Item 8.01. Other Events

 

Risk Factors

 

This report contains both historical and forward-looking statements. We are making the forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend the forward-looking statements in this report or made by us elsewhere to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with and relying upon these safe harbor provisions. We have based these forward-looking statements on our current expectations and projections about future events, trends and uncertainties. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions, such as, among other things, the information discussed below. If any of the following risks or uncertainties develops into actual events, this could significantly and adversely affect our business, prospects, financial condition or operating results. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial also may adversely affect our business. In making these statements, we are not undertaking to address or update each factor in future filings or communications regarding our business or results. Our business is highly complicated, regulated and competitive with many different factors affecting results. If any of the following risks or uncertainties develops into actual events, this could significantly and adversely affect our business, prospects, financial condition and operating results. In that case, the trading price of our common stock could decline materially.

 

We may be unable to execute our plan to respond to the challenges resulting from the passage into law of the Medicare Improvements for Patients and Providers Act of 2008

 

On July 15, 2008, the Medicare Improvements for Patients and Providers Act of 2008, which amends the Medicare provisions of the Social Security Act, became law. Among many other things, the Act revises requirements for Medicare Advantage private fee-for-service plans, which we expect will have the effect of ending these plans in plan year 2011.

 

We anticipated many of the Act’s provisions, and had undertaken initiatives to replace the private fee-for-service revenue that we thought might be lost to us, depending on the final text of the bill. In particular, we have been working to establish preferred provider organization, or PPO, networks in strategic locations, some of which have been established for the 2009 plan year and others of which we are continuing to establish for the 2010 plan year and beyond.

 

We could experience difficulty in building these PPO networks, which must be approved by CMS. In addition, the cost of building PPO networks can be substantial. Accordingly, if

 

·      we are unable to build the PPO networks we plan to build in accordance with our plans,

 

·      the cost of building the networks exceeds our estimates, or

 

·      we do not receive approval from CMS for our PPO networks,

 

then we could experience a material adverse effect on our revenues, results of operations and financial condition.

 

In addition, the Act places prohibitions and limitations on specified sales and marketing activities under Medicare Advantage plans and prescription drug plans. We are working to complete our plans to comply with these prohibitions and limitations.  Many of these prohibitions and limitations are required to be interpreted through regulations established by CMS, and we are awaiting the promulgation of these regulations.  The prohibitions and limitations, and the regulations promulgated by CMS, could have the effect of making it more difficult to sell our products to potential members and beneficiaries, which could materially adversely affect our revenues, results of operations and financial condition. In addition, if we are unable to comply fully with these prohibitions and limitations and their attendant regulations, we could be subject to investigation or audit by regulators or to complaints by members and beneficiaries, and potential members and beneficiaries, which could lead to sanctions, including but not limited to financial penalties, an enrollment freeze, and the requirement that we make

 


 

changes in our operations, and these could materially adversely affect our results of operations and financial condition.

 

We are subject to extensive government regulation; compliance with laws and regulations is complex and expensive, and any violation of the laws and regulations applicable to us could reduce our revenues and profitability and otherwise adversely affect our operating results.

 

There is substantial Federal and state governmental regulation of our business. Several laws and regulations adopted by the Federal government, such as the Sarbanes-Oxley Act of 2002, the Gramm-Leach-Bliley Act, the Health Insurance Portability and Accountability Act, known as HIPAA, the MMA, the USA PATRIOT Act, the False Claims Act, anti-kickback laws and “Do Not Call” regulations, have created administrative and compliance requirements for us. The requirements of these laws and regulations are continually evolving, and the cost of compliance may have an adverse effect on our profitability. As laws and regulations evolve, the costs of compliance, which are already significant, will tend to increase. If we fail to comply with existing or future applicable laws and regulations, we could suffer civil, criminal or administrative penalties. Different interpretations and enforcement policies of these laws and regulations could subject our current practices to allegations of impropriety or illegality, or could require us to make significant changes to our operations. In addition, we cannot predict the impact of future legislation and regulatory changes on our business or assure you that we will be able to obtain or maintain the regulatory approvals required to operate our business.

 

Laws in each of the states in which we operate our health plans and insurance companies also regulate our sales practices, operations, the scope of benefits, rate formulas, delivery systems, utilization review procedures, quality assurance, complaint systems, enrollment requirements, claim payments, marketing, and advertising. These state regulations generally require, among other things, prior approval or notice of new products, premium rates, benefit changes and specified material transactions, such as dividend payments, purchases or sales of assets, inter-company agreements, and the filing of various financial and operational reports.

 

We are also subject to various governmental reviews, audits and investigations to verify our compliance with our contracts and applicable laws and regulations. State departments of insurance audit our health plans and insurance companies for financial and contractual compliance. State departments of health audit our health plans for compliance with health services. State attorneys general, CMS, the Office of the Inspector General of Health and Human Services, the Office of Personnel Management, the Department of Justice, the Department of Labor, the Government Accountability Office, and state departments of insurance and departments of health also conduct audits and investigations of us. Several state attorneys general, state departments of insurance and Congressional committees are currently investigating practices used by companies in the health care industry and insurance brokers generally. We have historically incurred, and expect to continue to incur, significant costs to respond to governmental reviews,

 


 

audits and investigations, and we expect these costs to increase over time as regulation increases and becomes more complex and as regulatory agencies become more sophisticated and thorough.

 

Any adverse review, audit or investigation could result in:

 

·      repayment of amounts we have been paid pursuant to our government contracts;

 

·      imposition of civil or criminal penalties, fines or other sanctions on us;

 

·      loss of licensure or the right to participate in Medicare and other government-sponsored programs;

 

·      damage to our reputation in various markets; and

 

·      increased difficulty in marketing our products and services.

 

Any of these events could make it more difficult for us to sell our products and services, reduce our revenues and profitability and otherwise adversely affect our operating results. For more information on governmental regulation of our business, see the section captioned “Regulation” in Part I, Item 1 of our annual report on Form 10-K for the year ended December 31, 2007.

 

CMS has released proposed regulations that, if adopted, would, among other things, place tighter restrictions on marketing processes relative to the Medicare Advantage program and prescription drug benefit program. Depending upon the final content of these regulations, if CMS adopts them, compliance with and enforcement of the regulations could have a material adverse effect on our results of operations.

 

Changes in governmental regulation or legislative reform could increase our costs of doing business and adversely affect our profitability.

 

The Federal government and the states in which we operate extensively our regulate health plans, insurance companies and other business. The laws and regulations governing our operations are generally intended to benefit and protect policyholders, health plan members and providers rather than shareholders. From time to time, Congress has considered various forms of “Patients’ Bill of Rights” legislation, which, if adopted, could alter the treatment of coverage decisions under applicable federal employee benefits laws. There have also been legislative attempts at the state level to limit the preemptive effect of Federal employee benefits laws on state laws. If adopted, these types of limitations could increase our liability exposure and could permit greater state regulation of our operations. The government agencies administering these laws and regulations have broad latitude to enforce them. These laws and regulations, along with the terms of our government contracts, regulate how we do business, what services we offer, and how we interact with our policyholders, members, providers and the public. Healthcare laws and regulations are subject to frequent change and differing

 


 

interpretations. Changes in the political climate or 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:

 

·      imposing additional license, registration, or capital reserve requirements;

 

·      increasing our administrative and other costs;

 

·      forcing us to undergo a corporate restructuring;

 

·      increasing mandated benefits without corresponding premium increases;

 

·      limiting our ability to engage in inter-company transactions with our affiliates and subsidiaries;

 

·      adversely affecting our ability to operate under the Medicare program and to continue to serve our members and attract new members;

 

·      forcing us to alter or restructure our relationships with providers and agents, such as making changes to the “deeming” rules for Private Fee for Service Medicare Advantage products;

 

·      restricting our ability to market our products;

 

·      increasing governmental regulation of healthcare and PBM services, such as potential regulation of the PBM industry by the U.S. Food and Drug Administration, or direct regulation of pharmacies by regulatory and quasi-regulatory bodies;

 

·      requiring that health plan members have greater access to non-formulary drugs;

 

·      expanding the ability of health plan members to sue their plans;

 

·      requiring us to implement additional or different programs and systems;

 

·      increasing antitrust lawsuits challenging PBM pricing practices;

 

·      instituting state legislation regulating PBMs or imposing fiduciary status on PBMs; and

 

·      instituting drug pricing “most favored nation” pricing and “unitary pricing” legislation or other drug pricing legislation.

 

While it is not possible to predict when and whether fundamental policy changes would occur, policy changes on the local, state and federal level could fundamentally change the dynamics of our industry, such as policy changes mandating a much larger

 


 

role of the government in the health care arena. Changes in public policy could materially affect our profitability, our ability to retain or grow business, or our financial condition. State and federal governmental authorities are continually considering changes to laws and regulations applicable to us and are currently considering regulations relating to:

 

·      health insurance access and affordability;

 

·      disclosure of provider quality information;

 

·      electronic access to pharmacy and medical records;

 

·      formation of regional or national association health plans for small employers;

 

·      universal health coverage; and

 

·      disclosure of provider fee schedules and other data about payments to providers, sometimes called transparency.

 

All of these proposals could apply to us and could result in new regulations that increase the cost of our operations. Healthcare organizations also may reduce or delay the purchase of PBM services, and manufacturers may reduce administrative fees and rebates or reduce supplies of some products. There can be no assurance that legislative or regulatory change will not affect our ability to negotiate rebate and administrative fee arrangements with manufacturers and will not have a material adverse effect on our business.

 

Both Congress and state legislatures are expected to consider legislation to increase governmental regulation of managed care plans. Some of these initiatives would, among other things, require that health plan members have greater access to drugs not included on a plan’s formulary and give health plan members the right to sue their health plans for malpractice when they have been denied care. The scope of the managed care reform proposals under consideration by Congress and state legislatures and enacted by states to date vary greatly, and we cannot predict the extent of future legislation. However, these initiatives could limit our business practices and impair our ability to serve our clients.

 

In addition, CMS has proposed regulations that, if adopted, would, among other things, place tighter restrictions on marketing processes relative to the Medicare Advantage program and prescription drug benefit program. Depending upon the final content of these regulations, if CMS adopts them, compliance with and enforcement of the regulations could have a material adverse effect on our results of operations.

 


 

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 HIPAA require us to comply with standards regarding the exchange of health information within our company and with third parties, such as healthcare providers, business associates and our members. These regulations impose standards for common healthcare transactions, such as

 

·      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, HIPAA does not preempt the state standards and laws.

 

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 ability to comply with the HIPAA requirements is uncertain and the costs of compliance are significant. Furthermore, a state’s ability to promulgate stricter laws, and uncertainty regarding many aspects of 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. We could be subject to criminal penalties and civil sanctions for failing to comply with the HIPAA health information provisions, which could result in the incurrence of 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.

 

Compliance with HIPAA regulations requires significant systems enhancements, training and administrative effort. HIPAA could also expose us to additional liability for violations by our business associates. A business associate is a person or entity, other than a member of the work force, who on behalf of an entity subject to HIPAA performs or assists in the performance of a function or activity involving the use or disclosure of individually identifiable health information, or provides legal, accounting, consulting, data aggregation, management, administrative, accreditation or financial services.

 


 

Legal and regulatory investigations and actions are increasingly common in the insurance and managed care business and may result in financial losses and harm our reputation.

 

We face a significant risk of class action lawsuits and other litigation and regulatory investigations and actions in the ordinary course of operating our businesses. Due to the nature of our businesses, we are subject to a variety of legal and regulatory actions relating to our business operations, such as the design, management and offering of products and services. The following are examples of the types of potential litigation and regulatory investigations we face:

 

·      claims relating to sales or underwriting practices;

 

·      claims relating to the methodologies for calculating premiums;

 

·      claims relating to the denial or delay of health care benefit payments;

 

·      claims relating to claims payments and procedures;

 

·      additional premium charges for premiums paid on a periodic basis;

 

·      claims relating to the denial, delay or rescission of insurance coverage;

 

·      challenges to the use of software products used in administering claims;

 

·      claims relating to our administration of our Medicare Part D and other healthcare and insurance offerings and PBM;

 

·      claims by government agencies relating to compliance with laws and regulations;

 

·      medical malpractice or negligence actions based on our medical necessity decisions or brought against us on the theory that we are liable for our providers’ alleged malpractice or negligence;

 

·      claims relating to product design;

 

·      allegations of anti-competitive and unfair business activities;

 

·      provider disputes over compensation and termination of provider contracts;

 

·      allegations of discrimination;

 

·      claims related to the failure to disclose business practices;

 

·      allegations of breaches of duties to customers;

 


 

·      claims relating to inadequate or incorrect disclosure or accounting in our public filings;

 

·      allegations of agent misconduct;

 

·      claims relating to suitability of annuity products;

 

·      claims relating to customer audits and contract performance; and

 

·      claims relating to dispensing of drugs associated with our in-house mail order pharmacy.

 

Plaintiffs in class action and other lawsuits against us may seek very large or indeterminate amounts, and punitive and treble damages, which may remain unknown for substantial periods of time. We are also subject to various regulatory inquiries, such as information requests, formal and informal inquiries, subpoenas and books and record examinations, from state, Federal and international regulators and other authorities. A substantial legal liability or a significant regulatory action against us could have an adverse effect on our business, financial condition and results of operations.

 

Items headed “Legal Proceedings” and “Commitments and Contingencies” in  the notes to the consolidated financial statements included in the reports into which this report may be incorporated by reference may contain a description of material legal actions in which we are currently or recently have been involved.

 

We cannot predict the outcome of actions we face with certainty, and we have incurred and are incurring expenses in the defense of our past and current matters. We also may be subject to additional litigation in the future. Litigation could materially adversely affect our business or results of operations because of the costs of defending these cases, the costs of settlement or judgments against us, or the changes in our operations that could result from litigation. The defense of any these actions may be time-consuming and costly, and may distract our management’s attention. In addition, we could suffer significant harm to our reputation, which could have an adverse effect on our business, financial condition and results of operations. As a result, we may incur significant expenses and may be unable to effectively operate our business.

 

Potential liabilities may not be covered by insurance or indemnity, insurers or indemnifying parties may dispute coverage or may be unable to meet their obligations or the amount of our insurance or indemnification coverage may be inadequate. In addition, some types of damages, like punitive damages or damage for willful acts, may not be covered by insurance. The cost of business insurance coverage has increased, and may in the future increase, significantly. Insurance coverage for all or some forms of liability may become unavailable or prohibitively expensive in the future. 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.

 


 

The health care industry continues to receive significant negative publicity regarding the public’s perception of it. This publicity and public perception have been accompanied by increased litigation, in some cases resulting in

 

·      large jury awards,

 

·      legislative activity,

 

·      regulation and

 

·      governmental review of industry practices.

 

These factors, as well as any negative publicity about us in particular, could adversely affect our ability to market our products or services and to attract and retain members, may require us to change our products or services, may increase the regulatory burdens under which we operate and may require us to pay large judgments or fines. Any combination of these factors could further increase our cost of doing business and adversely affect our financial position, results of operations and cash flows.

 

After the termination of our strategic alliance for the Prescription Pathwaysm product, we may not receive the intended benefit of the members allocated to us, or we could have difficulty retaining the members allocated to us.

 

As we have previously announced, we have agreed to terminate our strategic alliance with CVS Caremark relating to the Prescription Pathwaysm product. In the agreement terminating the alliance, we have agreed to allocate the Prescription Pathway members between us and Caremark such that each party receives equal benefit of the members allocated to it. It is possible that we will not, in fact, receive equal benefit, or that we could have difficulty retaining the members allocated to us. In either of these events, we could experience a material adverse effect on our revenues or results of operations.

 

The integration of MemberHealth and any future acquisition with our current business may not be successful, which could have a material adverse effect on our business, financial condition and results of operations.

 

Our management will be required to devote a significant amount of time and attention to the process of integrating the operations of MemberHealth’s business and any future acquisition with our historical business. This may decrease the time they will have to service existing customers, attract new customers and develop new services or strategies. The integration of the businesses may present significant systems and operational integration risks. We may be unable to integrate any acquired business into our

 


 

historical operations in an efficient, timely and effective manner, which could have a material adverse effect on our business, financial condition and results of operations.

 

We may fail to realize the anticipated synergies, cost savings and growth opportunities we anticipate from the MemberHealth acquisition and any future acquisition, which could result in a material adverse effect on our financial position, results of operations and cash flows.

 

The success of the MemberHealth acquisition and any future acquisition will depend, in part, on our ability to realize synergies, cost savings and growth opportunities that we anticipate from integrating our historical businesses with those of the acquired business. Our success in realizing these synergies, cost savings and growth opportunities, and the timing of this realization, depends on the successful integration of the businesses and operations. Even if we are able to integrate the businesses and operations successfully, there can be no assurance that this integration will result in the realization of the full benefits of synergies, cost savings and growth opportunities that we would expect from this integration or that these benefits will be achieved within the time frame we anticipate. For example, the elimination of duplicative costs may not be possible or may take longer than anticipated, the benefits from the acquisition may be offset by costs incurred or delays in integrating the businesses and regulatory authorities could impose conditions on the combined company’s business.

 

The growth of our Medicare Advantage and Medicare Part D business is an important part of our business strategy. Any failure to achieve this growth may have a material adverse effect on our financial position, results of operations or cash flows. In addition, the expansion of our Medicare Advantage and Medicare Part D business in relation to our other businesses may intensify the regulatory and other risks to us inherent in the Medicare Advantage and Medicare Part D business, which we describe elsewhere in this document. These expansion efforts may result in less diversification of our revenue stream.

 

There can be no assurance that we will be able to successfully implement our operational and strategic initiatives that are intended to position us for future growth, or that the products we design will be accepted or adopted in the time periods assumed. We also make no assurance that investments in these initiatives will recoup their costs or be profitable in the future. Failure to implement this strategy may result in a material adverse effect on our financial position, results of operations and cash flows.

 

The completion of the MemberHealth acquisition or any future acquisition could impact or cause disruptions in our businesses, which could have an adverse effect on our results of operations and financial condition.

 

Specifically:

 

·      our employees may experience uncertainty about their future roles with the combined company, which might adversely affect the combined company’s ability to retain and hire key managers and other employees;

 

·      the potential availability of “change in control” benefits could result in increased costs for us and difficulties in retaining our officers and employees;

 

·      the direction of the attention of our management toward the completion of the acquisition and transaction-related considerations during the pendency of the transaction may prove to have diverted their attention from the day-to-day business operations of their respective companies, and the direction of the attention of our management toward the integration of the acquisition may currently and in the future divert their attention from the day-to-day business operations of their respective companies; and

 

·      pharmaceutical manufacturers, retail pharmacies, pharmacy benefit management, or PBM, companies or other vendors or suppliers may seek to modify or terminate their business relationships with us.

 

We will not be able to continue for an indefinite period all of the prescription drug plans that we currently operate.

 

Current rules promulgated by the Centers for Medicare and Medicaid Services, or CMS, will allow us to operate both Prescription Pathway and Community CCRx historical Part D plans, a total of six plans, for the 2009 plan year. CMS has required that we reduce the aggregate number of plans we offer to five in 2010, four in 2011 and three in 2012 and thereafter. We may be allowed to offer up to four plans in a given region depending upon whether benefits under one, some or all plans include coverage of the donut hole and coverage of all generics and all preferred brands through the entire gap period. The restriction on the number of plans we may offer could adversely affect our results of operations.

 

Sales of our common stock and the ownership of common stock by the former shareholders of MemberHealth and by the equity investors, or by the former shareholders of or the investors who finance any future acquisitions, may negatively affect the market price of our common stock.

 

The market price of our common stock could decline as a result of sales of increased number of shares of our common stock in the market after the completion of the MemberHealth acquisition and any future acquisition or upon the sale of shares by the equity investors who finance any acquisition, or the perception that these sales could occur. All shares of our common stock received by an

 


 

acquired company’s shareholders in the acquisition and not otherwise subject to the contractual restrictions are freely transferable following the consummation of the acquisition. All shares of our series A preferred stock and series B preferred stock received by the equity investors pursuant to the securities purchase agreements entered into in connection with the MemberHealth acquisition, and common shares issuable upon the direct or indirect conversion of those shares of preferred stock, will be transferable after a period of one year following the acquisition of the series A preferred stock and series B preferred stock by the equity investors. Shares of our stock issued to finance any future acquisition may be similarly transferable. These sales, or the possibility that these sales may occur, may also make it more difficult for us to obtain additional capital by selling equity securities in the future at a time and at a price that we deem appropriate.

 

Following the MemberHealth acquisition and the completion of the transactions contemplated by the securities purchase agreements entered into in connection with the acquisition, the former shareholders of MemberHealth and the equity investors own a significant block of our voting shares and have the ability to appoint six of our thirteen directors. A similar situation could arise following a future acquisition. This may negatively affect the market price of our common stock.

 

The MemberHealth acquisition may not be accretive and may cause dilution to our earnings per share, which may harm the market price of our common stock.

 

Prior to the consummation of the MemberHealth acquisition, we anticipated that the acquisition would be accretive to earnings per share during the first full calendar year after the acquisition. This expectation was based on preliminary estimates and assumptions which may materially change after the completion of the acquisition.

 

The combined businesses could encounter additional transaction and integration-related costs or other factors such as the failure to realize all of the benefits anticipated in the acquisition. These or other factors could cause dilution to our earnings per share or decrease the expected accretive effect of the acquisition and cause a decrease in the price of our common stock.

 

Some of our directors and executive officers may have interests that are different from, or in addition to, the interests of our shareholders generally.

 

Some of our directors and executive officers may have significant equity ownership in us, employment, indemnification and severance benefit arrangements, potential rights to other benefits on a change in control and rights to ongoing indemnification and insurance that provide them with interests that may differ from the interests of our shareholders generally. The receipt of compensation or other benefits by our directors or executive officers in connection with the MemberHealth acquisition or any future acquisition may make it more difficult for the combined company to retain their services after the acquisition, or require the combined company to expend additional sums to continue to retain their services. In addition, consistent with our compensation philosophy of senior executives being awarded approximately 5% of our aggregate equity ownership, some of our executives are likely to receive additional equity grants as a result of the increase in our outstanding shares due to the acquisition and the investment by the equity investors.

 

We may be unable to continue to provide Medicare Advantage or Medicare Part D plans profitably.

 

Beginning in 2006, organizations that offer Medicare Advantage plans of the type we currently offer were required to offer a prescription drug benefit, as defined by CMS, and Medicare Advantage enrollees were required to obtain their drug benefit from their Medicare Advantage plan. These combined managed care plans offering drug benefits are, under the new law, called MA-PDs. Current enrollees may prefer a stand-alone drug plan and may disenroll from the Medicare Advantage plan altogether in order to participate in another drug plan, which could reduce our profitability and membership enrollment.

 

Some enrollees may have chosen our Medicare Advantage plan in the past rather than a competitor’s Medicare Advantage plan because of the added drug benefit that we offer with our Medicare Advantage plans. Effective January 1, 2006, Medicare beneficiaries began having the opportunity to obtain a drug benefit without joining a managed care plan. Additionally, Medicare beneficiaries who participate in a Medicare Advantage plan and enroll in a stand-alone Prescription Drug Plan, known as a PDP, will be automatically disenrolled from their Medicare Advantage plan. Accordingly, the existence of PDPs in the regions in which we sell Medicare Advantage plans could result in our members intentionally disenrolling or automatically being disenrolled from our Medicare Advantage plans and reduce our membership and profitability.

 

We began marketing our MA-PDs and PDPs in October 2005 and began enrolling members on November 15, 2005, effective as of January 1, 2006, as did MemberHealth with its PDPs. Our ability to operate our MA-PDs and PDPs profitably will depend on our ability to attract members, to continue to develop the necessary core systems and processes and to manage our medical expenses related to these plans, and other factors. Because there has only been two full years and one partial year of experience with CMS’s Medicare Part D program, there remains uncertainty as to the ultimate market size, consumer demand, and related medical loss ratio. Accordingly, we are uncertain whether we will be able to operate our MA-PDs or PDPs profitably or competitively in the future, and our failure to do so could have a material adverse effect on our results of operations and financial condition; even if we are able to operate our MA-PDs or PDPs profitably and competitively in the future, our margins on these products may decline over time.

 

The Medicare Prescription Drug, Improvement and Modernization Act of 2003, known as the MMA, provides for “risk corridors” that are expected 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 per member per month bids submitted to CMS in excess of specified ranges. 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%. We anticipate that the initial risk corridors in 2006 and 2007 will provide more protection against excess losses than will be available beginning in 2008 and future years as the thresholds increase and the reimbursement percentages decrease or disappear.

 

In addition, we expect there will be a delay in obtaining reimbursement from CMS for reimbursable losses pursuant to the risk corridors. In that event, we expect there would be a negative impact on our results of operation, cash flows and financial condition as a result of being required to finance excess losses until we receive reimbursement. In addition, as the risk corridors are designed to be symmetrical, a plan whose actual costs fall below its expected costs would be required to reimburse CMS based on a similar methodology as set forth above. Furthermore, reconciliation payments for estimated upfront Federal reinsurance payments and payments for low income cost sharing subsidies, are made retroactively on an annual basis, which could expose plans to upfront costs in providing the benefit. Accordingly, it may be difficult to accurately predict or report the operating results associated with our drug benefits. We anticipate settling with CMS on amounts related to the risk corridor adjustment and subsidies for a given plan year in the following year.

 

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.

 

All of the Medicare Advantage programs we offer are offered through Medicare. As a result, our profitability is dependent, in large part, on continued funding for government healthcare programs at or above current levels. The reimbursement rates paid to health plans like ours by the Federal government are established by contract, although the rates differ depending on a combination of factors such as a member’s health status, age, gender, county or region, benefit mix, member eligibility categories, and the plans’ risk scores.

 

CMS has implemented a risk adjustment model that apportions premiums paid to Medicare health plans according to health severity. A risk adjustment model pays more for enrollees with predictably higher costs. CMS has completely phased 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 such as

 

·                  hospital inpatient diagnoses,

 

·                  diagnosis data from ambulatory treatment settings, such as hospital outpatient facilities and physician visits,

 

·                  gender,

 

·                  age, and

 

·                  Medicaid eligibility.

 

Under the risk adjustment methodology, all Medicare health plans must capture, collect and submit the necessary diagnosis code information from inpatient and ambulatory treatment settings to CMS within prescribed deadlines. The CMS risk adjustment model uses this diagnosis data to calculate the risk adjusted premium payment to Medicare health plans. As a result of this process, it is difficult to predict with certainty our future revenue or profitability. In addition, our own risk scores for any period may result in favorable or unfavorable adjustments to the payments we receive from CMS and our Medicare premium revenue. Because diagnosis coding is a manual process, there is the potential for human error in the recording of codings, and there can be no assurance that our contracting physicians and hospitals will be successful in improving the accuracy of recording diagnosis code information, thereby enhancing our risk scores.

 

Coincident with phase-in of the risk-adjustment methodology, CMS also adjusted payments to Medicare Advantage plans by a “budget neutrality” factor. CMS implemented the budget neutrality factor to prevent overall health plan payments from being reduced during the transition to the risk-adjustment payment model. CMS first developed the payment adjustments for budget neutrality in 2002 and began to use them with the 2003 payments. CMS will begin phasing out the budget neutrality adjustment in 2007 and will fully eliminate it by 2011. The risk adjustment methodology and phase-out of the budget neutrality factor will reduce our plans’ premiums unless our risk scores increase. We do not know if our risk scores will increase in the future or, if they do, that they will be large enough to offset the elimination of this adjustment. As a result of the CMS payment methodology described previously, the amount and timing of our CMS monthly premium payments per member may change materially, either favorably or unfavorably. In addition, there exists the possibility that CMS may reduce revenues in 2009 or thereafter for plans whose risk scores have increased significantly greater than the general Medicare average increase in risk scores. If our risk scores increase significantly greater than the general Medicare average increase, and CMS introduces this approach, it could adversely affect our results of operations.

 


 

Our ability to market some of our Part D plans is substantially dependent on two of our strategic relationships with third parties.

 

Our ability to market some of our Part D plans is substantially dependent on our strategic alliance with the National Community Pharmacists Association, known as the NCPA, which provides outreach and communications for our CCRx Part D plans to NCPA’s independent pharmacy membership. NCPA member pharmacies make up over one-third of MemberHealth’s pharmacy network and, in 2007, accounted for approximately 60% of the prescriptions filled under MemberHealth’s Part D plans. Additionally, we are substantially dependent on its strategic relationship with Community Care Outreach Services LLC, or CCOS, an insurance marketing operation that provides the historical MemberHealth business its primary “outsourced” sales force. If either of these strategic relationships are terminated, or do not provide us with the services and benefits we anticipate, our ability to market CCRx Part D plans could be materially and adversely affected. Further, to the extent that CMS or other regulatory authorities determine that any provisions of our agreements with NCPA or CCOS conflict with any applicable law, regulation or policy, we may not be able to realize fully the benefits we anticipate from the acquisition, and we could potentially incur regulatory liability.

 

There are significant risks associated with our participation in the Medicare Part D program, the occurrence of which could have an adverse effect on our results of operations.

 

Effective January 1, 2006, we began offering Medicare-approved PDPs to Medicare-eligible beneficiaries. MemberHealth’s business consists primarily of Medicare Part D members. Our actual results may differ from our assumptions regarding the Medicare Part D program. Our participation in the Medicare Part D program involves the following risks, the occurrence of any or all of which could have an adverse effect on our financial condition, results of operations and cash flows:

 

·                  CMS continues to release regulations on Medicare Part D, including important requirements related to the implementation and marketing of the Medicare Part D prescription drug benefit plan. This may create challenges for planning, implementing and operating the Medicare Part D program, and we can provide no assurance that Congress or CMS will not alter the program in a manner that will be detrimental to us.

 

·                  CMS has released call letters on Medicare Part D that impact the revenue that can be earned by our strategic alliance, PDMS, in 2008, the last year of its existence, or by our successor Part D plans in 2009 and thereafter.

 

·                  We anticipate that the level of earnings of our successor Part D plans to PDMS will be significantly reduced beginning in 2009 resulting from CMS’s indication in its recent call letter that amounts paid by the PDP sponsor’s PBM to the retail pharmacy, rather than the amounts paid by the PDP sponsor to its PBM, be reported as part of the risk corridor calculation. We presently report only our share of this difference in our risk corridor calculation but not the Caremark share. This expected change in risk corridor reporting methodology is likely to reduce our revenues in 2009 and beyond.

 

·                  Our contracts with CMS, as well as applicable Medicare Part D regulations and Federal and state laws, require us, among other obligations, to:

 

·                  comply with specified disclosure, filing, record-keeping and marketing rules;

 

·                  operate quality assurance, drug utilization management and medication therapy management programs;

 

·                  support e-prescribing initiatives;

 

·                  implement grievance, appeals and formulary exception processes;

 

·                  comply with payment protocols, which require the return of overpayments to CMS and, in specified circumstances, coordination with state pharmacy assistance programs;

 

·                  use approved networks and formularies, and provide access to these networks to any willing pharmacy;

 

·                  provide emergency out-of-network coverage; and

 

·                  adopt a comprehensive Medicare and fraud, waste and abuse compliance program.

 

Any contractual or regulatory non-compliance on our part could entail significant sanctions and monetary penalties, which in turn could negatively affect the market price of our common stock.

 

·                  We cannot be certain that other regulatory changes, such as a restructuring of the Medicare Part D program, will not affect our ability to operate under the Part D program or increase our costs or reduce our reimbursements.

 

·                  We cannot be certain that our products will be competitive with the products offered by other PDPs. We cannot be certain that our future bids will be competitive with the bids submitted by other PDPs. We cannot be certain that our future bids will be under the benchmark bids calculated by CMS.

 

·                  PDP bids are submitted annually, no less than six months in advance of the corresponding benefit year. We endeavor to use the best available member eligibility, claims and risk score data at the time of developing the bid. Futhermore, we are making actuarial assumptions about the utilization of benefits in our PDPs. Because Medicare Part D is a relatively new program, there is little historical basis for these assumptions, and we cannot be assured that the data and assumptions used at the time of bid development will prove to be correct and that premiums will be sufficient to cover benefits.

 


 

·                  We may experience higher benefit expenses as a result of an increase in the cost of pharmaceuticals, possible changes in our pharmacy rebate program with drug manufacturers, higher than expected utilization and new mandated benefits or other regulatory changes that increase our costs.

 

·                  As of December 31, 2007, CMS had automatically assigned dual eligibles to our PDPs in regions where our premiums for our standard plans were under the CMS established regional benchmarks. We cannot guarantee that all of these dual eligibles assigned to us will continue to participate in our PDPs in the future because dual eligible beneficiaries can change their PDP each month. Moreover, we also cannot guarantee whether dual eligibles will be auto assigned to us in the future for a region since we are required to bid anew each year and there exists the possibility that our bid for the region could be above the applicable benchmark; if our bid is below the benchmark, we cannot predict the number of dual eligibles that will be assigned to us.

 

·                  Medicare Part D is a relatively new program and the competitive landscape is uncertain. We expect to encounter competition from other PDP sponsors, some of which may have significantly greater resources and brand recognition than we do. Our marketing arrangement with CVS Caremark will end after the 2008 plan year, and we cannot predict whether we will enter into other marketing arrangements with competitors. We cannot predict whether we will be able to effectively compete in this new market.

 

·                  If our current pharmacies and other providers terminate their contracts, we will have to contract with other providers to take their place.

 

·                  CMS and other service providers may not be able to deliver or process information completely, timely and accurately relating to our PDP, which could negatively impact our operations.

 

·                  There is uncertainty as to whether marketing practices will be restricted, which could negatively impact our ability to market and sell our product.

 

·                  There may be other unforeseen occurrences that could negatively impact our PDP operations.

 

Our inability to collect receivables owed to us by other Medicare Part D PDPs may disrupt or adversely affect our PDPs.

 

During 2006, we incurred Medicare Part D prescription expenses on behalf of Medicare beneficiaries who were not members of our PDPs. Likewise, we received notice of claims from other plans that paid claims on behalf of our members. CMS established a plan-to-plan, known as P2P, reconciliation process to address this condition and provide a means of settlement between plans. Additionally, CMS recently published its state-to-plan, known as S2P, reconciliation process whereby health plans will settle with state Medicaid programs that paid claims on behalf of Medicare beneficiaries. We have recorded our estimated liabilities under P2P and S2P as of December 31, 2007. Ultimate resolution of the P2P and S2P reconciliation processes could result in adjustments, positive or negative, to the amounts currently estimated and recoverable.

 

Although CMS has initiated a process for reconciling these errors in membership and drug costs, there can be no assurance that we will be fully reimbursed for these costs by CMS or another PDP sponsor. Although we intend to actively pursue amounts due us in the CMS reconciliation process, we cannot assure you that we will receive reimbursements from any other plan. Any amounts not collectible will be reported as additional claim costs and are subject to both reinsurance and the risk corridor adjustment.

 

Our liabilities related to the CMS policy regarding the special transition period for retroactive enrollment may result in an unknown amount of liability, which could adversely affect our PDPs.

 

On May 25, 2007, CMS issued a memorandum to clarify Medicare Part D sponsors’ obligations under the Prescription Drug Benefit Manual on Coordination of Benefits, Chapter 14, Section 50.10, entitled “Special Transition for Retroactive Enrollment Situations.” Under Section 50.10, Part D plans must provide a special transition period in 2007 to accommodate specified claims incurred by or on behalf of beneficiaries whom CMS has retroactively enrolled in a Part D plan. Part D plans must accommodate claims incurred by or on behalf of these beneficiaries during a no greater than seven-month retroactive eligibility period, which may extend into 2006.

 

In the May 25, 2007 memorandum CMS emphasized that Part D sponsors may not use the March 31, 2007 coverage year deadline, which is the cut-off date for the submission of claims associated with payment reconciliation, to deny requests for reimbursement of claims incurred during retroactive enrollment periods. Indeed, CMS noted that Part D plans are liable for claims received after March 31st even if retroactive enrollment is not an issue, subject to contractual provisions regarding timely claims filing for network pharmacies. To ensure that third party payors have the opportunity to request reimbursement for claims incurred during a retroactive enrollment period on behalf of dual eligible beneficiaries, CMS stated that Part D sponsors must use the date of Medicaid notification to establish a new timely claims filing period. CMS also provided an attachment describing how the special transition period policy applied in various retroactive enrollment scenarios. We could face an unknown amount of liability as a result of complying with this special transition policy on retroactive enrollment, which could negatively affect our business.

 


 

Financial accounting for the Medicare Part D benefits is complex.

 

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 and calculation of the risk corridor, taken together with the complexity of the Medicare Part D product and challenges in reconciling CMS Medicare 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 us as to the impacts of our Medicare PDPs on our full year results.

 

We rely on the accuracy of information provided by CMS regarding the eligibility of an individual to participate in our Medicare Part D 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 it for premiums that we received from CMS based