HEALTHSPRING, INC. - FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Fiscal Year Ended December 31, 2006
OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
Commission File Number 001-32739
HealthSpring, Inc.
(Exact Name of Registrant as Specified in Its Charter)
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| Delaware
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20-1821898 |
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(State or Other Jurisdiction of Incorporation or
Organization)
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(I.R.S. Employer Identification No.) |
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44 Vantage Way, Suite 300
Nashville, Tennessee
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37228 |
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(Zip Code) |
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(615) 291-7000
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Exchange Act:
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| Common Stock, par value $0.01 per share
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New York Stock Exchange |
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(Name of Each Exchange on which
Registered) |
Securities registered pursuant to Section 12(g) of the Exchange Act:
NONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes o No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer o Accelerated Filer o Non-Accelerated Filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The aggregate market value of the Common Stock held by non-affiliates of the registrant, based
on the closing price of these shares on the New York Stock Exchange on June 30, 2006, was
approximately $637.5 million. For the purposes of this disclosure
only, the registrant has included shares beneficially owned by its directors, executive officers, and beneficial owners of 10% or more of the registrant’s
common stock as stock held by affiliates of the registrant, provided that such persons may disclaim such status.
As
of March 13, 2007 there were outstanding 57,327,632 shares of the registrant’s Common Stock,
par value $0.01 per share.
Documents Incorporated by Reference
Portions of the registrant’s definitive Proxy Statement for the 2007 Annual Meeting of
Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Statements contained in this Annual Report on Form 10-K that are not historical fact may be
forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934
(the “Exchange Act”). In some cases, you can identify forward-looking statements by terms including
“anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,”
“predicts,” “projects,” “should,” “will,” “would,” and similar expressions intended to identify
forward-looking statements. We intend such statements to be covered by the safe harbor provisions
for forward-looking statements contained in Section 21E of the Exchange Act. These statements
involve known and unknown risks, uncertainties and other factors, including those described in Item
1A. “Risk Factors,” that may cause our actual results, performance or achievements to be materially
different from any future results, performances or achievements expressed or implied by the
forward-looking statements. Forward-looking statements reflect our current views with respect to
future events and are based on assumptions and subject to risks and uncertainties. Given these
uncertainties, you should not place undue reliance on these forward-looking statements. We
undertake no obligation beyond that required by law to update publicly any forward-looking
statements for any reason, even if new information becomes available or other events occur in the
future. You should read this report and the documents that we reference in this report and have
filed as exhibits to this report completely and with the understanding that our actual future
results may be materially different from what we expect.
PART I
Item 1. Business
Overview
HealthSpring, Inc. is a managed care organization in the United States whose primary focus is
Medicare, the federal government-sponsored health insurance program for retired U.S. citizens aged
65 and older, qualifying disabled persons, and persons suffering from end-stage renal disease.
Pursuant to the Medicare Advantage program and the new Medicare Part D program, Medicare
beneficiaries may receive healthcare benefits, including prescription drugs, through a managed care
health plan. Our concentration on Medicare, and the Medicare Advantage program in particular,
provides us with opportunities to understand the complexities of the Medicare program, design
competitive products, manage medical costs, and offer high quality healthcare benefits to Medicare
beneficiaries in our local service areas. Our Medicare Advantage experience allows us to build
collaborative and mutually beneficial relationships with healthcare providers, including
comprehensive networks of hospitals and physicians, that are experienced in managing the healthcare
needs of Medicare populations.
Currently, we operate Medicare Advantage plans in Tennessee, Texas, Alabama, Illinois, and
Mississippi. We also utilize our infrastructure and provider networks in Alabama and Tennessee to
offer commercial health plans to employer groups. For the year ended December 31, 2006, Medicare
premiums accounted for approximately 87.8% of our total revenue. As of December 31, 2006, our
Medicare Advantage plans had over 115,000 members. On January 1, 2006, we began offering
prescription drug benefits in accordance with Medicare Part D to our Medicare Advantage plan
members, in addition to continuing to provide other medical benefits. We also began offering
prescription drug benefits on a stand-alone basis in accordance with Medicare Part D in each of our
markets. We expanded our stand-alone PDP program on a national basis in 2007. We sometimes refer
to our Medicare Advantage plans after January 1, 2006 collectively as “Medicare Advantage” plans
and separately as “MA-only” for plans without prescription drug benefits and as “MA-PD” for plans
with prescription drug benefits. We refer to our stand-alone prescription drug plans as
“stand-alone PDPs” or “PDPs.” For purposes of additional analysis, the Company provides membership
and certain financial information, including premium revenue and medical expense, for our Medicare
Advantage (including MA-PD) and PDP plans. As of December 31, 2006, our PDP had over 88,000
members.
Our management team has extensive experience managing providers and provider networks and
creating mutually beneficial incentives to efficiently manage medical expenses. Through our
relationships with providers, we have achieved medical loss ratios, or MLRs, that we believe are
below industry averages. We have also implemented comprehensive disease management and utilization
management programs, primarily designed to treat our members and promote the wellness of the
chronically ill, which account for a significant portion of the costs of managed care populations.
We believe our analytical, data-driven approach to our operations further enhances our medical
expense management capabilities.
Our corporate headquarters are located at 44 Vantage Way, Suite 300, Nashville, Tennessee
37228, and our telephone number is (615) 291-7000. Our corporate website address is
www.myhealthspring.com. Information contained on our website is not incorporated by reference into
this report and we do not intend the information on or linked to our website to constitute part of
this report. We make available our annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and any amendments to those reports on our website, free of charge, to
individuals interested in acquiring such reports. The reports can be accessed at our website as
soon as reasonably practicable after they are electronically filed with, or furnished to, the
Securities and Exchange Commission, or SEC. The public may read and copy these materials
at the SEC’s public reference room located at 100 F. Street, N.E., Washington, D.C. 20549 or on
their website at http://www.sec.gov. Questions regarding the operation of the public reference
room may be directed to the SEC at 1-800-732-0330. References to “HealthSpring,” “the company,”
“we,” “our,” and “us” refer to HealthSpring, Inc. together with our subsidiaries and our
predecessor entities, unless the context suggests otherwise.
The Medicare Program and Medicare Advantage
Medicare is the health insurance program for retired United States citizens aged 65 and older,
qualifying disabled persons, and persons suffering from end-stage renal disease. Medicare is funded
by the federal government and administered by the Centers for Medicare and Medicaid Services, or
CMS.
1
The Medicare program, created in 1965, offers both hospital insurance, known as Medicare Part
A, and medical insurance, known as Medicare Part B. In general, Medicare Part A covers hospital
care and some nursing home, hospice, and home care. Although there is no monthly premium for
Medicare Part A, beneficiaries are responsible for significant deductibles and co-payments. All
United States citizens eligible for Medicare are automatically enrolled in Medicare Part A when
they turn 65. Enrollment in Medicare Part B is voluntary. In general, Medicare Part B covers
outpatient hospital care, physician services, laboratory services, durable medical equipment, and
some other preventive tests and services. Beneficiaries that enroll in Medicare Part B pay a
monthly premium, $93.50 in 2007, that is usually withheld from their Social Security checks.
Medicare Part B generally pays 80% of the cost of services and beneficiaries pay the remaining 20%
after the beneficiary has satisfied a $131 deductible. To fill the gaps in traditional
fee-for-service Medicare coverage, individuals often purchase Medicare supplement products,
commonly known as “Medigap,” to cover deductibles, copayments, and coinsurance.
Initially, Medicare was offered only on a fee-for-service basis. Under the Medicare
fee-for-service payment system, an individual can choose any licensed physician accepting Medicare
patients and use the services of any hospital, healthcare provider, or facility certified by
Medicare. CMS reimburses providers if Medicare covers the service and CMS considers it “medically
necessary.” There is currently no fee-for-service coverage for certain preventive services,
including annual physicals and wellness visits, eyeglasses, and hearing aids.
As an alternative to the traditional fee-for-service Medicare program, in geographic areas
where a managed care plan has contracted with CMS pursuant to the Medicare Advantage program,
Medicare beneficiaries may choose to receive benefits from a managed care plan. The current
Medicare managed care program was established in 1997 when Congress created Medicare Part C,
formerly known as Medicare+Choice and now known as Medicare Advantage. Pursuant to Medicare Part C
and the new Medicare Part D, Medicare Advantage plans contract with CMS to provide benefits at
least comparable to those offered under the traditional fee-for-service Medicare program in
exchange for a fixed monthly premium payment per member from CMS. The monthly premium varies based
on the county in which the member resides, as adjusted to reflect the plan members’ demographics
and the plans’ risk scores as more fully described below. Individuals who elect to participate in
the Medicare Advantage program typically receive greater benefits than traditional fee-for-service
Medicare beneficiaries including, in some Medicare Advantage plans including ours, additional
preventive services and vision benefits. Medicare Advantage plans typically have lower deductibles
and co-payments than traditional fee-for-service Medicare, and plan members do not need to purchase
supplemental Medigap policies. In exchange for these enhanced benefits, members are generally
required to use only the services and provider network provided by the Medicare Advantage plan.
Most Medicare Advantage plans have no additional monthly premiums. In some geographic areas,
however, and for plans with open access to providers, members may be required to pay a monthly
premium.
Prior to 1997, CMS reimbursed health plans participating in the Medicare program primarily on
the basis of the demographic data of the plans’ members. One of CMS’s primary directives in
establishing the Medicare+Choice program was to make it more attractive to managed care plans to
enroll members with higher intensity illnesses. To accomplish this, CMS implemented a risk
adjustment payment system for Medicare health plans in 1997 pursuant to the Balanced Budget Act of
1997, or BBA. This payment system was further modified pursuant to the Medicare, Medicaid, and
SCHIP Benefits Improvement and Protection Act of 2000, or BIPA. CMS is phasing-in this risk
adjustment payment methodology with a model that bases a portion of the total CMS reimbursement
payments on various clinical and demographic factors including hospital inpatient diagnoses,
additional diagnosis data from ambulatory treatment settings, hospital outpatient department and
physician visits, gender, age, and Medicaid eligibility. CMS requires that all managed care
companies capture, collect, and submit the necessary diagnosis code information to CMS twice a year
for reconciliation with CMS’s internal database. Under this system, the risk adjusted portion of
the total CMS payment to the Medicare Advantage plans will equal the local rate set forth in the
traditional demographic rate book, adjusted to reflect the plan’s average gender, age, and
disability demographics. During 2003, risk adjusted payments accounted for only 10% of Medicare
health plan payments, with the remaining 90% being reimbursed in accordance with the traditional
demographic rate book. The portion of risk-adjusted payments was increased to 30% in 2004, 50% in
2005, 75% in 2006, and 100% in 2007.
The 2003 Medicare Modernization Act
Overview. In December 2003 Congress passed the Medicare Prescription Drug, Improvement and
Modernization Act, which is known as the Medicare Modernization Act, or MMA. The MMA increased the
amounts payable to Medicare Advantage plans such as ours, expanded Medicare beneficiary healthcare
options by,
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among other things, creating a transitional temporary prescription drug discount card program
for 2004 and 2005, and added a Medicare Part D prescription drug benefit beginning in 2006, as
further described below.
One of the goals of the MMA was to reduce the costs of the Medicare program by increasing
participation in the Medicare Advantage program. Effective January 1, 2004, the MMA increased
Medicare Advantage statutory payment rates, generally increasing payments per member to Medicare
Advantage plans. Medicare Advantage plans are required to use these increased payments to improve
the healthcare benefits that are offered, to reduce premiums, or to strengthen provider networks.
We believe the reforms proposed by the MMA, including in particular the increased reimbursement
rates to Medicare Advantage plans, have allowed and will continue to allow Medicare Advantage plans
to offer more comprehensive and attractive benefits, including better preventive care benefits,
while also reducing out-of-pocket expenses for beneficiaries. As a result of these reforms,
including the Part D prescription drug benefit, we expect enrollment in Medicare’s managed care
programs to increase in the coming years.
Prescription Drug Benefit. As part of the MMA, effective January 1, 2006, every Medicare
recipient was able to select a prescription drug plan through Medicare Part D. Medicare Part D
replaced the transitional prescription drug discount program and replaced Medicaid prescription
drug coverage for dual-eligible beneficiaries. The Medicare Part D prescription drug benefit is
largely subsidized by the federal government and is additionally supported by risk-sharing with the
federal government through risk corridors for 2006 and 2007 designed to limit the profits or losses
of the drug plans and reinsurance for catastrophic drug costs. The government subsidy is based on
the national weighted average monthly bid for this coverage, adjusted for member demographics and
risk factor payments. Additional subsidies are provided for dual-eligible beneficiaries and
specified low-income beneficiaries.
The Medicare Part D benefits are available to Medicare Advantage plan enrollees as well as
Medicare fee-for-service enrollees. Medicare Advantage plan enrollees who elect to participate may
pay a monthly premium for this Medicare Part D prescription drug benefit, or MA-PD, while
fee-for-service beneficiaries are able to purchase a stand-alone prescription drug plan, or PDP,
from a list of CMS-approved PDPs available in their area. Our Medicare Advantage members were
automatically enrolled in our MA-PD plans as of January 1, 2006 unless they chose another
provider’s prescription drug coverage or one of our other plan options without drug coverage. Any
Medicare Advantage member enrolling in a stand-alone PDP, however, is automatically disenrolled
from the Medicare Advantage plan altogether, thereby resuming traditional fee-for-service Medicare.
In addition, certain dual-eligible beneficiaries are automatically enrolled with approved PDPs in
their region, as described below.
Under the standard Part D drug coverage for 2007, beneficiaries enrolled in a stand-alone PDP
pay a $265 deductible, co-insurance payments equal to 25% of the drug costs between $265 and the
initial annual coverage limit of $2,400, and all drug costs between $2,400 and $5,451.25 which is
commonly referred to as the Part D “doughnut hole.” After the beneficiary has incurred $3,850 in
out-of-pocket drug expenses, 95% of the beneficiaries’ remaining out-of-pocket drug costs for that
year are covered by the plan or the federal government. MA-PDs are not required to mirror these
limits, but are required to provide, at a minimum, coverage that is actuarially equivalent to the
standard drug coverage delineated in the MMA. The deductible, co-pay, and coverage amounts will be
adjusted by CMS on an annual basis. As additional incentive to enroll in a Part D prescription drug
plan, CMS imposes a cumulative penalty added to a beneficiary’s monthly Part D plan premium in an
amount equal to 1% of the applicable premium for each month between the date of a beneficiary’s
enrollment deadline and the beneficiary’s actual enrollment. This penalty amount is passed through
the plan to the government. Each Medicare Advantage plan is required to offer a Part D drug
prescription plan as part of its benefits. We currently offer
prescription drug benefits through our national PDP and through our MA-PD plans in each of our markets.
Dual-Eligible Beneficiaries. A “dual-eligible” beneficiary is a person who is eligible for
both Medicare, because of age or other qualifying status, and Medicaid, because of economic status.
Health plans that serve dual-eligible beneficiaries receive a higher premium from CMS for
dual-eligible members. Currently, CMS pays a higher premium for a dual-eligible beneficiary because
a dual-eligible member generally has a higher risk score corresponding to his or her higher medical
costs. By managing utilization and implementing disease management programs, many Medicare
Advantage plans can profitably care for dual-eligible members. The MMA provides Part D subsidies
and reduced or eliminated deductibles for certain low-income beneficiaries, including dual-eligible
individuals. Pursuant to the MMA, as of January 1, 2006 dual-eligible individuals receive their
drug coverage from the Medicare program rather than the Medicaid program. Companies offering
stand-alone PDPs with bids at or below the regional weighted average bid resulting from the annual
bidding process received a pro-rata allocation and auto-enrollment of the dual-eligible
beneficiaries within the applicable region. For 2007, our national PDP bid was
3
below the
benchmark in 29 of the 34 CMS regions. Substantially all of our stand-alone PDP members
result from CMS’s auto-assignment of dual-eligibles.
Bidding Process. Although Medicare Advantage plans will continue to be paid on a capitated,
or per member per month, or PMPM, basis, as of January 1, 2006, CMS uses a new rate calculation
system for Medicare Advantage plans. The new system is based on a competitive bidding process that
allows the federal government to share in any cost savings achieved by Medicare Advantage plans. In
general, the statutory payment rate for each county, which is primarily based on CMS’s estimated
per beneficiary fee-for-service expenses, was relabeled as the “benchmark” amount, and local
Medicare Advantage plans will annually submit bids that reflect the costs they expect to incur in
providing the base Medicare Part A and Part B benefits in their applicable service areas. If the
bid is less than the benchmark for that year, Medicare will pay the plan its bid amount, risk
adjusted based on its risk scores, plus a rebate equal to 75% of the amount by which the benchmark
exceeds the bid, resulting in an annual adjustment in reimbursement rates. Plans will be required
to use the rebate to provide beneficiaries with extra benefits, reduced cost sharing, or reduced
premiums, including premiums for MA-PD and other supplemental benefits. CMS will have the right to
audit the use of these proceeds. The remaining 25% of the excess amount will be retained in the
statutory Medicare trust fund. If a Medicare Advantage plan’s bid is greater than the benchmark,
the plan will be required to charge a premium to enrollees equal to the difference between the bid
amount and the benchmark, which is expected to make such plans less
competitive. For 2007, our average reimbursement rates for our
Medicare Advantage (excluding MA-PD) plans to date have increased by
4.1% over 2006, reflecting increases in county benchmarks and
our plans’ average risk scores. Average reimbursement rates for
Medicare Advantage (including MA-PD) plans to date have increased
2.6% for 2007 as compared to 2006. Reimbursement rates for
stand-alone PDPs to date have decreased by
9.5% in 2007 as compared to 2006.
Annual Enrollment and Lock-in. Prior to the MMA, Medicare beneficiaries were permitted to
enroll in a Medicare managed care plan or change plans at any point during the year. As of January
1, 2006, Medicare beneficiaries have defined enrollment periods, similar to commercial plans, in
which they can select a Medicare Advantage plan, stand-alone PDP, or traditional fee-for-service
Medicare. For 2007 and subsequent years, the annual enrollment period for a PDP is from November 15
through December 31 of each year, and enrollment in Medicare Advantage plans occurs from November
15 through March 31 of the subsequent year. Enrollment on or prior to December 31 will be effective
as of January 1 of the following year and enrollment on or after January 1 and within the
enrollment period will be effective as of the first day of the month following the date on which
the enrollment occurred. After these defined enrollment periods end, generally only seniors turning
65 during the year, Medicare beneficiaries who permanently relocate to another service area,
dual-eligible beneficiaries and others who qualify for special needs plans and employer group
retirees will be permitted to enroll in or change health plans during that plan year. Eligible
beneficiaries who fail to timely enroll in a Part D plan are subject to the penalties described
above if they later decide to enroll in a Part D plan.
Products and Services
We currently offer Medicare health plans, including MA-only and MA-PD in each of our markets.
We also offer a national stand-alone PDP plan. Of our January 1,
2007 PDP membership of approximately 108,000, approximately
85% reside in our five current Medicare Advantage service areas. Our Medicare Advantage plans cover Medicare eligible
members with benefits that are at least comparable to those offered under traditional Medicare
fee-for-service plans. Through our plans, we have the flexibility to offer benefits not covered
under traditional fee-for-service Medicare. Our plans are designed to be attractive to seniors and
offer a broad range of benefits that vary across our markets and service areas but may include, for
example, mental health benefits, vision and hearing benefits, transportation services, preventive
health services such as health and fitness programs, routine physicals, various health screenings,
immunizations, chiropractic services, and mammograms. Most of our Medicare Advantage members pay no
monthly premium but are subject in some cases to co-payments and deductibles, depending upon the
market and benefit. Our Medicare Advantage members are required to use a primary care physician
within our network of providers, except in limited cases, including emergencies, and generally must
receive referrals from their primary care physician in order to see a specialist or other ancillary
provider. In addition to our typical Medicare Advantage benefits, we offer a special needs zero
premium, zero co-payment plan, or SNP, to dual-eligible individuals in each of our markets.
The amount of premiums we receive for each Medicare member is established by contract,
although it varies according to various demographic factors, including the member’s geographic
location, age, and gender, and is further adjusted based on the member’s risk score. During the
month of December 2006, our Medicare Advantage premiums (including MA-PD) across our service areas
ranged from $698.51 to $907.05 PMPM. In addition to the premiums payable
to us, our contracts with CMS regulate, among other matters, benefits provided, quality assurance
procedures, and marketing and advertising for our Medicare Advantage and PDP products.
4
In addition to our Medicare Advantage and stand-alone PDP products, we offer commercial
managed care products and services in certain of our markets. Our commercial plans cover employer
groups with medical coverage and benefits that differ from plan to plan for a set monthly premium.
Our commercial products include:
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commercial health maintenance organization, or HMO, plans in Alabama and Tennessee; and |
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Preferred provider organization, or PPO, network rental, which allows third party
administrators to use our provider network for an access fee, in Tennessee. |
We also offer management services to independent physician associations in our Alabama, Tennessee,
and Texas markets, including claims processing, provider relations, credentialing, reporting and
other general business office services.
Our Health Plans
We operate Medicare Advantage and commercial health plans through HMO subsidiaries. Each of
the HMO subsidiaries is regulated by the department of insurance, and in some cases the department
of health, in its respective state. In addition, we own and operate non-regulated management
company subsidiaries that provide administrative and management services to the HMO subsidiaries in
exchange for a percentage of the HMO subsidiaries’ income pursuant to management agreements and
administrative services agreements. Those services include:
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negotiation, monitoring, and quality assurance of contracts with third party healthcare providers; |
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medical management, credentialing, marketing, and product promotion; |
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support services and administration; |
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financial services; and |
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claims processing and other general business office services. |
The following table summarizes our Medicare Advantage (including MA-PD), stand-alone PDP and
commercial plan membership as of the dates indicated:
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December 31, |
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2006 |
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2005 |
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2004 |
Medicare Advantage Membership
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Tennessee |
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46,261 |
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42,509 |
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29,862 |
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Texas |
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34,638 |
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29,706 |
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21,221 |
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Alabama |
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27,307 |
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24,531 |
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12,709 |
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Illinois(1) |
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6,284 |
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4,166 |
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— |
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Mississippi(2) |
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642 |
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369 |
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— |
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Total |
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115,132 |
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101,281 |
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63,792 |
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Medicare Stand-Alone PDP Membership |
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88,753 |
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— |
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— |
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Commercial Membership(3) |
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Tennessee |
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29,341 |
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29,859 |
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32,139 |
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Alabama |
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2,629 |
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11,910 |
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16,241 |
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Total |
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31,970 |
(4) |
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41,769 |
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48,380 |
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| (1) |
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We commenced operations in Illinois in December 2004. |
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We commenced enrollment efforts in Mississippi in July 2005. The annual enrollment
and lock-in provisions of the MMA were suspended in our service areas in Mississippi for
2006 as a result of Hurricane Katrina. |
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Does not include members of commercial PPOs owned and operated by unrelated third
parties that pay us a fee for access to our contracted provider network. |
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| (4) |
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As a result of the non-renewal by several large employers in Tennessee and Alabama,
total commercial membership as of January 1, 2007 was approximately 16,500. |
5
Tennessee
We began operations in Tennessee in September 2000 when we purchased a 50% interest in an HMO
in the Nashville, Tennessee area that offered commercial and Medicare products. When we purchased
the plan, it had approximately 8,000 Medicare Advantage members in five counties and 22,000
commercial members in 27 counties. We purchased an additional 35% interest in the HMO in 2003 and
purchased the remaining 15% in March 2005.
As of December 31, 2006, our Tennessee HMO, known as HealthSpring of Tennessee, had
approximately 75,600 members in 27 counties, including approximately 46,300 Medicare Advantage
members, and 29,300 commercial members. As a result of the discontinued coverage by several large
employers, total commercial membership as of January 1, 2007 was approximately 15,700. In
addition, through Signature Health Alliance, our wholly-owned PPO network subsidiary, we provided
access to our provider networks for approximately 71,500 members as of December 31, 2006,
throughout the 20-county area of Middle Tennessee. Our Tennessee market is primarily divided into
three major service areas including Middle Tennessee, the three-county greater Memphis area, and
the four-county greater Chattanooga area.
Based upon the number of members, we believe we operate the largest Medicare Advantage health
plan in the State of Tennessee. We believe the primary competing Medicare Advantage plans in our
service areas in Tennessee are Windsor Health Group, Humana, Inc., Cariten Healthcare, UnitedHealth
Group and Blue Cross Blue Shield.
Texas
We began operations in Texas in November 2000 as an independent physician association
management company. We began operating an HMO in Texas in November 2002 when we acquired
approximately 7,800 Medicare lives from a managed care plan in state receivership.
As of December 31, 2006, our Texas HMO, known as Texas HealthSpring, had approximately 34,600
Medicare Advantage members in 20 counties. Our Texas market is primarily divided into three major
service areas, including the 14-county greater Houston area, a four-county area northeast of
Houston, and a two-county Rio Grande Valley area. In January 2007, we expanded our Texas operations
into five additional counties northeast of Houston.
Our primary competitors in our Texas service areas include traditional Medicare
Advantage and private fee-for-service, or PFFS, plans operated by Humana, Inc., Universal American
Financial Corp., United Health Group, AMERIGROUP and Valley Baptist Health Plan, and Universal
Health Care, Inc.
Alabama
We began operations in Alabama in November 2002 when we purchased an HMO with approximately
23,000 commercial members and approximately 2,800 Medicare members in two counties. As of December
31, 2006, our Alabama HMO, known as HealthSpring of Alabama, served over 29,900 members, including
approximately 27,300 Medicare Advantage members and 2,600 commercial members in 42 counties (which
reduced to 33 counties as of January 1, 2007). As we generally operate statewide, we do not have
distinct primary service areas in Alabama.
We discontinued offering commercial benefits to individuals and small group employers in
Alabama effective May 31, 2006. Prior to May 31, 2006, small employer groups enrolled in our
commercial plans could elect to continue participating in our plans through May 31, 2007. As of
January 1, 2007, there were approximately 800 commercial members participating in our individual
and small employer group plans in Alabama. Pursuant to Alabama and federal law, as a result of our
decision to exit the individual and small group commercial markets, we may not reenter the
individual and small group employer commercial markets in Alabama until November 30, 2010.
We believe that our market position in Alabama as of December 2006, based on membership, was
second. Our primary Medicare Advantage competitors are UnitedHealth Group, Viva Health, a member of
the University of Alabama at Birmingham Health System, Blue Cross Blue Shield and Humana, Inc.
6
Illinois
We began operations in Illinois in December 2004 and, as of December 31, 2006, our Medicare
Advantage plan in Illinois, known as HealthSpring of Illinois, served approximately 6,300
beneficiaries in five counties in the Chicago area. We believe our primary competitors are Humana,
Inc., Wellcare Health Plans, Inc., Aetna, Inc. and Aveta Health, Inc.
Prior to the impact of the budget restrictions and other changes to the Medicare program
following the BBA, there were approximately 150,000 Medicare beneficiaries in the Chicago
metropolitan area enrolled in Medicare managed care plans.
Mississippi
We commenced our enrollment efforts in July 2005 for our Medicare Advantage plan, known as
HealthSpring of Mississippi, in two counties in northern Mississippi located near Memphis,
Tennessee. We entered these service areas consistent with our growth strategy to leverage existing
operations to expand to new service areas located near or contiguous to our existing service areas.
In 2006, we expanded our operations in our Mississippi market to include six counties in southern
Mississippi located near Mobile, Alabama.
Currently, we believe Humana, Inc. is the only other managed care company offering a competing
Medicare Advantage plan in the State of Mississippi.
National Part D Plan
On January 1, 2006, we began offering prescription drug benefits in accordance with Medicare
Part D to our Medicare Advantage plan members, in addition to continuing to provide other medical
benefits. We also began offering prescription drug benefits on a stand-alone basis in accordance
with Medicare Part D in each of our markets. We expanded our stand-alone PDP
program on a national basis in 2007. For 2007, our national PDP bid was below the benchmark in 29
of the 34 CMS regions. Of our January 1, 2007 PDP membership, approximately 85% reside in our five
Medicare Advantage service areas.
7
Medical Health Services Management and Provider Networks
One of our primary goals is to arrange for high quality healthcare for our members. To achieve
our goal of ensuring high quality, cost-effective healthcare, we have established various quality
management programs. Our health services quality management programs primarily include disease
management and utilization management programs.
Our disease management programs are focused on prevention and care and are designed to support
the coordination of healthcare intervention, physician/patient relationships and plans of care,
preventive care and patient empowerment with the goal of improving the quality of patient care and
controlling related costs. Our disease management programs are focused primarily on high-risk care
management and the treatment of our chronically ill members, which often account for a significant
portion of costs of managed care plans. These programs are designed to efficiently treat patients
with specific high risk or chronic conditions such as coronary artery disease, congestive heart
failure, prenatal and premature infant care, end stage renal disease, diabetes, asthma related
conditions, and certain other conditions. In addition to internal disease management efforts, we
work with outsourced disease management companies.
We also have implemented utilization, or case, management programs to provide more efficient
and effective use of healthcare services by our members. Our case management programs are designed
to improve outcomes for members with chronic conditions through standardization, proactive
management, coordinating fragmented healthcare systems to reduce healthcare duplication, provide
“gate-keeping” services and improve collaboration with physicians. We have contractors that monitor
hospitalization, coordinate care, and ensure timely discharge from the hospital. In addition, we
use internal case management programs and contracts with other third parties to manage severely and
chronically ill patients. We utilize on-site critical care intensivists, hospitalists and
concurrent review nurses, who manage the appropriate times for outpatient care, hospitalization,
rehabilitation or home care. We also offer prenatal case management programs as part of our
commercial plans.
We have information technology systems that support our quality improvement and management
activities by allowing us to identify opportunities to improve care and track the outcomes of the
services provided to achieve those improvements. We utilize this information as part of our monthly
analytical reviews and to enhance our preventive care and disease and case management programs
where appropriate.
Additionally, we internally monitor and evaluate, and seek to enhance, the performance of our
providers. Our related programs include:
| |
• |
|
review of utilization of preventive measures and disease/case management resources and
related outcomes; |
| |
| |
• |
|
member satisfaction surveys; |
| |
| |
• |
|
review of grievances and appeals by members and providers; |
| |
| |
• |
|
orientation visits to, and site audits of, select providers; |
| |
| |
• |
|
ongoing provider and member education programs; and |
| |
| |
• |
|
medical record audits. |
As more fully described below under “— Provider Arrangements and Payment Methods,” our
reimbursement methods are also designed to encourage providers to utilize preventive care and our
other disease and case management services in an effort to improve clinical outcomes.
We
believe strong provider relationships are essential to increasing our
membership and improving
the quality of care to our members on a cost efficient basis. We have established comprehensive
networks of providers in each of the areas we serve. We seek providers who have experience in
managing the Medicare population, including through a risk-sharing or other relationship with a
Medicare Advantage plan. Our goal is to create mutually beneficial and collaborative arrangements
with our providers. We believe provider incentive arrangements should not only help us attract
providers, but also help align their interests with our objective of providing high-quality,
cost-effective healthcare and ultimately encourage providers to deliver a level of care that
promotes member wellness, reduces avoidable catastrophic outcomes, and improves clinical results.
8
In some markets, we have entered into semi-exclusive arrangements with provider
organizations or networks. For example, in Texas we have partnered with Renaissance Physician
Organization, or RPO, a large group of 13 independent physician associations with over 1,100
physicians, including approximately 450 primary care physicians, or PCPs, and approximately 28,300
enrolled members located primarily in seven counties in the State of Texas.
In our efforts to improve the quality and cost-effectiveness of healthcare for our members, we
continue to refine and develop new methods of medical management and physician engagement. Two such
initiatives are currently underway. We have had encouraging preliminary results from the initial
pilot of our “pay-for-quality” initiative, which provides quality and outcomes-based financial
incentives to physicians, with approximately 7,500 members in 12 PCP offices in multiple markets.
The program, as piloted, includes an in-office resource, usually a nurse, in the physician practice
that is dedicated to serving our members. We also provide a dedicated call center resource for
disease management support. We are currently in the process of expanding the program to
approximately 24,000 to 25,000 members in Tennessee, Alabama, and Texas to determine whether the
early results can be replicated across markets.
In December 2006, we opened our first Living Well Health Center clinic dedicated to our
Medicare plan members, contracted with a medical group in Tennessee that experienced encouraging
pay-for-quality results discussed above. The clinic was designed with the Medicare member in mind,
with amenities designed to minimize any barrier to patient access such as single floors (no
elevators or stairs); adjacent parking or valet service and in some cases, pick up and return
services; open reception areas; on-site nutritionists, dieticians, and nurse educators; wide
corridors and doors; handicapped-accessible facilities; and electronic medical records. We believe
clinics have the potential to improve member satisfaction, service levels, and clinical outcomes
and provide for a more satisfying and cost-efficient manner for the physician to deliver care. We
also believe clinics will give us an advantage over our competitors not offering clinics, creating
a more attractive network for our members. We currently plan to open two additional clinics in
2007 prior to the 2008 open enrollment period.
The following table shows the number of physicians, specialists, and other providers
participating in our Medicare Advantage networks as of December 31, 2006:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Primary |
|
|
|
|
|
Specialists and |
| |
|
Care |
|
|
|
|
|
Other |
| Market |
|
Physicians |
|
Hospitals |
|
Providers |
Tennessee |
|
|
1,439 |
|
|
|
57 |
|
|
|
4,368 |
|
Texas |
|
|
827 |
|
|
|
50 |
|
|
|
1,619 |
|
Alabama |
|
|
1,001 |
|
|
|
68 |
|
|
|
2,831 |
|
Illinois |
|
|
452 |
|
|
|
24 |
|
|
|
1,636 |
|
Mississippi |
|
|
81 |
|
|
|
3 |
|
|
|
374 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
3,800 |
|
|
|
202 |
|
|
|
10,828 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Generally, we contract for pharmacy services through an unrelated pharmacy benefits manager,
or PBM, who is reimbursed at a discount to the “average wholesale price” for the provision of
covered outpatient drugs. Our HMOs are entitled to share in drug manufacturers’ rebates based on
pharmacy utilization relating to certain qualifying medications. We also contract with a third
party behavioral health vendor who provides mental health and substance abuse services for our
members.
We strive to be the preferred Medicare Advantage partner for providers in each market we
serve. In addition to risk-sharing and other incentive-based financial arrangements, we seek to
promote a provider-friendly relationship by paying claims promptly, providing periodic performance
and efficiency evaluations, providing convenient, web-based access to eligibility data and other
information, and encouraging provider input on plan benefits. We also emphasize quality assurance
and compliance by periodically reviewing our networks and providers. By fostering a collaborative,
interactive relationship with our providers, we are better able to gather data relevant to
improving the level of preventive healthcare available under our plans, monitor the utilization of
medical treatment and the accuracy of patient encounter data, risk coding and the risk scores of
our plans, and otherwise ensure our contracted providers are providing high-quality and timely
medical care.
9
Provider Arrangements and Payment Methods
We attempt to structure our provider arrangements and payment methods in a manner that
encourages the medical provider to deliver high quality medical care to our members. We also
attempt to structure our provider contracts in a way that mitigates some or all of our medical risk
either through capitation or other risk-sharing arrangements. In general, there are two types of
medical risk — professional and institutional. Professional risk primarily relates to physician
and other outpatient services. Institutional risk primarily relates to hospitalization and other
inpatient or institutionally-based services.
We generally pay our providers under one of three payment methods:
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• |
|
fee-for-service, based on a negotiated fixed-fee schedule where we are fully
responsible for managing institutional and professional risk; |
| |
| |
• |
|
capitation, based on a PMPM payment, where physicians generally assume the professional
risk, or on a case-rate or per diem basis where a hospital or health system generally
assumes the institutional or professional risk, or both; and |
| |
| |
• |
|
risk-sharing arrangements, typically with a physician group, where we advance, on a
PMPM basis, amounts designed to cover the anticipated professional risk and then adjust
payments, on a monthly basis, between us and the physician group based on actual experience
measured against pre-determined sharing ratios. |
Under any of these payment methods, we may also supplement provider payments with incentive
arrangements based, in general, on the quality of healthcare delivery. For example, as an incentive
to encourage our providers to deliver high quality care for their patients and assist us with our
quality assurance and medical management programs, we often seek to implement incentive
arrangements whereby we compensate our providers for “quality performance,” including increased
fee-for-service rates for specified preventive health services and additional payments for
providing specified encounter data on a timely basis. We also seek to implement financial
incentives relating to other operational matters where appropriate.
In a limited number of cases, we may be at risk for medical expenses above and beyond a
negotiated amount (a so-called “stop loss” provision), which amount is typically calculated by
reference to a percentage of billed charges, in some cases back to the first dollar of medical
expense. When our members receive services for which we are responsible from a provider with whom
we have not contracted, such as in the case of emergency room services from non-contracted
hospitals, we generally attempt to negotiate a rate with that provider. In some cases, we may be
obligated to pay the full rate billed by the provider. In the case of a Medicare patient who is
admitted to a non-contracting hospital, we are only obligated to pay the amount that the hospital
would have received from CMS under traditional fee-for-service Medicare.
We believe our incentive and risk-sharing arrangements help to align the interests of the
physician with us and our members and improve both clinical and financial outcomes. We will
continue to seek to implement these arrangements where possible in our existing and new service
areas.
Sales and Marketing Programs
As of December 31, 2006, our sales force consisted of approximately 650 appointed third party
agents and 80 internal licensed sales employees (including in-house telemarketing personnel). Our
third party agents are compensated on a commission basis. Medicare Advantage enrollment is
generally a decision made individually by the member. Accordingly, our sales agents and
representatives focus their efforts on in-person contacts with potential enrollees as well as
telephonic and group selling venues. To date, we have not actively marketed our PDPs and have
relied primarily on auto-assignments of dual-eligibles by CMS.
In addition to traditional marketing methods including direct mail, telemarketing, radio,
television, internet and other mass media, and cooperative advertising with participating hospitals
and medical groups to generate leads, we also conduct community outreach programs in churches and
community centers and in coordination with government agencies. We regularly participate in local
community health fairs and events, and seek to become involved with local senior citizen
organizations to promote our products and the benefits of preventive care.
10
Our sales and marketing programs include an integrated multimedia advertising campaign
featuring Major League Baseball Hall of Fame member Willie Mays, our national spokesperson. Campaigns are
tailored to each of our local service areas and are designed with the goal of educating,
attracting, and retaining members and providers. In addition, we seek to create ethnically and
culturally competent marketing programs where appropriate that reflect the diversity of the areas
that we serve.
Our marketing and sales activities are heavily regulated by CMS and other governmental
agencies. For example, CMS has oversight over all, and in some cases has imposed advance approval
requirements with respect to, marketing materials used by our Medicare Advantage plans, and our
sales activities are limited to activities such as conveying information regarding the benefits of
preventive care, describing the operations of managed care plans, and providing information about
eligibility requirements. The activities of our third-party brokers and agents are also heavily
regulated. We maintain active and ongoing training and oversight of all employed and contracted
sales representatives, agents and brokers.
Medicare beneficiaries have a limited annual enrollment period during which they can choose
between a Medicare Advantage plan and traditional fee-for-service Medicare. After this annual
enrollment period ends, generally only seniors turning 65 during the year, dual-eligible
beneficiaries and others who qualify for special needs plans, Medicare beneficiaries permanently
relocating to another service area, and employer group retirees will be permitted to enroll in or
change health plans. The annual enrollment period is from November 15 through December 31 each year
for stand-alone PDPs and through March 31 of the following year for Medicare Advantage plans. We
have significantly adjusted the timing and intensity of our marketing efforts to align with the
limited open enrollment period.
Quality Assurance
As part of our quality assurance program, we have implemented processes designed to ensure
compliance with regulatory and accreditation standards. Our quality assurance program also consists
of internal programs that credential providers and programs designed to help ensure we meet the
audit standards of federal and state agencies, including CMS and the state departments of
insurance, as well as applicable external accreditation standards. For example, we monitor and
educate, in accordance with audit tools developed by CMS, our claims, credentialing, customer
service, enrollment, health services, providers relations, contracting, and marketing departments
with respect to compliance with applicable laws, regulations, and other requirements.
Our providers must satisfy specific criteria, such as licensing, credentialing, patient
access, office standards, after-hours coverage, and other factors. Our participating hospitals must
also meet specific criteria, including accreditation criteria established by CMS.
Competition
We historically operated in areas where there have been few or no competing Medicare Advantage
plans, although we are currently operate in an increasingly competitive environment, particularly
with the recent advent of PFFS plans resulting from the passage of the MMA. Our principal competitors
for contracts, members, and providers vary by local service area and are principally national,
regional and local commercial managed care organizations, including PDPs, that serve Medicare
recipients, including, among others, UnitedHealth Group, Humana, Inc., and Universal American
Financial Corp. In addition, the MMA (including Medicare Part D) has caused a number of other
managed care organizations, some of which are already in our service areas, to decide to enter the
Medicare Advantage market. Furthermore, the implementation of Medicare Part D prescription drug
benefits in 2006 has caused national and regional pharmaceutical distributors and retailers,
pharmacy benefit managers, and managed care organizations to enter our markets and provide services
and benefits to the Medicare eligible population. Medicare PFFS plans allow their members more
flexibility to select physicians than HMO Medicare Advantage plans.
We believe the principal factors influencing a Medicare recipient’s choice among health plan
options are:
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• |
|
additional premiums, if any, payable by the beneficiary; |
| |
| |
• |
|
benefits offered; |
| |
| |
• |
|
location and choice of healthcare providers; |
11
| |
• |
|
quality of customer service and administrative efficiency; |
| |
| |
• |
|
reputation for quality care; |
| |
| |
• |
|
financial stability of the plan; and |
| |
| |
• |
|
accreditation results. |
A number of these competitive elements are partially dependent upon and can be positively
affected by financial resources available to a health plan. We face competition from other managed
care companies that have greater financial and other resources, larger enrollments, broader ranges
of products and benefits, broader geographical coverage, more established reputations in the
national market and in our markets, greater market share, larger contracting scale and lower costs.
Superior benefit design, provider network and community perception may also provide a distinct
competitive advantage.
Our Competitive Advantages
We believe the following are our key competitive advantages:
Focus on Medicare Advantage Market. We are focused primarily on the Medicare Advantage
market. We believe our focus on designing and operating Medicare Advantage health plans tailored to
each of our local service areas enables us to offer superior Medicare Advantage plans and to
operate those plans with what we believe to be lower MLRs. Our focus allows us to:
| |
• |
|
build relationships with provider networks that deliver the care desired by Medicare
beneficiaries in their local service areas at contractual rates that take into account
Medicare reimbursement schedules; |
| |
| |
• |
|
direct our sales and marketing efforts primarily to Medicare beneficiaries and their
families, customized to the demographics of the communities in which we operate; and |
| |
| |
• |
|
staff each of our service areas with locally-based senior managers who understand the
particular dynamics influencing behavior of local Medicare beneficiaries and providers as
well as political and legislative impacts on our programs. |
Leading Presence in Attractive, Underpenetrated Markets. We have a significant market
position in our established service areas and in many of our service areas we are the market leader
in terms of the number of Medicare Advantage members. Medicare Advantage penetration is highly
variable across the country as a result of various factors, including infrastructure and provider
accessibility. We focus our efforts primarily on service areas we believe to be underpenetrated,
providing opportunities for us to increase the membership of our plans.
We believe our market position provides us with competitive advantages including operating
efficiencies; comprehensive provider networks; and “HealthSpring” name recognition with potential
new members within our service areas and in areas located contiguous to or near our existing
service areas.
Effective Medical Management. Our medical management efforts are designed primarily for the
Medicare Advantage program. We believe our ability to predict and manage our medical expenses is
primarily the result of the following factors:
| |
• |
|
Analytical Focus — We have institutionalized, throughout our management team, a
data-driven analytical focus on our operations. We intensively review, on a monthly basis,
actuarial analyses of claims data, IBNR claims, medical cost trends and loss ratios, and
other relevant data by service area and product. We also assess provider relations monthly
based upon reports prepared by the senior management team for each of our markets. The
monthly reviews are attended by senior management of the company and our local markets and
allow us to identify and address favorable and adverse trends in a timely manner. |
| |
| |
• |
|
Provider Networks— Our management team has extensive experience managing providers and
provider networks, including independent physician associations. We believe this experience
provides us a |
12
| |
|
|
competitive advantage in structuring our provider contracts and provider relations generally.
Our provider networks include over 13,500 physicians and 200 hospitals. We seek providers who
have experience in managing the Medicare population. We attempt to contract with our
providers by, among other things, aligning physician interests with our interests and the
interests of our members by way of incentive compensation and risk-sharing arrangements.
These incentive arrangements are designed to encourage our providers to deliver a level of
care that promotes member wellness, reduces avoidable catastrophic outcomes, and improves
clinical and financial results. Additionally, we internally monitor and evaluate the
performance of our providers on a periodic basis to ensure these relationships are successful
in meeting their goals and engage our providers directly when appropriate to address
performance deficiencies individually or within their networks. |
| |
| |
• |
|
Focus on Promoting Member Wellness and Managing Medical Care Utilization — We practice
a “gatekeeper” approach to managing care. Each member selects a primary care physician who
coordinates care for that member and, in conjunction with the company, monitors and
controls the member’s utilization of the network. Although the primary care physician is
primarily responsible for managing member utilization and promoting member wellness, we
have also implemented comprehensive quality management programs to help
ensure high quality, cost-effective healthcare for our members, and in particular the
chronically ill. We actively manage improvements in beneficiary care through internal and
outsourced disease management programs for members with chronic medical conditions. We have
also designed case management programs to provide more effective utilization of healthcare
services by our members, including through the employment of on-site critical care
intensivists, hospitalists, and concurrent review nurses who are trained to know the
appropriate times for outpatient care, hospitalization, rehabilitation, or home care, and
through partnerships with third party case management specialists. We work closely with our
disease and case management partners in a hands-on approach to help ensure the desired
outcomes. Our providers are trained and encouraged to utilize our disease and case
management programs in an effort to improve clinical and financial outcomes. |
Scalable Operating Structure. We have centralized certain functions of our health plans,
including claims payment, actuarial review, health risk assessment, and benefit design for
operational efficiencies and to facilitate our analytical, data-driven approach to operations.
Other functions, including member services, sales and marketing, provider relations, medical
management, and financial reporting and analysis, are customized for each of our local service
areas. We believe this combination of centralized administrative functions and local service area
focus, including localized medical management programs and on-site personnel at facility locations,
gives us an advantage over competitors who have standardized and centralized many or all of these
operating and member services functions. Additionally, we have designed our centralized and local
administrative and information services functions to be scalable to accommodate our growth in
existing or new service areas.
Regulation
Overview
As a managed care organization, our operations are and will continue to be subject to
substantial federal, state, and local government regulation which will have a broad effect on the
operation of our health plans. The laws and regulations affecting our industry generally give state
and federal regulatory authorities broad discretion in their exercise of supervisory, regulatory
and administrative powers. These laws and regulations are intended primarily for the benefit of the
members and providers of the health plans.
In addition, our right to obtain payment from Medicare is subject to compliance with numerous
regulations and requirements, many of which are complex, and evolving as a result of the MMA, and
are subject to administrative discretion. Moreover, since we are contracting only with the Medicare
program to provide coverage for beneficiaries of our Medicare Advantage plans, our Medicare
revenues are completely dependent upon the reimbursement levels and coverage determinations in
effect from time to time in the Medicare Advantage program.
In addition, in order to operate our Medicare Advantage plans, we must obtain and maintain
certificates of authority or license from each state in which we operate. In order to remain
certified we generally must demonstrate, among other things, that we have the financial resources
necessary to pay our anticipated medical care expenses and the infrastructure needed to account for
our costs and otherwise meet applicable licensing requirements. Accordingly, in order to remain
qualified for the Medicare Advantage program, it may be necessary for our Medicare Advantage plans
to make changes from time to time in their operations, personnel, and services. Although
13
we intend for our Medicare Advantage plans to maintain certification and to continue to
participate in those reimbursement programs, there can be no assurance that our Medicare Advantage
plans will continue to qualify for participation.
Each of our health plans is also required to report quarterly on its financial performance to
the appropriate regulatory agency in the state in which the health plan is licensed. Each plan also
undergoes periodic reviews of our quality of care and financial status by the applicable state
agencies.
The MMA generally requires PDP sponsors to be licensed under state
law as a risk-bearing entity eligible to offer health insurance or health benefits coverage in each
state in which the sponsor wishes to offer a PDP. CMS has implemented
two waiver processes, however, to allow PDP sponsors to begin operations prior to obtaining state licensure or certification in
all states in which they do business, even if the state already has in place a licensing process
for PDP sponsors. For plan year 2007, PDP sponsors may seek a “single state waiver” in such states
by submitting to CMS a waiver application. A “regional plan
waiver” is also available to PDP sponsors that have obtained licensure as a
risk-bearing entity in at least one state in a PDP region.
Federal Regulation
Medicare. Medicare is a federally sponsored healthcare plan for persons aged 65 and over,
qualifying disabled persons and persons suffering from end-stage renal disease which provides a
variety of hospital and medical insurance benefits. We contract with CMS to provide services to
Medicare beneficiaries pursuant to the Medicare Advantage program. As a result, we are subject to
extensive federal regulations, some of which are described in more detail elsewhere in this report.
CMS may audit any health plan operating under a Medicare contract to determine the plan’s
compliance with federal regulations and contractual obligations.
Additionally, the marketing activities of Medicare Advantage plans are strictly regulated by
CMS. For example, CMS has oversight over all, and in some cases has imposed advance approval
requirements with respect to, marketing materials used by our Medicare Advantage plans, and our
sales activities are limited to activities such as conveying information regarding the benefits of
preventive care, describing the operations of managed care plans, and providing information about
eligibility requirements. Federal law precludes states from imposing additional marketing
restrictions on Medicare Advantage plans. States, however, remain free to regulate, and typically
do regulate, the marketing activities of plans that enroll commercial beneficiaries.
Fraud and Abuse Laws. The federal anti-kickback statute imposes criminal and civil penalties
for paying or receiving remuneration (which includes kickbacks, bribes, and rebates) in connection
with any federal healthcare program, including the Medicare program. The law and related
regulations have been interpreted to prohibit the payment, solicitation, offering or receipt of any
form of remuneration in return for the referral of federal healthcare program patients or any item
or service that is reimbursed, in whole or in part, by any federal healthcare program. In some of
our markets, states have adopted similar anti-kickback provisions, which apply regardless of the
source of reimbursement.
With respect to the federal anti-kickback statute, there are two safe harbors addressing
certain risk-sharing arrangements. In addition, the Office of the Inspector General has adopted
other safe harbors related to managed care arrangements. These safe harbors describe relationships
and activities that are deemed not to violate the federal anti-kickback statute. However, failure
to satisfy each criterion of an applicable safe harbor does not mean that an arrangement
constitutes a violation of the law; rather the arrangement must be analyzed on the basis of its
specific facts and circumstances. Business arrangements that do not fall within a safe harbor do
create a risk of increased scrutiny by government enforcement authorities. We have attempted to
structure our risk-sharing arrangements with providers, the incentives offered by our health plans
to Medicare beneficiaries, and the discounts our plans receive from contracting healthcare
providers to satisfy the requirements of these safe harbors. There can be no assurance, however,
that upon review regulatory authorities will determine that our arrangements do not violate the
federal anti-kickback statute.
CMS has promulgated regulations that prohibit health plans with Medicare contracts from
including any direct or indirect payment to physicians or other providers as an inducement to
reduce or limit medically necessary services
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to a Medicare beneficiary. These regulations impose disclosure and other requirements relating
to physician incentive plans including bonuses or withholdings that could result in a physician
being at “substantial financial risk” as defined in Medicare regulations. Our ability to maintain
compliance with these regulations depends, in part, on our receipt of timely and accurate
information from our providers. We conduct our operations in an attempt to comply with these
regulations; however, we are subject to future audit and review. It is possible that regulatory
authorities may challenge our provider arrangements and operations and there can be no assurance
that we would prevail if challenged.
Federal False Claims Act. We are subject to a number of laws that regulate the presentation
of false claims or the submission of false information to the federal government. For example, the
federal False Claims Act provides, in part, that the federal government may bring a lawsuit against
any person or entity whom it believes has knowingly presented, or caused to be presented, a false
or fraudulent request for payment from the federal government, or who has made a false statement or
used a false record to get a claim approved. The federal government has taken the position that
claims presented in violation of the federal anti-kickback statute may be considered a violation of
the federal False Claims Act. Violations of the False Claims Act are punishable by treble damages
and penalties of up to $11,000 per false claim. In addition to suits filed by the government, a
special provision under the False Claims Act allows a private individual (e.g., a “whistleblower”
such as a disgruntled former employee, competitor or patient) to bring an action under the False
Claims Act on behalf of the government alleging that an entity has defrauded the federal government
and permits the whistleblower to share in any settlement or judgment that may result from that
lawsuit. Although we strive to operate our business in compliance with all applicable rules and
regulations, we may be subject to investigations and lawsuits under the False Claims Act that may
be initiated either by the government or a whistleblower. It is not possible to predict the impact
such actions may have on our business.
Health Insurance Portability and Accountability Act of 1996. The Health Insurance Portability
and Accountability Act of 1996, or HIPAA, imposes requirements relating to a variety of issues that
affect our business, including the privacy and security of medical information, limits on
exclusions based on preexisting conditions for our plans, guaranteed renewability of healthcare
coverage for most employers and individuals and administrative simplification procedures involving
the standardization of transactions and the establishment of uniform healthcare provider, payor and
employer identifiers. Various federal agencies have issued regulations to implement certain
sections of HIPAA.
For example, the Department of Health and Human Services, or DHHS, issued a final rule that
establishes the standard data content and format for the electronic submission of claims and other
administrative health transactions. Although we believe our operations are compliant with the
electronic data standards established by the final rule, to the extent that we submit to Medicare
electronic healthcare claims and payment transactions that are deemed not to be in compliance with
these standards, payments to us may be delayed or denied. Additionally, DHHS has issued a final
privacy rule and final security standards that apply to individually identifiable health
information. The primary purposes of the privacy rule are to protect and enhance the rights of
consumers by providing them access to their health information and controlling the inappropriate
use of that information, and to improve the efficiency and effectiveness of healthcare delivery by
creating a national framework for health privacy protection that builds on efforts by states,
health systems, individual organizations, and individuals. The final rule for security standards
establishes minimum standards for the security of individually identifiable health information that
is transmitted or maintained electronically. We will conduct our operations in an attempt to comply
with the requirements of the privacy rule and the security standards. There can be no assurance,
however, that upon review regulatory authorities will find that we are in compliance with these
requirements.
On January 8, 2001, the U.S. Department of Labor’s Pension and Welfare Benefits
Administration, the IRS and DHHS issued two regulations that provide guidance on the
nondiscrimination provisions under HIPAA as they relate to health factors and wellness programs.
These provisions prohibit a group health plan or group health insurance issuer from denying an
individual eligibility for benefits or charging an individual a higher premium based on a health
factor. We do not believe that these regulations will have a material adverse effect on our
business.
Employee Retirement Income Security Act of 1974. The provision of services to certain
employee health benefit plans is subject to the Employee Retirement Income Security Act of 1974, or
ERISA. ERISA regulates certain aspects of the relationships between plans and employers who
maintain employee benefit plans subject to ERISA. Some of our administrative services and other
activities may also be subject to regulation under ERISA.
The U.S. Department of Labor adopted federal regulations that establish claims procedures for
employee benefit plans under ERISA. The regulations shorten the time allowed for health and
disability plans to respond to claims and
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appeals, establish requirements for plan responses to appeals and expand required disclosures
to participants and beneficiaries. These regulations have not had a material adverse effect on our
business.
State Regulation
Though generally governed by federal law, each of our HMO subsidiaries is licensed in the
market in which it operates and is subject to the rules, regulations, and oversight by the
applicable state department of insurance in the areas of licensing and solvency. Our HMO
subsidiaries file reports with these state agencies describing their capital structure, ownership,
financial condition, certain inter-company transactions and business operations. Our HMO
subsidiaries are also generally required to demonstrate among other things, that we have an
adequate provider network, that our systems are capable of processing
providers’ claims in a timely
fashion and of collecting and analyzing the information needed to manage their business. State
regulations also require the prior approval or notice of acquisitions or similar transactions
involving an HMO, and of certain transactions between an HMO and its parent or affiliated entities
or persons. Generally, our HMOs are limited in their ability to pay dividends.
Our HMO subsidiaries are required to maintain minimum levels of statutory capital. The minimum
statutory capital requirements differ by state and are generally based on a percentage of
annualized premium revenue, a percentage of annualized healthcare costs, or risk-based capital, or
RBC, requirements. The RBC requirements are based on guidelines established by the National
Association of Insurance Commissioners, or NAIC, and are administered by the states. If adopted,
the RBC requirements may be modified as each state legislature deems appropriate for that state.
Currently, only our Texas HMO subsidiary is subject to statutory RBC requirements and our other HMO
subsidiaries are subject to other minimum statutory capital requirements mandated by the states in
which they are licensed. These requirements assess the capital adequacy of an HMO subsidiary based
upon investment asset risks, insurance risks, interest rate risks and other risks associated with
its business to determine the amount of statutory capital believed to be required to support the
HMO’s business. If the HMO’s statutory capital level falls below certain required capital levels,
the HMO may be required to submit a capital corrective plan to the state department of insurance,
and at certain levels may be subjected to regulatory orders, including regulatory control through
rehabilitation or liquidation proceedings.
Technology
We
have developed and implemented information technology solutions that
we believe are
critical to our success and our goal to provide high quality healthcare for our members. Our
systems collect and process information centrally and support our core administrative functions,
including premium billing, claims processing, utilization management, reporting, medical cost
trending, planning and analysis, as well as certain member and provider service functions,
including enrollment, member eligibility verification, claims status inquiries, and referrals and
authorizations. Additionally, we recently enhanced our disease and case management software
functionality.
We augment our own technology services through independent third parties, such as DST Health
Solutions, Inc. and OAO Health Solutions, Inc., with whom we have entered into what we believe are
customary agreements for the provision of software and related consulting services with respect to
our information technology systems. We are in the process of developing increased internal
software development capability to support and enhance our core processing systems and in order to
respond to rapidly changing market, regulatory, and operational requirements.
We
have completed our initial business continuity and disaster recovery planning and have begun
implementation on a primary data center in Nashville, Tennessee and secondary data center in
Birmingham, Alabama. We will continue testing and implementation through 2007.
Employees
At December 31, 2006, we had approximately 1,200 employees, substantially all of whom were
full-time. None of our employees are presently covered by a collective bargaining agreement. We
consider relations with our employees to be good.
Service Marks
The name “HealthSpring” is a registered service mark with the United States Patent and
Trademark Office. We also have other registered service marks. Prior use of our service marks by
third parties may prevent us from using
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our service marks in certain geographic areas. We intend to protect our service marks by
appropriate legal action whenever necessary.
EXECUTIVE OFFICERS OF THE COMPANY
The following are our executive officers and their biographies and ages as of February 28,
2007:
Herbert A. Fritch, age 56, has served as the Chairman of the Board of Directors, President,
and Chief Executive Officer of the company and its predecessor, NewQuest, LLC, since the
commencement of operations in September 2000. Beginning his career in 1973 as an actuary, Mr.
Fritch has over 30 years of experience in the managed healthcare business. Prior to founding
NewQuest, LLC, Mr. Fritch founded and served as president of North American Medical Management,
Inc., or NAMM, an independent physician association management company, from 1991 to 1999. NAMM was
acquired by PhyCor, Inc., a physician practice management company, in 1995. Mr. Fritch served as
vice president of managed care for PhyCor following PhyCor’s acquisition of NAMM. Prior to NAMM,
Mr. Fritch served as a regional vice president for Partners National Healthplans from 1988 to 1991,
where he was responsible for the oversight of seven HMOs in the southern region. Mr. Fritch holds a
B.A. in Mathematics from Carleton College. Mr. Fritch is a fellow of the Society of Actuaries and a
member of the Academy of Actuaries.
Jeffrey L. Rothenberger, age 47, has served as Executive Vice President and Chief Operating
Officer of the company since March 2005, and served in various capacities, including chief
operating officer, for the company’s predecessor since September 2000. Prior to joining NewQuest,
LLC, Mr. Rothenberger served as vice president for NAMM from 1996 to August 2000, with operating
responsibility for several markets. Mr. Rothenberger also served as chief financial officer for the
Houston independent physician associations affiliated with NAMM in 1995. Mr. Rothenberger holds a
B.B.A. in Accounting from the University of Georgia and an M.B.A. from the University of Houston.
In addition, Mr. Rothenberger is a certified public
accountant (inactive). Mr. Rothenberger has announced his
retirement from the Company effective April 30, 2007.
Gerald
V. Coil, age 58, was hired as Executive Vice President and Chief Operating Officer of the
company in December 2006 in anticipation of Mr. Rothenberger’s retirement. Prior to joining the
company, he was president of MHN, the behavioral health division of HealthNet, Inc., a publicly
held managed care organization, from October 2002 to December 2006. From January 2002 to October
2002, Mr. Coil served in various capacities for Kaiser Permanente, a not-for-profit integrated
healthcare system. Prior to January 2002, Mr. Coil worked for NAMM in various capacities, including as head of its
West Coast operations. Mr. Coil holds a B.S. in Sociology and Social Work from Arizona State
University.
Kevin
M. McNamara, age 50, has served as Executive Vice President and Chief Financial Officer
and Treasurer of the company since April 2005. Mr. McNamara served from April 2005 to January 2006
as non-executive chairman of ProxyMed, Inc., a provider of automated healthcare business and cost
containment solutions for financial, administrative and clinical transactions in the healthcare
payments marketplace, and served as interim chief executive officer of ProxyMed, Inc. from December
2004 through June 2005. Mr. McNamara served as chief financial officer of HCCA International, Inc.,
a healthcare management and recruitment company, from October 2002 to April 2005. From November
1999 until February 2001, Mr. McNamara served as chief executive officer and a director of Private
Business, Inc., a provider of electronic commerce solutions that help community banks provide
accounts receivable financing to their small business customers. From 1996 to 1999, Mr. McNamara
served as senior vice president and chief financial officer of Envoy Corporation, a provider of
electronic transactions processing services to participants in the healthcare industry. Mr.
McNamara also serves on the board of directors of Luminex Corporation, a diagnostic and life
sciences tool and consumables manufacturer. Mr. McNamara is a certified public accountant
(inactive) and holds a B.S. in Accounting from Virginia Commonwealth University and an M.B.A. from
the University of Richmond.
J. Gentry Barden, age 45, has served as Senior Vice President, Corporate General Counsel, and
Secretary of the company since July 2005. From September 2003 to July 2005, Mr. Barden was a member
of Brentwood Capital Advisors LLC, an investment banking firm based in Nashville, Tennessee that
advised the company in the recapitalization. From September 2000 to February 2003, Mr. Barden was a
managing director of McDonald Investments Inc., an investment-banking subsidiary of Cleveland,
Ohio-based KeyCorp, in its Nashville office. From December 1998 to June 2000, Mr. Barden was a
managing director and member of J.C. Bradford & Co., LLC, a Nashville-based investment-banking
firm, and co-directed its mergers and acquisitions operations. Mr. Barden was a corporate and
securities lawyer from 1986 through 1998, including with Bass, Berry & Sims PLC in Nashville,
Tennessee. Mr. Barden graduated with a B.A. from The University of the South (Sewanee) and with a
J.D. from the University of Texas.
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Craig S. Schub, age 51, has served as Senior Vice President and Chief Marketing Officer since
April 2006. Mr. Schub was a senior vice president and chief marketing officer for Advance PCS, a
pharmacy benefit management company from August 2001 until March 2004 when it was acquired by
merger with Caremark Rx, Inc. For over ten years prior to February 2001, Mr. Schub served in various
capacities for PacifiCare Health Systems, including as senior vice president of marketing and
senior vice president of its Secure Horizons division, which operated PacifiCare’s Medicare
Advantage plan. Mr. Schub graduated with a B.S. in business administration from California State
University and served in the United States Air Force.
David L. Terry, Jr, age 56, has served as Senior Vice President and Chief Actuary of the
company since March 2005, and served in various capacities, including Chief Actuary, for the
company’s predecessor since July 2003. Prior to joining NewQuest, LLC, Mr. Terry served as senior
consultant for Reden & Anders, Ltd., a healthcare consulting firm, from July 2000 to July 2003. Mr.
Terry holds a B.S. in Statistics from Colorado State University and an M.S. in actuarial science
from the University of Nebraska.
Mark
A. Tulloch, age 44, joined the company in July 2006. He was
Senior Vice President of Pharmacy Operations from July through
December 2006 and, effective January 2007, became Senior Vice President of Managed
Care Operations. Prior to joining the company, he served from March 2003 to July 2006 as senior
vice president of operations for United Surgical Partners International (“USPI”), a publicly-held
owner and operator of short-stay surgical facilities. Prior to March 2003, Mr. Tulloch spent seven
years with OrthoLink Physicians Corporation, a subsidiary of USPI specializing in orthopaedic
practice management and ancillary development. Mr. Tulloch served in various capacities for
Ortholink, including as president and chief operating officer. Mr. Tulloch holds an M.B.A. from the
Massey School at Belmont University, a M.Ed. from Vanderbilt University, and a B.S. from Middle
Tennessee State University.
Item 1A. Risk Factors
You should consider carefully the risks and uncertainties described below, and all information
contained in this report, in evaluating our company and our business. The occurrence of any of the
following risks or uncertainties described below could significantly and adversely affect our
business, prospects, financial condition, and operating results. In any such event, the trading
price of our common stock could decline.
Risks Related to Our Industry
Reductions in Funding for Medicare Programs Could Significantly Reduce Our Profitability.
Medicare premiums, including premiums from our PDP plans, accounted for approximately
87.8% of our total revenue for the year ended December 31, 2006. As a result, our revenue and
profitability are dependent on government funding levels for Medicare programs. The premium rates
paid to Medicare health plans like ours are established by contract, although the rates differ
depending on a combination of factors, including upper payment limits established by CMS, a
member’s health profile and status, age, gender, county or region, benefit mix, member eligibility
categories, and the plan’s risk scores. Future Medicare premium rate levels may be affected by
continuing government efforts to contain healthcare related expenditures, including prescription
drug costs, and other federal budgetary constraints. Changes in the Medicare program, including
with respect to funding, may lead to reductions in the amount of reimbursement, elimination of
coverage for certain benefits, or reductions in the number of persons enrolled in or eligible for
Medicare, which in turn could reduce the number of beneficiaries enrolled in our health plans and
our revenues and profitability.
CMS’s Risk Adjustment Payment System and Budget Neutrality Factors Make Our Revenue and
Profitability Difficult to Predict and Could Result In Material Retroactive Adjustments to Our
Results of Operations.
CMS has implemented a risk adjustment payment system for Medicare health plans to improve the
accuracy of payments and establish incentives for Medicare plans to enroll and treat less healthy
Medicare beneficiaries. CMS is phasing-in this payment methodology with a risk adjustment model
that bases a portion of the total CMS reimbursement payments on various clinical and demographic
factors including hospital inpatient diagnoses, diagnosis data from ambulatory treatment settings,
including hospital outpatient facilities and physician visits, gender, age, and Medicaid
eligibility. CMS requires that all managed care companies capture, collect, and submit the
necessary diagnosis code information to CMS twice a year for reconciliation with CMS’s internal
database. As part of the phase-in, during 2003, risk adjusted payments accounted for 10% of
Medicare health plan payments, with the remaining 90% being reimbursed in accordance with the
traditional CMS demographic rate books. The portion of risk adjusted payments was increased to 30%
in 2004, 50% in 2005, 75% in 2006, and 100% in 2007. As a result
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of this process, it is difficult to predict with certainty our future revenue or
profitability. In addition, our plans’ risk scores for any period may result in favorable or
unfavorable adjustments to the payments we receive from CMS and our Medicare premium revenue.
CMS
has recently initiated studies designed to assess the degree of coding pattern differences between Medicare fee-for-service and Medicare Advantage and the extent to which any
differences could be appropriately addressed by an adjustment to the
CMS risk scores. Diagnosis coding is
one of the components used to determine the risk scores of individual
members. In the event these
studies reveal differences in the capture of coding between traditional Medicare fee-for-service
and Medicare Advantage, there may be an impact on the risk adjustment
payments to Medicare Advantage plans.
Payments to Medicare Advantage plans are also adjusted by a “budget neutrality” factor that
was implemented in 2003 by Congress and CMS to prevent health plan payments from being reduced
overall while, at the same time, directing risk adjusted payments to plans with more chronically
ill enrollees. In general, this adjustment favorably impacted payments to Medicare Advantage plans.
In February 2006, the President signed legislation that reduced federal funding for Medicare
Advantage plans by approximately $6.5 billion over five years. Among other changes, the legislation
provided for an accelerated phase-out of budget neutrality for risk adjusted payments made to
Medicare Advantage plans. These legislative changes will have the effect of reducing payments to
Medicare Advantage plans in general. Consequently, our plans’ premiums will be reduced over the
phase-out period unless our risk scores increase in a manner sufficient, when considered together
with inflation-related increases in rates, to offset the elimination of this adjustment. Although
our plans’ risk scores have increased historically, there is no assurance that the increases will
continue or, if they do, that they will be large enough to offset the elimination of this
adjustment.
Our Records May Contain Inaccurate Information Regarding the Risk Adjustment Scores of Our Members,
Which Could Cause Us to Overstate or Understate Our Revenue.
We maintain claims and encounter data that support the risk adjustment scores of our members,
which determine, in part, the revenue to which we are entitled for these members. This data is
submitted to our HMO subsidiaries based on medical charts and diagnosis codes prepared by providers
of medical care. Inaccurate coding by medical providers and inaccurate records for new members in
our plans could result in inaccurate premium revenue and risk adjustment payments, which is subject
to correction or update in later periods. Payments that we receive in connection with this
corrected or updated information may be reflected in financial statements for periods subsequent to
the period in which the revenue was earned. We may also find that our data regarding our members’
risk adjustment scores, when reconciled, requires that we refund a portion of the revenue that we
received.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003 Made Changes to the
Medicare Program That Will Materially Impact Our Operations and Could Reduce Our Profitability and
Increase Competition for Members.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003, or MMA,
substantially changed the Medicare program and modified how we operate our Medicare Advantage
business. Many of these changes became effective in 2006. Although many of these changes are
designed to benefit Medicare Advantage plans generally, certain provisions of the MMA may increase
competition, create challenges for us with respect to educating our existing and potential members
about the changes, and create other risks and substantial and potentially adverse uncertainties,
including the following:
Increased competition could adversely affect our enrollment and results of operations.
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The MMA increased reimbursement rates for Medicare Advantage plans, which we
believe has increased the number of plans that participate in the Medicare program and
created additional competition. In addition, as a result of Medicare Part D, a number
of new competitors, such as pharmacy benefits managers and prescription drug retailers
and wholesalers, have established PDPs that compete with some of our Medicare programs. |
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Managed care companies began offering various new products beginning in 2006
pursuant to the MMA, including PFFS plans and regional preferred provider
organizations, or PPOs. Medicare PFFS plans and PPOs allow their members more
flexibility in selecting providers outside of a designated network than Medicare
Advantage HMOs such as ours, which typically require members to coordinate care through
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primary care physician. The MMA has encouraged the creation of regional PPOs through
various incentives, including certain risk corridors, or cost-reimbursement provisions, a
stabilization fund for incentive payments, and special payments to hospitals not otherwise
contracted with a Medicare Advantage plan that treats regional plan enrollees. There can
be no assurance that PFFS plans and regional Medicare PPOs in our service areas will not
in the future adversely affect our Medicare Advantage plans’ relative attractiveness to
existing and potential Medicare members. |
The limited annual enrollment process may adversely affect our growth and ability to market
our products.
Medicare beneficiaries generally have a limited annual enrollment period during which
they can choose to participate in a Medicare Advantage plan rather than receive benefits
under the traditional fee-for-service Medicare program. After the annual enrollment period,
most Medicare beneficiaries will not be permitted to change their Medicare benefits. The new
annual enrollment process and subsequent “lock-in” provisions of the MMA may adversely
affect our growth as it will limit our ability to enter new service areas and market to or
enroll new members in our established service areas outside of the annual enrollment period.
The limited annual enrollment period may make it difficult to retain an adequate sales force.
As a result of the limited annual enrollment period and the subsequent “lock-in”
provisions of the MMA, our sales force, including our independent sales brokers and agents,
are limited in their ability to market our products year-round. Our agents rely
substantially on sales commissions for their income. Given the limited annual sales window,
it may become more difficult to find agents to market and promote our products. The annual
enrollment window may also make hiring full-time sales employees impracticable, which could
increase our already substantial reliance on outside agents. Accordingly, we may not be able
to retain an adequate sales force to support our growth strategy. As our members are
primarily enrolled through in-person sales calls, a reduction in our sales force may
adversely affect our future enrollment, including our expansion efforts, and, accordingly,
adversely and materially affect our profitability and results of operations.
The competitive bidding process may adversely affect our profitability.
Payments for local and regional Medicare Advantage plans are based on a competitive
bidding process that may decrease the amount of premiums paid to us or cause us to increase
the benefits we offer without a corresponding increase in premiums. As a result of the
competitive bidding process, in order to maintain our current level of profitability we may
in the future be required to reduce benefits or charge our members an additional premium,
either of which could make our health plans less attractive to members and adversely affect
our membership.
We derive a significant portion of our Medicare revenues from our PDP operations, and legislative
or regulatory actions, economic conditions, or other factors that adversely affect those operations
could materially reduce our revenues and profits.
We may be unable to sustain our PDP operation’s profitability over the long-term, and our
failure to do so could have an adverse effect on our results of operations. Factors that
could affect our PDP operations include:
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Congress may make changes to the Medicare program, including changes to the
Part D benefit. We cannot predict what these changes might include or what effect they
might have on our revenue or medical expense or plans for growth. |
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We are making actuarial assumptions about the utilization of prescription drug
benefits in our MA-PD plans and our PDPs. Because this is a new program, there is
limited historical basis for these assumptions, and we cannot assure you that these
assumptions will prove to be correct or that premiums will be sufficient to cover the
benefits provided. |
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We have encountered competition from other PDPs, some of which may have
significantly greater resources and brand recognition than we do and new PDPs are
entering the business. |
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Medicare beneficiaries who are dual-eligibles generally are able to disenroll
and choose another PDP at any time, and certain Medicare beneficiaries also have a
limited ability to disenroll from the plan they initially select and choose a different
PDP. Medicare beneficiaries who are not dually eligible will be able to change PDPs
during the annual open enrollment period. We may not be able to retain the
auto-assigned members or those members who affirmatively choose our PDPs, and we may
not be able to attract new PDP members. |
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In February 2007, The U.S. House of Representatives’
Committee on Oversight and Government Reform sent a letter to a
number of Medicare plans requesting information submitted
by the plans to CMS relating to, among other things, Part D plan
profits and administrative costs; discounts, rebates, and other
price concessions from drug manufacturers and pharmacies; and
concessions passed through to beneficiaries. We did not
receive a similar letter. This initial Congressional inquiry could
lead to hearings and
further Congressional investigation into Part D related profits and
perhaps into the profitability of Medicare managed care plans
generally. |
Financial accounting for the Medicare Part D benefits is complex and requires difficult
estimates and assumptions.
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The MMA provides for “risk corridors” that are designed to limit to some extent
the losses MA-PDs or PDPs would incur if their costs turned out to be higher than those
in the plans’ bids submitted to CMS. For example, for 2006 and 2007 drug plans will
bear all gains and losses up to 2.5% of their expected costs, but will be reimbursed
for 75% of the losses between 2.5% and 5%, and 80% of losses in excess of 5%. The
initial risk corridors in 2006 and 2007 will not be available in 2008 or future years.
As the risk corridors are designed to be symmetrical, a plan whose actual costs fall
below their expected costs, such as for our plans in 2006, is required to reimburse CMS
based on a similar methodology as set forth above. Reconciliation payments for
estimated upfront federal reinsurance payments, or, in some cases, the entire amount of
the reinsurance payments, for Medicare beneficiaries who reach the drug benefit’s
catastrophic threshold are made retroactively on an annual basis, which could expose
plans to upfront costs in providing the benefit. The company
anticipates settling with CMS on amounts related to the risk corrider adjustments
and subsidies in 2007 as part of a final settlement of Part
D payments in the 2006 plan year. |
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The accounting and regulatory guidance regarding the proper method of
accounting for Medicare Part D, particularly as it relates to the timing of revenue and
expense recognition, taken together with the complexity of the Part D product and
recent challenges in reconciling CMS Part D membership data with our records, may lead
to variability in our reporting of quarter-to-quarter earnings and to uncertainty among
investors and research analysts following the company as to the impacts of our Medicare
Part D plans on our full year results. |
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During 2006, we incurred Part D medical expenses on behalf of Medicare
beneficiaries who were not members of our prescription drug plans. Likewise, we received notice of
claims from other plans who paid claims on behalf of our members. CMS established a
plan-to-plan, or P2P, reconciliation process to address this condition and provide a
means of settlement between plans. We believe the majority of P2P claims occurring in
2006 were settled as of December 31, 2006. Additionally, CMS recently published
its state-to-plan, or S2P, reconciliation process whereby health plans will settle with
state Medicaid programs who paid claims on behalf of Medicare beneficiaries. We have
recorded our estimated liabilities under P2P and S2P at December 31, 2006. Ultimate resolution
of the P2P and S2P reconciliation processes could result in adjustments, up or down, to
the amounts currently estimated and recoverable. |
Our Business Activities Are Highly Regulated and New and Proposed Government Regulation or
Legislative Reforms Could Increase Our Cost of Doing Business, and Reduce Our Membership,
Profitability, and Liquidity.
Our health plans are subject to substantial federal and state regulation. These laws and
regulations, along with the terms of our contracts and licenses, regulate how we do business, what
services we offer, and how we interact with our members, providers, and the public. Healthcare laws
and regulations are subject to frequent change and varying interpretations. Changes in existing
laws or regulations, or their interpretations, or the enactment of new laws or the issuance of new
regulations could adversely affect our business by, among other things:
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imposing additional license, registration, or capital reserve requirements; |
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increasing our administrative and other costs; |
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reducing the premiums we receive from CMS; |
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forcing us to undergo a corporate restructuring; |
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increasing mandated benefits without corresponding premium increases; |
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limiting our ability to engage in inter-company transactions with our affiliates and subsidiaries; |
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forcing us to restructure our relationships with providers; and |
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requiring us to implement additional or different programs and systems. |
It is possible that future legislation and regulation and the interpretation of existing and
future laws and regulations could have a material adverse effect on our ability to operate under
the Medicare program and to continue to serve our members and attract new members.
If We Are Required to Maintain Higher Statutory Capital Levels for Our Existing Operations or if We
Are Subject to Additional Capital Reserve Requirements as We Pursue New Business Opportunities, Our
Cash Flows and Liquidity May Be Adversely Affected.
Our health plans are operated through subsidiaries in various states. These subsidiaries are
subject to state regulations that, among other things, require the maintenance of minimum levels of
statutory capital, or net worth, as defined by each state. One or more of these states may raise
the statutory capital level from time to time. Other states have adopted risk-based capital
requirements based on guidelines adopted by the National Association of Insurance Commissioners,
which tend to be, although are not necessarily, higher than existing statutory capital
requirements. Currently, Texas is the only jurisdiction in which we operate that has adopted
risk-based capital requirements. Regardless of whether the other states in which we operate adopt
risk-based capital requirements, the state departments of insurance can require our HMO
subsidiaries to maintain minimum levels of statutory capital in excess of amounts required under
the applicable state laws if they determine that maintaining additional statutory capital is in the
best interests of our members. Any changes in these requirements could materially increase our
statutory capital requirements. In addition, as we continue to expand our plan offerings in new
states or pursue new business opportunities, including our strategy to offer PDPs on a national
basis in 2007, we may be required to maintain additional statutory capital. In either case, our
available funds could be materially reduced, which could harm our ability to implement our business
strategy.
If State Regulators Do Not Approve Payments, Including Dividends and Other Distributions, by Our
Health Plans to Us, Our Business and Growth Strategy Could Be Materially Impaired or We Could Be
Required to Incur Indebtedness to Fund These Strategies.
Our health plan subsidiaries are subject to laws and regulations that limit the amount of
dividends and distributions they can pay to us for purposes other than to pay income taxes related
to the earnings of the health plans. These laws and regulations also limit the amount of management
fees our health plan subsidiaries may pay to affiliates of our health plans, including our
management subsidiaries, without prior approval of, or notification to, state regulators. The
pre-approval and notice requirements vary from state to state with some states, such as Texas,
generally allowing, subject to advance notice requirements, dividends to be declared, provided the
HMO meets or exceeds the applicable deposit, net worth, and risk-based capital requirements. The
discretion of the state regulators, if any, in approving a dividend is not always clearly defined.
Health plans that declare non-extraordinary dividends must usually provide notice to the regulators
in advance of the intended distribution date. Historically, we have not relied on dividends or
other distributions from our health plans to fund a material amount of our operating cash
requirements. If the regulators were to deny or significantly restrict our subsidiaries’ requests
to pay dividends to us or to pay management and other fees to the affiliates of our health plan
subsidiaries, however, the funds available to us would be limited, which could impair our ability
to implement our business and growth strategy. Alternatively, we could be required to incur
indebtedness to fund these strategies.
Corporate Practice of Medicine and Fee-Splitting Laws May Govern Our Business Operations, and
Violation of Such Laws Could Result in Penalties and Adversely Affect Our Arrangements With
Contractors and Our Profitability.
Numerous states, including Tennessee and Illinois, have laws known as the corporate practice
of medicine laws that prohibit a business corporation from practicing medicine, employing
physicians to practice medicine, or exercising control over medical treatment decisions by
physicians. In these states, typically only medical professionals or a professional corporation in
which the shares are held by licensed physicians or other medical professionals may provide medical
care to patients. Many states also have some form of fee-splitting law, prohibiting certain
business arrangements that involve the splitting or sharing of medical professional fees earned by
a physician or another medical professional for the delivery of healthcare services.
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We perform only non-medical administrative and business services for physicians and physician
groups. We do not represent that we offer medical services, and we do not exercise control over the
practice of medical care by providers with whom we contract. We do, however, monitor medical
services to ensure they are provided and reimbursed within the appropriate scope of licensure. In
addition, we have developed close relationships with our network providers that include our review
and monitoring of the coding of medical services provided by those providers. We also have
compensation arrangements with providers that may be based on a percentage of certain provider fees
and in certain cases our network providers have agreed to exclusivity arrangements. In each case,
we believe we have structured these and other arrangements on a basis that complies with applicable
state law, including the corporate practice of medicine and fee-splitting laws.
Despite our structuring these arrangements in ways that we believe comply with applicable law,
regulatory authorities may assert that we are engaged in the corporate practice of medicine or that
our contractual arrangements with providers constitute unlawful fee-splitting. Moreover, we cannot
predict whether changes will be made to existing laws or if new ones will be enacted, which could
cause us to be out of compliance with these requirements. If our arrangements are found to violate
corporate practice of medicine or fee-splitting laws, our provider or independent physician
association management contracts could be found legally invalid and unenforceable, which could
adversely affect our operations and profitability and we could be subject to civil or, in some
cases, criminal, penalties.
We Are Required to Comply With Laws Governing the Transmission, Security and Privacy of Health
Information That Require Significant Compliance Costs, and Any Failure to Comply With These Laws
Could Result in Material Criminal and Civil Penalties.
Regulations under the Health Insurance Portability and Accountability Act of 1996, or HIPAA,
require us to comply with standards regarding the exchange of health information within our company
and with third parties, including healthcare providers, business associates, and our members. These
regulations include standards for common healthcare transactions, including claims information,
plan eligibility, and payment information; unique identifiers for providers and employers;
security; privacy; and enforcement. HIPAA also provides that to the extent that state laws impose
stricter privacy standards than HIPAA privacy regulations, a state seeks and receives an exception
from the Department of Health and Human Services regarding certain state laws, or state laws
concern certain specified areas, such state standards and laws are not preempted.
We conduct our operations in an attempt to comply with all applicable HIPAA requirements.
Given the complexity of the HIPAA regulations, the possibility that the regulations may change, and
the fact that the regulations are subject to changing and, at times, conflicting interpretation,
our ongoing ability to comply with the HIPAA requirements is uncertain. Furthermore, a state’s
ability to promulgate stricter laws, and uncertainty regarding many aspects of such state
requirements, make compliance more difficult. To the extent that we submit electronic healthcare
claims and payment transactions that do not comply with the electronic data transmission standards
established under HIPAA, payments to us may be delayed or denied. Additionally, the costs of
complying with any changes to the HIPAA regulations may have a negative impact on our operations.
Sanctions for failing to comply with the HIPAA health information provisions include criminal
penalties and civil sanctions, including significant monetary penalties. In addition, our failure
to comply with state health information laws that may be more restrictive than the regulations
issued under HIPAA could result in additional penalties.
Risks Related to Our Business
If Our Medicare Contracts Are Not Renewed or Are Terminated, Our Business Would Be Substantially
Impaired.
We provide services to our Medicare eligible members through our Medicare Advantage health
plans and PDPs pursuant to a limited number of contracts with CMS. These contracts generally have
terms of one year and must be renewed each year. Each of our contracts with CMS is terminable for
cause if we breach a material provision of the contract or violate relevant laws or regulations. If
we are unable to renew, or to successfully rebid or compete for any of these contracts, or if any
of these contracts are terminated, our business would be materially impaired.
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Because Our Premiums, Which Generate Most of Our Revenue, Are Established by Contract and Cannot Be
Modified During the Contract Terms, Our Profitability Will Likely Be Reduced or We Could Cease to
Be Profitable if We Are Unable to Manage Our Medical Expenses Effectively.
Substantially all of our revenue is generated by premiums consisting of monthly payments per
member that are established by contracts with CMS for our Medicare Advantage plans and PDPs or by
contracts with our commercial customers, all of which are typically renewable on an annual basis.
If our medical expenses exceed our estimates, except in very limited circumstances or as a result
of risk score adjustments for Medicare member health acuity, we will be unable to increase the
premiums we receive under these contracts during the then-current terms. As a result, our
profitability depends, to a significant degree, on our ability to adequately predict and
effectively manage our medical expenses related to the provision of healthcare services. Relatively
small changes in our MLR can create significant changes in our financial results. Accordingly, the
failure to adequately predict and control medical expenses and to make reasonable estimates and
maintain adequate accruals for incurred but not reported, or IBNR, claims, may have a material
adverse effect on our financial condition, results of operations, or cash flows.
Historically, our medical expenses as a percentage of premium revenue have fluctuated. Factors
that may cause medical expenses to exceed our estimates include:
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an increase in the cost of healthcare services and supplies, including pharmaceuticals,
whether as a result of inflation or otherwise; |
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higher than expected utilization of healthcare services; |
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periodic renegotiation of hospital, physician, and other provider contracts; |
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changes in the demographics of our members and medical trends affecting them; |
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new mandated benefits or other changes in healthcare laws, regulations, and practices; |
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new treatments and technologies; |
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consolidation of physician, hospital, and other provider groups; |
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contractual disputes with providers, hospitals, or other service providers; and |
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the occurrence of catastrophes, major epidemics, or acts of terrorism. |
Because of the relatively high average age of the Medicare population, medical expenses for
our Medicare Advantage plans may be particularly difficult to control. We attempt to control these
costs through a variety of techniques, including capitation and other risk-sharing payment methods,
collaborative relationships with primary care physicians and other providers, advance approval for
hospital services and referral requirements, case and disease management and quality assurance
programs, information systems, and, with respect to our commercial products, reinsurance. Despite
our efforts and programs to manage our medical expenses, we may not be able to continue to manage
these expenses effectively in the future. If our medical expenses increase, our profits could be
reduced or we may not remain profitable.
Our Failure to Estimate IBNR Claims Accurately Would Affect Our Reported Financial Results.
Our medical care costs include estimates of our IBNR claims. We estimate our medical expense
liabilities using actuarial methods based on historical data adjusted for payment patterns, cost
trends, product mix, seasonality, utilization of healthcare services, and other relevant factors.
Actual conditions, however, could differ from those we assume in our estimation process. We
continually review and update our estimation methods and the resulting accruals and make
adjustments, if necessary, to medical expense when the criteria used to determine IBNR change and
when actual claim costs are ultimately determined. As a result of the uncertainties associated with
the factors used in these assumptions, the actual amount of medical expense that we incur may be
materially more or less than the amount of IBNR originally estimated. If our estimates of IBNR are
inadequate in the future, our reported results of operations would be negatively impacted. Further,
our inability to estimate IBNR accurately may also affect our ability to take timely corrective
actions, further exacerbating the extent of any adverse effect on our results.
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Competition in Our Industry, Particularly New Sources of Competition Since the Implementation of
Medicare Part D, May Limit Our Ability to Maintain or Attract Members, Which Could Adversely Affect
Our Results of Operations.
We operate in a highly competitive environment subject to significant changes as a result of
business consolidations, evolving Medicare products (including PDPs and PFFS plans), new strategic
alliances, and aggressive marketing practices by other managed care organizations that compete with
us for members. Our principal competitors for contracts, members, and providers vary by local
service area and have traditionally been comprised of national, regional, and local managed care
organizations that serve Medicare recipients, including, among others, UnitedHealth Group, Humana,
Inc., and Universal American Financial Corp. In addition, we have experienced significant
competition from new competitors, including pharmacy benefit managers and prescription drug
retailers and wholesalers, and our traditional managed care organization competitors whose PFFS
plans and stand-alone PDPs have been attracting our Medicare Advantage and PDP members. As a result
of the foregoing factors, among others, we experienced disenrollments from our plans during 2006 at
rates higher than we previously experienced or anticipated. Many managed care companies and other
new Part D plan participants have greater financial and other resources, larger enrollments,
broader ranges of products and benefits, broader geographical coverage, more established
reputations in the national market and our markets, greater market share, larger contracting scale,
and lower costs than us. Our failure to maintain or attract members to our health plans as a result
of such competition could adversely affect our results of operations.
Our Inability to Maintain Our Medicare Advantage and PDP Members or Increase Our Membership Could
Adversely Affect Our Results of Operations.
A reduction in the number of members in our Medicare Advantage and PDP plans, or the failure
to increase our membership, could adversely affect our results of operations. In addition to
competition, factors that could contribute to the loss of, or failure to attract and retain,
members include:
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negative accreditation results or loss of licenses or contracts to offer Medicare Advantage plans; |
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negative publicity and news coverage relating to us or the managed healthcare industry generally; |
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litigation or threats of litigation against us; |
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automatic disenrollment, whether intentional or inadvertent, as a result of members
choosing a stand-alone PDP; and |
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our inability to market to and re-enroll members who enroll with our competitors
because of the new annual enrollment and lock-in provisions under the MMA. |
A Disruption in Our Healthcare Provider Networks Could Have an Adverse Effect on Our Operations and
Profitability.
Our operations and profitability are dependent, in part, upon our ability to contract with
healthcare providers and provider networks on favorable terms. In any particular service area,
healthcare providers or provider networks could refuse to contract with us, demand higher payments,
or take other actions that could result in higher healthcare costs, disruption of benefits to our
members, or difficulty in meeting our regulatory or accreditation requirements. In some service
areas, healthcare providers may have significant market positions. If healthcare providers refuse
to contract with us, use their market position to negotiate favorable contracts, or place us at a
competitive disadvantage, then our ability to market products or to be profitable in those service
areas could be adversely affected. Our provider networks could also be disrupted by the financial
insolvency of a large provider group. Any disruption in our provider network could result in a loss
of membership or higher healthcare costs.
Our Texas operations comprised 30% of our Medicare Advantage members and 32% of our total
revenue for the year ended December 31, 2006. A significant proportion of our providers in our
Texas market are affiliated with RPO, a large group of independent physician associations. As of
December 31, 2006, physicians associated with RPO served as the primary care physicians for
approximately 85% of our members in our Texas market. Our agreements with RPO generally have a term
expiring December 31, 2014, but may be terminated sooner by RPO for cause or in connection with a
change in control of the company that results in the termination of senior management
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and otherwise raises a reasonable doubt as to our successor’s ability to perform the
agreements. If our Texas HMO subsidiary’s agreement with RPO were terminated, we would be required
to sign direct contracts with the RPO physicians or additional physicians in order to avoid a
material disruption in care of our Houston-area members. It could take significant time to
negotiate and execute direct contracts, and we would be forced to reassign members to new primary
care physicians if all of the current primary care physicians did not sign direct contracts. This
would result in loss of membership assuming that not all members would accept the reassignment to a
new primary care physician. Accordingly, any significant disruption in, or termination of, our
relationship with RPO could materially and adversely impact our results of operations. Moreover,
RPO’s ability to terminate its agreements with us in connection with certain changes in control of
the company could have the effect of delaying or frustrating a potential acquisition or other
change in control of the company.
We Rely on the Accuracy of Lists Provided by CMS Regarding the Eligibility of a Person to
Participate in Our Plans, and Any Inaccuracies in Those Lists Could Cause CMS to Recoup Premium
Payments From Us with Respect to Members Who Turn Out Not to be Ours, Which Could Reduce Our
Revenue and Profitability.
Premium payments that we receive from CMS are based upon eligibility lists produced by federal
and local governments. From time to time, CMS requires us to reimburse them for premiums that we
received from CMS based on eligibility and dual-eligibility lists that CMS later discovers
contained individuals who were not in fact residing in our service areas or eligible for any
government-sponsored program or were eligible for a different premium category or a different
program. We may have already provided services to these individuals. In addition to recoupment of
premiums previously paid, we also face the risk that CMS could fail to pay us for members for whom
we are entitled to payment. Our profitability would be reduced as a result of such failure to
receive payment from CMS if we had made related payments to providers and were unable to recoup
such payments from them.
Outsourced Service Providers May Make Mistakes and Subject Us to Financial Loss or Legal Liability.
We outsource certain of the functions associated with the provision of managed care and
management services, including claims processing related to the provision of Medicare Part D
prescription drug benefits. The service providers to whom we outsource these functions could
inadvertently or incorrectly adjust, revise, omit, or transmit the data with which we provide them
in a manner that could create inaccuracies in our risk adjustment data, cause us to overstate or
understate our revenue, cause us to authorize incorrect payment levels to members of our provider
networks, or violate certain laws and regulations, such as HIPAA.
We May Be Unsuccessful in Implementing Our Growth Strategy If We Are Unable to Complete
Acquisitions on Favorable Terms or Integrate the Businesses We Acquire into Our Existing
Operations, or If We Are Unable to Otherwise Expand into New Service Areas in a Timely Manner in
Accordance with Our Strategic Plans.
Opportunistic acquisitions of contract rights and other health plans are an important element
of our growth strategy. We may be unable to identify and complete appropriate acquisitions in a
timely manner and in accordance with our or our investors’ expectations for future growth. The
market price of businesses that operate Medicare Advantage plans has generally increased recently,
which may increase the amount we are required to pay to complete any future acquisitions. Some of
our competitors have greater financial resources than we have and may be willing to pay more for
these businesses. In addition, we are generally required to obtain regulatory approval from one or
more state agencies when making acquisitions, which may require a public hearing, regardless of
whether we already operate a plan in the state in which the business to be acquired is located. We
may be unable to comply with these regulatory requirements for an acquisition in a timely manner,
or at all. Moreover, some sellers may insist on selling assets that we may not want or transferring
their liabilities to us as part of the sale of their companies or assets. Even if we identify
suitable acquisition targets, we may be unable to complete acquisitions or obtain the necessary
financing for these acquisitions on terms favorable to us, or at all.
To the extent we complete acquisitions, we may be unable to realize the anticipated benefits
from acquisitions because of operational factors or difficulties in integrating the acquisitions
with our existing businesses. This may include the integration of:
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additional employees who are not familiar with our operations; |
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new provider networks, which may operate on terms different from our existing networks; |
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additional members, who may decide to transfer to other healthcare providers or health plans; |
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disparate information technology, claims processing, and record-keeping systems; and |
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accounting policies, including those that require a high degree of judgment or complex
estimation processes, including estimates of IBNR claims, accounting for goodwill,
intangible assets, stock-based compensation, and income tax matters. |
For all of the above reasons, we may not be able to successfully implement our acquisition
strategy. Furthermore, in the event of an acquisition or investment, we may issue stock that would
dilute existing stock ownership, incur debt that would restrict our cash flow, assume liabilities,
incur large and immediate write-offs, incur unanticipated costs, divert management’s attention from
our existing business, experience risks associated with entering markets in which we have no or
limited prior experience, or lose key employees from the acquired entities.
Additionally, we are likely to incur additional costs if we enter new service areas or states
where we do not currently operate, which may limit our ability to expand to, or further expand in,
those areas. Our rate of expansion into new geographic areas may also be limited by:
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the time and costs associated with obtaining an HMO license to operate in the new area
or expanding our licensed service area, as the case may be; |
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our inability to develop a network of physicians, hospitals, and other healthcare
providers that meets our requirements and those of the applicable regulators; |
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competition, which could increase the costs of recruiting members, reduce the pool of
available members, or increase the cost of attracting and maintaining our providers; |
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the cost of providing healthcare services in those areas; |
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demographics and population density; and |
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the new annual enrollment period and lock-in provisions of the MMA. |
Negative Publicity Regarding the Managed Healthcare Industry Generally or Us in Particular Could
Adversely Affect Our Results of Operations or Business.
Negative publicity regarding the managed healthcare industry generally or us in particular may
result in increased regulation and legislative review of industry practices that further increase
our costs of doing business and adversely affect our results of operations by:
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requiring us to change our products and services; |
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increasing the regulatory burdens under which we operate; |
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adversely affecting our ability to market our products or services; or |
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adversely affecting our ability to attract and retain members. |
We Are Dependent Upon Our Executive Officers, and the Loss of Any One or More of These Officers and
Their Managed Care Expertise Could Adversely Affect Our Business.
Our operations are highly dependent on the efforts of Herbert A. Fritch, our President and
Chief Executive Officer, and certain other senior executives who have been instrumental in
developing our business strategy and forging our business relationships. Although certain of our
executives, including Mr. Fritch, have entered into employment agreements with us, these agreements
may not provide sufficient incentives for those executives to continue their employment with us.
Although we believe we could replace any executive we lose, the loss of the leadership, knowledge,
and experience of Mr. Fritch and our other executive officers could adversely affect our business.
Moreover, replacing one or more of our executives may be difficult or may require an extended
period of time. We do not currently maintain key man insurance on any of our executive officers.
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Violation of the Laws and Regulations Applicable to Us Could Expose Us to Liability, Reduce Our
Revenue and Profitability, or Otherwise Adversely Affect Our Operations and Operating Results.
The federal and state agencies administering the laws and regulations applicable to us have
broad discretion to enforce them. We are subject, on an ongoing basis, to various governmental
reviews, audits, and investigations to verify our compliance with our contracts, licenses, and
applicable laws and regulations. An adverse review, audit, or investigation could result in any of
the following:
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loss of our right to participate in the Medicare program; |
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loss of one or more of our licenses to act as an HMO or to otherwise provide a service; |
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forfeiture or recoupment of amounts we have been paid pursuant to our contracts; |
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imposition of significant civil or criminal penalties, fines, or other sanctions on us and our key employees; |
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damage to our reputation in existing and potential markets; |
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increased restrictions on marketing our products and services; and |
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inability to obtain approval for future products and services, geographic expansions, or acquisitions. |
The U.S. Department of Health and Human Services Office of the Inspector General, Office of
Audit Services, or OIG, is conducting a national review of Medicare Advantage plans to determine
whether they used payment increases consistent with the requirements of the MMA. Under the MMA,
when a Medicare Advantage plan receives a payment increase, it must reduce beneficiary premiums or
cost sharing, enhance benefits, put additional payment amounts in a benefit stabilization fund, or
use the additional payment amounts to stabilize or enhance access. We cannot assure you that the
findings of an audit or investigation of our business would not have an adverse effect on us or
require substantial modifications to our operations. In addition, private citizens, acting as
whistleblowers, are entitled to bring enforcement actions under a special provision of the federal
False Claims Act.
Claims Relating to Medical Malpractice and Other Litigation Could Cause Us to Incur Significant
Expenses.
From time to time, we are party to various litigation matters, some of which seek monetary
damages. Managed care organizations may be sued directly for alleged negligence, including in
connection with the credentialing of network providers or for alleged improper denials or delay of
care. In addition, Congress and several states have considered or are considering legislation that
would expressly permit managed care organizations to be held liable for negligent treatment
decisions or benefits coverage determinations. Of the states in which we currently operate, only
Texas has enacted legislation relating to health plan liability for negligent treatment decisions
and benefits coverage determinations. In addition, our providers involved in medical care decisions
may be exposed to the risk of medical malpractice claims. Some of these providers do not have
malpractice insurance. Although our network providers are independent contractors, claimants
sometimes allege that a managed care organization should be held responsible for alleged provider
malpractice, particularly where the provider does not have malpractice insurance, and some courts
have permitted that theory of liability.
Similar to other managed care companies, we may also be subject to other claims of our members
in the ordinary course of business, including claims of improper marketing practices by our
independent and employee sales agents and claims arising out of decisions to deny or restrict
reimbursement for services.
We cannot predict with certainty the eventual outcome of any pending litigation or potential
future litigation, and we cannot assure you that we will not incur substantial expense in defending
future lawsuits or indemnifying third parties with respect to the results of such litigation. The
loss of even one of these claims, if it results in a significant damage award, could have a
material adverse effect on our business. In addition, our exposure to potential liability under
punitive damage or other theories may significantly decrease our ability to settle these claims on
reasonable terms.
We maintain errors and omissions insurance and other insurance coverage that we believe are
adequate based on industry standards. Potential liabilities may not be covered by insurance, our
insurers may dispute coverage or may be unable to meet their obligations, or the amount of our
insurance coverage and related reserves may be inadequate.
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We cannot assure you that we will be able to obtain insurance coverage in the future, or that
insurance will continue to be available on a cost-effective basis, if at all. Moreover, even if
claims brought against us are unsuccessful or without merit, we would have to defend ourselves
against such claims. The defense of any such actions may be time-consuming and costly and may
distract our management’s attention. As a result, we may incur significant expenses and may be
unable to effectively operate our business.
The Inability or Failure to Properly Maintain Effective and Secure Management Information Systems,
Successfully Update or Expand Processing Capability, or Develop New Capabilities to Meet Our
Business Needs Could Result in Operational Disruptions and Other Adverse Consequences.
Our business depends significantly on effective and secure information systems. The
information gathered and processed by our management information systems assists us in, among other
things, marketing and sales tracking, underwriting, billing, claims processing, medical management,
medical care cost and utilization trending, financial and management accounting, reporting,
planning and analysis and e-commerce. These systems also support on-line customer service
functions, provider and member administrative functions and support tracking and extensive analyses
of medical expenses and outcome data. These information systems and applications require continual
maintenance, upgrading, and enhancement to meet our operational needs and handle our expansion and
growth. Any inability or failure to properly maintain management information systems or related
disaster recovery programs, successfully update or expand processing capability or develop new
capabilities to meet our business needs in a timely manner, could result in operational
disruptions, loss of existing customers, difficulty in attracting new customers or in implementing
our growth strategies, disputes with customers and providers, regulatory problems, increases in
administrative expenses, loss of our ability to produce timely and accurate reports, and other
adverse consequences. To the extent a failure in maintaining effective information systems occurs,
we may need to contract for these services with third-party management companies, which may be on
less favorable terms to us and significantly disrupt our operations and information flow.
Furthermore, our business requires the secure transmission of confidential information over
public networks. Because of the confidential health information we store and transmit, security
breaches could expose us to a risk of regulatory action, litigation, possible liability, and loss.
Our security measures may be inadequate to prevent security breaches, and our business operations
and profitability would be adversely affected by cancellation of contracts, loss of members, and
potential criminal and civil sanctions if they are not prevented.
If We Are Unable to Maintain Effective Internal Controls Over Financial Reporting, Investors Could
Lose Confidence in the Reliability of Our Financial Statements, Which Could Result in a Decrease in
the Price of Our Common Stock.
Because of our status as a public company, we are required to enhance and test our financial,
internal, and management control systems to meet obligations imposed by the Sarbanes-Oxley Act of
2002. We are working with our independent legal, accounting, and financial advisors to identify
those areas in which changes should be made to our financial and management control systems. These
areas include corporate governance, corporate control, internal audit, disclosure controls and
procedures, and financial reporting and accounting systems. Consistent with the Sarbanes-Oxley Act
and the rules and regulations of the SEC, management’s assessment of our internal controls over
financial reporting and the audit opinion of the Company’s independent registered accounting firm
as to the effectiveness of our controls will be first required in connection with the Company’s
filing of its Annual Report on Form 10-K for the year ending December 31, 2007. If we are unable to
timely identify, implement, and conclude that we have effective internal controls over financial
reporting or if our independent auditors are unable to conclude that our internal controls over
financial reporting are effective, investors could lose confidence in the reliability of our
financial statements, which could result in a decrease in the value of our common stock. Our
assessment of our internal controls over financial reporting may also uncover weaknesses or other
issues with these controls that could also result in adverse investor reaction. These results may
also subject us to adverse regulatory consequences.
State Insurance Laws and Anti-takeover Provisions in Our Organizational Documents Could Make an
Acquisition of Us More Difficult and May Prevent Attempts by Our Stockholders to Replace or Remove
Our Current Management.
Provisions of state insurance laws and in our amended and restated certificate of
incorporation and our second amended and restated bylaws may delay or prevent an acquisition of us
or a change in our management or similar change in control transaction, including transactions in
which stockholders might otherwise receive a premium for their
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shares over then current prices or that stockholders may deem to be in their best interests.
In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace
or remove our current management by making it more difficult for stockholders to replace members of
our board of directors. Because our board of directors is responsible for appointing the members of
our management team, these provisions could in turn affect any attempt by our stockholders to
replace current members of our management team. These provisions provide, among other things, that:
| |
• |
|
special meetings of our stockholders may be called only by the chairman of the board of
directors, by our chief executive officer, or by the board of directors pursuant to a
resolution adopted by a majority of the directors; |
| |
| |
• |
|
any stockholder wishing to properly bring a matter before a meeting of stockholders
must comply with specified procedural and advance notice requirements; |
| |
| |
• |
|
actions taken by the written consent of our stockholders require the consent of the
holders of at least 662/3% of our outstanding shares; |
| |
| |
• |
|
our board of directors is classified into three classes, with each class serving a staggered three-year term; |
| |
| |
• |
|
the authorized number of directors may be changed only by resolution of the board of directors; |
| |
| |
• |
|
our second amended and restated bylaws and certain sections of our amended and restated
certificate of incorporation relating to anti-takeover provisions may generally only be
amended with the consent of the holders of at least 662/3% of our
outstanding shares; |
| |
| |
• |
|
directors may be removed other than at an annual meeting only for cause; |
| |
| |
• |
|
any vacancy on the board of directors, however the vacancy occurs, may only be filled
by the directors; and |
| |
| |
• |
|
our board of directors has the ability to issue preferred stock without stockholder
approval. |
Additionally, the insurance company laws and regulations of the jurisdictions in which we
operate restrict the ability of any person to acquire control of an insurance company, including an
HMO, without prior regulatory approval. Under certain of those statutes and regulations, without
such approval or an exemption therefrom, no person may acquire any voting security of a domestic
insurance company, including an HMO, or an insurance holding company that controls a domestic
insurance company or HMO, if as a result of such transaction such person would own more than a
specified percentage, such as 5% or 10%, of the total stock issued and outstanding of such
insurance company or HMO, or, in some cases, more than a specified percentage of the issued and
outstanding shares of an insurance holding company. HealthSpring is an insurance holding company
for purposes of these statutes and regulations.
Item 1 B. Unresolved Staff Comments
None.
30
Item 2. Properties
Our
principal properties consist of leased office space. We believe our facilities are adequate for our present and currently anticipated needs. We lease office space
in the following locations:
| |
|
|
|
|
|
|
|
|
| Location |
|
Square footage |
|
Expiration Date |
Nashville, Tennesse |
|
|
128,163 |
(1) |
|
December 2010 |
Birmingham, Alabama |
|
|
103,796 |
(2) |
|
October 2007 |
Houston, Texas |
|
|
41,185 |
|
|
October 2010 |
Chicago, Illinois |
|
|
7,768 |
|
|
March 2008 |
|
|
|
| (1) |
|
Includes shared office space for our corporate headquarters
and our Tennessee health plan. Also includes a lease executed in January 2007 for approximately
54,000 square feet of office space, which lease expires in May 2014. |
| |
| (2) |
|
Includes 41,870 square feet of space sublet to other
tenants. We are
currently negotiating a new lease for our Alabama operations. |
Item 3. Legal Proceedings
We
are not currently involved in any pending legal proceedings that we
believe are material to our financial condition and results of
operations,
including the related lawsuits described below. We are, however, involved from time
to time in routine legal matters and other claims incidental to our business, including
employment-related claims, claims relating to our HMO subsidiaries’ contractual relationships with
providers and members, and claims relating to marketing practices of
sales representatives that are employed
by, or independent contractors to, our HMO subsidiaries.
Alabama Litigation
In
2006, our Alabama HMO subsidiary and certain of its independent sales representatives were sued in
five separate lawsuits in state courts in Wilcox County and Dallas County, Alabama by current and
former HealthSpring plan members. The courts in which these proceedings were initiated, the dates
originally filed, and the principal parties thereto are as follows: Lorine Phillips, Velma
Williams, Rosetta Anderson and Hattie Thompson v. HealthSpring of Alabama, Inc., James Edward
Ellis, Bedford Jeremy McNeill, Marcus Emanual Raine, Circuit Court of Wilcox County, Alabama,
CV-2006-008 (January 9, 2006); Flora Brown, Eugene Johnson, Dolly B. Smith, Martha McDaniel,
Raymond Mosely v. HealthSpring of Alabama, Inc., Bedford Jeremy McNeill, Marcus E. Raine, James
Ellis and Joseph Parker, Circuit Court of Wilcox County, Alabama, CV-2006-039 (March 10, 2006);
Willie James Moton, Bettie Mae Gordon, Nancy Wheeler, Birdie McMillon and Janie Murphy v.
HealthSpring of Alabama, Inc.,Sylvester Betts, Bedford Jeremy McNeill, Marcus E. Raine and James
Ellis, Circuit Court of Wilcox County, Alabama, CV-2006-046 (March 22, 2006); Bernice Phillips v.
HealthSpring of Alabama, Inc. and Sylvester Betts, Circuit Court of Wilcox County, Alabama, CV
2006-246 (October 6, 2006) (collectively, the “Wilcox County Cases”); and Sarah Latham v.
HealthSpring of Alabama, Inc. and Marcus Emanual Raine, Circuit Court of Dallas County, Alabama,
CV-2006-246 (August 3, 2006) (the “Dallas County
Case”) (collectively, the “Pending Litigation”).
Although they assert a number of state law theories, the plaintiffs’ allegations in the Pending
Litigation focus on two primary claims: (1) alleged misrepresentations by the sales
representatives in enrolling the plaintiffs in the Alabama plan; and (2) alleged negligence in
hiring, training, and supervising the sales representatives. In the Wilcox County Cases, the sales
representatives filed cross-claims against the Alabama HMO alleging, among other things, that the
representations made by them regarding the plan were directed by the Alabama HMO and in accordance
with their training. The plaintiffs and cross-claimants sought compensatory and punitive damages.
We
have recently entered into agreements with the plaintiffs and the sales
representatives tentatively settling and dismissing the Wilcox County Cases. The terms of the
settlement, including contingencies relating thereto, are confidential. Substantially all of the amounts paid or payable with respect to the
settled claims are within insurance limits, as supplemented by
litigation reserves accrued by the company in
2006. The Dallas County Case is ongoing and we intend to defend
ourselves vigorously.
31
Item 4. Submission of Matters to a Vote of Security Holders
None.
32
PART II
|
|
|
| Item 5. |
|
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases
of Equity Securities |
Market for Common Stock
Our common stock was listed and began trading on the New York Stock Exchange, or NYSE, on
February 3, 2006 under the trading symbol “HS.” Prior to that date, there was no established public
trading market for our common stock.
The following table sets forth the quarterly range of the high and low sales prices of the
common stock on the NYSE during the calendar period indicated.
| |
|
|
|
|
|
|
|
|
| |
|
2006 |
| |
|
High |
|
Low |
First Quarter (beginning February 3) |
|
$ |
24.19 |
|
|
$ |
16.61 |
|
Second Quarter |
|
|
19.42 |
|
|
|
15.41 |
|
Third Quarter |
|
|
22.44 |
|
|
|
16.66 |
|
Fourth Quarter |
|
|
22.62 |
|
|
|
17.73 |
|
The
last reported sale price of our common stock on the NYSE on
March 13, 2007 was $21.52, and
we had approximately 248 holders of record of our common stock on such date.
Dividends
We have not declared or paid any cash dividends on our common stock since our formation. Our
predecessor, which was a pass-through limited liability company for tax purposes, made no
distributions to its members in 2005 prior to the recapitalization. We currently intend to retain any future
earnings to fund the operation, development, and expansion of our business, and therefore we do not
anticipate paying cash dividends in the foreseeable future. Furthermore, our revolving credit
facility restricts our ability to
declare cash dividends on our common stock. Our ability to pay dividends is also dependent on the
availability of cash dividends from our regulated HMO subsidiaries, which are restricted by the
laws of the states in which we operate, as well as the requirements of CMS relating to the
operations of our Medicare health plans. Any future determination to declare and pay dividends
will be at the discretion of our board of directors, subject to compliance with applicable law and
the other limitations described above.
Issuer Purchases of Equity Securities
During the fourth quarter of 2006, the company repurchased shares of its common stock as
follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ISSUER PURCHASES OF EQUITY SECURITIES |
| |
|
|
|
|
|
|
|
|
|
Total Number of |
|
Approximate Dollar Value |
| |
|
Total |
|
|
|
|
|
Shares Purchased as |
|
of Shares that May Yet Be |
| |
|
Number of |
|
|
|
|
|
Part of Publicly |
|
Purchased Under the |
| |
|
Shares |
|
Price Paid |
|
Announced Plans |
|
Plans or Programs |
| Period |
|
Purchased |
|
per Share |
|
or Programs |
|
($000) |
| |
10/1/06 — 10/31/06 |
|
|
896 |
(1) |
|
$ |
.20 |
|
|
|
— |
|
|
$ |
— |
|
11/1/06 — 11/30/06 |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
12/1/06 — 12/31/06 |
|
|
2,205 |
(2) |
|
|
20.35 |
|
|
|
— |
|
|
|
— |
|
| |
Total fourth quarter |
|
|
3,101 |
|
|
$ |
14.53 |
|
|
|
— |
|
|
$ |
— |
|
| |
|
|
|
| (1) |
|
Shares repurchased pursuant to the terms of the restricted stock purchase agreements
between a terminated employee and the company at $.20 per share, an amount equal to the employee’s cost per share. |
| |
| (2) |
|
Shares withheld for employee payroll taxes on vesting of restricted stock awards as
permitted under the terms of the 2006 Equity Incentive Plan. |
33
Performance
Graph
The
following graph compares the change in the cumulative total return
(including the reinvestment of dividends) on the company’s
common stock for the period from February 3, 2006, the date our shares of common stock began
trading on the NYSE, to the change in the cumulative total return on the stocks included in the
Standard & Poor’s 500 Stock Index and to a company-selected Peer Group Index over the same period.
The graph assumes an investment of $100 made in our common stock at a
price of $21.98 per share, the closing sale price on February 3, 2006,
our first day of trading following our IPO (at $19.50 per share), and
an investment in each of the other indices on
February 3, 2006. We did not pay any dividends during the period reflected in the graph.
The
Peer Group Index consists of the following 14 companies, which is a group of companies
in the healthcare services industry of comparable market
capitalization that we have used to assist in evaluating the competitiveness of our executive compensation plans
and policies: Amerigroup Corporation, AmSurg Corp., Apria Healthcare Group Inc., Centene
Corporation, Emergency Medical Services Corporation, Healthways,
Inc., Lifepoint Hospitals, Inc.,
Magellan Health Services, Inc., Pediatrix Medical Group, Inc., Psychiatric Solutions, Inc., Sierra
Health Services, Inc., United Surgical Partners International, Inc., Universal American Financial
Corp., and WellCare Health Plans, Inc.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
| |
|
|
2/3/2006 |
|
|
|
3/31/2006 |
|
|
|
6/30/2006 |
|
|
|
9/30/2006 |
|
|
|
12/31/2006 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
HealthSpring,
Inc. |
|
|
$ |
100.00 |
|
|
|
$ |
84.67 |
|
|
|
$ |
85.30 |
|
|
|
$ |
87.58 |
|
|
|
$ |
92.58 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
S&P
500 Index |
|
|
|
100.00 |
|
|
|
|
101.25 |
|
|
|
|
99.79 |
|
|
|
|
105.44 |
|
|
|
|
112.50 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Peer Group
Index |
|
|
|
100.00 |
|
|
|
|
104.19 |
|
|
|
|
103.59 |
|
|
|
|
101.60 |
|
|
|
|
112.62 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
34
Item 6. Selected Financial Data
The following tables present selected historical financial data and other information for the
company and its predecessor, NewQuest, LLC. We derived the selected historical statement of income,
cash flow, and balance sheet data as of and for the years ended December 31, 2002, 2003, and 2004
and for the period from January 1, 2005 to February 28, 2005 from the audited consolidated
financial statements of NewQuest, LLC and as of and for the period from March 1, 2005 to December
31, 2005 and the year ended December 31, 2006 from the audited
consolidated financial statements of
the company. The audited consolidated financial statements and the related notes to the audited
consolidated financial statements of NewQuest, LLC and the company as of December 31, 2005 and
2006, and for the years ended December 31, 2004, 2005, and 2006 together with the related report of
our independent registered public accounting firm are included elsewhere in this report. We
derived the selected balance sheet data as of February 28, 2005 from the unaudited consolidated
financial statements of NewQuest, LLC.
The selected consolidated financial data and other information set forth below should be read
in conjunction with the consolidated financial statements included in this report and the related
notes and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of
Operations.”
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
HealthSpring, Inc. |
|
|
|
|
|
|
|
|
HealthSpring, Inc. |
|
|
Predecessor |
|
| |
|
|
|
|
|
|
|
|
|
|
|
Period from |
|
|
Period from |
|
|
|
|
| |
|
|
|
|
|
|
Combined Twelve |
|
|
|
March |
|
|
January 1, |
|
|
|
|
| |
|
|
|
|
|
|
Months Ended |
|
|
|
1, 2005 to |
|
|
2005 to |
|
|
|
|
| |
|
Year Ended |
|
|
|
December |
|
|
|
December 31, |
|
|
February 28, |
|
|
Year Ended December 31, |
|
| |
|
December 31, 2006 |
|
|
|
31, 2005(1) |
|
|
|
2005(2) |
|
|
2005(2) |
|
|
2004(3) |
|
|
2003(4) |
|
|
2002(5) |
|
| |
|
|
|
(dollars in thousands, except share and unit data) |
|
Statement of Income Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medicare premiums |
|
$ |
1,149,844 |
|
|
|
$ |
705,677 |
|
|
|
$ |
610,913 |
|
|
$ |
94,764 |
|
|
$ |
433,729 |
|
|
$ |
240,037 |
|
|
$ |
N/A |
(6) |
Commercial premiums |
|
|
120,504 |
|
|
|
|
126,872 |
|
|
|
|
106,168 |
|
|
|
20,704 |
|
|
|
146,318 |
|
|
|
120,877 |
|
|
|
N/A |
(6) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premiums |
|
|
1,270,348 |
|
|
|
|
832,549 |
|
|
|
|
717,081 |
|
|
|
115,468 |
|
|
|
580,047 |
|
|
|
360,914 |
|
|
|
24,939 |
|
Management and other fees |
|
|
26,688 |
|
|
|
|
20,416 |
|
|
|
|
16,955 |
|
|
|
3,461 |
|
|
|
17,919 |
|
|
|
11,054 |
|
|
|
1,099 |
|
Investment income |
|
|
11,920 |
|
|
|
|
3,798 |
|
|
|
|
3,337 |
|
|
|
461 |
|
|
|
1,449 |
|
|
|
695 |
|
|
|
78 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
|
1,308,956 |
|
|
|
|
856,763 |
|
|
|
|
737,373 |
|
|
|
119,390 |
|
|
|
599,415 |
|
|
|
372,663 |
|
|
|
26,116 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medicare expense |
|
|
900,358 |
|
|
|
|
553,084 |
|
|
|
|
478,553 |
|
|
|
74,531 |
|
|
|
338,632 |
|
|
|
187,368 |
|
|
|
N/A |
(6) |
Commercial expense |
|
|
108,168 |
|
|
|
|
107,095 |
|
|
|
|
90,783 |
|
|
|
16,312 |
|
|
|
124,743 |
|
|
|
104,164 |
|
|
|
N/A |
(6) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total medical expense |
|
|
1,008,526 |
|
|
|
|
660,179 |
|
|
|
|
569,336 |
|
|
|
90,843 |
|
|
|
463,375 |
|
|
|
291,532 |
|
|
|
12,631 |
|
Selling, general and administrative |
|
|
156,940 |
|
|
|
|
111,854 |
|
|
|
|
97,187 |
|
|
|
14,667 |
|
|
|
68,868 |
|
|
|
50,576 |
|
|
|
11,133 |
|
Transaction expense |
|
|
— |
|
|
|
|
10,941 |
|
|
|
|
4,000 |
|
|
|
6,941 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Phantom stock compensation |
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
|
|
24,200 |
|
|
|
— |
|
|
|
— |
|
Depreciation and amortization |
|
|
10,154 |
|
|
|
|
7,305 |
|
|
|
|
6,990 |
|
|
|
315 |
|
|
|
3,210 |
|
|
|
2,361 |
|
|
|
275 |
|
Interest expense |
|
|
8,695 |
|
|
|
|
14,511 |
|
|
|
|
14,469 |
|
|
|
42 |
|
|
|
214 |
|
|
|
256 |
|
|
|
25 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
1,184,315 |
|
|
|
|
804,790 |
|
|
|
|
691,982 |
|
|
|
112,808 |
|
|
|
559,867 |
|
|
|
344,725 |
|
|
|
24,064 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity in earnings of unconsolidated
affiliates |
|
|
309 |
|
|
|
|
282 |
|
|
|
|
282 |
|
|
|
— |
|
|
|
234 |
|
|
|
2,058 |
|
|
|
4,148 |
|
Option amendment gain |
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
4,170 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before minority interest and
income taxes |
|
|
124,950 |
|
|
|
|
52,255 |
|
|
|
|
45,673 |
|
|
|
6,582 |
|
|
|
39,782 |
|
|
|
29,996 |
|
|
|
10,370 |
|
Minority interest |
|
|
(303 |
) |
|
|
|
(3,227 |
) |
|
|
|
(1,979 |
) |
|
|
(1,248 |
) |
|
|
(6,272 |
) |
|
|
(5,519 |
) |
|
|
(1,315 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
124,647 |
|
|
|
|
49,028 |
|
|
|
|
43,694 |
|
|
|
5,334 |
|
|
|
33,510 |
|
|
|
24,477 |
|
|
|
9,055 |
|
Income tax expense |
|
|
(43,811 |
) |
|
|
|
(19,772 |
) |
|
|
|
(17,144 |
) |
|
|
(2,628 |
) |
|
|
(9,193 |
) |
|
|
(5,417 |
) |
|
|
(363 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
80,836 |
|
|
|
|
29,256 |
|
|
|
|
26,550 |
|
|
|
2,706 |
|
|
|
24,317 |
|
|
|
19,060 |
|
|
|
8,692 |
|
Preferred dividends |
|
|
(2,021 |
) |
|
|
|
(15,607 |
) |
|
|
|
(15,607 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common
stockholders and members |
|
$ |
78,815 |
|
|
|
$ |
13,649 |
|
|
|
$ |
10,943 |
|
|
$ |
2,706 |
|
|
$ |
24,317 |
|
|
$ |
19,060 |
|
|
$ |
8,692 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per unit: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
$ |
0.55 |
|
|
$ |
5.31 |
|
|
$ |
4.67 |
|
|
$ |
2.13 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
$ |
0.55 |
|
|
$ |
5.31 |
|
|
$ |
4.67 |
|
|
$ |
2.13 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average units outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
|
4,884,176 |
|
|
|
4,578,176 |
|
|
|
4,078,176 |
|
|
|
4,078,176 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
— |
|
|
|
|
— |
|
|
|
|
— |
|
|
|
4,884,176 |
|
|
|
4,578,176 |
|
|
|
4,078,176 |
|
|
|
4,078,176 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share available
to common stockholders: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
1.44 |
|
|
|
$ |
— |
|
|
|
$ |
0.34 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
$ |
1.44 |
|
|
|
|
— |
|
|
|
$ |
0.34 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares
outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
54,617,744 |
|
|
|
|
— |
|
|
|
|
32,173,707 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
54,720,373 |
|
|
|
|
— |
|
|
|
|
32,215,288 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flow Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures |
|
$ |
7,177 |
|
|
|
$ |
2,802 |
|
|
|
$ |
2,653 |
|
|
$ |
149 |
|
|
$ |
2,512 |
|
|
$ |
3,198 |
|
|
$ |
190 |
|
Cash provided by (used in): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating activities |
|
|
167,659 |
|
|
|
|
72,103 |
|
|
|
|
57,139 |
|
|
|
14,964 |
|
|
|
24,665 |
|
|
|
63,392 |
|
|
|
6,569 |
|
Investing activities |
|
|
(450 |
) |
|
|
|
(276,346 |
) |
|
|
|
(270,877 |
)(7) |
|
|
(5,469 |
) |
|
|
(34,615 |
) |
|
|
42,647 |
|
|
|
(6,123 |
) |
Financing activities |
|
|
61,149 |
|
|
|
|
322,935 |
|
|
|
|
323,823 |
(7) |
|
|
(888 |
) |
|
|
(23,311 |
) |
|
|
(11,750 |
) |
|
|
5,748 |
|
35
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
HealthSpring, Inc. |
|
|
|
|
|
|
|
|
HealthSpring, Inc. |
|
|
Predecessor |
|
| |
|
|
|
|
|
|
|
|
|
|
|
Period from |
|
|
Period from |
|
|
|
|
| |
|
|
|
|
|
|
Combined Twelve |
|
|
|
March |
|
|
January 1, |
|
|
|
|
| |
|
|
|
|
|
|
Months Ended |
|
|
|
1, 2005 to |
|
|
2005 to |
|
|
|
|
| |
|
Year Ended |
|
|
|
December |
|
|
|
December 31, |
|
|
February 28, |
|
|
Year Ended December 31, |
|
| |
|
December 31, 2006 |
|
|
|
31, 2005(1) |
|
|
|
2005(2) |
|
|
2005(2) |
|
|
2004(3) |
|
|
2003(4) |
|
|
2002(5) |
|
| |
|
|
|
(dollars in thousands) |
|
Balance Sheet Data (at period end): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash
equivalents |
|
$ |
338,443 |
|
|
|
$ |
110,085 |
|
|
|
$ |
110,085 |
|
|
$ |
76,441 |
|
|
$ |
67,834 |
|
|
$ |
101,095 |
|
|
$ |
6,806 |
|
Total assets |
|
|
842,645 |
|
|
|
|
591,838 |
|
|
|
|
591,838 |
|
|
|
157,350 |
|
|
|
142,674 |
|
|
|
132,420 |
|
|
|
37,559 |
|
Total long-term debt, including current
maturities |
|
|
— |
|
|
|
|
188,526 |
|
|
|
|
188,526 |
|
|
|
5,358 |
|
|
|
5,475 |
|
|
|
6,175 |
|
|
|
4,958 |
|
Stockholders’/members’ equity |
|
|
575,282 |
|
|
|
|
260,544 |
|
|
|
|
260,544 |
|
|
|
58,131 |
|
|
|
55,435 |
|
|
|
22,969 |
|
|
|
14,504 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Statistics: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical loss ratio — Medicare
Advantage (8) |
|
|
78.8 |
% |
|
|
|
78.4 |
% |
|
|
|
78.3 |
% |
|
|
78.7 |
% |
|
|
78.1 |
% |
|
|
78.1 |
% |
|
|
N/A |
(6) |
Medical loss ratio — Commercial (8) |
|
|
89.8 |
% |
|
|
|
84.4 |
% |
|
|
|
85.5 |
% |
|
|
78.8 |
% |
|
|
85.3 |
% |
|
|
86.2 |
% |
|
|
N/A |
(6) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical loss ratio — PDP (8) |
|
|
73.42 |
% |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Selling, general and administrative
expense ratio(9) |
|
|
11.98 |
% |
|
|
|
13.06 |
% |
|
|
|
13.18 |
% |
|
|
12.28 |
% |
|
|
11.49 |
% |
|
|
13.57 |
% |
|
|
42.63 |
% |
Members — Medicare Advantage (10) |
|
|
115,132 |
|
|
|
|
101,281 |
|
|
|
|
101,281 |
|
|
|
69,236 |
|
|
|
63,792 |
|
|
|
47,899 |
|
|
|
33,579 |
|
Members — Commercial (10) |
|
|
31,970 |
|
|
|
|
41,769 |
|
|
|
|
41,769 |
|
|
|
40,523 |
|
|
|
48,380 |
|
|
|
54,280 |
|
|
|
53,605 |
|
|
|
|
| (1) |
|
The combined financial information for the twelve months ended December 31, 2005 includes
the results of operations of NewQuest, LLC, for the period from January 1, 2005 through
February 28, 2005 and the results of operations of the company for the period from March 1,
2005 through December 31, 2005. The combined financial information is for illustrative
purposes only, reflects the combination of the two-month period and the ten month period to
provide a comparison with the comparable twelve month periods, and is not presented in
accordance with U.S. Generally Accepted Accounting Principles (GAAP). |
| |
| (2) |
|
On November 10, 2004, NewQuest, LLC and its members entered into a purchase and exchange
agreement with the company as part of a recapitalization. Pursuant to this agreement and a
related stock purchase agreement, on March 1, 2005, the GTCR Funds and certain other persons
contributed $139.7 million of cash to the company and the members of NewQuest, LLC contributed
a portion of their membership units in exchange for preferred and common stock of the company.
Additionally, we entered into a $165.0 million term loan, with an additional $15.0 million
available pursuant to a revolving loan facility, and issued $35.0 million of subordinated
notes. We used the cash contribution and borrowings to acquire the members’ remaining
membership units in NewQuest, LLC for approximately $295.4 million in cash. The aggregate
transaction value for the recapitalization was $438.6 million, which included $5.3 million of
capitalized acquisition related costs. Additionally, the company incurred $6.3 million of
deferred financing costs. In addition, NewQuest, LLC incurred $6.9 million of transaction
costs which were expensed during the two-month period ended February 28, 2005 and the company
incurred $4.0 million of transaction costs that were expensed during the ten-month period
ended December 31, 2005. The transactions resulted in the company recording $315.0 million in
goodwill and $91.2 million in identifiable intangible assets. |
| |
| (3) |
|
On January 1, 2004, the minority members of TennQuest Health Solutions, LLC, or TennQuest, an
84.375% owned subsidiary of NewQuest, LLC, converted their ownership of TennQuest into 500,000
membership units in NewQuest, LLC, and on February 2, 2004 TennQuest was merged into NewQuest,
LLC. Effective December 31, 2004, holders of phantom membership units in NewQuest, LLC
converted their phantom units into 306,000 membership units of NewQuest, LLC. In connection
with the conversion, the company recognized phantom stock compensation expense of $24.2
million. |
| |
| (4) |
|
On April 1, 2003, TennQuest exercised an option to acquire an additional 33% interest in
HealthSpring Management, Inc., or HSMI, from another shareholder of HSMI. As a result of the
acquisition of these shares, the company held 83% of the ownership interests in HSMI and
consolidated the results of operations of HealthSpring of Tennessee with the company’s
operations for the period from April 1, 2003. Prior to April 1, 2003, the company accounted
for its ownership interest in HSMI under the equity method. On December 19, 2003, HSMI and
HealthSpring USA, LLC each redeemed certain of their outstanding ownership interests, which
resulted in the company owning 84.8% of the outstanding ownership interests of HSMI and
HealthSpring USA, LLC at December 31, 2003. |
| |
| (5) |
|
In November, 2002, NewQuest, LLC acquired The Oath — A Health Plan for Alabama, Inc.,
subsequently renamed HealthSpring of Alabama, Inc., an Alabama for-profit HMO. |
| |
| (6) |
|
Premium revenues and medical expense are reported in total only and are not separated into
Medicare and commercial for 2002 as the company did not report information in this format. As
a result, the company is not able to determine the Medicare and commercial medical loss ratios
for 2002. |
| |
| (7) |
|
A substantial portion of the cash flows for investing and financing activities for the
ten-month period ended December 31, 2005 relate to the recapitalization. See Item 7.
“Management’s Discussion and Analysis of Financial Condition and Results of Operations — The
Recapitalization.” |
| |
| (8) |
|
The medical loss ratio represents medical expense incurred for plan participants as a
percentage of premium revenue for plan participants. |
| |
| (9) |
|
The selling, general and administrative expense ratio represents selling, general and
administrative expenses as a percentage of total revenue. |
| |
| (10) |
|
At the end of each period presented. |
36
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of financial condition and results of operations should
be read in conjunction with our audited consolidated financial statements, the notes to our audited
consolidated financial statements, and the other financial information appearing elsewhere in this
report. We intend for this discussion to provide you with information that will assist you in
understanding our financial statements, the changes in certain key items in those financial
statements from year to year, and the primary factors that accounted for those changes. It includes
the following sections:
| |
• |
|
Overview; |
| |
| |
• |
|
Results of Operations; |
| |
| |
• |
|
Liquidity and Capital Resources; |
| |
| |
• |
|
Off-Balance Sheet Arrangements; |
| |
| |
• |
|
Critical Accounting Policies and Estimates; and |
| |
| |
• |
|
Recent Accounting Pronouncements. |
This discussion contains forward-looking statements based on our current expectations that by
their nature involve risks and uncertainties. Our actual results and the timing of selected events
could differ materially from those anticipated in these forward-looking statements. Moreover, past
financial and operating performance are not necessarily reliable indicators of future performance
and you are cautioned in using our historical results to anticipate future results or to predict
future trends. In evaluating any forward-looking statement, you should specifically consider the
information set forth under the caption “Special Note Regarding Forward-Looking Statements” and in
“Item 1A. Risk Factors,” as well as other cautionary statements contained elsewhere in this
report, including the matters discussed in “Critical Accounting Policies and Estimates” below.
Overview
We are a managed care organization that focuses primarily on Medicare, the health insurance
program for retired United States citizens aged 65 and older, qualifying disabled persons, and
persons suffering from end-stage renal disease. Medicare is funded by the federal government and
administered by CMS. As of December 31, 2006, we owned and operated Medicare health plans,
including stand-alone prescription drug plans, in Tennessee, Texas, Alabama, Illinois, and
Mississippi. For the year ended December 31, 2006, approximately 87.8% of our total revenue
consisted of premiums we received from CMS pursuant to our Medicare contracts. Although we
concentrate on Medicare plans, we also utilize our infrastructure and provider networks in
Tennessee and Alabama to offer commercial health plans to employer groups. We expect revenue from
our Medicare business will continue to increase as a percentage of our total revenue in 2007 as our
Medicare business grows and our commercial business contracts.
On January 1, 2006, we began offering prescription drug benefits in accordance with Medicare
Part D to our Medicare Advantage plan members, in addition to continuing to provide other medical
benefits. We sometimes refer to these plans after January 1, 2006 collectively as Medicare
Advantage plans and separately as “MA-only” (in other words, without prescription drug benefits)
and “MA-PD” (with prescription drug benefits) plans. On January 1, 2006, we also began offering
prescription drug benefits on a stand-alone basis in accordance with Medicare Part D. We refer to
these as “stand-alone PDP” or “PDP” plans. For purposes of additional analysis, the Company
provides membership and certain financial information, including premium revenue and medical
expense, for our Medicare Advantage (including MA-PD) and PDP plans. Effective January 1, 2007, we
began operation as a national PDP plan. As of January 1, 2007, approximately 85% of our PDP
members were located in our five current Medicare Advantage markets.
2006 Highlights
| |
• |
|
Medicare Advantage membership in 2006 increased 13.7% over the prior year. |
| |
| |
• |
|
Total revenue for 2006 was $1.3 billion; an increase of 52.8% over combined 2005 results. |
| |
| |
• |
|
Medicare Advantage (including MA-PD) premiums were $1.05 billion for 2006, reflecting
an increase of 48.6% over the prior year. Stand-alone PDP premiums were $101.4 million. |
| |
| |
• |
|
Medicare Advantage medical loss ratio (MLR) was 78.8% for 2006 and PDP MLR was 73.4%. |
| |
| |
• |
|
Net cash provided by operating activities for 2006 was $167.7 million, or 2.1 times net income. |
37
| |
• |
|
Total cash at December 31, 2006 was $338.4 million, including cash of $78.5 million
held at unregulated subsidiaries. |
In February 2006, we completed our initial public offering, or IPO, of common stock. In the
IPO, we issued 10.6 million shares of common stock at a price of $19.50 per share. We used the net
proceeds of the IPO of approximately $188.6 million to repay all of our outstanding indebtedness,
including accrued and unpaid interest and other expenses related to the IPO. In connection with the
IPO, the minority interests in our Texas HMO subsidiary were exchanged for 2,040,194 shares of
common stock. In addition, as a result of the IPO, all of our outstanding shares of preferred stock
and accrued but unpaid dividends automatically converted into shares of common stock at the IPO
price.
On October 10, 2006, we completed a secondary public offering of our common stock. In
connection with the secondary offering certain stockholders of the company, including funds
affiliated with GTCR Golder Rauner, LLC, or the GTCR Funds, sold 11,600,000 shares of common stock
at a price of $18.98 per share. We did not receive any proceeds from the sale of the shares in the
secondary offering.
Basis of Presentation
The Recapitalization
HealthSpring, Inc. was formed in October 2004 in connection with a recapitalization
transaction, which was accounted for using the purchase method, involving our predecessor,
NewQuest, LLC, its members, the GTCR Funds, and certain other investors and lenders. The
recapitalization was completed on March 1, 2005. In connection with the recapitalization, the
company, NewQuest, LLC, its members, the GTCR Funds, and certain other investors entered into a
purchase and exchange agreement and other related agreements pursuant to which the GTCR Funds and
certain other investors purchased shares of our preferred stock and common stock for an aggregate
purchase price of $139.7 million. In addition, upon the closing of the recapitalization, the
company issued shares of restricted common stock to employees of the company for an aggregate
purchase price of $257,250. The company used the proceeds from the sale of preferred and common
stock and $200.0 million of borrowings under our senior credit facility and senior subordinated
notes to fund $295.4 million in cash payments to the members of NewQuest, LLC and to pay expenses
and other payments relating to the transaction.
Prior to the recapitalization, approximately 15% of the ownership interests in two of our
Tennessee management subsidiaries and approximately 27% of the membership interests of our Texas
HMO subsidiary, Texas HealthSpring, LLC, were owned by outside investors. Contemporaneously with
the recapitalization, we purchased all of the minority interests in our Tennessee subsidiaries for
an aggregate consideration of approximately $27.5 million and a portion of the membership interests
held by the minority investors in Texas HealthSpring, LLC for aggregate consideration of
approximately $16.8 million. Following the purchase, the outside investors in Texas HealthSpring,
LLC owned an approximately 9% ownership interest. In June 2005, Texas HealthSpring completed a
private placement pursuant to which it issued new membership interests to existing and new
investors, primarily physicians affiliated with RPO, for net proceeds of $7.9 million. Following
this private placement, and as of December 31, 2005, the outside investors owned an approximately
15.9% interest in Texas HealthSpring, LLC, which interest was automatically exchanged, without
additional consideration, for 2,040,194 shares of our common stock immediately prior to the IPO.
For purposes of comparing our 2005 twelve-month results with the comparable 2006 and 2004
periods, we have combined the results of operations of the predecessor from January 1, 2005 through
February 28, 2005 and of the company for the period from March 1, 2005 through December 31, 2005.
This combined presentation is not in accordance with GAAP; however, we believe it is useful in
analyzing and comparing certain of our operating trends for the last three fiscal years. The
combined and consolidated results of operations include the accounts of HealthSpring, Inc. and all
of its subsidiaries. Significant intercompany accounts and transactions have been eliminated.
Revenue
General. Our revenue consists primarily of (i) premium revenue we generate from our Medicare
and commercial lines of business; (ii) fee revenue we receive for management and administrative
services provided to
38
independent physician associations, health plans, and self-insured employers, and for access
to our provider networks; and (iii) investment income.
Premium Revenue. Our Medicare and commercial lines of business include all premium revenue we
receive in our health plans. Our Medicare contracts entitle us to premium payments from CMS, on
behalf of each Medicare beneficiary enrolled in our plans, generally on a per member per month, or
PMPM, basis. In our commercial HMOs, we receive a monthly payment from or on behalf of each
enrolled member. In both our commercial and Medicare plans, we recognize premium revenue during the
month in which the company is obligated to provide services to an enrolled member. Premiums we
receive in advance of that date are recorded as deferred revenue.
Premiums for our Medicare and commercial products are generally fixed by contract in advance
of the period during which health care is covered. Each of our Medicare plans submits rate
proposals to CMS, generally by county or service area, in June for each Medicare product that will
be offered beginning January 1 of the subsequent year. Retroactive rate adjustments are made
periodically with respect to each of our Medicare plans based on the aggregate health status and
risk scores of our plan populations. During 2006 and 2005 these rate adjustments were recorded as
received. Effective January 1, 2007, the Company began recording estimated risk payment adjustments
on a monthly basis and will adjust the estimated amounts to actual when the ultimate adjustments
are received from CMS. Our commercial premiums are generally fixed for the plan year, in most
cases beginning January 1.
As with our traditional Medicare Advantage plans, we provide written bids to CMS for our Part
D plans, which include the estimated costs of providing prescription drug benefits over the plan
year. Premium payments from CMS are based on these estimated costs. The amount of CMS payments
relating to the Part D standard coverage for our MA-PD and PDP plans is subject to adjustment,
positive or negative, based upon the application of risk corridors that compare our prescription
drug costs in our bids to CMS to our actual prescription drug costs. Variances exceeding certain
thresholds may result in CMS making additional payments to us or our refunding to CMS a portion of
the premium payments we previously received. We estimate and recognize adjustments to premium
revenue related to estimated risk corridor payments as of each quarter end based upon our actual
prescription drug costs for each reporting period as if the annual contract were to end at the end
of each reporting period. Actual risk corridor payments upon final settlement with CMS could
differ materially, favorably or unfavorably, from our estimates.
Because of the Part D product benefit design, the Company incurs prescription drug costs
unevenly throughout the year, resulting in fluctuations in quarterly MA-PD and PDP earnings. As a
result of product features such as co-payments and deductibles, the coverage gap (sometimes
referred to as “the donut hole”), risk corridors, and reinsurance, we incur a disproportionate
amount of prescription drug costs in the first half of the year. As a result, our Part D-related
earnings increase in the second half of the year as compared to the first half of the year.
Certain Part D-related payments we receive from CMS represent payments for claims that we pay
on behalf of CMS for which we assume no risk, including reinsurance and low-income costs subsidies.
We account for these subsidies as funds held for the benefit of members on our balance sheet and as
a financing activity in our statement of cash flows. We do not recognize premium revenue or claims
expense for these subsidies as these amounts represent pass-through payments from CMS to fund
deductibles, co-payments, and other member benefits. We recognize prescription drug costs as
incurred, net of rebates from drug companies.
Fee Revenue. Fee revenue primarily includes amounts paid to us for management services
provided to independent physician associations and health plans. Our management subsidiaries
typically generate fee revenue on one of three bases: (1) as a percentage of revenue collected by
the relevant health plan; (2) as a fixed PMPM payment or percentage of revenue for members serviced
by the relevant independent physician association; or (3) as fees we receive for offering access to
our provider networks and for administrative services we offer to self-insured employers. Fee
revenue is recognized in the month in which services are provided. In addition, pursuant to certain
of our management agreements with independent physician associations, or IPA’s, we receive fees
based on a share of the profits of the independent physician associations. To the extent these fees
relate to members of our HMO subsidiaries, the fees are recognized as a credit to medical expense.
Management fees calculated based on profits are recognized, as fee revenue or as a credit to
medical expenses, if applicable, when we can readily determine that such fees have been earned,
which determination is typically made on a monthly basis.
Investment Income. Investment income consists of interest income and gross realized gains and
losses from sales of available-for-sale investments.
39
Medical Expense
Our largest expense is the cost of medical services we arrange for our members, or medical
expense. Medical expense for our Medicare and commercial plans primarily consist of payments to
physicians, hospitals, pharmacies, and other health care providers for services and products
provided to our Medicare and commercial members. We generally pay our providers on one of three
bases: (1) fee-for-service contracts based on negotiated fee schedules; (2) capitated arrangements,
generally on a fixed PMPM payment basis, whereby the provider generally assumes some or all of the
medical expense risk; and (3) risk-sharing arrangements, whereby we advance a capitated PMPM amount
and share the risk of the medical costs of our members with the provider based on actual experience
as measured against pre-determined sharing ratios. Pharmacy cost represents payments for member’s
prescription drug benefits, net of rebates from drug manufacturers. Rebates are recognized when
earned, according to the contractual arrangements with the respective
manufacturers.
One of our primary tools for managing our business and measuring our profitability is our
medical loss ratio, or MLR, the ratio of our medical expenses to the premiums we receive.
Relatively small changes in the ratio of our medical expenses relative to the premium we receive
can result in significant changes in our financial results. Changes in the MLR from period to
period result from, among other things, changes in Medicare funding or commercial premiums, changes
in benefits offered by our plans, our ability to manage medical expense, changes in accounting
estimates related to incurred but not reported, or IBNR, claims, and our Part-D-related earnings
relative to CMS’ risk corridors. We use MLRs both to monitor our management of medical expenses and
to make various business decisions, including what plans or benefits to offer, what geographic
areas to enter or exit, and our selection of healthcare providers. We analyze and evaluate our
Medicare and commercial MLRs separately.
40
Results of Operations
Percentage Comparisons
The following table sets forth the consolidated and combined statements of income data
expressed in dollars (in thousands) and as a percentage of revenues for each period indicated.
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, |
|
| |
|
2006 |
|
|
2005 (combined) |
|
|
2004 |
|
| |
Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medicare premiums |
|
$ |
1,149,844 |
|
|
|
87.8 |
% |
|
$ |
705,677 |
|
|
|
82.4 |
% |
|
$ |
433,729 |
|
|
|
72.4 |
% |
Commercial premiums |
|
|
120,504 |
|
|
|
9.2 |
|
|
|
126,872 |
|
|
|
14.8 |
|
|
|
146,318 |
|
|
|
24.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premium revenue |
|
|
1,270,348 |
|
|
|
97.1 |
|
|
|
832,549 |
|
|
|
97.2 |
|
|
|
580,047 |
|
|
|
96.8 |
|
Management and other fees |
|
|
26,688 |
|
|
|
2.0 |
|
|
|
20,416 |
|
|
|
2.4 |
|
|
|
17,919 |
|
|
|
3.0 |
|
Investment income |
|
|
11,920 |
|
|
|
0.9 |
|
|
|
3,798 |
|
|
|
0.4 |
|
|
|
1,449 |
|
|
|
0.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue |
|
|
1,308,956 |
|
|
|
100.0 |
|
|
|
856,763 |
|
|
|
100.0 |
|
|
|
599,415 |
|
|
|
100.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medicare expense |
|
|
900,358 |
|
|
|
68.8 |
|
|
|
553,084 |
|
|
|
64.5 |
|
|
|
338,632 |
|
|
|
56.5 |
|
Commercial expense |
|
|
108,168 |
|
|
|
8.3 |
|
|
|
107,095 |
|
|
|
12.5 |
|
|
|
124,743 |
|
|
|
20.8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total medical expense |
|
|
1,008,526 |
|
|
|
77.0 |
|
|
|
660,179 |
|
|
|
77.0 |
|
|
|
463,375 |
|
|
|
77.3 |
|
Selling, general and administrative |
|
|
156,940 |
|
|
|
12.0 |
|
|
|
122,795 |
|
|
|
14.4 |
|
|
|
93,068 |
|
|
|
15.5 |
|
Depreciation and amortization |
|
|
10,154 |
|
|
|
0.8 |
|
|
|
7,305 |
|
|
|
0.8 |
|
|
|
3,210 |
|
|
|
0.6 |
|
Interest expense |
|
|
8,695 |
|
|
|
0.7 |
|
|
|
14,511 |
|
|
|
1.7 |
|
|
|
214 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
1,184,315 |
|
|
|
90.5 |
|
|
|
804,790 |
|
|
|
93.9 |
|
|
|
559,867 |
|
|
|
93.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before equity in earnings of
unconsolidated affiliates, minority interest
and income taxes |
|
|
124,641 |
|
|
|
9.5 |
|
|
|
51,973 |
|
|
|
6.1 |
|
|
|
39,548 |
|
|
|
6.6 |
|
Equity in earnings of unconsolidated affiliates |
|
|
309 |
|
|
|
— |
|
|
|
282 |
|
|
|
— |
|
|
|
234 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before minority interest and income taxes |
|
|
124,950 |
|
|
|
9.5 |
|
|
|
52,255 |
|
|
|
6.1 |
|
|
|
39,782 |
|
|
|
6.6 |
|
Minority interest |
|
|
(303 |
) |
|
|
— |
|
|
|
(3,227 |
) |
|
|
(0.4 |
) |
|
|
(6,272 |
) |
|
|
(1.0 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
124,647 |
|
|
|
9.5 |
|
|
|
49,028 |
|
|
|
5.7 |
|
|
|
33,510 |
|
|
|
5.6 |
|
Income tax expense |
|
|
(43,811 |
) |
|
|
3.3 |
|
|
|
(19,772 |
) |
|
|
2.3 |
|
|
|
(9,193 |
) |
|
|
1.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
80,836 |
|
|
|
6.2 |
|
|
|
29,256 |
|
|
|
3.4 |
|
|
|
24,317 |
|
|
|
4.1 |
|
Preferred dividends |
|
|
(2,021 |
) |
|
|
0.2 |
|
|
|
(15,607 |
) |
|
|
1.8 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common stockholders
or members |
|
$ |
78,815 |
|
|
|
6.0 |
% |
|
$ |
13,649 |
|
|
|
1.6 |
% |
|
$ |
24,317 |
|
|
|
4.1 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
41
Membership
Our primary source of revenue is monthly premium payments we receive based on membership
enrolled in our managed care plans. The following table summarizes our Medicare Advantage
(including MA-PD), stand-alone PDP, and commercial plan membership, by state, as of the dates
indicated.
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
December 31, |
| |
|
2006 |
|
2005 |
|
2004 |
Medicare Advantage Membership |
|
|
|
|
|
|
|
|
|
|
|
|
Tennessee |
|
|
46,261 |
|
|
|
42,509 |
|
|
|
29,862 |
|
Texas |
|
|
34,638 |
|
|
|
29,706 |
|
|
|
21,221 |
|
Alabama |
|
|
27,307 |
|
|
|
24,531 |
|
|
|
12,709 |
|
Illinois (1) |
|
|
6,284 |
|
|
|
4,166 |
|
|
|
— |
|
Mississippi(2) |
|
|
642 |
|
|
|
369 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
115,132 |
|
|
|
101,281 |
|
|
|
63,792 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medicare Stand-Alone PDP Membership |
|
|
88,753 |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial Membership(3) |
|
|
|
|
|
|
|
|
|
|
|
|
Tennessee |
|
|
29,341 |
|
|
|
29,859 |
|
|
|
32,139 |
|
Alabama |
|
|
2,629 |
|
|
|
11,910 |
|
|
|
16,241 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
31,970 |
(4) |
|
|
41,769 |
|
|
|
48,380 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
We commenced operations in Illinois in December 2004. |
| |
| (2) |
|
We commenced enrollment efforts in Mississippi in July 2005. The annual enrollment and
lock-in provisions of the MMA were suspended in our service areas in Mississippi for 2006 as a
result of Hurricane Katrina. |
| |
| (3) |
|
Does not include members of commercial PPOs owned and operated by unrelated third
parties that pay us a management fee for access to our contracted provider network. |
| |
| (4) |
|
As a result of the non-renewal by several large employers in Tennessee and Alabama,
total membership as of January 1, 2007 was approximately 16,500. |
Medicare Advantage. Our Medicare Advantage membership increased by 13.7% to 115,132 members
at December 31, 2006 as compared to 101,281 members at December 31, 2005. The substantial majority
of this increase was attributable to growth in membership in our existing core markets through
increased penetration in existing service areas. Medicare Advantage (including MA-PD) membership as
of January 1, 2007 was 117,615, reflecting incremental increases in each of our markets.
Stand-Alone PDP. Stand-alone PDP membership was 88,753 at December 31, 2006. PDP membership
as of January 1, 2007 was approximately 108,000 as a result of an additional auto-assignment by CMS
effective as of the start of the year (which we expect will remain relatively stable throughout the
year). We do not actively market our PDPs and have relied for membership on CMS auto-assignments
of dual-eligible beneficiaries.
Commercial. Our commercial HMO membership declined from 41,769 members at December 31, 2005
to 31,970 members at December 31, 2006, or by 23.5%, primarily as a result of our decision to
increase premiums to maintain our commercial margins and the discontinuance of certain unprofitable
customer and provider relationships in Alabama and Tennessee.
Comparison of the Year Ended December 31, 2006 to the Combined Twelve-Month Period Ended December 31, 2005
Revenue
Total revenue was $1,309.0 million for 2006 as compared with $856.8 million in the combined
twelve months of 2005, representing an increase of $452.2 million, or 52.8%. The components of
revenue were as follows:
Premium Revenue: Total premium revenue for the year ended December 31, 2006 was $1,270.3
million as compared with $832.5 million in the combined twelve months of 2005, representing an
increase of $437.8 million, or 52.6%. The components of premium revenue and the primary reasons for
changes were as follows:
42
Medicare Advantage: Medicare Advantage (including MA-PD) premiums were $1,048.5 million for
2006 versus $705.7 million in the prior year, representing an increase of $342.8 million, or
48.6%. The increase in Medicare Advantage (including MA-PD) premiums in 2006 is attributable to
increases in membership (which we measure in member months) and PMPM premium rates and the
addition of Part D premiums. Membership months increased 30.4% to 1,299,088 for 2006 from
996,296 for 2005. PMPM premium increased 14.0% to $807.08 for 2006 from $708.30 for 2005,
primarily as a result of additional PMPM premium relating to the Part D benefit received by
MA-PD members beginning January 1, 2006. Our Medicare Advantage premiums (excluding the Part
D-related premium under MA-PD) calculated on a PMPM basis was $737.44 for 2006, compared with
$708.30 for 2005, reflecting an increase of 4.1% primarily as a result of increases in rates and
risk scores and the mix of our members qualifying as dual-eligibles.
For 2007, our average reimbursement rates for our Medicare Advantage
(excluding MA-PD) plans to date have increased by 4.1% over 2006,
reflecting increases in county benchmarks and our plans’ average
risk scores. Average reimbursement rates for Medicare Advantage
(including MA-PD) plans increased 2.6% for 2007 to date as compared
to 2006.
PDP: PDP premiums (after risk corridor adjustments) were $101.4 million in 2006. Our
average PMPM premiums received from CMS (after risk corridor adjustments) were $100.10 for PDP
members for 2006. Because the Medicare Part D program was implemented effective January 1,
2006, there are no comparable PDP operating or financial results for
2005. Reimbursement rates for our stand-alone PDPs to date have decreased by 9.5%
in 2007 as compared to 2006.
Commercial: Commercial premiums were $120.5 million in 2006 as compared with $126.9 million
in the combined twelve months of 2005, reflecting a decrease of $6.4 million, or 5.0%. The
decrease was attributable to the decline in membership, which was partially offset by average
commercial premium increases of approximately 7.4%. Because of our expansion of our Medicare
program into new areas in existing markets, continuing Medicare member growth in existing
service areas, the implementation of Medicare Part D and the non-renewal of coverage by several
large employers in Tennessee and Alabama, we expect commercial premium revenue as a percentage
of total premium revenue and total revenue to continue to decline in the future.
Fee Revenue. Fee revenue was $26.7 million in 2006 as compared with $20.4 million in the
combined twelve months of 2005, representing an increase of $6.3 million, or 30.7%. Of the
increase, $4.3 million was attributable to the addition of a management agreement with a health
plan in Florida, which was terminated as of December 31, 2006. The remaining increase is from
increased member volumes in the IPAs managed by the company.
Investment Income Investment income was $11.9 million for 2006 versus $3.8 million for the
combined twelve months of 2005, reflecting an increase of $8.1 million, or 213.9%. The increase is
attributable to an increase in average invested and cash balances, coupled with a higher average
yield on these balances.
Medical Expense
Medicare Advantage. Medicare Advantage (including MA-PD) medical expense for 2006 increased
$272.8 million, or 49.3%, to $825.9 million from $553.1 million for the combined twelve months of
2005, primarily as a result of increased membership, increasing medical costs, and Part D
prescription drug coverage for MA-PD members beginning January 1, 2006. For 2006, Medicare
Advantage (including MA-PD) MLR was 78.8% versus 78.4% for 2005. Our Medicare Advantage (including
MA-PD) medical expense calculated on a PMPM basis was $635.77 for 2006, compared with $555.14 for
2005, reflecting an increase of 14.6%. The primary driver of the current year period increase in
PMPM expense is the additional expense resulting from the Part D prescription drug benefit
effective as of January 1, 2006. Our Medicare Advantage medical expense (excluding MA-PD)
calculated on a PMPM basis was $576.73 for 2006, compared with $555.14 for 2005, reflecting an
increase of 3.9%.
PDP. PDP medical expense for 2006 was $74.4 million reflecting an MLR of 73.4%. PDP medical
expense on a PMPM basis for 2006 was $73.50.
Commercial. Commercial medical expense increased by $1.1 million, or 1.0%, to $108.2 million
for 2006 as compared to $107.1 million for the combined twelve months of 2005. The commercial MLR
was 89.8% for 2006 as compared with 84.4% in 2005, an increase of 540 basis points, which was
primarily attributable to an unusually large number of high dollar in-patient cases during 2006.
43
Selling, General, and Administrative Expense
SG&A expense for 2006 was $156.9 million as compared with $111.9 million (not including $10.9
million of transaction expense incurred in conjunction with the recapitalization) for the prior
year, an increase of $45.0 million, or 40.3%. As a percentage of revenue, SG&A expense was 12.0%
for 2006 as compared with 13.0% (as adjusted) for the prior year.
The increase in SG&A expense was attributable to an increase in personnel and related costs,
including increases of $15.9 million associated with supporting and sustaining our membership
growth and in corporate personnel, $9.4 million associated with the implementation of Part D and
our operations related thereto, stock compensation expense totaling $5.3 million recorded in connection with
the adoption of SFAS No. 123R and incremental advertising and selling costs of $3.7 million. The
remaining increase is due to public company and other corporate costs, including expenses related
to compliance with the Sarbanes-Oxley Act of 2002.
Depreciation and Amortization Expense
Depreciation and amortization expense was $10.2 million in 2006 as compared with $7.3 million
in the combined twelve months of 2005, representing an increase of $2.9 million, or 39.0%. The
increase is primarily attributable to the amortization of identifiable intangible assets recorded
in conjunction with the recapitalization in 2005. Amortization of $7.5 million was recorded during
2006 as compared with $5.0 million 2005. Amortization in 2006 includes approximately $1.7 million
as a result of the accelerated amortization of recorded intangibles for customer relationships in
Alabama, as a result of decreases in membership.
Interest Expense
Interest expense was $8.7 million in 2006 as compared with $14.5 million in the combined
twelve months of 2005. Most of the company’s interest expense in 2006 related to the write-off of
deferred financing costs in the amount of $5.4 million and a prepayment premium of $1.1 million
related to the payoff of all the company’s outstanding indebtedness and related accrued interest
with proceeds from the IPO. Interest expense in 2005 related primarily to the company’s
indebtedness incurred in connection with the recapitalization. As of December 31, 2006, the company
had no borrowings outstanding.
Minority Interest
Minority interest was $0.3 million in 2006 as compared with $3.2 million in the combined
twelve months of 2005. The change is attributable to minority interest ownership in our Tennessee
HMO and management subsidiaries and a higher minority interest ownership in our Texas HMO
subsidiary for the two months of 2005 prior to the recapitalization. Contemporaneously with the
recapitalization, we purchased all of the minority interests in the Tennessee subsidiaries. In
conjunction with the IPO in February 2006, all minority interest ownership in the Texas HMO
subsidiary was exchanged for company common stock.
Income Tax Expense
For 2006, income tax expense was $43.8 million, reflecting an effective tax rate of 35.1%,
versus $19.8 million, reflecting an effective tax rate of 40.3%, for the combined twelve months of
2005. The higher effective tax rate in 2005 was the result of losses at several of our
subsidiaries, which were consolidated for accounting purposes, but not for tax purposes because
such subsidiaries were pass-through entities prior to the recapitalization. Additionally, the
lower tax rate in 2006 reflects changes in estimates identified upon the completion of the 2005
consolidated federal tax return, and state tax planning.
Preferred Dividend
In 2006, the company accrued $2.0 million of dividends payable on the preferred stock issued
in connection with the recapitalization as compared to a dividend accrued in the same combined
period in 2005 of $15.6 million for the ten months following the recapitalization. In February
2006, in connection with the IPO, the preferred stock and all accrued and unpaid dividends were
converted into common stock.
44
Comparison of the Combined Twelve Month Period Ended December 31, 2005 to the Year Ended December 31, 2004
Membership
Our Medicare Advantage membership increased by 58.8% to 101,281 members at December 31, 2005
as compared to 63,792 members at December 31, 2004. The substantial majority of this increase was
attributable to growth in membership in our existing core markets in Tennessee, Texas and Alabama
through increased penetration in existing service areas and geographic expansion into new counties
contiguous to existing service areas. Enrollment efforts in our new markets, Illinois and
Mississippi, which commenced in December 2004 and July 2005, respectively, also contributed to the
increase. Our commercial HMO membership declined by 13.7% over the same period, from 48,380 to
41,769, primarily as a result of our decision to increase premiums to maintain our commercial
margins and the discontinuance of certain unprofitable customer and provider relationships in
Alabama and Tennessee.
Revenue
Total revenue was $856.8 million in the combined twelve months of 2005 as compared with $599.4
million for 2004, representing an increase of $257.4 million, or 42.9%. The components of revenue
were as follows:
Premium Revenue. Total premium revenue for the combined twelve months of 2005 was $832.5
million as compared with $580.0 million in 2004, representing an increase of $252.5 million, or
43.5%. The components of premium revenue and the primary reasons for changes were as follows:
Medicare: Medicare premiums were $705.7 million in the combined twelve months of 2005
versus $433.7 million in the prior year, representing an increase of $272.0 million, or 62.7%.
The primary factors affecting changes in Medicare premium revenue include membership, premium
rates and risk scores, the geographic mix of our Medicare members, and the mix of our members
qualifying as dual-eligibles. The increase in Medicare premiums in 2005 is primarily
attributable to the 46.1% increase in membership months to 996,929 for the combined twelve
months of 2005 from 682,331 for the comparable period of 2004. An increase in our average PMPM
premium to $707.85 for the combined twelve months of 2005 from $635.66 for 2004, or by 11.4%,
also contributed to the increase in premium revenue.
Commercial: Commercial premiums were $126.9 million in the combined twelve months of 2005
as compared with $146.3 million in 2004, reflecting a decrease of $19.4 million, or 13.3%. The
decline in commercial premiums is attributable to the decline in commercial membership months to
497,973 for the combined twelve month period ended December 31, 2005 from 614,295 for 2004, or
by 18.9%, which was partially offset by average commercial premium increases of approximately
7.0% over the same period.
Fee Revenue. Fee revenue was $20.4 million in the combined twelve months of 2005 as compared
with $17.9 million in 2004, representing an increase of $2.5 million, or 13.9%. The increase was
primarily attributable to the addition of a new independent physician association in Tennessee in
January 2005, increases in independent physician association management fees, which are calculated
by reference to increased PMPM premiums, and the increase in Medicare Advantage membership.
Investment Income. Investment income was $3.8 million for the combined twelve months of 2005
versus $1.4 million for 2004, reflecting an increase of $2.4 million, or 171.4%. The increase is
attributable primarily to an increase in average invested and cash balances, coupled with a higher
average yield on these balances.
Medical Expense
Medicare medical expense for the combined twelve months ended December 31, 2005 increased
$214.5 million, or 63.3%, to $553.1 million from $338.6 million for 2004, primarily as a result of
increased membership. Commercial medical expense decreased by $17.6 million, or 14.2%, to $107.1
million for the combined twelve months of 2005 as compared to $124.7 million for 2004, primarily as
a result of the decrease in commercial membership over the same period.
For the combined twelve months ended December 31, 2005, the Medicare MLR was 78.4% versus
78.1% for 2004, reflecting an increase of 30 basis points, which was attributable to general
medical cost inflation, higher
45
Medicare inpatient admissions per thousand, an increase in the average cost per admission, and
an increase in benefits, including implementation of a fitness program in all markets and increased
drug benefits in selected markets, offset in part by favorable Medicare premium rates. Our Medicare
medical expense calculated on a PMPM basis was $555.14 for the combined twelve months ended
December 31, 2005, compared with $496.29 for 2004, reflecting an increase of 11.8%, which was
primarily attributable to a higher mix of dual-eligible beneficiaries in 2005. The commercial MLR
was 84.4% for the combined twelve months of 2005 as compared with 85.3% in 2004, a decrease of 90
basis points, which was primarily attributable to improvement in commercial premiums and relatively
flat cost trends.
Selling, General, and Administrative Expense
Selling, general, and administrative, or SG&A, expense for the combined twelve months ended
December 31, 2005 was $111.9 million (not including $10.9 million of transaction expense described
below) as compared with $68.9 million for the prior year (not including $24.2 million of phantom
stock compensation described below), an increase of $43.0 million, or 62.4%. As a percentage of
revenue, SG&A expense was 13.06% for the combined twelve months of 2005 versus 11.49% for the prior
year, an increase of 157 basis points. The increase in SG&A expense was attributable, in part, to
an increase in personnel, including increases in corporate personnel in anticipation of the IPO,
increased sales commissions resulting from the increased membership, and other spending associated
with supporting and sustaining our membership growth, including expansion into new geographic
areas. During late 2004 and early 2005, we commenced expansion into selected counties surrounding
Chattanooga and Memphis, Tennessee as well as into the Chicago, Illinois metropolitan area. As we
expand into new service areas, we incur a significant amount of expense in advance of the effective
member enrollment dates, when we begin to collect revenue for new members. During 2005, the company
incurred approximately $6.8 million of expense associated with this expansion activity. In
addition, in 2005 we incurred approximately $4.0 million of incremental expense relating primarily
to sales and marketing activities associated with the implementation of our Medicare Part D
programs and new membership recruitment and enrollment and $377,000
of compensation expense
related to restricted stock.
SG&A for the combined twelve months of 2005 includes transaction expense of $10.9 million
incurred in conjunction with the recapitalization. This expense includes fees paid to financial and
legal advisors and other expenses, including $4.0 million related to a settlement with RPO. See
Note 8 to the Consolidated Financial Statements. SG&A for 2004 includes phantom stock compensation
of $24.2 million incurred in conjunction with the recapitalization.
Depreciation and Amortization Expense
Depreciation and amortization expense was $7.3 million in the combined twelve months of 2005
as compared with $3.2 million in 2004, representing an increase of $4.1 million, or 128.1%. The
increase is primarily attributable to the amortization of identifiable intangible assets recorded
in conjunction with the recapitalization. Amortization related to the recapitalization in the
amount of $5.0 million was recorded during the combined twelve months of 2005.
Interest Expense
Interest expense was $14.5 million in the combined twelve months of 2005. Almost all of the
company’s interest expense related to the senior credit facility and senior subordinated notes put
in place in conjunction with the recapitalization. For the combined twelve months ended December
31, 2005, we recorded interest expense of $9.0 million related to our senior credit facility and
$4.5 million related to our senior subordinated notes. Additionally, interest expense in the
combined twelve months of 2005 includes $0.9 million for amortization of deferred finance costs.
The effective annual interest rate during the combined twelve months of 2005 on the senior credit
facility was 6.6% and on the senior subordinated notes was 15%, 12% of which was payable in cash
and 3% of which accrued quarterly and was added to the outstanding principal amount. In February
2006, in connection with the IPO, the company repaid all of its outstanding indebtedness and
related accrued interest, and wrote off related deferred financing costs of $5.4 million.
Minority Interest
Minority interest was $3.2 million in the combined twelve months of 2005 as compared with $6.3
million in 2004. The change is attributable to the elimination of minority interest ownership in
our Tennessee HMO and
46
management subsidiaries and the reduction of minority interest ownership interest in our Texas
HMO subsidiary in connection with the recapitalization. The earnings of these subsidiaries
increased in 2005 as compared with 2004, which would have resulted in an increase in minority
interest if it had not been offset by the company’s increases in ownership. In conjunction with the
IPO, all minority interest ownership in the Texas HMO subsidiary was exchanged for company common
stock.
Income Tax Expense
For the combined twelve months ended December 31, 2005, income tax expense was $19.8 million,
reflecting an effective tax rate of 40.3%, versus $9.2 million, reflecting an effective tax rate of
27.4%, for 2004. The increase in the effective tax rate is a result of the fact that our
predecessor and several of its subsidiaries were pass-through tax entities that were taxed at the
member level and the successor is taxed on a consolidated basis at the corporate level.
Preferred Dividend
In the combined twelve months ended December 31, 2005, we accrued $15.6 million of dividends
payable on the preferred stock issued in connection with the recapitalization. The $227.2 million
liquidation value of preferred stock had an accumulating dividend of 8%, whether declared or paid.
In February 2006, in connection with the IPO, the preferred stock and all accrued and unpaid
dividends were automatically converted into common stock.
Liquidity and Capital Resources
We have historically financed our operations primarily through internally generated funds. All
of our outstanding funded indebtedness, principally incurred in connection with the
recapitalization in 2005, was repaid in February 2006 with proceeds from the IPO. Although we
eliminated our funded debt, we may borrow up to $75.0 million pursuant to our senior secured
revolving credit facility, which amount may be increased to an aggregate of $125.0 million subject
to certain conditions. See “—Indebtedness” below.
We generate cash primarily from premium revenue and our primary use of cash is the payment of
medical and SG&A expenses. We anticipate that our current level of cash on hand, internally
generated cash flows, and borrowings available under our senior secured revolving credit facility
will be sufficient to fund our working capital needs and anticipated capital expenditures over the
next twelve months.
The reported changes in cash and cash equivalents for the years ended December 31, 2006, 2005
and 2004, are summarized below:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, |
|
| (in thousands) |
|
2006 |
|
|
2005 |
|
|
2004 |
|
| |
|
|
|
|
(combined) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
$ |
167,621 |
|
|
$ |
72,103 |
|
|
$ |
24,665 |
|
Net cash used in investing activities |
|
|
(336 |
) |
|
|
(276,346 |
) |
|
|
(34,615 |
) |
Net cash provided by (used in) financing activities |
|
|
61,073 |
|
|
|
322,935 |
|
|
|
(23,311 |
) |
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in cash and cash equivalents |
|
$ |
228,358 |
|
|
$ |
118,692 |
|
|
$ |
(33,261 |
) |
|
|
|
|
|
|
|
|
|
|
The change in cash and cash equivalents for the combined twelve month period ended December
31, 2005 above includes our predecessor for the period from January 1, 2005 through February 28,
2005 and the company for the period from March 1, 2005 through December 31, 2005. The 2005
investing and financing activities were significantly affected by the recapitalization.
Cash Flows from Operating Activities
Our primary sources of liquidity are cash flow provided by our operations, available cash on
hand and our revolving credit facility. We generated cash from operating activities of $167.6
million during the year ended December 31, 2006, compared to $72.1 during the year ended December
31, 2005.
Our cash flows are significantly influenced by the timing of the Medicare premium remittance
from CMS, which is payable to us on the first day of each month. This payment is sometimes received
in the last several days of the month prior to the month of medical coverage. When this happens, we
record the receipt in deferred revenue and
47
recognize it as premium revenue in the month of medical coverage. The January 2004 payment in
the amount of $28.6 million was received in December of 2003, which had the effect of increasing
operating cash flows in 2003 with a corresponding decrease in 2004. Adjusting our operating cash
flows in 2004 for the effect of the timing of this payment, our operating cash flows would have
been as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Year Ended December 31, |
|
| (in thousands) |
|
2006 |
|
|
2005 |
|
|
2004 |
|
| |
|
|
|
|
|
(combined) |
|
|
|
|
|
Net cash provided by operating activities, as reported |
|
$ |
167,621 |
|
|
$ |
72,103 |
|
|
$ |
24,665 |
|
Timing effect of CMS payment |
|
|
— |
|
|
|
— |
|
|
|
28,597 |
|
|
|
|
|
|
|
|
|
|
|
Adjusted cash flow |
|
$ |
167,621 |
|
|
$ |
72,103 |
|
|
$ |
53,262 |
|
|
|
|
|
|
|
|
|
|
|
2006 Compared With 2005
The increase in adjusted cash flow provided by operating activities to $167.6 million for the
year ended December 31, 2006 as compared with $72.1 million for the combined twelve months ended
December 31, 2005 is primarily attributable to increases in Medicare Advantage membership and
premiums and earnings from Part D as of January 1, 2006. In addition, the following working
capital items had a significant impact on cash flows from operating activities for the year ended
December 31, 2006:
| |
• |
|
Risk corridor payable to CMS associated with the Part D drug program increased $27.6
million in the current year. |
| |
| |
• |
|
Medical claims liability increased $40.1 million in the current year as a result of
the 30.4% increase in Medicare Advantage (including MA-PD) member months. |
Net income has been reduced as a result of depreciation and amortization in the amount of
$10.2 million, stock compensation of $5.7 million, the write-off of deferred financing fees of $5.4
million and minority interest of $303,000, all of which represented non-cash items.
2005 Compared With 2004
The increase in adjusted cash flow provided by operating activities to $72.1 million for the
combined twelve months ended December 31, 2005 as compared with $53.3 million for 2004, as
adjusted, is primarily attributable to increases in membership and premiums. For the combined
twelve months of 2005, we generated $29.3 million of net income and increased working capital by
$33.1 million. Net income had been reduced as a result of depreciation and amortization in the
amount of $7.3 million, and minority interest of $3.2 million, all of which represented non-cash
items.
Cash Flows from Investing and Financing Activities
For the year ended December 31, 2006, the primary investing activities consisted of $7.1
million in property and equipment additions, approximately $10.4 million used to purchase
investments, and $18.3 million in proceeds from the sale and maturity of investment securities.
The Company expects capital expenditures in 2007 to be at or below 1.0% of total revenues. Our
ongoing capital expenditures are primarily related to our technology initiatives and the
development of medical clinics as part of our Living Well Health Center initiative.
During the year ending December 31, 2006, the Company’s financing activities consisted of
proceeds received from the issuance of common stock related to the IPO in February 2006 of $188.5
million, which was used in its entirety to pay off all outstanding indebtedness, and $62.1 million
of funds received from CMS for the benefit of members with Part D drug coverage. These funds from CMS are recorded
as a liability on our balance sheet at December 31, 2006. We
anticipate settling this amount with CMS in
2007 as part of the final settlement of Part D for the 2006 plan year. Because the
Medicare Part D program was implemented effective January 1, 2006, there are no comparable
subsidies received in prior years. We expect cash flows in 2007 to include inflows for similar
subsidies (or funds) from CMS related to the 2007 Medicare year.
For the combined twelve months ended December 31, 2005, the primary investing and financing
activities related to the recapitalization. The Company also had $2.8 million of capital
expenditures. During 2004, the company made distributions to its members and minority interest
holders of its subsidiary companies in the amount
48
of $22.6 million and purchased $32.2 million of investments. Additionally, the company had
capital expenditures in the amount of $2.5 million in 2004.
Statutory Capital Requirements
Our HMO subsidiaries are required to maintain satisfactory minimum net worth requirements
established by their respective state departments of insurance. At December 31, 2006, our Texas
(minimum $7.6 million; actual $35.5 million), Tennessee (minimum $9.6 million; actual $35.7
million) and Alabama (minimum $1.1 million; actual $30.1 million) HMO subsidiaries were in
compliance with statutory minimum net worth requirements. Notwithstanding the foregoing, the state
departments of insurance can require our HMO subsidiaries to maintain minimum levels of statutory
capital in excess of amounts required under the applicable state law if they determine that
maintaining additional statutory capital is in the best interest of our members.
The HMOs are restricted from making distributions without appropriate regulatory notifications
and approvals or to the extent such distributions would put them out of compliance with statutory
net worth requirements. At December 31, 2006, $305.1 million of the Company’s $383.6 million of
cash, cash equivalents, investment securities and restricted investments were held by the Company’s
HMO subsidiaries and subject to these dividend restrictions. Our Texas HMO subsidiary distributed
$30.0 million and $6.0 million in cash to the parent company in August 2006 and December 2006,
respectively.
Indebtedness
In April 2006, the company and certain of its non-HMO subsidiaries as guarantors entered into
a senior revolving credit facility, which provides for borrowings of up to a maximum aggregate
principal amount outstanding of $75.0 million, including a $2.5 million swingline subfacility and a
maximum of $5.0 million in outstanding letters of credit. The obligations under our senior
revolving credit facility are secured by all of our assets. We may request an expansion of the
aggregate commitments under the senior credit facility up to a maximum of $125.0 million, subject
to certain conditions precedent including the consent of the lenders providing the increased credit
availability. Loans under the senior credit facility accrue interest on the basis of either a base
rate or a LIBOR rate plus, in each case, an applicable margin depending on our leverage ratio. The
applicable margin for base rate loans (including swingline loans) ranges from 0.00% to 0.75%, and
the applicable margin for LIBOR loans ranges from 1.00% to 1.75%. We pay a fee of 0.375% per annum
on the unfunded portion of the lenders’ aggregate commitments under the facility.
The senior credit facility contains conditions to making loans, representations, warranties
and covenants, including financial covenants, customary for a transaction of this type. Financial
covenants include (i) a ratio of total indebtedness to consolidated EBITDA not to exceed 2.50 to
1.00; (ii) minimum risk-based capital for each HMO subsidiary; and (iii) a minimum fixed charge
coverage ratio of 1.75 to 1.00. The senior credit facility also contains customary events of
default as well as restrictions on undertaking certain specified corporate actions including, among
others, asset dispositions, acquisitions and other investments, dividends, changes in control,
issuance of capital stock, fundamental corporate changes such as mergers and consolidations,
incurrence of additional indebtedness, creation of liens, transactions with affiliates, and
agreements as to certain subsidiary restrictions. If an event of default occurs that is not
otherwise waived or cured, the lenders may terminate their obligations to make loans under the
senior credit facility and the obligations of the issuing banks to issue letters of credit and may
declare the loans then outstanding under the senior credit facility to be due and payable. We
believe we are currently in compliance with our financial and other covenants under the senior
credit facility. As of December 31, 2006, no amounts were outstanding under the senior revolving
credit facility.
Off-Balance Sheet Arrangements
At December 31, 2006, we did not have any off-balance sheet arrangement requiring disclosure.
49
Commitments and Contingencies
The following table sets forth information regarding our contractual obligations as of
December 31, 2006:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Payments due by period: |
|
| |
|
(in thousands) |
|
| |
|
|
|
|
|
Less than |
|
|
1 to 3 |
|
|
3 to 5 |
|
|
More than |
|
| Contractual Obligations |
|
Total |
|
|
1 year |
|
|
years |
|
|
years |
|
|
5 years |
|
Revolving
credit agreement (1) |
|
$ |
1,195 |
|
|
$ |
281 |
|
|
$ |
562 |
|
|
$ |
352 |
|
|
|
— |
|
Medical claims |
|
|
122,778 |
|
|
|
122,778 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Operating
lease obligations (2) |
|
|
15,407 |
|
|
|
5,327 |
|
|
|
6,547 |
|
|
|
2,783 |
|
|
|
750 |
|
Other contractual obligations |
|
|
240 |
|
|
|
72 |
|
|
|
144 |
|
|
|
24 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
139,620 |
|
|
$ |
128,458 |
|
|
$ |
7,253 |
|
|
$ |
3,159 |
|
|
$ |
750 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| (1) |
|
Amounts represent the commitment fee on undrawn borrowings
under the
company’s revolving credit agreement. |
| |
| (2) |
|
Effective January 15, 2007 we entered into a new seven-year operating lease for approximately 54,000 square feet of office space in Nashville, Tennessee. The average annual rent for the new space is approximately
$775,000. |
Critical Accounting Policies and Estimates
The preparation of our consolidated financial statements requires our management to make a
number of estimates and assumptions relating to the reported amount of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the consolidated financial
statements and the reported amounts of revenues and expenses during the period. We base our
estimates on historical experience and on various other assumptions that we believe are reasonable
under the circumstances. Changes in estimates are recorded if and when better information becomes
available. Actual results could significantly differ from those estimates under different
assumptions and conditions. We believe that the accounting policies discussed below are those that
are most important to the presentation of our financial condition and results of operations and
that require our management’s most difficult, subjective, and complex judgments.
Medical Expense and Medical Claims Liability
Medical expense is recognized in the period in which services are provided and includes an
estimate of the cost of medical expense that has been incurred but not yet reported, or IBNR.
Medical expense includes claim payments, capitation payments, and pharmacy costs, net of rebates,
as well as estimates of future payments of claims incurred, net of reinsurance. Capitation payments
represent monthly contractual fees disbursed to physicians and other providers who are responsible
for providing medical care to members. Pharmacy costs represent payments for members’ prescription
drug benefits, net of rebates from drug manufacturers. Rebates are recognized when earned,
according to the contractual arrangements with the respective vendors. Premiums we pay to
reinsurers are reported as medical expenses and related reinsurance recoveries are reported as
deductions from medical expenses.
Medical claims liability includes medical claims reported to the plans but not yet paid as
well as an actuarially determined estimate of claims that have been incurred but not yet reported
to the plans.
The following table presents the components of our medical claims liability as of the dates
indicated:
| |
|
|
|
|
|
|
|
|
| |
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
| |
|
(in thousands) |
|
Incurred but not reported (IBNR) |
|
$ |
85,731 |
|
|
$ |
74,393 |
|
Reported claims |
|
|
37,047 |
|
|
|
8,252 |
|
|
|
|
|
|
|
|
Total medical claims liability |
|
$ |
122,778 |
|
|
$ |
82,645 |
|
|
|
|
|
|
|
|
The IBNR component of total medical claims liability is based on our historical claims data,
current enrollment, health service utilization statistics, and other related information.
Estimating IBNR is complex and involves a significant amount of judgment. Accordingly, it
represents our most critical accounting estimate. Changes in this estimate can materially affect,
either favorably or unfavorably, our consolidated operating results and overall financial position.
50
Our policy is to record each plan’s best estimate of medical expense IBNR. Using actuarial
models, we calculate a minimum amount and maximum amount of the IBNR component. To most accurately
determine the best estimate, our actuaries determine the point estimate within their minimum and
maximum range by similar medical expense categories within lines of business. The medical expense
categories we use are: in-patient facility, outpatient facility, all professional expense, and
pharmacy. The lines of business are Medicare and commercial. At each of December 31, 2005 and 2006,
our point estimate was between the mid-point and the maximum amount of our IBNR range. The
development of the IBNR estimate generally considers favorable and unfavorable prior period
developments and uses standard actuarial developmental methodologies, including completion factors,
claims trends, and provisions for adverse claims developments.
The completion factors estimates liabilities for claims based upon the historical lag between
the month when services are rendered and the month claims are paid and takes into consideration
factors such as expected medical cost inflation, seasonality patterns, product mix, and membership
changes. The completion factor is a measure of how complete the claims paid to date are relative to
the estimate of the total claims for services rendered for a given reporting period. Although the
completion factor is generally reliable for older service periods, it is more volatile, and hence
less reliable, for more recent periods given that the typical billing lag for services can range
from a week to as much as 90 days from the date of service.
Our use of the claims trend factors considers many aspects of the managed care business. These
considerations are aggregated in the medical expense trend and include the incidences of illness or
disease state (such as cardiac heart failure cases, cases of upper respiratory illness, the length
and severity of the flu season, diabetes, and the number of neonatal intensive care babies).
Accordingly, we rely upon our historical experience, as continually monitored, to reflect the
ever-changing mix, needs, and growth of our members in our trend assumptions. 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 capitated as opposed
to a fee-for-service basis. Other external factors such as government-mandated benefits or other
regulatory changes, catastrophes, and epidemics may impact medical expense 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 expense trends. Medical
expense trends potentially are more volatile than other segments of the economy.
We apply different estimation methods depending on the month of service for which incurred
claims are being estimated. For the more recent months, which constitute the majority of the amount
of IBNR, we estimate our claims incurred by applying the observed trend factors to the PMPM. For
prior months, costs have been estimated using completion factors. In order to estimate the PMPMs
for the most recent months, we validate our estimates of the most recent months’ utilization levels
to the utilization levels in older months using 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.
Our provision for adverse claims development is intended to account for variability in the
following types of factors:
| |
• |
|
changes in claims payment patterns to the extent to which emerging claims payment
patterns differ from the historical payment patterns selected to calculate the IBNR reserve
estimate; |
| |
| |
• |
|
differences between the estimated PMPM incurred expense for the most recent months and
the expected PMPM based on historical PMPM incurred estimates and the estimated trend from
the historical period to the most recent months; |
| |
| |
• |
|
differences between the estimated impact of known differences in environmental factors
and the actual impact of known environmental factors; and |
| |
| |
• |
|
the healthcare expense impact of present but unknown environmental factors that differ
from historical norms. |
We believe that our provision for adverse claims development is appropriate because our
hindsight analysis indicates this additional provision is needed to cover additional unknown
adverse claims not anticipated by the standard assumptions used to produce the IBNR estimates that
were incurred prior to but paid after a period end. For the years ended December 31, 2006 and 2005,
our provision for adverse claims development has been relatively
51
consistent, varying as of the end of each annual period by less than 1.0% of the medical
claims liability. Fluctuations within those periods and as of the period ends are primarily
attributable to differences in membership mix between Medicare and commercial plans and differences
in services (such as in-patient or outpatient services) provided by our plans. Based on these
fluctuations, we expect that our experience on a going-forward basis would result in our provision
for adverse claims, as a percentage of medical claims liability, not varying by more than 1.0% from
one quarterly period to the next.
The completion and claims trend factors are the most significant factors impacting the IBNR
estimate. The following table illustrates the sensitivity of these factors and the impact on our
operating results caused by changes in these factors that management believes are reasonably likely
based on our historical experience and December 31, 2006 data:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| Completion Factor(a) |
|
Claims Trend Factor(b) |
| |
|
Increase |
|
|
|
|
|
Increase |
| Increase |
|
(Decrease) |
|
Increase |
|
(Decrease) |
| (Decrease) |
|
in Medical |
|
(Decrease) |
|
in Medical |
| in Factor |
|
Claims Liability |
|
in Factor |
|
Claims Liability |
| (dollars in thousands) |
3% |
|
$ |
(3,214 |
) |
|
|
(3 |
)% |
|
$ |
(1,543 |
) |
2 |
|
|
(2,168 |
) |
|
|
(2 |
) |
|
|
(1,027 |
) |
1 |
|
|
(1,097 |
) |
|
|
(1 |
) |
|
|
(513 |
) |
(1) |
|
|
1,123 |
|
|
|
1 |
|
|
|
512 |
|
|
|
|
| (a) |
|
Impact due to change in completion factor for the most recent three months. Completion
factors indicate how complete claims paid to date are in relation to estimates for a given
reporting period. Accordingly, an increase in completion factor results in a decrease in the
remaining estimated liability for medical claims. |
| |
| (b) |
|
Impact due to change in annualized medical cost trends used to estimate PMPM costs for the
most recent three months. |
Each month, we re-examine the previously established medical claims liability estimates based
on actual claim submissions and other relevant changes in facts and circumstances. As the liability
estimates recorded in prior periods become more exact, we increase or decrease the amount of the
estimates, and include the changes in medical expenses in the period in which the change is
identified. In every annual reporting period, our operating results include the effects of more
completely developed medical claims liability estimates associated with prior years.
The following table provides a reconciliation of changes in medical claims liability for the
years ended December 31, 2006 and 2005. The 2005 presentation represents a combined summary for the
twelve months ended December 31, 2005. See Note 15 to the Consolidated Financial Statements.
| |
|
|
|
|
|
|
|
|
| |
|
Year ended December 31, |
|
| (in thousands) |
|
2006 |
|
|
2005 |
|
| |
|
|
|
|
|
|
(combined) |
|
Balance at beginning of period |
|
$ |
82,645 |
|
|
$ |
53,187 |
|
Incurred related to: |
|
|
|
|
|
|
|
|
Current period |
|
|
1,017,100 |
|
|
|
665,407 |
|
Prior period |
|
|
(8,574 |
) |
|
|
(5,228 |
) |
|
|
|
|
|
|
|
Total incurred |
|
|
1,008,526 |
|
|
|
660,179 |
|
|
|
|
|
|
|
|
Paid related to: |
|
|
|
|
|
|
|
|
Current period |
|
|
894,684 |
|
|
|
582,944 |
|
Prior period |
|
|
73,709 |
|
|
|
47,777 |
|
|
|
|
|
|
|
|
Total paid |
|
|
968,393 |
|
|
|
630,721 |
|
|
|
|
|
|
|
|
Balance at the end of the period |
|
$ |
122,778 |
|
|
$ |
82,645 |
|
|
|
|
|
|
|
|
The negative amounts reported in the table above for incurred related prior periods result
from claims being ultimately settled for amounts less than originally estimated (a favorable
development). A positive amount reported for incurred related to prior periods would result from
claims ultimately being settled for amounts greater than
52
originally estimated (an unfavorable development). For the years ended December 31, 2006, and
2005 actual claims expense developed favorably by 1.3% and 1.1%, respectively, as compared to
estimated medical claims expense.
Our medical claims liability also considers premium deficiency situations and evaluates the
necessity for additional related liabilities. Premium deficiency accruals were approximately $0.7
million and $1.5 million as of December 31, 2006 and 2005, respectively.
Premium Revenue Recognition
We generate revenues primarily from premiums we receive from CMS and, to a lesser extent our
commercial customers, to provide healthcare benefits to our members. We receive premium payments on
a PMPM basis from CMS to provide healthcare benefits to our Medicare members, which premium is
fixed on an annual basis by contract with CMS. Although the amounts we receive from CMS for each
member is fixed, the amount varies among Medicare plans according to, among other things,
demographics, geographic location, age, gender, and the relative risk score of the plan’s
membership.
We generally receive premiums on a monthly basis in advance of providing services. Premiums
collected in advance are deferred and reported as deferred revenue. We recognize premium revenue
during the period in which we are obligated to provide services to our members. Any amounts that
have not been received are recorded on the balance sheet as accounts receivable.
We experience adjustments to our revenue based on member retroactivity, which reflect changes
in the number and eligibility status of enrollees subsequent to when revenue is received. We
estimate the amount of outstanding retroactivity each period and adjust premium revenue
accordingly. The estimates of retroactivity adjustments are based on historical trends, premiums
billed, the volume of member and contract renewal activity, and other information. We refine our
estimates and methodologies based upon actual retroactivity experienced. To date, member-based
retroactivity adjustments have not been significant.
Additionally, our Medicare premium revenue is adjusted periodically to give effect to a risk
component. Risk adjustment uses health status indicators to improve the accuracy of payments and
establish incentives for plans to enroll and treat less healthy Medicare beneficiaries. CMS
initially phased in this payment methodology in 2003 whereby the risk adjusted payment represented
10% of the payment to Medicare health plans, with the remaining 90% being based on demographic
factors. In 2005 and 2006, the portion of risk adjusted payments was increased to 50% and 75%,
respectively, and will increase to 100% in 2007. The PDP payment methodology is based 100% on the
risk adjustment model.
Under risk adjustment methodology, managed care plans must capture, collect, and submit
diagnosis code information to CMS twice a year. After reviewing the respective submissions, CMS
adjusts the payments to Medicare plans generally at the beginning of the calendar year and during
the third quarter and then issues a final payment in a subsequent
year. During 2005 and 2006 we were not able to estimate the impact of these risk adjustments and as such recorded them on an as-received
basis. Our retroactivity adjustments in 2005 and 2006 were positive. Beginning in January 2007, we
are able to estimate and record risk adjustment payment amounts on a monthly basis.
The monthly Part D payments HealthSpring receives from CMS generally represents HealthSpring’s
bid amount for providing prescription drug coverage, both standard and supplemental, and is
recognized as premium revenue. Payments from CMS are based on these estimated costs. The amount of
CMS payments relating to the Part D standard coverage for HealthSpring Medicare Advantage
(including MA-PD) and PDP plans is subject to adjustment, positive or negative, based upon the
application of risk corridors that compare HealthSpring’s prescription drug costs in its original
bids to CMS to HealthSpring’s actual prescription drug costs. Variances exceeding certain
thresholds, or symmetric risk corridors, may result in CMS making additional payments to
HealthSpring or HealthSpring’s refunding to CMS a portion of the premium payments it previously
received. HealthSpring estimates and recognizes an adjustment to premium revenue related to
estimated risk corridor payments based upon its actual prescription drug cost for each reporting
period as if the annual contract were to end at the end of each reporting period, in accordance
with EITF No. 93-14, “Accounting for Multiple-Year Retrospectively Rated Insurance Contracts by
Insurance Enterprises and Other Enterprises.” Net liabilities to CMS of approximately $27.6 million
related to estimated risk corridor adjustments are included on the Company’s December 31, 2006
balance sheet. This net liability arises as a result of the Company’s actual costs to-date in
providing Part D benefits being lower than its bids. The amount was also recognized in the
statement of income as a reduction of premium revenue. Risk corridor adjustments do not take into
account estimated future prescription drug
53
cost experience. Actual risk corridor payments upon settlement with CMS could differ
materially, favorably or unfavorably, from our estimates.
Goodwill and Other Intangible Assets
Goodwill represents the excess of cost over fair value of assets of businesses acquired.
Substantially all of our goodwill and other intangible assets were recorded in connection with the
recapitalization. Our primary identifiable intangible assets include our Medicare member network,
our HealthSpring trade name, our provider networks, customer relationships, and non-compete
agreements. Goodwill is determined to have an indefinite useful life and is not amortized, but
instead is tested for impairment at least annually. The Company has established December 31 as its
annual testing date. Poor operating results or changes in market conditions could result in an
impairment of goodwill. Other intangible assets are amortized over their respective estimated
useful lives to their estimated residual values and reviewed for impairment at least annually.
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of
an asset to future undiscounted cash flows expected to be generated by the asset. If the carrying
amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by
the amount by which the carrying amount of the asset exceeds its estimated future cash flows.
Accounting for Income Taxes
The Company uses the asset and liability method of accounting for income taxes. Under this
method, deferred income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes and net operating loss and tax credit carry forwards. The amount of
deferred taxes on these temporary differences is determined using the tax rates that are expected
to apply to the period when the asset is realized or the liability is settled, as applicable, based
on tax rates and laws in the respective tax jurisdiction enacted as of the balance sheet date.
The Company reviews its deferred tax assets for recoverability and establishes a valuation
allowance based on historical taxable income, projected future taxable income, applicable tax
strategies, and the expected timing of the reversals of existing temporary differences. A valuation
allowance is provided when it is more likely than not that some portion or all of the deferred tax
assets will not be realized.
The Company also has accruals for taxes and associated interest that may become payable in
future years as a result of audits by tax authorities. We accrue for tax contingencies when it is
probable that a liability to a taxing authority has been incurred and the amount of the contingency
can be reasonably estimated. Although we believe that the positions taken on previously filed tax
returns are reasonable, we nevertheless have established tax and interest reserves in recognition
that various taxing authorities may challenge the positions taken by us resulting in additional
liabilities for taxes and interest. These amounts are reviewed as circumstances warrant and
adjusted as events occur that affect our potential liability for additional taxes, such as lapsing
of applicable statutes of limitations, conclusion of tax audits, additional exposure based on
current calculations, identification of new issues, release of administrative guidance, or
rendering of a court decision affecting a particular tax issue. This policy may be impacted by the
adoption of the Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting
for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”) in 2007.
Recent Accounting Pronouncements
In July 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109,
“Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. In addition, FIN 48 provides guidance on recognition,
classification, interest and penalties, accounting in interim periods, disclosure and transition.
The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this
standard. Only tax positions that meet the relevant recognition threshold at the effective date
may be recognized or continue to be recognized upon adoption of FIN 48. The cumulative effect of
applying the provisions of FIN 48 should be reported as an adjustment to the opening balance of
retained earnings in the year adopted. The provisions of FIN 48 are effective for fiscal years
beginning after December 15, 2006. We are currently evaluating the impact of the adoption of FIN
48 but do not currently anticipate the cumulative effect of adoption of this new standard to have a
material impact on our financial position, results of operations or cash flows.
54
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. SFAS No. 157 defines
fair value, establishes a framework for measuring fair value in generally accepted accounting
principles and expands disclosures about fair value measurements. This Statement applies under
other accounting pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is the relevant measurement
attribute. Accordingly, this Statement does not require any new fair value measurements. SFAS No.
157 is effective for fiscal years beginning after November 15, 2007. SFAS No. 157 is effective for
us beginning with the first quarter of fiscal 2008. We do not expect the adoption of SFAS 157 to
have a material impact on our consolidated financial position or results of operations.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets
and Financial Liabilities”. SFAS No. 159 permits entities to choose to measure at fair value many
financial instruments and certain other items that are not currently required to be measured at
fair value. Subsequent changes in fair value for designated items will be required to be reported
in earnings in the current period. SFAS No. 159 also establishes presentation and disclosure
requirements for similar types of assets and liabilities measured at fair value. SFAS No. 159 is
effective for fiscal years beginning after November 15, 2007. We are currently assessing the effect
of implementing this guidance, which directly depends on the nature and extent of eligible items
elected to be measured at fair value, upon initial application of the standard on January 1, 2008.
55
Item 7 A. Quantitative and Qualitative Disclosures About Market Risk
As of December 31, 2006 and 2005, we had the following assets that may be sensitive to changes
in interest rates:
| |
|
|
|
|
|
|
|
|
| |
|
December 31, |
| Asset Class |
|
2006 |
|
2005 |
| |
|
(in thousands) |
Investment securities, available for sale |
|
$ |
7,874 |
|
|
$ |
8,646 |
|
Investment securities, held to maturity: |
|
|
|
|
|
|
|
|
Current portion |
|
|
10,566 |
|
|
|
14,313 |
|
Long-term portion |
|
|
19,560 |
|
|
|
22,993 |
|
Restricted investments |
|
|
7,195 |
|
|
|
5,652 |
|
We have not purchased any of our investments for trading purposes. Our investment securities
classified as available for sale are repurchase agreements. For all other investment securities, we
intend to hold them to their maturity and classify them as current on our balance sheet if they
mature between three and 12 months from the balance sheet date and as long-term if their maturity
is more than one year from the balance sheet date. These investment securities, both current and
long-term, consist of highly liquid government and corporate debt obligations, a substantial
majority of which mature in five years or less. The investments are subject to interest rate risk
and will decrease in value if market rates increase. Because of the relatively short-term nature of
our investments, however, we would not expect the value of these investments to decline
significantly as a result of a sudden change in market interest rates. Moreover, because of our
ability and intent to hold these investments until maturity, we would not expect foreseeable
changes in interest rates to materially impair their carrying value. Restricted investments consist
of certificates of deposit and government securities deposited or pledged to state departments of
insurance in accordance with state rules and regulations. At December 31, 2005 and December 31,
2006, these restricted assets are recorded at amortized cost and classified as long-term regardless
of the contractual maturity date because of the restrictive nature of the states’ requirements.
Assuming a hypothetical and immediate 1% increase in market interest rates at December 31,
2006, the fair value of our fixed income investments would decrease by approximately $370,000.
Similarly, a 1% decrease in market interest rates at December 31, 2006 would result in an increase
of the fair value of our investments of approximately $370,000. Unless we determined, however, that
the increase in interest rates caused more than a temporary impairment in our investments, or
unless we were compelled by a currently unforeseen reason to sell securities, such a change should
not affect our future earnings or cash flows.
As required by our previous term loan facility, we entered into an interest rate swap
agreement in July 2005, pursuant to which $25.0 million of the principal amount outstanding under
the term loan facility bore interest at a fixed annual rate of 4.25% plus the applicable margin
(3.00%) for the period from January 1, 2006 to the date we repaid the outstanding indebtedness in
February 2006. The swap did not qualify for hedge accounting. Accordingly, the company recorded the
change in the swap’s fair market value as a component of earnings. At December 31, 2005, the fair
market value of the swap was approximately $51,000. This loan facility was paid off and the swap
was settled in connection with the IPO in February 2006. Accordingly, the company is not currently
exposed to market interest rate fluctuations on borrowings.
56
Item 8. Financial Statements and Supplementary Data
INDEX TO FINANCIAL STATEMENTS
| |
|
|
|
|
| |
|
Page |
|
|
|
|
58 |
|
| |
|
|
|
59 |
|
| |
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|
60 |
|
| |
|
|
|
61 |
|
| |
|
|
|
63 |
|
| |
|
|
|
65 |
|
| |
|
|
|
87 |
|
57
Report of Independent Registered Public Accounting Firm
The Board
of Directors and Stockholders
HealthSpring, Inc.:
We have audited the accompanying consolidated balance sheets of HealthSpring, Inc. and subsidiaries
(HealthSpring or the Company) as of December 31, 2006 and 2005, and the related consolidated
statements of income, changes in stockholders’ equity and comprehensive income, and cash flows for
the year ended December 31, 2006, and the ten-month period from March 1, 2005 (inception) to December
31, 2005; and the consolidated statements of income, changes in members’ equity and comprehensive
income, and cash flows of NewQuest, LLC and subsidiaries (Predecessor) for the two months ended
February 28, 2005 and for the year ended December 31, 2004. In connection with our audits of the
consolidated financial statements, we also have audited financial statement Schedule I — Condensed
Financial Information of HealthSpring, Inc. (Parent only). The consolidated financial statements
and financial statement schedule are the responsibility of the Company’s management. Our
responsibility is to express an opinion on the consolidated financial statements and financial
statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the consolidated financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of HealthSpring, Inc. and subsidiaries as of December 31,
2006 and 2005 and the results of their operations and their cash flows for the year ended December
31, 2006 and the ten-month period from March 1, 2005 through December 31, 2005; and the results of
NewQuest, LLC and subsidiaries operations and their cash flows for the two months ended February
28, 2005 and for the year ended December 31, 2004, in conformity with U.S. generally accepted
accounting principles. Also in our opinion, the related financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006
the Company adopted the fair value method of accounting for share-based compensation as required by
Statement of Financial Accounting Standards No. 123(R), Share-Based Payment.
/s/ KPMG LLP
Nashville, Tennessee
March 13, 2007
58
HEALTHSPRING, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
| |
|
|
|
|
|
|
|
|
| |
|
December 31, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
|
|
|
|
|
|
|
|
|
Assets |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
338,443 |
|
|
|
110,085 |
|
Accounts receivable, net of allowance for doubtful accounts
of $3,524 and $1,165 at December 31, 2006 and 2005,
respectively |
|
|
17,588 |
|
|
|
7,248 |
|
Investment securities available for sale |
|
|
7,874 |
|
|
|
8,646 |
|
Current portion of investment securities held to maturity |
|
|
10,566 |
|
|
|
14,313 |
|
Deferred income tax asset |
|
|
3,644 |
|
|
|
5,778 |
|
Prepaid expenses and other assets |
|
|
4,047 |
|
|
|
3,148 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
382,162 |
|
|
|
149,218 |
|
Investment securities held to maturity, less current portion |
|
|
19,560 |
|
|
|
22,993 |
|
Property and equipment, net |
|
|
8,831 |
|
|
|
4,287 |
|
Goodwill |
|
|
341,619 |
|
|
|
315,057 |
|
Intangible assets, net |
|
|
81,175 |
|
|
|
87,675 |
|
Investment in and receivable from unconsolidated affiliate |
|
|
1,301 |
|
|
|
1,469 |
|
Deferred financing fee |
|
|
802 |
|
|
|
5,487 |
|
Restricted investments |
|
|
7,195 |
|
|
|
5,652 |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
842,645 |
|
|
|
591,838 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Stockholders’ Equity |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Medical claims liability |
|
$ |
122,778 |
|
|
|
82,645 |
|
Current portion of long-term debt |
|
|
— |
|
|
|
16,500 |
|
Accounts payable and accrued expenses |
|
|
25,149 |
|
|
|
17,408 |
|
Funds held for the benefit of members |
|
|
62,125 |
|
|
|
— |
|
Risk corridor payable to CMS |
|
|
27,587 |
|
|
|
— |
|
Other current liabilities |
|
|
899 |
|
|
|
727 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
238,538 |
|
|
|
117,280 |
|
Long-term debt, less current portion |
|
|
— |
|
|
|
172,026 |
|
Deferred income tax liability |
|
|
28,444 |
|
|
|
29,782 |
|
Other long-term liabilities |
|
|
381 |
|
|
|
316 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
267,363 |
|
|
|
319,404 |
|
|
|
|
|
|
|
|
Minority interest |
|
|
— |
|
|
|
11,890 |
|
|
|
|
|
|
|
|
Commitments and contingencies (see notes) |
|
|
|
|
|
|
|
|
Stockholders’ equity: |
|
|
|
|
|
|
|
|
Convertible preferred stock, $.01 par value,
authorized 1,000,000 shares, 227,154 shares issued and
outstanding at December 31, 2005 |
|
|
— |
|
|
|
2 |
|
Common stock, $.01 par value, 180,000,000 shares authorized,
57,527,549 issued and 57,261,157 outstanding at December 31,
2006, and 74,000,000 shares authorized, 32,283,950 shares
issued and 32,083,950 shares outstanding at December 31,
2005 |
|
|
575 |
|
|
|
322 |
|
Additional paid-in capital |
|
|
485,002 |
|
|
|
251,202 |
|
Unearned
compensation |
|
|
— |
|
|
|
(1,885 |
) |
Retained earnings |
|
|
89,758 |
|
|
|
10,943 |
|
Treasury stock, at cost, 266,392 shares at December 31,
2006, and 200,000 shares at December 31, 2005 |
|
|
(53 |
) |
|
|
(40 |
) |
|
|
|
|
|
|
|
Total stockholders’ equity |
|
|
575,282 |
|
|
|
260,544 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ equity |
|
$ |
842,645 |
|
|
|
591,838 |
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
59
HEALTHSPRING, INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF INCOME
(in thousands, except share and unit data)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
Predecessor |
|
| |
|
|
|
|
|
Ten-Month |
|
|
|
Two-Month |
|
|
|
|
| |
|
Year Ended |
|
|
Period Ended |
|
|
|
Period Ended |
|
|
Year Ended |
|
| |
|
December 31, 2006 |
|
|
December 31, 2005 |
|
|
|
February 28, 2005 |
|
|
December 31, 2004 |
|
Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Premium: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medicare premiums |
|
$ |
1,149,844 |
|
|
|
610,913 |
|
|
|
|
94,764 |
|
|
|
433,729 |
|
Commercial premiums |
|
|
120,504 |
|
|
|
106,168 |
|
|
|
|
20,704 |
|
|
|
146,318 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total premium revenue |
|
|
1,270,348 |
|
|
|
717,081 |
|
|
|
|
115,468 |
|
|
|
580,047 |
|
Management and other fees |
|
|
26,688 |
|
|
|
16,955 |
|
|
|
|
3,461 |
|
|
|
17,919 |
|
Investment income |
|
|
11,920 |
|
|
|
3,337 |
|
|
|
|
461 |
|
|
|
1,449 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
|
1,308,956 |
|
|
|
737,373 |
|
|
|
|
119,390 |
|
|
|
599,415 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medical expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medicare expense |
|
|
900,358 |
|
|
|
478,553 |
|
|
|
|
74,531 |
|
|
|
338,632 |
|
Commercial expense |
|
|
108,168 |
|
|
|
90,783 |
|
|
|
|
16,312 |
|
|
|
124,743 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total medical expenses |
|
|
1,008,526 |
|
|
|
569,336 |
|
|
|
|
90,843 |
|
|
|
463,375 |
|
Selling, general and administrative |
|
|
156,940 |
|
|
|
101,187 |
|
|
|
|
21,608 |
|
|
|
93,068 |
|
Depreciation and amortization |
|
|
10,154 |
|
|
|
6,990 |
|
|
|
|
315 |
|
|
|
3,210 |
|
Interest expense |
|
|
8,695 |
|
|
|
14,469 |
|
|
|
|
42 |
|
|
|
214 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
1,184,315 |
|
|
|
691,982 |
|
|
|
|
112,808 |
|
|
|
559,867 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before equity in earnings of
unconsolidated affiliate, minority interest and
income taxes |
|
|
124,641 |
|
|
|
45,391 |
|
|
|
|
6,582 |
|
|
|
39,548 |
|
Equity in earnings of unconsolidated affiliate |
|
|
309 |
|
|
|
282 |
|
|
|
|
— |
|
|
|
234 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before minority interest and income taxes |
|
|
124,950 |
|
|
|
45,673 |
|
|
|
|
6,582 |
|
|
|
39,782 |
|
Minority interest |
|
|
(303 |
) |
|
|
(1,979 |
) |
|
|
|
(1,248 |
) |
|
|
(6,272 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
124,647 |
|
|
|
43,694 |
|
|
|
|
5,334 |
|
|
|
33,510 |
|
Income tax expense |
|
|
(43,811 |
) |
|
|
(17,144 |
) |
|
|
|
(2,628 |
) |
|
|
(9,193 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
80,836 |
|
|
|
26,550 |
|
|
|
|
2,706 |
|
|
|
24,317 |
|
Preferred dividends |
|
|
(2,021 |
) |
|
|
(15,607 |
) |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to common stockholders and
members |
|
$ |
78,815 |
|
|
|
10,943 |
|
|
|
|
2,706 |
|
|
|
24,317 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share available to
common stockholders: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
$ |
1.44 |
|
|
|
0.34 |
|
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
$ |
1.44 |
|
|
|
0.34 |
|
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
54,617,744 |
|
|
|
32,173,707 |
|
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
54,720,373 |
|
|
|
32,215,288 |
|
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per member unit: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
— |
|
|
|
— |
|
|
|
$ |
.55 |
|
|
|
5.31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
— |
|
|
|
— |
|
|
|
$ |
.55 |
|
|
|
5.31 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average member units outstanding: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
|
|
— |
|
|
|
— |
|
|
|
|
4,884,196 |
|
|
|
4,578,176 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted |
|
|
— |
|
|
|
— |
|
|
|
|
4,884,196 |
|
|
|
4,578,176 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
60
HEALTHSPRING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ AND MEMBERS’ EQUITY
AND COMPREHENSIVE INCOME
(in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Number of |
|
|
|
|
|
|
Number of |
|
|
|
|
|
|
Additional |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
| |
|
Preferred |
|
|
Preferred |
|
|
Common |
|
|
Common |
|
|
Paid-in |
|
|
Unearned |
|
|
Retained |
|
|
Treasury |
|
|
Stockholders’ |
|
| |
|
Shares |
|
|
Stock |
|
|
Shares |
|
|
Stock |
|
|
Capital |
|
|
Compensation |
|
|
Earnings |
|
|
Stock |
|
|
Equity |
|
Successor |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at March 1, 2005
(inception) |
|
|
— |
|
|
$ |
— |
|
|
|
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
— |
|
Preferred shares issued |
|
|
227 |
|
|
|
2 |
|
|
|
— |
|
|
|
— |
|
|
|
227,198 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
227,200 |
|
Preferred dividends accrued |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
15,607 |
|
|
|
— |
|
|
|
(15,607 |
) |
|
|
— |
|
|
|
— |
|
Common shares issued |
|
|
|
|
|
|
— |
|
|
|
30,445 |
|
|
|
304 |
|
|
|
5,785 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
6,089 |
|
Issuance of restricted shares |
|
|
— |
|
|
|
— |
|
|
|
1,839 |
|
|
|
18 |
|
|
|
2,888 |
|
|
|
(2,538 |
) |
|
|
— |
|
|
|
— |
|
|
|
368 |
|
Purchase of 200 shares of
restricted common stock |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(276 |
) |
|
|
276 |
|
|
|
— |
|
|
|
(40 |
) |
|
|
(40 |
) |
Share-based compensation |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
377 |
|
|
|
— |
|
|
|
— |
|
|
|
377 |
|
Comprehensive income — net
income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
26,550 |
|
|
|
— |
|
|
|
26,550 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at December 31, 2005 |
|
|
227 |
|
|
|
2 |
|
|
|
32,284 |
|
|
|
322 |
|
|
|
251,202 |
|
|
|
(1,885 |
) |
|
|
10,943 |
|
|
|
(40 |
) |
|
|
260,544 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Preferred dividends accrued |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2,021 |
|
|
|
— |
|
|
|
(2,021 |
) |
|
|
— |
|
|
|
— |
|
Preferred Shares converted
to common shares |
|
|
(227 |
) |
|
|
(2 |
) |
|
|
12,553 |
|
|
|
126 |
|
|
|
(124 |
) |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Minority interest converted
to common shares |
|
|
— |
|
|
|
— |
|
|
|
2,040 |
|
|
|
21 |
|
|
|
39,763 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
39,784 |
|
Common shares issued at IPO,
net |
|
|
— |
|
|
|
— |
|
|
|
10,600 |
|
|
|
106 |
|
|
|
188,333 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
188,439 |
|
Restricted shares issued |
|
|
— |
|
|
|
— |
|
|
|
45 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Stock-option exercises |
|
|
— |
|
|
|
— |
|
|
|
5 |
|
|
|
— |
|
|
|
12 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
12 |
|
Purchase of
66 shares of
restricted common stock |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(13 |
) |
|
|
(13 |
) |
Share-based compensation
expense-Restricted shares |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
5,680 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
5,680 |
|
Reclassification of unearned
compensation upon adoption
of SFAS No. 123R |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(1,885 |
) |
|
|
1,885 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Comprehensive income — net
income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
— |
|
|
|
80,836 |
|
|
|
— |
|
|
|
80,836 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at December 31, 2006 |
|
|
— |
|
|
$ |
— |
|
|
|
57,527 |
|
|
$ |
575 |
|
|
$ |
485,002 |
|
|
$ |
— |
|
|
$ |
89,758 |
|
|
$ |
(53 |
) |
|
$ |
575,282 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes to consolidated financial statements.
61
HEALTHSPRING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ AND MEMBERS’ EQUITY
AND COMPREHENSIVE INCOME (cont.)
(in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Number of |
|
|
|
|
|
|
Accumulated |
|
|
|
|
|
|
|
|
| |
|
Founders and |
|
|
Founders and |
|
|
Other |
|
|
|
|
|
|
Total |
|
| |
|
Membership |
|
|
Members’ |
|
|
Comprehensive |
|
|
Retained |
|
|
Members’ |
|
| |
|
Units |
|
|
Units |
|
|
Income, Net |
|
|
Earnings |
|
|
Equity |
|
Predecessor |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at December 31, 2003 |
|
|
4,078 |
|
|
$ |
4,007 |
|
|
$ |
85 |
|
|
$ |
18,877 |
|
|
$ |
22,969 |
|
Conversion of minority
interest in consolidated
subsidiary |
|
|
500 |
|
|
|
3,572 |
|
|
|
— |
|
|
|
— |
|
|
|
3,572 |
|
Conversion of phantom
membership plan to member
units |
|
|
306 |
|
|
|
24,208 |
|
|
|
— |
|
|
|
— |
|
|
|
24,208 |
|
Distributions to members |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
(19,546 |
) |
|
|
(19,546 |
) |
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
24,317 |
|
|
|
24,317 |
|
Unrealized holding losses
on securities available for
sale, net of tax |
|
|
— |
|
|
|
— |
|
|
|
(85 |
) |
|
|
— |
|
|
|
(85 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
24,232 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at December 31, 2004 |
|
|
4,884 |
|
|
|
31,787 |
|
|
|
— |
|
|
|
23,648 |
|
|
|
55,435 |
|
Comprehensive income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
2,706 |
|
|
|
2,706 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,706 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances at February 28, 2005 |
|
|
4,884 |
|
|
$ |
31,787 |
|
|
$ |
— |
|
|
$ |
26,354 |
|
|
$ |
58,141 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
62
HEALTHSPRING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
Predecessor |
|
| |
|
|
|
|
|
Ten-Month |
|
|
|
Two-Month |
|
|
|
|
| |
|
Year Ended |
|
|
Period Ended |
|
|
|
Period Ended |
|
|
Year Ended |
|
| |
|
December 31, 2006 |
|
|
December 31, 2005 |
|
|
|
February 28, 2005 |
|
|
December 31, 2004 |
|
Cash from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
80,836 |
|
|
|
26,550 |
|
|
|
|
2,706 |
|
|
|
24,317 |
|
Adjustments to reconcile net income to net cash provided
by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization expense |
|
|
10,154 |
|
|
|
6,990 |
|
|
|
|
315 |
|
|
|
3,210 |
|
Amortization of accrued loss on assumed lease |
|
|
— |
|
|
|
— |
|
|
|
|
(97 |
) |
|
|
(580 |
) |
Amortization of deferred financing cost |
|
|
242 |
|
|
|
879 |
|
|
|
|
— |
|
|
|
— |
|
Paid-in-kind (PIK) interest on subordinated notes |
|
|
116 |
|
|
|
901 |
|
|
|
|
— |
|
|
|
— |
|
Share-based compensation |
|
|
5,650 |
|
|
|
377 |
|
|
|
|
— |
|
|
|
|
|
Equity in earnings of unconsolidated affiliate |
|
|
(309 |
) |
|
|
(282 |
) |
|
|
|
— |
|
|
|
(234 |
) |
Minority interest |
|
|
303 |
|
|
|
1,979 |
|
|
|
|
1,248 |
|
|
|
6,272 |
|
Write-off of deferred financing fee |
|
|
5,375 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Deferred taxes (benefit) expense |
|
|
796 |
|
|
|
(1,060 |
) |
|
|
|
93 |
|
|
|
2,163 |
|
Compensation expense on phantom stock plan cancellation |
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
|
24,200 |
|
Increase (decrease) in cash equivalents due to change in: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(10,340 |
) |
|
|
9,827 |
|
|
|
|
(2,470 |
) |
|
|
(9,977 |
) |
Prepaid expenses and other current assets |
|
|
(899 |
) |
|
|
(4,725 |
) |
|
|
|
1,240 |
|
|
|
(4,148 |
) |
Medical claims liability |
|
|
40,133 |
|
|
|
23,629 |
|
|
|
|
5,829 |
|
|
|
5,458 |
|
Accounts
payable, accrued expenses, and other current liabilities |
|
|
8,214 |
|
|
|
(7,460 |
) |
|
|
|
6,202 |
|
|
|
2,562 |
|
Risk corridor payable to CMS |
|
|
27,587 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Deferred revenue |
|
|
(301 |
) |
|
|
(131 |
) |
|
|
|
(113 |
) |
|
|
(28,578 |
) |
Other long-term liabilities |
|
|
64 |
|
|
|
(335 |
) |
|
|
|
|
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
|
167,621 |
|
|
|
57,139 |
|
|
|
|
14,964 |
|
|
|
24,665 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase of property and equipment |
|
|
(7,063 |
) |
|
|
(2,653 |
) |
|
|
|
(149 |
) |
|
|
(2,512 |
) |
Purchase of investment securities held-to-maturity |
|
|
(10,368 |
) |
|
|
(16,313 |
) |
|
|
|
(5,942 |
) |
|
|
(23,777 |
) |
Purchase of investments, available for sale |
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
|
(8,460 |
) |
Maturity of investments held-to-maturity |
|
|
18,283 |
|
|
|
12,524 |
|
|
|
|
836 |
|
|
|
— |
|
Purchase of restricted investments |
|
|
(1,543 |
) |
|
|
(119 |
) |
|
|
|
(214 |
) |
|
|
— |
|
Distributions received from unconsolidated affiliate |
|
|
355 |
|
|
|
— |
|
|
|
|
— |
|
|
|
134 |
|
Purchase of minority interest |
|
|
— |
|
|
|
(44,358 |
) |
|
|
|
— |
|
|
|
— |
|
Acquisitions, net of cash acquired |
|
|
— |
|
|
|
(219,958 |
) |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities |
|
|
(336 |
) |
|
|
(270,877 |
) |
|
|
|
(5,469 |
) |
|
|
(34,615 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from issuance of long-term debt |
|
|
— |
|
|
|
200,000 |
|
|
|
|
— |
|
|
|
— |
|
Payments on long-term debt |
|
|
(188,642 |
) |
|
|
(17,733 |
) |
|
|
|
(117 |
) |
|
|
— |
|
Deferred financing costs |
|
|
(932 |
) |
|
|
(6,366 |
) |
|
|
|
— |
|
|
|
— |
|
Payments on notes payable to members |
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
|
(700 |
) |
Proceeds from issuance of common and preferred stock |
|
|
188,493 |
|
|
|
140,087 |
|
|
|
|
|
|
|
|
— |
|
Purchase of treasury stock |
|
|
(13 |
) |
|
|
(40 |
) |
|
|
|
— |
|
|
|
— |
|
Tax benefit
from stock option exercised |
|
|
30 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Proceeds
from stock options exercised |
|
|
12 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Funds received for the benefit of members, net |
|
|
62,125 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Proceeds from sale of units in consolidated subsidiary |
|
|
— |
|
|
|
7,875 |
|
|
|
|
— |
|
|
|
— |
|
Distributions to members |
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
|
(19,546 |
) |
Distributions to minority stockholders |
|
|
— |
|
|
|
— |
|
|
|
|
(1,771 |
) |
|
|
(3,065 |
) |
Cash advanced in recapitalization |
|
|
— |
|
|
|
— |
|
|
|
|
1,000 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
61,073 |
|
|
|
323,823 |
|
|
|
|
(888 |
) |
|
|
(23,311 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase (decrease) in cash and cash equivalents |
|
|
228,358 |
|
|
|
110,085 |
|
|
|
|
8,607 |
|
|
|
(33,261 |
) |
Cash and cash equivalents at beginning of period |
|
|
110,085 |
|
|
|
— |
|
|
|
|
67,834 |
|
|
|
101,095 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
338,443 |
|
|
|
110,085 |
|
|
|
|
76,441 |
|
|
|
67,834 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
63
HEALTHSPRING, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (cont.)
(in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
Predecessor |
|
| |
|
|
|
|
|
Ten-Month |
|
|
|
Two-Month |
|
|
|
|
| |
|
Year Ended |
|
|
Period Ended |
|
|
|
Period Ended |
|
|
Year Ended |
|
| |
|
December 31, 2006 |
|
|
December 31, 2005 |
|
|
|
February 28, 2005 |
|
|
December 31, 2004 |
|
Supplemental disclosures: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest |
|
$ |
3,504 |
|
|
|
11,229 |
|
|
|
|
42 |
|
|
|
274 |
|
Cash paid for taxes |
|
$ |
37,686 |
|
|
|
19,477 |
|
|
|
|
279 |
|
|
|
7,704 |
|
Conversion of minority interest in consolidated subsidiary |
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
|
3,572 |
|
Capitalized tenant improvement allowances |
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
|
715 |
|
Non-cash transaction: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common shares in exchange for minority shares |
|
$ |
39,784 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Issuance of common shares in conjunction with recapitalization |
|
|
— |
|
|
$ |
93,877 |
|
|
|
|
— |
|
|
|
— |
|
Unearned compensation related to issuance of restricted
common stock |
|
|
— |
|
|
$ |
2,262 |
|
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of acquisitions: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net assets acquired |
|
|
— |
|
|
$ |
(438,576 |
) |
|
|
|
— |
|
|
|
— |
|
Preferred stock issued |
|
|
— |
|
|
|
91,082 |
|
|
|
|
— |
|
|
|
— |
|
Common stock issued |
|
|
— |
|
|
|
2,442 |
|
|
|
|
— |
|
|
|
— |
|
Purchase of minority interest |
|
|
— |
|
|
|
44,358 |
|
|
|
|
— |
|
|
|
— |
|
Capitalized transaction costs |
|
|
— |
|
|
|
5,295 |
|
|
|
|
— |
|
|
|
— |
|
Cash acquired |
|
|
— |
|
|
|
75,441 |
|
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Acquisition, net of cash acquired |
|
|
— |
|
|
$ |
(219,958 |
) |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying notes to consolidated financial statements.
64
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
(1) Organization and Summary of Significant Accounting Policies
(a) Description of Business and Basis of Presentation
HealthSpring, Inc., a Delaware corporation (the “Company”), is a managed care organization
that focuses primarily on Medicare, the federal government sponsored health insurance program for
retired U.S. citizens aged 65 and older, qualifying disabled persons, and persons suffering from
end stage renal disease. Through its health maintenance organization (“HMO”) subsidiaries, the
Company operates Medicare Advantage and stand-alone Medicare prescription drug plans in the states
of Tennessee, Texas, Alabama, Illinois and Mississippi. Effective January 1, 2007, the Company
began offering Medicare Part D prescription drug plans on a nationwide basis. In addition, the
Company also utilizes its infrastructure and provides networks in Tennessee and Alabama to offer
commercial health plans to individuals and employer groups. The
Company also provides management services to heathcare plans and physician partnerships.
HealthSpring, Inc. was formed in October 2004 in connection with a recapitalization
transaction including NewQuest, LLC and its members, certain investment funds affiliated with GTCR
Golder Rauner II, LLC (“GTCR”) and certain other investors. The recapitalization was completed on
March 1, 2005; which was the inception of HealthSpring, Inc. See Note 8.
The consolidated financial statements include the accounts of HealthSpring, Inc. and its
wholly and majority owned subsidiaries as of December 31, 2006 and 2005, for the year ended
December 31, 2006, for the ten-month period from March 1, 2005 (inception) to December 31, 2005,
and NewQuest, LLC and subsidiaries (collectively, the “Predecessor”), for the two-month period
ended February 28, 2005 and for the year ended December 31, 2004. The financial statements of
HealthSpring, Inc. and the Predecessor are presented in comparative format. Although their
accounting policies are consistent, their financial statements are not directly comparable
primarily because of the purchase accounting adjustments resulting from the recapitalization, which
was accounted for as a purchase. All significant inter-company accounts and transactions have been
eliminated in consolidation. For purposes of these financial statements and notes, where
appropriate the term “Company” includes HealthSpring, Inc. and Predecessor. The Company considers
its businesses and related operating structure as one reporting segment.
On February 8, 2006, the Company completed an underwritten initial public offering of its
common stock. See Note 9.
(b) Use of Estimates
The preparation of the consolidated financial statements requires management of the Company to
make a number of estimates and assumptions relating to the reported amount of assets and
liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during the period. The most
significant item subject to estimates and assumptions is the actuarial calculation for obligations
related to medical claims. Other significant items subject to estimates and assumptions include the
allowance for doubtful accounts receivable and certain amounts recorded related to the Part D
program. Actual results could differ from those estimates.
(c) Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company considers all highly
liquid investments that have maturities of three months or less at the date of purchase to be cash
equivalents. Cash equivalents include such items as certificates of deposit.
(d) Investment Securities and Restricted Investments
The Company classifies its debt and equity securities in three categories: trading, available
for sale, or held to maturity. Trading securities are bought and held principally for the purpose
of selling them in the near term. Held-
65
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
to-maturity securities are those securities in which the Company has the ability and intent to
hold the security until maturity. All securities not included in trading or held to maturity are
classified as available for sale.
Trading and available-for-sale securities are recorded at fair value. Held to maturity debt
securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums
or discounts. Unrealized holding gains and losses on trading securities are included in earnings.
Unrealized holding gains and losses, net of the related tax effect, on available for sale
securities are excluded from earnings and are reported as a separate component of other
comprehensive income until realized. Realized gains and losses from the sale of available for sale
securities are determined on a specific identification basis. Purchases and sales of investments
are recorded on their trade dates. Dividend and interest income are recognized when earned.
A decline in the market value of any available-for-sale or held-to-maturity security below
cost that is deemed to be other than temporary results in a reduction in its carrying amount to
fair value. The impairment is charged to earnings and a new cost basis for the security is
established. To determine whether an impairment is other than temporary, the Company considers
whether it has the ability and intent to hold the investment until a market price recovery and
considers whether evidence indicating the cost of the investment is recoverable outweighs evidence
to the contrary. Evidence considered in this assessment includes the reasons for the impairment,
the severity and duration of the impairment, changes in value subsequent to year end, and
forecasted performance of the investee.
Restricted investments include U.S. Government securities and certificates of deposit held by
the various state departments of insurance to whose jurisdiction the Company’s subsidiaries are
subject. All of the Company’s restricted investments were classified as held-to-maturity at
December 31, 2006 and 2005.
(e) Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation on
property and equipment is calculated on the straight line method over the estimated useful lives of
the assets. The estimated useful life of property and equipment ranges from 1 to 5 years. Leasehold
improvements for assets under operating leases are amortized over the lesser of their useful life
or the expected term of the lease. Maintenance and repairs are charged to operating expense when
incurred. Major improvements that extend the lives of the assets are capitalized.
(f) Impairment of Long Lived Assets
Long lived assets, such as property and equipment and purchased intangibles subject to
amortization, are reviewed for impairment whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and
used is measured by a comparison of the carrying amount of an asset to estimated future
undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset
exceeds its estimated fair value, an impairment charge is recognized by the amount by which
the carrying amount of the asset exceeds the estimated future cash flows. Assets to be disposed of
would be separately presented in the balance sheet and reported at the lower of the carrying amount
or fair value less costs to sell, and are no longer depreciated.
(g) Income Taxes
The Company uses the asset and liability method of accounting for income taxes. Under this
method, deferred income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts used
for income tax purposes and net operating loss and tax credit carry forwards. The amount of
deferred taxes on these temporary differences is determined using the tax rates that are expected
to apply to the period when the asset is realized or the liability is settled, as applicable, based
on tax rates and laws in the respective tax jurisdiction enacted as of the balance sheet date.
The Company reviews its deferred tax assets for recoverability and establishes a valuation
allowance based on historical taxable income, projected future taxable income, applicable tax
strategies, and the expected timing of the reversals of existing temporary differences. A valuation
allowance is provided when it is more likely than not that some portion or all of the deferred tax
assets will not be realized.
66
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
(h) Goodwill and Other Intangible Assets
Goodwill represents the excess of cost over fair value of assets of businesses acquired.
Goodwill and intangible assets acquired in a purchase business combination and determined to have
an indefinite useful life are not amortized, but instead are tested for impairment at least
annually. The Company has selected December 31 as its annual testing date. Intangible assets with
estimable useful lives are amortized over their respective estimated useful lives and are reviewed
for impairment whenever events or changes in circumstances indicate that an intangible asset’s
carrying value may not be recoverable. No impairment losses were recognized during the years ended
December 31, 2006, 2005 and 2004.
An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s
fair value. This determination is made at the reporting unit level and consists of two steps.
First, the Company determines the fair value of the reporting unit and compares it to its carrying
amount. Second, if the carrying amount of the reporting unit exceeds its fair value, an impairment
loss is recognized for any excess of the carrying amount of the unit’s goodwill over the implied
fair value of that goodwill. The implied fair value of goodwill is determined by allocating the
fair value of the reporting units in a manner similar to a purchase price allocation, in accordance
with SFAS No. 141, “Business Combinations.” The residual fair value after this allocation is the
implied fair value of the reporting unit’s goodwill. The Company operates as four reporting units,
in Tennessee, Alabama, Texas, and Illinois. The Company conducted an annual impairment
test as of December 31, 2006 and concluded that the carrying value of the reporting units did not
exceed their fair value.
(i) Medical Claims Liability and Medical Expenses
Medical claims liability represents the Company’s liability for services that have been
performed by providers for its Medicare Advantage and commercial HMO members that have not been
settled as of any given balance sheet date. The liability consists of medical claims reported to
the plans as well as an actuarially determined estimate of claims that have been incurred but not
yet reported to the plans, or IBNR.
Medical expenses consist of claim payments, capitation payments, and pharmacy costs, net of
rebates, as well as estimates of future payments of claims provided for services rendered prior to the end of the reporting period. Capitation payments represent monthly contractual fees disbursed to physicians and other
providers who are responsible for providing medical care to members. Pharmacy costs (including
Medicare Part D costs — see Note 2) represent payments for members’ prescription drug benefits,
net of rebates from drug manufacturers. Rebates are recognized when the rebates are earned
according to the contractual arrangements with the respective vendors. Premiums the Company pays to
reinsurers are reported as medical expenses and related reinsurance recoveries are reported as
reductions from medical expenses.
(j) Premium Revenue
Health plan premiums are due monthly and are recognized as revenue during the period in which
the Company is obligated to provide services to the members. Certain
monthly payments for Part D from the Centers for Medicare and
Medicaid Services (“CMS”), represent payments for claims for
which the Company assumes risk for the costs of
services or products delivered to its Part D members, whereas other
Part D payments from CMS represent payments for claims for which it assumes no risk (See Note 2). The Company recognizes premium revenue for the Part D payments received from CMS for which it assumes risk.
Deferred revenue consists of premium payments received by the Company for covered lives for which
the services will be rendered and revenue recognized in future months.
(k) Fee Revenue
Fee revenue primarily includes amounts paid to the Company for management services provided to
independent physician associations and health plans. The Company’s management subsidiaries
typically generate this fee revenue on one of three principal bases: (1) as a percentage of revenue
collected by the relevant health plan; (2) as a fixed PMPM payment or percentage of revenue for
members serviced by the relevant independent physician association; or (3) as fees the Company
receives for offering access to its provider networks and for administrative services it offers to
self-insured employers. Fee revenue is recognized in the month in which services are provided. In
addition, pursuant to certain of our management agreements with independent physician associations,
we receive additional fees based on a share of the profits of the independent physician
association, which are recognized monthly as either fee revenue or as a reduction to medical
expense dependent upon whether the profit relates to members of one of the Company’s HMO
subsidiaries.
67
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
The Company characterizes its management arrangements with independent physician associations
servicing the Company’s HMO subsidiaries membership as reciprocal-based arrangements. Accordingly,
“profits payments” to the Company management subsidiaries are evaluated to determine whether they
are a partial return of the capitation-based advance payment made by the Company HMO subsidiary. If
so, the profits payments are recognized as a reduction to medical expense when the Company can
readily determine that such profits have been earned.
(l) Comprehensive Income
Comprehensive income in 2006 and 2005 consists of only net income.
(m) Reinsurance and Capitation
Certain of the Company’s HMO subsidiaries have reinsurance arrangements with respect to its
commercial lines of business with well-capitalized, highly-rated reinsurance providers. These
arrangements include maximum medical payment amounts per member per year and per such member’s
lifetime. Premiums paid and amounts recovered under these agreements have not been material in any
period covered by these financial statements.
The Company’s HMO subsidiaries also maintain risk-sharing arrangements with its providers,
including independent physician associations. See Note 12.
(n) Net Income Per Common Share and Member Unit
Net income per common share and member unit is measured at two levels: basic net income per
common share and member unit and diluted net income per common share and member unit. Basic net
income per common shares and member unit is computed by dividing net income available to common
stockholders and members by the weighted average number of common shares or member units
outstanding during the period. Diluted net income per common share is computed by dividing net
income available to common stockholders by the weighted average number of common shares outstanding
after considering the dilution related to stock options and restricted stock. Diluted net income
per member unit is computed by dividing net income by the weighted average number of member units
outstanding after considering dilution related to warrants to purchase 500,000 Series A units of
NewQuest, LLC.
(o) Stock Based Compensation
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS
No. 123R “Share-Based Payment” (“SFAS No. 123R”), using the modified prospective method. Under this
method, compensation costs are recognized based on the estimated fair value of the respective
options and the period during which an employee is required to provide service in exchange for the
award.
Prior to January 1, 2006, the Company applied the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to
Employees” and related interpretations including Financial Accounting Standards Board (FASB)
Interpretation No. 44, “Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25,” to account for its fixed-plan stock options. Under this
method, compensation expense was recorded for fixed-plan stock options only if the current market
price of the underlying stock exceeded the exercise price on the date of grant. SFAS No. 123
“Accounting for Stock-Based Compensation,” and SFAS No. 148, “Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment to FASB Statement No. 123,” established
accounting and disclosure requirements using a fair-value-based method of accounting for
stock-based employee compensation plans. As allowed by SFAS No. 123, the Company had elected to
continue to apply the intrinsic-value-based method of accounting described above, and had adopted
only the disclosure requirements of these statements.
68
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
(p) Recent Accounting Pronouncements
In July 2006, the FASB issued FIN 48, which clarifies the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109,
“Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. In addition, FIN 48 provides guidance on recognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. The provisions of FIN 48 are to be applied to all tax
positions upon initial adoption of this standard. Only tax positions that meet the relevant
recognition threshold at the effective date may be recognized or continue to be recognized upon
adoption of FIN 48. The cumulative effect of applying the provisions of FIN 48 should be reported
as an adjustment to the opening balance of retained earnings in the year adopted. The provisions
of FIN 48 are effective for fiscal years beginning after December 15, 2006. The Company is
currently evaluating the impact of the adoption of FIN 48 but does not currently anticipate the
cumulative effect of adoption of this new standard to have a material impact on its financial
position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines
fair value, establishes a framework for measuring fair value in generally accepted accounting
principles and expands disclosures about fair value measurements. This Statement applies under
other accounting pronouncements that require or permit fair value measurements, the FASB having
previously concluded in those accounting pronouncements that fair value is the relevant measurement
attribute. Accordingly, this Statement does not require any new fair value measurements. SFAS No.
157 is effective for fiscal years beginning after November 15, 2007. SFAS No. 157 is effective for
us beginning with the first quarter of fiscal 2008. The Company does not expect the adoption of
SFAS No. 157 to have a material impact on its consolidated financial position or results of
operations.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets
and Financial Liabilities”. SFAS No. 159 permits entities to choose to measure at fair value many
financial instruments and certain other items that are not currently required to be measured at
fair value. Subsequent changes in fair value for designated items will be required to be reported
in earnings in the current period. SFAS No. 159 also establishes presentation and disclosure
requirements for similar types of assets and liabilities measured at fair value. SFAS No. 159 is
effective for fiscal years beginning after November 15, 2007. The Company is currently assessing
the effect of implementing this guidance, which directly depends on the nature and extent of
eligible items elected to be measured at fair value, upon initial application of the standard on
January 1, 2008.
(2) Accounting for Prescription Drug Benefits under Part D
On January 1, 2006, the Company began providing prescription drug benefits pursuant to
Medicare Part D. The Company refers to these plans after January 1, 2006 collectively as Medicare
Advantage plans and separately as Medicare Advantage (without Part D prescription drug benefits)
and Medicare Advantage Part D (including Part D prescription drug benefits, or MA-PD) plans. On
January 1, 2006, the Company also began providing prescription drug benefits on a stand-alone basis
to Medicare eligible beneficiaries. The Company refers to these plans as “stand-alone PDP” or “PDP”
plans.
Prescription drug benefits under Medicare Advantage and PDP plans vary in
terms of coverage levels and out-of-pocket costs for premiums, deductibles, and co-insurance. All
Part D plans are required by law to offer either standard coverage or its actuarial equivalent
(with out-of-pocket threshold and deductible amounts that do not exceed those of standard
coverage). In addition to standard coverage plans, the Company offers supplemental benefits in
excess of the standard coverage.
To participate in Part D, the Company was required to provide written bids to CMS, which among
other items, included the estimated costs of providing prescription drug benefits. Payments from
CMS are based on these estimated costs. The monthly Part D payments the Company receives from CMS for Part D plans generally represent the
Company’s bid amount for providing insurance coverage, both standard and supplemental, and is
recognized monthly as premium revenue. The amount of CMS payments relating to the Part D standard
coverage for MA-PD and PDP plans is subject to adjustment, positive or negative, based upon the
application of risk corridors that compare the Company’s prescription drug costs in its bids to CMS
to the Company’s actual prescription drug costs. Variances exceeding certain thresholds may result
in CMS making additional payments to the Company or the Company’s refunding to CMS a portion of the
premium payments it
69
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
previously received. The Company estimates and recognizes an adjustment to
premium revenue related to estimated risk corridor payments based upon its actual prescription drug
cost for each reporting period as if the annual contract were to end at the end of each reporting
period, in accordance with Emerging Issues Task Force “EITF” No. 93-14, “Accounting for
Multiple-Year Retrospectively Rated Insurance Contracts by Insurance Enterprises and Other
Enterprises.” Risk corridor adjustments do not take into account estimated future prescription drug costs. Net liabilities to CMS of approximately $27.6 million related to estimated risk
corridor adjustments are included on the Company’s December 31, 2006 balance sheet. This net
liability arises as a result of the Company’s actual costs to date in providing Part D benefits being lower than its bids. The amount was
also recognized in the statement of income as a reduction of premium revenue.
Certain Part D payments from CMS represent payments for claims the Company pays for which it
assumes no risk, including reinsurance and low-income cost subsidies. The Company accounts for
these subsidies as funds held for the benefit of members on its balance sheet and as a financing
activity in its statements of cash flows. Such amounts equaled $62.1 million as of and for the year
ended December 31, 2006. The Company does not recognize premium revenue or claims expense for these
subsidies as these amounts represent pass-through payments from CMS to fund deductibles,
co-payments, and other member benefits. The Company anticipates
settling this amount with CMS in 2007 as
part of the final settlement of Part D for the 2006 plan year. The Company
recognizes prescription drug costs as incurred, net of rebates from drug companies. The Company has
subcontracted the prescription drug claims administration to a third party pharmacy benefit
manager.
(3) Accounts Receivable
Accounts receivable at December 31, 2006 and 2005 consisted of the following:
| |
|
|
|
|
|
|
|
|
| |
|
2006 |
|
|
2005 |
|
Rebates |
|
$ |
9,432 |
|
|
|
1,039 |
|
Commercial HMO premium receivables |
|
|
4,696 |
|
|
|
3,814 |
|
Medicare premium receivables |
|
|
4,907 |
|
|
|
2,139 |
|
Other |
|
|
2,077 |
|
|
|
1,421 |
|
|
|
|
|
|
|
|
|
|
|
21,112 |
|
|
|
8,413 |
|
Allowance for doubtful accounts |
|
|
(3,524 |
) |
|
|
(1,165 |
) |
|
|
|
|
|
|
|
Total |
|
$ |
17,588 |
|
|
|
7,248 |
|
|
|
|
|
|
|
|
Rebates for drug costs represent estimated rebates owed to the Company from prescription drug
companies. The Company has entered into contracts with certain drug manufacturers which provide for
rebates to the Company based on the utilization of prescription drugs by the Company’s members.
Accounts receivable relating to unpaid health plan enrollee premiums are recorded during the period
the Company is obligated to provide services to enrollees and do not bear interest. The Company
does not have any off balance sheet credit exposure related to its health plan enrollees.
The allowance for doubtful accounts is the Company’s best estimate of the amount of probable
losses in the Company’s existing accounts receivable and is based on a number of factors, including
a review of past due balances, with a particular emphasis on past due balances greater than 90 days
old. Account balances are charged off against the allowance after all means of collection have been
exhausted and the potential for recovery is considered remote.
(4) Investment Securities
There were no investment securities classified as trading as of December 31, 2006 or
2005.
Investment
securities classified as available for sale as of December 31,
2006 and 2005 consist of
repurchase agreements whose cost approximates fair value and which are classified as current assets
as of December 31, 2006 and 2005.
70
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
Investment securities classified as held to maturity by major security type and class of
security classified as current assets were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
| |
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
| December 31, 2006: |
|
Cost |
|
|
Holding Gains |
|
|
Holding Losses |
|
|
Fair Value |
|
Municipal bonds |
|
$ |
8,895 |
|
|
|
— |
|
|
|
(40 |
) |
|
|
8,855 |
|
Government agencies |
|
|
272 |
|
|
|
— |
|
|
|
— |
|
|
|
272 |
|
Corporate debt securities |
|
|
1,399 |
|
|
|
— |
|
|
|
(4 |
) |
|
|
1,395 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
10,566 |
|
|
|
— |
|
|
|
(44 |
) |
|
|
10,522 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
| December 31, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
743 |
|
|
|
— |
|
|
|
(2 |
) |
|
|
741 |
|
Municipal bonds |
|
|
11,348 |
|
|
|
— |
|
|
|
(64 |
) |
|
|
11,284 |
|
Government agencies |
|
|
800 |
|
|
|
— |
|
|
|
(2 |
) |
|
|
798 |
|
Corporate debt securities |
|
|
1,422 |
|
|
|
— |
|
|
|
(6 |
) |
|
|
1,416 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
14,313 |
|
|
|
— |
|
|
|
(74 |
) |
|
|
14,239 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Investment securities classified as held to maturity by major security type and class of
security classified as long-term assets were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
Gross |
|
|
|
|
| |
|
Amortized |
|
|
Unrealized |
|
|
Unrealized |
|
|
Estimated |
|
| December 31, 2006: |
|
Cost |
|
|
Holding Gains |
|
|
Holding Losses |
|
|
Fair Value |
|
U.S. Treasury securities |
|
$ |
769 |
|
|
|
— |
|
|
|
(3 |
) |
|
|
766 |
|
Municipal bonds |
|
|
15,908 |
|
|
|
3 |
|
|
|
(99 |
) |
|
|
15,812 |
|
Government agencies |
|
|
1,410 |
|
|
|
2 |
|
|
|
(6 |
) |
|
|
1,406 |
|
Corporate debt securities |
|
|
1,473 |
|
|
|
— |
|
|
|
(9 |
) |
|
|
1,464 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
19,560 |
|
|
|
5 |
|
|
|
(117 |
) |
|
|
19,448 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
| December 31, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury securities |
|
$ |
149 |
|
|
|
— |
|
|
|
(2 |
) |
|
|
147 |
|
Municipal bonds |
|
|
20,924 |
|
|
|
— |
|
|
|
(185 |
) |
|
|
20,739 |
|
Government agencies |
|
|
711 |
|
|
|
— |
|
|
|
(9 |
) |
|
|
702 |
|
Corporate debt securities |
|
|
1,209 |
|
|
|
— |
|
|
|
(13 |
) |
|
|
1,196 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
22,993 |
|
|
|
— |
|
|
|
(209 |
) |
|
|
22,784 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
71
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
Maturities of debt securities classified as held to maturity were as follows at December
31, 2006:
| |
|
|
|
|
|
|
|
|
| |
|
Amortized |
|
|
Estimated |
|
| |
|
Cost |
|
|
Fair Value |
|
Due within one year |
|
$ |
10,566 |
|
|
|
10,522 |
|
Due after one year through five years |
|
|
18,687 |
|
|
|
18,584 |
|
Due after five years through ten years |
|
|
315 |
|
|
|
308 |
|
Due after ten years |
|
|
558 |
|
|
|
556 |
|
|
|
|
|
|
|
|
|
|
$ |
30,126 |
|
|
|
29,970 |
|
|
|
|
|
|
|
|
Gross unrealized losses on investment securities and the fair value of the related securities,
aggregated by investment category and length of time that individual securities have been in a
continuous unrealized loss position, at December 31, 2006, were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Less Than |
|
|
More Than |
|
|
|
|
| |
|
12 Months |
|
|
12 Months |
|
|
Total |
|
| |
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
| |
|
Losses |
|
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
|
Value |
|
U.S. Treasury securities |
|
$ |
2 |
|
|
|
493 |
|
|
|
1 |
|
|
|
148 |
|
|
|
3 |
|
|
|
641 |
|
Municipal bonds |
|
|
33 |
|
|
|
7,343 |
|
|
|
107 |
|
|
|
16,259 |
|
|
|
140 |
|
|
|
23,602 |
|
Government agencies |
|
|
1 |
|
|
|
441 |
|
|
|
5 |
|
|
|
496 |
|
|
|
6 |
|
|
|
936 |
|
Corporate debt securities |
|
|
3 |
|
|
|
1,102 |
|
|
|
10 |
|
|
|
1,190 |
|
|
|
13 |
|
|
|
2,293 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
39 |
|
|
|
9,379 |
|
|
|
123 |
|
|
|
18,093 |
|
|
|
162 |
|
|
|
27,472 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross unrealized losses on investment securities and the fair value of the related
securities, aggregated by investment category and length of time that individual securities have
been in a continuous unrealized loss position, at December 31, 2005, were as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Less Than |
|
|
More Than |
|
|
|
|
| |
|
12 Months |
|
|
12 Months |
|
|
Total |
|
| |
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
|
Unrealized |
|
|
Fair |
|
| |
|
Losses |
|
|
Value |
|
|
Losses |
|
|
Value |
|
|
Losses |
|
|
Value |
|
U.S. Treasury securities |
|
$ |
4 |
|
|
|
888 |
|
|
|
— |
|
|
|
— |
|
|
|
4 |
|
|
|
888 |
|
Municipal bonds |
|
|
102 |
|
|
|
15,269 |
|
|
|
147 |
|
|
|
16,754 |
|
|
|
249 |
|
|
|
32,023 |
|
Government agencies |
|
|
7 |
|
|
|
796 |
|
|
|
4 |
|
|
|
704 |
|
|
|
11 |
|
|
|
1,500 |
|
Corporate debt securities |
|
|
19 |
|
|
|
2,612 |
|
|
|
— |
|
|
|
— |
|
|
|
19 |
|
|
|
2,612 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
132 |
|
|
|
19,565 |
|
|
|
151 |
|
|
|
17,458 |
|
|
|
283 |
|
|
|
37,023 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Treasury Securities, Municipal Bonds and Government Agencies: The unrealized
gains/losses on investments in U.S. Treasury securities, municipal bonds and government agencies
were caused by interest rate decreases/increases. The contractual terms of these investments do not
permit the issuer to settle the securities at a price less than the amortized cost of the
investment. Because the Company has the ability and intent to hold these investments until a market
price recovery or maturity, these investments are not considered other-than-temporarily impaired.
Corporate Debt Securities: The unrealized losses on corporate debt securities were caused by
interest rate increases. The contractual terms of the bonds do not allow the issuer to settle the
securities as a price less than the face value of the bonds. Because the decline in fair value is attributable to changes in
interest rates and not credit quality, and the Company has the intent and ability to hold these
investments until a market price recovery or maturity, these investments are not considered
other-than-temporarily impaired.
72
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
(5) Property and Equipment
A summary of property and equipment at December 31, 2006 and 2005 is as follows:
| |
|
|
|
|
|
|
|
|
| |
|
2006 |
|
|
2005 |
|
Furniture and equipment |
|
$ |
6,442 |
|
|
|
5,066 |
|
Computer equipment |
|
|
15,094 |
|
|
|
9,723 |
|
Leasehold improvements |
|
|
220 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
21,756 |
|
|
|
14,789 |
|
Less accumulated depreciation and amortization |
|
|
(12,925 |
) |
|
|
(10,502 |
) |
|
|
|
|
|
|
|
|
|
$ |
8,831 |
|
|
|
4,287 |
|
|
|
|
|
|
|
|
(6) Goodwill and Intangible Assets
Goodwill and intangible assets at December 31, 2006 and 2005 consist of the following:
| |
|
|
|
|
|
|
|
|
| |
|
2006 |
|
|
2005 |
|
Goodwill |
|
$ |
341,619 |
|
|
|
315,057 |
|
Intangible assets, net |
|
|
81,175 |
|
|
|
87,675 |
|
|
|
|
|
|
|
|
Total |
|
$ |
422,794 |
|
|
|
402,732 |
|
|
|
|
|
|
|
|
Changes to goodwill during 2006 are as follows:
| |
|
|
|
|
Balance at December 31, 2005 |
|
$ |
315,057 |
|
Purchase of minority interest (See Note 9) |
|
|
26,562 |
|
|
|
|
|
Balance at December 31, 2006 |
|
$ |
341,619 |
|
|
|
|
|
A breakdown of the identifiable intangible assets, their assigned value and accumulated
amortization at December 31, 2006 and 2005 is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
2006 |
|
|
2005 |
|
| |
|
Gross |
|
|
|
|
|
|
Gross |
|
|
|
|
| |
|
Carrying |
|
|
Accumulated |
|
|
Carrying |
|
|
Accumulated |
|
| |
|
Amount |
|
|
Amortization |
|
|
Amount |
|
|
Amortization |
|
Trade name |
|
$ |
24,500 |
|
|
|
— |
|
|
|
24,500 |
|
|
|
— |
|
Noncompete agreements |
|
|
800 |
|
|
|
293 |
|
|
|
800 |
|
|
|
133 |
|
Provider network |
|
|
7,100 |
|
|
|
868 |
|
|
|
7,100 |
|
|
|
394 |
|
Medicare member network |
|
|
49,528 |
|
|
|
7,488 |
|
|
|
48,500 |
|
|
|
3,368 |
|
Customer relationships |
|
|
10,300 |
|
|
|
3,803 |
|
|
|
10,300 |
|
|
|
1,132 |
|
Management contract right |
|
|
1,554 |
|
|
|
155 |
|
|
|
1,554 |
|
|
|
52 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
93,782 |
|
|
|
12,607 |
|
|
|
92,754 |
|
|
|
5,079 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Changes to the gross carrying amount of identifiable intangible assets are as follows:
| |
|
|
|
|
Balance at December 31, 2005 |
|
$ |
92,754 |
|
Medicare member network acquired in connection with minority interest (See Note 9) |
|
|
1,028 |
|
|
|
|
|
Balance at December 31, 2006 |
|
$ |
93,782 |
|
|
|
|
|
73
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
The weighed-average amortization periods of the acquired intangible assets are as follow:
| |
|
|
|
|
| |
|
Weighed-Average |
| |
|
Amortization |
| |
|
Period (In Years) |
Trade name |
|
indefinite |
Non-compete agreements |
|
|
5 |
|
Provider network |
|
|
15 |
|
Medicare member network |
|
|
12 |
|
Customer relationship |
|
|
7.6 |
|
Management contract right |
|
|
15 |
|
|
|
|
|
|
Total intangibles |
|
|
11.6 |
|
|
|
|
|
|
Amortization expense on identifiable intangible assets for the year ended December 31, 2006,
the ten months ended December 31, 2005, the two months ended February 28, 2005, and the year ended
December 31, 2004 was $7,528, $5,027, $52 and $250, respectively. Amortization expense expected to
be recognized during fiscal years subsequent to December 31, 2006 is as follows:
| |
|
|
|
|
2007 |
|
$ |
6,233 |
|
2008 |
|
|
5,580 |
|
2009 |
|
|
5,580 |
|
2010 |
|
|
5,447 |
|
2011 |
|
|
5,420 |
|
Thereafter |
|
|
28,415 |
|
|
|
|
|
Total |
|
$ |
56,675 |
|
|
|
|
|
(7) Restricted Investments
Restricted investments at December 31, 2006 and 2005 are summarized as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Gross |
|
|
|
|
| |
|
|
|
|
|
Unrealized |
|
|
|
|
| |
|
Amortized |
|
|
Holding |
|
|
Estimated |
|
| |
|
Cost |
|
|
Gains |
|
|
Losses |
|
|
Fair Value |
|
December 31, 2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit |
|
$ |
3,087 |
|
|
|
— |
|
|
|
— |
|
|
|
3,087 |
|
U.S. governmental securities |
|
|
4,108 |
|
|
|
— |
|
|
|
(17 |
) |
|
|
4,091 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
7,195 |
|
|
|
— |
|
|
|
(17 |
) |
|
|
7,178 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
December 31, 2005 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates of deposit |
|
$ |
2,563 |
|
|
|
— |
|
|
|
— |
|
|
|
2,563 |
|
U.S. governmental securities |
|
|
3,089 |
|
|
|
— |
|
|
|
(55 |
) |
|
|
3,034 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
5,652 |
|
|
|
— |
|
|
|
(55 |
) |
|
|
5,597 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The unrealized losses on investments in government securities were caused by interest rate
increases. The contractual terms of these investments do not permit the issuer to settle the
securities at a price less than the amortized cost of the investment. Because the Company has the
ability and intent to hold these investments until a market price recovery or maturity, the
impairment of these held to maturity investments is not considered other-than-temporary.
(8) Recapitalization
HealthSpring, Inc. was formed in October 2004 in connection with a recapitalization
transaction involving NewQuest, LLC and its members, certain investment funds affiliated with GTCR
and certain other investors. The
74
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
recapitalization was completed on March 1, 2005. Prior to the recapitalization, NewQuest was
owned 43.9% by its officers and employees, 38.2% by the non-employee directors of NewQuest, and
17.9% by outside investors.
In connection with the recapitalization, HealthSpring, Inc., NewQuest, LLC, the members of
NewQuest, LLC, GTCR, and certain other investors entered into a purchase and exchange agreement and
other related agreements pursuant to which GTCR and certain other investors purchased an aggregate
of 136,072 shares of HealthSpring, Inc.’s preferred stock and 18,237,587 shares of HealthSpring,
Inc.’s common stock for an aggregate purchase price of $139,719. The members of NewQuest, LLC
exchanged their ownership interests in NewQuest, LLC for an aggregate of $295,399 in cash
(including $17,200 placed in escrow to secure contingent post-closing indemnification liabilities),
91,082 shares of HealthSpring, Inc.’s preferred stock, and 12,207,631 shares of HealthSpring,
Inc.’s common stock. In addition, upon the closing of the recapitalization, HealthSpring, Inc.
issued an aggregate of 1,286,250 shares of restricted common stock to employees of HealthSpring,
Inc. for an aggregate purchase price of $258. HealthSpring, Inc. used the proceeds from the sale of
preferred and common stock and $200,000 of borrowings under new credit facilities to fund the cash
payments to the members of NewQuest, LLC and to pay expenses and certain other payments relating to
the transaction. Immediately following the recapitalization, HealthSpring, Inc. was owned 55.1% by
GTCR, 28.7% by executive officers and employees of HealthSpring, Inc., and 16.2% by outside
investors, including HealthSpring, Inc.’s non-employee directors.
Prior to the recapitalization, approximately 15% of the ownership interests in two of
NewQuest, LLC’s Tennessee management subsidiaries and approximately 27% of the membership interests
of NewQuest, LLC’s Texas HMO subsidiary, Texas HealthSpring, LLC, were owned by outside investors.
Contemporaneously with the recapitalization, HealthSpring, Inc. purchased all of the minority
interests in the Tennessee subsidiaries for an aggregate consideration of approximately $27,546 and
a portion of the membership interests held by the minority investors in Texas HealthSpring, LLC for
aggregate consideration of approximately $16,812. Following the purchase, the outside investors in
Texas HealthSpring, LLC owned an approximate 9% ownership interest. In June 2005, Texas
HealthSpring, LLC completed a private placement pursuant to which it issued new membership
interests to existing and new investors for net proceeds of $7,875, which was accounted for as a
capital transaction and no gain was recognized due to the fact that it was an integral part of the
recapitalization. Following this private placement, and as of December 31, 2005, the outside
investors owned an approximate 15.9% interest in Texas HealthSpring, LLC. The minority interest was
exchanged for shares of the Company’s common stock immediately prior to the initial public offering
transaction completed on February 8, 2006.
The recapitalization was accounted for using the purchase method. The aggregate transaction
value for the recapitalization was $438,576, which was substantially in excess of NewQuest, LLC’s
book value. The transaction value included $5,295 of capitalized acquisition related costs and
$6,366 of deferred financing costs. In addition, NewQuest, LLC incurred $6,941 of transaction costs
which were expensed during the two-month period ended February 28, 2005 and the Company incurred
$4,000 of transaction costs which were expensed during the ten-month period ended December 31,
2005.
75
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
The following table summarizes the estimated fair value of the net assets acquired:
| |
|
|
|
|
Cash |
|
$ |
75,441 |
|
Other current assets |
|
|
38,704 |
|
Property and equipment |
|
|
3,249 |
|
Investment securities |
|
|
31,782 |
|
Other assets |
|
|
2,293 |
|
Identifiable intangible assets |
|
|
91,200 |
|
Goodwill |
|
|
315,057 |
|
|
|
|
|
Total assets |
|
|
557,726 |
|
|
|
|
|
|
|
|
|
|
Current liabilities assumed |
|
|
80,199 |
|
Long-term liabilities assumed |
|
|
38,951 |
|
|
|
|
|
Total liabilities |
|
|
119,150 |
|
|
|
|
|
| |
Net assets acquired |
|
$ |
438,576 |
|
|
|
|
|
A breakdown of the identifiable intangible assets, their assigned value and expected lives is
as follows:
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Expected Life |
|
| |
|
Assigned Value |
|
|
(Years) |
|
Trade name |
|
$ |
24,500 |
|
|
indefinite |
Noncompete agreements |
|
|
800 |
|
|
|
5 |
|
Provider network |
|
|
7,100 |
|
|
|
15 |
|
Medicare member network |
|
|
48,500 |
|
|
|
12 |
|
Customer relationships |
|
|
10,300 |
|
|
|
2 to 10 |
|
|
|
|
|
|
|
|
|
Total amount of identified intangible assets |
|
$ |
91,200 |
|
|
|
|
|
|
|
|
|
|
|
|
|
(9) Stockholders’ Equity
In conjunction with the recapitalization, the Company sold 227,200 shares of preferred stock
to GTCR, members of the Predecessor, and certain other new investors. The holders of the preferred
stock were entitled to an 8% cumulative dividend per year, which accrued on a daily basis and
accumulated quarterly commencing on March 31, 2005 on the sum of $1 per share plus all accumulated
and unpaid dividends. The dividends were to be paid when declared by the board of directors,
provided that these dividends accrue whether or not they have been declared. As of December 31, 2005, accrued but unpaid dividends totaled $15,607. The preferred stock and accrued but unpaid
dividends thereon were converted into 12,552,905 shares of the Company’s common stock on February
8, 2006 in conjunction with the initial public offering.
On February 8, 2006, the Company completed an initial public offering, or IPO, of its common
stock. In connection with the IPO, the Company sold 10.6 million shares of common stock at a price
of $19.50 per share. Total proceeds to the Company were approximately
$188,400, net of $18,300 of offering
costs. From the proceeds of the offering and available cash, the Company repaid all of its
long-term debt and accrued interest, including a $1,100 prepayment penalty, totaling $189,900.
Additionally, the Company issued approximately 12,600,000 shares of common stock in exchange for
all of the outstanding preferred stock, including cumulative dividends.
In connection with the IPO the Company also issued approximately 2.0 million shares of common
stock in exchange for all the minority interest in the membership units of its Texas HMO
subsidiary. The total value of the purchase of the minority interest was approximately $39,800,
which resulted in additional goodwill of $26,562 and identifiable intangible assets of $1,028.
On October 10, 2006, the Company completed a secondary public offering of its common stock. In
connection with the secondary offering certain stockholders of the Company, including funds
affiliated with GTCR Golder Rauner, LLC, sold 11,600,000 shares of common stock at a price of
$18.98 per share. The Company did not receive any proceeds from the sale of the shares in the
secondary offering. The Company incurred and expensed offering-related expenses of approximately
$800 related to this secondary public offering.
(10) Stock Based Compensation
Stock Options
The Company has options outstanding under its 2005 Stock Option Plan and its 2006 Equity
Incentive Plan.
Nonqualified
options to purchase an aggregate of 168,000 shares of common stock
were granted in 2005 at an exercise
price of $2.50 per share and were outstanding under the 2005 Stock Option Plan at December 31, 2006.
These options vest and become exercisable generally over a five-year period. No options vested or
were exercised during 2005. The options expire ten years from the grant date. In the event of a
76
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
change in control of the Company, these options will immediately vest and become exercisable in
full. No options were issued under the 2005 Stock Option Plan in 2006 and no additional options may
be granted under the plan.
The Company adopted the 2006 Equity Incentive Plan, or 2006 Plan, effective as of February 2,
2006. A total of 6,250,000 shares of common stock were authorized for issuance under the 2006 Plan,
in the form of stock options, restricted stock, restricted stock units or other share-based awards.
The Company granted nonqualified options to purchase 3,392,000 shares of common stock pursuant to
the 2006 Equity Incentive Plan during the year ended December 31, 2006, and options for the
purchase of 3,211,000 shares of common stock were outstanding under this plan at December 31, 2006.
The outstanding options vest and become exercisable based on time, generally over a four-year
period, and expire ten years from their grant dates. Upon exercise, options are settled with
authorized but unissued Company stock.
The fair value for all options as determined on the date of grant was estimated using the
Black-Scholes option-pricing model with the following assumptions:
| |
|
|
|
|
Expected dividend yield |
|
|
0.0 |
% |
Expected volatility |
|
|
45.0 |
% |
Expected term |
|
5 years |
Risk-free interest rates |
|
|
4.54 — 5.08 |
% |
Because the Company did not have publicly traded common stock prior to the completion of the
IPO, the expected volatility over the term of the respective option was based on industry peer
information. Additionally, because the Company had no outstanding stock options until September
2005, the expected term assumption was also based on industry peer
information. The
risk-free interest rate was based on a traded zero-coupon U.S. Treasury bond with a term substantially equal
to the option’s expected term. The Company recognized a deferred
income tax benefit of approximately $2,242 and $132 in the years
ended December 31, 2006 and 2005, respectively,
related to the share-based compensation expense. The actual tax benefit realized from stock options
exercised during 2006 was $30. There was no capitalized stock-based compensation expense in 2006 or 2005.
An analysis of stock option activity for the year ended December 31, 2006 under the Company’s
stock incentive plans is as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted |
|
|
Weighted Average |
|
| |
|
|
|
|
|
Average |
|
|
Grant Date |
|
| |
|
Options |
|
|
Exercise Price |
|
|
Fair Value |
|
2006 Equity Incentive Plan: |
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2005 |
|
|
— |
|
|
$ |
— |
|
|
$ |
— |
|
Granted |
|
|
3,392,000 |
|
|
|
19.40 |
|
|
|
8.86 |
|
Exercised |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Forfeited |
|
|
(181,000 |
) |
|
|
19.50 |
|
|
|
8.88 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2006 |
|
|
3,211,000 |
|
|
$ |
19.40 |
|
|
$ |
8.86 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005 Stock Option Plan |
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2005 |
|
|
195,000 |
|
|
$ |
2.50 |
|
|
$ |
1.12 |
|
Granted |
|
|
— |
|
|
|
— |
|
|
|
— |
|
Exercised |
|
|
(5,000 |
) |
|
|
2.50 |
|
|
|
1.12 |
|
Forfeited |
|
|
(22,000 |
) |
|
|
2.50 |
|
|
|
1.12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31, 2006 |
|
|
168,000 |
|
|
$ |
2.50 |
|
|
$ |
1.12 |
|
|
|
|
|
|
|
|
|
|
|
77
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Weighted Average |
|
|
|
|
| |
|
Shares Under |
|
Weighted Average |
|
Remaining |
|
Intrinsic Value Per |
|
Aggregate Intrinsic |
| |
|
Option |
|
Exercise Price |
|
Contractual Term |
|
Share (1) |
|
Value (1) |
2006 Equity Incentive Plan: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at December 31, 2006 |
|
|
18,750 |
|
|
$ |
19.50 |
|
|
9.3 Years |
|
$ |
0.92 |
|
|
$ |
17 |
|
Options vested and expected to vest at
December 31, 2006(2) |
|
|
3,103,680 |
|
|
|
19.40 |
|
|
9.4 Years |
|
|
1.02 |
|
|
|
3,166 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2005
Stock Option Plan: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options exercisable at December 31, 2006 |
|
|
31,000 |
|
|
$ |
2.50 |
|
|
8.7 Years |
|
$ |
17.92 |
|
|
$ |
556 |
|
Options vested and expected to vest at
December 31, 2006(2) |
|
|
158,410 |
|
|
|
2.50 |
|
|
8.7 Years |
|
|
17.92 |
|
|
|
2,839 |
|
|
|
|
| (1) |
|
Computed based upon the amount by which the fair market value of our common stock at
December 31, 2006 of $20.42 per share exceeded the weighted average exercise price. |
| |
| (2) |
|
The Company began estimating forfeitures under SFAS 123R upon adoption on January 1, 2006. |
The total intrinsic value of stock options exercised during 2006 was $84. Cash received
from stock option exercises for the year ended December 31, 2006
totaled $12. Total compensation expenses related to nonvested
options not yet recognized was $21,578 at December 31, 2006. The
Company expects to recognize this
compensation expense over a weighted average period of 3.3 years.
Restricted Stock
During the year ended December 31, 2006, the Company granted 45,500 shares of restricted stock
to non-employee directors, employees and a non-employee contractor pursuant to the 2006 Equity
Incentive Plan, all of which were outstanding at December 31, 2006. The restrictions relating to
the restricted stock awards made in 2006 lapse over a period not exceeding two years from the
grant date.
During
the year ended December 31, 2005, the Company sold 1,838,750 shares of restricted common stock to certain employees at a price of $0.20 per share, the same price at which GTCR
purchased shares of the Company’s common stock in connection with the recapitalization. Each
employee’s shares of restricted common stock are subject to the terms and conditions of a
restricted stock purchase agreement. The restrictions on these shares lapse based on time and in
the event of certain changes in control. All the outstanding shares of restricted stock have the
same voting and dividend rights as the underlying shares of common stock. Pursuant to the
restricted stock purchase agreements, the Company has the right but not the obligation to purchase
all or any portion of an employee’s restricted stock if his or her employment is terminated. The
purchase price for securities purchased pursuant to this repurchase option will be:
| |
• |
|
in the case of shares where the restrictions have not lapsed, the lesser of the
original cost and the fair market value of such shares; and |
| |
| |
• |
|
in the case of shares where the restrictions have lapsed, the fair market value of such
shares; provided that, if employment is terminated with cause, then the purchase price
shall be the lesser of the original cost and the fair market value of such shares. |
Based on a valuation completed shortly after the recapitalization, the Company determined that
the fair market value of the common stock on the dates of purchase of the restricted stock was
$1.58 per share. The difference
between the $0.20 per share purchase price and the $1.58 per share fair market value is amortized as compensation expense over a period of four to five years (the period over which the
restrictions lapse), as applicable.
The 2006 restricted stock awards were granted with a fair value equal to the market price of
the Company’s common stock on the date of grant. Compensation expense related to the restricted stock awards
is based on the market price
78
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
of the underlying common stock on the grant date and is recorded straight-line over the
vesting period, generally five years from the date of grant. The weighted average grant date fair
value of our restricted stock awards was $19.51 and $1.58 for the years ended December 31, 2006 and
2005, respectively. Activity of restricted stock awards was as follows for the year ended
December 31, 2006:
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Weighted Average |
|
| |
|
|
|
|
|
Grant Date Fair |
|
| |
|
Shares |
|
|
Value |
|
Nonvested restricted stock at December 31, 2005 |
|
|
1,638,750 |
|
|
$ |
1.58 |
|
Granted |
|
|
45,500 |
|
|
|
19.51 |
|
Vested |
|
|
(615,229 |
) |
|
|
1.83 |
|
Purchased by the Company |
|
|
(66,392 |
) |
|
|
1.58 |
|
|
|
|
|
|
|
|
Nonvested restricted stock at December 31, 2006 |
|
|
1,002,629 |
|
|
$ |
2.39 |
|
|
|
|
|
|
|
|
The fair value of shares vested during the years ended December 31, 2006, and 2005 was $1,128
and $-0-, respectively. Total compensation expense related to nonvested restricted stock awards not
yet recognized was $1,812 at December 31, 2006. The Company
expects to recognize this compensation expense
over a weighted average period of approximately 2.9 years. There are no other contractual terms
covering restricted stock awards under the 2006 Plan once the vesting restrictions have lapsed.
Stock-based Compensation
Total
stock-based compensation for the year ended December 31, 2006 was
$5,650, including $4,687 relating to stock options and $963 relating
to restricted stock. Stock-based compensation expense in 2005 was
$377 and related to restricted stock. Stock-based compensation is included in selling, general and administrative expense.
(11) Net Income Per Common Share
The following table presents the calculation of the Company’s net income per common share
available to common shareholders — basic and diluted. The Predecessor did not have any potentially
dilutive units outstanding during the two months ended
February 28, 2005 or the year ended December 31, 2004.
| |
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
Ten-Month Period |
|
| |
|
Year Ended |
|
|
Ended December 31, |
|
| |
|
December 31, 2006 |
|
|
2005 |
|
Numerator: |
|
|
|
|
|
|
|
|
Net income available to common stockholders |
|
$ |
78,815 |
|
|
$ |
10,943 |
|
|
|
|
|
|
|
|
Denominator: |
|
|
|
|
|
|
|
|
Weighted average common shares outstanding — basic |
|
|
54,617,744 |
|
|
|
32,173,707 |
|
Dilutive effect of stock options |
|
|
96,360 |
|
|
|
41,581 |
|
Dilutive effect of unvested director shares |
|
|
6,269 |
|
|
|
— |
|
|
|
|
|
|
|
|
Weighted average common shares outstanding — diluted |
|
|
54,720,373 |
|
|
|
32,215,288 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share available to common
stockholders: |
|
|
|
|
|
|
|
|
Basic |
|
$ |
1.44 |
|
|
$ |
0.34 |
|
|
|
|
|
|
|
|
Diluted |
|
$ |
1.44 |
|
|
$ |
0.34 |
|
|
|
|
|
|
|
|
Options for the purchase of 2,678,500 shares of common stock were not included in the
calculation of diluted net income per common share available to common stockholders for the year
ended December 31, 2006 because their exercise prices were greater than the average market price of
the Company’s common stock for the periods and, therefore, the effect would be anti-dilutive.
(12) Related Party Transactions
Renaissance Physician Organization (RPO) is a Texas non-profit corporation the members of
which are GulfQuest L.P., one of the Company’s wholly owned HMO management subsidiaries, and 13
affiliated independent physician associations, comprised of over 1,000 physicians, providing
medical services primarily in and around
counties surrounding and including the Houston, Texas metropolitan area. Texas HealthSpring,
LLC, the Company’s Texas HMO, has contracted with RPO to provide professional medical and covered
medical services and procedures to members of its Medicare Advantage plans. Pursuant to that
agreement, RPO shares risk relating to the provision of such services, both upside and downside,
with the Company on a 50%/50% allocation. Another agreement the Company has with RPO delegates
responsibility to GulfQuest L.P. for medical management, claims
79
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
processing, provider relations, credentialing, finance, and reporting services for RPO’s
Medicare and commercial members. Pursuant to that agreement, GulfQuest L.P. receives a management
fee, calculated as a percentage of Medicare premiums, plus a dollar amount per member per month for
RPO’s commercial members, plus 25% of the profits from RPO’s operations. Both agreements have a ten
year term that expires on December 31, 2014 and automatically renew for additional one to three
year terms thereafter, unless notice of non-renewal is given by either party at least 180 days
prior to the end of the then-current term. The agreements also contain certain restrictions on the
Company’s ability to enter into agreements with delegated physician networks in certain counties
where RPO provides services. Likewise, RPO is subject to restrictions regarding providing coverage
to plans competitive with Texas HealthSpring, LLC’s Medicare Advantage plan.
For the year ended December 31, 2006, the ten months ended December 31, 2005, the two months
ended February 28, 2005 and the year ended December 31, 2004, RPO paid GulfQuest L.P. management
and other fees of approximately $15,630, $11,359, $2,060, and $10,412, respectively. In addition,
Texas HealthSpring, LLC paid RPO approximately $98,391, $67,172, $11,398, and $53,846 for the year
ended December 31, 2006, for the ten months ended December 31, 2005, two months ended February 28,
2005 and the year ended December 31, 2004, respectively, to provide medical services to its
members.
In connection with certain agreements made by RPO and its related
physician groups as a condition to the recapitalization, the Predecessor and RPO agreed to the
issuance to RPO of approximately 1% of the common equity in the Company following the
recapitalization. It was understood and agreed that this equity would be issued based on RPO
achieving certain performance goals over the five year period following the recapitalization. In
February 2006, the Company and RPO negotiated a settlement of the obligation by a cash payment to
RPO which would eliminate the future performance requirements. The Company incurred an additional
transaction expense of $4.0 million in the ten-month period ended December 31, 2005 relating to
this commitment.
Under a professional services agreement, dated March 1, 2005, between the Company and GTCR,
the Company engaged GTCR as a financial and management consultant. Two of the Company’s directors
are principals of GTCR. During the term of its engagement, GTCR agreed to consult on business and
financial matters, including corporate strategy, budgeting of future corporate investments,
acquisition and divestiture strategies, and debt and equity financings for an annual management fee
of $500, payable in equal monthly installments, and reimbursement for certain related expenses.
GTCR was paid approximately $375 under this agreement through December 31, 2005. Additionally, GTCR
was paid a placement fee of approximately $1,341 under the professional services agreement in
connection with the sale of the Company’s securities in the recapitalization. The placement fee was
included in capitalized transaction expenses in connection with the recapitalization. The
professional services agreement was terminated in connection with the IPO in February 2006.
(13) Lease Obligations
The Company leases certain facilities and equipment under noncancelable operating lease
arrangements with varying terms. The facility leases generally contain renewal options of five
years. For the year ended December 31, 2006, the ten months ended December 31, 2005, the two months
ended February 28, 2005, and the year ended December 31, 2004, the Company recorded lease expense
of $5,108, $3,274, $501, and $2,746, respectively.
Future payments under these lease obligations as of December 31, 2006 were as follows:
| |
|
|
|
|
2007 |
|
$ |
5,327 |
|
2008 |
|
|
3,345 |
|
2009 |
|
|
3,202 |
|
2010 |
|
|
2,395 |
|
2011 |
|
|
388 |
|
Thereafter |
|
|
750 |
|
|
|
|
|
|
|
$ |
15,407 |
|
|
|
|
|
80
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
Effective January 15, 2007 the Company entered into a new seven-year operating lease for
additional office space in Nashville, Tennessee. The average annual rent for the new space is
approximately $775.
(14) Long-Term Debt
Long-term debt at December 31, 2006 and 2005 consisted of the following:
| |
|
|
|
|
|
|
|
|
| |
|
2006 |
|
|
2005 |
|
Senior secured term loan |
|
$ |
— |
|
|
|
152,625 |
|
Senior subordinated notes |
|
|
— |
|
|
|
35,901 |
|
|
|
|
|
|
|
|
Total |
|
|
— |
|
|
|
188,526 |
|
Less current portion of long-term debt |
|
|
— |
|
|
|
16,500 |
|
|
|
|
|
|
|
|
Long-term debt less current portion |
|
$ |
— |
|
|
|
172,026 |
|
|
|
|
|
|
|
|
On April 21, 2006, HealthSpring, Inc. and certain of its non-HMO subsidiaries as guarantors
entered into a $75.0 million, five-year senior secured revolving credit agreement (the “New Credit
Agreement”) with UBS Securities LLC, Citigroup Global Markets, Inc. and the lenders party thereto,
which replaced the Prior Credit Facility (as defined below). The New Credit Agreement provides up
to a maximum aggregate principal amount outstanding of $75.0 million, including a $2.5 million
swingline subfacility and a maximum of $5.0 million in outstanding letters of credit. The Company
may request an expansion of the aggregate commitments under the New Credit Agreement to a maximum
of $125.0 million, subject to certain conditions precedent including the consent of the lenders
providing the increased credit availability. Loans under the New Credit Agreement accrue interest
on the basis of either a base rate or a LIBOR rate plus, in each case, an applicable margin
depending on the Company’s leverage ratio. The applicable margin for base rate loans (including
swingline loans) ranges from 0.00% to 0.75%, and the applicable margin for LIBOR loans ranges from
1.00% to 1.75%. The Company pays a commitment fee of 0.375% per annum on the unfunded portion of
the lenders’ aggregate commitments under the facility.
The New Credit Agreement contains conditions to making loans, representations, warranties and
covenants, including financial covenants, customary for a transaction of this type. Financial
covenants include (i) a ratio of total indebtedness to consolidated EBITDA not to exceed 2.50 to
1.00; (ii) minimum risk-based capital for each HMO subsidiary; and (iii) a minimum fixed charge
coverage ratio of 1.75 to 1.00.
The New Credit Agreement also contains customary events of default as well as restrictions on
undertaking certain specified corporate actions including, among others, asset dispositions,
acquisitions and other investments, dividends, changes in control, issuance of capital stock,
fundamental corporate changes such as mergers and consolidations, incurrence of additional
indebtedness, creation of liens, transactions with affiliates, and agreements as to certain
subsidiary restrictions. If an event of default occurs that is not otherwise waived or cured, the
lenders may terminate their obligations to make loans under the New Credit Agreement and the
obligations of the issuing banks to issue letters of credit and may declare the loans then
outstanding under the New Credit Agreement to be due and payable. The Company believes it is
currently in compliance with its financial and other covenants under the New Credit Agreement. At
December 31, 2006, there were no amounts outstanding under the New Credit
Agreement.
In connection with the recapitalization, the Company entered into a senior credit facility
(“Prior Credit Facility”) and issued senior subordinated notes. The borrowings under the Prior
Credit Facility and proceeds from the issuance of the senior subordinated notes, net of $6.4
million of fees recorded as deferred financing costs, as well as proceeds from the issuance of the
preferred and common stock were used to fund the cash payments to the members of the Predecessor in
the recapitalization and for other related expenses and payments.
The Prior Credit Facility provided for borrowings in an aggregate principal amount of up to
$180.0 million, which included:
81
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
| |
• |
|
A senior secured term loan facility in an aggregate principal amount of up to $165.0
million, (the term loan facility), which had $152.6 million principal amount outstanding as
of December 31, 2005, and which was repaid with proceeds from the IPO in February 2006 and
terminated; and |
| |
| |
• |
|
A senior secured revolving credit facility in an aggregate principal amount of up to
$15.0 million, none of which had been drawn as of December 31, 2005. |
The senior subordinated notes, issued by the Company, bore interest at an annual rate of 15%,
12% of which was payable quarterly in cash and 3% of which accrued quarterly and was added to the
outstanding principal amount. Approximately $35.9 million aggregate principal amount and $368 of
accrued and unpaid interest was outstanding at December 31, 2005. These amounts, together with a
prepayment premium of approximately $1.1 million were repaid with proceeds from the IPO.
(15) Medical Claims Liability
Medical claims liability represents the liability for services that have been performed by
providers for the Company’s Medicare Advantage and commercial HMO members. The liability includes
medical claims reported to the plans as well as an actuarially determined estimate of claims that
have been incurred but not yet reported to the plans, or IBNR. The IBNR component is based on our
historical claims data, current enrollment, health service utilization statistics, and other
related information.
The following table presents the components of the medical claims liability as of the dates
indicated:
| |
|
|
|
|
|
|
|
|
| |
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
| |
Incurred but not reported (IBNR) |
|
$ |
85,731 |
|
|
|
74,393 |
|
Reported claims |
|
|
37,047 |
|
|
|
8,252 |
|
|
|
|
|
|
|
|
Total medical claims liability |
|
$ |
122,778 |
|
|
|
82,645 |
|
|
|
|
|
|
|
|
The Company develops its estimate for IBNR by using standard actuarial developmental
methodologies, including the completion factor method. This method estimates liabilities for claims
based upon the historical lag between the month when services are rendered and the month claims are
paid and takes into consideration factors such as expected medical cost inflation, seasonality
patterns, product mix, and membership changes. The completion factor is a measure of how complete
the claims paid to date are relative to the estimate of the total claims for services rendered for
a given reporting period. Although the completion factors are generally reliable for older service
periods, they are more volatile, and hence less reliable, for more recent periods given that the
typical billing lag for services can range from a week to as much as 90 days from the date of
service. As a result, for the most recent two to four months, the estimate for incurred claims is
developed from a trend factor analysis based on per member per month claims trends experienced in
the preceding months. The liability includes estimates of premium deficiencies. At December 31,
2006 and 2005, the Company had estimated premium deficiency liabilities of approximately $700 and
$1,460, respectively.
Each period, the Company re-examines the previously established medical claims liability
estimates based on actual claim submissions and other relevant changes in facts and circumstances.
As the liability estimates recorded in prior periods become more exact, the Company increases or
decreases the amount of the estimates, and includes the changes in medical expenses in the period
in which the change is identified. In every reporting period, the Company’s operating results
include the effects of more completely developed medical claims liability estimates associated with
prior periods.
The following table provides a reconciliation of changes in the medical claims liability for
the year ended December 31, 2006, the ten-month period ended December 31, 2005 and the Predecessor
for the two-month period ended February 28, 2005 and the year ended 2004:
82
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Predecessor |
|
| |
|
Year ended |
|
|
Ten month period |
|
|
Two month period |
|
|
Year ended |
|
| |
|
December 31, |
|
|
ended |
|
|
ended February 28, |
|
|
December 31, |
|
| |
|
2006 |
|
|
December 31, 2005 |
|
|
2005 |
|
|
2004 |
|
Balance at beginning of period |
|
$ |
82,645 |
|
|
|
— |
|
|
|
53,187 |
|
|
|
47,729 |
|
Purchase of NewQuest, LLC |
|
|
— |
|
|
|
59,016 |
|
|
|
— |
|
|
|
— |
|
Incurred related to: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current period |
|
|
1,017,100 |
|
|
|
576,180 |
|
|
|
97,843 |
|
|
|
467,289 |
|
Prior period |
|
|
(8,574 |
) |
|
|
(6,844 |
) |
|
|
(7,000 |
) |
|
|
(3,914 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Total incurred |
|
|
1,008,526 |
|
|
|
569,336 |
|
|
|
90,843 |
|
|
|
463,375 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paid related to: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current period |
|
|
894,684 |
|
|
|
493,901 |
|
|
|
44,397 |
|
|
|
415,136 |
|
Prior period |
|
|
73,709 |
|
|
|
51,807 |
|
|
|
40,617 |
|
|
|
42,781 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total paid |
|
|
968,393 |
|
|
|
545,708 |
|
|
|
85,014 |
|
|
|
457,917 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at the end of the period |
|
$ |
122,778 |
|
|
|
82,645 |
|
|
|
59,016 |
|
|
|
53,187 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(16) Income Taxes
Income tax expense (benefit) on income consisted of the following for the periods presented:
| |
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Current |
|
|
Deferred |
|
|
Total |
|
Year ended December 31, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Federal |
|
$ |
39,836 |
|
|
|
1,337 |
|
|
|
41,173 |
|
State and local |
|
|
3,179 |
|
|
|
(541 |
) |
|
|
2,638 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
43,015 |
|
|
|
796 |
|
|
|
43,811 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ten-month period ended December 31, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Federal |
|
$ |
17,396 |
|
|
|
(1,127 |
) |
|
|
16,269 |
|
State and local |
|
|
808 |
|
|
|
67 |
|
|
|
875 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
18,204 |
|
|
|
(1,060 |
) |
|
|
17,144 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Predecessor: |
|
|
|
|
|
|
|
|
|
|
|
|
Two-month period ended February 28, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Federal |
|
$ |
2,108 |
|
|
|
122 |
|
|
|
2,230 |
|
State and local |
|
|
427 |
|
|
|
(29 |
) |
|
|
398 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2,535 |
|
|
|
93 |
|
|
|
2,628 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year ended December 31, 2004: |
|
|
|
|
|
|
|
|
|
|
|
|
U.S. Federal |
|
$ |
5,390 |
|
|
|
2,225 |
|
|
|
7,615 |
|
State and local |
|
|
1,640 |
|
|
|
(62 |
) |
|
|
1,578 |
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
7,030 |
|
|
|
2,163 |
|
|
|
9,193 |
|
|
|
|
|
|
|
|
|
|
|
A reconciliation of the U.S. federal statutory rate to the effective tax rate is as follows
for the periods presented:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
Predecessor |
|
| |
|
|
|
|
|
Ten month period |
|
|
Two month period ended |
|
|
|
|
| |
|
Year Ended December |
|
|
ended December |
|
|
February |
|
|
Year Ended December |
|
| |
|
31, 2006 |
|
|
31, 2005 |
|
|
28, 2005 |
|
|
31, 2004 |
|
U.S. Federal statutory rate on income before income taxes |
|
$ |
43,626 |
|
|
|
15,293 |
|
|
|
1,867 |
|
|
|
11,729 |
|
Income not subject to federal income tax due to partnership
status |
|
|
— |
|
|
|
— |
|
|
|
423 |
|
|
|
(4,316 |
) |
State income taxes, net of federal tax effect |
|
|
1,525 |
|
|
|
569 |
|
|
|
259 |
|
|
|
1,026 |
|
Other |
|
|
(1,340 |
) |
|
|
1,282 |
|
|
|
79 |
|
|
|
754 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax expense |
|
$ |
43,811 |
|
|
|
17,144 |
|
|
|
2,628 |
|
|
|
9,193 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
83
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
The tax effects of temporary differences that give rise to significant portions of the
deferred tax assets and liabilities at December 31, 2006 and 2005 were as follows:
| |
|
|
|
|
|
|
|
|
| |
|
2006 |
|
|
2005 |
|
Deferred tax assets: |
|
|
|
|
|
|
|
|
Medical claims liabilities, principally
due to medical loss liability
discounted for tax purposes |
|
|
$1,248 |
|
|
|
1,098 |
|
Property and equipment |
|
|
1,599 |
|
|
|
1,809 |
|
Accrued compensation |
|
|
1,695 |
|
|
|
3,031 |
|
Allowance for doubtful accounts |
|
|
1,295 |
|
|
|
137 |
|
Federal net operating loss carryover |
|
|
1,954 |
|
|
|
2,872 |
|
State net operating loss carryover |
|
|
1,340 |
|
|
|
260 |
|
Other liabilities and accruals |
|
|
1,692 |
|
|
|
852 |
|
|
|
|
|
|
|
|
Total gross deferred tax assets |
|
|
10,823 |
|
|
|
10,059 |
|
Less valuation allowance |
|
|
(606 |
) |
|
|
(734 |
) |
|
|
|
|
|
|
|
Deferred tax assets |
|
|
10,217 |
|
|
|
9,325 |
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
Amortization |
|
|
(33,888 |
) |
|
|
(32,494 |
) |
Prepaid contract cost |
|
|
(1,129 |
) |
|
|
(835 |
) |
|
|
|
|
|
|
|
Total net deferred tax liabilities |
|
$ |
(24,800 |
) |
|
|
(24,004 |
) |
|
|
|
|
|
|
|
The above amounts are classified as current or long-term in the consolidated balance sheets in
accordance with the asset or liability to which they relate or, when applicable, based on the
expected timing of the reversal. Current deferred tax assets at December 31, 2006 and 2005 were
$3,644 and $5,778, respectively. Non-current deferred tax liabilities at December 31, 2006 and
2005 were $28,444 and $29,782, respectively.
The Company records a valuation allowance to reduce its net deferred tax assets to the amount
that is more likely than not to be realized. As of December 31, 2006 and 2005, the Company carried
a valuation allowance against deferred tax assets of $606 and $734, respectively. To the extent the
valuation allowance is reduced that was previously recorded as a result of business combinations,
the offsetting credit will be recognized first as a reduction to goodwill, then to other intangible
assets, and lastly as a reduction in the current period’s income tax provision. No portion of the
valuation allowance related to the 2005 recapitalization transaction has been reduced for any
periods presented in these financial statements.
The Company currently benefits from federal and state net operating loss carryforwards. The
Company’s consolidated federal net operating loss carryforwards available to reduce future tax
income are approximately $5.6 and $8.2 million at December 31, 2006 and 2005, respectively, and
will begin to expire in 2009. State net operating loss carryforwards at December 31, 2006 and 2005
are approximately $31.7 and $4.6 million, respectively, and will begin to expire in 2012. In
addition, the Company has alternative minimum tax credits which do not have an expiration date.
Overall, the Company’s utilization of these various tax attributes, at both the federal and
state level, may be limited due to the ownership changes that resulted from the recapitalization
transaction, as well as previous acquisitions. This limitation is incorporated in the above table
by the valuation allowance recorded against a portion of the deferred tax assets. The Company also
recognized goodwill resulting from the recapitalization transaction that is reflected in the
accompanying consolidated balance sheets. A portion of this goodwill is deductible for federal and
state income tax purposes.
(17) Retirement Plan
The Company contributed approximately $1,118, $898, $111, and $961 to its defined contribution
plans during the year ended December 31, 2006, the ten months ended December 31, 2005, the two
months ended February 28, 2005, and the year ended December 31, 2004, respectively. Employees are
always 100% vested in their contributions and vest in employer contributions at a rate of 50% after the first two years of service and 100% after the third year of service.
(18) Statutory Capital Requirements
The HMOs are required to maintain satisfactory minimum net worth requirements established by
their respective state departments of insurance. At December 31, 2006, the statutory minimum net
worth requirements and actual statutory net worth were $9,621 and $35,700 for the Tennessee HMO;
$1,112 and $30,071 for the Alabama HMO; and $7,565 and $35,486 for the Texas HMO, respectively.
Each of these subsidiaries were in compliance with applicable statutory requirements as of December
31, 2006. The HMOs are restricted from making dividend
84
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
payments to the Company without appropriate regulatory notifications and approvals or to the extent such dividends would put them out of compliance with statutory capital requirements. At December 31, 2006,
$305.1 million of the Company’s $383.6 million of cash, cash equivalents, investment securities and
restricted investments were held by the Company’s HMO subsidiaries and subject to these dividend
restrictions.
(19) Commitments and Contingencies
Legal Proceedings
The Company is from time to time involved in routine legal matters and other claims incidental
to its business, including employment-related claims, claims relating to our relationships with
providers and members, and claims relating to marketing practices of sales agents that are employed
by, or independent contractors to, the Company. When it appears probable in management’s judgment
that the Company will incur monetary damages or other costs in connection with any claims or
proceedings, and such costs can be reasonably estimated, liabilities are recorded in the financial
statements and charges are recorded against earnings. Although there can be no assurances, the
Company does not believe that the resolution of such routine matters and other incidental claims,
taking into account accruals and insurance, will have a material adverse effect on the Company’s
consolidated financial position or results of operations.
(20) Concentrations of Business and Credit Risks
The Company’s primary lines of business, operating health maintenance organizations and
managing independent physician associations, are significantly impacted by healthcare cost trends.
The healthcare industry is impacted by health trends as well as being significantly impacted
by government regulations. Changes in government regulations may significantly affect management’s
medical claims estimates and the Company’s performance.
Most of the Company’s customers are located in Tennessee, Texas, Alabama, and Illinois.
Concentrations of credit risk with respect to commercial premiums receivable are limited as a
result of the large number of customers. Approximately 90.5% and 84.8% of premium revenue was
received from CMS in 2006 and 2005, respectively.
Financial instruments that potentially subject the Company to concentrations of credit risk
consist primarily of investments in investment securities and receivables generated in the ordinary
course of business. Investments in investment securities are managed by professional investment
managers within guidelines established by the Company that, as a matter of policy, limit the
amounts that may be invested in any one issuer. Receivables include premium receivables from
individual and commercial customers, rebate receivables from pharmaceutical manufacturers,
receivables related to prepayment of claims on behalf of members under the Medicare program and
receivables owed to the Company from providers under risk-sharing arrangements. The Company had no
significant concentrations of credit risk at December 31, 2006.
(21) Fair Value of Financial Instruments
The Company’s 2006 and 2005 consolidated balance sheets include the following financial
instruments: cash and cash equivalents, accounts receivable, investment securities, restricted
investments, accounts payable, medical claims liabilities, and long-term debt. The carrying amounts
of accounts receivable, accounts payable and medical claims liabilities approximate their fair
value because of the relatively short period of time between the origination of these instruments
and their expected realization. The fair value of the investment securities and restricted
investments are presented at Notes 4 and 7. The carrying value of the long-term debt is estimated
by management to approximate fair value based upon the term and nature of the obligations.
85
HEALTHSPRING, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and unit data)
(22) Quarterly Financial Information (unaudited)
Selected unaudited quarterly financial data in 2006 and 2005 are as follows:
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
HealthSpring, Inc. |
| |
|
For the Three Month Period Ended |
| |
|
March 31, 2006 |
|
June 30, 2006 |
|
September 30, 2006 |
|
December 31, 2006 |
Total revenues |
|
$ |
306,622 |
|
|
|
322,803 |
|
|
|
343,861 |
(1) |
|
|
335,670 |
(1) |
Income before income taxes |
|
|
13,661 |
|
|
|
33,507 |
|
|
|
47,016 |
|
|
|
30,463 |
|
Net income available to
common stockholders |
|
|
6,552 |
|
|
|
21,109 |
|
|
|
31,053 |
|
|
|
20,101 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income per share — basic |
|
$ |
0.14 |
|
|
|
0.37 |
|
|
|
0.54 |
|
|
|
0.35 |
|
Income per share — diluted |
|
$ |
0.14 |
|
|
|
0.37 |
|
|
|
0.54 |
|
|
|
0.35 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
Predecessor |
|
HealthSpring, Inc. |
| |
|
For the Two Month |
|
For the One Month |
|
|
| |
|
Period Ended |
|
Period Ended |
|
|
| |
|
February 28, |
|
March 31, |
|
For the Three Month Period Ended |
| |
|
2005 |
|
2005 |
|
June 30, 2005 |
|
September 30, 2005 |
|
December 31, 2005 |
Total revenues |
|
$ |
119,390 |
|
|
|
61,568 |
|
|
|
196,243 |
|
|
|
233,121 |
(2) |
|
|
246,062 |
(2) |
Income before income taxes |
|
|
5,334 |
|
|
|
2,987 |
|
|
|
15,581 |
|
|
|
14,638 |
|
|
|
12,993 |
|
Net income available to
unit/common stockholders |
|
|
2,706 |
|
|
|
327 |
|
|
|
4,325 |
|
|
|
4,113 |
|
|
|
3,140 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income per share — basic |
|
$ |
— |
|
|
|
0.01 |
|
|
|
0.13 |
|
|
|
0.13 |
|
|
|
0.10 |
|
Income per share — diluted |
|
$ |
— |
|
|
|
0.01 |
|
|
|
0.13 |
|
|
|
0.13 |
|
|
|
0.10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income per unit — basic |
|
$ |
0.55 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
Income per unit — diluted |
|
$ |
0.55 |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
|
| (1) |
|
Revenue for the quarter ended September 30, 2006 includes $15.5 million of retroactive
risk adjustment payments associated with the 2006 Medicare plan year received in the third
quarter of 2006. Revenue for the quarter ended December 31, 2006 includes $5.7 million of
retroactive risk adjustment payments associated with the 2005 Medicare plan year received in
the fourth quarter of 2006. |
| |
| (2) |
|
Revenue for the quarter ended September 30, 2005 includes $8.2 million of retroactive risk adjustment payments associated with the 2005 Medicare plan year received in the third quarter of 2005. Revenue for the quarter ended December 31, 2005 includes $1.6 million of
retroactive risk adjustment payments associated with the 2004 Medicare plan year received in the fourth quarter of 2005. |
86
SCHEDULE
I — CONDENSED FINANCIAL INFORMATION OF HEALTHSPRING,
INC. (Parent only)
BALANCE SHEETS
December 31, 2006 and 2005
(in thousands)
| |
|
|
|
|
|
|
|
|
| |
|
2006 |
|
|
2005 |
|
| Assets |
|
|
|
|
|
|
|
|
| |
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
58,151 |
|
|
|
3,253 |
|
Prepaid expenses and other current assets |
|
|
771 |
|
|
|
1,908 |
|
Deferred tax assets |
|
|
115 |
|
|
|
— |
|
Due from related party |
|
|
181,638 |
|
|
|
— |
|
|
|
|
|
|
|
|
Total current assets |
|
|
240,675 |
|
|
|
5,161 |
|
Investment in subsidiaries |
|
|
334,310 |
|
|
|
263,418 |
|
Property and equipment, net |
|
|
4,592 |
|
|
|
231 |
|
Intangible assets |
|
|
507 |
|
|
|
668 |
|
Deferred financing fee |
|
|
802 |
|
|
|
— |
|
Deferred tax asset, excluding current portion |
|
|
2,914 |
|
|
|
— |
|
|
|
|
|
|
|
|
Total assets |
|
$ |
583,800 |
|
|
|
269,478 |
|
|
|
|
|
|
|
|
| Liabilities and Stockholders’ Equity |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Due to related parties |
|
$ |
— |
|
|
|
4,989 |
|
Accounts payable and accrued expenses |
|
|
8,289 |
|
|
|
3,336 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
8,289 |
|
|
|
8,325 |
|
Deferred rent |
|
|
229 |
|
|
|
— |
|
Deferred tax liabilities |
|
|
— |
|
|
|
609 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
8,518 |
|
|
|
8,934 |
|
|
|
|
|
|
|
|
Stockholders’ equity: |
|
|
|
|
|
|
|
|
Redeemable convertible preferred stock |
|
|
— |
|
|
|
2 |
|
Common stock |
|
|
575 |
|
|
|
322 |
|
Additional paid in capital |
|
|
485,002 |
|
|
|
251,202 |
|
Unearned
compensation |
|
|
— |
|
|
|
(1,885 |
) |
Retained earnings |
|
|
89,758 |
|
|
|
10,943 |
|
Treasury stock |
|
|
(53 |
) |
|
|
(40 |
) |
|
|
|
|
|
|
|
Total stockholders’ equity |
|
|
575,282 |
|
|
|
260,544 |
|
|
|
|
|
|
|
|
Total liabilities and stockholders’ equity |
|
$ |
583,800 |
|
|
|
269,478 |
|
|
|
|
|
|
|
|
See accompanying report of independent registered public accounting firm.
87
SCHEDULE
I — CONDENSED FINANCIAL INFORMATION OF HEALTHSPRING, INC.
(Parent only)
CONDENSED STATEMENTS OF INCOME
(in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
Predecessor |
|
| |
|
Year ended |
|
|
Ten months ended |
|
|
|
Two months ended |
|
|
Year ended |
|
| |
|
December 31, |
|
|
December 31, |
|
|
|
February 28, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
|
|
2005 |
|
|
2004 |
|
Revenue: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Management fees from affiliates |
|
$ |
— |
|
|
|
— |
|
|
|
|
122 |
|
|
|
793 |
|
Investment income |
|
|
478 |
|
|
|
— |
|
|
|
|
16 |
|
|
|
48 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue |
|
|
478 |
|
|
|
— |
|
|
|
|
138 |
|
|
|
841 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries and benefits |
|
|
13,401 |
|
|
|
377 |
|
|
|
|
1,261 |
|
|
|
24,236 |
|
Administrative expenses |
|
|
9,772 |
|
|
|
6,577 |
|
|
|
|
5,760 |
|
|
|
611 |
|
Interest expense |
|
|
330 |
|
|
|
— |
|
|
|
|
30 |
|
|
|
151 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
23,503 |
|
|
|
6,954 |
|
|
|
|
7,051 |
|
|
|
24,998 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss before equity in
subsidiaries’ earnings and
income taxes |
|
|
(23,025 |
) |
|
|
(6,954 |
) |
|
|
|
(6,913 |
) |
|
|
(24,157 |
) |
Equity in subsidiaries’ earnings |
|
|
93,591 |
|
|
|
31,070 |
|
|
|
|
9,623 |
|
|
|
48,286 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
70,566 |
|
|
|
24,116 |
|
|
|
|
2,710 |
|
|
|
24,129 |
|
Income tax benefit (expense) |
|
|
10,270 |
|
|
|
2,434 |
|
|
|
|
(4 |
) |
|
|
188 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
80,836 |
|
|
|
26,550 |
|
|
|
|
2,706 |
|
|
|
24,317 |
|
Preferred dividends |
|
|
(2,021 |
) |
|
|
(15,607 |
) |
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income available to
common stockholders and
members |
|
$ |
78,815 |
|
|
|
10,943 |
|
|
|
|
2,706 |
|
|
|
24,317 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying report of independent registered public accounting firm.
88
SCHEDULE
I — CONDENSED FINANCIAL INFORMATION OF HEALTHSPRING, INC.
(Parent only)
CONDENSED STATEMENTS OF CASH FLOWS
(in thousands)
| |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
|
|
Predeccessor |
|
| |
|
|
|
|
|
Ten months |
|
|
|
Two months |
|
|
|
|
| |
|
Year ended |
|
|
ended |
|
|
|
ended |
|
|
Year ended |
|
| |
|
December 31, |
|
|
December 31, |
|
|
|
February 28, |
|
|
December 31, |
|
| |
|
2006 |
|
|
2005 |
|
|
|
2005 |
|
|
2004 |
|
| |
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
80,836 |
|
|
|
26,550 |
|
|
|
|
2,706 |
|
|
|
24,317 |
|
Adjustments
to reconcile net income to net cash (used in) provided
by operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
expense and amortization |
|
|
745 |
|
|
|
189 |
|
|
|
|
— |
|
|
|
— |
|
Compensation expense related to phantom stock plan
cancellation |
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
|
24,200 |
|
Equity in subsidiaries’ earnings |
|
|
(93,591 |
) |
|
|
(31,070 |
) |
|
|
|
(9,623 |
) |
|
|
(48,286 |
) |
Share-based compensation |
|
|
5,650 |
|
|
|
377 |
|
|
|
|
— |
|
|
|
— |
|
Deferred income taxes |
|
|
(4,294 |
) |
|
|
609 |
|
|
|
|
— |
|
|
|
— |
|
Amortization of deferred financing cost |
|
|
130 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Increase (decrease) due to change in: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
— |
|
|
|
— |
|
|
|
|
(1 |
) |
|
|
(9,249 |
) |
Interest receivable |
|
|
— |
|
|
|
— |
|
|
|
|
2 |
|
|
|
(9 |
) |
Prepaid expenses and other current assets |
|
|
1,793 |
|
|
|
(1,908 |
) |
|
|
|
(178 |
) |
|
|
(480 |
) |
Due to related parties |
|
|
(163,928 |
) |
|
|
89,459 |
|
|
|
|
(5,597 |
) |
|
|
4,575 |
|
Accounts payable, accrued expenses, and other
current liabilities |
|
|
4,953 |
|
|
|
3,336 |
|
|
|
|
8,335 |
|
|
|
3,853 |
|
Deferred rent |
|
|
229 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by operating activities |
|
|
(167,477 |
) |
|
|
87,542 |
|
|
|
|
(4,356 |
) |
|
|
(1,079 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributions received from subsidiaries |
|
|
— |
|
|
|
— |
|
|
|
|
15,851 |
|
|
|
31,546 |
|
Purchase of property and equipment |
|
|
(4,950 |
) |
|
|
(420 |
) |
|
|
|
— |
|
|
|
— |
|
Acquisitions, net of cash acquired |
|
|
— |
|
|
|
(219,958 |
) |
|
|
|
— |
|
|
|
— |
|
Distributions from affiliates |
|
|
39,617 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities |
|
|
34,667 |
|
|
|
(220,378 |
) |
|
|
|
15,851 |
|
|
|
31,546 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments on notes payable to members |
|
|
— |
|
|
|
(3,958 |
) |
|
|
|
(83 |
) |
|
|
(500 |
) |
Proceeds from issuance of common and preferred stock |
|
|
188,611 |
|
|
|
140,087 |
|
|
|
|
— |
|
|
|
— |
|
Deferred financing costs |
|
|
(932 |
) |
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Purchase of treasury stock |
|
|
(13 |
) |
|
|
(40 |
) |
|
|
|
— |
|
|
|
— |
|
Proceeds
from stock options exercised |
|
|
12 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Tax benefit
from stock options exercised |
|
|
30 |
|
|
|
— |
|
|
|
|
— |
|
|
|
— |
|
Distributions to members |
|
|
— |
|
|
|
— |
|
|
|
|
— |
|
|
|
(19,546 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
187,708 |
|
|
|
136,089 |
|
|
|
|
(83 |
) |
|
|
(20,046 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents |
|
|
54,898 |
|
|
|
3,253 |
|
|
|
|
11,412 |
|
|
|
10,421 |
|
Cash and cash equivalents at beginning of period |
|
|
3,253 |
|
|
|
— |
|
|
|
|
10,827 |
|
|
|
406 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
58,151 |
|
|
|
3,253 |
|
|
|
|
22,239 |
|
|
|
10,827 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying report of independent registered public accounting firm.
89
|
|
|
| Item 9. |
|
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
|
|
|
| Item 9A. |
|
Controls and Procedures |
Our senior management carried out an evaluation required by Rule 13a-15 under the Securities
Exchange Act of 1934, as amended (the “Exchange Act”), under the supervision and with the
participation of our President and Chief Executive Officer (“CEO”) and Chief Financial Officer
(“CFO”), of the effectiveness of our disclosure controls and procedures as defined in Rule 13a-15
and 15d-15 under the Exchange Act (“Disclosure Controls”). Based on the evaluation, our senior
management, including our CEO and CFO, concluded that, subject to the limitations noted herein, as
of December 31, 2006, our Disclosure Controls are effective in timely alerting them to material
information required to be included in our reports filed with the SEC.
Changes in Internal Control Over Financial Reporting
There have been no changes in our internal control over financial reporting identified in
connection with the evaluation that occurred during the quarter ended December 31, 2006 that has
materially affected, or is reasonably likely to materially affect, our internal control over
financial reporting.
Limitations on the Effectiveness of Controls
Our management, including our CEO and CFO, does not expect that our Disclosure Controls and
internal controls will prevent all errors and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of
the control system are met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if any, with the Company
have been detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple error and mistake.
Additionally, controls can be circumvented by the individual acts of some persons, by collusion of
two or more people or by management override of controls.
The design of any system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time, a control may become
inadequate because of changes in conditions or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and may not be detected.
|
|
|
| Item 9B. |
|
Other Information |
None.
90
PART III
|
|
|
| Item 10. |
|
Directors, Executive Officers and Corporate Governance |
Information with respect to the directors of the Company, set forth in the Company’s
Definitive Proxy Statement for the Company’s 2007Annual Meeting of Stockholders to be held on or
about June 6, 2007 (the “Proxy Statement”), under the caption “Election of Directors,” is
incorporated herein by reference. Pursuant to General Instruction G(3), information concerning
executive officers of the Registrant is included in Item 1 of this Annual Report on Form 10-K under
the caption “Executive Officers of the Company.”
Information with respect to compliance with Section 16(a) of the Securities Exchange Act of
1934, set forth in the Proxy Statement, under the caption “Section 16(a) Beneficial Ownership
Reporting Compliance,” is incorporated herein by reference.
Information with respect to our code of ethics, set forth in the Proxy Statement, under the
caption “Code of Conduct,” is incorporated herein by reference.
|
|
|
| Item 11. |
|
Executive Compensation |
Information with respect to executive officers of the Company, set forth in the Proxy
Statement, under the caption “Executive Compensation,” is incorporated herein by reference.
|
|
|
| Item 12. |
|
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters |
Information with respect to security ownership of certain beneficial owners and management and
related stockholder matters and our equity compensation plans, set
forth in the Proxy Statement, under the captions “Stock Ownership”
and “Equity Compensation Plan Information,” is incorporated herein by reference.
|
|
|
| Item 13. |
|
Certain Relationships and Related Transactions, and Director Independence |
Information
with respect to certain relationships and related transactions and
director independence, set forth in the
Proxy Statement, under the captions “Certain Relationships and
Related Transactions” and “Corporate Governance,” is incorporated herein by reference.
|
|
|
| Item 14. |
|
Principal Accountant Fees and Services |
Information with respect to the fees paid to and services provided by our independent
registered public accounting firm, set forth in the Proxy Statement, under the caption “Fees Billed
to Us by KPMG LLP During 2006 and 2005” is incorporated herein by reference.
91
PART IV
|
|
|
| Item 15. |
|
Exhibits and Financial Statement Schedules |
| (a) |
|
Financial Statements and Financial Statement Schedules |
| |
(1) |
|
Financial Statements are listed in the Index to Consolidated Financial Statements on
page 57 of this report. |
| |
| |
(2) |
|
Financial Statement Schedules are listed in the Index to Consolidated Financial
Statements on page 57 of this report. |
| |
| |
(3) |
|
Exhibits — See the Exhibit Index at end of this report which is incorporated herein by
reference. |
See the Exhibit Index at end of this report which is incorporated herein by reference.
We are filing as part of this report the financial schedule listed on the index immediately
preceding the financial statements in Item 8 of this report.
92
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
| |
|
|
|
|
| |
HEALTHSPRING, INC.
|
|
| Date: March 14, 2007 |
By |
/s/ Kevin M. McNamara
|
|
| |
|
Name: Kevin M. McNamara |
|
| |
|
Title: Executive
Vice President,
Chief
Financial Officer, and Treasurer |
|
| |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacities and on the
dates indicated.
| |
|
|
|
|
| Signature |
|
Title |
|
Date |
|
|
|
|
|
/s/ Herbert A. Fritch
Herbert A. Fritch
|
|
Chairman of the Board of
Directors, President and
Chief Executive Officer
(Principal Executive Officer)
|
|
March 14, 2007 |
|
|
|
|
|
/s/ Kevin M. McNamara
Kevin M. McNamara
|
|
Executive Vice President,
Chief Financial Officer and
Treasurer (Principal
Financial and Accounting
Officer)
|
|
March 14, 2007 |
|
|
|
|
|
/s/ Bruce M. Fried
Bruce M. Fried
|
|
Director
|
|
March 14, 2007 |
|
|
|
|
|
/s/ Robert Z. Hensley
Robert Z. Hensley
|
|
Director
|
|
March 14, 2007 |
|
|
|
|
|
/s/ Russell K. Mayerfeld
Russell K. Mayerfeld
|
|
Director
|
|
March 14, 2007 |
|
|
|
|
|
/s/ Joseph P. Nolan
Joseph P. Nolan
|
|
Director
|
|
March 14, 2007 |
|
|
|
|
|
/s/ Martin S. Rash
Martin S. Rash
|
|
Director
|
|
March 14, 2007 |
|
|
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/s/ Daniel L. Timm
Daniel L. Timm
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Director
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March 14, 2007 |
INDEX OF EXHIBITS
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| Exhibits |
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Description |
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3.1
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Form of Amended and Restated Certificate of Incorporation of HealthSpring, Inc. (1) |
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3.2
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Form of Second Amended and Restated Bylaws of HealthSpring, Inc. (1) |
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4.1
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Reference is made to Exhibits 3.1 and 3.2 |
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4.2
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Specimen of Common Stock Certificate (1) |
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4.3
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Registration Agreement, dated as of March 1, 2005, by and among HealthSpring, Inc., GTCR Fund
VIII, L.P., GTCR Fund VIII/B, L.P., GTCR Co-Invest II, L.P., and each of the other
stockholders of HealthSpring, Inc. whose names appear on the schedules thereto or on the
signature pages or joinders to the Registration Rights Agreement (1) |
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10.1
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Purchase and Exchange Agreement, dated as of November 10, 2004, by and among NewQuest, LLC,
HealthSpring, Inc., NewQuest, Inc., the stockholders’ representative and each of the other
stockholders of HealthSpring, Inc. whose names appear on the schedules or signature pages
thereto, as amended (1) |
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10.2
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Stock Purchase Agreement, dated as of March 1, 2005, among GTCR Fund VIII, L.P., GTCR Fund
VIII/B, L.P., GTCR Co-Invest II, L.P., and each of the other stockholders thereto (1) |
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10.3
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Form of HealthSpring, Inc. Amended and Restated Restricted Stock Purchase Agreement* (1) |
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10.4
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HealthSpring, Inc. 2005 Stock Option Plan* (1) |
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10.5
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Form of Non-Qualified Stock Option Agreement (Option Plan)* (1) |
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10.6
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HealthSpring, Inc. 2006 Equity Incentive Plan* (1) |
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10.7
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Form of Non-Qualified Stock Option Agreement (Equity Incentive Plan)* (1) |
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10.8
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Form of Incentive Stock Option Agreement (Equity Incentive Plan)* (1) |
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10.9
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Form of Restricted Stock Award Agreement (Employees and Officers) (Equity Incentive Plan)* (1) |
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10.10
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Form of Restricted Stock Award Agreement (Directors) (Equity Incentive Plan)* (1) |
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10.11
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Amended and Restated Employment Agreement between Registrant and Herbert A. Fritch* (1) |
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10.12
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Amended and Restated Employment Agreement between Registrant and Jeffrey L. Rothenberger* (1) |
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10.13
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Amended and Restated Employment Agreement between Registrant and Kevin M. McNamara* (1) |
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10.14
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Employment Agreement between
Registrant and Gerald V. Coil* (2) |
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10.15
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Employment Agreement between
Registrant and Craig S. Schub* (3) |
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10.16
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Form of Indemnification Agreement (1) |
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10.17
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Contract H4454 between Centers for Medicare & Medicaid Services and HealthSpring of
Tennessee, Inc. (renewed effective as of January 1, 2007) (1) |
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10.18
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Contract H4513 between Centers for Medicare & Medicaid Services and Texas HealthSpring I, LLC
(renewed effective as of January 1, 2007) (1) |
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10.19
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Contract H0150 between Centers for Medicare & Medicaid Services and HealthSpring of Alabama,
Inc. (renewed effective as of January 1, 2007) (1) |
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10.20
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Contract H1415 between Centers for Medicare & Medicaid Services and HealthSpring of Illinois
(renewed effective as of January 1, 2007) (1) |
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10.21
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Contract H4407 between Centers for Medicare & Medicaid Services and HealthSpring of
Tennessee, Inc. (d/b/a HealthSpring of Mississippi) (renewed
effective as of January 1, 2007) (1) |
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| Exhibits |
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Description |
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10.22
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Amended and Restated IPA Services Agreement dated March 1, 2003 by and between Texas
HealthSpring, LLC and Renaissance Physician Organization, as amended (1) |
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10.23
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Full-Service Management Agreement dated April 16, 2001 by and between GulfQuest, L.P. and
Renaissance Physician Organization, as amended (1) |
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10.24
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Agreement dated May 28,1993 between the Baptist Hospital and DST Health Solutions, Inc.
(f/k/a CSC Healthcare Systems, Inc.), as amended (1) |
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10.25
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Master Service Agreement dated June 13, 2003 between OAO HealthCare Solutions, Inc. and
TexQuest, LLC, on behalf of GulfQuest, L.P. (1) |
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10.26
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Credit Agreement dated as of April 21, 2006 among HealthSpring, Inc., as borrower, the other
guarantors party thereto, the lenders party thereto, UBS Securities LLC and Citigroup Global
Markets, Inc., as joint lead arrangers and joint bookrunners, Citicorp USA, Inc., as
syndication agent, Bank of America, N.A., as documentation agent, UBS AG, Stamford Branch, as
issuing bank, administrative agent and collateral agent, and UBS Loan Finance LLC, as
swingline lender (4) |
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10.27
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Stand-Alone PDP Contract between
Centers for Medicare & Medicaid Services and HealthSpring, Inc. and HealthSpring of Alabama,
Inc. (renewed effective as of January 1, 2007 in connection with
national PDP service area expansion) |
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10.28
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2006 Executive and Director Compensation
Summary * (5) |
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21.1
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Subsidiaries of the Registrant |
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23.1
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Consent of KPMG LLP |
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31.1
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Certification of President and Chief Executive Officer pursuant to Section 302 of
Sarbanes-Oxley Act of 2002 |
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31.2
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Certification Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002 |
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32.1
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Certification of President and Chief Executive Officer pursuant to Section 906 of
Sarbanes-Oxley Act of 2002 |
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32.2
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Certification of Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002 |
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| * |
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Indicates management contract or compensatory plan, contract or arrangement. |
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| (1) |
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(Previously filed as an Exhibit to the Company’s Registration Statement on Form S-1 (File No.
333-128939), filed October 11, 2005, as amended.) |
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(Previously filed as an Exhibit to the Company’s Current Report on Form 8-K, filed December
27, 2006.) |
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(Previously filed as an Exhibit to the Company’s Current Report on Form 8-K, filed May 31,
2006.) |
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| (4) |
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(Previously filed as an Exhibit to the Company’s Current Report on Form 8-K, filed April 27,
2006.) |
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| (5) |
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(Previously filed as an Exhibit to the Company’s Annual
Report on Form 10-K, filed March 31,
2006.) |
