upon a requirement of CMS, we consolidated our PrescribaRxSM prescription drug plan into the Community CCRxSM plan. Our Community CCRx plan bid under the benchmark, or used de minimis rules to retain membership, in 29 of the 34 regions.
On December 30, 2010, we entered into (i) an Agreement and Plan of Merger (the "CVS Agreement") with CVS Caremark Corporation ("CVS Caremark") and Ulysses Merger Sub, L.L.C., an indirect wholly-owned subsidiary of CVS Caremark, to provide for the purchase of our Medicare Part D Business by CVS Caremark and (ii) a Separation Agreement with Universal American Spin Corp., a newly-formed wholly-owned subsidiary of the Company ("Newco"), to provide for the separation of our Medicare Part D Business from our remaining businesses, which include our Medicare Advantage and Traditional Insurance businesses (collectively, the "Newco Businesses.") We refer to the sale of our Medicare Part D Business to CVS Caremark and related transactions as the "Part D Sale Transaction" or the "Transactions."
Pursuant to the CVS Agreement, CVS Caremark will pay Universal American shareholders $1.25 billion plus the excess capital in the entities that operate our Medicare Part D Business as of December 31, 2010, less the amount of our outstanding debt and trust preferred securities and certain other amounts. At the effective time of the merger, we expect that each share of common stock and preferred stock of the Company will be cancelled and converted into the right to receive one share of common stock of Newco which will own the Newco Businesses and approximately $13.00 to $13.20 per share in cash. The transaction is expected to close by the end of the second quarter of 2011 and is subject to customary closing conditions, including approval of our shareholders and necessary regulatory approvals. On February 28, 2011 the Federal Trade Commission granted early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 with respect to the Part D Sale Transaction. We expect to file a Registration Statement on Form S-4/Proxy Statement Prospectus with the SEC by the middle of March that will contain additional information regarding the Part D Sale Transaction.
On April 26, 2010, we entered into an agreement to sell the outstanding common stock of CHCS, our administrative services company, to Patni Americas, Inc, a wholly-owned subsidiary of Patni Computer Systems Limited (NYSE: PTI), for $6.0 million in cash, subject to an adjustment for any net working capital remaining at CHCS on the closing date. The transaction closed on June 9, 2010, with an effective date of April 1, 2010. The operations of CHCS are included in consolidated results up to the effective date of the sale. The total consideration was approximately $7.5 million. Our carrying value of the assets disposed of in connection with the sale of CHCS was approximately $7.1 million, including $4.4 million of goodwill. After consideration of transaction costs of approximately $0.3 million, we recognized an immaterial gain on the disposition.
We also report the activities of our holding company in a separate segment. See Note 26-Business Segment Information in the Notes to Consolidated Financial Statements included in this annual report on Form 10-K for a description of our segments.
We report inter-segment revenues and expenses on a gross basis in each of the operating segments but eliminate them in the consolidated results. These inter- segment revenues and expenses affect the amounts reported on the individual financial statement line items, but we eliminate them in consolidation and they do not change income before taxes. The significant items eliminated are
Our Medicare Part D segment generated income before income taxes of $184.8 million for the year ended December 31, 2010 compared to income before taxes of $178.3 million, for the year ended December 31, 2009. The $6.4 million, or 3.6%, increase in segment income was attributable to a $14.9 million of expense savings due to improvement in operating efficiencies and increased scale and a $9.0 million increase in positive prior year development. These increases were offset by a $17.5 million decline in segment income attributable to our 2010 bidding strategy described below (in the segment results discussion on Medicare Part D) and higher drug costs, partially offset by growth in membership.
Results for our Traditional Insurance segment improved by $21.7 million compared to the year ended December 31, 2009. The improvement primarily results from an overall decrease in the combined medical loss and administrative expense ratios of 577 basis points from 110.5% in 2009 to 104.7% in 2010. The transaction with Commonwealth in April 2009 to reinsure substantially all of the net retained life and annuity business impacted the comparison of year over year results as we recognized $9.0 million of charges related to the transaction in 2009, including a loss and other related costs on the transaction and a restructuring charge as a result of our re-alignment of operations for the lower level of net retained business. This was offset by a decline in net investment income of $8.2 million caused by a lower invested asset base due to the transfer of assets in conjunction with the reinsurance transaction with Commonwealth.
Our Senior Managed Care-Medicare Advantage segment generated income before income taxes of $134.8 million for the year ended December 31, 2009, an increase of $40.2 million compared to the year ended December 31, 2008. These results reflect $21.1 million of favorable CMS reconciliations and reserve development in 2009 as compared to $42.1 million in 2008. The increase in earnings was driven by higher medical operating income generated by higher premium, an improvement in the medical benefit ratio of 80 basis points and higher net investment income, partially offset by the $3.5 million restructuring costs incurred during the second quarter and continued investment in the development of provider networks for our expansion PPO markets. The improvement in the medical benefit ratio is due primarily to higher premium per member related to changes in members' risk scoring process in 2009 and the $18.9 million in false claims submitted by fictitious providers, in our PFFS business during the fourth quarter of 2008.
Our Medicare Part D segment income before income taxes for the year ended December 31, 2009 increased by $50.9 million versus the comparable period in 2008. These results reflect favorable CMS reconciliations and reserve development of $0.5 million in 2009 as compared to net negative prior period development of $0.6 million in 2008. In addition, premium growth and improved benefit and expense ratios exceeded the elimination of income generated from our interest in PDMS and the amortization of the below market contract liability by approximately $50 million.
release of a bonus accrual in the first quarter of 2008, higher stock-based compensation costs for equity awards to employees and directors, higher levels of expense and lower net investment income, partially offset by lower borrowing costs.
Our Senior Managed Care-Medicare Advantage segment generated income before income taxes of $149.1 million for the year ended December 31, 2010, an increase of $14.3 million compared to the year ended December 31, 2009. The increase in earnings was driven by membership growth in all products that resulted in a 23% increase in member months for the year. These improvements were partially offset by a higher medical expense ratio of 120 basis points and higher expenses due to the growth in membership. The increase in the medical expense ratio is due primarily due to a lower premium per member primarily in PFFS as a result of change in pricing in 2010 offset partially by the increase in favorable prior year development in 2010 compared to 2009. For the year ended December 31, 2010, there was $36.7 million of net favorable prior year development compared to $21.1 million for the year ended December 31, 2009. 2009 also included a $3.5 million restructuring charge related to the in-sourcing of billing and enrollment for our HMO business.
Revenues. Net premiums for the Senior Managed Care-Medicare Advantage segment increased by $212.5 million compared to the year ended December 31, 2008, primarily due to premium growth resulting from an increase in overall premium rates per member, growth in HMO membership and net premium generated by our new PPO markets. Total member months in our Medicare Advantage Plans for the year ended December 31, 2009 were down slightly from prior year with gains in membership in our HMO Plans being offset by lapses in our PFFS Plans. In addition, net investment income increased due to higher investment levels, partially offset by lower yields.
Medical expenses. Medical expenses increased by $155.4 million compared to the year ended December 31, 2008, consistent with the higher level of earned premium. The Medicare Advantage medical expense ratio decreased to 82.4% for the year ended December 31, 2009 from 83.2% for the same period in 2008, primarily as a result of the items discussed above.
Reported results for our Medicare Part D segment are subject to anticipated seasonality during a given calendar year. This is due to the nature of the standard benefit design under Medicare Part D. Consequently, this business generally incurs higher claims experience in the first two quarters of the year while beneficiaries are in the deductible and initial coverage phases of the benefit design. As the beneficiary reaches the coverage gap and catastrophic phases of the benefit design, the Plan experiences lower claims liability which is generally in the last two quarters of the year. As a result, we generally anticipate a pattern of net losses from our Medicare Part D segment during the early part of the year, with a break-even point during the third quarter and most of the segment's net income earned during the fourth quarter resulting in a pattern of increasing reported net income.
As a result of changes made by the federal government to the standard benefit design in 2010 and due to the more conservative way in which we bid our business for the 2010 plan year, which resulted in a lower planned target margin, we experienced a greater degree of seasonality in our Medicare Part D segment throughout 2010 as compared to 2009, with higher losses in the first half of the year and higher profitability for the second half of the year, namely in the fourth quarter. For a discussion of the accounting for our Medicare Part D segment-see Note 3- Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements.
Our Medicare Part D segment generated income before income taxes of $184.8 million for the year ended December 31, 2010 compared to income before taxes of $178.3 million, for the year ended December 31, 2009. The $6.4 million, or 3.6%, increase in segment income was attributable to $14.9 million of expense savings due to improvement in operating efficiencies and increased scale and a $9.0 million increase in positive prior year development. These increases were offset by a $17.5 million decline in segment income attributable to our 2010 bidding strategy described above and higher drug costs, partially offset by growth in membership.
The risk corridor adjustment calculation compares the target amount of prescription drug costs (limited to costs under the standard coverage as defined by CMS) less rebates in our annual Plan bid to actual experience. The $8.1 million decrease in risk corridor payable adjustment for the year ended December 31, 2010 versus the comparable period in 2009 consisted of $13.7 million which was expected primarily due to the 2010 plan year bidding strategy, offset by $5.6 million in prior year development. The risk corridor adjustment for the year ended December 31, 2010 included unfavorable prior year development of $3.2 million, compared with favorable development of $2.4 million for the year ended December 31, 2009. See further discussion of the risk corridor adjustment under "Critical Accounting Policies."
Membership. At December 31, 2009, total membership for Medicare Part D, based on enrollment information provided by CMS, was approximately 1,697,000 members, an increase of 125,000 members, or 8.0%, compared to net retained membership of 1,572,000 members at December 31, 2008. Net retained membership at December 31, 2008 excludes members that were reinsured to CVS Caremark. The increase in membership was principally attributable to growth from open enrollment and dual eligible members automatically assigned to our Plans in 2009.
Net premiums. Net premiums for the year ended December 31, 2009 increased by $178.8 million, or 10%, versus the comparable period in 2008. The increase in net premiums was primarily attributable to an increase in net retained membership of 125,000 members, offset by a decrease in the government risk corridor receivable. Net premiums for the year ended December 31, 2009 included items related to prior plan years, which increased total revenue by approximately $14.7 million (net of the impact of government risk corridor). These items were comprised of $9.2 million in risk adjustment revenue (net of the impact of government risk corridor) related to our 2008 membership and $5.5 million related to the final CMS prescription drug event, known as PDE, reconciliations for prior plan years. Net premiums for the year ended December 31, 2008 included items which reduced total revenue by approximately $3.9 million (net of the impact of the government risk corridor) related to final CMS PDE reconciliation for the 2007 plan year. In addition, net premiums for the year ended December 31, 2008 included $39.2 million in amortization of a below market contract liability.
Other Part D income-PDMS for the year ended December 31, 2009, decreased by $72.5 million versus the comparable period in 2008, as a result of the termination of our strategic alliance with CVS
Pharmacy Benefits. Pharmacy benefits for the year ended December 31, 2009, increased by $54.0 million, or 3.5%, compared to the year ended December 31, 2008. The ratio of incurred prescription drug benefits to net premium, after risk corridor adjustment, was 80.1% and 85.1% for the years ended December 31, 2009 and 2008, respectively. The improvement in the ratio of incurred prescription drug benefits to net premium is attributable to more competitive network rates available through our claims processor, combined with higher rebates that resulted from the consolidation of our Medicare Part D contracts with pharmaceutical manufacturers. In addition, pharmacy benefits for the year ended December 31, 2009 include $14.2 million in items related to prior plan years. These items increased benefits and are primarily attributable to co-pay refunds that will be issued to members for the 2008 plan year, partially offset by rebates earned in prior periods. Pharmacy benefits for the year ended December 31, 2008 included a $2.0 million reduction related to the final 2007 CMS PDE and plan to plan membership reconciliations.
Commissions and general expenses. Commissions and general expenses for the year ended December 31, 2009 decreased by $16.6 million versus the comparable period in 2008 with the decrease largely attributable to our restructuring of the Medicare Part D call center, other member services and PBM services which began during 2008 and was completed in 2009.
combined medical loss and administrative expense ratios of 577 basis points from 110.5% in 2009 to 104.7% in 2010. The transaction with Commonwealth in April 2009 to reinsure substantially all of the net retained life and annuity business impacted the comparison of year over year results as we recognized $9.0 million of charges related to the transaction in 2009, including a loss and other related costs on the transaction and a restructuring charge as a result of our re-alignment of operations for the lower level of net retained business. This was offset by a decline in net investment income of $8.2 million caused by a lower invested asset base due to the transfer of assets in conjunction with the reinsurance transaction with Commonwealth.
The following tables detail premium for the segment by major lines of business:
Policyholder Benefits. Policyholder benefits incurred declined by $32.9 million, or 12.9%, compared to the year ended December 31, 2009. This decline was principally due to the overall decline of insurance in-force in the senior market and specialty health lines of business, as well as a decrease in the policyholder benefit ratios for the year ended December 31, 2010 from the same period last year. The policyholder benefit ratio for senior market health was 72.4%, compared with 72.8% for the same period last year, and for specialty health, the policyholder benefit ratio was 98.9%, compared with 100.5% for the same period last year. Additionally, the reinsurance transaction with Commonwealth in April 2009 resulted in a decrease in life insurance and annuity policyholder benefits retained during year ended December 31, 2010 compared to the prior year.
Results for our Traditional Insurance segment decreased by $25.4 million compared to the year ended December 31, 2008. The reinsurance transaction with Commonwealth to reinsure substantially all of the net retained life and annuity business resulted in a loss and other related costs of approximately $7.6 million. Additionally, a $1.4 million restructuring charge was recorded as a result of re-alignment of operations with the lower level of net retained business. Excluding these impacts, the decrease to net income was primarily caused by a $37.1 million decrease in net investment income caused by a lower invested asset base due to the transfer of assets in conjunction with the reinsurance transaction noted above and by lower average yields on retained business, which was offset by a reduction in commissions and general expenses of $19.5 million.
Policyholder Benefits. Policyholder benefits incurred declined by $62.4 million, or 19.6%, compared to the year ended December 31, 2008. This decline was due to the reinsurance transaction with Commonwealth, which resulted in a decrease in net life and annuity benefits retained of $21.4 million, and a net reduction in senior market product benefits of $30.7 million. The reduction in senior market benefits is mainly a result of a decline in the business in-force. Individual loss ratios for the twelve months ended December 31, 2009 were 72.8% for senior market, compared with 75.2% for the same period last year, and 100.5% for specialty health, compared with 91.7% for the same period last year. The increase in the Specialty loss ratio was primarily caused by an increase in frequency of long-term care claims.
The net amortization of deferred acquisition cost decreased $6.5 million, or 45.4%. This was primarily caused by the elimination of the deferred acquisition costs and the related amortization on the life and annuity business reinsured to Commonwealth.
Commissions and general expenses, net of allowances, decreased by $19.5 million compared to the year ended December 31, 2008. The lower level of commissions is associated with the continued aging of our in-force renewal premium and less new business production that has higher commission rates. Other operating costs decreased $10.4 million for the year ended December 31, 2009, compared to the twelve months ended December 31, 2008. This is primarily due to the lower levels of business in-force. Allowances received from reinsurers decreased $1.4 million for the year ended December 31, 2009 from the year ended December 31, 2008, primarily due to the termination of the State of Connecticut employees reinsurance arrangement with PharmaCare Re effective June 30, 2008 partially offset by an increase in allowances received on life and annuity business reinsured to Commonwealth.
The following table presents the primary components comprising the loss from the segment:
the former Senior Administrative Services and Corporate segments in one segment called Corporate & Other.
The loss before income taxes from our Corporate & Other segment increased by $12.7 million, or 24%, for the year ended December 31, 2010 compared to 2009. This was primarily due to the $7.8 million decline in net income-Senior Administrative Services as a result of the sale of CHCS effective April 1, 2010. In addition, we recorded $4.0 million of expenses related to the Part D transaction. During 2010 and 2009 we recorded charges related to the realignment of our distribution channels amounting to $15.0 million and $13.6 million, respectively.
Amortization of capitalized loan origination fees was $0.5 million higher in 2010, compared with the same period in 2009 due to additional amortization related to the costs associated with the amendment of our credit facility in July 2010 and November 2009.
Other parent company expenses, net of revenues, increased $3.9 million. This was driven by $4.0 million of legal and consulting costs incurred in 2010 in connection with the recently announced sale of the Part D business and a $15 million charge in 2010 related to realignment of our distribution channels in response to the impact of the CMS sanctions restricting our ability to sell Medicare Advantage business, compared with a $13.6 million charge in 2009 for under-performing field offices.
The loss before income taxes from our Corporate & Other segment increased by $37.1 million for the year ended December 31, 2009 compared to 2008. This was due primarily to a $13.6 million charge related to the proposed closing and restructuring of certain career sales offices in 2009, $13.5 million lower profitability of the former Senior Administrative Services segment, a significant non-recurring release of a bonus accrual in the first quarter of 2008, higher stock-based compensation costs for equity awards to employees and directors, higher levels of expense and lower net investment income, partially offset by lower borrowing costs.
The decrease in interest expense of $3.8 million is due primarily to a reduction in the interest rates charged on the debt, as compared to 2008. The weighted average interest rate on our loan payable was 4.0% for 2009 compared to 4.6% for 2008. The weighted average interest rate on our other long-term debt was 6.2% for 2009 compared to 7.4% for 2008. See "Liquidity and Capital Resources" for additional information regarding our loan payable and other long-term debt.
The increase in stock-based compensation expense of $2.3 million resulted primarily from new equity awards granted in the last quarter of 2008 and the first nine months of 2009, to directors, officers and other employees approved by the compensation committee.
with a company-wide cost reduction effort, we recorded a $13.6 million charge to earnings. The remaining variance was primarily due to the release in the first quarter of 2008 of a 2007 bonus accrual that was $5.6 million in excess of the final amounts approved by the compensation committee and paid in 2008, compared with a $0.5 million release for similar reasons in the first quarter of 2009 as well as increased staffing and outside service costs. In addition, net investment income decreased $2.7 million as a result of lower invested assets at a lower rate.
Our contractual obligations as of December 31, 2010, are shown below.
(3)Reflects scheduled amortization through final maturity in 2012. The loan payable is floating rate debt, although we pay a fixed rate on $250 million through the use of swap agreements. We did not project future changes in the base interest rates. For the purpose of this schedule, we applied the rate in effect at December 31, 2010 to all future periods.
(4)Reflects minimum obligations on our outsourcing contracts, See "Outsourcing Arrangements" in Part 1, Item 1 of this annual report on Form 10-K. The amount of service provided under the contracts and the levels of business processed affect our actual monthly payments. Currently, our actual payments exceed the minimums stated in the contracts. Therefore our actual payments will exceed the amounts presented in the above schedule based upon anticipated future service levels.
•dividends and surplus note payments from and capital contributions to our insurance and HMO subsidiaries;
•dividends from the cash flows of our other subsidiaries, including our HMO third-party administrator and our PBM subsidiary;
•debt principal and interest payments and access to $150 million under the revolving portion of our Credit Facility;
PBM and HMO third-party administrator cash flows. The primary sources of liquidity for these subsidiaries are fees collected from clients, including our insurance and HMO subsidiaries, for performing administrative, marketing and management services. The primary uses of liquidity are the payments for salaries and expenses associated with providing these services. We believe the sources of cash for these subsidiaries will exceed scheduled uses of cash and result in amounts available to dividend to our parent holding company. In December, 2010, our PBM and HMO third party administrators paid dividends to our parent holding company of $12.3 million and $20.0 million, respectively.
Debt principal and interest-Credit Facility, Swaps and Other Long-Term Debt. We currently have a credit facility consisting of a $350 million term loan and a $150 million revolver (the "2007 Credit Facility"). This credit facility has customary covenants and requirements including a leverage ratio test, minimum risk based capital requirements for our insurance companies and, under certain conditions, the ability to pose limitations on certain investments, dispositions and our ability to make restricted payments. We are in compliance with all covenants in the Credit Agreement.
exchange for prepayments of Term Loan principal and increases in borrowing spreads. In August 2010, we announced and paid a special cash dividend totaling $156 million and, per the terms of the July 2010 Amendment, made prepayments of term loan principal of $78.1 million. As of December 31, 2010, $232.9 million was outstanding under the term loan agreement and the weighted average interest rate on the term loan portion of the credit facility was 1.41%. All $232.9 million of the term loan outstanding has been swapped from a LIBOR-based floating rate to an average fixed rate of 4.14% (see Note 15-Derivative Instruments-Interest Rate Swaps in Notes to Consolidated Financial Statements and the ensuing paragraph), resulting in a total blended interest rate of 5.26% as of December 31, 2010. We pay a commitment fee on the unutilized revolving loan facility at an annualized rate of 25 basis points. We had not drawn on the revolving loan facility as of the date of this report. We made regularly scheduled principal payments totaling $2.8 million, and interest payments totaling $4.0 million during 2010.
On December 4, 2007, we entered into two separate interest rate swap agreements on a total notional amount of $250 million, where we pay an average locked-in fixed rate of 4.14% and receive a floating rate based on LIBOR. During 2010, we paid a net amount of $9.6 million in association with these swap agreements. Due primarily to the $78 million debt prepayment made in the third quarter of 2010 discussed above, the outstanding principal balance on the hedged Credit Facility was reduced to $232.9 million at December 31, 2010; $17.1 million lower than the $250 million notional amounts on the swaps. As a result, this portion of the swaps was deemed ineffective and the notional amount on one of the swaps was decreased by $17.1 million to $107.9 million, which resulted in a realized loss of $1.3 million. In addition, we evaluated the likelihood of additional debt paydowns prior to the scheduled maturity of the Credit Facility and the related interest rate swaps in September 2012, and identified an additional $4.5 million of the swaps that would be considered ineffective as hedges. As a result, we realized an additional loss of $0.3 million on this ineffective portion of the swap, resulting in total realized losses on the cash flow hedge of $1.6 million in 2010. No other terms of the swaps were changed.
In 2010, we began investing our cash in longer duration securities, including corporate bonds, asset-backed securities, municipal securities, and in non-Government short term investments. As a result, as of December 31, 2010, approximately 10% of our portfolio is in cash equivalents, of which approximately 6% is invested in U.S. government short term securities, as compared with 47% in cash equivalents at December 31, 2009. In the aggregate, approximately 26% of our cash and invested assets are in securities backed by the U.S. government or its agencies, as compared with 82% at December 31, 2009. The aggregate credit quality of our total investment portfolio was AA- at December 31, 2010 compared with AA at December 31, 2009.
The net yields on our cash and invested assets decreased to 2.6% for 2010, from 2.9% for 2009. The overall drop in yield for the year ended December 31, 2010, compared with the same period in
Reserves and other policy liabilities-life represents the gross amount of liabilities on our life insurance business, including policyholder account balances on our investment and universal life-type policies, future policy benefit reserves on our traditional life insurance policies and policy and contract claims on our life policies. Beginning in April, 2009, we reinsured substantially all of our in force life insurance and annuity business under a 100% coinsurance treaty. A portion of our traditional business was not included in that reinsurance transaction, however much of that business is reinsured under separate treaties. We continue to sell traditional life products, primarily senior life.
Our net retained reserves for life insurance products were $9.7 million, or 2% of our direct and assumed reserves for life insurance product, as of December 31, 2010. Our net retained reserves for life insurance products were $4.3 million, or 1% of our direct and assumed reserves for life insurance products as of December 31, 2009.
Reserves for future policy benefits-health represents the present value of estimated future benefits to be paid to or on behalf of policyholders, less the future value of net premiums. We calculate this amount based on actuarially recognized methods using morbidity and mortality tables, which we modify to reflect our actual experience when appropriate.
evidenced by the policyholder continuing to make premium payments. In establishing these reserves, we must evaluate assumptions about mortality, morbidity, lapse rates and the rate at which new claims are submitted to us. We estimate the future policy benefits reserve for these products using the above assumptions and actuarial principles. For long-duration insurance contracts, we use these original assumptions throughout the life of the policy and generally do not subsequently modify them.
We develop our estimate for IBNR using actuarial methodologies and assumptions, primarily based upon historical claim payment and claim receipt patterns, as well as historical medical cost trends. Depending on the period for which we are estimating incurred claims, we apply a different method in determining our estimate. For periods prior to the most recent three months, the key assumption we
•changes in the utilization of hospital facilities, physician services, prescription drugs, and new medical technologies, and
ASC 350, Goodwill and Other Intangible Assets, requires that goodwill balances be reviewed for impairment at the reporting unit level at least annually or more frequently if events occur or
circumstances change that would indicate that a triggering event, as defined in ASC 350, has occurred. A reporting unit is defined as an operating segment or one level below an operating segment. Our reporting units are equivalent to our operating segments. We had goodwill allocated to the following reporting units as follows (in thousands):
$8 billion assessment on the health insurance industry beginning in 2014. These changes will impact how we do business and could restrict growth in certain products and market segments, restrict premium rate increases for certain products and market segments, increase our medical and administrative costs or expose us to an increased risk of liability, any or all of which could have a material adverse effect on us. We also anticipate that the Health Reform Legislation will further increase attention on the need for health care cost containment and improvements in quality, as well as in prevention, wellness and disease management.
During each quarter, we perform a review of certain key components of our valuation of our reporting units, including the operating performance of the reporting units compared to plan (which was the primary basis for the prospective financial information included in our goodwill impairment test as of October 1, 2010), our weighted average cost of capital and our stock price and market capitalization. Based on our review of these items through the reporting date, we believe that our estimate of fair value for each of our reporting units remains reasonable.
The fair value for fixed maturity securities is largely determined by third party pricing service market prices. The typical inputs that third party pricing services use are
Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported trades, the third party pricing services may use matrix or model processes to develop a security price where they develop future cash flow expectations based upon collateral performance and discount this at an estimated market rate. Included in the pricing for mortgage-backed and asset-backed securities are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates. See Part I, Item 3, Quantitative and Qualitative Disclosures About Market Risk, for a discussion regarding the interest rate sensitivity of our investment portfolio.
The following table presents the fair value of fixed maturity securities that are carried at fair value by ASC 820 hierarchy levels, as of December 31, 2010 (in thousands):
•If we intend to sell a debt security, or it is more likely than not that we will be required to sell the debt security before recovery of its amortized cost basis, we recognize an OTTI in earnings equal to the entire difference between the debt security's amortized cost basis and its fair value.
We have a security monitoring process overseen by our Investment Committee, consisting of investment and accounting professionals who identify securities that, due to specified characteristics, as described below, we subject to an enhanced analysis on a quarterly basis. We review our fixed maturity securities at least quarterly to determine if an other-than-temporary impairment is present based on specified quantitative and qualitative factors. The primary factors that we consider in evaluating whether a decline in value is other-than-temporary are:
•whether the debtor is current on contractually obligated interest and principal payments, and
We hold securities with exposure to subprime residential mortgages, or mortgage loans to borrowers with weak credit profiles. The significant decline in U.S. housing prices and relaxed underwriting standards by some subprime loan originators have led to higher delinquency and loss rates, resulting in a significant reduction in the market valuation of these securities sector wide.
In the third quarter of 2010, we sold subprime holdings with par values of approximately $29.9 million, realizing net pre-tax losses totaling $10.2 million. As of December 31, 2010, we held subprime securities with par values of $22.1 million, an amortized cost of $21.6 million and a fair value of $15.8 million representing approximately 1.1% of our cash and invested assets, with collateral comprised substantially of first lien mortgages in senior or senior mezzanine level tranches, with an average Standard & Poor's, or equivalent, rating of A-.
We continue to review the estimated fair values indicated by pricing provided by the third party pricing services. However, we cannot give assurance that there will be no further impairments on these securities.
Part C-Under the Medicare Advantage program, private plans provide Medicare-covered health care benefits to enrollees and can include prescription drug coverage. Part C benefits are provided through private HMO, PPO and PFFS plans. An individual must have Medicare Part A and Part B in order to join a Medicare Advantage Plan.
We receive monthly payments from CMS related to members in our HMO, PPO and PFFS Plans. The recognition of the premium and cost reimbursement components under these Plans is described below:
CMS Direct Premium Subsidy-We receive a monthly premium from CMS based on the Plan year bid we submitted to CMS. The monthly payment is a risk-adjusted amount per member and is based upon the member's health status, as determined by CMS. The CMS premium is recognized over the contract period and reported as premium revenue. In addition, under Medicare Secondary Payer, or MSP provisions, the premium will be reduced by CMS if CMS has determined that it is secondary to other insurance coverage.
Low-Income Premium Subsidy-For qualifying low-income status, or LIS, members of our Medicare Advantage Health Benefit Plans with Part D benefits, CMS pays us for some or all of the LIS member's monthly premium. The CMS payment is dependent upon a member's income level which is determined by the Social Security Administration. Low-income premium is recognized over the contract period and reported as premium revenue.
amount per member per month, and are determined based upon the Plan year bid we submitted to CMS. After the close of the annual Plan year, CMS reconciles actual experience to low-income cost sharing subsidies paid to the Plan and any differences are settled between CMS and the Plan. The low-income subsidy is accounted for as deposit accounting and therefore not recognized in operations.
We receive monthly payments from CMS related to members in our stand-alone Part D Plans. The recognition of the premium and subsidy components under Part D is described below:
CMS Direct Premium Subsidy-We receive a monthly premium from CMS based on the Plan year bid we submitted to CMS. The monthly payment is a risk-adjusted amount per member and is based upon the member's health status, as determined by CMS. The CMS premium is recognized over the contract period and reported as premium revenue.
Catastrophic Reinsurance Subsidy-CMS reimburses Plans for 80% of the drug costs after a member reaches his or her out of pocket catastrophic threshold through a catastrophic reinsurance subsidy. Catastrophic reinsurance subsidies are paid by CMS prospectively as a fixed amount per member per month, and are determined based upon the Plan year bid we submitted to CMS. After the close of the annual Plan year, CMS reconciles actual experience compared to catastrophic reinsurance subsidies paid to the Plan and any differences are settled between CMS and the Plan. See "Deposit Accounting" below for a description of the accounting for catastrophic reinsurance subsidies.
We establish valuation allowances on our deferred tax assets for amounts that we determine will not be recoverable based upon our analysis of projected taxable income and our ability to implement prudent and feasible tax planning strategies. We recognize increases in these valuation allowances as deferred tax expense. We reflect portions of the valuation allowances subsequently determined to be no longer necessary as deferred tax benefits.
We file a consolidated life-nonlife return for Federal income tax purposes that includes all US subsidiaries. At December 31, 2010, the Company had a net capital loss carryforwards of approximately $7.7 million that expire in 2014.
We carried valuation allowances on deferred tax assets of $7.8 million at December 31, 2010 and $5.8 million at December 31, 2009 primarily related to the tax benefits associated with a New York state net operating loss carryforward. At December 31, 2010, we recorded our deferred tax assets based on the amount that was more likely than not to be realized under ASC 740, Income Taxes. Management believes it is more likely than not that the Company will realize the recorded value of its net deferred tax assets.
Some of our U.S. insurance company subsidiaries are taxed as life insurance companies as provided in the Internal Revenue Code. The Omnibus Budget Reconciliation Act of 1990 amended the Internal Revenue Code to require a portion of the expenses incurred in selling insurance products be capitalized and amortized over a period of years, as opposed to an immediate deduction in the year incurred. Instead of measuring actual selling expenses, the amount capitalized for tax purposes is based on a percentage of premiums. In general, the capitalized amounts are subject to amortization over a ten-year period. Since this change only affects the timing of the deductions, it does not, assuming stability of income tax rates, affect the provisions for taxes reflected in our financial statements prepared in accordance with GAAP. However, by deferring deductions, the change has the effect of increasing our current tax expense and reducing statutory surplus.
At December 31, 2010, we had unrecognized tax benefits of $10.0 million, net of federal income tax, primarily related to refund claims filed in various state jurisdictions during 2010. We recognize
The financial statements and supplementary schedules are listed in the accompanying Index to Consolidated Financial Statements and Financial Statement Schedules in this Annual Report on Form 10-K on Page.