WELLCARE HEALTH PLANS, INC. – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.
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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Item 6 - Selected Financial Data and our consolidated financial statements and related notes appearing elsewhere in this 2012 Form 10-K. The following discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause our actual results to differ materially from management's expectations. Factors that could cause such differences include those set forth under Part I, Item 1 - Business and Part I, Item 1A - Risk Factors, as well as Forward-Looking Statements discussed earlier in this 2012 Form 10-K.
We are a leading provider of managed care services to government-sponsored health care programs, focusing on
Medicaidand Medicare. Headquartered in Tampa, Florida, we offer a variety of health plans for families, children, and the aged, blind and disabled, as well as prescription drug plans. As of December 31, 2012, we served approximately 2.7 million members nationwide. We believe that our broad range of experience and exclusive government focus allows us to effectively serve our members, partner with our providers and government clients, and efficiently manage our ongoing operations.
Summary of Consolidated Financial Results
Summarized below are the key highlights for the year ended
• Membership increased 4%, reflecting growth in our
Kentucky, which commenced in November 2011and had a subsequent open enrollment in November 2012, and in Florida, as well as growth in our Medicare MA membership due to service area expansion. • Premiums increased 21%, mainly reflecting the membership growth in our
in certain of our
• Net Income decreased 30%, primarily due to a decrease in our
segment results, and higher selling, general and administrative expense
("SG&A") expense - mainly due to our spending on quality and growth
initiatives; partially offset by improved results in our MA and PDP
segments. 2011 results also benefited from a pre-tax gain of
on the repurchase of subordinated notes. The decrease in
results was due mainly to a lower amount of net favorable development of
prior period medical benefits payable in 2012 than occurred in 2011, and a
relatively higher MBR in the Kentucky Medicaid program due to transition
of members into managed care.
Key Developments and Accomplishments
Our strategic priorities for 2012 included improving health care quality and access for our members, ensuring a competitive cost position and delivering prudent and profitable growth.
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 and for 2013, prior to the filing of this 2012 Form 10-K.
MO HealthNet Medicaid program members in 54 counties across the state. • In
January 2013, we acquired UnitedHealthcare Group Incorporated's Medicaidbusiness in South Carolina, which participates in South
Carolina's Healthy Connections Choices program across 39 of the state's 46
Health Plan, Inc.'sDesert Canyon Community Care (" Desert Canyon") MA plans. Approximately 4,000 Desert Canyonplan members in Mohave and Yavapai Counties became members of our Arizona MA health plan on January 1, 2013. 48
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("Easy Choice"). As of
52,000 MA plan members. Easy Choice increased its 2013 service area to 11• As of
Californiacounties, including the San Diegoarea and five counties in northern California. Easy Choice began offering MA chronic condition special needs plans in five of the 11 counties in its service area in January 2013. • In October 2012, we added approximately 20,000 new Florida Healthy Kids members as a result of our expansion from serving 18 counties to 65 of Florida's67 counties. We now offer Florida Healthy Kids services in more counties than any other participating plan.
program to include all 67 counties across
Florida. We also received a premium rate increase of approximately 3.0% to 3.5% retroactive to September 1, 2012. • In October 2012, we were awarded a contract by the Commonwealth of
beneficiaries in Region 3 effective
2013, our membership for this region was estimated to be more than 20,000. • The
Commonwealth of Kentuckyrecently completed its initiative to ensure
cost-effective care to members on a sustainable, long-term basis. As a
7.0% premium rate increase for the Kentucky Medicaid program. The
Commonwealth also has accelerated to
previously scheduled for
Human Services to case manage, authorize and facilitate the delivery of
behavioral health services to
mental illnesses, and who are participants in the state's QUEST Expanded
Access (QExA) health program on a statewide basis. We anticipate services
March 2013. • We continue to expand the geographic footprint of our MA plans and offer
D-SNPs for those who are dually-eligible for
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
MA membership as of
from 213,000 as of
December 31, 2012. For the 2013 plan year, we now offer plans in a total of 204 counties.
a 2.5 Star summary rating. We are focused on improving quality across all
of our lines of business. For example, as a result of our quality
improvement measures, we met the performance requirements of our contracts
under the New York Medicaid and FHP programs, which were subject to
termination if our quality scores did not improve, and we will continue to
provide services to members of our
New Yorkhealth plans, and we now have quality health plan status.
• Our 2012 quality accomplishments include the new health plan accreditation
health plans were awarded NCQA accreditation. We continue to target
accreditation for all of our health plans, and anticipate further progress
in 2013. • With respect to our strategic priority of ensuring a competitive cost
structure, 2012 was a year of significant progress. Our administrative
expense ratio decreased 120 basis points year-over-year to 9.4% in 2012 compared to 10.6% in 2011. 49
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Business and Financial Outlook
General Economic, Political Environment and Health Care Reform
A number of states are evaluating new strategies for their
Medicaidprograms. Given ongoing fiscal challenges, economic conditions, and the success of Medicaidmanaged 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. Additionally, we believe that the 2010 Acts will bring about significant changes to the American health care system. For further discussion of the current and political environment that is affecting our business, including health care reform and its potential impact on our business, see Part I, Item 1 - Business, General Economic and Political Environment Impacting our Business. In addition, refer to the risks and uncertainties related to health care reform as discussed in Part I, Item 1A - Risk Factors - Future changes in health care law present challenges for our business that could have a material adverse effect on our results of operations and cash flows. MedicaidOur Florida Medicaid contracts expire in August 2015, however we currently anticipate that these will be terminated early, possibly as early as the end of 2013. The Floridaagency that operates the state's Medicaidprogram, AHCA, recently began a competitive procurement process to award contracts for Medicaidmanaged care across the state. The agency has not yet announced the implementation schedule, but it expects to award contracts under the competitive procurement in 2013. We currently intend to submit a proposal under this process but we cannot assure you our proposal will be successful. Additionally in Florida, AHCAplans to amend the DRG schedule that it uses to set rates for certain providers whose contracts are tied to Medicaideffective July 1, 2013, which may increase or decrease our payments to these providers. In addition, our recent amendments to our Medicaidcontracts with AHCArequired us to comply with federal law related to increased reimbursements to Medicaidproviders. We do not currently expect to increase the reimbursement amounts until we receive an adjustment to the premium rates we receive, but if we are required to do so in the future, our medical benefits expense and medical benefits ratio would increase. In 2012, the Georgia Department of Community Health(the "Georgia DCH") announced further refinements to its Medicaidredesign 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 an additional one-year renewal option exercisable by the Georgia DCH. The Georgia DCH exercised its option to extend the term of our Georgia Medicaid contract until June 30, 2013and the remaining renewal option potentially extends the contract through June 30, 2014. The Georgia DCH has also indicated its intent to amend our Georgia Medicaidcontract to include two additional one-year renewal options, exercisable by the Georgia DCH, that could potentially extend the contract term to June 30, 2016. The Georgia DCH also plans to move forward with several changes to modernize the Georgia Families program. These may include the promotion of a Primary Care Medical Home initiative, a move to value-based purchasing, and the adoption of a common preferred drug list. Additionally, the state is looking to simplify the administrative process for providers by moving all three care management organizations operating in the state to a common platform for functions such as credentialing, and prior authorization management. We look forward to working with the Georgia DCH to accomplish these initiatives. Beginning with the fourth quarter 2012, the Commonwealth of Kentuckyeliminated its caps on the risk adjustment of premium rates for the Medicaidprogram. We began serving Medicaidbeneficiaries in Region 3 of the Commonwealth of Kentuckyon January 1, 2013. As of January 1, 2013, our membership for this region was estimated to be more than 20,000. Region 3 members will have the opportunity to change their health plan through the end of March. In addition, the members assigned to us in January will be served under a 30 day transition of care period. As a result of our quality improvement measures, we met the performance requirements of our contracts under the New York Medicaid and FHP programs, which were subject to termination if our quality scores did not improve, and we will continue to provide services to members of our New Yorkhealth plans, and we now have quality health plan status. 50
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With respect to
Medicaidrates, we continue to expect the environment to be challenging, given state and federal fiscal conditions. The ultimate premium rate is based on program type, demographic mix and geographic location. We estimate that our rates will decrease approximately 0.3% in Georgiaretroactive to July 1, 2012. In Florida, we estimate that our rates will increase approximately 3.0 to 3.5%, retroactive to September 1, 2012. We estimate that our rates will increase by approximately 7.0% in Kentuckyretroactive to January 1, 2013. In addition, we expect the approximately 3.0% rate increase we were scheduled to receive on October 1, 2013will be accelerated to July 1, 2013. These rate increases apply to all regions other than the newly launched Region 3. Although premiums are generally contractually payable to us before or during the month in which we are obligated to provide services to our members, we have experienced delays in premium payments from certain states. Given the budget shortfalls in many states with which we contract, additional payment delays may occur in the future. Provider reimbursement levels are subject to change by the states and the Centers for Medicare and Medicaid Services("CMS"). In addition, some hospital contracts are directly tied to state Medicaidfee schedules, resulting in reimbursement levels that may be adjusted up or down, generally on a prospective basis, based on adjustments made by the state to the fee schedule. We have experienced, and may continue to experience, such adjustments. Unless such adjustments are mitigated by corresponding changes in premiums, our profitability will be negatively impacted.
As a result of the 2013 annual election period, we have expanded our MA service area to a total of 204 counties. Upon the completion of the acquisitions of Easy Choice and
Desert Canyon, we expanded our MA services to Californiaand Arizonaand grew our presence in Florida, Georgia, Illinois, New York, and Texas. We also now offer our MA plans to some of the dually eligible members we currently serve through the Kentucky Medicaid program.
Prescription Drug Plans (PDP)
Based on the outcome of our 2013 stand-alone prescription drug plan ("PDP") bids, our plans are below the benchmarks in 14 of the 34 CMS regions and within the de minimis range of the benchmark in five other CMS regions. Comparatively, in 2012, our plans were below the benchmark in five regions and within the de minimis range in 17 other regions. In 2013, we will be auto-assigned newly-eligible members into our plans for the 14 regions that are below the benchmark. We will retain our auto-assigned members in the five regions in which we bid within the de minimis range, however, we will not be auto-assigned new members in those regions during 2013. Members previously auto-assigned to our PDP plans in regions for which our 2013 bids were not within the de minimus range will be reassigned to other plans in 2013. Consequently, membership has declined to approximately 750,000 as of
January 2013, a decrease from 869,000 as of December 31, 2012due to the reassignment to other plans of members who were previously auto-assigned to us, primarily in California, offset in part by additional auto-assignments to us in other regions and an increase in the members who actively chose our PDP plans. We expect membership for the remainder of 2013 to be relatively stable. A decrease in premium rates will further affect our PDP segment's results of operations in 2013.
January 2013, three states have executed Memorandums of Agreement with CMS to participate in the Duals Alignment Demonstration Program, a key step in demonstration implementation, and eighteen States are still negotiating with CMS on their demonstration parameters. CMS has issued guidance that no programs will begin before April 1, 2013and the target enrollment will be limited to 1 to 2 million beneficiaries. Exact implementation times vary by state. 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 MA 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'squality 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 Program will only be able to elect to remain in or join a WellCareplan during the annual enrollment period or special election periods. 51
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The guidance promulgated by CMS requires a cost savings to both
Medicareand 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 states' programs have not permitted us to participate, due to our plan's program design. For those states that have a Duals-Eligible Demonstration Program in which we do not participate, the membership in our MA and PDP plans in those states would be reduced. Per CMS guidance, Part D auto assignments to another PDP will be limited to January 1, 2014, and January 1, 2015, for 2013 and 2014 demonstration states, respectively.
RESULTS OF OPERATIONS
Consolidated Financial Results
The following table sets forth condensed data from our consolidated statements of comprehensive income (loss), as well as other key data used in our results of operations discussion for the year ended
December 31, 2012, compared to the years ended December 31, 2011and 2010. The historical results are not necessarily indicative of results to be expected for any future period. For the Years Ended December 31, 2012 2011 2010 Revenues: (Dollars in millions, except per share data) Premium $ 7,400.2 $ 6,098.1 $ 5,430.2 Investment and other income 8.8 8.7 10.0 Total revenues 7,409.0 6,106.8 5,440.2 Expenses: Medical benefits 6,303.9 4,948.0 4,594.5 Selling, general and administrative 690.8 642.1 838.0 Medicaid premium taxes 82.2 76.2 56.4 Depreciation and amortization 31.6 26.4 23.9 Interest 4.1 6.5 0.2 Total expenses 7,112.6 5,699.2 5,513.0 Income (loss) from operations 296.4 407.6 (72.8 ) Gain on repurchase of subordinated notes - 10.8 - Income (loss) before income taxes 296.4 418.4 (72.8 ) Income tax (benefit) expense 111.7 154.2 (19.4 ) Net income (loss) $ 184.7 $ 264.2 $ (53.4 ) Effective Tax Rate 37.7 % 36.9 % 26.7 % Membership by Segment Medicaid 1,587,000 1,451,000 1,340,000 MA 213,000 135,000 116,000 PDP 869,000 976,000 768,000 Total 2,669,000 2,562,000 2,224,000 52
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December 31, 2012, we served approximately 2,669,000 members; an increase of approximately 107,000 members from December 31, 2011. We experienced membership growth in both our Medicaidand MA segments when compared to December 31, 2011, which was offset by a decline in PDP membership. Medicaidsegment membership increased by 136,000 mainly from membership growth in Florida, membership growth in our Kentucky Medicaid program following its launch in the fourth quarter of 2011 and subsequent open enrollment in November 2012, and membership growth in our Hawaii Medicaid program due to our participation in Hawaii'sQUEST program beginning in July 2012. Our Kentucky Medicaid membership increased from 129,000 at December 31, 2011to 207,000 at December 31, 2012. Members participating in the Kentucky Medicaid program were able to switch plans until January 31, 2012, and membership has also increased due to retroactive member re-assignments. MA segment membership increased by 78,000 compared to December 31, 2011, due to the Easy Choice acquisition, and as a result of the annual election period during 2011, 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. Excluding the Easy Choice plan, December membership was 174,000, up 29% from December 2011. In our PDP segment, membership decreased by 107,000 compared to December 31, 2011as 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.
2011 vs. 2010
December 31, 2011, we served approximately 2,562,000 members; an increase of 338,000 members from December 3, 2010. We experienced membership growth in all of our segments. Our Medicaidsegment grew with the launch of the Kentucky Medicaidprogram on November 1, 2011. As of December 31, 2011, we served 129,000 Medicaidmembers in Kentucky. For our MA segment, we focused on our membership growth activities during the annual election period in the fourth quarter of 2010. Our products have benefit designs that are attractive to both current and prospective members. We invested in strengthening our sales processes and organization and ensuring an effective on-boarding experience for our new members. We added approximately 19,000 MA members from December 31, 2010. In our PDP segment, our plans were below the benchmark in 20 of the 34 CMS regions in 2011, an increase of one region from 2010. Additionally, we were within the de minimis range in eight additional regions. As a result, we added approximately 208,000 PDP members compared to December 31, 2010.
Net income (loss)
2012 vs. 2011
For the year ended
December 31, 2012, our net income was $184.7 millioncompared to $264.2 millionfor the same period in 2011. Excluding the impact of investigation-related settlements and litigation costs and the 2011 gain on repurchase of subordinated notes, which amounted to a net expense of $30.9 millionand $27.2 million, net of tax, for the years ended December 31, 2012and 2011, respectively, net income decreased by $75.8 millionin 2012 compared to 2011. The decrease resulted mainly from a decrease in our Medicaidsegment results, higher SG&A expense, partially offset by improved results in our MA and PDP segments. The decrease in our Medicaidsegment results were due to the impact of higher net favorable development of prior period medical benefits payable experienced in 2011, the relatively higher MBR in the Kentucky Medicaidprogram, and a $21.4 millionreduction to premium revenue recorded during the third and fourth quarters of 2012 related to a reconciliation of duplicate member records in Georgiadating back to the beginning of the program in 2006. These decreases were partially offset by the impact of higher membership and related premium revenues and the impact of rate increases in certain markets. The improved result in our MA segment was 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 rate of increase in premium revenues. 53
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2011 vs. 2010
For the year ended
December 31, 2011, our net income was $264.2 millioncompared to a net loss of <money>$53.4 million for the same period in 2010. Excluding the impact of investigation-related settlements, litigation costs and gain on repurchase of subordinated notes, all of which amounted to a net expense of $27.2 millionand $167.6 million, net of tax, for the years ended December 31, 2011and 2010, respectively, net income increased by $177.2 million, or 155%, in 2011 compared to 2010. The increase in 2011 resulted mainly from improved results in our Medicaidsegment, largely driven by increased premium revenue and the impact of net favorable reserve development of prior period medical benefits payable, rate increases in certain markets, and to a lesser extent, improved results in our PDP segment, mainly driven by an increase in membership. Such increases were partially offset by an increase in SG&A expense and interest incurred on debt. Premium revenue 2012 vs. 2011 Premium revenue for the year ended December 31, 2012increased by approximately $1,302.1 million, or 21%, compared to the same period in the prior year. The increase is primarily attributable to membership growth in our Medicaidand MA segments and rate increases in certain of our Medicaidmarkets, offset by a $21.4 millionreduction to premium revenue related to a reconciliation of duplicate member records in the Georgia Medicaid program dating back to the beginning of the program in 2006. Premium revenue includes $82.2 millionand $76.2 millionof Medicaidpremium taxes for the years ended December 31, 2012and 2011, respectively. 2011 vs. 2010 Premium revenue for the year ended December 31, 2011increased by approximately $667.9 million, or 12%, compared to the same period in the prior year primarily due to membership growth during 2011 in our PDP and MA segments, rate increases in certain of our Medicaidmarkets, the launch of our Kentucky Medicaid program in November 2011and additional premiums recognized in connection with retrospective maternity claims in Georgia. Premium revenue includes $76.2 millionand $56.4 millionof Medicaidpremium taxes for the years ended December 31, 2011and 2010, respectively.
Investment and other income
2012 vs. 2011
Investment and other income amounted to
2011 vs. 2010
Investment and other income amounted to
$8.7 millionin 2011 compared to $10.0 millionin 2010. The decrease was due to lower volumes of specialty prescription drugs sold to non-members, partially offset by an increase in investment income resulting from higher average investment balances.
Medical benefits expense
2012 vs. 2011
Total medical benefits expense for the year ended
December 31, 2012increased $1,356.0 million, or 27%, compared to the same period in 2011. The increase is due mainly to increased membership in the Medicaidand MA segments, higher overall utilization in the Medicaidand MA segments in the first half of 2012 and 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 a decrease in the PDP segment. For the year ended December 31, 2012, medical benefits expense was impacted by approximately $76.7 millionof net favorable development related to prior periods compared to $191.2 millionof such development recognized in 2011. 54
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2011 vs. 2010
Total medical benefits expense for the year ended
December 31, 2011increased $353.5 million, or 8%, compared to the same period in 2010. The increase in medical benefits expense is due mainly to the increase in PDP membership, the increase in MBR in the PDP segment that was consistent with our bids, and increased membership and higher MBR in the MA segment. The increases were partially offset by lower expense in the Medicaidsegment resulting principally from the impact of net favorable prior period development in medical benefits payable and our medical expense initiatives. For the year ended December 31, 2011, medical benefits expense was impacted by approximately $191.2 millionof net favorable development related to prior years. For the year ended December 31, 2010, medical benefits expense was impacted by approximately $56.2 millionof net favorable reserve development related to prior years. The increased net favorable development of prior years' medical benefits payable experienced in 2011 compared to 2010 was primarily related to unusually low utilization in our Medicaidsegment in 2010 that became clearer over time as claim payments were processed and more complete claims information was obtained. 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 Healthand 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 years ended
December 31, 2011and 2010 is as follows: For the Year Ended December 31, 2011 Previously Amounts As Reported Reclassified Adjusted (Dollars in millions)
$ 2,890.1 Medicaid MBR % 80.9 % 1.5 % 82.4 % MA medical benefits expense 1,180.5 18.3
MA MBR % 79.8 % 1.2 % 81.0 % PDP medical benefits expense 853.9 5.2
PDP MBR% 82.4 % 0.5 % 82.9 % Consolidated medical benefits expense $ 4,872.0 $ 76.0 $ 4,948.0 For the Year Ended December 31, 2010 Previously Amounts As Reported Reclassified Adjusted (Dollars in millions)
$ 2,888.5 Medicaid MBR % 87.5 % 1.3 % 88.8 % MA medical benefits expense 1,054.1 13.1
MA MBR % 78.9 % 1.0 % 79.9 % PDP medical benefits expense 635.2 3.6
PDP MBR% 80.9 % 0.5 % 81.4 % Consolidated medical benefits expense $ 4,536.6 $ 57.9 $ 4,594.5 55
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Selling, general and administrative expense
SG&A expense includes aggregate costs related to the resolution of the previously disclosed governmental and Company investigations and litigation, such as settlement accruals and related fair value accretion, legal fees and other similar costs; net of
$25.8 millionof directors and officers liability insurance recoveries during December 31, 2010related to the putative class action complaints. Please refer to Note 12-Commitments and Contingencies within the Consolidated Financial Statements 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. For the years ended December 31, 2011and 2010, SG&A expense decreased by $76.0 millionand $57.9 million, respectively, due to the reclassification.
A reconciliation of SG&A expense, which reflects the SG&A reclassification previously discussed, is presented below.
For the Years Ended December 31, 2012 2011 2010 (In millions) SG&A expense $ 690.8 $ 642.1 $ 838.0 Adjustments: Investigation-related litigation and other resolution costs (3.8 ) (7.7 ) (258.7 ) Investigation-related administrative costs, net of D&O insurance policy recovery (47.7 ) (39.3 ) (7.2 ) Total investigation-related litigation and other resolution costs (51.5 ) (47.0 ) (265.9 ) SG&A expense, excluding investigation-related litigation and other resolution costs $ 639.3 $
SG&A ratio 9.4 % 10.6 % 15.6 % SG&A ratio, excluding investigation-related litigation and other resolution costs 8.7 % 9.9 % 10.6 % 2012 vs. 2011 Excluding investigation-related litigation and other resolution costs, our SG&A expense for the year ended
December 31, 2012increased approximately $44.2 million, or 7%, to $639.3 million. The increase 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 Medicaidprogram, 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 9.4% for the year ended December 31, 2012compared to 10.6% for the same period in 2011. After excluding the investigation-related litigation and other resolution costs, our SG&A ratio in 2012 was 8.7% compared to 9.9% 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 from debt incurred in 2011 to settle investigation-related litigation that was later redeemed in the fourth quarter of 2011, and quality, regulatory and growth initiatives. Looking ahead to 2013, our growth and other initiatives are driving a need for certain investments. In particular, the integration of our recent acquisitions into our infrastructure will result in incremental expenditures. In addition, we will invest to improve the performance of these businesses and position them for further growth. Finally, as we plan for 2014, we will be making investments to meet the needs of our state and federal customers resulting from implementation of the provisions of the 2010 Acts. As a result of these and other expenditures, we anticipate that our adjusted administrative expense ratio, excluding investigation-related litigation and other resolution costs for 2013 will be consistent with 2012. 56
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2011 vs. 2010
Excluding investigation-related litigation and other resolution costs, our SG&A expense increased approximately
$23.0 million, or 4%, in 2011 compared to the same period in 2010. Our SG&A ratio was 10.6% in the 2011 period compared to 15.6% for the same period in the prior year. After excluding the investigation-related litigation and other resolution costs, our SG&A ratio for 2011 was 9.9% compared to 10.6% for the same period in 2010. The improvement in our SG&A ratio, excluding investigation-related litigation and other resolution costs, represents solid progress toward our long-term goal of ensuring our competitive cost position, based on our current business and geographic mix. Business simplification projects, process management in our shared services functions, and continued evaluation of our organizational design continued to drive improvement in our administrative cost structure, partially offset by spending related to the launch of our Kentucky Medicaid program, increased costs associated with our Medicareannual election period strong sales performance, and costs incurred for other growth, regulatory and quality initiatives. An additional factor impacting the comparability of the periods was the impact of relatively low equity-based compensation expense resulting from a larger impact from forfeiture activity in 2010 compared to 2011.
2012 vs. 2011
Medicaidpremium taxes incurred in the year ended December 31, 2012were $82.2 millioncompared to $76.2 million, for the same period in 2011. The increase corresponds to the increase in Medicaidpremium revenues.
2011 vs. 2010
Medicaidpremium taxes incurred in the years ended December 31, 2011and 2010 amounted to $76.2 millionand $56.4 million, respectively. The increase in Medicaidpremium taxes in 2011 was mainly due to the reinstatement of premium taxes by Georgiain July 2010. In October 2009, Georgiastopped assessing taxes on Medicaidpremiums remitted to us, which resulted in an equal reduction to premium revenues and Medicaidpremium taxes. However, effective July 1, 2010, Georgiabegan assessing premium taxes again on Medicaidpremiums. Therefore, during the first half of 2010, we were not assessed, nor did we remit, any taxes on premiums in Georgia. Interest expense 2012 vs. 2011 Interest expense for the year ended December 31, 2012was $4.1 millioncompared to $6.5 millionfor the same period in 2011. The decrease in interest expense from 2011 is mainly from debt incurred in 2011 to settle investigation-related litigation that was later redeemed in the fourth quarter of 2011, as discussed below, partially offset by interest on the $150.0 millionborrowed under a term loan on August 1, 2011. 2011 vs. 2010 Interest expense for the year ended December 31, 2011was $6.5 millioncompared to $0.2 millionfor the same period in 2010. The increase in interest expense in 2011 is mainly driven by $6.1 millionof interest related to the $112.5 millionsubordinated notes issued in September 2011, and to a lesser extent, interest on the $150.0 millionterm loan, which closed on August 1, 2011. We issued $112.5 million(aggregate par value) of tradable unsecured subordinated notes on September 30, 2011in connection with the stipulation and settlement agreement, which was approved in May 2011to resolve the putative class action complaints previously filed against us in 2007. The subordinated notes had a fixed coupon of 6% and interest was retroactive to May 2011.
Gain on repurchase of subordinated notes
2011 vs. 2010:
December 15, 2011, we repurchased at 90% of face value all of the $112.5 millionof subordinated notes issued in September 2011. The notes had an original a maturity date of December 31, 2016. We recorded a gain on the repurchase of subordinated notes in the amount of $10.8 million. For further information regarding the subordinated notes, refer to Note 11 -Debt within the Consolidated Financial Statements. 57
Table of Contents Income tax expense (benefit) 2012 vs. 2011 Income tax expense for the year ended
December 31, 2012decreased by $42.5 millioncompared to the same period in 2011. Our effective income tax rate on pre-tax income was 37.7% for the year ended December 31, 2012compared to 36.9% for the same period in 2011. The effective tax rate for the year ended December 31, 2012increased compared to the same period in 2011 due to the settlement of a state tax matter in 2012 which increased the effective rate, partially offset by a decrease in the prevailing state income tax rate which lowered the effective rate.
2011 vs. 2010
Income tax expense for the year ended
December 31, 2011was $154.2 millioncompared to an income tax benefit of $19.4 millionfor the same period in 2010. Our effective income tax rate on pre-tax income was 36.9% for the year ended December 31, 2011compared to 26.7% on a pre-tax loss for the same period in 2010. The comparability of the effective tax rates between 2011 and 2010 was impacted by changes related to estimated non-deductible amounts associated with investigation resolution payments, the favorable resolution of prior years' state tax matters in 2011 and the incurrence of a pre-tax loss in 2010. Additionally, the effective tax rate for the 2010 period was impacted by limitations on the deductibility of certain administrative expenses associated with the resolution of investigation-related matters.
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 Company'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 PDP.
Segment 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 premiums revenue excluding
Medicaidpremium taxes. Gross margin is defined as our premium revenue less medical benefits expense. For further information regarding premium revenues and medical benefits expense, please refer below to "Premium Revenue Recognition and Premiums Receivable", and "Medical Benefits Expense and Medical Benefits Payable "under "Critical Accounting Estimates." Our primary tools for measuring profitability are gross margin and MBR. Changes in gross margin and MBR from period to period depend in large part on our ability to, among other things, effectively price our medical and prescription drug plans, manage medical costs and changes in estimates related to IBNR claims, predict and effectively manage medical benefits expense relative to the primarily fixed premiums we receive, negotiate competitive rates with our health care providers, and attract and retain members. In addition, factors such as changes in health care laws, regulations and practices, changes in Medicaidand Medicarefunding, changes in the mix of membership, escalating health care costs, competition, levels of use of health care services, general economic conditions, major epidemics, terrorism or bio-terrorism, new medical technologies and other external factors affect our operations and may have a material impact on our business, financial condition and results of operations. 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. 58
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The following table reconciles our reportable segment results with our income (loss) before income taxes, as reported under GAAP.
For the Years Ended December 31, 2012 2011 2010 Gross Margin: (In millions) Medicaid $ 579.2 $ 691.5 $ 420.3 MA 305.8 281.0 268.9 PDP 211.3 177.7 146.5 Total gross margin 1,096.3 1,150.2 835.7 Investment and other income 8.8 8.7 10.0 Other expenses (808.7 ) (751.2 ) (918.5 )
Income (loss) from operations
Medicaidsegment includes plans for beneficiaries of Temporary Assistance for Needy Families ("TANF"), Supplemental Security Income ("SSI"), Aged Blind and Disabled ("ABD") and other state-based programs that are not part of the Medicaidprogram, such CHIP, Family Health Plus ("FHP") and Managed Long-Term Care ("MLTC") programs. As of December 31, 2012, we operated Medicaidhealth plans in Florida, Georgia, Hawaii, Illinois, Kentucky, New Yorkand Ohio. For the Years Ended December 31, 2012 2011 2010 (In millions) Premium revenue $ 4,389.0 $ 3,505.4 $ 3,252.4 Medicaid premium taxes 82.2 76.2 56.4 Total premiums 4,471.2 3,581.6 3,308.8 Medical benefits expense 3,892.0 2,890.1 2,888.5 Gross margin $ 579.2 $ 691.5 $ 420.3 Medicaid Membership: Georgia 570,000 562,000 566,000 Florida 454,000 404,000 415,000 Kentucky 207,000 129,000 - Other states 356,000 356,000 359,000 1,587,000 1,451,000 1,340,000
Medicaid MBR, including premium taxes 87.0 % 80.7 % 87.3 % Medicaid MBR (1)
88.7 % 82.4 % 88.8 %
(1) MBR measures the ratio of our medical benefits expense to premiums earned,
included in the premium rates established in certain of our
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,
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2012 vs. 2011
Medicaidpremium taxes, Medicaidpremium revenue for the year ended December 31, 2012increased 25% when compared to the same period in 2011. The increase was driven mainly by the Kentucky Medicaid program operating for a full year in 2012, compared to two months in 2011, as well as membership growth in that program, both the managed long-term care program and the carve-in of the pharmacy benefit in our New York Medicaid program, membership growth in Florida, and rate increases implemented in most markets in late 2011. The increase in Kentucky Medicaid premiums also reflects the open enrollment in November 2012. Partially offsetting these increases was a $21.4 millionreduction of premium revenue recorded during the third and fourth quarters of 2012 related to a reconciliation of duplicate member records in Georgiadating back to the beginning of the program in 2006. Medicaidmedical benefits expense for the year ended December 31, 2012increased 35% when compared to the same period in 2011. The increase was due mainly to the increase in membership and the relatively higher MBR in the Kentucky Medicaid program and less net favorable development of prior year's medical benefits payable in 2012 than we recognized in 2011, partially offset by the impact of medical cost initiatives that we have implemented. Our Medicaid MBR for the year ended December 31, 2012increased by 630 basis points when compared to the same period in 2011. The increase was mainly driven by the relatively higher MBR in the Kentucky Medicaid program, the $21.4 millionreduction of premium revenue for duplicate member record reconciliation adjustments, and the impact of less net favorable development of prior year's medical benefits payable in 2012 than we recognized in 2011. The Kentucky Medicaid program MBR for the year ended December 31, 2012was approximately 105.1% due to the relatively high transitional medical benefit expenses for the program, including the impact of new members from the November 2012open enrollment which have a higher MBR than previously existing members. We continue to focus on our clinical management capabilities to appropriately address the characteristics of the Kentuckymembers we serve. In particular, we are executing on emergency room, inpatient, behavioral, and pharmacy cost management activities, all of which are reducing medical costs. We believe the actions we have taken, and are taking, to improve care coordination and manage costs, combined with expected 2013 revenue enhancements and rate increases, will make a meaningful contribution to our 2013 Medicaidgross margin and the long-term stability and soundness of our Kentucky Medicaid program.
2011 vs. 2010
Medicaidpremium taxes, Medicaidpremium revenue for the year ended December 31, 2011increased 8% when compared to the same period in 2010. The increase in premium revenue was mainly due to rate increases in certain markets, the launch of the Kentucky Medicaid program on November 1, 2011and additional premiums related to certain retrospective maternity claims that were impacted by a change that the Georgia DCH made to its methodology for determining and accepting qualifying maternity claims. Medicaidmedical benefits expense for the year ended December 31, 2011decreased slightly when compared to the same period in 2010 due mainly to the impact of net favorable reserve development of prior period medical benefits payable and the impact of medical cost initiatives that we have implemented, partially offset by a change in member mix and the launch of the Kentucky Medicaid program in November 2011. The net favorable reserve development resulted primarily from unusually low utilization in 2010. Our Medicaid MBR improved by approximately 640 basis points in 2011 compared to 2010, and the decrease was also driven by the net favorable reserve development of prior period medical benefits payable, the impact of medical cost initiatives, rate increases in certain of our Medicaidmarkets and additional premiums recognized in connection with retrospective maternity claims in Georgia.
Medicaidsegment premium revenue to increase in excess of 14% percent, mainly as a result of the Kentuckyprogram expansion and the South Carolinaacquisition. We currently anticipate our 2013 premium revenue from the Kentucky Medicaidprogram will be in excess of $1.0 billion. We currently anticipate that our Medicaidsegment MBR will be lower in 2013 as a result of improved performance for the Kentuckyprogram, offset in part by MBR increases in certain other programs and the continuing shift in the mix of our Medicaidsegment programs toward higher MBR populations. 60
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We contract with CMS under the
Medicareprogram to provide a comprehensive array of Part C and Part D benefits to Medicareeligible persons, provided through our MA plans. Our MA plans are comprised of coordinated care plans ("CCPs"), which are administered through HMOs and generally require members to seek health care services and select a primary care physician from a network of health care providers. In addition, we offer Medicare Part Dcoverage, which provides prescription drug benefits, as a component of our MA plans. As of December 31, 2012, we operated our MA CCPs in California, Connecticut, Florida, Georgia, Hawaii, Illinois, Louisiana, Missouri, New Jersey, New York, Ohioand Texas. For the Years Ended December 31, 2012 2011 2010 (In millions) Premium revenue $ 1,936.4 $ 1,479.8 $ 1,336.1 Medical benefits expense 1,630.6 1,198.8 1,067.2 Gross margin $ 305.8 $ 281.0 $ 268.9 MA Membership 213,000 135,000 116,000 MA MBR 84.2 % 81.0 % 79.9 % 2012 vs. 2011 MA premium revenue for the year ended December 31, 2012increased 31% when compared to the same period in 2011 and was mainly attributable to an increase in membership, which increased by approximately 78,000 members between December 31, 2012and 2011 due to our product design, strengthening of our sales processes and heightened focus on membership growth activities during the annual election period in 2011 and the Easy Choice acquisition. MA segment MBR increased by 320 basis points for the year ended December 31, 2012compared to the same period in 2011. The changes in the MBR were primarily due to increased quality improvement costs and less net favorable development of prior year's medical benefits payable in 2012 than we recognized in 2011.
2011 vs. 2010
MA premium revenue for the year ended
December 31, 2011increased 11% when compared to the same period in 2010 mainly from an increase in membership. Membership increased by approximately 19,000 members between December 31, 2010and 2011. The increase in MA premium revenue and membership was attributable to our product design, strengthening of our sales processes and heightened focus on membership growth activities during the annual election periods in 2010 and 2011. MA medical expense increased by 12% in 2011, due to the increase in membership, as well as an increase in the segment MBR. MA segment MBR increased by approximately 110 basis points for the year ended December 31, 2011compared to the same period in 2010, primarily due to the favorable reserve development we experienced in 2010 from the wind-down of our PFFS plans and increased quality improvement costs. As a result, the segment gross margin increase in 2011 amounted to 4%. Outlook For the MA segment, membership as of January 1, 2013was approximately 250,000, an increase from 213,000 as of December 31, 2012based on the outcome of the recently completed open enrollment. Excluding Arizonaand California, our January 2013enrollment was approximately 194,000, an increase of 11% from 174,000 as of December 2012. Currently, we expect MA segment membership to continue to grow during the remaining months of 2013, as we leverage our success in serving dually-eligible beneficiaries as well as the broader growth in the Medicarepopulation. Consequently, we expect MA premium revenue to increase by approximately 50% in 2013. Our benefits and cost sharing terms for 2013 have been designed to achieve what we believe is an appropriate financial rate of return with plans that are attractive to both current and prospective members. For the MA segment, we expect the MBR to increase in 2013, driven by the Easy Choice acquisition as well as higher MBRs in many of our other states, consistent with our expectations based on our 2013 bids. 61
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Prescription Drug Plans (PDP)
We have contracted with CMS to serve as a plan sponsor offering stand-alone Medicare Part D PDP plans to
For the Years Ended December 31, 2012 2011 2010 (In millions)
859.1 638.9 Gross margin $ 211.3 $ 177.7 $ 146.4 PDP Membership 869,000 976,000 768,000 PDP MBR 78.7 % 82.9 % 81.4 % 2012 vs. 2011 PDP premium revenue decreased 4% for the year ended
December 31, 2012when compared to the same period in 2011, primarily due to the decline in membership. Membership decreased by approximately 107,000 members from December 31, 2011due 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 year ended December 31, 2012decreased 420 basis points over the same period in 2011 due to the outcome of our 2012 bids and improvements in our pharmacy claims experience, resulting from our focus on member utilization, cost sharing patterns and generic medication utilization.
2011 vs. 2010
PDP premium revenue increased 32% for the year ended
December 31, 2011when compared to the same period in 2010, resulting primarily from increased membership, partially offset by the impact of lower pricing consistent with our bid results. Membership increased by 27% in 2011, largely due to an increase in auto-assigned members resulting from our 2011 bids and the addition of one CMS region. The PDP MBR increased by 150 basis points in 2011 compared to 2010 due to our bid results, member mix and higher utilization. The segment gross margin increased by approximately 21%.
PDP membership as of
January 1, 2013was approximately 750,000, a decrease of approximately 14% from 869,000 as of December 31, 2012, based on the outcome of our stand-alone 2013 PDP bids. We expect membership for the remainder of 2013 to be relatively stable as we focus on marketing to those who actively choose our product to offset normal attrition. For the PDP segment, we anticipate the MBR to increase mainly due to the outcome of our 2013 bids and from the addition of our new enhanced product. The decrease in membership and in premium rates is expected to result in a minimum 20% reduction in our PDP segment's premium revenue in 2013 when compared to 2012.
LIQUIDITY AND CAPITAL RESOURCES
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. Additionally, we operate as a holding company in a highly regulated industry. The parent and other non-regulated companies ("non-regulated subsidiaries") are dependent upon dividends and management fees from our regulated subsidiaries, most of which are subject to regulatory restrictions. For a further discussion of risks that can affect our liquidity, see Part I - Item 1A - Risk Factors included in this 2012 Form 10-K. 62
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The Company maintains liquidity at two levels: the regulated subsidiary level and the non-regulated subsidiary level.
Our regulated subsidiaries' primary liquidity requirements include:
• payment of medical claims and other health care services;
• management fees paid to our non-regulated administrator subsidiary under intercompany services agreements and direct administrative costs, which
are not covered by the intercompany services agreement, such as selling
expenses and legal costs; and • federal tax payments to the parent company under an intercompany tax sharing agreement.
Our regulated subsidiaries meet their liquidity needs by:
• maintaining appropriate levels of cash, cash equivalents and
• generating cash flows from operating activities, mainly from premium revenue;
• cash flows from investing activities, including investment income and sales of investments; and
• capital contributions received from our non-regulated subsidiaries.
We refer collectively to the cash, cash equivalents and investment balances maintained by our regulated subsidiaries as "regulated cash and investments," respectively. Our regulated subsidiaries generally receive premiums in advance of payments of claims for medical and other health care services; however, regulated cash and cash equivalents can fluctuate significantly in a particular period depending on the timing of receipts for premiums from our government partners. Our unrestricted regulated cash and investments was
$1,224.0 millionas of December 31, 2012, a decrease of $74.2 millionfrom December 31, 2011. Included in this change is $192.0 millionin dividends and surplus capital paid to, and $119.6 millionof contributions received from our non-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. We continue to maintain significant levels of aggregate excess statutory capital and surplus in our regulated subsidiaries. See further discussion under Regulatory Capital Requirements and Dividend Restrictions below.
Parent and non-regulated subsidiaries
Liquidity requirements at the non-regulated parent level generally consist of:
• payment of administrative costs not related to our regulated operations,
including, but limited to, business development, branding and certain
information technology services;
• capital contributions paid to our regulated subsidiaries;
• capital expenditures; • debt service; and • federal tax payments.
Our non-regulated subsidiaries normally meet their liquidity requirements by:
• management fees received from our non-regulated administrator subsidiary
under intercompany services agreements;
• dividends received from our regulated subsidiaries;
• collecting federal tax payments from the regulated subsidiaries;
• proceeds from issuance of debt and equity securities; and
• cash flows from investing activities, including investment income and sales of investments. 63
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Our unregulated cash, cash equivalents and investments was
$193.5 millionas of December 31, 2012, a decrease of $115.0 millionfrom a balance of $308.5 millionas of December 31, 2011. The decrease is mainly attributable to $126.6 millionin net cash used in relation to our recent acquisitions, payment of certain investigation-related litigation and other resolution costs in connection with our settlement of the Civil Divisionof the U.S. Department of Justice(the "Civil Division") and $119.6 millionin capital contributions made to certain of our regulated subsidiaries that were partially offset by $192.0 millionin dividends and surplus capital received from our regulated subsidiaries.
December 31, 2012, $32.0 millionof 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-K, 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 25 years. The weighted-average life of the underlying securities for our auction rate securities portfolio is 20 years.
Cash flow activities
Our cash flows from operations are summarized as follows:
For the Years Ended December 31, 2012 2011 2010 (In millions)
Net cash (used in) provided by operations $ (30.7 )
(222.8 ) (111.6 ) (60.5 ) Net cash provided by (used in) financing activities 28.9 (84.9 ) 38.9 Total net (decrease) increase in cash and cash equivalents $ (224.6 ) $ (34.5 ) $ 201.5
Net cash (used in) provided by operations
For the year ended
December 31, 2012, cash from operating activities was negatively impacted by certain delayed Medicaidpremiums, primarily associated with our Georgia Medicaid supplemental payments for obstetric deliveries and newborns, and the $39.8 millionpayment made to the Civil Divisionof the U.S. Department of Justice("Civil Division") on March 30, 2012. Cash provided by operating activities, modified for the impact of the timing of receipts from, and payments to, our government customers, increased in 2011 when compared to 2010 due to improved results from operations, partially offset by $87.5 millionof investigation-related litigation and other resolution payments. 64
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Net cash used in investing activities
For the year ended
December 31, 2012, cash used in investing activities, excluding acquisitions, primarily reflects our investment in marketable securities and restricted investments of approximately $502.3 millionand purchases of property and equipment of $61.3 million, partially offset by $467.3 millionof proceeds from maturities of marketable securities and restricted investments. Cash consideration paid for acquisitions, net of cash acquired, was $126.6 millionin 2012 related to the Easy Choice and Desert Canyonacquisitions. In 2011, cash used in investing activities primarily reflects our investment of proceeds provided by our term loan into higher yielding investment alternatives, which had a net impact totaling approximately $108.7 million, and purchases of software and equipment totaling approximately $49.6 million, partially offset by $46.7 millionof proceeds from the maturities of restricted investments net of purchases.
Net cash provided by (used in) financing activities
Included in financing activities are funds receivable for the benefit of members, which decreased approximately
Included in 2011 financing activities are the repurchase of the subordinated notes in full, which approximated
$101.7 million, as well as funds held for the benefit of members, which increased approximately $129.6 millionin 2011. These funds represent certain subsidies funded by CMS in connection with the Medicare Part Dprogram for which we assume no risk. This activity is partially offset with the $147.4 millionof proceeds from the issuance of the term loan under the Amended Credit Agreement, net of issuance costs.
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 Divisionand certain other federal and state enforcement agencies (the "Settlement"), WellCareagreed to pay the Civil Divisiona total of $137.5 millionover 36 months plus interest accrued at 3.125%. On March 30, 2012, we made a payment of $39.8 millionto the Civil Division, consisting of a $34.4 millionprincipal payment and $5.5 millionof accrued interest. The estimated fair value of the discounted remaining liability, to be paid in three annual installments of $34.4 millionon March 30of each year, and related interest, was $105.5 millionat December 31, 2012. The Settlement also provides for a contingent payment of an additional $35.0 millionin 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.
We currently maintain directors' and officers' liability insurance in the amount of
August 2011, we entered into a $300.0 millionsenior secured credit agreement, amended on July 20, 2012(the "Amended Credit Agreement") that can be used for general corporate purposes. The Amended Credit Agreement provides for a $150.0 millionterm loan facility as well as a $150.0 millionrevolving credit facility. In August 2011, we borrowed $150.0 millionpursuant to the term loan facility. On February 12, 2013, we borrowed an additional $230.0 millionin term loans in connection with the execution of an amended senior secured credit agreement (the "Second Amended Credit Agreement"). The Second Amended Credit Agreement provides for an additional $230.0 millionin term loans and a total available credit facility of $515.0 million. As of the date of this 2012 Form 10-K, $365.0 millionwas outstanding under the Second Amended Credit Agreement. For additional information, see Note 19 - Subsequent Events to the Consolidated Financial Statements. Each of the term loans and revolving credit facility are set to expire in August 2016. Payments of principal on the term loans are due on a quarterly basis through July 31, 2016. As of December 31, 2012, our remaining term loan balance was $135.0 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 1.75% as of December 31, 2012. For additional information on our long-term debt, see Note 11 - Debt to the Consolidated Financial Statements. 65
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August 2012, we filed a shelf registration statement on Form S-3 with the SECthat became automatically effective covering the registration, issuance and sale of an indeterminate amount of our securities, including common stock, preferred stock, senior or subordinated debt securities, depository shares, securities purchase contracts, units or warrants. We may publicly offer securities in the future at prices and terms to be determined at the time of the offering.
Issuance and Repurchase of Subordinated Notes
September 30, 2011, we issued tradable unsecured subordinated notes having an aggregate par value of $112.5 million, in connection with the settlement of putative class action complaints filed against us in 2007. On December 15, 2011, we paid $101.7 millionto repurchase the subordinated notes at a 10% discount and paid accrued interest of approximately $4.1 million. For further information regarding the subordinated notes, refer to Note 11 - Debt to the Consolidated Financial Statements. Initiatives to Increase Our Unregulated Cash We are pursuing alternatives to raise additional unregulated cash. Some of these initiatives include, but are not limited to, consideration of obtaining dividends from certain of our regulated subsidiaries to the extent that we are able to access any available excess capital and/or accessing the debt and equity capital markets. However, we cannot provide any assurances that we will obtain applicable state regulatory approvals for additional dividends to our non-regulated subsidiaries by our regulated subsidiaries or be successful in accessing the capital markets if we determine to do so. Regulatory Capitaland Dividend Restrictions 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, risk-based capital ("RBC") requirements or other financial ratios. The RBC requirements are based on guidelines established by the NAIC, and have been adopted by most states. As of December 31, 2012, our operating HMO and insurance company subsidiaries in all states except California, New Yorkand Floridawere 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 a minimum of the greater of 200% of the required ACL or the minimum statutory net worth requirement calculated pursuant to pre-RBC guidelines. Our subsidiaries operating in Texasand Ohioare required to maintain statutory capital at RBC levels equal to 225% and 300%, respectively, of the applicable ACL. Failure to maintain these requirements would trigger regulatory action by the state. At December 31, 2012, our HMO and insurance subsidiaries were in compliance with these minimum capital requirements. The combined statutory capital and surplus of our HMO and insurance subsidiaries was approximately $926.0 millionand $858.0 millionat December 31, 2012and 2011, respectively, compared to the required surplus of approximately $383.0 millionand $310.0 millionat December 31, 2012and 2011, respectively. The statutory framework for our regulated subsidiaries' minimum capital requirements changes over time. For instance, RBC requirements may be adopted by more of the states in which we operate. These subsidiaries are also subject to their state regulators' overall oversight powers. For example, the state of New Yorkadopted regulations that increase the reserve requirement annually until 2018. In addition, regulators could require our subsidiaries to maintain minimum levels of statutory net worth in excess of the amount required under the applicable state laws if the regulators determine that maintaining such additional statutory net worth is in the best interest of our members and other constituencies. Moreover, if we expand our plan offerings in a state or pursue new business opportunities, we may be required to make additional statutory capital contributions. In addition to the foregoing requirements, our regulated subsidiaries are subject to restrictions on their ability to make dividend payments, loans and other transfers of cash. Dividend restrictions vary by state, but the maximum amount of dividends which can be paid without prior approval from the applicable state is subject to restrictions relating to statutory capital, surplus and net income for the previous year. Some states require prior approval of all dividends, regardless of amount. States may disapprove any dividend that, together with other dividends paid by a subsidiary in the prior 12 months, exceeds the regulatory maximum as computed for the subsidiary based on its statutory surplus and net income. For the years ended December 31, 2012, 2011 and 2010, we received $192.0 million, $92.0 millionand $45.7 millionrespectively, in cash dividends from our regulated subsidiaries. 66
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For additional information on regulatory requirements, see Note 16 -
Commitments and Contingencies
The following table sets forth information regarding our contractual obligations as of
December 31, 2012. Payments due to period Less Than 1 - 3 3 - 5 More than Total 1 Year Years Years 5 Years (In millions) Operating leases $ 70.9 $ 19.3 $ 37.5 $ 9.6 $ 4.5 Capital leases 3.3 1.6 1.7 - - Purchase obligations (1) 148.9 78.7 70.2 - - Amounts accrued related to investigation resolution (2) 105.5 37.3 68.2 - - Long-term debt 135.0 15.0 120.0 - - Total $ 463.6 $ 151.9 $ 297.6 $ 9.6 $ 4.5
(1) Our purchase obligations include commitments under contracts for equipment
leases, software maintenance and the purchase of pharmaceuticals from our
pharmacy benefit manager. (2) Based on the terms of the settlement agreement reached with the
Civil Divisioneffective as of March 23, 2012, as discussed in Note 12 -
Commitments and Contingencies to the Consolidated Financial Statements.
We are not an obligor under or guarantor of any indebtedness of any other party; however, we may have to pay referral claims of health care providers under contract with us who are not able to pay costs of medical services provided by other providers.
OFF BALANCE SHEET ARRANGEMENTS
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 and premiums receivable, 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.
Premium Revenue Recognition and Premiums Receivable
Medicarecontracts with CMS renew annually. Our contracts with various state Medicaidprograms generally are multi-year contracts subject to annual renewal provisions. Our Medicareand Medicaidcontracts establish fixed, monthly rates per member ("PMPM"). However, our Medicarecontracts also have additional provisions as described in the Medicaresection below. The premiums we receive for each member vary according to the specific government program and are generally determined at the beginning of each new contract renewal period or each state's fiscal year; however, premiums may be adjusted by CMS and state agencies throughout the terms of the contracts in certain cases, as described below. Annual rate changes are recorded when they become effective. For a full description of the revenue elements related to our segments, see Part I - Item 1 - Business - OUR PRODUCT SEGMENTS. 67 -------------------------------------------------------------------------------- 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. On a monthly basis, we bill members for any premiums for which they are responsible according to their respective plan. 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. 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 Medicaidreceivables 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. 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 those members. 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.
In some instances, our
Medicaidfixed base PMPM premiums are subject to risk score adjustments based on the health profile 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 Medicaidmembership. In some states, supplemental payments are received for certain services such as high cost drugs and early childhood prevention screenings. In contracts with certain states, 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. We have settled with the Georgia Department of Community Health(the " GeorgiaDCH") regarding retroactive premium adjustments related to a reconciliation of duplicate member records dating back to the beginning of the program in 2006. As a result, we revised our previous estimate for additional premium revenue receivable related to a previous settlement negotiated with the Georgia DCH in 2011 and we have recorded related reductions of premium revenue totaling approximately $21.4 millionduring the third and fourth quarters of 2012. The settlement resolved issues with certain premium payments that covered the period from the inception of the program through the settlement, and resulted from a comprehensive review and negotiation involving the three health plans that operate in the program.
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 results of operations as reductions of premium. 68
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 "Medicare Risk-Adjusted Premiums" below. We also offer coverage of prescription drug benefits under the
Medicare Part Dprogram as a component of most of our MA plans. See further discussion of revenue recognition policies specific to Medicare Part Din "PDP" below.
Medicare Risk-Adjusted Premiums
CMS employs a risk-adjustment model to determine the premium amount it pays for each
Medicaremember. The risk-adjustment model apportions premiums paid to all plans according to the health status of each beneficiary enrolled and pays more for MA members with predictably higher costs. We collect claims and encounter data from inpatient and ambulatory treatment settings and submit the data to CMS, within prescribed deadlines, which are used to calculate the risk-adjusted premiums we receive. 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, or other data, and predictive models as sufficient member risk score data becomes available over the course of each CMS plan year. Our estimates 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. Historically, we have not experienced significant differences between the amounts that we have recorded and ultimately received; however, it is possible that adjustments to premium revenue could have a material effect on our results of operations, financial position and cash flows in a particular period. 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 payable to CMS, future refunds could materially reduce premium revenue in the year in which CMS determines a refund is required.
Substantially all the premium that we receive for
Medicare Part Dcoverage is paid by CMS, and the balance is due from enrolled members. The premium amounts received from CMS are 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 "Medicare 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.
Low-income cost sharing, catastrophic reinsurance and coverage gap discount subsidies
Low-income cost sharing, catastrophic reinsurance and coverage gap discount 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 revenues or 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 a financing activity in our consolidated statements of cash flows. Approximately nine months after the close of the annual plan year, except for the coverage gap discount which has a longer settlement timeframe, CMS reconciles actual experience to prospective payments paid to our plans and any differences are settled between CMS and our plans. 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 or coverage gap discount subsidies, due to its recent implementation. 69 --------------------------------------------------------------------------------
CMS risk corridor
Premiums received from CMS are subject to risk sharing through the
Medicare Part Drisk 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.
Estimating Medical Benefits Expense and Medical Benefits Payable
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 such as preventive health and wellness, care management, case and disease management, and other quality improvement costs are included in medical benefits expense. Other medically-related administrative costs such as utilization review services, network and provider credentialing and claims handling costs, are recorded in selling, general, and administrative expenses. The following table provides a detail of the components of medical benefits payable: % of % of December 31, 2012 Total December 31, 2011 Total (In millions) IBNR $ 547.4 75% $ 526.7 71% Other medical benefits payable 185.6 25% 218.1 29% Total medical benefits payable $ 733.0 100% $
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. 70 -------------------------------------------------------------------------------- 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
December 31, 2012is 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 year ended December 31, 2012were decreased by 1%, our net income would decrease by approximately $73.1 million. If the completion factors were increased by 1%, our net income would increase by approximately $71.5 million. 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 such 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 moderately adverse conditions that may cause actual claims to be higher than estimated compared to the base reserve. 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 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. 71 -------------------------------------------------------------------------------- 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.
The following table provides a reconciliation of the beginning and ending balance of medical benefits payable:
Years Ended December 31, 2012 2011 2010 (In millions)
Balances as of beginning of period
6,450.5 5,200.1 4,711.2 Prior periods (146.6 ) (252.1 ) (116.3 ) Total 6,303.9 4,948.0 4,594.9 Medical benefits paid related to: Current period (5,754.9 ) (4,533.9 ) (4,084.6 ) Prior periods (560.8 ) (412.3 ) (569.8 ) Total (6,315.7 ) (4,946.2 ) (4,654.4 )
Balances as of end of period
Medical benefits payable recorded at
December 31, 2011, 2010 and 2009 developed favorably by approximately $146.6 million, $252.1 millionand $116.3 millionin 2012, 2011 and 2010, respectively. A portion of the prior period development was attributable to the release of the provision for moderately adverse conditions, which is included as part of the assumptions. The release of the provision for moderately adverse conditions was substantially offset by the provision for moderately adverse conditions established for claims incurred in the current year. Accordingly, the change in the amount of the incurred claims related to prior years in the Medical benefits payable does not directly correspond to an increase in net income recognized during the period. In addition to the release of the provision for moderately adverse conditions, medical benefits expense for the years ended December 31, 2012, 2011 and 2010 was impacted by approximately $76.7 million, $191.2 millionand $56.2 millionrespectively, of net favorable development related to prior years. The net favorable development in 2012 was due to the medical cost trend emerging favorably, mostly in our Medicaidsegment and to a lesser extent in our MA and PDP segments, primarily due to lower than projected utilization, partially offset by higher than expected medical services in Kentucky. The net favorable development during 2011 was attributable to the 2010 medical cost trend emerging favorably than we originally estimated, mostly in our Medicaidsegment and to a lesser extent in our MA segment, primarily due to lower than projected utilization. The net favorable development in 2010 was primarily associated with the exit of the PFFS product on December 31, 2009. The factors impacting the changes in the determination of medical benefits payable discussed above were not discernible in advance. The impact became clearer over time as claim payments were processed and more complete claims information was obtained. 72 --------------------------------------------------------------------------------
Goodwill and Other Intangible Assets
We review goodwill and intangible assets for impairment at least annually, or more frequently if events or changes in our business climate occur that may potentially affect the estimated useful life or the recoverability of the remaining balance of goodwill or intangible assets. Events or changes in circumstances would include significant changes in membership, state funding, federal and state government contracts and provider networks. Goodwill is evaluated for impairment by first performing a qualitative assessment to determine whether a quantitative assessment is necessary. If, based on the qualitative assessment, we determine the fair value of the reporting unit is more likely than not less than the carrying value, we perform a two-step quantitative goodwill impairment test. The first step is to determine the fair value of the reporting unit 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 may produce significantly different results. If the fair value of the reporting unit is less than its carrying value, we measure and record the amount of the goodwill impairment, if any, by comparing the implied fair value of the reporting unit's goodwill with the carrying value. We select the second quarter of each year for our annual goodwill 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. Based on the results of the qualitative assessments performed as of our most recent testing date in 2012, and our review at
December 31, 2012, we determined that the fair value of our Medicaidreporting unit is more likely than not greater than the carrying value as of December 31, 2012. Our review included consideration of the termination of our Missouriand Ohio Medicaid contracts as discussed in Part I - Item 1 - Business - "OUR PRODUCT SEGMENTS."
RECENTLY ADOPTED ACCOUNTING STANDARDS
Refer to Note 2 - Summary of Significant Accounting Policies, included in the Consolidated Financial Statements for information and disclosures related to new accounting standards which are incorporated herein by reference.