Forward-Looking Statements
Statements contained in this Form 10-Q for the quarterly period ended June 30,
2012 ("2012 Form 10-Q") that are not historical fact may be forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995 and Section 21E of the Securities Exchange Act of 1934, as amended, and we
intend such statements to be covered by the safe harbor provisions for
forward-looking statements contained therein. Such statements, which may
address, among other things, market acceptance of our products and services,
product development, our ability to finance growth opportunities, our ability to
respond to changes in laws and government regulations, implementation of our
sales and marketing strategies, projected capital expenditures, liquidity and
the availability of additional funding sources may be found in the section of
this 2012 Form 10-Q entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and generally elsewhere in this report. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "targets," "predicts," "potential," "continues" or the negative of
such terms or other comparable terminology. You are cautioned that
forward-looking statements involve risks and uncertainties, including economic,
regulatory, competitive and other factors that may affect our business. Please
refer to Risk Factors in Part I, Item 1A of our Annual Report on Form 10-K for
the year ended December 31, 2011 ("2011 Form 10-K") and in Part II, Item 1A of
this 2012 Form 10-Q, for a discussion of certain risk factors which could
materially affect our business, financial condition, cash flows, and results of
operations. These forward-looking statements are inherently susceptible to
uncertainty and changes in circumstances, as they are based on management's
current expectations and beliefs about future events and circumstances. We
undertake no obligation beyond that required by law to update publicly any
forward-looking statements for any reason, even if new information becomes
available or other events occur in the future.
Overview
We are a leading provider of managed care services to government-sponsored
health care programs, serving approximately 2.6 million members nationwide as of
June 30, 2012. We operate exclusively within the Medicare and Medicaid programs,
serving the full spectrum of eligibility groups, with a focus on lower-income
beneficiaries. Our primary mission is to help our government customers deliver
cost-effective health care solutions, while improving health care quality and
access to these programs. We are committed to operating our business in a manner
that serves our key constituents - members, providers, government clients, and
associates - while delivering competitive returns for our investors.
Our strategic priorities for 2012 include improving health care quality and
access for our members, achieving a competitive cost position, and delivering
prudent, profitable growth.
Key Developments and Accomplishments
Presented below are key developments and accomplishments relating to progress on
our strategic business priorities that occurred or impacted our financial
condition and results of operations during 2012.
? In July 2012, the New York State Department of Health approved our
participation in the expansion of its Managed Long-Term Care (MLTC) program by
5 additional counties, beginning in August 2012. With this expansion, we will
serve four of the five New York City boroughs as well as five upstate
counties. The MLTC program is designed to help people with chronic illnesses
or who have disabilities and need health and long-term care services, such as
home care or adult day care, stay in their homes and communities as long as
possible.
? In July 2012, the Florida Healthy Kids Corporation informed us that our Florida Children's Health Insurance Program plans were chosen as part of a
re-procurement effort to continue providing comprehensive managed care
coverage to children enrolled in the Florida Healthy Kids Program. Services
under a new contract are expected to begin on October 1, 2012, and will
expand our current service offering from 18 counties to 65 of Florida's 67
counties. With this expansion, we will offer Florida Healthy Kids services
in more counties than any other participating plan.
? We recently expanded our service area in the Florida Medicaid program to
include Bay County and De Soto County. With this expansion, we now serve 38
of the 67 counties across Florida.
? In July 2012, we were approved by the Florida Department of Elder Affairs to
participate in the state's Long-Term Care Community Diversion Pilot Project
(the "Diversion Program"). Our services under this new program began on July
1, 2012 and initially focused on program enrollees in Escambia and Santa Rosa
Counties. We could potentially expand our services under this program to
additional counties in the future. The Florida Diversion Program has been
designed to provide frail elders, age 65 and older, with alternatives to
nursing home care. Enrollees in the program are dually eligible Medicare and
Medicaid recipients who qualify for Medicaid nursing home placement and
include as many as 20,000 beneficiaries across the state. We will serve these
members by coordinating care that is integrated with community-based services,
which will help ensure these members have access to what they need to remain
safely in their homes and communities as an alternative to institutionalized
care.
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? In July 2012, we entered into a definitive agreement with Humana to acquire
certain assets of Arcadian Health Plan, Inc.'s Desert Canyon Community Care
("Desert Canyon") Medicare Advantage plans. Under the agreement, Desert
Canyon plan members in Mohave and Yavapai Counties, Arizona will become
members of our Arizona MA Health Plan. Currently, the Desert Canyon plans
have approximately 5,000 members. The transaction is expected to close on
December 31, 2012, subject to customary regulatory approvals and closing
conditions. The membership transfer is expected to occur on January 1,
2013.
? In April 2012, our Hawaii health plan received accreditation from the National
Committee for Quality Assurance ("NCQA"). Previously, our Missouri and Georgia
health plans received NCQA accreditation. The NCQA measures health plans'
commitment to high-quality care, effective management, and accountability. We
remain dedicated to our long-term target of accreditation for all of our
health plans.
? We continue to expand the geographic footprint of our Medicare Advantage
("MA") plans and offer special needs plans ("D-SNPs") for those who are
dually-eligible for Medicare and Medicaid in all of the MA markets we serve. This expansion is consistent with our focus on the lower-income
demographic of the market and our ability over time to serve both the
Medicaid- and Medicare-related coverage of these members. MA membership as
of June 30, 2012 was approximately 158,000, an increase from 150,000 as of
March 31, 2012. We project that MA segment membership will continue to grow
during the remaining months of 2012.
? We have continued to enhance our care management capabilities. For example, we
recently strengthened our resources that are focused exclusively on outreach
to our Medicaid members to both educate them on care gaps and facilitate the
closure of such care gaps. Intervention and support activities include
arranging transportation assistance and three-way calls with a member and his
or her primary care physician to schedule appointments, as well as language
translation for non-English speaking members. Also, we have made enhancements
to our case management model to more effectively serve our most medically
complex members. The model leverages both field-based and telephonic resources
using state-specific, multi-disciplinary care teams. Additionally, we are
upgrading our systems related to Healthcare Effectiveness Data and Information
Set reporting, replacing our care and medical management technology platform
and launching a web-based care gap eligibility check tool.
? On April 3, 2012, we were notified that the Deferred Prosecution Agreement
(the "DPA") entered into on May 5, 2009 among the United States Attorney's
Office for the Middle District of Florida (the "USAO"), the Florida Attorney
General's Office and us was terminated effective immediately. The criminal
charges against us were dismissed on April 4, 2012. These actions acknowledge
that we have fulfilled all of our obligations under the DPA.
Business and Financial Outlook
Market Developments
A number of states are evaluating new strategies for their Medicaid programs.
Given ongoing fiscal challenges, economic conditions, and the success of
Medicaid managed care programs over the long run, states continue to recognize
the value of collaborating with managed care plans to deliver quality,
cost-effective health care solutions.
The Florida Agency for Health Care Administration (AHCA) recently released an
invitation to negotiate for the Florida Statewide Medicaid Managed Care Long
Term Care program. The total number of eligible participants in this program is
estimated at 85,000 and includes seniors and adults with disabilities across 11
regions in the state. Services for the first region are expected to begin on
August 1, 2013. We are interested in the opportunity to expand our presence in
Florida. We are anticipating a highly competitive process, with several other
plans expected to participate.
We currently expect AHCA to renew our Florida Medicaid contracts for an interim
period beginning September 1, 2012. The ultimate contract term may be superseded
by the implementation of a reform of the statewide Medicaid Managed Care program
(the "Medicaid Reform Program"). We expect the state to publish a request for
proposals in January 2013 for participation in the Medicaid Reform Program for a
5 year contract term; however, the implementation date of the Medicaid Reform
Program is uncertain. We are anticipating a highly competitive process, with as
many as 20 companies, including us, expected to participate.
Recently, the Georgia Department of Community Health (the "Georgia DCH")
announced further refinements to its Medicaid redesign initiatives. At this
time, the Georgia DCH will not conduct a re-procurement of the Georgia Families
program, which currently serves Temporary Assistance for Needy Families ("TANF")
and Children's Health Insurance Program ("CHIP") members, and will not begin to
include aged, blind and disabled ("ABD") beneficiaries as previously planned,
given what the Georgia DCH describes as increasing uncertainty at the federal
level. Our current Georgia Medicaid contract provides for two one-year renewal
options exercisable by the Georgia DCH. The Georgia DCH exercised its option to
extend the term of our Georgia Medicaid contract until June 30, 2013 and the
remaining renewal option potentially extends the contract through June 30, 2014.
The Georgia DCH has also indicated its intent to amend our Georgia Medicaid
contract to include two additional one-year renewal options, exercisable by the
Georgia DCH, that potentially extend the contract term through June 30, 2016.
With respect to Medicaid rates, we continue to expect the environment to be
challenging, given state and federal fiscal conditions.
As we look toward the 2013 annual election period, we are expanding our MA
service area by 53 counties, to a total of 191 counties. In addition to growing
our presence in our existing states of Florida, Georgia, Illinois, New York, and
Texas, we will for the first time offer MA plans in Kentucky. This will enable
our offering MA plans to some of the dually eligible members we currently serve
through the Kentucky Medicaid program.
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Kentucky is requesting proposals to coordinate physical, behavioral and dental
care for over 170,000 Medicaid eligible beneficiaries in Medicaid Managed Care
Region 3, which consists of 16 counties. Kentucky currently intends to select at
least 2 health plans that will begin serving Medicaid beneficiaries effective
January 1, 2013. We are interested in the opportunity to expand our presence in
Kentucky.
Twenty-six states have submitted applications to participate in the CMS "Duals
Alignment Demonstration Program," covering approximately 2 million individuals
fully eligible for both Medicare and Medicaid, or dual eligible beneficiaries.
This program is intended to provide integrated care on a capitated or fee for
service basis. Of the 26 states, 21 are proposing capitated programs and 5 are
proposing managed fee for service programs. Thirteen of the 26 states are
proposing to begin implementation in 2013. The remaining implementations are
scheduled to begin in 2014. CMS has issued guidance that no programs will begin
before April 1, 2013 and the project will be limited to 2.4 million enrollees.
Exact implementation times vary by state. None of the states have yet received
approval of their proposals. CMS has issued guidance indicating that dual
eligible beneficiaries participating in the states' duals alignment
demonstration programs cannot be forced to remain in a duals alignment plan and
will be allowed to switch between plans on a monthly basis. However, enrollment
in a Medicare Advantage plan is limited to the federally designated annual
enrollment period or in the event of a special election period unless the
individual seeks to enroll in a plan that has obtained a score of 5 on
Medicare's quality performance system ("Star Ratings"). None of our health plans
have yet achieved 5 stars. For this reason, dual eligible beneficiaries subject
to a dual alignment demonstration programs will only be able to elect to remain
in or join a WellCare plan during the annual enrollment period or special
election periods.
To date, rates have not been released for any state's duals alignment program.
The guidance promulgated by CMS requires a cost savings to both Medicare and
Medicaid. To the extent that the assumed savings are deemed unrealistic, these
programs could limit the number of states in which we choose to provide
services. If the rates are deemed sufficient to support the provision of high
quality care, we may choose to bid for participation in these programs. In
addition, certain state's programs have not permitted us to participate in their
project, due to our plan's program design. We have submitted a bid proposal to
participate in the dual demonstration project in Ohio. For those states that
have a dual demonstration program in which we do not participate, the membership
in our MA and PDP plans in those states would be reduced.
Financial Impact of Government Investigations and Litigation
For further discussion of government investigations and litigation including the
associated financial impact, please refer to our "Selling, General and
Administrative Expense" discussion under "Results of Operations" below and Part
I - Item 1 - Note 10 - "Commitments and Contingencies."
General Economic and Political Environment
The political environment is uncertain. The U.S. Congress continues to attempt
to repeal, amend or restrict funding for various aspects of The Patient
Protection and Affordable Care Act and The Health Care and Education
Reconciliation Act of 2010 (collectively, the "2010 Acts"). Several states filed
suits challenging the constitutionality of certain aspects of the 2010 Acts.
Those cases ultimately reached the U.S. Supreme Court, which, on June 28, 2012,
upheld the constitutionality of the provisions of the 2010 Acts requiring all
Americans meeting certain income qualifications to purchase health insurance
meeting certain standards or to pay a financial penalty. The Supreme Court also
modified the Acts' requirement that all states expand their Medicaid programs to
individuals up to 133% of the federal poverty line, making that expansion
optional for states; however, the effect of the modification to the Medicaid
expansion requirements remains to be seen. We expect some, but not all, of the
states we operate in will participate in the Medicaid expansion. We also
anticipate further guidance will be released regarding, among other things, the
delivery of care to individuals under 65 with incomes up to 133 percent of
poverty, who reside in those states that elect not to participate in the
Medicaid expansion.
The economic environment remains challenging, with continued high unemployment
throughout 2012 and sluggish job growth. As a result, budgetary challenges at
the federal and state level may continue. We expect that the state and the
federal governments will continue to look for budgetary cost control savings
through reductions in health care costs. We may also experience delays in
premium payments from our state customers. The "maintenance of eligibility"
requirements under the 2010 Acts generally prohibit states from restricting
Medicaid eligibility or tightening enrollment procedures. These provisions are
due to phase out for adults in Medicaid in 2014 and for children in 2019.
However, the Supreme Court decision has created some uncertainty regarding
whether the maintenance of eligibility provisions can be enforced. In the event
that they cannot, states which have engaged in a wide array of cost containment
efforts throughout the course of the recession could seek to restrict
eligibility or tighten enrollment procedures.
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On August 2, 2011, the President signed into law the Budget Control Act of 2011,
and the Congressional Super Committee has since failed to reach an agreement on
a budget. As a result, in the absence of Congressional intervention,
approximately $1.2 trillion in domestic and defense spending reductions would
begin on January 1, 2013. The Budget Control Act of 2011 stipulates that
payments to Medicare providers may be reduced by no more than 2% and exempts
Medicaid from the automatic spending cuts. At this time, we cannot predict the
impact that of this pending action. Congressional leaders have announced that
they have agreed to a budget deal that Congress is expected to vote on in
September 2012 that would continue funding at current levels through March 2013.
This would have no impact on the budget cuts required by the Budget Control
Act, which will occur in absence of further Congressional action.
The November 2012 election campaigns have focused substantially on the role of
the government in health care as well as the nation's fiscal challenges. The
Republican Party has generally expressed their intent to repeal or significantly
limit provisions of the 2010 Acts and to implement significant reforms related
to Medicare and Medicaid in response to domestic and defense spending
reductions. The Democratic Party has generally expressed an opinion in favor of
continuing to implement the 2010 Acts and to preserve the Medicare and Medicaid
programs for current beneficiaries. The results of the November election could
have a significant impact on the implementation of the Acts, and the funding and
future design of Medicare and Medicaid and other programs created by the Acts.
Because the rate of growth of the expenses for Medicare are outpacing the growth
rate of the economy, and the trust funds are not adequately funded, Congress has
proposed several plans to restructure Medicare that would change Medicare from a
defined benefit to a defined contribution program and to move the selection of
Medicare benefits into an exchange-like facilitated selection venue. We do not
know whether these proposals will pass, or the effect their ultimate form will
have on our business.
In addition, Congress has annually appropriated funds to avoid the imposition of
the Sustainable Growth Rate formula, enacted by the Balanced Budget Act of 1997,
on physician payments under Medicare. The cut to physician payments that would
result from the imposition of the Sustainable Growth Rate formula would be more
than 30% at the start of 2013. The cuts could have a significant impact on
health care provider willingness to participate in the Medicare and MA programs.
Congress has not yet appropriated funds for these payments for 2013 and may fail
to do so, or may delay doing so which could cause delays in receipt of payments
from CMS for our MA plans.
Basis of Presentation
Segments
Reportable operating segments are defined as components of an enterprise for
which discrete financial information is available and evaluated on a regular
basis by the enterprise's decision-makers to determine how resources should be
allocated to an individual segment and to assess performance of those segments.
Accordingly, we have three reportable segments: Medicaid, MA and our stand-alone
Medicare prescription drug plans ("PDPs").
Medicaid
Medicaid was established to provide medical assistance to low-income and
disabled persons. It is operated and implemented by state agencies, although it
is funded and regulated by both the state and federal governments. Our Medicaid
segment includes TANF, Supplemental Security Income ("SSI"), ABD, Managed
Long-Term Care ("MLTC"), and other state-based programs that are not part of the
Medicaid program, such as CHIP and Family Health Plus for qualifying families
who are not eligible for Medicaid because they exceed the applicable income
thresholds. TANF generally provides assistance to low-income families with
children. ABD and SSI generally provide assistance to low-income aged, blind or
disabled individuals. The MLTC program is designed to help people with chronic
illnesses or who have disabilities and need health and long-term care services,
such as home care or adult day care, stay in their homes and communities as long
as possible.
The Medicaid programs and services we offer to our members vary by state and
county and are designed to effectively serve our various constituencies in the
communities we serve. Although our Medicaid contracts determine to a large
extent the type and scope of health care services that we arrange for our
members, in certain markets we customize our benefits in ways that we believe
make our products more attractive. Our Medicaid plans provide our members with
access to a broad spectrum of medical benefits from many facets of primary care
and preventive programs to full hospitalization and tertiary care.
In general, members are required to use our network, except in cases of
emergencies, transition of care or when network providers are unavailable to
meet their medical needs, and generally must receive a referral from their
primary care provider ("PCP") in order to receive medical services from
specialists, such as surgeons or neurologists. Members do not pay any premiums,
deductibles or co-payments for most of our Medicaid plans.
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MA
Medicare is a federal program that provides eligible persons age 65 and over,
and some disabled persons with a variety of hospital, medical and prescription
drug benefits. Our MA segment consists of MA plans, comprised of coordinated
care plans ("CCPs"). MA is Medicare's managed care alternative to original
Medicare fee-for-service ("Original Medicare"), which provides individuals
standard Medicare benefits directly through the Centers for Medicare & Medicaid
Services ("CMS"). Our CCPs are administered through our health maintenance
organizations ("HMOs") and insurance subsidiaries, and generally require members
to seek health care services and select a PCP from a network of health care
providers. In addition, we offer Medicare Part D coverage, which provides
prescription drug benefits, as a component of most of our MA plans.
We cover a wide spectrum of medical services through our MA plans, including in
some cases, additional benefits not covered by Original Medicare, such as
vision, dental and hearing services. Through these enhanced benefits, the
out-of-pocket expenses incurred by our members are reduced, which allows our
members to better manage their health care costs.
Most of our MA plans require members to pay a co-payment, which varies depending
on the services and level of benefits provided. Typically, members of our MA
CCPs are required to use our network of providers except in cases such as
emergencies, transition of care or when specialty providers are unavailable to
meet a member's medical needs. MA CCP members may see out-of-network specialists
if they receive referrals from their PCPs and may pay incremental cost-sharing.
In all of our MA markets, we also offer special needs plans to individuals who
are dually eligible for Medicare and Medicaid. These plans, commonly called
D-SNPs, are designed to provide specialized care and support for beneficiaries
who are eligible for both Medicare and Medicaid. We believe that our D-SNPs are
attractive to these beneficiaries due to the enhanced benefit offerings and
clinical support programs.
PDP
We offer stand-alone Medicare Part D coverage to Medicare-eligible beneficiaries
through our PDP segment. The Medicare Part D prescription drug benefit is
supported by risk sharing with the federal government through risk corridors
designed to limit the losses and gains of the drug plans and by reinsurance for
catastrophic drug costs. The government subsidy is based on the national
weighted average monthly bid for this coverage, adjusted for risk factor
payments. Additional subsidies are provided for dually-eligible beneficiaries
and specified low-income beneficiaries. The Medicare Part D program offers
national in-network prescription drug coverage that is subject to limitations in
certain circumstances.
Depending on medical coverage type, a beneficiary has various options for
accessing drug coverage. Beneficiaries enrolled in Original Medicare can either
join a stand-alone PDP or forego Medicare Part D drug coverage. Beneficiaries
enrolled in MA CCPs can join a plan with Medicare Part D coverage, select a
separate Medicare Part D plan, or forego Medicare Part D coverage.
Segment Financial Performance Measures
We use three measures to assess the performance of our reportable operating
segments: premium revenue, medical benefits ratio ("MBR") and gross margin. MBR
measures the ratio of medical benefits expense to premium revenue excluding
Medicaid premium taxes. Gross margin is defined as premium revenue less medical
benefits expense.
Our profitability depends in large part on our ability to, among other things,
effectively price our health and prescription drug plans; predict and
effectively manage medical benefits expense relative to the primarily fixed
premiums we receive, including reserve estimates and pharmacy costs; contract
with health care providers; and attract and retain members. In addition, factors
such as regulation, competition and general economic conditions affect our
operations and profitability. The effect of escalating health care costs, as
well as any changes in our ability to negotiate competitive rates with our
providers may impose further risks to our profitability and may have a material
impact on our business, financial condition and results of operations.
Premium Revenue
We receive premiums from CMS and state government agencies for the members that
are assigned to, or have selected, us to provide health care services under our
Medicare and Medicaid contracts. The primarily fixed premiums we receive for
each member varies according to the specific government program. The premiums we
receive under each of our government benefit plans are generally determined at
the beginning of the contract period. These premiums are subject to adjustment
throughout the term of the contract, although such adjustments are typically
made at the commencement of each new contract period. For further information
regarding premium revenues, please refer below to "Premium Revenue Recognition"
under "Critical Accounting Estimates."
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Medical Benefits Expense
Our largest expense is the cost of medical benefits that we provide, which is
based primarily on our arrangements with health care providers and utilization
of health care services by our members. Our arrangements with providers
primarily fall into two broad categories: capitation arrangements, pursuant to
which we pay the capitated providers a fixed per member per month fee or a fixed
fee-for-service, and risk-sharing arrangements, pursuant to which the provider
assumes a portion of the risk of the cost of the health care provided. Other
components of medical benefits expense are variable and require estimation and
ongoing cost management.
We use a variety of techniques to manage our medical benefits expense, including
payment methods to providers, referral requirements, quality and disease
management programs, reinsurance and member co-payments and premiums for some of
our Medicare plans. National health care costs have been increasing at a higher
rate than the general inflation rate and relatively small changes in our medical
benefits expense relative to premiums that we receive can create significant
changes in our financial results. Changes in health care laws, regulations and
practices, levels of use of health care services, competitive pressures,
hospital costs, major epidemics, terrorism or bio-terrorism, new medical
technologies and other external factors could reduce our ability to manage our
medical benefits expense effectively.
Estimation of medical benefits payable and medical benefits expense is our most
significant critical accounting estimate. For further information regarding
medical benefits expense, please refer below to "Estimating Medical Benefits
Payable and Medical Benefits Expense" under "Critical Accounting Estimates."
Gross Margin and MBR
Our primary tools for measuring profitability are gross margin and MBR. Changes
in gross margin and MBR from period to period result from, among other things,
changes in Medicaid and Medicare funding, changes in the mix of Medicaid and
Medicare membership, our ability to manage medical costs and changes in
accounting estimates related to incurred but not reported ("IBNR") claims. We
use gross margin and MBRs both to monitor our management of medical benefits and
medical benefits expense and to make various business decisions, including which
health care plans to offer, which geographic areas to enter or exit and which
health care providers to select. Although gross margin and MBRs play an
important role in our business strategy, we may be willing to enter new
geographical markets and/or enter into provider arrangements that might produce
a less favorable gross margin and MBR if those arrangements, such as capitation
or risk sharing, would likely lower our exposure to variability in medical costs
or for other reasons.
Results of Operations
Summary of Consolidated Financial Results
The following table sets forth consolidated statements of operations data, as
well as other key data used in our results of operations discussion for the
three months and six months ended June 30, 2012 compared to the three and six
months ended June 30, 2011. These historical results are not necessarily
indicative of results to be expected for any future period.
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For the Three Months Ended
June 30, Change
2012 2011 Dollars Percentage
Revenues: (In millions)
Premium $ 1,809.2 $ 1,485.3 $ 323.9 21.8 %
Investment and other income 1.9 2.3 (0.4 ) (17.4 )%
Total revenues 1,811.1 1,487.6 323.5 21.7 %
Expenses:
Medical benefits (1) 1,546.2 1,202.0 344.2 28.6 %
Selling, general and administrative (1) 159.0 147.0 12.0 8.2 %
Medicaid premium taxes 20.1 18.1 2.0 11.0 %
Depreciation and amortization 7.5 6.9 0.6 8.7 %
Interest 1.0 0.1 0.9 897.0 %
Total expenses 1,733.8 1,374.1 359.7 26.2 %
Income before income taxes 77.3 113.5 (36.2 ) (31.9 )%
Income tax expense 30.9 43.9 (13.0 ) (29.6 )%
Net income $ 46.4 $ 69.6 $ (23.2 ) (33.3 )%
Consolidated MBR (1) 86.4 % 81.9 % 4.5 %
Effective tax rate 40.0 % 38.7 % 1.3 %
For the Six Months Ended
June 30, Change
2012 2011 Dollars Percentage
Revenues: (In millions)
Premium $ 3,597.8 $ 2,957.8 $ 640.0 21.6 %
Investment and other income 4.7 4.6 0.1 2.2 %
Total revenues 3,602.5 2,962.4 640.1 21.6 %
Expenses:
Medical benefits (1) 3,067.9 2,465.3 602.6 24.4 %
Selling, general and administrative (1) 320.7 298.0 22.7 7.6 %
Medicaid premium taxes 40.5 37.0 3.5 9.5 %
Depreciation and amortization 14.5 13.4 1.1 8.2 %
Interest 2.1 0.2 1.9 950.0 %
Total expenses 3,445.7 2,813.9 631.8 22.5 %
Income before income taxes 156.8 148.5 8.3 5.6 %
Income tax expense 59.1 57.6 1.5 2.6 %
Net income $ 97.7 $ 90.9 $ 6.8 7.5 %
Consolidated MBR (1) 86.2 % 84.4 % 1.8 %
Effective tax rate 37.7 % 38.8 % (1.1 )%
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(1) Medical benefits expense, MBR, and selling, general and administrative
expense for the three months and six months ended June 30, 2011 reflect the
reclassification of certain quality improvement costs from selling, general
and administrative expense to medical benefits expense as discussed within
"Medical Benefits Expense" below.
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Membership
At June 30, 2012 At December 31, 2011 At June 30, 2011
Percentage of Percentage of Percentage of
Segment Membership Total Membership Total Membership Total
Medicaid 1,518,000 59.2% 1,451,000 56.6% 1,317,000 55.1%
MA 158,000 6.2% 135,000 5.3% 124,000 5.2%
PDP 886,000 34.6% 976,000 38.1% 950,000 39.7%
Total 2,562,000 100.0% 2,562,000 100.0% 2,391,000 100.0%
As of June 30, 2012, we served approximately 2,562,000 members, consistent with
membership at December 31, 2011 and an increase of approximately 171,000 members
from June 30, 2011. We experienced membership growth in both our Medicaid and MA
segments when compared to December 31, 2011, which was offset by a decline in
PDP membership. Medicaid segment membership increased by 67,000 compared to
December 31, 2011 mainly from membership growth in Florida and membership growth
in our Kentucky Medicaid program following its launch in the fourth quarter of
2011. Members participating in the Kentucky Medicaid program were able to switch
plans until January 31, 2012. Additionally, membership has increased due to
retroactive member re-assignments. Our Kentucky Medicaid membership increased
from 129,000 at December 31, 2011 to 154,000 at June 30, 2012. MA segment
membership increased by 23,000 compared to December 31, 2011 based on results of
the annual election period, which resulted in an increase of approximately
10,000 members effective January 1, 2012, as well as our continued focus on
dually-eligible beneficiaries and expansion into 19 new counties. In our PDP
segment, membership decreased by 90,000 compared to December 31, 2011 as a
result of our 2012 PDP bids, which resulted in the reassignment to other plans,
effective January 1, 2012, of members who were auto-assigned to us in 2011 or
prior years.
During the remaining months of 2012, we anticipate relatively stable membership
in the Kentucky Medicaid program, given that members are no longer able to
switch plans outside the annual election period. At this time, we are unable to
estimate the additional membership we will receive from our new contract with
Hawaii's QUEST program to serve TANF and CHIP members beginning on July 1, 2012.
We were one of five plans selected to serve approximately 230,000 beneficiaries
across the state. We project that MA segment membership to continue to grow
during the remaining months of 2012 due to our ability to market to and enroll
dually-eligible beneficiaries, as well as the growth in the broader Medicare
population. We anticipate PDP segment membership will decrease slightly during
the remainder of 2012 due to normal attrition being offset by fewer new members
as we will be auto-assigned newly eligible members in fewer regions.
Net Income
For the three and six months ended June 30, 2012, our net income was $46.4
million and $97.7 million, respectively, compared to net income of $69.6 million
and $90.9 million for the same three and six month periods in 2011. Excluding
investigation-related litigation and other resolution costs of $8.0 million and
$7.1 million, net of tax, for the three months ended June 30, 2012 and 2011,
respectively, net income decreased by $22.2 million, or 29%, in 2012 compared to
the same three month period in 2011. Excluding investigation-related litigation
and other resolution costs of $14.1 million and $13.9 million, net of tax, for
the six months ended June 30, 2012 and 2011, respectively, net income increased
by $6.9 million, or 7%, in 2012 compared to the same six month period in 2011.
The decrease for the three months ended June 30, 2012 compared to the same
period in 2011 resulted mainly from a decrease in our Medicaid segment results,
higher selling, general and administrative expense ("SG&A") expense and a higher
effective income tax rate, partially offset by improved results in our MA and
PDP segments. The increase for the six months ended June 30, 2012 resulted from
improved results in our MA and PDP segments, partially offset by a decrease in
our Medicaid segment results and increased SG&A expense. The decreases in our
Medicaid segment results were due to the impact of higher net favorable
development of prior period medical benefits payable experienced in 2011 and the
relatively higher MBR in the Kentucky Medicaid program, partially offset by the
impact of higher membership and related premium revenues and the impact of rate
increases in certain markets. The improved results in our MA segment were due to
increased membership and related premium revenues, while the improvement in the
PDP segment resulted mainly from favorable claims experience. The increase in
SG&A was driven primarily by higher membership, but the rate of increase was
lower than the overall increase in premium revenues.
Premium Revenue
Premium revenue for the three months ended June 30, 2012 increased by
approximately $323.9 million, or 21.8%, compared to the same period in the prior
year. Premium revenue for the six months ended June 30, 2012 increased by
approximately $640.0 million, or 21.6%, compared to the same period in the prior
year. The increase is primarily attributable to membership growth in our
Medicaid and MA segments and rate increases in certain of our Medicaid markets.
Premium revenue includes $20.1 million and $40.5 million of Medicaid premium
taxes for the three and six months ended June 30, 2012, respectively, and $18.1
million and $37.0 million for the same three and six months in 2011,
respectively.
32
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Medical Benefits Expense
Total medical benefits expense for the three months ended June 30, 2012
increased $344.2 million, or 28.6%, compared to the same period in 2011. Total
medical benefits expense for the six months ended June 30, 2012 increased $602.6
million, or 24.4%, compared to the same period in 2011. The increase is due
mainly to increased membership in the Medicaid and MA segments and the impact of
higher net favorable development of prior period medical benefits payable
experienced in 2011, partially offset by a decrease in the PDP segment. For the
three months ended June 30, 2012, medical benefits expense was impacted by
approximately $7.2 million of net unfavorable development related to
prior periods, which includes approximately $19.4 million of favorable
development related to prior fiscal years that was more than offset by $26.6
million of unfavorable development related to the first quarter of 2012. For
the six months ended June 30, 2012, medical benefits expense was impacted by
approximately $71.8 million of net favorable development related to prior years.
Net favorable development of prior period medical benefits payable amounted to
$67.1 million and $118.0 million for the three and six months ended June 30,
2011. Our consolidated MBR was 86.4% and 86.2% for the three and six months
ended June 30, 2012, respectively, compared to 81.9% and 84.4% for the same
periods in 2011. The increase in MBR was primarily due to the impact of
favorable prior period developments of medical benefits payable in 2011 and the
relatively high MBR in the Kentucky Medicaid program, partially offset by rate
increases in certain of our Medicaid markets and the impact of our medical cost
initiatives.
Effective January 1, 2012, we reclassified to medical benefits expense
certain costs related to quality improvement activities that were formerly
reported in SG&A expense. The quality improvement costs that we reclassified are
consistent with the criteria specified and defined in guidance issued by the
Department of Health and Human Services ("HHS") for costs that qualify to be
reported as medical benefits under the minimum medical loss ratio provision of
the 2010 Acts and include:
· Preventive health and wellness and care management;
· Case and disease management;
· Health plan accreditation costs;
· Provider education and incentives for closing care gaps;
· Health risk assessments and member outreach; and
· Information technology costs related to the above activities.
The reclassification of these quality improvement costs impacted our medical
benefits expense and MBR by reportable segment for the three and six months
ended June 30, 2011 as follows.
For the Three Months Ended June 30, 2011
Previously Amounts As
Reported Reclassified Adjusted
(Dollars in millions)
Medicaid medical benefits expense $ 647.7 $ 11.9 $ 659.6
Medicaid MBR % 78.5 % 1.4 % 79.9 %
MA medical benefits expense 298.1 4.7 302.8
MA MBR % 81.5 % 1.3 % 82.8 %
PDP medical benefits expense 238.5 1.1 239.6
PDP MBR% 86.4 % 0.4 % 86.8 %
Consolidated medical benefits expense $ 1,184.3 $ 17.7 $ 1,202.0
Consolidated MBR % 80.7 % 1.2 % 81.9 %
The reclassification of quality improvement costs impacted our consolidated MBR
by approximately 1.3%, 1.1% and 0.8% for the fiscal years ended December 31,
2011, 2010 and 2009, respectively, and impacted our SG&A ratio by approximately
1.3%, 1.0% and 0.8% for the same periods, respectively.
33
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For the Six Months Ended June 30, 2011
Previously Amounts As
Reported Reclassified Adjusted
(Dollars in millions)
Medicaid medical benefits expense $ 1,351.4 $ 24.4 $ 1,375.8
Medicaid MBR % 81.3 % 1.5 % 82.8 %
MA medical benefits expense 575.1 9.4 584.5
MA MBR % 79.8 %
1.3 % 81.1 %
PDP medical benefits expense 502.8 2.2 505.0
PDP MBR% 93.4 %
0.4 % 93.8 %
Consolidated medical benefits expense $ 2,429.3 $
36.0 $ 2,465.3
Consolidated MBR % 83.2 % 1.2 % 84.4 %
Selling, General and Administrative Expense
SG&A expense includes aggregate costs related to the resolution of the
previously disclosed governmental and Company investigations and related
litigation, such as settlement accruals and related fair value accretion, legal
fees and other similar costs. Refer to Part I - Item 1 - Note 10 - "Commitments
and Contingencies" for additional discussion of investigation-related litigation
and other resolution costs. We believe it is appropriate to evaluate SG&A
expense exclusive of these investigation-related litigation and other resolution
costs because we do not consider them to be indicative of long-term business
operations. Additionally, as discussed above, we reclassified costs related to
quality improvement activities that were formerly reported in SG&A expenses to
medical benefits expense effective January 1, 2012. Prior year amounts have been
reclassified to conform to the current year presentation.
The reconciliation of SG&A expense, including and excluding such costs, as well
as the reclassification of quality improvement costs, is as follows:
For the Three Months Ended June 30,
2012 2011
Previously Amounts As
Reported Reclassified Adjusted
(In millions)
SG&A expense $ 159.0 $ 164.7 $ (17.7 ) $ 147.0
Adjustments:
Investigation-related litigation and
other resolution costs (0.8 ) (4.2 ) - (4.2 )
Investigation-related administrative
costs (11.7 ) (7.9 ) - (7.9 )
Total investigation-related
litigation and other resolution costs (12.5 ) (12.1 ) - (12.1 )
SG&A expense, excluding
investigation-related litigation and
other resolution costs $ 146.5 $ 152.6 $ (17.7 ) $ 134.9
SG&A ratio 8.9 % 11.2 % -1.2 % 10.0 %
SG&A ratio, excluding
investigation-related litigation and
other resolution costs 8.2 % 10.4 % -1.2 % 9.2 %
34--------------------------------------------------------------------------------
For the Six Months Ended June 30,
2012 2011
Previously Amounts As
Reported Reclassified Adjusted
(In millions)
SG&A expense $ 320.7 $ 334.0 $ (36.0 ) $ 298.0
Adjustments:
Investigation-related litigation and
other resolution costs (2.2 ) (6.2 ) - (6.2 )
Investigation-related administrative
costs (23.1 ) (16.7 ) - (16.7 )
Total investigation-related litigation
and other resolution costs (25.3 ) (22.9 ) - (22.9 )
SG&A expense, excluding
investigation-related litigation and
other resolution costs $ 295.4 $ 311.1 $ (36.0 ) $ 275.1
SG&A ratio 9.0 % 11.4 % -1.2 % 10.2 %
SG&A ratio, excluding
investigation-related litigation and
other resolution costs 8.3 % 10.6 % -1.2 % 9.4 %
Excluding total investigation-related litigation and other resolution costs, our
SG&A expense for the three months ended June 30, 2012, increased approximately
$11.6 million, or 8.6%, to $146.5 million from $134.9 million for the same
period in 2011. Similarly, our SG&A expense for the six months ended June 30,
2012, increased approximately $20.3 million, or 7.3%, to $295.4 million from
$275.1 million for the same period in 2011. The increase in both periods was due
to technology investments, including those required by regulatory changes, as
well as medical cost initiatives, increased spending related to the launch of
our Kentucky Medicaid program and other growth initiatives. These increases were
partially offset by improvements in operating efficiency. Our SG&A expense as a
percentage of total revenue, excluding premium taxes ("SG&A ratio"), was 8.9%
for the three months ended June 30, 2012 compared to 10.0% for the same period
in 2011. After excluding the investigation-related litigation and other
resolution costs, our SG&A ratio for the three months ended June 30, 2012 was
8.2% compared to 9.2% for the same period in 2011. Our SG&A ratio was 9.0% for
the six months ended June 30, 2012 compared to 10.2% for the same period in
2011. After excluding the investigation-related litigation and other resolution
costs, our SG&A ratio for the six months ended June 30, 2012 was 8.3% compared
to 9.4% for the same period in 2011. The improvement in our SG&A ratio,
excluding investigation-related litigation and other resolution costs, is
related to the growth in premium revenue and improvement in our administrative
cost structure driven by business simplification projects, process management in
our shared services functions, and continued evaluation of our organizational
design. The improvement was partially offset by costs incurred for growth and
regulatory and quality initiatives.
Medicaid Premium Taxes
Medicaid premium taxes incurred for the three and six months ended June 30, 2012
were $20.1 million and $40.5 million, respectively, compared to $18.1 million
and $37.0 million, respectively, for the same three and six month periods in
2011. The increase corresponds to the increase in related premium revenues.
Interest Expense
Interest expense for the three and six months ended June 30, 2012 was $1.0
million and $2.1 million, respectively, compared to $98,000 and $175,000,
respectively, for the same periods in 2011. The increase in interest expense is
mainly driven by interest on the $150.0 million borrowed under the term loan on
August 1, 2011.
Income Tax Expense
Income tax expense for the three and six months ended June 30, 2012 was $30.9
million and $59.1 million, respectively, compared to $43.9 million and $57.6
million, respectively, for the same three and six month periods in the prior
year. Our effective income tax rate on pre-tax income was 40.0% and 37.7% for
the three and six months ended June 30, 2012, respectively, compared to 38.7%
and 38.8% for the same three and six month periods in 2011. The effective tax
rate was higher for the three months ended June 30, 2012 compared to the same
period in 2011 primarily due to the settlement of a state income tax matter
partially offset by a decrease in the prevailing effective state income tax
rate. The effective tax rate was lower for the six months ended June 30, 2012
compared to the same period in 2011 primarily due to changes in the estimated
non-deductible amounts associated with investigation-related litigation and
other resolution costs and a decrease in the prevailing effective state income
tax rate, that was partially offset by the settlement of a state tax matter in
the current year.
35
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Reconciling Segment Results
The following table reconciles our reportable segment results to income before
income taxes, as reported in conformity with accounting principles generally
accepted in the United States ("GAAP").
For the Three Months Ended
June 30, Change
2012 2011 Dollar Percentage
(In millions)
Gross Margin (1):
Medicaid $ 136.7 $ 183.7 $ (47.0 ) (25.6 )%
MA 76.0 63.1 12.9 20.4 %
PDP 50.3 36.5 13.8 37.8 %
Total gross margin 263.0 283.3 (20.3 ) (7.2 )%
Investment and other income 2.0 2.3 (0.3 ) (13.0 )%
Other expenses (1) (187.6 ) (172.1 ) (15.5 ) 9.0 %
Income before income taxes $ 77.4 $ 113.5 $ (36.1 ) (31.8 )%
For the Six Months Ended
June 30, Change
2012 2011 Dollar Percentage
(In millions)
Gross Margin (1):
Medicaid $ 307.7 $ 323.5 $ (15.8 ) (4.9 )%
MA 168.9 135.8 33.1 24.4 %
PDP 53.2 33.1 20.1 60.7 %
Total gross margin 529.8 492.4 37.4 7.6 %
Investment and other income 4.7 4.6 0.1 2.2 %
Other expenses (1) (377.8 ) (348.5 ) (29.3 ) 8.4 %
Income before income taxes $ 156.7 $ 148.5 $ 8.2 5.5 %
--------------------------------------------------------------------------------
(1) Gross margin by reportable segment and other expenses shown above reflects
the reclassification of quality improvement costs from selling, general and
administrative expense to medical benefits expense as discussed in "Medical
Benefits Expense" under "Summary of Consolidated Results." Refer to Part I -
Item 1 - Note 2 - "Segment Reporting" for reclassification by reportable
segment through the gross margin level.
36--------------------------------------------------------------------------------
Medicaid Segment Results
For the Three Months Ended
June 30, Change
2012 2011 Dollar Percentage
(Dollars in millions)
Premium revenue $ 1,077.3 $ 825.2 $ 252.1 30.6 %
Medicaid premium taxes 20.1 18.1 2.0 11.0 %
Total premiums 1,097.4 843.3 254.1 30.1 %
Medical benefits expense (2) 960.7 659.6 301.1 45.6 %
Gross margin (2) $ 136.7 $ 183.7 $ (47.0 ) (25.6 )%
Medicaid MBR (excluding premium taxes) (1) (2) 89.2 % 79.9 % 9.3 %
For the Six Months Ended
June 30, Change
2012 2011 Dollar Percentage
(Dollars in millions)
Premium revenue $ 2,131.6 $ 1,662.3 $ 469.3 28.2 %
Medicaid premium taxes 40.5 37.0 3.5 9.5 %
Total premiums 2,172.1 1,699.3 472.8 27.8 %
Medical benefits expense (2) 1,864.4 1,375.8 488.6 35.5 %
Gross margin (2) $ 307.7 $ 323.5 $ (15.8 ) (4.9 )%
Medicaid membership:
Georgia 569,000 559,000 1.8 %
Florida 436,000 404,000 7.9 %
Other states 513,000 354,000 44.9 %
1,518,000 1,317,000 15.3 %
Medicaid MBR (excluding premium taxes) (1) (2) 87.5 % 82.8 % 4.7 %
--------------------------------------------------------------------------------
(1) MBR measures the ratio of our medical benefits expense to premium revenue
excluding Medicaid premium taxes. Because Medicaid premium taxes are
included in the premium rates established in certain of our Medicaid
contracts and also recognized separately as a component of expense, we
exclude these taxes from premium revenue when calculating key ratios as we
believe that their impact is not indicative of operating performance. For
GAAP reporting purposes, Medicaid premium taxes are included in premium
revenue.
(2) Medicaid medical benefits expense, MBR and gross margin shown above reflect
the reclassification of quality improvement costs from selling, general and
administrative expenses to medical benefits expense as discussed in Medical
Benefits Expense under Summary of Consolidated Results. Refer to Part I -
Item 1 - Note 2 - "Segment Reporting" for reclassification of Medicaid
segment results through the gross margin level.
Excluding Medicaid premium taxes, Medicaid premium revenue for the three and six
months ended June 30, 2012 increased 30.6% and 28.2%, respectively, when
compared to the same periods in 2011. The increase was mainly due to premiums
associated with our Kentucky Medicaid program, which was launched on November 1,
2011, the carve-in of the pharmacy benefit in our New York and Ohio Medicaid
programs which were effective in October 2011, membership growth in Florida, and
rate increases implemented in most markets in late 2011.
Medicaid medical benefits expense for the three and six months ended June 30,
2012 increased 45.6% and 35.5%, respectively, when compared to the same periods
in 2011. The increase was due mainly to the increase in membership and the
relatively higher MBR in the Kentucky Medicaid program and the impact of higher
net favorable development of prior period medical benefits payable experienced
in 2011 compared to 2012, partially offset by the impact of medical cost
initiatives that we have implemented. Our Medicaid MBR for the three and six
months ended June 30, 2012 increased by 930 and 470 basis points, respectively,
when compared to the same three and six month periods in 2011. The increase was
driven by the relatively higher MBR in the Kentucky Medicaid program and the
impact of the higher net favorable development experienced in 2011 compared to
2012. The Kentucky Medicaid program MBR for the six month period ending June 30,
2012 was approximately 105.9% due to the relatively high transitional medical
benefit expenses for the program. As a result of processes that we have begun to
implement to improve care coordination and manage costs, and revenue
enhancements that are expected in later periods during 2012, we currently expect
the Kentucky Medicaid program to operate with an MBR below 100% during the
remainder of 2012.
37--------------------------------------------------------------------------------
Outlook
During the remaining months of 2012, we anticipate relatively stable membership
in our Medicaid segment and in the Kentucky Medicaid program in particular,
given that members are no longer able to switch plans outside the annual
election period. At this time, we are unable to estimate the additional
membership we will receive from our new contracts with Hawaii's QUEST program,
New York MLTC, Florida Healthy Kids and Florida Diversion Program. We expect the
full year MBR for our Medicaid segment to be higher in 2012 when compared to
2011, due to the high amount of favorable development of medical benefits
payable that we recognized in 2011.
MA Segment Results
For the Three Months Ended
June 30, Change
2012 2011 Dollar Percentage
(Dollars in
millions)
Premium revenue $ 455.5 $ 365.8 $ 89.7 24.5 %
Medical benefits expense (1) 379.5 302.7 76.8 25.4 %
Gross margin (1) $ 76.0 $ 63.1 $ 12.9 20.4 %
MA MBR (1) 83.3 % 82.8 % 0.5 %
For the Six Months Ended
June 30, Change
2012 2011 Dollar Percentage
(Dollars in
millions)
Premium revenue $ 893.7 $ 720.4 $ 173.3 24.1 %
Medical benefits expense (1) 724.8 584.6 140.2 24.0 %
Gross margin (1) $ 168.9 $ 135.8 $ 33.1 24.4 %
MA Membership 158,000 124,000 27.4 %
MA MBR (1) 81.1 % 81.1 % 0.0 %
--------------------------------------------------------------------------------
(1) Medicare medical benefits expense, MBR and gross margin shown above reflect
the reclassification of quality improvement costs from selling, general and
administrative expense to medical benefits expense as discussed in "Medical
Benefits Expense" under "Summary of Consolidated Results." Refer to Part I -
Item 1 - Note 2 - "Segment Reporting" for reclassification of Medicare
segment results through the gross margin level.
MA premium revenue for the three and six months ended June 30, 2012 increased
24.5% and 24.1%, respectively, when compared to the same three and six month
periods in 2011 and was mainly attributable to an increase in membership, which
increased by approximately 34,000 members between June 30, 2011 and June 30,
2012 due to our product design, strengthening of our sales processes and
heightened focus on membership growth activities during the annual election
period in 2011. MA segment MBR increased by 50 basis points for the three months
ended June 30, 2012, but remained unchanged for the six months ended June 30,
2012, compared to the same periods in 2011. The changes in the MBR were
primarily due to a change in the demographic mix of our members.
38
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Outlook
Currently, we expect MA segment membership to continue to grow during the
remaining months of 2012, as we leverage our success in serving dually-eligible
beneficiaries and as a result of the growth in the broader Medicare-eligible
population. We expect ultimate 2012 MBR for the MA segment to be higher than
that in the prior year due to the reduction of 2011 MBR for the recognition of
significant prior period development.
PDP Segment Results
For the Three Months Ended
June 30, Change
2012 2011 Dollar Percentage
(Dollars in
millions)
Premium revenue $ 256.3 $ 276.2 $ (19.9) (7.2 )%
Medical benefits expense (1) 206.0 239.7 (33.7) (14.1 )%
Gross margin (1) $ 50.3 $ 36.5 $ 13.8 37.8 %
PDP MBR (1) 80.4 % 86.8% (6.4 )%
For the Six Months Ended
June 30, Change
2012 2011 Dollar Percentage
(Dollars in
millions)
Premium revenue $ 531.9 $ 538.1 $ (6.2) (1.2 )%
Medical benefits expense (1) 478.7 505.0 (26.3) (5.2 )%
Gross margin (1) $ 53.2 $ 33.1 $ 20.1 60.7 %
PDP Membership 886,000 950,000 (6.7 )%
PDP MBR (1) 90.0 % 93.8 % (3.8 )%
--------------------------------------------------------------------------------
(1) PDP medical benefits expense, MBR and gross margin shown above reflect the
reclassification of quality improvement costs from selling, general and
administrative expense to medical benefits expense as discussed in "Medical
Benefits Expense" under "Summary of Consolidated Results." Refer to Part I -
Item 1 - Note 2 - "Segment Reporting" for reclassification of PDP segment
results through the gross margin level.
PDP premium revenue for the three and six months ended June 30, 2012
decreased by 7.2% and 1.2%, respectively, when compared to the same periods in
2011 primarily due to the decline in membership. Membership decreased by
approximately 64,000 members from June 30, 2011 to June 30, 2012 due to the
reassignment to other plans, effective January 1, 2012, of members who were
auto-assigned to us in 2011 or prior years. PDP MBR for the three and six months
ended June 30, 2012 decreased 640 and 380 basis points, respectively, over the
same periods in 2011 due to the outcome of our 2012 bids, improved pharmacy
claims experience and favorable development of prior period medical benefits
payable.
Outlook
We expect PDP membership and premium revenues to decrease slightly during
the remainder of 2012 due to normal attrition being offset by fewer new members
as we will be auto-assigned newly eligible members in only the five regions
where we are below the benchmark. Additionally, we now expect that our PDP
segment MBR will decrease in 2012 compared to 2011 based on the segment
operating results for the six months period ended June 30, 2012.
39--------------------------------------------------------------------------------
Liquidity and Capital Resources
Overview
Each of our existing and anticipated sources of cash is impacted by operational
and financial risks that influence the overall amount of cash generated and the
capital available to us. For a further discussion of risks that can affect our
liquidity, see Part I - Item 1A - "Risk Factors" included in our 2011 Form 10-K
and Part II - Item 1A - Risk Factors in this 2012 Form 10-Q.
Cash and Investment Positions
Our business consists of operations conducted by our regulated subsidiaries,
including HMOs and insurance subsidiaries, and our non-regulated subsidiaries.
The primary sources of cash for our regulated subsidiaries include premium
revenue, investment income and capital contributions made by us to our regulated
subsidiaries. Our regulated subsidiaries are each subject to applicable state
regulations that, among other things, require the maintenance of minimum levels
of capital and surplus. Our regulated subsidiaries' primary uses of cash include
payment of medical expenses, management fees to our non-regulated third-party
administrator subsidiary (the "TPA") and direct administrative costs, which are
not covered by the agreement with the TPA, such as selling expenses and legal
costs. We refer collectively to the cash and investment balances maintained by
our regulated subsidiaries as "regulated cash" and "regulated investments,"
respectively.
The primary sources of cash for our non-regulated subsidiaries are management
fees and dividends received from our regulated subsidiaries and investment
income. Our non-regulated subsidiaries' primary uses of cash include payment of
administrative costs not charged to our regulated subsidiaries for corporate
functions, including, but not limited to, business development, branding,
certain information technology services and debt service. Other primary uses
include capital contributions made by our non-regulated subsidiaries to our
regulated subsidiaries. We refer collectively to the cash and investment
balances available in our non-regulated subsidiaries as "unregulated cash" and
"unregulated investments," respectively.
Regulated cash and cash equivalents can fluctuate significantly in a particular
period depending on the timing of receipts for premiums from our government
partners. As further described in Net Cash Used In Operating Activities under
Cash Flow Activities, the Georgia DCH has delayed the payment of certain
premiums. We consider the delays to be a timing issue and we believe we have
adequate liquidity to manage the delays. Our unregulated cash, cash equivalents
and investments was $168.3 million as of June 30, 2012. During the six months
ended June 30, 2012, our non-regulated subsidiaries advanced funds to our
Georgia regulated entity to help offset the impact of Georgia DCH's delayed
payment of premiums, provided capital contributions to certain of our regulated
subsidiaries, and made payment of certain investigation-related litigation and
other resolution costs in connection with our settlement of the Civil Division
of the U.S. Department of Justice (the "Civil Division"). These decreases in
unregulated cash were partially offset by $100.0 million in dividends and
surplus capital received from certain of our regulated subsidiaries. Subsequent
to June 30, 2012, our Georgia health plan has received approximately
$164.0 million related to premiums receivable at June 30, 2012, which allowed it
to repay the amounts previously funded by our non-regulated subsidiaries. As a
result, our unregulated cash flow has increased subsequent to June 30, 2012.
40
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Regulatory Capital and Dividend Restrictions
Our operations are conducted primarily through HMO and insurance subsidiaries.
Each of these subsidiaries is licensed by the insurance department in the state
in which it operates, except our New York HMO subsidiary, which is licensed by
the New York State Department of Health, and is subject to the rules, regulation
and oversight of the applicable state agency in the areas of licensing and
solvency. State insurance laws and regulations prescribe accounting practices
for determining statutory net income and capital and surplus. Each of our
regulated subsidiaries is required to report regularly on its operational and
financial performance to the appropriate regulatory agency in the state in which
it is licensed. These reports describe each of our regulated subsidiaries'
capital structure, ownership, financial condition, certain intercompany
transactions and business operations. From time to time, any of our regulated
subsidiaries may be selected to undergo periodic audits, examinations or reviews
of our operational and financial assertions by the applicable state agency.
Each of our regulated subsidiaries generally must obtain approval from, or
provide notice to, the state in which it is domiciled before entering into
certain transactions such as declaring dividends in excess of certain
thresholds, entering into other arrangements with related parties, and
acquisitions or similar transactions involving an HMO or insurance company, or
any change in control. For purposes of these laws, in general, control commonly
is presumed to exist when a person, group of persons or entity, directly or
indirectly, owns, controls or holds the power to vote 10% or more of the voting
securities of another entity.
Each of our HMO and insurance subsidiaries must maintain a minimum amount of
statutory capital determined by statute or regulation. The minimum
statutory capital requirements differ by state and are generally based on a
percentage of annualized premium revenue, a percentage of annualized health care
costs, a percentage of certain liabilities, a statutory minimum RBC requirement
or other financial ratios. However, one or more of our regulators could require
one or more of our subsidiaries to maintain minimum levels of statutory net
worth in excess of the amount required under the current applicable state laws
if the regulators were to determine that such a requirement were in the interest
of our members. The risk-based capital ("RBC") requirements are based on
guidelines established by the National Association of Insurance Commissioners
("NAIC"), and have been adopted by most states. As of June 30, 2012, our HMO
operations in Connecticut, Georgia, Illinois, Indiana, Louisiana, Missouri, New
Jersey, Ohio and Texas as well as three of our insurance company subsidiaries
were subject to RBC requirements. The RBC requirements may be modified as each
state legislature deems appropriate for that state. The RBC formula, based on
asset risk, underwriting risk, credit risk, business risk and other factors,
generates the authorized control level ("ACL"), which represents the amount
of capital required to support the regulated entity's business. For states in
which the RBC requirements have been adopted, the regulated entity typically
must maintain minimum capital equal to the greater of 200% of the ACL and the
minimum statutory net worth requirement calculated pursuant to pre-RBC
guidelines. Our subsidiaries operating in Texas, Georgia and Ohio are required
to maintain statutory capital at RBC levels equal to 225%, 250% and 300%,
respectively, of the applicable ACL. Failure to maintain these requirements
would trigger regulatory action by the state. At June 30, 2012, our HMO and
insurance subsidiaries were in compliance with these minimum capital
requirements.
Credit Agreement
In 2011, we entered into a $300.0 million senior secured credit agreement (the
"Credit Agreement") that can be used for general corporate purposes. The Credit
Agreement provides for a $150.0 million term loan facility as well as a $150.0
million revolving credit facility. Upon closing, we borrowed $150.0 million
pursuant to the term loan facility and incurred approximately $2.5 million of
debt issuance costs that have been deferred and amortized over the life of the
agreement.
Both the term loan and revolving credit facility are set to expire in August
2016. Payments of principal on the term loan are due on a quarterly basis
through July 31, 2016. As of June 30, 2012, our remaining term loan balance was
$142.5 million, which is included in the current portion of long-term debt and
long-term debt line items in our consolidated balance sheet.
Our term loan bears interest at 2.00% as of June 30, 2012. Loans designated by
us at the time of borrowing as Alternate Base Rate ("ABR") Loans that are
outstanding under the credit facility bear interest at a rate per annum equal to
(i) the greatest of (a) the prime rate in effect on such day; (b) the federal
funds effective rate in effect on such day plus 0.50%; and (c) the adjusted
London Inter-Bank Offered Rate ("Adjusted LIBOR") for a one-month interest
period on such day plus 1% plus (ii) the applicable margin. Loans designated by
us at the time of borrowing as "Eurodollar Loans" that are outstanding under the
credit facility bear interest at a rate per annum equal to the Adjusted LIBOR
for the interest period in effect for such borrowing plus the applicable margin.
The "applicable margin" means a percentage ranging from 0.50% to 2.00% per annum
for ABR Loans and a percentage ranging from 1.50% to 3.00% per annum for
Eurodollar Loans, depending upon our ratio of total debt to consolidated
earnings before interest, taxes, depreciation and amortization ("EBITDA").
Unutilized commitments under the Credit Agreement are subject to a fee of 0.25%
to 0.45% depending upon the Company's ratio of total debt to cash flow. Interest
on the term loan is payable based on the LIBOR election period, which ranges
from one to six months based upon our election, with interest on the unutilized
commitment payable quarterly. Interest on the unutilized revolving credit
facility and borrowings under the term loan were $0.2 million and $1.6 million,
respectively, for a total interest expense amount of $1.8 million for the six
month period ended June 30, 2012. As of June 30, 2012 interest payable for the
term loan was $0.2 million.
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The Credit Agreement is subject to customary covenants and restrictions which,
among other things, limit our ability to incur additional indebtedness. In
addition, the Credit Agreement also includes certain financial covenants that
require (a) a total consolidated debt to consolidated EBITDA ratio (as defined
in the Credit Agreement) ("the Cash Flow Leverage Ratio") of not more than 2.25
times; (b) a minimum fixed charge coverage ratio (as defined in the Credit
Agreement) of 3.00 times; (c) a minimum level of statutory net worth for our HMO
and insurance subsidiaries; and (d) a requirement to maintain cash in an amount
equal to one year of payment obligations due and payable to the Civil Division
during the next twelve consecutive months, so long as such obligations remain
outstanding. For more information regarding our obligations to the Department of
Justice see Item 1 - Financial Statements - Note 10, Commitments and
Contingencies - Government Investigations.
On July 20, 2012, we amended our Credit Agreement to increase our ability to
incur indebtedness outside the Credit Agreement. The amendment increases the
maximum Cash Flow Leverage Ratio from 2.25 times to 2.75 times. Additionally,
the amendment permits us to incur senior and subordinated unsecured indebtedness
provided that our Cash Flow Leverage Ratio, calculated to include any such debt
incurred, is at least 0.25 times less than the maximum Cash Flow Leverage Ratio.
The limitation on our permitted capital expenditures under the Credit Agreement
increased from 1.0% to 1.75% of total consolidated revenue. Under the amendment,
if the Cash Flow Leverage Ratio exceeds 2.25 times, the applicable margin
applied to the prevailing interest rate would increase to 2.25% for ABR loans
and 3.25% for Adjusted LIBOR loans. Additionally, if our Cash Flow Leverage
Ratio exceeds 2.25 times, our unutilized commitment fee would increase to 0.50%.
The Credit Agreement also contains customary representations and warranties and
events of default. The payment of outstanding principal under the Credit
Agreement and accrued interest thereon may be accelerated and become immediately
due and payable upon our default of payment or other performance obligations or
our failure to comply with financial or other covenants in the Credit Agreement,
subject to applicable notice requirements and cure periods as provided in the
Credit Agreement.
As of the date of this filing, the revolving credit facility has not been drawn
upon and we remain in compliance with all covenants.
Auction Rate Securities
As of June 30, 2012, $32.9 million of our long-term investments were comprised
of municipal note securities with an auction reset feature ("auction rate
securities"), which are issued by various state and local municipal entities for
the purpose of financing student loans, public projects and other activities and
carry investment grade credit ratings. Liquidity for these auction rate
securities is typically provided by an auction process which allows holders to
sell their notes and resets the applicable interest rate at pre-determined
intervals, usually every seven or 35 days. As of the date of this 2012 Form
10-Q, auctions have failed for our auction rate securities and there is no
assurance that auctions will succeed in the future. An auction failure means
that the parties wishing to sell their securities could not be matched with an
adequate volume of buyers. In the event that there is a failed auction the
indenture governing the security requires the issuer to pay interest at a
contractually defined rate that is generally above market rates for other types
of similar instruments. The securities for which auctions have failed will
continue to accrue interest at the contractual rate and be auctioned every seven
or 35 days until the auction succeeds, the issuer calls the securities, or they
mature. As a result, our ability to liquidate and fully recover the carrying
value of our remaining auction rate securities in the near term may be limited
or non-existent. In addition, while all of our auction rate securities currently
carry investment grade ratings, if the issuers are unable to successfully close
future auctions and their credit ratings deteriorate, we may in the future be
required to record an impairment charge on these investments.
Although auctions continue to fail, we believe we will be able to liquidate
these securities without significant loss. There are government guarantees or
municipal bond insurance in place and we have the ability and the present intent
to hold these securities until maturity or market stability is restored.
Accordingly, we do not believe our auction rate securities are impaired and as a
result, we have not recorded any impairment losses for our auction rate
securities. However, it could take until the final maturity of the underlying
securities to realize our investments' recorded value. The final maturity of the
underlying securities could be as long as 27 years. The weighted-average life of
the underlying securities for our auction rate securities portfolio is 23 years.
Financial Impact of Government Investigation and Litigation
Under the terms of settlement agreements entered into on April 26, 2011, and
finalized on March 23, 2012, to resolve matters under investigation by the Civil
Division of the U.S. Department of Justice ("Civil Division") and certain other
federal and state enforcement agencies (the "Settlement"), WellCare agreed to
pay the Civil Division a total of $137.5 million over 36 months plus interest
accrued at 3.125%. On March 30, 2012, we made a payment of $39.8 million to the
Civil Division, consisting of a $34.4 million principal payment and $5.5 million
of accrued interest. The estimated fair value of the discounted remaining
liability, to be paid in three annual installments of $34.4 million, and related
interest, was $103.8 million at June 30, 2012.
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The Settlement also provides for a contingent payment of an additional $35.0
million in the event that we are acquired or otherwise experience a change in
control within three years of the effective date of the Settlement, provided
that the change in control transaction exceeds certain minimum transaction value
thresholds as specified in the Settlement.
Cash Flow Activities
Our cash flows are summarized as follows:
For the Six Months Ended June
30,
2012 2011
(In millions)
Net cash used in operating activities $ (193.6 ) $ (31.3 )
Net cash used in investing activities (96.0 ) (99.0 )
Net cash provided by financing activities 114.7 26.8
Total net decrease in cash and cash equivalents $ (174.9 ) $ (103.5 )
Net Cash Used In Operating Activities
We generally receive premiums in advance of payments of claims for health care
services; however, cash flows related to our operations can fluctuate
significantly in a particular period depending on the timing of premiums
receipts from our government partners or payments related to the resolution of
government investigations and related litigation. For the six months ended June
30, 2012, cash provided by operating activities benefited from the receipt of
$241 million for July 2012Medicare premiums, but was negatively impacted by the
delayed premiums associated with our Georgia Medicaid program and the $39.8
million payment made to the Civil Division on March 30, 2012.
The Georgia DCH has delayed the payment of certain premiums, primarily related
to May and June 2012, approximating $241.7 million as of June 30, 2012.
Subsequent to June 30, 2012, we received payment of the full amount of the July
2012 premiums, as well as $164.0 million related to premiums receivable at June
30, 2012. The subsequent payments have reduced the cumulative delayed premium
payments down to approximately $77.0 million as of August 3, 2012. If delays
continue through the third quarter of 2012, our consolidated operating cash flow
will be materially impacted. However, at this time, the delays are considered to
be a timing issue and we believe we have adequate liquidity to manage the
delays. We do not expect these delays to impact the operation of our programs in
Georgia or elsewhere.
Net cash used in operating activities for the six months ended June 30, 2011
primarily consisted of an increase in premiums receivable of $82.0 million, a
$52.5 million payment related to the investigation resolution and $42.0 million
of payments on accounts payable and other accrued expenses, partially offset by
an increase in income taxes payable of $29.5 million and $25.3 million in
deferred taxes.
Net Cash Used In Investing Activities
During the six months ended June 30, 2012, cash used in investing activities
primarily reflects our investment in marketable securities and restricted
investments of approximately $257.2 million and purchases of property and
equipment of $34.6 million, partially offset by $195.8 million of proceeds from
maturities of marketable securities and restricted investments.
During the six months ended June 30, 2011, cash used in investing activities
primarily reflects the $120.6 million net impact of our investment into higher
yielding investment alternatives and purchases of software and equipment
totaling approximately $17.2 million, partially offset by $38.7 million of
proceeds from the maturities of restricted investments, net of purchases.
Net Cash Provided By Financing Activities
Included in financing activities are funds receivable for the benefit of
members, which decreased approximately $112.3 million and $23.1 million during
the six months ended June 30, 2012 and 2011, respectively. These funds represent
reinsurance and low-income cost subsidies funded by CMS in connection with the
Medicare Part D program, for which we assume no risk.
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Contractual Obligations
In our 2011 Form 10-K, we reported our contractual obligations as of December
31, 2011. Since then, the Company entered into new operating lease agreements
for additional office space in Tampa, Florida. Expected future cash payments
under these leases as of June 30, 2012 are set forth below.
Payments due within: (In millions)
Less than 1 year $ 1.2
1 - 3 years 5.8
3 - 5 years 6.6
More than 5 years 5.0
$ 18.6
Critical Accounting Estimates
In the ordinary course of business, we make a number of estimates and
assumptions relating to the reporting of our results of operations and financial
condition in conformity with GAAP. We base our estimates on historical
experience and on various other assumptions that we believe to be reasonable
under the circumstances. Actual results could differ significantly from those
estimates under different assumptions and conditions. We believe that our
accounting estimates relating to premium revenue recognition, medical benefits
expense and medical benefits payable, and goodwill and intangible assets, are
those that are most important to the portrayal of our financial condition and
results and require management's most difficult, subjective and complex
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain. We have not changed our methodology in
deriving these critical accounting estimates from those previously disclosed in
our 2011 Form 10-K.
Premium Revenue Recognition
We receive premiums from CMS and state agencies for the members that are
assigned to, or have selected, us to provide health care services under our
Medicare and Medicaid contracts. The premiums we receive for each member vary
according to the specific government program and are generally determined at the
beginning of the respective contract period. These premiums are subject to
adjustment by CMS and state agencies throughout the term of the contracts,
although such adjustments are typically made at the commencement of each new
contract renewal period.
We recognize premium revenue in the period in which we are obligated to provide
services to our members. We are generally paid by CMS and state agencies in the
month in which we provide services. Any amounts that have been earned and have
not been received are recorded in our consolidated balance sheets as premiums
receivable. Any amounts received by us in advance of the period of service are
recorded as unearned premiums in the consolidated balance sheets and are not
recognized as revenue until the respective services have been provided. On a
monthly basis, we bill members for any premiums for which they are responsible
according to their respective plan. We estimate, on an ongoing basis, the amount
of member billings that may not be fully collectible based on historical trends.
An allowance is established for the estimated amount that may not be
collectible. Historically, the allowance for member premiums receivable has not
been significant relative to premium revenue. In addition, we routinely monitor
the collectability of specific premiums receivable, including Medicaid
receivables for obstetric deliveries and newborns (see "Medicaid" below) and net
receivables for member retroactivity as described below, and reflect any
required adjustments in current operations.
We record adjustments to premium revenue based on member retroactivity. These
adjustments reflect changes in the number and eligibility status of enrollees
subsequent to when revenue was billed. Premium payments are based upon
eligibility lists produced by CMS and state agencies. We verify these lists to
determine whether we have been paid for the correct premium category and
program. From time to time, CMS and state agencies require us to reimburse them
for premiums that we received for individuals who were subsequently determined
by us, or by CMS or state agencies, to be ineligible for any
government-sponsored program or to belong to a plan other than ours.
Additionally, the verification of membership may result in additional premiums
due to us from CMS and state agencies for individuals who were subsequently
determined to belong to our plan for periods in which we received no premium for
that member. We estimate the amount of outstanding retroactivity adjustments
each period and adjust premium revenue accordingly. As applicable, the estimates
of retroactivity adjustments are based on historical trends, premiums billed,
the volume of member and contract renewal activity and other information. The
amounts receivable or payable identified by us through reconciliation and
verification of membership eligibility lists, which relate to current and prior
periods, are included in premiums receivable, net and other accrued expenses and
liabilities in the accompanying consolidated balance sheets.
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Medicaid
Medicaid was established to provide medical assistance to low-income and
disabled persons. It is state operated and implemented, although it is funded
and regulated by both state and federal governments. Our Medicaid segment
generates revenue primarily from per member per month ("PMPM") premiums earned
pursuant to our contracts with government agencies in the states in which we
operate health plans. Our Medicaid contracts with state agencies are generally
multi-year contracts subject to annual renewal provisions. Annual rate changes
are recorded when they become effective. In some instances, our fixed base PMPM
premiums are subject to risk score adjustments based on the acuity of our
membership. Generally, the risk score is determined by the state agency's
analysis of encounter submissions of processed claims data to determine the
acuity of our membership relative to the entire state's Medicaid membership. In
Georgia, Illinois, Kentucky, Missouri, New York and Ohio, we are eligible to
receive supplemental payments for obstetric deliveries and newborns. Each
contract is specific as to how and when these supplemental payments are earned
and paid. Upon delivery of a newborn, the state agency is notified according to
the contract terms. Revenue is recognized in the period that the delivery occurs
and the related services are provided to our member. Additionally, in some
states, supplemental payments are received for certain services such as high
cost drugs and early childhood prevention screenings.
Minimum Medical Expense Provisions
Our Florida Medicaid and Healthy Kids contracts and Illinois Medicaid contract
require us to expend a minimum percentage of premiums on eligible medical
benefits expense. To the extent that we expend less than the minimum percentage
of the premiums on eligible medical benefits expense, we are required to refund
all or some portion of the difference between the minimum and our actual
allowable medical benefits expense. We estimate the amounts due to the state
agencies as a return of premium based on the terms of our contracts with the
applicable state agency. Such amounts are included in operations as reductions
of premium.
MA
The amount of premiums we receive for each MA member is established by contract,
although the rates vary according to a combination of factors, including upper
payment limits established by CMS, a member's geographic location, age, gender,
medical history or condition, or the services rendered to the member. Changes to
monthly premiums are also based upon a member's health status as described under
"Risk-Adjusted Premiums" below. MA premiums are due monthly and are recognized
as revenue during the period in which we are obligated to provide services to
members. Our MA contracts with CMS generally have terms of one year and expire
at the end of each calendar year. We also offer coverage of prescription drug
benefits under the Medicare Part D program as a component of our MA plans. See
further discussion of revenue recognition policies specific to Medicare Part D
in "PDP" below.
Risk-Adjusted Premiums
CMS employs a risk-adjustment model to determine the premium amount it pays for
each MA member. This model apportions premiums paid to all plans according to
the health status of each beneficiary enrolled. As a result, our CMS PMPM
premiums may change materially, either favorably or unfavorably. The CMS
risk-adjustment model pays more for MA members with predictably higher costs.
Diagnosis data from inpatient and ambulatory treatment settings are used to
calculate the risk-adjusted premiums we receive. We collect claims and encounter
data for our MA members and submit the necessary diagnosis data to CMS within
prescribed deadlines. After reviewing the respective submissions, CMS
establishes the premium payments to MA plans generally at the beginning of the
plan year, and then adjusts premium levels on two separate occasions on a
retroactive basis. The first retroactive adjustment for a given plan year
generally occurs during the third quarter of that year. This initial settlement
represents the update of risk scores for the current plan year based on the
severity of claims incurred in the prior plan year. CMS then issues a final
retroactive risk-adjusted premium settlement for that plan year in the following
year.
We develop our estimates for MA risk-adjusted premiums utilizing historical
experience and predictive models as sufficient member risk score data becomes
available over the course of each CMS plan year. Our models are populated with
available risk score data on our members. Risk premium adjustments are based on
member risk score data from the previous year. Because we are not privy to risk
score data for members new to our plans in the current plan year, we make
assumptions regarding these members' risk scores in our models. Estimates of
risk-adjusted premiums are periodically updated as additional diagnosis code
information is reported to CMS and are adjusted to actual amounts when the
ultimate adjustment settlements are either received from CMS or we receive
notification from CMS of such settlement amounts. As a result of the variability
of factors that determine our estimates for MA risk-adjusted premiums, the
actual amount of the CMS retroactive payment could be materially more or less
than our estimates. Resulting changes in estimate are reflected in current
operations as adjustments to premium revenue and could have a material adverse
effect on our results of operations, financial position and cash
flows. Historically, we have not experienced significant differences between the
amounts that we have recorded and ultimately received.
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Additionally, the data provided to CMS to determine members' risk scores is
subject to audit by CMS even after the annual settlements occur. An audit may
result in the refund of premiums to CMS. While our experience to date has not
resulted in a material refund, future refunds could materially reduce premium
revenue in the year in which CMS determines a refund is required.
PDP
We offer Medicare Part D coverage on a stand-alone basis through our PDPs. PDP
premiums received from CMS are also based upon contracts with CMS that have
terms of one year and expire at the end of each calendar year. Annually, we
provide written bids to CMS for our PDPs, which reflect the estimated costs of
providing prescription drug benefits over the plan year. Substantially all of
the premium for Medicare Part D coverage is paid by CMS, and the balance is due
from enrolled members. Payments received under the Medicare Part D program are
described below.
Member Premium-We bill members for monthly premiums for which they are
responsible based on the plan year bid submitted to CMS. The member premium,
which is fixed for the entire plan year, is recognized over the contract period
and reported as premium revenue. We establish an allowance for uncollectible
member premiums as previously disclosed.
CMS Direct Premium Subsidy-We receive a PMPM premium from CMS based on the plan
year bid 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, as
more fully described above under "MA - Risk Adjusted Premiums". As we do not
have access to diagnosis data with respect to our stand-alone PDP members, we
cannot anticipate changes in our members' risk scores. Changes in CMS premiums
related to risk-score adjustments for our stand-alone PDP membership are
recognized when the amounts become determinable and collectability is reasonably
assured, which occurs when we are notified by CMS of such adjustments. Although
we have not historically experienced material adjustments, future adjustments
could be material to our results of operations, financial position and cash
flows.
Low-Income Premium Subsidy-For qualifying low-income subsidy ("LIS") members,
CMS pays for some or all of the LIS members' monthly premium. The CMS payment is
dependent upon the member's income level as determined by the Social Security
Administration.
Low-Income Cost Sharing Subsidy-For qualifying LIS members, CMS reimburses us
for all or a portion of deductible, coinsurance and co-payment amounts above the
out-of-pocket threshold. Low-income cost sharing subsidies are paid by CMS
prospectively as a fixed PMPM amount and are determined based upon the plan year
bid submitted to CMS.
Catastrophic Reinsurance Subsidy-CMS reimburses us 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 PMPM amount and are determined based upon the plan
year bid submitted to CMS.
Coverage Gap Discount Subsidy-We receive monthly prospective payments from CMS
for advancing gap coverage discounts at the point of sale. The prospective
discount payments are determined based upon the plan year bid submitted by plan
sponsors to CMS and current plan enrollment. On a quarterly basis, CMS bills
pharmaceutical manufacturers for discounts provided by us and pharmaceutical
manufacturers remit payments for invoiced amounts directly to us. Subsequent
prospective payments made to us by CMS are then reduced by these discount
amounts billed to manufacturers. We do not have a history of adjustments for the
coverage gap discount subsidy due to the 2011 implementation.
After the close of the annual plan year, CMS reconciles our actual experience to
prospective payments we received for low income cost sharing, catastrophic
reinsurance, and coverage gap discount subsidies and any differences are settled
between CMS and our plans. As such, these subsidies represent funding from CMS
for which we assume no risk. The receipt of these subsidies and the payments of
the actual prescription drug costs related to the low-income cost sharing,
catastrophic reinsurance and coverage gap discounts are not recognized as
premium revenue or medical benefits expense, but are reported on a net basis as
funds receivable/held for the benefit of members in the consolidated balance
sheets. These receipts and payments are reported as financing activities in our
consolidated statements of cash flows. Historically, we have not experienced
material adjustments related to the CMS annual reconciliation of prior plan year
low-income cost sharing and catastrophic reinsurance subsidies.
CMS Risk Corridor- Premiums received from CMS are subject to risk sharing
through the Medicare Part D risk corridor provisions. The CMS risk corridor
calculation compares our actual experience to the target amount of prescription
drug costs, limited to costs under the standard coverage as defined by CMS, less
rebates included in our submitted plan year bid. Variances of more than 5% above
the target amount result in additional payments by CMS to us. Variances of more
than 5% below the target amount require us to refund amounts to CMS. We estimate
the risk corridor receivable or payable throughout the year as if the annual
contract were to terminate at the end of the reporting period and reflect any
adjustments to premium in current operations. This estimate provides no
consideration of future pharmacy claims experience, but does require us to
consider factors that may not be certain, including membership, risk scores,
prescription drug events, and rebates. Approximately nine months after the close
of the annual plan year, CMS reconciles actual experience to the target amount
and any differences are settled between CMS and our plans. Historically, we have
not experienced material adjustments related to the CMS settlement of prior
years' risk corridor estimates.
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Estimating Medical Benefits Payable and Medical Benefits Expense
The cost of medical benefits is recognized in the period in which services are
provided and includes an estimate of the cost of incurred but not reported
("IBNR") medical benefits. Medical benefits payable represents amounts for
claims fully adjudicated but not yet paid and estimates for IBNR and includes
direct medical expenses and medically-related administrative costs. Direct
medical expenses include amounts paid or payable to hospitals, physicians and
providers of ancillary services, such as laboratories and pharmacies. Recorded
direct medical expenses are reduced by the amount of pharmacy rebates earned,
which are estimated based on historical utilization of specific pharmaceuticals,
current utilization and contract terms. Pharmacy rebates earned but not yet
received from pharmaceutical manufacturers are included in pharmacy rebates
receivable in the accompanying consolidated balance sheets. Direct medical
expenses may also include reserves for estimated referral claims related to
health care providers under contract with us who are financially troubled or
insolvent and who may not be able to honor their obligations for the costs of
medical services provided by other providers. In these instances, we may be
required to honor these obligations for legal or business reasons. Based on our
current assessment of providers under contract with us, such losses have not
been and are not expected to be significant. Also, included in direct medical
expense are estimates for provider settlements due to clarification of contract
terms, out-of-network reimbursement, claims payment differences and amounts due
to contracted providers under risk-sharing arrangements. Medically-related
administrative costs include items such as preventative health and wellness,
care management, case and disease management, and other quality improvement
costs which are included in medical benefits expense, and other costs, such as
utilization review services, network and provider credentialing and claims
handling costs, which are recorded in selling, general, and administrative
expenses.
Medical benefits payable is the most significant estimate included in the
consolidated financial statements. We use a consistent methodology to record
management's best estimate of medical benefits payable based on the experience
and information available to us at the time. This estimate is determined
utilizing standard actuarial methodologies based upon historical experience and
key assumptions consisting of trend factors and completion factors using an
assumption of moderately adverse conditions, which vary by business segment.
These standard actuarial methodologies include using, among other factors,
contractual requirements, historic utilization trends, the interval between the
date services are rendered and the date claims are paid, denied claims activity,
disputed claims activity, benefits changes, expected health care cost inflation,
seasonality patterns, maturity of lines of business and changes in membership.
The factors and assumptions described above that are used to develop our
estimate of medical benefits expense and medical benefits payable inherently are
subject to greater variability when there is more limited experience or
information available to us. The ultimate claims payment amounts, patterns and
trends for new products and geographic areas cannot be precisely predicted at
their onset, since we, the providers and the members do not have experience in
these products or geographic areas. Standard accepted actuarial methodologies,
discussed above, would allow for this inherent variability. This can result in
larger differences between the originally estimated medical benefits payable and
the actual claims amounts paid. Conversely, during periods where our products
and geographies are more stable and mature, we have more reliable claims payment
patterns and trend experience. With more reliable data, we should be able to
more closely estimate the ultimate claims payment amounts; therefore, we may
experience smaller differences between our original estimate of medical benefits
payable and the actual claim amounts paid.
In developing our estimates, we apply different estimation methods depending on
the month for which incurred claims are being estimated. For the more recent
months, which constitute the majority of the amount of the medical benefits
payable, we estimate claims incurred by applying observed trend factors to the
fixed fee PMPM costs for prior months, which costs have been estimated using
completion factors, in order to estimate the PMPM costs for the most recent
months. We validate our estimates of the most recent PMPM costs by comparing the
most recent months' utilization levels to the utilization levels in prior months
and actuarial techniques that incorporate a historical analysis of claim
payments, including trends in cost of care provided and timeliness of submission
and processing of claims.
Many aspects of the managed care business are not predictable. These aspects
include the incidences of illness or disease (such as congestive heart failure
cases, cases of upper respiratory illness, the length and severity of the flu
season, diabetes cases, the number of full-term versus premature births and the
number of neonatal intensive care babies). Therefore, we must continually
monitor our historical experience in determining our trend assumptions to
reflect the ever-changing mix, needs and size of our membership. Among the
factors considered by management are changes in the level of benefits provided
to members, seasonal variations in utilization, identified industry trends and
changes in provider reimbursement arrangements, including changes in the
percentage of reimbursements made on a capitation as opposed to a
fee-for-service basis. These considerations are reflected in the trends in our
medical benefits expense. Other external factors such as government-mandated
benefits or other regulatory changes, catastrophes and epidemics may impact
medical cost trends. Other internal factors such as system conversions and
claims processing interruptions may impact our ability to accurately predict
estimates of historical completion factors or medical cost trends. Medical cost
trends potentially are more volatile than other segments of the economy.
Management uses considerable judgment in determining medical benefits expense
trends and other actuarial model inputs. We believe that the amount of medical
benefits payable as of June 30, 2012 is adequate to cover our ultimate liability
for unpaid claims as of that date; however, actual payments may differ from
established estimates. If the completion factors we used in estimating our IBNR
for the six months ended June 30, 2012 were decreased by 1%, our net income
would decrease by approximately $39.4 million. If the completion factors were
increased by 1%, our net income would increase by approximately $38.4 million.
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Changes in medical benefits payable estimates are primarily the result of
obtaining more complete claims information and medical expense trend data over
time. Volatility in members' needs for medical services, provider claims
submissions and our payment processes result in identifiable patterns emerging
several months after the causes of deviations from assumed trends occur. Since
our estimates are based upon PMPM claims experience, changes cannot typically be
explained by any single factor, but are the result of a number of interrelated
variables, all of which influence the resulting medical cost trend. Differences
between actual experience and estimates used to establish the liability, which
we refer to as prior period developments, are recorded in the period when such
differences become known and have the effect of increasing or decreasing the
reported medical benefits expense in such periods.
After determining an estimate of the base reserve, actuarial standards of
practice require that a margin for uncertainty be considered in determining the
estimate for unpaid claim liabilities. If a margin is included, the claim
liabilities should be adequate under moderately adverse conditions. Therefore,
we make an additional estimate in the process of establishing the IBNR, which
also uses standard actuarial techniques, to account for adverse conditions that
may cause actual claims to be higher than estimated compared to the base
reserve, for which the model is not intended to account. We refer to this
additional liability as the provision for moderately adverse conditions. The
provision for moderately adverse conditions is a component of our overall
determination of the adequacy of our IBNR reserve and the provision for
moderately adverse conditions is intended to capture the potential adverse
development from factors such as our entry into new geographical markets, our
provision of services to new populations such as the aged, blind and disabled,
the variations in utilization of benefits and increasing medical cost, changes
in provider reimbursement arrangements, variations in claims processing speed
and patterns, claims payment, the severity of claims, and outbreaks of disease
such as the flu. Because of the complexity of our business, the number of states
in which we operate, and the need to account for different health care benefit
packages among those states, we make an overall assessment of IBNR after
considering the base actuarial model reserves and the provision for moderately
adverse conditions. We consistently apply our IBNR estimation methodology from
period to period. We review our overall estimates of IBNR on a monthly basis. As
additional information becomes known to us, we adjust our assumptions
accordingly to change our estimate of IBNR. Therefore, if moderately adverse
conditions do not occur, evidenced by more complete claims information in the
following period, then our prior period estimates will be revised downward,
resulting in favorable development. However, when a portion of the development
related to the prior year incurred claims is offset by an increase determined to
address moderately adverse conditions for the current year incurred claims, we
do not consider that development amount as having any impact on net income
during the period. If moderately adverse conditions occur and are more than we
estimated, then our prior period estimates will be revised upward, resulting in
unfavorable development, which would decrease current period net income.
For the three months ended June 30, 2012, medical benefits expense was
impacted by approximately $7.2 million of net unfavorable development related to
prior periods, which includes approximately $19.4 million of favorable
development related to prior fiscal years that was more than offset by $26.6
million of unfavorable development related to the first quarter of 2012. For
the six months ended June 30, 2012, medical benefits expense was impacted by
approximately $71.8 million of net favorable development related to prior years.
For the three and six months ended June 30, 2011, medical benefits expense was
impacted by approximately $67.1 million and $118.0 million, respectively, of net
favorable development related to prior periods. The unfavorable development
recognized in the three months ended June 30, 2012 relating to earlier periods
in 2012 was primarily due to higher than expected medical services in our
Medicaid segment, particularly in Kentucky, that were not discernible until the
impact became clearer over time as claim payments were processed. The net
favorable prior year development recognized in 2012 was due mainly to lower than
projected utilization in all of our segments. The net favorable prior year and
prior period development in 2011 was attributable to the medical cost trend
emerging favorably, mostly in our Medicaid segment and to a lesser extent in our
MA segment, primarily due to lower than projected utilization.
Goodwill and Intangible Assets
We review goodwill and other intangible assets for potential impairment at least
annually, or more frequently if events or changes in circumstances occur that
may affect the estimated useful life or the recoverability of the remaining
balance of goodwill or other intangible assets. Such events or changes in
circumstances would include significant changes in membership, state funding,
federal and state government contracts and provider networks. We evaluate the
potential impairment of goodwill and other intangible assets using both the
income and market approach. In doing so, we must make assumptions and estimates,
such as projected revenues and the discount factor, in estimating fair values.
While we believe these assumptions and estimates are appropriate, other
assumptions and estimates could be applied and might produce significantly
different results. We use a two-step process to review goodwill for impairment.
The first step is a screen for potential impairment, and the second step
measures the amount of impairment, if any. An impairment loss is recognized for
goodwill and intangible assets if the carrying value of such assets exceeds its
fair value. We select the second quarter of each year for our annual goodwill
potential impairment test, which generally coincides with the finalization of
federal and state contract negotiations and our initial budgeting process, with
the test completed during the third quarter of that year. As of our most recent
testing date in 2011, we have determined that the estimated fair value of the
Medicaid reporting segment exceeded its carrying value. Based on our review at
June 30, 2012, including consideration of the termination of our Missouri and
Ohio Medicaid contracts as discussed in Part I - Item 1 - Note 1 -
"Organization, Basis of Presentation and Significant Accounting Policies", we
determined that there was no impairment of recorded goodwill and intangible
assets as of June 30, 2012.
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Commitments and Contingencies
Based on the nature of our business, we are subject to regulatory reviews or
other investigations by various state insurance and health care regulatory
authorities and other state and federal regulatory authorities. These
authorities regularly scrutinize the business practices of health insurance and
benefits companies and their reviews focus on numerous facets of our business,
including claims payment practices, provider contracting, competitive practices,
commission payments, privacy issues and utilization management practices, among
others. Some of these reviews have historically resulted in fines imposed on us
and some have required changes to our business practices. We continue to be
subject to such reviews, which may result in additional fines and/or sanctions
being imposed or additional changes in our business practices.
We are also involved in other legal actions in the normal course of our
business, including without limitation, wage and hour disputes, tax disputes,
vendor disputes and provider disputes regarding payment of claims. Some of these
actions seek monetary damages, including claims for liquidated or punitive
damages, which are not covered by insurance. We accrue losses for such
contingencies to the extent that we believe it is probable that a liability has
been incurred and the amount of the loss can be reasonably estimated. It is
possible the actual outcomes of legal actions may differ materially from our
current estimates and may materially impact our results of operations, financial
condition and cash flows.
