Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010

or

 

¨ 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: 1-10864

 

 

UnitedHealth Group Incorporated

(Exact name of registrant as specified in its charter)

 

Minnesota   41-1321939

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

UnitedHealth Group Center

9900 Bren Road East

Minnetonka, Minnesota

  55343
(Address of principal executive offices)   (Zip Code)

(952) 936-1300

(Registrant’s telephone number, including area code)

 

 

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  ¨

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    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. (Check one):

Large accelerated filer  þ    Accelerated filer   ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ

As of October 29, 2010, there were 1,099,938,251 shares of the registrant’s Common Stock, $.01 par value per share, issued and outstanding.

 

 

 


Table of Contents

 

UNITEDHEALTH GROUP

Table of Contents

 

     Page  

Part I. Financial Information

  

Item 1. Financial Statements

     1   

Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009

     1   

Condensed Consolidated Statements of Operations for the three and nine months ended September  30, 2010 and 2009

     2   

Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2010 and 2009

     3   

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009

     4   

Notes to the Condensed Consolidated Financial Statements

     5   

Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     30   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     44   

Item 4. Controls and Procedures

     45   

Part II. Other Information

  

Item 1. Legal Proceedings

     46   

Item 1A. Risk Factors

     46   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     46   

Item 6. Exhibits

     47   

Signatures

     48   


Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1.     FINANCIAL STATEMENTS

UnitedHealth Group

Condensed Consolidated Balance Sheets

(Unaudited)

 

(in millions, except per share data)

   September 30,
2010
    December 31,
2009
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 9,577      $ 9,800   

Short-term investments

     1,426        1,239   

Accounts receivable, net

     2,082        1,954   

Assets under management

     2,508        2,383   

Deferred income taxes

     505        448   

Other current receivables

     1,708        1,838   

Prepaid expenses and other current assets

     450        538   
                

Total current assets

     18,256        18,200   

Long-term investments

     14,749        13,311   

Property, equipment and capitalized software, net

     2,033        2,140   

Goodwill

     22,855        20,727   

Other intangible assets, net

     3,008        2,381   

Other assets

     2,122        2,286   
                

Total assets

   $ 63,023      $ 59,045   
                

Liabilities and shareholders’ equity

    

Current liabilities:

    

Medical costs payable

   $ 9,177      $ 9,362   

Accounts payable and accrued liabilities

     7,152        6,283   

Other policy liabilities

     4,074        3,137   

Commercial paper and current maturities of long-term debt

     2,929        2,164   

Unearned revenues

     1,110        1,217   
                

Total current liabilities

     24,442        22,163   

Long-term debt, less current maturities

     8,076        9,009   

Future policy benefits

     2,341        2,325   

Other liabilities

     2,553        1,942   
                

Total liabilities

     37,412        35,439   
                

Commitments and contingencies (Note 14)

    

Shareholders’ equity:

    

Preferred stock, $0.001 par value — 10 shares authorized; no shares issued or outstanding

     0        0   

Common stock, $0.01 par value — 3,000 shares authorized; 1,099 and 1,147 issued and outstanding

     11        11   

Retained earnings

     25,109        23,342   

Accumulated other comprehensive income (loss):

    

Net unrealized gains on investments, net of tax effects

     514        277   

Foreign currency translation losses

     (23     (24
                

Total shareholders’ equity

     25,611        23,606   
                

Total liabilities and shareholders’ equity

   $     63,023      $     59,045   
                

See Notes to the Condensed Consolidated Financial Statements

 

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Table of Contents

 

UnitedHealth Group

Condensed Consolidated Statements of Operations

(Unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in millions, except per share data)

   2010     2009     2010     2009  

Revenues:

        

Premiums

   $     21,467      $     19,729      $     63,720      $     59,586   

Services

     1,469        1,336        4,246        3,939   

Products

     596        490        1,701        1,378   

Investment and other income

     136        140        458        451   
                                

Total revenues

     23,668        21,695        70,125        65,354   
                                

Operating costs:

        

Medical costs

     17,192        16,171        51,583        49,248   

Operating costs

     3,548        3,156        10,183        9,321   

Cost of products sold

     536        442        1,553        1,268   

Depreciation and amortization

     247        250        744        733   
                                

Total operating costs

     21,523        20,019        64,063        60,570   
                                

Earnings from operations

     2,145        1,676        6,062        4,784   

Interest expense

     (119     (137     (363     (407
                                

Earnings before income taxes

     2,026        1,539        5,699        4,377   

Provision for income taxes

     (749     (504     (2,108     (1,499
                                

Net earnings

   $ 1,277      $ 1,035      $ 3,591      $ 2,878   
                                

Basic net earnings per common share

   $ 1.15      $ 0.90      $ 3.18      $ 2.45   
                                

Diluted net earnings per common share

   $ 1.14      $ 0.89      $ 3.15      $ 2.43   
                                

Basic weighted-average number of common shares outstanding

     1,115        1,153        1,129        1,173   

Dilutive effect of common stock equivalents

     9        11        10        11   
                                

Diluted weighted-average number of common shares outstanding

     1,124        1,164        1,139        1,184   
                                

Anti-dilutive shares excluded from the calculation of dilutive effect of common stock equivalents

     97        110        98        115   

Cash dividends per common share

   $ 0.125      $ 0.000      $ 0.280      $ 0.030   

See Notes to the Condensed Consolidated Financial Statements

 

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UnitedHealth Group

Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Unaudited)

 

            Additional
Paid-In
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
Shareholders’
Equity
 
     Common Stock           

(in millions)

   Shares     Amount           

Balance at January 1, 2010

     1,147      $     11       $ 0      $     23,342      $     253      $     23,606   

Net earnings

            3,591          3,591   

Unrealized holding gains on investment securities during the period, net of tax expense of $154

              273        273   

Reclassification adjustment for net realized gains included in net earnings, net of tax expense of $19

              (36     (36

Foreign currency translation gain

              1        1   

Issuances of common stock, and related tax benefits

     11        0         126            126   

Common stock repurchases

     (59     0         (381     (1,511       (1,892

Share-based compensation, and related tax benefits

          255            255   

Common stock dividend

            (313       (313
                                                 

Balance at September 30, 2010

     1,099      $ 11       $ 0      $ 25,109      $ 491      $ 25,611   
                                                 

Balance at January 1, 2009

     1,201      $ 12       $ 38      $ 20,782      $ (52   $ 20,780   

Net earnings

            2,878          2,878   

Unrealized holding gains on investment securities during the period, net of tax expense of $226

              383        383   

Reclassification adjustment for net realized gains included in net earnings, net of tax expense of $2

              (4     (4

Foreign currency translation gains

              2        2   

Issuances of common stock, and related tax benefits

     18        0         190            190   

Common stock repurchases

     (66     0         (420     (1,148       (1,568

Share-based compensation, and related tax benefits

          273            273   

Common stock dividend

            (36       (36
                                                 

Balance at September 30, 2009

     1,153      $ 12       $ 81      $ 22,476      $ 329      $ 22,898   
                                                 

See Notes to the Condensed Consolidated Financial Statements

 

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UnitedHealth Group

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

     Nine Months Ended
September 30,
 

(in millions)

   2010     2009  

Operating activities

    

Net earnings

   $     3,591      $     2,878   

Noncash items:

    

Depreciation and amortization

     744        733   

Deferred income taxes

     (4     6   

Share-based compensation

     250        259   

Other

     25        14   

Net change in other operating items, net of effects from acquisitions and changes in AARP balances:

    

Accounts receivable

     (35     27   

Other assets

     94        (158

Medical costs payable

     (152     514   

Accounts payable and other liabilities

     297        227   

Other policy liabilities

     93        (73

Unearned revenues

     (71     (82
                

Cash flows from operating activities

     4,832        4,345   
                

Investing activities

    

Cash paid for acquisitions, net of cash assumed

     (2,072     (402

Purchases of property, equipment and capitalized software

     (548     (483

Purchases of investments

     (5,177     (4,861

Sales of investments

     1,927        3,516   

Maturities of investments

     2,236        2,116   
                

Cash flows used for investing activities

     (3,634     (114
                

Financing activities

    

Proceeds from (repayments of) commercial paper, net

     1,131        (99

Payments for retirement of long-term debt

     (1,333     (1,350

Proceeds from interest rate swap termination

     0        513   

Common stock repurchases

     (1,892     (1,568

Proceeds from common stock issuances

     189        247   

Share-based compensation excess tax benefit

     10        34   

Customer funds administered

     1,014        402   

Dividends paid

     (313     (36

Checks outstanding

     (221     (236

Other

     (6     (29
                

Cash flows used for financing activities

     (1,421     (2,122
                

(Decrease) increase in cash and cash equivalents

     (223     2,109   

Cash and cash equivalents, beginning of period

     9,800        7,426   
                

Cash and cash equivalents, end of period

   $ 9,577      $ 9,535   
                

See Notes to the Condensed Consolidated Financial Statements

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.    Basis of Presentation, Use of Estimates and Significant Accounting Policies

Basis of Presentation

The accompanying Condensed Consolidated Financial Statements include the consolidated accounts of UnitedHealth Group Incorporated and its subsidiaries (the Company). The Company has eliminated intercompany balances and transactions. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by U.S. Generally Accepted Accounting Principles (U.S. GAAP). In accordance with the rules and regulations of the U.S. Securities and Exchange Commission (SEC), the Company has omitted certain footnote disclosures that would substantially duplicate the disclosures contained in its annual audited Consolidated Financial Statements. As such, these Condensed Consolidated Financial Statements should be read together with the Consolidated Financial Statements and the Notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 as filed with the SEC (2009 10-K). The accompanying Condensed Consolidated Financial Statements include all normal recurring adjustments necessary to present the interim financial statements fairly.

Use of Estimates

These Condensed Consolidated Financial Statements include certain amounts based on the Company’s best estimates and judgments. The Company’s most significant estimates relate to medical costs, medical costs payable, revenues, goodwill, other intangible assets, investments, income taxes and contingent liabilities. These estimates require the application of complex assumptions and judgments, often because they involve matters that are inherently uncertain and will likely change in subsequent periods. The impact of any changes in estimates is included in earnings in the period in which the estimate is adjusted.

Recent Accounting Standards

Recently Adopted Accounting Standards. In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2010-06, “Improving Disclosures about Fair Value Measurements” (ASU 2010-06). This update amends the fair value guidance of the FASB Accounting Standards Codification (ASC) to require additional disclosures regarding (i) transfers in and out of Level 1 and Level 2 fair value measurements and (ii) activity in Level 3 fair value measurements. ASU 2010-06 also clarifies existing disclosure requirements regarding (i) the level of asset and liability disaggregation and (ii) fair value measurement inputs and valuation techniques. The new disclosures and clarifications of existing disclosures are effective for the Company’s fiscal year 2010, except for the disclosures about purchases, sales, issuances and settlements in the roll forward of activity in Level 3 fair value measurements, which will be effective for the Company’s fiscal year 2011. The Company’s fair value disclosures, including the new disclosures effective in 2010, have been included in Note 3 of Notes to the Condensed Consolidated Financial Statements.

The Company has determined that there have been no recently issued accounting standards that will have a material impact on its Condensed Consolidated Financial Statements, or apply to its operations.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

2.    Investments

A summary of short-term and long-term investments is as follows:

 

(in millions)

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair
Value
 

September 30, 2010

          

Debt securities — available-for-sale:

          

U.S. government and agency obligations

   $ 2,072       $ 64       $ 0      $ 2,136   

State and municipal obligations

     6,048         357         (2     6,403   

Corporate obligations

     4,384         291         (1     4,674   

U.S. agency mortgage-backed securities

     1,709         65         0        1,774   

Non-U.S. agency mortgage-backed securities

     458         35         0        493   
                                  

Total debt securities — available-for-sale

     14,671         812         (3     15,480   
                                  

Equity securities — available-for-sale

     481         20         (14     487   

Debt securities — held-to-maturity:

          

U.S. government and agency obligations

     173         7         0        180   

State and municipal obligations

     16         0         0        16   

Corporate obligations

     19         0         0        19   
                                  

Total debt securities — held-to-maturity

     208         7         0        215   
                                  

Total investments

   $ 15,360       $ 839       $ (17   $ 16,182   
                                  

December 31, 2009

          

Debt securities — available-for-sale:

          

U.S. government and agency obligations

   $ 1,566       $ 12       $ (11   $ 1,567   

State and municipal obligations

     6,080         248         (11     6,317   

Corporate obligations

     3,278         149         (6     3,421   

U.S. agency mortgage-backed securities

     1,870         64         (3     1,931   

Non-U.S. agency mortgage-backed securities

     535         8         (5     538   
                                  

Total debt securities — available-for-sale

     13,329         481         (36     13,774   
                                  

Equity securities — available-for-sale

     579         12         (14     577   

Debt securities — held-to-maturity:

          

U.S. government and agency obligations

     158         4         0        162   

State and municipal obligations

     17         0         0        17   

Corporate obligations

     24         0         0        24   
                                  

Total debt securities — held-to-maturity

     199         4         0        203   
                                  

Total investments

   $     14,107       $     497       $     (50   $     14,554   
                                  

Included in the Company’s investment portfolio were securities collateralized by sub-prime home equity lines of credit with fair values of $6 million and $9 million as of September 30, 2010 and December 31, 2009, respectively. Also included were Alt-A securities with fair values of $16 million and $19 million as of September 30, 2010 and December 31, 2009, respectively.

 

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Table of Contents

UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The fair values of the Company’s mortgage-backed securities by credit rating and non-U.S. agency mortgage-backed securities by origination as of September 30, 2010 were as follows:

 

(in millions)

   AAA      A      Non-
Investment
Grade
     Total Fair
Value
 

2007

   $ 77       $ 0       $ 3       $ 80   

2006

     130         0         16         146   

2005

     143         1         11         155   

Pre-2005

     111         1         0         112   

U.S agency mortgage-backed securities

     1,774         0         0         1,774   
                                   

Total

   $     2,235       $     2       $     30       $     2,267   
                                   

The amortized cost and fair value of available-for-sale debt securities as of September 30, 2010, by contractual maturity, were as follows:

 

(in millions)

   Amortized
Cost
     Fair
Value
 

Due in one year or less

   $ 1,638       $ 1,648   

Due after one year through five years

     5,094         5,382   

Due after five years through ten years

     3,601         3,869   

Due after ten years

     2,171         2,314   

U.S. agency mortgage-backed securities

     1,709         1,774   

Non-U.S. agency mortgage-backed securities

     458         493   
                 

Total debt securities — available-for-sale

   $     14,671       $     15,480   
                 

The amortized cost and fair value of held-to-maturity debt securities as of September 30, 2010, by contractual maturity, were as follows:

 

(in millions)

   Amortized
Cost
     Fair
Value
 

Due in one year or less

   $ 71       $ 72   

Due after one year through five years

     98         101   

Due after five years through ten years

     29         30   

Due after ten years

     10         12   
                 

Total debt securities — held-to-maturity

   $     208       $     215   
                 

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The fair value of available-for-sale investments with gross unrealized losses by investment type and length of time that individual securities have been in a continuous unrealized loss position were as follows:

 

     Less Than 12 Months     12 Months or Greater     Total  

(in millions)

   Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
    Fair Value      Gross
Unrealized
Losses
 

September 30, 2010

               

Debt securities — available-for-sale:

               

State and municipal obligations

   $ 145       $ (1   $ 18       $ (1   $ 163       $ (2

Corporate obligations

     272         (1     0         0        272         (1
                                                   

Total debt securities — available-for-sale

   $ 417       $ (2   $ 18       $ (1   $ 435       $ (3
                                                   

Equity securities — available-for-sale

   $ 202       $ (13   $ 11       $ (1   $ 213       $ (14
                                                   

December 31, 2009

               

Debt securities — available-for-sale:

               

U.S. government and agency obligations

   $ 437       $ (11   $ 4       $ 0      $ 441       $ (11

State and municipal obligations

     392         (6     100         (5     492         (11

Corporate obligations

     304         (3     69         (3     373         (6

U.S. agency mortgage-backed securities

     355         (3     2         0        357         (3

Non-U.S. agency mortgage-backed securities

     134         (1     86         (4     220         (5
                                                   

Total debt securities — available-for-sale

   $     1,622       $     (24   $     261       $     (12   $     1,883       $     (36
                                                   

Equity securities — available-for-sale

   $ 169       $ (13   $ 1       $ (1   $ 170       $ (14
                                                   

Investments classified as held-to-maturity have been excluded from the above analysis. These investments are predominantly held in U.S. government or agency obligations. Additionally, the fair values of these investments approximate their amortized cost.

The unrealized losses from all securities as of September 30, 2010 were generated from approximately 500 positions out of a total of approximately 13,000 positions. The Company believes that it will collect the principal and interest due on its investments that have an amortized cost in excess of fair value. The unrealized losses on investments in state and municipal obligations and corporate obligations as of September 30, 2010 were primarily caused by interest rate increases and not by unfavorable changes in the credit ratings associated with these securities. The Company evaluates impairment at each reporting period for securities where the fair value of the investment is less than its amortized cost. The Company evaluated the underlying credit quality of the issuers and the credit ratings of the state and municipal obligations and the corporate obligations, noting neither a significant deterioration since purchase nor other factors leading to an other-than-temporary impairment (OTTI). As of September 30, 2010, the Company did not have the intent to sell any of the securities in an unrealized loss position.

As of September 30, 2010, the Company’s holdings of non-U.S. agency mortgage-backed securities included $8 million of commercial mortgage loans in default. These investments were acquired in the first quarter of 2008

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

pursuant to an acquisition and were recorded at fair value. They represented less than 1% of the Company’s total mortgage-backed security holdings as of September 30, 2010.

A portion of the Company’s investments in equity securities and venture capital funds consists of investments held in various public and nonpublic companies concentrated in the areas of health care services and related information technologies. Market conditions that affect the value of health care and related technology stocks will likewise impact the value of the Company’s equity portfolio. The equity securities and venture capital funds were evaluated for severity and duration of unrealized loss, overall market volatility and other market factors.

Net realized gains, before taxes, were from the following sources:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in millions)

       2010             2009             2010             2009      

Total OTTI

   $     (13   $     (18   $     (18   $     (56

Portion of loss recognized in other comprehensive income

     0        0        0        0   
                                

Net OTTI recognized in earnings

     (13     (18     (18     (56

Gross realized losses from sales

     0        (9     (3     (38

Gross realized gains from sales

     14        27        76        100   
                                

Net realized gains

   $ 1      $ 0      $ 55      $ 6   
                                

For the three and nine months ended September 30, 2010 and 2009, all of the recorded OTTI charges resulted from the Company’s intent to sell certain impaired securities.

3.    Fair Value

Fair values of available-for-sale debt and equity securities are based on quoted market prices, where available. The Company obtains one price for each security primarily from a third-party pricing service (pricing service), which generally uses quoted or other observable inputs for the determination of fair value. The pricing service normally derives the security prices through recently reported trades for identical or similar securities, making adjustments through the reporting date based upon available observable market information. For securities not actively traded, the pricing service may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, non-binding broker quotes, benchmark yields, credit spreads, default rates and prepayment speeds. As the Company is responsible for the determination of fair value, it performs quarterly analyses on the prices received from the pricing service to determine whether the prices are reasonable estimates of fair value. Specifically, the Company compares the prices received from the pricing service to prices reported by its custodian, its investment consultant and third-party investment advisors. Additionally, the Company compares changes in the reported market values and returns to relevant market indices to test the reasonableness of the reported prices. Based on the Company’s internal price verification procedures and review of fair value methodology documentation provided by independent pricing services, the Company has not historically adjusted the prices obtained from the pricing service.

In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

measurement in its entirety. The Company’s assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.

The fair value hierarchy is as follows:

Level 1 — Quoted (unadjusted) prices for identical assets/liabilities in active markets.

Level 2 — Other observable inputs, either directly or indirectly, including:

 

   

Quoted prices for similar assets/liabilities in active markets;

 

   

Quoted prices for identical or similar assets in non-active markets (e.g., few transactions, limited information, non-current prices, high variability over time);

 

   

Inputs other than quoted prices that are observable for the asset/liability (e.g., interest rates, yield curves, volatilities, default rates); and

 

   

Inputs that are derived principally from or corroborated by other observable market data.

Level 3 — Unobservable inputs that cannot be corroborated by observable market data.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The following table presents information about the Company’s financial assets and liabilities, excluding AARP Program-related assets and liabilities, which are measured at fair value on a recurring basis, according to the valuation techniques the Company used to determine their fair values. See Note 11 of Notes to the Condensed Consolidated Financial Statements for further detail on AARP.

 

(in millions)

  Quoted Prices
in Active
Markets
(Level 1)
    Other
Observable
Inputs
(Level 2)
    Unobservable
Inputs

(Level 3)
    Total Fair
Value
 

September 30, 2010

       

Cash and cash equivalents

  $ 8,672      $ 905      $ 0      $ 9,577   

Debt securities — available-for-sale:

       

U.S. government and agency obligations

    1,412        724        0        2,136   

State and municipal obligations

    0        6,403        0        6,403   

Corporate obligations

    33        4,503        138        4,674   

U.S. agency mortgage-backed securities

    0        1,774        0        1,774   

Non-U.S. agency mortgage-backed securities

    0        485        8        493   
                               

Total debt securities — available-for-sale

    1,445        13,889        146        15,480   

Equity securities — available-for-sale

    282        2        203        487   
                               

Total cash, cash equivalents and investments at fair value

    10,399        14,796        349        25,544   
                               

Interest rate swap assets

    0        89        0        89   
                               

Total assets at fair value

  $ 10,399      $ 14,885      $ 349      $ 25,633   
                               

Percentage of total assets at fair value

    41     58     1     100
                               

December 31, 2009

       

Cash and cash equivalents

  $ 9,135      $ 665      $ 0      $ 9,800   

Debt securities — available-for-sale:

       

U.S. government and agency obligations

    1,024        543        0        1,567   

State and municipal obligations

    0        6,317        0        6,317   

Corporate obligations

    18        3,293        110        3,421   

U.S. agency mortgage-backed securities

    0        1,931        0        1,931   

Non-U.S. agency mortgage-backed securities

    0        528        10        538   
                               

Total debt securities — available-for-sale

    1,042        12,612        120        13,774   

Equity securities — available-for-sale

    262        3        312        577   
                               

Total cash, cash equivalents and investments at fair value

  $     10,439      $     13,280      $     432      $     24,151   
                               

Percentage of total cash, cash equivalents and investments at fair value

    43     55     2     100
                               

There were no transfers between Levels 1 and 2 during the three and nine months ended September 30, 2010.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The following methods and assumptions were used to estimate the fair value of each class of financial instrument:

Cash and Cash Equivalents. The carrying value of cash and cash equivalents approximates fair value as maturities are less than three months. Fair values of cash equivalent instruments that do not trade on a regular basis in active markets are classified as Level 2.

Debt Securities. The estimated fair values of debt securities held as available-for-sale are based on quoted market prices and/or other market data for the same or comparable instruments and transactions in establishing the prices. Fair values of debt securities that do not trade on a regular basis in active markets are classified as Level 2.

Equity Securities. Equity securities are held as available-for-sale investments. Fair value estimates for Level 1 and Level 2 publicly traded equity securities are based on quoted market prices and/or other market data for the same or comparable instruments and transactions in establishing the prices. The fair values of Level 3 investments in venture capital portfolios are estimated using market modeling approaches that rely heavily on management assumptions and qualitative observations. These investments totaled $166 million as of September 30, 2010. The fair values of the Company’s various venture capital investments are computed using limited quantitative and qualitative observations of activity for similar companies in the current market. The key inputs utilized in the Company’s market modeling include, as applicable, transactions for comparable companies in similar industries and having similar revenue and growth characteristics; similar preferences in the capital structure; discounted cash flows; liquidation values and milestones established at initial funding; and the assumption that the values of the Company’s venture capital investments can be inferred from these inputs. The Company’s remaining Level 3 equity securities holdings of $37 million mainly consist of preferred stock for which there is no active market.

Interest Rate Swaps. Fair values of the Company’s interest rate swaps are estimated using the terms of the swaps and publicly available market yield curves. Because the swaps are unique and not actively traded, the fair values are classified as Level 2.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

A reconciliation of the beginning and ending balances of assets measured at fair value on a recurring basis using Level 3 inputs is as follows:

 

     Three Months Ended     Nine Months Ended  

(in millions)

   Debt
Securities
    Equity
Securities
    Total     Debt
Securities
    Equity
Securities
    Total  

September 30, 2010

            

Balance at beginning of period

   $     107      $     186      $     293      $     120      $     312      $     432   

Purchases (sales), net

     39        15        54        25        (127     (102

Net unrealized gains in accumulated other comprehensive income

     0        3        3        0        9        9   

Net realized (losses) gains in investment and other income

     0        (1     (1     1        9        10   
                                                

Balance at end of period

   $ 146      $ 203      $ 349      $ 146      $ 203      $ 349   
                                                

September 30, 2009

            

Balance at beginning of period

   $ 60      $ 309      $ 369      $ 62      $ 304      $ 366   

(Sales) purchases, net

     (3     4        1        (5     9        4   

Net unrealized gains in accumulated other comprehensive income

     1        6        7        1        11        12   

Net realized losses in investment and other income

     (4     (10     (14     (4     (15     (19
                                                

Balance at end of period

   $ 54      $ 309      $ 363      $ 54      $ 309      $ 363   
                                                

There were no transfers into or from Level 3 for the three and nine months ended September 30, 2010 and 2009.

There were no significant fair value adjustments recorded during the three and nine months ended September 30, 2010 and 2009 for non-financial assets and liabilities or financial assets and liabilities that are measured at fair value on a nonrecurring basis. These assets and liabilities are subject to fair value adjustments only in certain circumstances, such as when the Company records impairments.

The table below includes fair values for certain financial instruments for which it is practicable to estimate fair value. The carrying values and fair values of these financial instruments were as follows:

 

     September 30, 2010      December 31, 2009  

(in millions)

   Carrying
Value
     Fair
Value
     Carrying
Value
     Fair
Value
 

Assets

           

Debt securities — available-for-sale

   $     15,480       $     15,480       $     13,774       $     13,774   

Equity securities — available-for-sale

     487         487         577         577   

Debt securities — held-to-maturity

     208         215         199         203   

AARP Program-related investments

     2,432         2,432         2,114         2,114   

Interest rate swap assets

     89         89         0         0   

Liabilities

           

Senior unsecured notes

     9,875         10,675         11,173         11,043   

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

In addition to the previously described methods and assumptions for debt and equity securities and interest rate swaps, the following are the methods and assumptions used to estimate the fair value of the other financial instruments:

AARP Program-related Investments. AARP Program-related investments consist of debt and equity securities held to fund costs associated with the AARP Program (see Note 11 of Notes to the Condensed Consolidated Financial Statements). The Company elected to measure the AARP assets under management at fair value pursuant to the fair value option. See the preceding discussion regarding the methods and assumptions used to estimate the fair value of investments in debt and equity securities.

Senior Unsecured Notes. The fair values of the senior unsecured notes are estimated based on third-party quoted market prices for the same or similar issues.

The carrying amounts reported in the Condensed Consolidated Balance Sheets for cash and cash equivalents, accounts and other current receivables, unearned revenues, commercial paper, accounts payable and accrued liabilities approximate fair value because of their short-term nature. These assets and liabilities are not listed in the table above.

4.    Medicare Part D Pharmacy Benefits Contract

The Condensed Consolidated Balance Sheets include the following amounts associated with the Medicare Part D program:

 

     September 30, 2010      December 31, 2009  

(in millions)

   CMS Subsidies (a)      Risk-Share      CMS Subsidies (a)      Risk-Share  

Other current receivables

   $         0       $         0       $         271       $         0   

Other policy liabilities

     544         353         0         268   

 

(a) Includes the Catastrophic Reinsurance Subsidy and the Low-Income Member Cost Sharing Subsidy.

The Catastrophic Reinsurance Subsidy and the Low-Income Member Cost Sharing Subsidy represent cost reimbursements under the Medicare Part D program. The Company is fully reimbursed by the Centers for Medicare and Medicaid Services (CMS) for costs incurred for these contract elements and, accordingly, there is no insurance risk to the Company. Amounts received for these subsidies are not reflected as premium revenues, but rather are accounted for as deposits in other policy liabilities in the Condensed Consolidated Balance Sheets. As of December 31, 2009, the amounts received for these subsidies were insufficient to cover the costs incurred for these contract elements; therefore, the Company recorded a receivable in other current receivables in the Condensed Consolidated Balance Sheets.

Premiums from CMS are subject to risk-sharing provisions based on a comparison of the Company’s annual bid estimates of prescription drug costs and the actual costs incurred. Variances may result in CMS making additional payments to the Company or require the Company to remit funds to CMS subsequent to the end of the year. The Company records risk-share adjustments to premium revenue and other policy liabilities or other current receivables in the Condensed Consolidated Balance Sheets.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

5.     Goodwill and Other Intangible Assets

Goodwill

Changes in the carrying amount of goodwill, by reporting segment, were as follows:

 

(in millions)

   Health
Benefits
    OptumHealth      Ingenix      Prescription
Solutions
     Consolidated  

Balance at December 31, 2009

   $     17,266      $     1,158       $     1,463       $     840       $     20,727   

Acquisitions

     0        179         1,904         0         2,083   

Subsequent Payments and Adjustments, net

     (3     0         48         0         45   
                                           

Balance at September 30, 2010

   $ 17,263      $ 1,337       $ 3,415       $ 840       $ 22,855   
                                           

Other Intangible Assets

Preliminary values assigned to finite-lived intangible assets, principally for technology related and customer contract intangibles, acquired in 2010 totaled $860 million. The effects of 2010 acquisitions on the Company’s Condensed Consolidated Financial Statements were not material.

6.    Medical Costs and Medical Costs Payable

Medical costs and medical costs payable include estimates of the Company’s obligations for medical care services that have been rendered on behalf of insured consumers, but for which claims have either not yet been received or processed, and for liabilities for physician, hospital and other medical cost disputes. The Company develops estimates for medical costs incurred but not reported using an actuarial process that is consistently applied, centrally controlled and automated. The actuarial models consider factors such as time from date of service to claim receipt, claim backlogs, care provider contract rate changes, medical care consumption and other medical cost trends. The Company estimates liabilities for physician, hospital and other medical cost disputes based upon an analysis of potential outcomes, assuming a combination of litigation and settlement strategies. Each period, the Company re-examines previously established medical costs payable estimates based on actual claim submissions and other changes in facts and circumstances. As the medical costs payable estimates recorded in prior periods develop, the Company adjusts the amount of the estimates and includes the changes in estimates in medical costs in the period in which the change is identified.

For the three months ended September 30, 2010, there was $80 million of net favorable medical cost development related to prior fiscal years and $150 million of net favorable medical cost development related to the first half of 2010. For the nine months ended September 30, 2010, medical costs included $660 million of net favorable medical cost development related to prior fiscal years. The favorable development for both the three and nine months ended September 30, 2010 was primarily driven by lower than expected health system utilization levels and more efficient claims handling and processing.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

For the three months ended September 30, 2009, there was $100 million of net favorable medical cost development related to prior fiscal years and $90 million of net favorable medical cost development related to the first half of 2009. For the nine months ended September 30, 2009 medical costs included $300 million of net favorable medical cost development related to prior fiscal years. None of the factors discussed above were individually material to the net favorable medical cost development in the three and nine months ended September 30, 2009.

7.    Commercial Paper and Long-Term Debt

Commercial paper and long-term debt consisted of the following:

 

    September 30, 2010     December 31, 2009  

(in millions)

  Par
Value
    Carrying
Value (a, b)
    Fair
Value (c)
    Par
Value
    Carrying
Value (b)
    Fair
Value (c)
 

Commercial paper

  $ 1,130      $ 1,130      $ 1,130      $ 0      $ 0      $ 0   

Senior unsecured floating-rate notes due June 2010

    0        0        0        500        500        499   

5.1% senior unsecured notes due November 2010

    250        251        251        250        257        259   

Senior unsecured floating-rate notes due February 2011

    250        250        251        250        250        251   

5.3% senior unsecured notes due March 2011 (d)

    705        717        719        750        781        777   

5.5% senior unsecured notes due November 2012 (d)

    352        376        382        450        480        481   

4.9% senior unsecured notes due February 2013 (d)

    534        544        574        550        549        575   

4.9% senior unsecured notes due April 2013 (d)

    409        429        441        450        464        472   

4.8% senior unsecured notes due February 2014 (d)

    172        189        187        250        268        256   

5.0% senior unsecured notes due August 2014 (d)

    389        433        430        500        540        518   

4.9% senior unsecured notes due March 2015 (d)

    416        467        459        500        544        513   

5.4% senior unsecured notes due March 2016 (d)

    601        688        684        750        847        772   

5.4% senior unsecured notes due November 2016

    95        95        108        95        95        98   

6.0% senior unsecured notes due June 2017 (d)

    441        510        515        500        587        523   

6.0% senior unsecured notes due November 2017 (d)

    156        177        183        250        285        258   

6.0% senior unsecured notes due February 2018

    1,100        1,099        1,284        1,100        1,099        1,136   

Zero coupon senior unsecured notes due November 2022 (e)

    1,095        581        670        1,095        558        611   

5.8% senior unsecured notes due March 2036

    850        844        889        850        844        762   

6.5% senior unsecured notes due June 2037

    500        495        573        500        495        493   

6.6% senior unsecured notes due November 2037

    650        645        757        650        645        651   

6.9% senior unsecured notes due February 2038

    1,100        1,085        1,318        1,100        1,085        1,138   
                                               

Total commercial paper and long-term debt

  $   11,195      $   11,005      $   11,805      $   11,340      $   11,173      $   11,043   
                                               

 

(a) The carrying value of debt has been adjusted based upon the applicable interest rate swap fair values discussed under “Interest Rate Swap Contracts” below.
(b) The carrying value of debt reflects accretion of issuance discounts and unamortized net gains or losses on related interest rate swap contracts, which terminated in January 2009.
(c) Estimated based on third-party quoted market prices for the same or similar issues.
(d) A portion of these notes was included in current maturities of long-term debt in the Condensed Consolidated Balance Sheets as of December 31, 2009 due to the debt tender offers discussed under “Debt Tender” below.
(e) These notes have been included in current maturities of long-term debt in the Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009 due to a current note holder option to “put” the note to the Company beginning on November 15, 2010, and on each November 15 thereafter until 2022 (except 2014), at accreted value.

Commercial Paper and Bank Credit Facility

Commercial paper consists of senior unsecured debt sold on a discount basis with maturities up to 270 days. As of September 30, 2010, the Company’s outstanding commercial paper had a weighted-average annual interest rate of 0.4%.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The Company has a $2.5 billion five-year revolving bank credit facility with 23 banks, which matures in May 2012. This facility supports the Company’s commercial paper program and is available for general corporate purposes. There were no amounts outstanding under this facility as of September 30, 2010. The interest rate is variable based on term and amount and is calculated based on the London Interbank Offered Rate (LIBOR) plus a spread. As of September 30, 2010, the annual interest rate on this facility, had it been drawn, would have ranged from 0.5% to 0.7%.

Debt Covenants

The Company’s bank credit facility contains various covenants including requiring the Company to maintain a debt-to-total-capital ratio, calculated as debt divided by the sum of debt and shareholders’ equity, below 50%. The Company was in compliance with its debt covenants as of September 30, 2010.

Debt Tender

In the first quarter of 2010, the Company completed cash tender offers for $775 million in aggregate principal of certain of its outstanding fixed-rate notes to improve the matching of interest rate exposure related to its floating rate assets and liabilities on its balance sheet.

Subsequent Event

In October 2010, the Company issued $750 million in senior unsecured notes under its February 2008 S-3 shelf registration statement. The issuance included $450 million of 3.875% fixed-rate notes due October 2020 and $300 million of 5.700% fixed-rate notes due October 2040. Concurrent with the issuance, the Company entered into interest rate swap contracts to convert the $450 million of 3.875% fixed-rate notes to floating rates.

Interest Rate Swap Contracts

During 2010, the Company entered into interest rate swap contracts with creditworthy bank counterparties to convert a portion of its interest rate exposure from fixed rates to floating rates to more closely align interest expense with interest income received on its cash equivalent and investment balances. The floating rates are benchmarked to LIBOR. The swaps are designated as fair value hedges of fixed-rate debt issues maturing between March 2011 and March 2016. Since the specific terms and notional amounts of the swaps match those of the debt being hedged, they were assumed to be highly effective hedges and all changes in fair value of the swaps were recorded on the Condensed Consolidated Balance Sheets with no net impact recorded in the Condensed Consolidated Statements of Operations.

The following table summarizes the location and fair value of fair value hedges on the Company’s Condensed Consolidated Balance Sheets as of September 30, 2010:

 

Type of Fair Value Hedge

   Notional
Amount
    

Balance Sheet Location

   Fair Value  
     (in millions)           (in millions)  

Interest rate swap contracts

   $     3,578      

Other assets

   $     89   

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The following table provides a summary of the effect of changes in fair value of fair value hedges on the Company’s Condensed Consolidated Statements of Operations:

 

Type of Fair Value Hedge

   Income Statement
Location of
Derivative Gain
     Hedge Gain
Recognized
     Hedged Item      Income Statement
Location of
Hedged Item Loss
     Hedged
Item Loss
Recognized
 
            (in millions)                    (in millions)  

Three Months Ended
September 30, 2010

              

Interest rate swap contracts

     Interest expense       $     56         Fixed rate debt         Interest expense       $     (56)   

Nine Months Ended September 30, 2010

              

Interest rate swap contracts

     Interest expense       $ 89         Fixed rate debt         Interest expense       $ (89)   

8.    Income Taxes

The Company’s income tax rates for both the three and nine months ended September 30, 2010 were 37.0%. The Company’s income tax rate for the three and nine months ended September 30, 2009 was 32.7% and 34.2%, respectively. The increase in the effective income tax rate resulted primarily from a benefit in the 2009 tax rate from the resolution of various historical state income tax matters, as well as from the limitations on the future deductibility of certain compensation related to the Patient Protection and Affordable Care Act, as modified by the Health Care and Education Reconciliation Act of 2010 (Health Reform Legislation), which was signed into law during the first quarter of 2010.

9.    Shareholders’ Equity

Share Repurchase Program

Under its Board of Directors’ authorization, the Company maintains a share repurchase program. The objectives of the share repurchase program are to optimize the Company’s capital structure and cost of capital, thereby improving returns to shareholders, as well as to offset the dilutive impact of share-based awards. Repurchases may be made from time to time at prevailing prices in the open market, subject to certain Board restrictions. In February 2010, the Board renewed and increased the Company’s share repurchase program, and authorized the Company to repurchase up to 120 million shares of its common stock. During the nine months ended September 30, 2010, the Company repurchased 59 million shares at an average price of approximately $32 per share and an aggregate cost of $1.9 billion. As of September 30, 2010, the Company had Board authorization to purchase up to an additional 65 million shares of its common stock.

Dividends

In May 2010, the Company’s Board of Directors increased the Company’s cash dividend to shareholders and moved the Company to a quarterly dividend payment cycle. Declaration and payment of future quarterly dividends is at the discretion of the Board and may be adjusted as business needs or market conditions change. Prior to May 2010, the Company’s policy had been to pay an annual dividend.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The following table provides details of the Company’s dividend payments in 2010:

 

Record Date

   Payment Date      Amount per Share      Total Amount Paid  
                   (in millions)  

  4/6/2010

     4/20/2010       $ 0.030       $ 34   

  6/7/2010

     6/21/2010         0.125         140   

9/14/2010

     9/28/2010         0.125         139   

10.    Share-Based Compensation

As of September 30, 2010, the Company had 58.7 million shares available for future grants of share-based awards under its share-based compensation plan, including, but not limited to, incentive or non-qualified stock options, stock-settled stock appreciation rights (SARs), and up to 12.4 million of awards in restricted stock and restricted stock units (collectively, restricted shares). The Company’s outstanding share-based awards consist mainly of non-qualified stock options, SARs and restricted shares.

Stock Options and SARs

Stock options and SARs generally vest ratably over four to six years and may be exercised up to 10 years from the date of grant. Stock option and SAR activity for the nine months ended September 30, 2010 is summarized in the table below:

 

     Shares     Weighted-
Average Exercise
Price
     Weighted-Average
Remaining
Contractual Life
     Aggregate
Intrinsic Value
 
     (in thousands)            (in years)      (in millions)  

Outstanding at beginning of period

     124,146      $ 39         

Granted

     9,370        33         

Exercised

     (6,684     19         

Forfeited

     (5,987     45         
                      

Outstanding at end of period

     120,845      $ 39         5.3       $ 443   
                      

Exercisable at end of period

     90,574      $ 40         4.3       $ 351   

Vested and expected to vest end of period

     116,448      $     39         5.2       $     430   

To determine compensation expense related to the Company’s stock options and SARs, the fair value of each award is estimated on the date of grant using an option-pricing model. For purposes of estimating the fair value of the Company’s employee stock option and SAR grants, the Company uses a binomial model. The principal assumptions the Company used in applying the option-pricing models were as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended September 30,  
         2010             2009             2010             2009      

Risk free interest rate

     1.4     2.4     1.4% - 2.1     1.7% - 2.4

Expected volatility

     45.4     46.5     45.4% - 46.2     41.3% - 46.5

Expected dividend yield

     1.5     0.1     0.1% - 1.7     0.1

Forfeiture rate

     5.0     5.0     5.0     5.0

Expected life in years

     4.6        4.4        4.6 - 5.1       4.4 - 5.1   

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

Risk-free interest rates are based on U.S. Treasury yields in effect at the time of grant. Expected volatilities are based on the historical volatility of the Company’s common stock and the implied volatility from exchange-traded options on the Company’s common stock. The Company uses historical data to estimate option and SAR exercises and forfeitures within the valuation model. The expected lives of options and SARs granted represents the period of time that the awards granted are expected to be outstanding based on historical exercise patterns.

The weighted-average grant date fair value of stock options and SARs granted during the three and nine months ended September 30, 2010 was approximately $11 per share and $13 per share, respectively. The weighted-average grant date fair value of stock options and SARs granted during both the three and nine months ended September 30, 2009 was approximately $10 per share. The total intrinsic value of stock options and SARs exercised during the three and nine months ended September 30, 2010 was $33 million and $96 million, respectively. The total intrinsic value of stock options and SARs exercised during the three and nine months ended September 30, 2009 was $32 million and $247 million, respectively.

Restricted Shares

Restricted shares generally vest ratably over three to five years. Compensation expense related to restricted shares is based on the share price on date of grant. Restricted share activity for the nine months ended September 30, 2010 is summarized in the table below:

 

(shares in thousands)

   Shares     Weighted-
Average Grant
Date Fair Value
 

Nonvested at beginning of period

     10,620      $ 32   

Granted

     5,550        32   

Vested

     (2,694     32   

Forfeited

     (390     32   
                

Nonvested at end of period

     13,086      $     32   
                

The weighted-average grant date fair value of restricted shares granted during the three and nine months ended September 30, 2010 was approximately $29 per share and $32 per share, respectively. The weighted-average grant date fair value of restricted shares granted during the three and nine months ended September 30, 2009 was approximately $27 per share and $29 per share, respectively. The total fair value of restricted shares vested during the three and nine months ended September 30, 2010 was $2 million and $86 million, respectively. The total fair value of restricted shares vested during the three and nine months ended September 30, 2009 was $2 million and $56 million, respectively.

Share-Based Compensation Recognition

The Company recognizes compensation expense for share-based awards, including stock options, SARs and restricted shares, on a straight-line basis over the related service period (generally the vesting period) of the award, or to an employee’s eligible retirement date under the award agreement, if earlier. For the three and nine months ended September 30, 2010, the Company recognized compensation expense related to its share-based compensation plans of $83 million ($75 million net of tax effects) and $250 million ($227 million net of tax effects), respectively. For the three and nine months ended September 30, 2009, the Company recognized compensation expense related to its share-based compensation plans of $79 million ($53 million net of tax effects) and $259 million ($174 million net of tax effects), respectively. Share-based compensation expense is recognized in operating costs in the Company’s Condensed Consolidated Statements of Operations. As of September 30, 2010, there was $509 million of total unrecognized compensation cost related to share awards that

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

is expected to be recognized over a weighted-average period of 1.3 years. For the three and nine months ended September 30, 2010, the income tax benefit realized from share-based award exercises was $12 million and $56 million, respectively. For the three and nine months ended September 30, 2009, the income tax benefit realized from share-based award exercises was $11 million and $80 million, respectively.

As further discussed in Note 9 of Notes to the Condensed Consolidated Financial Statements, the Company maintains a share repurchase program. The objectives of the share repurchase program are to optimize the Company’s capital structure, cost of capital and return to shareholders, as well as to offset the dilutive impact of shares issued for share-based award exercises.

11.    AARP

The Company provides health insurance products and services to members of AARP under a Supplemental Health Insurance Program (the Program), and separate Medicare Advantage and Medicare Part D arrangements. The products and services under the Program include supplemental Medicare benefits (AARP Medicare Supplement Insurance), hospital indemnity insurance, including insurance for individuals between 50 to 64 years of age, and other related products.

Under the Program, the Company is compensated for transaction processing and other services, as well as for assuming underwriting risk. The Company is also engaged in product development activities to complement the insurance offerings.

The Company’s agreement with AARP on the Program provides for the maintenance of the Rate Stabilization Fund (RSF) that is held by the Company on behalf of policyholders. Underwriting gains or losses related to the AARP Medicare Supplement Insurance business are directly recorded as an increase or decrease to the RSF. The primary components of the underwriting results are premium revenue, medical costs, investment income, administrative expenses, member service expenses, marketing expenses and premium taxes. Underwriting gains and losses are recorded as an increase or decrease to the RSF and accrue to the overall benefit of the AARP policyholders, unless cumulative net losses were to exceed the balance in the RSF. To the extent underwriting losses exceed the balance in the RSF, losses would be borne by the Company. Deficits may be recovered by underwriting gains in future periods of the contract. To date, the Company has not been required to fund any underwriting deficits. The RSF balance is reported in other policy liabilities in the Condensed Consolidated Balance Sheets and changes in the RSF are reported in medical costs in the Condensed Consolidated Statements of Operations. The Company believes the RSF balance as of September 30, 2010 is sufficient to cover potential future underwriting and other risks and liabilities associated with the contract.

The effects of changes in balance sheet amounts associated with the Program also accrue to the overall benefit of the AARP policyholders through the RSF balance. Accordingly, the Company excludes the effect of such changes in its Condensed Consolidated Statements of Cash Flows.

Under the Company’s agreement with AARP, the Company separately manages the assets that support the Program. These assets are held at fair value in the Condensed Consolidated Balance Sheets as assets under management. These assets are invested at the Company’s discretion, within investment guidelines approved by the Program, and are used to pay costs associated with the Program. The Company does not guarantee any rates of investment return on these investments and upon any transfer of the Program to another entity, the Company would transfer cash in an amount equal to the fair value of these investments at the date of transfer. Interest earnings and realized investment gains and losses on these assets accrue to the overall benefit of the AARP policyholders through the RSF and, thus, are not included in the Company’s earnings.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The Company elected to measure the entirety of the AARP assets under management at fair value, pursuant to the fair value option.

The following AARP Program-related assets and liabilities were included in the Company’s Condensed Consolidated Balance Sheets:

 

(in millions)

   September 30,
2010
     December 31,
2009
 

Accounts receivable

   $         523       $         509   

Assets under management

     2,508         2,383   

Medical costs payable

     1,171         1,182   

Accounts payable and accrued liabilities

     5         40   

Other policy liabilities

     1,253         1,145   

Future policy benefits

     509         482   

Other liabilities

     93         43   

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

The fair value of cash, cash equivalents and investments associated with the Program, reflected as assets under management, and the fair value of other assets and other liabilities were classified in accordance with the fair value hierarchy as discussed in Note 3 of Notes to the Condensed Consolidated Financial Statements and were as follows:

 

(in millions)

   Quoted Prices
in Active
Markets
(Level 1)
     Other
Observable
Inputs
(Level 2)
     Unobservable
Inputs
(Level 3)
     Total Fair
Value
 

September 30, 2010

           

Cash and cash equivalents

   $ 76       $ 0       $ 0       $ 76   

Debt securities:

           

U.S. government and agency obligations

     541         290         0         831   

State and municipal obligations

     0         14         0         14   

Corporate obligations

     0         1,114         0         1,114   

U.S. agency mortgage-backed securities

     0         335         0         335   

Non-U.S. agency mortgage-backed securities

     0         136         0         136   
                                   

Total debt securities

     541         1,889         0         2,430   
                                   

Equity securities — available-for-sale

     0         2         0         2   
                                   

Total cash, cash equivalents and investments at fair value

   $ 617       $ 1,891       $ 0       $     2,508   
                                   

Other liabilities

   $ 0       $ 0       $     93       $ 93   
                                   

Total liabilities at fair value

   $ 0       $ 0       $ 93       $ 93   
                                   

December 31, 2009

           

Cash and cash equivalents

   $ 269       $ 0       $ 0       $ 269   

Debt securities:

           

U.S. government and agency obligations

     358         298         0         656   

State and municipal obligations

     0         9         0         9   

Corporate obligations

     0         955         0         955   

U.S. agency mortgage-backed securities

     0         343         0         343   

Non-U.S. agency mortgage-backed securities

     0         149         0         149   
                                   

Total debt securities

     358         1,754         0         2,112   
                                   

Equity securities — available-for-sale

     0         2         0         2   
                                   

Total cash, cash equivalents and investments at fair value

   $     627       $     1,756       $ 0       $ 2,383   
                                   

Other liabilities

   $ 0       $ 0       $ 43       $ 43   
                                   

Total liabilities at fair value

   $ 0       $ 0       $ 43       $ 43   
                                   

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

12.    Comprehensive Income

The table below presents comprehensive income, defined as changes in the equity of the Company’s business excluding changes resulting from investments by and distributions to its shareholders.

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in millions)

       2010             2009             2010             2009      

Net earnings

   $ 1,277      $ 1,035      $ 3,591      $ 2,878   

Unrealized holding gains on investment securities arising during the period, net of tax expense of $72, $143, $154 and $226, respectively

     125        236        273        383   

Reclassification adjustment for net realized gains included in net earnings, net of tax expense of $0, $0, $19 and $2, respectively

     (1     0        (36     (4

Foreign currency translation gains (losses)

     14        (1     1        2   
                                

Comprehensive income

   $     1,415      $     1,270      $     3,829      $     3,259   
                                

13.    Segment Financial Information

The Company has four reporting segments:

 

   

Health Benefits, which includes UnitedHealthcare Employer & Individual (formerly UnitedHealthcare), UnitedHealthcare Medicare & Retirement (formerly Ovations) and UnitedHealthcare Community & State (formerly AmeriChoice);

 

   

OptumHealth;

 

   

Ingenix; and

 

   

Prescription Solutions.

The following is a description of the types of products and services from which each of the Company’s reporting segments derives its revenues:

 

   

Health Benefits includes the combined results of operations of UnitedHealthcare Employer & Individual, UnitedHealthcare Medicare & Retirement and UnitedHealthcare Community & State because they have similar economic characteristics, products and services, types of customers, distribution methods and operational processes and operate in a similar regulatory environment. These businesses also share significant common assets, including a contracted network of physicians, health care professionals, hospitals and other facilities, information technology infrastructure and other resources. UnitedHealthcare Employer & Individual offers a comprehensive array of consumer-oriented health benefit plans and services for large national employers, public sector employers, mid-sized employers, small businesses, students and individuals nationwide. UnitedHealthcare Medicare & Retirement provides health and well-being benefits and services to individuals age 50 and older, addressing their unique needs for preventive and acute health care services as well as services dealing with chronic disease and other specialized issues for older individuals. UnitedHealthcare Community & State provides network-based health and well-being benefits and services to beneficiaries of State Medicaid and Children’s Health Insurance Programs (CHIP) and other government-sponsored health care programs.

 

   

OptumHealth provides behavioral benefit solutions, clinical care management, financial services and specialty offerings such as dental and vision. OptumHealth helps consumers navigate the heath care system, finance their health care needs and better achieve their health and well-being goals.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

   

Ingenix offers database and data management services, software products, publications, consulting services, outsourced services and pharmaceutical consulting and research services in conjunction with the development of pharmaceutical products on a national and an international basis.

 

   

Prescription Solutions offers a comprehensive suite of integrated pharmacy benefit management services, including retail network pharmacy management, mail order pharmacy services, specialty pharmacy services, benefit design consultation, drug utilization review, formulary management programs, disease management and compliance and therapy management programs.

Transactions between reporting segments principally consist of sales of pharmacy benefit products and services to Health Benefits customers by Prescription Solutions, certain product offerings sold to Health Benefits customers by OptumHealth, and consulting and other services sold to Health Benefits by Ingenix. These transactions are recorded at management’s estimate of fair value. Intersegment transactions are eliminated in consolidation.

The following table presents reporting segment financial information:

 

(in millions)

  Health
Benefits
    OptumHealth     Ingenix (a)     Prescription
Solutions
    Corporate and
Intersegment
Eliminations
    Consolidated  

Three Months Ended September 30, 2010

           

Revenues — external customers:

           

Premiums

  $     20,832      $ 635      $ 0      $ 0      $ 0      $ 21,467   

Services

    1,012        83        358        16        0        1,469   

Products

    0        0        23        573        0        596   
                                               

Total revenues — external customers

    21,844        718        381        589        0        23,532   

Total revenues — intersegment

    0        735        211        3,591        (4,537     0   

Investment and other income

    119        16        0        1        0        136   
                                               

Total revenues

  $ 21,963      $ 1,469      $     592      $ 4,181      $ (4,537   $     23,668   
                                               

Earnings from operations

  $ 1,793      $ 143      $ 70      $ 139      $ 0      $ 2,145   

Interest expense

    0        0        0        0        (119     (119
                                               

Earnings before income taxes

  $ 1,793      $ 143      $ 70      $ 139      $ (119   $ 2,026   
                                               

Three Months Ended September 30, 2009

           

Revenues — external customers:

           

Premiums

  $ 19,090      $ 639      $ 0      $ 0      $ 0      $ 19,729   

Services

    976        71        277        12        0        1,336   

Products

    0        0        23        467        0        490   
                                               

Total revenues — external customers

    20,066        710        300        479        0        21,555   

Total revenues — intersegment

    0        690        181        3,095        (3,966     0   

Investment and other income

    124        15        0        1        0        140   
                                               

Total revenues

  $ 20,190      $     1,415      $ 481      $     3,575      $     (3,966   $ 21,695   
                                               

Earnings from operations

  $ 1,244      $ 172      $ 64      $ 196      $ 0      $ 1,676   

Interest expense

    0        0        0        0        (137     (137
                                               

Earnings before income taxes

  $ 1,244      $ 172      $ 64      $ 196      $ (137   $ 1,539   
                                               

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

(in millions)

  Health
Benefits
    OptumHealth     Ingenix (a)     Prescription
Solutions
    Corporate and
Intersegment
Eliminations
    Consolidated  

Nine Months Ended September 30, 2010

           

Revenues — external customers:

           

Premiums

  $ 61,836      $ 1,884      $ 0      $ 0      $ 0      $ 63,720   

Services

    2,999        238        962        47        0        4,246   

Products

    0        0        48        1,653        0        1,701   
                                               

Total revenues — external customers

    64,835        2,122        1,010        1,700        0        69,667   

Total revenues — intersegment

    0        2,167        616        10,787        (13,570     0   

Investment and other income

    403        51        0        4        0        458   
                                               

Total revenues

  $ 65,238      $ 4,340      $ 1,626      $ 12,491      $ (13,570   $ 70,125   
                                               

Earnings from operations

  $ 5,019      $ 455      $ 183      $ 405      $ 0      $ 6,062   

Interest expense

    0        0        0        0        (363     (363
                                               

Earnings before income taxes

  $ 5,019      $ 455      $ 183      $ 405      $ (363   $ 5,699   
                                               

Nine Months Ended September 30, 2009

           

Revenues — external customers:

           

Premiums

  $ 57,797      $ 1,789      $ 0      $ 0      $ 0      $ 59,586   

Services

    2,949        210        746        34        0        3,939   

Products

    0        0        44        1,334        0        1,378   
                                               

Total revenues — external customers

    60,746        1,999        790        1,368        0        64,903   

Total revenues — intersegment

    0        2,055        497        9,298        (11,850     0   

Investment and other income

    398        49        0        4        0        451   
                                               

Total revenues

  $     61,144      $     4,103      $     1,287      $     10,670      $     (11,850   $     65,354   
                                               

Earnings from operations

  $ 3,638      $ 472      $ 172      $ 502      $ 0      $ 4,784   

Interest expense

    0        0        0        0        (407     (407
                                               

Earnings before income taxes

  $ 3,638      $ 472      $ 172      $ 502      $ (407   $ 4,377   
                                               

 

(a) As of September 30, 2010, Ingenix’s total assets were $5.2 billion as compared to $2.4 billion as of December 31, 2009. The increase was due to acquisitions completed in the third quarter of 2010.

14.    Commitments and Contingencies

Legal Matters

Because of the nature of its businesses, the Company is frequently made party to a variety of legal actions and regulatory inquiries related to, among other things, the design and management of its service offerings. The Company records liabilities for its estimates of probable costs resulting from these matters where appropriate. These matters include, but are not limited to, claims relating to health care benefits coverage, medical malpractice actions, contract disputes and claims related to certain business practices. The adverse resolution of any specific lawsuit or any potential regulatory proceeding or action could have a material adverse effect on the Company’s business, financial condition and results of operations.

Litigation Matters

MDL Litigation. Beginning in 1999, a series of class action lawsuits were filed against the Company by health care providers alleging various claims relating to the Company’s reimbursement practices, including alleged

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

violations of the Racketeer Influenced Corrupt Organization Act (RICO) and state prompt payment laws and breach of contract claims. Many of these lawsuits were consolidated in a multi-district litigation in the United States District Court for the Southern District Court of Florida (MDL). In the lead MDL lawsuit, the court certified a class of health care providers for certain of the RICO claims. In 2006, the trial court dismissed all of the claims against the Company in the lead MDL lawsuit, and the Eleventh Circuit Court of Appeals later affirmed that dismissal, leaving eleven related lawsuits that had been stayed during the litigation of the lead MDL lawsuit. In August 2008, the trial court, applying its rulings in the lead MDL lawsuit, dismissed seven of these lawsuits (the seven lawsuits). The trial court also dismissed all but one claim in an eighth lawsuit, and ordered the final claim to arbitration. In December 2008, at the plaintiffs’ request, the trial court dismissed without prejudice one of the three remaining lawsuits. The court also denied the plaintiffs’ request to remand the remaining two lawsuits to state court and a federal magistrate judge recommended dismissal of those suits. In April 2009, the plaintiffs in these last two suits filed amended class action complaints alleging breach of contract, but those amended complaints were subsequently dismissed without prejudice. In July 2010, the Eleventh Circuit reversed the trial court’s dismissal of the seven lawsuits and remanded those cases to the trial court for further proceedings. In addition, the Company is party to a number of arbitrations in various jurisdictions involving claims similar to those alleged in the seven lawsuits. The Company is vigorously defending against the remaining claims in these cases.

AMA Litigation. On March 15, 2000, a group of plaintiffs including the American Medical Association (AMA) filed a lawsuit against the Company in state court in New York, which was removed to federal court. The complaint and subsequent amended complaints asserted antitrust claims and claims based on the Employee Retirement Income Security Act of 1974, as amended (ERISA), as well as breach of contract and the implied covenant of good faith and fair dealing, deceptive acts and practices, and trade libel in connection with the calculation of reasonable and customary reimbursement rates for non-network health care providers by the Company’s affiliates. On January 14, 2009, after almost nine years of litigation and many rulings from the court on various motions, the parties announced an agreement to settle the lawsuit, along with a similar case filed in 2008 in federal court in New Jersey. Under the terms of the settlement, the Company and its affiliated entities will be released from claims relating to their out-of-network reimbursement policies from March 15, 1994 through the date of final court approval of the settlement and the Company agreed to pay $350 million (the settlement amount) to a fund for health plan members and out-of-network providers in connection with out-of-network procedures performed since March 15, 1994. The agreement contains no admission of wrongdoing. The court granted preliminary approval of the settlement over the objections of certain plaintiffs’ counsel on December 1, 2009, and granted final approval of the settlement on September 20, 2010. On October 18, 2010, the Company paid the settlement amount, plus interest, to an escrow account established by the plaintiffs. Several members of the plaintiff class have indicated an intent to appeal approval of the settlement. Other lawsuits in various jurisdictions relating to the calculation of reasonable and customary reimbursement rates for non-network health care providers remain pending against a number of health insurers, including the Company.

California Claims Processing Matter. In 2007, the California Department of Insurance (CDI) examined the Company’s PacifiCare health insurance plan in California. The examination findings related to the timeliness and accuracy of claims processing, interest payments, provider contract implementation, provider dispute resolution and other related matters. On January 25, 2008, the CDI issued an Order to Show Cause to PacifiCare Life and Health Insurance Company, a subsidiary of the Company, alleging violations of certain insurance statutes and regulations in connection with the CDI’s examination findings. On June 3, 2009, the Company filed a Notice of Defense to the Order to Show Cause denying all material allegations and asserting certain defenses. The matter has been the subject of an administrative hearing before a California administrative

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

law judge (ALJ) since December 2009. CDI has recently amended its Order to Show Cause, alleging a significant number of additional violations, also relating to claims processing. After the ALJ issues a ruling at the conclusion of the administrative proceeding, the California Insurance Commissioner may accept, reject or modify the ALJ’s ruling, issue his own decision, and impose a fine or penalty. The Commissioner’s decision is subject to challenge in court.

Historical Stock Option Practices. In 2006, a consolidated shareholder derivative action, captioned In re UnitedHealth Group Incorporated Shareholder Derivative Litigation was filed against certain of the Company’s current and former officers and directors in the United States District Court for the District of Minnesota. The consolidated amended complaint was brought on behalf of the Company by several pension funds and other shareholders and named certain of the Company’s current and former officers and directors as defendants, as well as the Company as a nominal defendant. The consolidated amended complaint generally alleged that the defendants breached their fiduciary duties to the Company, were unjustly enriched and violated the securities laws in connection with the Company’s historical stock option practices. On June 26, 2006, the Company’s Board of Directors created a Special Litigation Committee under Minnesota Statute 302A.241, consisting of two former Minnesota Supreme Court Justices, with the power to investigate the claims raised in the derivative actions and shareholder demands and determine whether the Company’s rights and remedies should be pursued.

A consolidated derivative action, captioned In re UnitedHealth Group Incorporated Derivative Litigation, was also filed in Hennepin County District Court, State of Minnesota. The action was brought by two individual shareholders and named certain of the Company’s current and former officers and directors as defendants, as well as the Company as a nominal defendant.

On December 6, 2007, the Special Litigation Committee concluded its review of claims relating to the Company’s historical stock option practices and published a report. The Special Litigation Committee reached settlement agreements on behalf of the Company with its former Chairman and Chief Executive Officer William W. McGuire, M.D., former General Counsel David J. Lubben and former director William G. Spears. In addition, the Special Litigation Committee concluded that all claims against all named defendants in the derivative actions, including current and former Company officers and directors, should be dismissed. Each settlement agreement is conditioned upon dismissal of claims in the derivative actions and resolution of any appeals. Following notice to shareholders, the federal court granted the parties’ motion for final approval of the proposed settlements on July 1, 2009, and entered final judgment dismissing the federal case with prejudice on July 2, 2009. The state court granted the parties’ motion for final approval of the proposed settlements and dismissed the state case with prejudice on May 14, 2009, and entered final judgment on July 17, 2009. The federal and state courts also awarded plaintiffs’ counsel fees and expenses of $30 million and $6 million, respectively, which have been paid by the Company. A shareholder has filed an appeal with the U.S. Court of Appeals for the Eighth Circuit challenging only the federal plaintiffs’ counsel’s fee award. Federal plaintiffs’ counsel is contesting the appeal. A hearing on the appeal is scheduled for November 16, 2010.

As previously disclosed, the Company also received inquiries from a number of federal and state regulators from 2006 through 2008 regarding its historical stock option practices. Many of those inquiries have been closed, resolved or inactive since 2008.

 

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UNITEDHEALTH GROUP

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(Unaudited)

 

 

Government Regulation

The Company’s business is regulated at federal, state, local and international levels. The laws and rules governing the Company’s business and interpretations of those laws and rules are subject to frequent change. Broad latitude is given to the agencies administering those regulations. Further, the Company must obtain and maintain regulatory approvals to market and sell many of its products.

The Company has been and is currently involved in various governmental investigations, audits and reviews. These include routine, regular and special investigations, audits and reviews by CMS, state insurance and health and welfare departments, state attorneys general, the Office of the Inspector General, the Office of Personnel Management, the Office of Civil Rights, U.S. Congressional committees, the U.S. Department of Justice, U.S. Attorneys, the SEC, the IRS, the U.S. Department of Labor, the Federal Deposit Insurance Corporation and other governmental authorities. Examples of audits include a review by the U.S. Department of Labor of the Company’s administration of applicable customer employee benefit plans with respect to ERISA compliance and audits of the Company’s Medicare health plans to validate the coding practices of and supporting documentation maintained by its care providers.

Such government actions can result in assessment of damages, civil or criminal fines or penalties, or other sanctions, including loss of licensure or exclusion from participation in government programs and could have a material adverse effect on the Company’s financial results. The coding audits may result in prospective and retrospective adjustments to payments made to health plans pursuant to CMS Medicare contracts.

During the first quarter of 2010, the Health Reform Legislation was signed into law. The Health Reform Legislation, and existing or future laws and rules, could force the Company to change how it does business, restrict revenue and enrollment growth in certain products and market segments, restrict premium growth rates for certain products and market segments, increase its medical and administrative costs and capital requirements, expose it to an increased risk of liability (including increasing its liability in federal and state courts for coverage determinations and contract interpretation) or put it at risk for loss of business. In addition, the Company’s operating results, financial position, including its ability to maintain the value of its goodwill, and cash flows could be materially adversely affected by such changes.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read together with the accompanying Condensed Consolidated Financial Statements and Notes. References to the terms “we,” “our” or “us” used throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations refer to UnitedHealth Group Incorporated and its subsidiaries.

EXECUTIVE OVERVIEW

General

UnitedHealth Group is a diversified health and well-being company, whose focus is on improving the overall health and well-being of the people we serve and their communities and enhancing the performance of the health system. We work with health care professionals and other key partners to expand access to high quality health care. We help people get the care they need at an affordable cost; support the physician/patient relationship; and empower people with the information, guidance and tools they need to make personal health choices and decisions.

Through our diversified family of businesses, we leverage core competencies in advanced technology-based transactional capabilities; health care data, knowledge and information; and health care resource organization and care facilitation to help make health care work better. These core competencies are focused in two market areas, health benefits and health services. Health benefits are offered in the individual and employer markets and the public and senior markets through our UnitedHealthcare Employer & Individual (formerly UnitedHealthcare), UnitedHealthcare Medicare & Retirement (formerly Ovations) and UnitedHealthcare Community & State (formerly AmeriChoice) businesses. Health services are provided to the participants in the health system itself, ranging from employers and health plans to physicians and life sciences companies through our OptumHealth, Ingenix and Prescription Solutions businesses. In aggregate, these businesses have more than two dozen distinct business units that address specific end markets. Each of these business units focuses on the key goals in health and well-being: access, affordability, quality and simplicity as they apply to their specific market.

Revenues

Our revenues are primarily comprised of premiums derived from risk-based health insurance arrangements in which the premium is fixed, typically for a one-year period, and we assume the economic risk of funding our customers’ health care benefits and related administrative costs. We also generate revenues from fee-based services performed for customers that self-insure the health care costs of their employees and employees’ dependants. For both risk-based and fee-based health care benefit arrangements, we provide coordination and facilitation of medical services; transaction processing; health care professional services; and access to contracted networks of physicians, hospitals and other health care professionals. We also generate service revenues from Ingenix health intelligence and contract research businesses. Product revenues are mainly comprised of products sold by our Prescription Solutions pharmacy benefit management business and sales of Ingenix publishing and software products. We derive investment income primarily from interest earned on our investments in debt securities. Our investment income also includes gains or losses when the securities are sold, or other-than-temporarily impaired.

Operating Costs

Medical Costs. Our operating results depend in large part on our ability to effectively estimate, price for and manage our medical costs through underwriting criteria, product design, negotiation of favorable care provider contracts and medical management programs. Controlling medical costs requires a comprehensive and integrated approach to organize and advance the full range of interrelationships among patients/consumers, health professionals, hospitals, pharmaceutical/technology manufacturers and other key stakeholders.

 

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Medical costs include estimates of our obligations for medical care services rendered on behalf of insured consumers for which we neither have received nor processed claims, and our estimates for physician, hospital and other medical cost disputes. In every reporting period, our operating results include the effects of more completely developed medical costs payable estimates associated with previously reported periods.

Our medical care ratio, calculated as medical costs as a percentage of premium revenues, reflects the combination of pricing, benefit designs, consumer health care utilization and comprehensive care facilitation efforts. We seek to sustain a stable medical care ratio for an equivalent mix of business. However, changes in business mix, such as expanding participation in comparatively higher medical care ratio government-sponsored public sector programs and recently enacted Health Reform Legislation may impact our premiums, medical costs and medical care ratio.

Operating Costs. Operating costs are primarily comprised of costs related to employee compensation and benefits, agent and broker commissions, premium taxes and assessments, professional fees, advertising and occupancy costs. We seek to improve our operating cost ratio, calculated as operating costs as a percentage of total revenues, for an equivalent mix of business. However, changes in business mix, such as increases in the size of our health services businesses, and recently enacted Health Reform Legislation, may impact our operating costs and operating cost ratio.

Cash Flows

We generate cash primarily from premiums, service and product revenues and investment income, as well as proceeds from the sale or maturity of our investments. Our primary uses of cash are for payments of medical claims and operating costs, purchases of investments, common stock repurchases, acquisitions, dividends to shareholders and payments on debt. For more information on our cash flows, see “Liquidity” below.

Business Trends

Our businesses participate in the U.S. health economy, which comprises approximately 17% of U.S. gross domestic product and which has grown consistently for many years. We expect overall spending on health care in the U.S. to continue to rise in the future, due to inflation, medical technology and pharmaceutical advancement, regulatory requirements, demographic trends in the U.S. population and national interest in health and well-being. The rate of market growth may be affected by a variety of factors, including macro-economic conditions and enacted health care reforms, which could also impact our results of operations.

Health Care Reforms. In the first quarter of 2010, the Patient Protection and Affordable Care Act and a reconciliation measure, the Health Care and Education Reconciliation Act of 2010, which we refer to together as the Health Reform Legislation, were signed into law. The Health Reform Legislation enhances access to coverage and modifies aspects of the commercial insurance market, as well as the Medicaid and Medicare programs, CHIP and other aspects of the health care system. Provisions of the Health Reform Legislation become effective at various dates over the next several years. The Department of Health and Human Services (HHS), the Department of Labor and the Treasury Department have issued interim final regulations on a few aspects of Health Reform Legislation, but we await final rules and interim guidance on other key aspects of the legislation.

Due to the complexity of the Health Reform Legislation, including yet to be promulgated implementing regulations, lack of interpretive guidance and gradual implementation, the impact of the Health Reform Legislation is not yet fully known. While we anticipate the Health Reform Legislation will open new opportunities for business growth, we have focused the description of this legislation and its impacts principally on the risks it introduces or heightens for our existing businesses.

 

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The following outlines certain provisions of the Health Reform Legislation that will take effect in 2010 through 2014:

Effective 2010: Expansion of dependent coverage to include adult children until age 26; elimination of certain annual and lifetime caps on the dollar value of certain essential health benefits (yet to be fully defined); elimination of pre-existing condition limits for enrollees under 19; prohibitions on certain policy rescissions; cost sharing obligations for out of network emergency services; and a requirement to provide coverage for preventive services without cost to members (for non-grandfathered plans).

These Health Reform Legislation changes are expected to increase medical cost trends and affect our underwriting policies in the individual and group commercial markets. We have begun to implement the new provisions of the Health Reform Legislation as they have become effective for new and renewed plans and policies on and after September 23, 2010.

Effective 2010: Development of an annual review process of “unreasonable” increases in premiums for commercial health plans.

HHS has not yet promulgated rules relating to an annual review of “unreasonable” increases in premiums for commercial health plans. Depending on how HHS defines an “unreasonable” premium increase and what the annual review process entails, there is a broad range of potential business impacts, including undue delays in necessary premium rate increases in state jurisdictions that could jeopardize our ability to adequately fund future claims costs.

Effective 2011: Establishment of minimum medical cost ratios for all commercial fully insured health plans in the large employer group, small employer group and individual markets (85% for large employer groups, 80% for small employer groups and 80% for individuals); the individual market medical cost ratio is subject to adjustment by HHS if HHS determines that the requirement is disruptive to the market.

Beginning in 2011, companies with medical cost ratios below these targets will be required to rebate premiums to their customers annually. While the National Association of Insurance Commissioners (NAIC) has submitted their recommendations to HHS, rules addressing several important aspects of this requirement have not been promulgated, including the appropriate measurement and application of these ratios, such as defining which expenses should be classified as medical and which should be classified as non-medical for purposes of the calculation; which taxes, fees and assessments may be excluded from premium calculations; the definition of large and small groups; whether these calculations should be prepared by companies at the national level or on some type of disaggregated basis; and how often and to which period this test should be applied. Depending on the results of the calculation, there is a broad range of potential rebate and other business impacts in the near term and there could be meaningful disruption in local health care markets if companies decide to adjust their offerings in response to these requirements. For example, companies could elect to change pricing, modify product features or benefits, adjust their mix of business or even exit segments of the market. Companies could also seek to adjust their operating costs to support reduced premiums by making changes to their distribution arrangements or decreasing spending on non-medical product features and services. Given the breadth of possible changes, the lack of definitive guidance from HHS and the potential for meaningful market disruption in 2011 and 2012, we are not able to fully project the impact these medical cost ratios will have on our market share, revenues and results of operations. However, in the individual market (which represents less than 5% of our annual consolidated revenues and operating earnings), the minimum medical cost ratio, if not adjusted by HHS, will require changes to our pricing, product offerings and approach. We have begun making changes to reduce our product distribution costs in the individual market in response to this legislation. These changes could impact future growth in these products. Other market participants could also implement changes to their business practices in response to this legislation, which could positively or negatively impact our growth and market share.

 

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Effective 2011: Mandating consumer discounts of 50% on brand name prescription drugs for Part D plan participants in the coverage gap.

This statutory reduction in drug prices for seniors in the coverage gap may cause people who may have had difficulty affording their medications to increase their pharmaceutical usage. The change in pricing could also have secondary effects, such as changing the mix of brand name and generic drug usage. We have incorporated the anticipated impact of these changes in our 2011 product pricing.

Effective 2011/2012: Reduction in Medicare Advantage rates.

As part of the Health Reform Legislation, Medicare Advantage payment benchmarks for 2011 were frozen at 2010 levels. Separately, CMS implemented a reduction in Medicare Advantage reimbursements of 1.6% for 2011. We expect the 2011 rates will be outpaced by medical trends, placing continued importance on effective medical management and ongoing improvements in administrative costs. Beginning in 2012, additional cuts to Medicare Advantage plans will take effect (plans will ultimately receive 95% of Medicare fee-for-service rates in high cost areas to 115% in low cost areas), with changes being phased-in over two to six years, depending on the level of payment reduction in a county. There are a number of annual adjustments we can make to our operations, which may partially offset any impact from these rate reductions. For example, we can adjust members’ benefits, decide on a county-by-county basis which geographies to participate in and seek to intensify our medical and operating cost management. Additionally, achieving high quality scores from CMS for improving upon certain clinical and operational performance standards will impact future quality bonuses. Quality bonuses may further offset these anticipated rate reductions as CMS star rating bonuses are phased in over three years beginning in 2012. Market wide decreases in the availability of Medicare Advantage products and in the quality of benefits beyond base Medicare may increase demand for other senior health benefits products such as Medicare Part D and Medicare Supplement insurance.

Effective 2013: Limitation on the deductibility of executive compensation under Section 162(m) of the Internal Revenue Code for insurance providers if at least 25% of the insurance provider’s gross premium income from health business is derived from health insurance plans that meet the minimum creditable coverage requirements.

This provision is effective beginning in 2013 with respect to services performed after 2009. For a discussion of the 2010 impact of this provision on our consolidated results, see “2010 Results of Operations Compared to 2009 Results – Income Tax Rate” below.

Effective 2013/2014: Increase in Medicaid fee-for-service and managed care program reimbursements for primary care services provided by primary care doctors (family medicine, general internal medicine or pediatric medicine) to 100% of the Medicare payment rates for 2013 and 2014 and provides 100% federal financing for the difference in rates based on rates applicable on July 1, 2009.

The increase in Medicaid rates to primary care doctors are expected to increase cost trends for Medicaid Managed Care plans, but the increase should be fully offset by federal funding for the temporary increase.

Effective 2014: Annual insurance industry assessment ($8 billion levied on the insurance industry in 2014 with increasing annual amounts thereafter), which is not deductible for income tax purposes; expansion of Medicaid eligibility for all individuals and families with incomes up to 133% of the federal poverty level (states can early adopt the expansion without increased federal funding prior to 2014); states receive full federal matching in 2014 through 2016; all individual and group health plans must offer coverage on a guaranteed issued and guaranteed renewal basis during annual open enrollment and cannot apply pre-existing condition exclusions or health status rating adjustments; elimination of annual limits on essential benefits coverage on certain plans; establishment of state-based exchanges for individuals and small employers (with up to 100 employees) as well as certain CHIP eligibles; introduction of standardized plan designs based on set actuarial values to increase comparability of competing products on the exchanges; and establishment of minimum medical cost ratio of 85% for Medicare Advantage plans.

 

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Due to the lack of enabling regulations and guidance, we are not able to project the impact these reform provisions will have on our revenues, results of operations and cash flows.

Given the breadth of possible changes resulting from the Health Reform Legislation and from implementing regulations that have not yet been drafted, the Health Reform Legislation and the related regulations could change how we do business, restrict revenue and enrollment growth in certain products and market segments, restrict premium growth rates for certain products and market segments, increase our medical and administrative costs, expose us to an increased risk of liability (including increasing our liability in federal and state courts for coverage determinations and contract interpretation) or put us at risk for loss of business. In addition, our results of operations, financial position, including our ability to maintain the value of our goodwill, and cash flows could be materially adversely affected by such changes.

We operate a diversified set of health care focused businesses, and our business model has been intentionally designed to address a multitude of market sectors. For example, in addition to the potential impacts on our businesses described above, we also anticipate that the Health Reform Legislation will further increase attention on the need for health care cost containment and improvements in quality, as well as in prevention, wellness and disease management. We believe demand for many of our service offerings, such as consulting services, data management, information technology and related infrastructure construction, disease management programs and wellness programs will continue to grow. Therefore, we could see simultaneous increases and decreases in demand for our various products and services. For additional information regarding our risks related to health care reforms, see “Item 1A. Risk Factors” in Part II of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 (March 2010 10-Q).

Adverse Economic Conditions. The current U.S. recessionary economic environment has impacted demand for some of our products and services. For example, decreases in employment have reduced the number of workers and dependants offered health care benefits by our employer customers, putting pressure on top line growth for our UnitedHealthcare Employer & Individual and OptumHealth businesses. This workplace attrition will continue to impact UnitedHealthcare Employer & Individual’s commercial risk and fee-based membership throughout 2010 and is expected to continue until national employment stabilizes. In contrast, our UnitedHealthcare Community & State business is experiencing growth in its state Medicaid offerings as employment rates fall. If the recessionary economic environment continues for a prolonged period, federal and state governments may decrease funding for various health care government programs in which we participate and/or impose new or higher levels of taxes or assessments. Our revenues are also impacted by U.S. monetary and fiscal policy. In response to recessionary conditions, the U.S. Federal Reserve has maintained the target federal funds rate at a range of zero to 25 basis points.

In general, we believe that economic recessions could impact our revenue growth rate and our operating profitability. We also believe that government funding pressure, coupled with recessionary economic conditions, will impact the financial positions of hospitals, physicians and other care providers and could therefore increase medical cost trends experienced by our businesses. For additional discussions regarding how the adverse economic conditions could affect our business, see “Item 1A. Risk Factors” in Part I of our 2009 10-K.

Mental Health Parity and Addiction Equity Act. The Paul Wellstone-Pete Domenici Mental Health Parity and Addiction Equity Act 2008 (Mental Health Parity Act) became effective for plan years beginning on or after October 3, 2009 and requires that financial requirements and treatment limitations applicable to mental health or substance abuse benefits be no more restrictive than those imposed on medical and surgical benefits. The Mental Health Parity Act does not require plans to offer mental health or substance abuse benefits. The Federal Mental Health Parity Act became effective on July 1, 2010 for some plans, depending on their renewal date. Based on our current interpretations of the regulatory changes, we expect to see some impacts to risk-based behavioral health benefit costs beginning in 2011. Based on our customer renewal cycle, we believe the impact on our 2010 consolidated results of operations will not be material. We anticipate pricing actions in 2011 will partially mitigate the impact of revised regulations on our margins.

 

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RESULTS SUMMARY

 

     Three Months Ended September 30,      Nine Months Ended September 30,  

(in millions, except percentages and

per share data)

               Increase
(Decrease)
           Increase
(Decrease)
 
   2010     2009     2010 vs. 2009      2010     2009     2010 vs. 2009  

Revenues:

                 

Premiums

   $ 21,467      $ 19,729      $ 1,738        9    $ 63,720      $ 59,586      $ 4,134        7

Services

     1,469        1,336        133        10         4,246        3,939        307        8   

Products

     596        490        106        22         1,701        1,378        323        23   

Investment and other income

     136        140        (4     (3      458        451        7        2   
                                                                 

Total revenues

     23,668        21,695        1,973        9         70,125        65,354        4,771        7   
                                                                 

Operating costs:

                 

Medical costs

     17,192        16,171        1,021        6         51,583        49,248        2,335        5   

Medical care ratio

     80.1     82.0       (1.9      81.0     82.7       (1.7

Operating costs

     3,548        3,156        392        12         10,183        9,321        862        9   

Operating cost ratio

     15.0     14.5       0.5         14.5     14.3       0.2   

Cost of products sold

     536        442        94        21         1,553        1,268        285        22   

Depreciation and amortization

     247        250        (3     (1      744        733        11        2   
                                                                 

Total operating costs

     21,523        20,019        1,504        8         64,063        60,570        3,493        6   
                                                                 

Earnings from operations

     2,145        1,676        469        28         6,062        4,784        1,278        27   

Operating margin

     9.1     7.7       1.4         8.6     7.3       1.3   

Interest expense

     (119     (137     18        13         (363     (407     44        11   
                                                                 

Earnings before income taxes

     2,026        1,539        487        32         5,699        4,377        1,322        30   

Provision for income taxes

     (749     (504     (245     (49      (2,108     (1,499     (609     (41

Tax rate

     37.0     32.7       4.3         37.0     34.2       2.8   
                                                                 

Net earnings

   $ 1,277      $ 1,035      $ 242        23    $ 3,591      $ 2,878      $ 713        25
                                                                 

Net margin

     5.4     4.8       0.6      5.1     4.4       0.7

Diluted net earnings per common share

   $ 1.14      $ 0.89      $ 0.25        28    $ 3.15      $ 2.43      $ 0.72        30

Return on equity (a)

     20.3     18.6       1.7      19.5     17.7       1.8

 

(a) Return on equity is calculated as annualized net earnings divided by average equity for the last two and four quarters, for the three and nine months ended September 30, respectively.

2010 RESULTS OF OPERATIONS COMPARED TO 2009 RESULTS

Consolidated Financial Results

Revenues

The increases in revenues for the three and nine months ended September 30, 2010 were primarily due to strong organic growth in risk-based benefit offerings in our public and senior markets businesses and commercial premium rate increases reflecting underlying medical cost trends. Growth in customers served by our health services businesses, particularly through pharmaceutical benefit management programs, increasing revenues from public sector programs and increased sales of health care technology software and services also contributed to our revenue growth.

Medical Costs

Medical costs for the three and nine months ended September 30, 2010 increased primarily due to growth in our public and senior markets risk-based businesses and medical cost inflation, which were partially offset by decreases in commercial risk-based membership and net favorable development of prior period medical costs.

Changes in medical cost estimates related to prior periods, resulting from more complete claim information identified in the current period, are included in total medical costs reported for the current period. For the three

 

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months ended September 30, 2010, there was $80 million of net favorable medical cost development related to prior fiscal years and $150 million of net favorable medical cost development related to the first half of 2010. For the nine months ended September 30, 2010, medical costs included $660 million of net favorable medical cost development related to prior fiscal years. The favorable development for both the three and nine months ended September 30, 2010 was primarily driven by lower than expected health system utilization levels and more efficient claims handling and processing.

For the three months ended September 30, 2009, there was $100 million of net favorable medical cost development related to prior fiscal years and $90 million of net favorable medical cost development related to the first half of 2009. For the nine months ended September 30, 2009 medical costs included $300 million of net favorable medical cost development related to prior fiscal years.

Operating Costs

Operating costs for the three and nine months ended September 30, 2010 increased due to acquired and organic growth in health services businesses, costs related to increased employee headcount and compensation, increased advertising costs, and the absorption of new business development and start-up costs.

Income Tax Rate

The increases in our effective income tax rate for both the three and nine months ended September 30, 2010 as compared to the comparable periods in 2009 resulted from a benefit in the 2009 tax rate from the resolution of various historical state income tax matters and an increase in the 2010 rate related to limitations on the future deductibility of certain compensation related to the Health Reform Legislation.

Reporting Segments

We have four reporting segments:

 

   

Health Benefits, which includes UnitedHealthcare Employer & Individual, UnitedHealthcare Medicare & Retirement and UnitedHealthcare Community & State;

 

   

OptumHealth;

 

   

Ingenix; and

 

   

Prescription Solutions.

See Note 13 of Notes to the Condensed Consolidated Financial Statements for a description of the types and services from which each of these reporting segments derives its revenues.

Transactions between reporting segments principally consist of sales of pharmacy benefit products and services to Health Benefits customers by Prescription Solutions, certain product offerings sold to Health Benefits customers by OptumHealth, and consulting and other services sold to Health Benefits by Ingenix. These transactions are recorded at management’s estimate of fair value. Intersegment transactions are eliminated in consolidation.

 

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The following summarizes the operating results of our reporting segments:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  

(in millions, except percentages)

               Increase
(Decrease)
                Increase
(Decrease)
 
   2010     2009     2010 vs. 2009     2010     2009     2010 vs. 2009  

Revenues

                

Health Benefits

   $ 21,963      $ 20,190      $ 1,773        9   $ 65,238      $ 61,144      $ 4,094        7

OptumHealth

     1,469        1,415        54        4        4,340        4,103        237        6   

Ingenix

     592        481        111        23        1,626        1,287        339        26   

Prescription Solutions

     4,181        3,575        606        17        12,491        10,670        1,821        17   

Eliminations

     (4,537     (3,966     (571     nm        (13,570     (11,850     (1,720     nm   
                                                                

Consolidated revenues

   $ 23,668      $ 21,695      $ 1,973        9   $ 70,125      $ 65,354      $ 4,771        7
                                                                

Earnings from operations

                

Health Benefits

   $ 1,793      $ 1,244      $ 549        44   $ 5,019      $ 3,638      $ 1,381        38

OptumHealth

     143        172        (29     (17     455        472        (17     (4

Ingenix

     70        64        6        9        183        172        11        6   

Prescription Solutions

     139        196        (57     (29     405        502        (97     (19
                                                                

Consolidated earnings from operations

   $ 2,145      $ 1,676      $ 469        28   $ 6,062      $ 4,784      $ 1,278        27
                                                                

Operating margin

                

Health Benefits

     8.2     6.2       2.0     7.7     5.9       1.8

OptumHealth

     9.7        12.2          (2.5     10.5        11.5          (1.0

Ingenix

     11.8        13.3          (1.5     11.3        13.4          (2.1

Prescription Solutions

     3.3        5.5          (2.2     3.2        4.7          (1.5

Consolidated operating margin

     9.1     7.7       1.4     8.6     7.3       1.3

nm = not meaningful

The following summarizes the number of individuals served by our Health Benefits businesses, by major market segment and funding arrangement, as of September 30, 2010 and 2009:

 

           

Increase

(Decrease)

 

(in thousands, except percentages)

   2010      2009      2010 vs. 2009  

Commercial risk-based

     9,330         9,460         (130     (1 )% 

Commercial fee-based

     15,370         15,295         75        0   
                                  

Total commercial

     24,700         24,755         (55     (0
                                  

Medicare Advantage

     2,060         1,770         290        16   

Medicaid

     3,235         2,795         440        16   

Standardized Medicare supplement

     2,750         2,660         90        3   
                                  

Total public and senior

     8,045         7,225         820        11   
                                  

Total Health Benefits

     32,745         31,980         765        2
                                  

Health Benefits

The revenue growth in Health Benefits for the three and nine months ended September 30, 2010 was primarily due to growth in the number of individuals served by our public and senior markets businesses and commercial premium rate increases reflecting underlying medical cost trends, partially offset by Medicare Advantage premium rate decreases and a decline in individuals served through risk-based commercial products, principally reflecting the decline in U.S. employment. For the three and nine months ended September 30, 2010 revenues

 

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were $10.4 billion and $30.6 billion for UnitedHealthcare Employer & Individual; $8.8 billion and $27.1 billion for UnitedHealthcare Medicare & Retirement; and $2.7 billion and $7.5 billion for UnitedHealthcare Community & State, respectively. For the three and nine months ended September 30, 2009 revenues were $10.1 billion and $30.7 billion for UnitedHealthcare Employer & Individual; $7.9 billion and $24.4 billion for UnitedHealthcare Medicare & Retirement; and $2.1 billion and $6.1 billion for UnitedHealthcare Community & State, respectively.

Health Benefits earnings from operations and operating margins for the three and nine months ended September 30, 2010 increased over the prior year primarily due to factors that increased revenues described above as well as moderated levels of overall health system utilization and the effect of increased net favorable development in prior period medical costs.

OptumHealth

Increased revenues in OptumHealth for the three and nine months ended September 30, 2010 were driven by new business development in large scale public sector programs and increased sales of benefits and services to external employer markets, partially offset by a decline in revenues associated with a decrease in UnitedHealthcare Employer & Individual commercial membership and a loss of some smaller specialty benefits customers.

Earnings from operations and operating margins for the three and nine months ended September 30, 2010 decreased primarily due to the mix effect of lower margin public sector business, new market development and startup costs and costs related to the implementation of the Mental Health Parity Act.

Ingenix

Increased revenues in Ingenix for the three and nine months ended September 30, 2010 were primarily due to the impact of acquisitions and growth in health care information technology offerings and services focused on cost and data management and regulatory compliance.

The decrease in operating margin for the three and nine months ended September 30, 2010 was primarily due to increases in the mix of lower margin business, continued margin pressure in the pharmaceutical services business and continued investments in new growth areas.

Prescription Solutions

The increased Prescription Solutions revenues for the three and nine months ended September 30, 2010 were primarily due to growth in customers served through Medicare Part D prescription drug plans by our UnitedHealthcare Medicare & Retirement business. Intersegment revenues eliminated in consolidation for the three and nine months ended September 30, 2010 were $3.6 billion and $10.8 billion, respectively. Intersegment revenues eliminated in consolidation for the three and nine months ended September 30, 2009 were $3.1 billion and $9.3 billion, respectively.

Prescription Solutions earnings from operations and operating margin for the three and nine months ended September 30, 2010 decreased primarily due to changes in performance-based pricing contracts with Medicare Part D plan sponsors, which were partially offset by prescription volume growth, increased usage of mail service and generic drugs by consumers and effective operating cost management.

 

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LIQUIDITY, FINANCIAL CONDITION AND CAPITAL RESOURCES

Liquidity

Introduction

We manage our liquidity and financial position in the context of our overall business strategy. We continually forecast and manage our cash, investments, working capital balances and capital structure to meet the short- and long-term obligations of our businesses while maintaining liquidity and financial flexibility. Cash flows generated from operating activities are principally from earnings before depreciation, amortization and other non-cash expenses. As a result, any future decline in our profitability may have a negative impact on our liquidity. The diversity of our businesses, our geographic and customer diversity and our disciplined underwriting and pricing processes for our risk-based businesses, which seek to match premium rate increases with future expected medical costs, partially mitigates the risk of rising medical and operating costs.

Our regulated subsidiaries generate significant cash flows from operations. A majority of the assets held by our regulated subsidiaries are in the form of cash, cash equivalents and investments. After considering expected cash flows from operating activities, we generally invest cash of regulated subsidiaries that exceeds our expected short-term obligations in longer term, liquid, investment-grade, debt securities to improve our overall investment return. We make these investments pursuant to our Board of Directors’ approved investment policy, which focuses on preservation of capital, credit quality, diversification, income and duration. The policy also generally governs return objectives, regulatory limitations, tax implications and risk tolerances.

Our regulated subsidiaries are subject to regulations and standards in their respective states of domicile. Most of these regulations and standards conform to those established by the NAIC. These standards, among other things, require these subsidiaries to maintain specified levels of statutory capital, as defined by each state, and restrict the timing and amount of dividends and other distributions that may be paid to their parent companies. Except in the case of extraordinary dividends, these standards generally permit dividends to be paid from statutory unassigned surplus of the regulated subsidiary and are limited based on the regulated subsidiary’s level of statutory net income and statutory capital and surplus. These dividends are referred to as “ordinary dividends” and generally can be paid without prior regulatory approval. If the dividend, together with other dividends paid within the preceding twelve months, exceeds a specified statutory limit or is paid from sources other than earned surplus, the entire dividend is generally considered an “extraordinary dividend” and must receive prior regulatory approval.

In 2010, based on the 2009 statutory net income and statutory capital and surplus levels, the maximum amount of ordinary dividends that can be paid is $3.2 billion. For the nine months ended September 30, 2010, our regulated subsidiaries paid their parent companies dividends of $2.1 billion, including $214 million of extraordinary dividends. Fo