Coventry Health Care 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2010
[ ] 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 1-16477
COVENTRY HEALTH CARE, INC.
(Exact name of registrant as specified in its charter)
6705 Rockledge Drive, Suite 900, Bethesda, Maryland 20817
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code (301) 581-0600
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 T No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes T No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes £ No T
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
COVENTRY HEALTH CARE, INC.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
ITEM 1: Financial Statements
CONSOLIDATED BALANCE SHEETS
See accompanying notes to the condensed consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
See accompanying notes to the condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to the condensed consolidated financial statements.
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A.BASIS OF PRESENTATION
The condensed consolidated financial statements of Coventry Health Care, Inc. and its subsidiaries (“Coventry” or the “Company”) contained in this report are unaudited but reflect all normal recurring adjustments which, in the opinion of management, are necessary for the fair presentation of the results of the interim periods reflected. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission (“SEC”). Therefore, it is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10–K for the year ended December 31, 2009. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. The year end balance sheet data included in this report was derived from audited financial statements.
B. NEW ACCOUNTING STANDARDS>
In January 2010, Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2010-06, “Improving Disclosures about Fair Value Measurements” was issued. ASU 2010-06 requires the disclosure of additional information about transfers in and out of Level 1 and Level 2 of the fair value hierarchy, requires the separate presentation (gross basis) of information about purchases, sales, issuances, and settlements of financial instruments in the roll forward of activity in fair value measurements using significant unobservable inputs (Level 3), and requires expanded disclosures regarding the determination of fair value measurements. The Company adopted the new disclosure provisions during the first quarter of 2010, except for the gross disclosures regarding purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which are required for the Company beginning with the filing of its quarterly filing on Form 10-Q for the quarter ended March 31, 2011. The adoption of ASU 2010-06 did not affect the Company’s disclosures for the quarter or six months ended June 30, 2010.
The Company has the following three reportable segments: Health Plan and Medical Services, Specialized Managed Care, and Workers’ Compensation. Each of these reportable segments, which the Company also refers to as “Divisions,” is separately managed and provides separate operating results that are evaluated by the Company’s chief operating decision maker.
The Health Plan and Medical Services Division is primarily comprised of the Company’s traditional health plan risk businesses and products. Additionally, through this Division the Company contracts with various federal employee organizations to provide health insurance benefits under the Federal Employees Health Benefits Program (“FEHBP”) and offers managed care and administrative products to businesses that self-insure the health care benefits of their employees. This Division also contains the dental services business. The Company did not renew its Medicare Advantage Private Fee-for-Service (“PFFS”) products effective for the 2010 plan year. Prior to the non-renewal, PFFS was part of this Division.
The Specialized Managed Care Division is comprised of the Company’s Medicare Part D program, its network rental business (“Network Rental”) and its mental-behavioral health benefits business. As discussed in Note E, Discontinued Operations, to the condensed consolidated financial statements, on July 31, 2009 the Company sold its Medicaid/Public entity business, First Health Services Corporation (“FHSC”). FHSC operations are excluded from the Company’s results of continuing operations.
The Workers’ Compensation Division is comprised of the Company’s workers’ compensation services businesses, which provide fee-based, managed care services such as access to the Company’s provider networks, pharmacy benefit management, and care management to underwriters and administrators of workers’ compensation insurance.
The tables below summarize the results from continuing operations of the Company’s reportable segments through the gross margin level, as that is the measure of profitability used by the chief operating decision maker to assess segment performance and make decisions regarding the allocation of resources. A reconciliation of gross margin to operating earnings at a consolidated level for continuing operations is also provided. Total assets by reportable segment are not disclosed as these assets are not reviewed separately by the Company’s chief operating decision maker. The dollar amounts in the segment tables are presented in thousands.
On June 30, 2010, the Company announced that it signed a definitive agreement to acquire MHP, Inc. and its subsidiaries (“Mercy Health Plans”), currently wholly-owned by Sisters of Mercy Health System. This transaction, which is subject to regulatory approvals, is expected to close in the fourth quarter of 2010. Mercy Health Plans is a diversified health plan with approximately 90,000 commercial risk members, 60,000 commercial self-funded members, and 30,000 Medicare Advantage Coordinated Care members throughout Missouri and northwest Arkansas.
On February 1, 2010, the Company completed its acquisition of Preferred Health Systems, Inc. (“PHS”) in an all-cash transaction for approximately $84.6 million, including excess statutory and working capital. PHS is a commercial health plan based in Wichita, Kansas serving approximately 100,000 commercial group risk members and 20,000 commercial self-funded members. The acquisition of PHS strengthens Coventry’s presence in the Kansas market and its overall health plan footprint. The acquisition was accounted for using the acquisition method of accounting and accordingly, PHS' operating results have been included in the Company's consolidated financial statements since the February 1, 2010 date of acquisition. As part of the acquisition, the Company recognized a liability for potential contingent earn-outs that are attributed to certain performance measures by PHS. At June 30, 2010, this liability was not significant.
E. DISCONTINUED OPERATIONS>
On July 31, 2009, the Company completed the sale of its fee-based Medicaid services subsidiary FHSC. In accordance with FASB Accounting Standards Codification (“ASC”) 205-20 “Discontinued Operations,” FHSC’s earnings and the impairment of its goodwill for the quarter and six months ended June 30, 2009 are presented as loss from discontinued operations, net of tax in the Company’s consolidated statements of operations. The following table summarizes FHSC discontinued operations information for the periods presented (in thousands):
The Company’s outstanding debt consisted of the following (in thousands):
The Company’s credit facility and senior notes contain covenants and restrictions regarding, among other things, additional debt, dividends or other restricted payments, transactions with affiliates, asset dispositions, and consolidations or mergers. The Company’s credit facility also requires compliance with a 3:1 leverage ratio. The Company’s credit facility and certain of its senior notes also include as an event of default the entry of a judgment against the Company or a subsidiary in excess of a specified amount ($50 million in the case of the credit agreement and $20 million in the case of the applicable senior notes) if enforcement proceedings are commenced or if enforcement is not stayed for a period of 30 consecutive days. The Company has filed a request for a discretionary appellate review of the judgment against First Health Group Corp. described in Note G, Contingencies, to the condensed consolidated financial statements, and enforcement of the judgment is stayed pending a determination regarding this request. The Company has sufficient funds to satisfy this judgment before enforcement proceedings would begin. As of June 30, 2010, the Company was in compliance with all applicable covenants and restrictions under its senior notes and credit facility.
As described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009, the Company received a subpoena from the U.S. Attorney for the District of Maryland, Northern Division, requesting information regarding the operational process for confirming Medicare eligibility for its Workers’ Compensation set-aside product. The Company is fully cooperating and is providing the requested information. The Company cannot predict what, if any, actions may be taken by the U.S. Attorney. However, based on the information known to date, the Company does not believe that the outcome of this inquiry will have a material adverse effect on its financial position or results of operations.
First Health Group Corp, Inc. (“FHGC”), a subsidiary of the Company, is a party to various lawsuits filed in the state and federal courts of Louisiana involving disputes between providers and workers’ compensation payors who access FHGC’s contracts with these providers to reimburse them for services rendered to injured workers. FHGC has written contracts with providers in Louisiana which expressly state that the provider agrees to accept a specified discount off their billed charges for services rendered to injured workers. The discounted rate set forth in the FHGC provider contract is less than the reimbursement amount set forth in the Louisiana Workers’ Compensation Fee Schedule. For this reason, workers’ compensation insurers and third party administrators (“TPAs”) for employers who self-insure workers’ compensation benefits, contract with FHGC to access the FHGC provider contracts. Thus, when a FHGC contracted provider renders services to an injured worker, the workers’ compensation insurer or the TPA reimburses the provider for those services in accordance with the discounted rate in the provider’s contract with FHGC. These workers’ compensation insurers and TPAs are referred to as “payors” in the FHGC provider contract and the contract expressly states that the discounted rate will apply to those payors who access the FHGC contract. Thus, the providers enter into these contracts with FHGC knowing that they will be paid the discounted rate by every payor who chooses to access the FHGC contract. So that its contracted providers know which payors are accessing their contract, FHGC sends regular written notices to its contracted providers and maintains a provider website which lists each and every payor who is accessing the FHGC contract.
Four providers who have contracts with FHGC filed a state court class action lawsuit against FHGC and certain payors alleging that FHGC violated Louisiana’s Any Willing Provider Act (the “Act”), which requires a payor accessing a preferred provider network contract to give a one time notice 30 days before that payor uses the discounted rate in the preferred provider network contract to pay the provider for services rendered to a member insured under that payor’s health benefit plan. These provider plaintiffs allege that the Act applies to medical bills for treatment rendered to injured workers and that the Act requires point of service written notice in the form of a benefit identification card. If a payor is found to have violated the Act’s notice provision, the court may assess up to $2,000 in damages for each instance when the provider was not given proper notice that a discounted rate would be used to pay for the services rendered. In response to the state court class action, FHGC and certain payors filed a suit in federal court against the same four provider plaintiffs in the state court class action seeking a declaratory judgment that FHGC’s contracts are valid and enforceable, that its contracts are not subject to the Act since that Act does not apply to medical services rendered to injured workers and that FHGC is exempt from the notice requirements of the Act because it has contracted directly with each provider in its network. The federal district court ruled in favor of FHGC and declared that its contracts are not subject to the Act, that FHGC was exempt from the Act’s notice provision because it contracted directly with the providers, and that FHGC’s contracts were valid and enforceable, i.e., the four provider plaintiffs were required to accept the discounted rate in accordance with the terms of their written contracts with FHGC.
Despite the federal court’s decision, the provider plaintiffs continued to pursue their state court class action against FHGC and filed a motion for partial summary judgment seeking damages of $2,000 for each provider visit where the provider was not given a benefit identification card at the time the service was performed. In response to the motion for partial summary judgment filed in the state court action, FHGC obtained an order from the federal court which enjoined, barred and prevented any of the four provider plaintiffs or their counsel from pursuing any claim against FHGC before any court or tribunal arising under the Act. Despite the issuance of this federal court injunction, the provider plaintiffs and their counsel pursued their motion for partial summary judgment in the state court action. Before the state court held a hearing on the motion for partial summary judgment, FHGC moved to decertify the class on the basis that the four named provider plaintiffs had been enjoined by the federal court from pursuing their claims against FHGC. The state court denied the motion to decertify the class but did enter an order permitting FHGC to file an immediate appeal of the state court’s denial of the motion. Even though FHGC had filed its appeal and there were no class representatives since all four named plaintiffs had been enjoined from pursuing their claims against FHGC, the state court held a hearing and granted the plaintiffs’ motion for partial summary judgment. The trial court granted the motion despite the fact that (1) the court lacked jurisdiction due to the appeal filed by FHGC challenging the denial of its motion to decertify the class; (2) there were no named class representatives because all four named plaintiffs had been enjoined from pursuing their claims against FHGC; (3) none of the providers in the class ever submitted a claim for payment to FHGC and therefore FHGC never made any discounted payments to any of the providers in the class in the absence of notice; (4) FHGC has contracted directly with every provider in the class and therefore, under the Act’s express language, FHGC was exempt from giving notice under the Act; and (5) the claims of the provider plaintiffs are time barred. The amount of the partial judgment was for $262 million. Class counsel will likely claim prejudgment interest and attorneys’ fees in addition to the $262 million judgment plus post judgment interest. FHGC appealed both the partial summary judgment order and the denial of class decertification order to the state’s intermediate appellate court. The intermediate appellate court has denied the class decertification appeal and FHGC’s rehearing petition. FHGC will file an application for a writ of appeal on the class decertification issue with the Louisiana Supreme Court. The decision to grant or deny the application for a writ of appeal is at the discretion of the Louisiana Supreme Court. The intermediate appellate court also denied FHGC’s appeal on the summary judgment order. FHGC’s petition for a rehearing is still pending before the intermediate appellate court. FHGC will file an application for a writ of appeal with the Louisiana Supreme Court if its rehearing petition is denied. FHGC also filed a motion with the federal court to enforce the federal court’s prior judgments and for sanctions against the provider plaintiffs for violating those judgments which barred and enjoined them from pursuing their claims against FHGC in the state courts. That motion also sought to enjoin the state courts from proceeding in order to protect and effectuate the federal court’s judgments. FHGC’s motion was denied by the federal court.
As a result of the Louisiana appellate court’s decision on July 1, 2010 to affirm the state trial court’s summary judgment order, the Company recorded a $278 million pre-tax charge to earnings during the second quarter of 2010. This amount represents the $262 million judgment amount plus post judgment interest in the amount of $16 million and is included in “accounts payable and other accrued liabilities” in the accompanying balance sheets as of June 30, 2010. The Company has accrued for legal fees expected to be incurred related to this case, which is included in “accounts payable and other accrued liabilities” in the accompanying balance sheets.
In a related matter, FHGC has filed another lawsuit in Louisiana federal district court against 85 Louisiana providers seeking a declaratory judgment that its contracts are valid and enforceable, that its contracts are not subject to the Act because its contracts pertain to payment for services rendered to injured workers, and FHGC is exempt from the notice provision of the Act because it has contracted directly with the providers. This lawsuit is assigned to the same federal district court judge who issued the decision and injunction in the lawsuit filed by FHGC against the four provider plaintiffs in the state court action.
On September 3, 2009, a shareholder, who owns less than 5,000 shares, filed a putative securities class action against the Company and three of its current and former officers in the federal district court of Maryland. Subsequent to the filing of the complaint, three other shareholders and/or investor groups filed motions with the court for appointment as lead plaintiff and approval of selection of lead and liaison counsel. By agreement, the four shareholders submitted a stipulation to the court regarding appointment of lead plaintiff and approval of selection of lead and liaison counsel. The court has approved the stipulation and ordered the lead plaintiff to file a consolidated and amended complaint by May 21, 2010. The amended complaint has been filed. The purported class period is February 9, 2007 to October 22, 2008. The amended complaint alleges that the Company’s public statements contained false, misleading and incomplete information regarding the Company’s profitability, particularly the profit margins for its PFFS products. The Company will vigorously defend against the allegations in the lawsuit. Although it cannot predict the outcome, the Company believes this lawsuit will not have a material adverse effect on its financial position or results of operations.
On October 13, 2009, two former employees and participants in the Coventry Health Care Retirement Savings Plan filed a putative ERISA class action lawsuit against the Company and several of its current and former officers, directors and employees in the U.S. District Court for the District of Maryland. Plaintiffs allege that defendants breached their fiduciary duties under ERISA by offering and maintaining Company stock in the Plan after it allegedly became imprudent to do so and by allegedly failing to provide complete and accurate information about the Company’s financial condition to plan participants in SEC filings and public statements. Three similar actions by different plaintiffs were later filed in the same court and were consolidated on December 9, 2009. As ordered by the court, the plaintiffs have filed a consolidated amended complaint. The Company intends to vigorously defend against the allegations in the consolidated complaint. Although it cannot predict the outcome, the Company believes this lawsuit will not have a material adverse effect on its financial position or results of operations.
There are several lawsuits filed against Vista Health Plan by non-participating providers seeking to be paid their full billed charges for services rendered to Vista's members. Vista reimburses non-participating providers at rates which are usual and customary for similar services in the same geographical area. Based on the various stages of development of these lawsuits, including discussions of settlement, the Company has recognized reserves for estimates of probable loss. Although it cannot predict the outcome, the Company believes these lawsuits will not have a material adverse effect on its financial position or results of operations.
Comprehensive income was as follows (in thousands):
The Company’s unrealized holding gains on its investment portfolio increased during the quarter and six months ended June 30, 2010 primarily due to movement in treasury yields.
I.INVESTMENTS AND FAIR VALUE MEASUREMENTS
The Company considers all of its investments as available-for-sale securities and accordingly records unrealized gains and losses within accumulated other comprehensive income in the stockholders’ equity section of its consolidated balance sheets.
The amortized cost, gross unrealized gain or loss, and estimated fair value of short-term and long-term investments by security type were as follows at June 30, 2010 and December 31, 2009 (in thousands):
(1) Includes FDIC insured Temporary Liquidity Guarantee Program securities.
(2) Agency pass-through, with the timely payment of principal and interest guaranteed.
(3) Includes auto loans, credit card debt, and rate reduction bonds.
(4) Includes investments in entities accounted for using the equity method of accounting and therefore are presented at their carrying value.
The amortized cost and estimated fair value of available for sale debt securities by contractual maturity were as follows at June 30, 2010 and December 31, 2009 (in thousands):
Investments with long-term option adjusted maturities, such as residential and commercial mortgage-backed securities, are included in the over 10 year category. Actual maturities may differ due to call or prepayment rights.
Gross investment gains of $11.7 million and gross investment losses of $4.3 million were realized on investment sales for the six months ended June 30, 2010. This compares to gross investment gains of $5.1 million and gross investment losses of $0.4 million that were realized on sales for the six months ended June 30, 2009. All realized gains and losses are recorded net of income taxes in other income, net in the Company’s consolidated statements of operations.
The following tables present the Company’s investments’ gross unrealized losses and estimated fair value, at June 30, 2010 and December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands).
The unrealized losses presented in these tables do not meet the criteria for treatment as an other-than-temporary impairment. The Company has not decided to sell and it is not more-likely-than not that the Company will be required to sell before a recovery of the amortized cost basis of these securities.
The Company continues to review its investment portfolios under its impairment review policy. Given the current market conditions and the significant judgments involved, there is a continuing risk that declines in fair value may occur and that other-than-temporary impairments may be recorded in future periods.
Fair Value Measurements
ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value and requires a three-tier fair value hierarchy that prioritizes the inputs used in measuring fair value based on the quality and reliability of the inputs or assumptions used in fair value measurements. These tiers include: Level 1 – defined as observable inputs such as quoted prices in active markets; Level 2 – defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3 – defined as unobservable inputs in which little or no market data exists, therefore requiring the Company to develop its own assumptions.
The following tables present the fair value hierarchy for the Company’s financial assets measured at fair value on a recurring basis at June 30, 2010 and December 31, 2009 (in thousands):
The following tables provide a summary of the changes in the estimated fair value of the Company’s Level 3 financial assets for the quarters and six months ended June 30, 2010 and 2009 (in thousands):
Quarter Ended June 30, 2010