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 March 31, 2013
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to _________________
COMMISSION FILE NUMBER 1-16477
  
COVENTRY HEALTH CARE, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
52-2073000
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification Number)
6720-B ROCKLEDGE DRIVE, SUITE 700, BETHESDA, MARYLAND 20817
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (301) 581-0600
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes  T  No  £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes  T No  £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  T
 
Accelerated filer  £
Non-accelerated filer  £ (Do not check if a smaller reporting company)
 
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  T
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
 
Outstanding at April 15, 2013
 
 
 
Common Stock $.01 Par Value
 
134,739,756




COVENTRY HEALTH CARE, INC.
FORM 10-Q
TABLE OF CONTENTS 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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PART I.  FINANCIAL INFORMATION
ITEM 1: Financial Statements
COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
 
March 31,
2013
 
December 31,
2012
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,531,678

 
$
1,399,162

Short-term investments
120,745

 
121,742

Accounts receivable, net
260,809

 
272,077

Other receivables, net
945,218

 
892,815

Other current assets
195,479

 
196,323

Total current assets
3,053,929

 
2,882,119

 
 
 
 
Long-term investments
2,713,291

 
2,658,582

Property and equipment, net
261,668

 
266,818

Goodwill
2,591,488

 
2,591,488

Other intangible assets, net
302,118

 
318,592

Other long-term assets
32,783

 
33,389

Total assets
$
8,955,277

 
$
8,750,988

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Medical liabilities
$
1,476,557

 
$
1,418,914

Accounts payable and other accrued liabilities
509,930

 
488,175

Deferred revenue
150,999

 
137,981

Total current liabilities
2,137,486

 
2,045,070

 
 
 
 
Long-term debt
1,585,312

 
1,585,190

Other long-term liabilities
396,476

 
397,813

Total liabilities
4,119,274

 
4,028,073

Stockholders’ equity:
 

 
 

Common stock, $.01 par value; 570,000 authorized;
197,196 issued and 134,688 outstanding in 2013;
197,080 issued and 134,573 outstanding in 2012
1,972

 
1,971

Treasury stock, at cost; 62,508 in 2013; 62,507 in 2012
(1,920,996
)
 
(1,920,749
)
Additional paid-in capital
1,981,156

 
1,970,877

Accumulated other comprehensive income, net
53,757

 
69,220

Retained earnings
4,720,114

 
4,601,596

Total stockholders’ equity
4,836,003

 
4,722,915

Total liabilities and stockholders’ equity
$
8,955,277

 
$
8,750,988

 
See accompanying notes to the condensed consolidated financial statements.


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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
 
Quarters Ended March 31,
 
2013
 
2012
Operating revenues:
 

 
 

Managed care premiums
$
3,236,663

 
$
3,386,268

Management services
283,572

 
305,699

Total operating revenues
3,520,235

 
3,691,967

Operating expenses:
 

 
 

Medical costs
2,686,651

 
2,808,348

Cost of sales
59,485

 
67,952

Selling, general and administrative
520,300

 
502,888

Depreciation and amortization
37,631

 
36,303

Total operating expenses
3,304,067

 
3,415,491

 
 
 
 
Operating earnings
216,168

 
276,476

 
 
 
 
Interest expense
24,582

 
25,557

Other income, net
30,330

 
24,434

 
 
 
 
Earnings before income taxes
221,916

 
275,353

 
 
 
 
Provision for income taxes
86,547

 
104,634

 
 
 
 
Net earnings
$
135,369

 
$
170,719

 
 
 
 
Net earnings per common share:
 

 
 

Basic earnings per common share
$
1.01

 
$
1.21

Diluted earnings per common share
$
1.00

 
$
1.20

 
 
 
 
Cash dividends declared per share
$
0.125

 
$
0.125

 
 
 
 
Other comprehensive income, net of tax:
 

 
 

Change in unrealized investment holding gains
(10,326
)
 
7,537

Reclassification adjustment, net
(12,513
)
 
(4,339
)
Income tax benefit (provision)
7,376

 
(2,732
)
Other comprehensive income, net of tax
$
(15,463
)
 
$
466

Comprehensive income
$
119,906

 
$
171,185

 
See accompanying notes to the condensed consolidated financial statements.


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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
Three Months Ended March 31,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net earnings
$
135,369

 
$
170,719

Adjustments to earnings:
 

 
 

Depreciation and amortization
37,631

 
36,303

Amortization of stock compensation
5,972

 
9,014

RADV release

 
(132,977
)
RADV release – deferred tax adjustment

 
50,531

Changes in assets and liabilities:
 

 
 

Accounts receivable, net
11,268

 
39,538

Other receivables, net
(52,403
)
 
(84,455
)
Medical liabilities
57,643

 
101,984

Accounts payable and other accrued liabilities
20,252

 
(145,907
)
Deferred revenue
13,018

 
343,163

Other operating activities
(6,525
)
 
32,602

Net cash from operating activities
222,225

 
420,515

 
 
 
 
Cash flows from investing activities:
 

 
 

Capital expenditures, net
(15,871
)
 
(23,517
)
Proceeds from sales of investments
282,922

 
249,120

Proceeds from maturities of investments
67,125

 
122,567

Purchases of investments
(411,368
)
 
(345,530
)
Payments for acquisitions, net of cash acquired

 
(46,980
)
Net cash from investing activities
(77,192
)
 
(44,340
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from issuance of stock
4,397

 
25,404

Payments for repurchase of stock
(664
)
 
(4,564
)
Repayment of debt

 
(233,903
)
Excess tax benefit from stock compensation
565

 
2,868

Payments for cash dividends
(16,815
)
 

Net cash from financing activities
(12,517
)
 
(210,195
)
 
 
 
 
Net change in cash and cash equivalents
132,516

 
165,980

 
 
 
 
Cash and cash equivalents at beginning of period
1,399,162

 
1,579,003

 
 
 
 
Cash and cash equivalents at end of period
$
1,531,678

 
$
1,744,983

 
See accompanying notes to the condensed consolidated financial statements.

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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
A.    BASIS OF PRESENTATION AND SIGNIFICANT EVENTS
Basis of Presentation 
The condensed consolidated financial statements of Coventry Health Care, Inc. and its subsidiaries (“Coventry” or the “Company”) contained in this report are unaudited but reflect all normal recurring adjustments which, in the opinion of management, are necessary for the fair presentation of the results of the interim periods reflected. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission (“SEC”). The Company has eliminated all significant intercompany balances and transactions. Therefore, it is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10–K for the year ended December 31, 2012. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. The year-end balance sheet data included in this report was derived from audited financial statements. 
Significant Events
Proposed Merger
On August 19, 2012, the Company, Aetna Inc. (“Aetna”) and Jaguar Merger Subsidiary, Inc. (“Merger Sub”) entered into an Agreement and Plan of Merger, pursuant to which, subject to the satisfaction or waiver of certain conditions, Merger Sub will be merged with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Aetna. A copy of the Agreement and Plan of Merger was filed as Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on August 20, 2012. The Company subsequently entered into Amendment No. 1 and Amendment No. 2 to the Agreement and Plan of Merger, which were filed as Exhibit 2.1 to the Company’s Current Reports on Form 8-K filed on October 23, 2012 and November 13, 2012, respectively. As used herein, the “Merger Agreement” means the Agreement and Plan of Merger, by and among Coventry, Aetna and Merger Sub, as amended. Under the terms of the Merger Agreement, the Company’s stockholders will receive $27.30 in cash, without interest, and 0.3885 of an Aetna common share for each share of the Company’s common stock. The total transaction was initially estimated at approximately $7.3 billion, including the assumption of Coventry debt, based on the closing price of Aetna common shares on August 17, 2012.
On November 21, 2012, the Company’s stockholders voted at the stockholder special meeting to approve the adoption of the Merger Agreement. Of the 104,941,398 shares voting at the special meeting of stockholders, more than 99% voted in favor of the adoption of the Merger Agreement, which represented approximately 78% of the Company’s total outstanding shares of common stock as of the October 15, 2012 record date.
The consummation of the Merger is subject to customary closing conditions, including, among others, the adoption of the Merger Agreement by the Company’s stockholders, the absence of certain legal impediments to the consummation of the Merger, the receipt of specified governmental consents and approvals, the early termination or expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, and, subject to certain exceptions, the accuracy of representations and warranties made by the Company and Aetna, respectively, and compliance by the Company and Aetna with their respective obligations under the Merger Agreement. The Merger is expected to close in mid-2013.
Revenue Recognition
As described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, the Centers for Medicare and Medicaid Services (“CMS”) periodically performs audits and may seek return of premium payments made to the Company if risk adjustment factors are not properly supported by medical record data. The Company estimates and records reserves for CMS audits based on information available at the time the estimates are made. The judgments and uncertainties affecting the application of these policies include, among other things, significant estimates related to the amount of hierarchical condition category (“HCC”) revenue subject to audit, anticipated error rates, sample methodologies, confidence intervals, enrollee selection, and payment error extrapolation methodology.
During the quarter ended March 31, 2012, CMS released a “Notice of Final Payment Error Calculation Methodology for Part C Medicare Advantage Risk Adjustment Data Validation (“RADV”) Contract-Level Audits.” Most importantly, CMS made significant changes regarding which contract years are subject to the CMS RADV audits and other core areas of the audit methodology. As a result of this notice, the Company released RADV reserves, for contract years 2007 through 2011, resulting in an increase in operating earnings of $133.0 million during the quarter ended March 31, 2012.


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B.    NEW ACCOUNTING STANDARDS
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this Update require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (“GAAP”) to be reclassified in its entirety to net income. ASU 2013-02 is effective for reporting periods beginning after December 15, 2012. The Company adopted ASU 2013-02 in 2013, and did not materially affect the Company’s financial position or results of operations and comprehensive income.
In October 2012, the FASB issued ASU No. 2012-04, “Technical Corrections and Improvements.” The amendments in this Update cover a wide range of topics in the Accounting Standards Codification. These amendments include technical corrections and improvements to the Accounting Standards Codification and conforming amendments related to fair value measurements. ASU 2012-04 will be effective for fiscal periods beginning after December 15, 2012. The Company adopted ASU 2012-04, and did not materially affect the Company's financial position or results of operations and comprehensive income.

C.    SEGMENT INFORMATION
The Company has the following three reportable segments: Commercial Products, Government Programs, and Workers’ Compensation. Each of these segments, which the Company also refers to as “Divisions,” is separately managed and provides separate operating results that are evaluated by the Company’s chief operating decision maker. 
The Commercial Products Division is primarily comprised of the Company’s traditional health plan based Commercial and Individual Risk business.  Additionally, through this Division the Company contracts with various federal employee organizations to provide health insurance benefits under the Federal Employees Health Benefits Program (“FEHBP”) and offers administrative services only products to businesses that self-insure their health benefits managed care. This Division also contains the dental services, network rental and behavioral health benefits products.
The Government Programs Division includes the Company’s Medicare Part D and traditional health plan based Medicare Advantage Coordinated Care Plans (“Medicare Advantage CCP”) and Medicaid products. 
The Workers’ Compensation Division is comprised of fee-based, managed care services, such as provider network access, bill review, pharmacy benefit management, durable medical equipment and ancillary services, and care management services to underwriters and administrators of workers’ compensation insurance.
The tables below summarize the operating results of the Company’s reportable segments through the gross margin level, as that is the measure of profitability used by the chief operating decision maker to assess segment performance and make decisions regarding the allocation of resources.  A reconciliation of gross margin to operating earnings at a consolidated level is also provided.  Total assets by reportable segment are not disclosed as these assets are not reviewed separately by the Company’s chief operating decision maker.  The dollar amounts in the segment tables are presented in thousands.
 
Quarter Ended March 31, 2013
 
Commercial Products Division
 
Government Programs Division
 
Workers’ Compensation
 
Elim.
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
Managed care premiums
$
1,322,718

 
$
1,928,726

 
$

 
$
(14,781
)
 
$
3,236,663

Management services
108,084

 

 
175,488

 

 
283,572

Total operating revenues
1,430,802

 
1,928,726

 
175,488

 
(14,781
)
 
3,520,235

Medical costs
1,021,785

 
1,679,647

 

 
(14,781
)
 
2,686,651

Cost of sales

 

 
59,485

 

 
59,485

Gross margin
$
409,017

 
$
249,079

 
$
116,003

 
$

 
$
774,099

 
 
 
 
 
 
 
 
 
 
Selling, general and administrative
 

 
 

 
 

 
 

 
520,300

Depreciation and amortization
 

 
 

 
 

 
 

 
37,631

Operating earnings
 

 
 

 
 

 
 

 
$
216,168


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Quarter Ended March 31, 2012
 
Commercial Products Division
 
Government Programs Division
 
Workers’ Compensation
 
Elim.
 
Total
Operating revenues
 
 
 
 
 
 
 
 
 
Managed care premiums
$
1,481,275

 
$
1,915,795

 
$

 
$
(10,802
)
 
$
3,386,268

Management services
113,777

 

 
191,922

 

 
305,699

Total operating revenues
1,595,052

 
1,915,795

 
191,922

 
(10,802
)
 
3,691,967

Medical costs
1,177,985

 
1,641,165

 

 
(10,802
)
 
2,808,348

Cost of sales

 

 
67,952

 

 
67,952

Gross margin
$
417,067

 
$
274,630

 
$
123,970

 
$

 
$
815,667

 
 
 
 
 
 
 
 
 
 
Selling, general and administrative
 

 
 

 
 

 
 

 
502,888

Depreciation and amortization
 

 
 

 
 

 
 

 
36,303

Operating earnings
 

 
 

 
 

 
 

 
$
276,476


D.    DEBT
The Company’s outstanding debt consisted of the following (in thousands): 
 
March 31,
2013
 
December 31,
2012
6.300% Senior notes due 8/15/14, net of unamortized discount of $322 at March 31, 2013
$
374,775

 
$
374,718

6.125% Senior notes due 1/15/15
228,845

 
228,845

5.950% Senior notes due 3/15/17, net of unamortized discount of $561 at March 31, 2013
382,674

 
382,639

5.450% Senior notes due 6/7/21, net of unamortized discount of $982 at March 31, 2013
599,018

 
598,988

Total debt, including current portion
1,585,312

 
1,585,190

Less current portion of total debt

 

Total long-term debt
$
1,585,312

 
$
1,585,190

 
In January 2012, at maturity, the Company repaid the $233.9 million outstanding balance of its 5.875% Senior Notes. 
During 2011, the Company entered into a Credit Agreement (the “Credit Facility”).  The Credit Facility provides for a five-year revolving credit facility in the principal amount of $750.0 million, with the Company having the ability to request an increase in the facility amount up to an aggregate principal amount not to exceed $1 billion.  As of March 31, 2013 and December 31, 2012, there were no amounts outstanding under the Credit Facility.
The Company’s senior notes and Credit Facility contain certain covenants and restrictions regarding, among other things, liens, asset dispositions and consolidations or mergers.  Additionally, the Company’s Credit Facility requires compliance with a leverage ratio of 3 to 1 and limits subsidiary debt.  As of March 31, 2013, the Company was in compliance with the applicable covenants and restrictions under its senior notes and Credit Facility. 

E.    CONTINGENCIES
Legal Proceedings 
In the normal course of business, the Company has been named as a defendant in various legal actions such as actions seeking payments for claims denied by the Company, medical malpractice actions, employment related claims and other various claims seeking monetary damages. The claims are in various stages of proceedings and some may ultimately be brought to trial. Incidents occurring through December 31, 2012 may result in the assertion of additional claims. The Company maintains general liability, professional liability and employment practices liability insurances in amounts that it believes are appropriate, with varying deductibles for which it maintains reserves. The professional errors and omissions liability and employment practices liability insurances are carried through its captive subsidiary. Although the results of pending litigation are always uncertain, the Company does not believe the results of such actions currently threatened or pending, including those described below, will individually or in the aggregate have a material adverse effect on its consolidated financial position or results of operations and comprehensive income. 

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On September 3, 2009, a shareholder filed a putative securities class action against the Company and three of its current and former officers in the U.S. District Court for the District of Maryland. Subsequent to the filing of the complaint, three other shareholders and/or investor groups filed motions with the court for appointment as lead plaintiff and approval of selection of lead and liaison counsel. By agreement, the four shareholders submitted a stipulation to the court regarding appointment of lead plaintiff and approval of selection of lead and liaison counsel. In December 2009, the court approved the stipulation and ordered the lead plaintiff to file a consolidated and amended complaint. The purported class period was February 9, 2007 to October 22, 2008. The consolidated and amended complaint alleges that the Company’s public statements contained false, misleading and incomplete information regarding the Company’s profitability, particularly with respect to the profit margins for its Medicare Advantage Private-Fee-For-Service products.  The Company filed a motion to dismiss the complaint. By Order, dated March 31, 2011, the court granted in part, and denied in part, the Company’s motion to dismiss the complaint.  The Company filed a motion for reconsideration with respect to that part of the court’s March 31, 2011 Order which denied the Company’s motion to dismiss the complaint. The motion for reconsideration was denied but the court did rule that the class period was further restricted to April 25, 2008 to June 18, 2008.  As a result of a court ordered mediation, the Company has entered into a settlement agreement with counsel for the plaintiffs and the class. The parties will be submitting a formal written settlement agreement to the court for preliminary approval. These lawsuits are a covered claim under the Company’s Directors and Officers Liability Policy (“D&O Policy”), and therefore, after exhaustion of the Company’s self-insured retention of $2.5 million, the settlement amount will be fully funded and paid under the D&O Policy. The Company has accrued an immaterial settlement amount in “accounts payable and other accrued liabilities” and an associated recovery amount from the D&O Policy in “other receivables, net” in the accompanying balance sheet. 
On October 13, 2009, two former employees and participants in the Coventry Health Care Retirement Savings Plan filed a putative ERISA class action lawsuit against the Company and several of its current and former officers, directors and employees in the U.S. District Court for the District of Maryland. Plaintiffs allege that defendants breached their fiduciary duties under ERISA by offering and maintaining Company stock in the Plan after it allegedly became imprudent to do so and by allegedly failing to provide complete and accurate information about the Company’s financial condition to plan participants in SEC filings and public statements. Three similar actions by different plaintiffs were later filed in the same court and were consolidated on December 9, 2009. An amended consolidated complaint has been filed.  The Company filed a motion to dismiss the complaint. By Order, dated March 31, 2011, the court denied the Company’s motion to dismiss the amended complaint.  The Company filed a motion for reconsideration of the court’s March 31, 2011 Order and filed an Alternative Motion to Certify the Court’s March 31, 2011 Order For Interlocutory Appeal to the Fourth Circuit Court of Appeals. Both of those motions were denied. The Company will vigorously defend against the allegations in the consolidated lawsuit.  The Company believes this lawsuit will not have a material adverse effect on its financial position or results of operations.
On August 23, 2012, a putative stockholder class action lawsuit captioned Coyne v. Wise et al., C.A. No. 367380, was filed in the Circuit Court for Montgomery County, Maryland, against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On August 27, 2012, a second putative stockholder class action lawsuit captioned O’Brien v. Coventry Health Care, Inc. et al., C.A. 367577, was filed in the Circuit Court for Montgomery County, Maryland, against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On September 5, 2012, a third putative stockholder class action lawsuit captioned Preze v. Coventry Health Care, Inc. et al., C.A. 367942, was filed in the Circuit Court for Montgomery County, Maryland, against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. These three (3) actions have been consolidated. The complaints allege, among other things, that the individual defendants breached their fiduciary duties owed to Coventry’s public stockholders in connection with the Merger because the merger consideration and certain other terms in the Merger Agreement are unfair. The complaints further allege that Aetna and Merger Sub aided and abetted these alleged breaches of fiduciary duty. In addition, the complaints allege that the proposed Merger improperly favors Aetna and that certain provisions of the Merger Agreement unduly restrict Coventry’s ability to negotiate with other potential bidders. Among other remedies, the complaints seek injunctive relief prohibiting the defendants from completing the proposed Merger or, in the event that an injunction is not awarded, unspecified money damages, costs and attorneys’ fees. In November 2012, the court, in response to a motion filed by the Company, entered an order which stayed all three (3) actions for 90 days. On February 13, 2013, the plaintiffs in each of the 3 lawsuits filed a Notice of Voluntary Dismissal of their lawsuits based on the settlement of the similar shareholder lawsuits filed in Delaware.
On August 31, 2012, a putative stockholder class action lawsuit captioned Brennan v. Coventry Health Care, Inc. et al., C.A. No. 7826-CS, was filed in the Court of Chancery of the State of Delaware against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On September 14, 2012, a second putative stockholder class action lawsuit captioned Nashelsky v. Coventry Health Care, Inc. et al., C.A. No. 7868-CS, was filed in the Court of Chancery of the State of Delaware against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On September 27, 2012, and September 28, 2012, putative stockholder class action lawsuits captioned Employees’ Retirement System of the Government of the Virgin Islands v. Coventry Health Care, Inc. et al., C.A. No. 7905-CS and Farina v. Coventry Health Care, Inc. et al., C.A. No. 7909-CS, were filed in the Court of Chancery of the State of Delaware against the Coventry Board of Directors, Coventry, Aetna and Merger Sub. On October 1, 2012, an amended complaint was filed in the Brennan v. Coventry Health Care, Inc. action. The complaints generally allege that, among other things, the individual defendants breached their fiduciary duties owed to the public stockholders of Coventry in connection with the Merger because the merger consideration and certain other terms in the merger agreement are unfair. The complaints further allege that Aetna and Merger Sub aided and abetted these alleged breaches of fiduciary duty. In addition, the complaints generally allege that certain provisions of the Merger Agreement unduly restrict Coventry’s ability to negotiate with other potential bidders and that the Merger Agreement lacks adequate safeguards on behalf of

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Coventry’s stockholders against the decline in the value of the stock component of the merger consideration. The complaints in the Employees’ Retirement System of the Government of the Virgin Islands, and Farina actions and the amended complaint in the Brennan action also generally allege that Aetna’s Registration Statement on Form S-4 filed on September 21, 2012, contained various deficiencies. Among other remedies, the complaints generally seek injunctive relief prohibiting the defendants from completing the proposed Merger, rescissionary and other types of damages and costs and attorneys’ fees.
On October 4, 2012, the Court of Chancery of the State of Delaware entered an order consolidating the four Delaware actions under the caption In re Coventry Health Care, Inc. Shareholder Litigation, Consolidated C.A. No. 7905-CS, appointing the Employees’ Retirement System of the Government of the Virgin Islands, the General Retirement System of the City of Detroit, and the Police and Fire Retirement System of the City of Detroit as Co-Lead Plaintiffs. On October 5, 2012, plaintiffs in the consolidated Delaware action filed a motion for expedited proceedings, and on October 10, 2012, plaintiffs in the consolidated Delaware action filed a motion to preliminarily enjoin the defendants from taking any action to consummate the Merger. The parties have since reached agreement on the schedule for those proceedings, which was entered by order of the Court on October 12, 2012. Pursuant to that scheduling order, a hearing on plaintiffs’ preliminary injunction motion was scheduled for November 20, 2012. On November 12, 2012, the Company and all named defendants entered into a Memorandum of Understanding (“MOU”) with the plaintiffs and their respective counsel which set forth an agreement in principle providing for the settlement of the In re Coventry Health Care, Inc. Shareholder Litigation. In consideration for the full settlement and dismissal with prejudice of the Shareholder Litigation and releases, the defendants agreed to (1) include additional disclosures in the definitive prospectus/proxy statement; (2) amend the Merger Agreement to reduce the Termination Fee payable by the Company upon termination of the Merger Agreement from $167,500,000 to $100,000,000; (3) amend the Merger Agreement to reduce the period during which the Company is required to discuss and negotiate with Aetna before making an Adverse Recommendation Change relating to a Superior Proposal from five calendar days to two calendar days; and (4) pay any attorneys’ fees and expenses awarded by the court. The MOU requires the parties to negotiate and execute a Stipulation of Settlement for submission to the court to obtain final court approval of the settlement and dismissal of the Shareholder Litigation.
Where available information indicates that it is probable that a loss has been incurred as of the date of the consolidated financial statements and the Company can reasonably estimate the amount of that loss, the Company accrues a liability of an estimated amount. In many proceedings, however, it is difficult to determine whether any loss is probable or reasonably possible. In addition, even where a loss is reasonably possible or an exposure to a loss exists in excess of the liability already accrued with respect to a previously identified loss contingency, it is not always possible to reasonably estimate the amount of the possible loss or range of loss.
There is significant judgment required in both the probability determination and as to whether an exposure to a loss can be reasonably estimated. No estimate of the possible loss, or range of loss, in excess of amounts accrued, if any, can be made at this time regarding the matters specifically described above due to the inherently unpredictable nature of legal proceedings. These matters can be affected by various factors; including, but not limited to, the procedural status of the dispute, the novel legal issues presented (including the legal basis for the majority of the alleged violations), the inherent difficulty in predicting regulatory judgments, fines and penalties, and the various remedies and levels of judicial review available to the Company in the event a judgment, fine or penalty is assessed. If one or more of these legal matters were resolved against the Company for amounts in excess of the Company’s expectations, the Company’s financial position or results of operations and comprehensive income could be materially adversely affected.
Guaranty Fund Assessments 
The Company operates in a regulatory environment that may require the Company to participate in assessments under state insurance guaranty association laws. The Company’s exposure to guaranty fund assessments is based on its share of business it writes in the relevant jurisdictions for certain obligations of insolvent insurance companies to policyholders and claimants.  An assessment could have a material adverse effect on the Company’s financial position and results of operations and comprehensive income.


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F.    INVESTMENTS
The Company considers all of its investments as available-for-sale securities. Realized gains and losses on the sale of investments are determined on a specific identification basis. 
The amortized cost, gross unrealized gain or loss and estimated fair value of short-term and long-term investments by security type were as follows as of March 31, 2013 and December 31, 2012 (in thousands): 
 
Amortized
Cost
 
Unrealized
Gain
 
Unrealized
Loss
 
Fair
Value
As of March 31, 2013
 
 
 
 
 
 
 
State and municipal bonds
$
1,120,913

 
$
66,748

 
$
(726
)
 
$
1,186,935

U.S. Treasury securities
114,448

 
577

 
(1
)
 
115,024

Government-sponsored enterprise securities
79,039

 
248

 
(2
)
 
79,285

Residential mortgage-backed securities (1)
328,940

 
9,051

 
(793
)
 
337,198

Commercial mortgage-backed securities
33,938

 
80

 
(126
)
 
33,892

Asset-backed securities (2)
22,226

 
356

 
(10
)
 
22,572

Corporate debt and other securities
1,022,287

 
13,284

 
(559
)
 
1,035,012

 
$
2,721,791

 
$
90,344

 
$
(2,217
)
 
$
2,809,918

Equity method investments (3)
 

 
 

 
 

 
24,118

 
 

 
 

 
 

 
$
2,834,036

 
Amortized
Cost
 
Unrealized
Gain
 
Unrealized
Loss
 
Fair
Value
As of December 31, 2012
 

 
 

 
 

 
 

State and municipal bonds
$
1,176,016

 
$
78,272

 
$
(499
)
 
$
1,253,789

U.S. Treasury securities
78,264

 
669

 
(2
)
 
78,931

Government-sponsored enterprise securities 
72,394

 
1,139

 
(1
)
 
73,532

Residential mortgage-backed securities (1)
302,012

 
10,703

 
(74
)
 
312,641

Commercial mortgage-backed securities
21,416

 
193

 
(19
)
 
21,590

Asset-backed securities (2)
23,421

 
211

 
(6
)
 
23,626

Corporate debt and other securities
971,230

 
20,726

 
(346
)
 
991,610

 
$
2,644,753

 
$
111,913

 
$
(947
)
 
$
2,755,719

Equity method investments (3)
 

 
 

 
 

 
24,605

 
 

 
 

 
 

 
$
2,780,324

(1) 
Includes Agency pass-through securities, with the timely payment of principal and interest guaranteed.
(2) 
Includes auto loans, credit card debt, and rate reduction bonds.
(3) 
Includes investments in entities accounted for under the equity method of accounting and therefore are presented at their carrying value.
The amortized cost and estimated fair value of available-for-sale debt securities by contractual maturity were as follows as of March 31, 2013 and December 31, 2012 (in thousands): 
 
As of March 31, 2013
 
As of December 31, 2012
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Maturities:
 
 
 
 
 
 
 
Within 1 year
$
468,436

 
$
470,166

 
$
362,116

 
$
363,559

1 to 5 years
725,945

 
747,376

 
798,143

 
822,448

5 to 10 years
711,930

 
745,058

 
652,941

 
693,504

Over 10 years
815,480

 
847,318

 
831,553

 
876,208

Total
$
2,721,791

 
$
2,809,918

 
$
2,644,753

 
$
2,755,719

 

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Investments with long-term option adjusted maturities, such as residential and commercial mortgage-backed securities, are included in the “Over 10 years” category.  Actual maturities may differ due to call or prepayment rights. 
Gross investment gains of $12.8 million and $0.3 million gross investment losses were realized on sales of investments for the quarter ended March 31, 2013. This compares to gross investment gains of $4.3 million and no gross investment losses realized on sales of investments for the quarter ended March 31, 2012. All realized gains and losses are recorded in other income, net in the Company’s consolidated statements of operations and comprehensive income. 
The following table shows the Company’s investments’ gross unrealized losses and fair value at March 31, 2013 and December 31, 2012, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands): 
 
Less than 12 months
 
12 months or more
 
Total
At March 31, 2013
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
State and municipal bonds
$
110,627

 
$
(725
)
 
$
102

 
$
(1
)
 
$
110,729

 
$
(726
)
U.S. Treasury securities
1,774

 
(1
)
 

 

 
1,774

 
(1
)
Government-sponsored enterprise securities
11,786

 
(2
)
 

 

 
11,786

 
(2
)
Residential mortgage-backed securities
120,987

 
(792
)
 
60

 
(1
)
 
121,047

 
(793
)
Commercial  mortgage-backed securities
21,456

 
(126
)
 

 

 
21,456

 
(126
)
Asset-backed securities
13,988

 
(10
)
 

 

 
13,988

 
(10
)
Corporate debt and other securities
94,947

 
(557
)
 
52

 
(2
)
 
94,999

 
(559
)
Total
$
375,565

 
$
(2,213
)
 
$
214

 
$
(4
)
 
$
375,779

 
$
(2,217
)
 
Less than 12 months
 
12 months or more
 
Total
At December 31, 2012
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
State and municipal bonds
$
61,342

 
$
(499
)
 
$

 
$

 
$
61,342

 
$
(499
)
U.S. Treasury securities
2,458

 
(1
)
 
1,065

 
(1
)
 
3,523

 
(2
)
Government-sponsored enterprise securities
15,714

 
(1
)
 

 

 
15,714

 
(1
)
Residential mortgage-backed securities
23,861

 
(73
)
 
59

 
(1
)
 
23,920

 
(74
)
Commercial  mortgage-backed securities
7,701

 
(19
)
 

 

 
7,701

 
(19
)
Asset-backed securities
14,492

 
(6
)
 

 

 
14,492

 
(6
)
Corporate debt and other securities
79,381

 
(345
)
 
614

 
(1
)
 
79,995

 
(346
)
Total
$
204,949

 
$
(944
)
 
$
1,738

 
$
(3
)
 
$
206,687

 
$
(947
)

The unrealized losses presented in the table above do not meet the criteria for treatment as an other-than-temporary impairment. The unrealized losses are the result of, among other factors, interest rate movements. The Company has not decided to sell, and it is not more-likely-than-not that the Company will be required to sell before a recovery of the amortized cost basis of these securities. 
The Company continues to review its investment portfolios under its impairment review policy. Given the current market conditions and the significant judgments involved, there is a continuing risk that declines in fair value may occur and that other-than-temporary impairments may be recorded in future periods. 


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G.    FAIR VALUE MEASUREMENTS
Financial Assets 
Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures,” defines fair value and requires a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value based on the quality and reliability of the inputs or assumptions used in fair value measurements. 
The Company’s Level 1 securities primarily consist of U.S. Treasury securities and cash.  The Company determines the estimated fair value for its Level 1 securities using quoted (unadjusted) prices for identical assets or liabilities in active markets. 
The Company’s Level 2 securities primarily consist of government-sponsored enterprise securities, state and municipal bonds, mortgage-backed securities, asset-backed securities, corporate debt and money market funds.  The Company determines the estimated fair value for its Level 2 securities using the following methods: quoted prices for similar assets/liabilities in active markets, quoted prices for identical or similar assets in non-active markets (few transactions, limited information, non-current prices and high variability over time), inputs other than quoted prices that are observable for the asset/liability (e.g., interest rates, yield curves, volatilities and default rates, among others), and inputs that are derived principally from or corroborated by other observable market data. 
For the Company’s Level 2 assets, the following inputs and valuation techniques were utilized in determining the fair value of its financial instruments: 
Cash Equivalents: Level 2 cash equivalents are valued using inputs that are principally from, or corroborated by, observable market data, primarily quoted prices for like or similar assets. 
Government-Sponsored Enterprise Securities:  These securities primarily consist of bonds issued by government-sponsored enterprises, such as the Federal Home Loan Bank, the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.  The fair value of government-sponsored enterprise securities are based upon observable market inputs such as quoted prices for like or similar assets, benchmark yields, reported trades and credit spreads. 
State and Municipal Bonds, Corporate Debt and Other Securities:  The fair value of the Company’s debt securities is determined by observable market inputs which include quoted prices for identical or similar assets that are traded in an active market, benchmark yields, new issuances, issuer ratings, reported trades of comparable securities and credit spreads. 
Residential and Commercial Mortgage-Backed Securities and Asset-Backed Securities:  The fair value of these securities is determined either by observable market inputs, which include quoted prices for identical or similar assets that are traded in an active market, or by a cash flow model which utilizes the following inputs: benchmark yields, prepayment speeds, collateral performance, credit spreads and default rates that are observable at commonly quoted intervals. 
The Company has no Level 3 securities.
The Company obtains one price for each security from an independent third-party valuation service provider, which uses quoted or other observable inputs for the determination of fair value as noted above.  As the Company is responsible for the determination of fair value, the Company performs quarterly analyses on the prices received from the third-party provider to determine whether the prices are reasonable estimates of fair value.

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The following table presents the fair value hierarchy for the Company’s financial assets measured at fair value on a recurring basis at March 31, 2013 and December 31, 2012 (in thousands): 
 
 
 
Quoted Prices in Active Markets for Identical Assets
 
Significant Other Observable Inputs
 
Significant Unobservable Inputs
At March 31, 2013
Total
 
Level 1
 
Level 2
 
Level 3
Cash and cash equivalents
$
1,531,678

 
$
1,398,584

 
$
133,094

 
$

State and municipal bonds
1,186,935

 

 
1,186,935

 

U.S. Treasury securities
115,024

 
115,024

 

 

Government-sponsored enterprise securities
79,285

 

 
79,285

 

Residential mortgage-backed securities
337,198

 

 
337,198

 

Commercial mortgage-backed securities
33,892

 

 
33,892

 

Asset-backed securities
22,572

 

 
22,572

 

Corporate debt and other securities
1,035,012

 

 
1,035,012

 

Total
$
4,341,596

 
$
1,513,608

 
$
2,827,988

 
$


 
 
 
Quoted Prices in Active Markets for Identical Assets
 
Significant Other Observable Inputs
 
Significant Unobservable Inputs
At December 31, 2012
Total
 
Level 1
 
Level 2
 
Level 3
Cash and cash equivalents
$
1,399,162

 
$
1,218,046

 
$
181,116

 
$

State and municipal bonds
1,253,789

 

 
1,253,789

 

U.S. Treasury securities
78,931

 
78,931

 

 

Government-sponsored enterprise securities
73,532

 

 
73,532

 

Residential mortgage-backed securities
312,641

 

 
312,641

 

Commercial mortgage-backed securities
21,590

 

 
21,590

 

Asset-backed securities
23,626

 

 
23,626

 

Corporate debt and other securities
991,610

 

 
991,610

 

Total
$
4,154,881

 
$
1,296,977

 
$
2,857,904

 
$

 
Transfers between levels, if any, are recorded as of the end of the reporting period. During the quarter ended March 31, 2013 and the quarter ended March 31, 2012, there were no transfers between Level 1 and Level 2 and there were no transfers between Level 2 and Level 3.
Financial Liabilities 
The Company’s fair value of its publicly-traded debt (senior notes) is based on Level 2 inputs, including quoted market prices for the same or similar debt or, if no quoted market prices are available, on the current market observable rates estimated to be available to the Company for debt of similar terms and remaining maturities.  The carrying value of the Company’s senior notes (including the long-term and current portions) was $1.59 billion at March 31, 2013 and $1.59 billion at December 31, 2012.  The estimated fair value of the Company’s senior notes (including the long-term and current portions) was $1.80 billion at March 31, 2013 and $1.81 billion at December 31, 2012
The carrying value of the revolving credit facility approximates the fair value due to the short maturity dates of the draws. The Company had no outstanding borrowings under its current credit facility at March 31, 2013 or December 31, 2012.

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H.    STOCK-BASED COMPENSATION
Performance Share Units
Performance Share Units (“PSUs”) represent hypothetical shares of the Company’s common stock. The PSUs vest (if at all) based upon the achievement of certain performance goals and other criteria at various periods through 2015. The Company granted PSUs in 2012 and 2013. The performance goals for the two-year cumulative period for the 2013 targets were finalized in the first quarter of 2013 for all grants, which established the measurement date for accounting purposes of the PSUs. All PSUs vest at various periods through 2015 and all PSUs that vest will be paid out in cash based upon the price of the Company’s stock. The Company recorded compensation expense of $2.9 million related to the PSUs for the quarter ended March 31, 2013 and no expense for the quarter ended March 31, 2012. The related liability was $2.9 million and accrued in “accounts payable and other accrued liabilities” in the accompanying balance sheet at March 31, 2013.
The following table summarizes PSU activity for the quarter ended March 31, 2013:
 
 
Units
 
 
(in thousands)
Balance, January 1, 2013
 
627

Granted
 
170

Vested and Paid
 

Forfeited
 

Balance, March 31, 2013
 
797


Restricted Share Units
Restricted Share Units (“RSUs”) represent hypothetical shares of the Company’s common stock. The holders of RSUs have no rights as stockholders with respect to the shares of the Company’s common stock to which the awards relate. Some of the RSUs require the achievement of certain performance goals and other criteria in order to vest. All RSUs vest at various periods through 2016 and all RSUs that vest will be paid out in cash based upon the price of the Company’s stock. The Company recorded compensation expense of $3.0 million and $1.0 million related to the RSUs for the quarter ended March 31, 2013 and March 31, 2012, respectively. The RSUs are classified as a liability by the Company. The related liability, accrued in “accounts payable and other accrued liabilities” in the accompanying balance sheet, at March 31, 2013 and December 31, 2012 was $10.2 million and $7.2 million, respectively.
The following table summarizes RSU activity for the quarter ended March 31, 2013:
 
 
Units
 
 
(in thousands)
Balance, January 1, 2013
 
604

Granted
 
92

Vested and Paid
 

Forfeited
 
(1
)
Balance, March 31, 2013
 
695


I.    STOCKHOLDERS’ EQUITY
Share Repurchases
The Company’s Board of Directors has approved a program to repurchase its outstanding common shares. Share repurchases may be made from time to time at prevailing prices on the open market, by block purchase, or in private transactions. Under the share repurchase program, the Company did not repurchase any shares of its common stock during the quarters ended March 31, 2013 and 2012. As of March 31, 2013, the total remaining number of common shares the Company is authorized to repurchase under this program is 6.5 million; however, the Company is subject to certain restrictions under the Merger Agreement. Excluded from these share repurchase program amounts are shares purchased in connection with the vesting of restricted stock awards to satisfy employees’ minimum statutory tax withholding obligations as these purchases are not part of this program.
Dividends 
On March 11, 2013, the Board of Directors declared a quarterly cash dividend to its shareholders. A quarterly cash dividend of $0.125 per share, or $16.8 million in the aggregate, was accrued in “accounts payable and other accrued liabilities” in the accompanying balance sheet at March 31, 2013, and subsequently paid on April 9, 2013 to all shareholders of record as of the close of business on March

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22, 2013. 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.

J.    EARNINGS PER SHARE
Earnings per share (“EPS”) is calculated under the two-class method under which all earnings (distributed and undistributed) are allocated to each class of common stock and participating securities based on their respective rights to receive dividends.  The Company grants restricted stock to certain employees under its stock-based compensation program, which entitles recipients to receive non-forfeitable cash dividends during the vesting period on a basis equivalent to the dividends paid to holders of common stock.  These unvested awards meet the definition of participating securities. In accordance with ASC 260, “Earnings Per Share,” the two-class method has been applied to all periods presented.
Basic EPS is calculated using the weighted average number of common shares outstanding during the period. Diluted EPS assumes the exercise of all options. Options issued under the stock-based compensation program that have an antidilutive effect are excluded from the computation of diluted EPS. Potential common stock equivalents to purchase 2.4 million and 7.5 million shares for the quarters ended March 31, 2013 and 2012, respectively, were excluded from the computation of diluted earnings per common share because the potential common stock equivalents were antidilutive. 
The table below provides the reconciliation of the earnings and number of shares used in the Company's calculations of basic and diluted earnings per share. 
 
Quarters Ended March 31,
 
2013
 
2012
(in thousands, except for per share data)
 
Basic earnings per common share
 
 
 
Net Earnings
$
135,369

 
$
170,719

Less: Distributed and undistributed earnings allocated to participating securities
(1,155
)
 
(2,472
)
Net earnings allocable to common shares
$
134,214

 
$
168,247

 
 
 
 
Basic weighted average common shares outstanding
133,464

 
139,323

Basic earnings per common share
$
1.01

 
$
1.21

 
 
 
 
Diluted earnings per common share
 

 
 

Net Earnings
$
135,369

 
$
170,719

Less: Distributed and undistributed earnings allocated to participating securities
(1,149
)
 
(2,459
)
Net earnings allocable to common shares
$
134,220

 
$
168,260

 
 
 
 
Basic weighted average common shares outstanding
133,464

 
139,323

Effect of dilutive options
836

 
844

Diluted weighted average common shares outstanding
134,300

 
140,167

Diluted earnings per common share
$
1.00

 
$
1.20



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K.    OTHER DISCLOSURES
Other Income, net
The following table presents the components of Other Income, net for the quarters ended March 31, 2013 and 2012 (in millions):
 
Quarters Ended March 31,
 
2013
 
2012
 
 
 
 
Interest income
$
16.5

 
$
18.4

Gains on sales of investments
$
12.5

 
$
4.3

Other income
$
1.3

 
$
1.7

Other income, net
$
30.3

 
$
24.4


Concentration of Credit Risk
The Company is a provider of health insurance coverage to State of Illinois employees and their dependents. As of December 31, 2012, the Company had an outstanding premium receivable from the State of Illinois of approximately $32.2 million. During the quarter, the Company started participating with the Vendor Assistance Program (“VAP”) which is run by a privately held company that has assumed receivables from certain of the State of Illinois vendors. As of March 31, 2013, the Company has an outstanding premium receivable balance from the State of Illinois of approximately $17.1 million, which represents three months of health insurance premiums owed at 100% and four months owed at 10%.  As the receivable is from a governmental entity which has been making payments, the Company believes that the full receivable balance will ultimately be realized and therefore has not reserved against the outstanding balance. The Company’s regulated subsidiaries are required to submit statutory-basis financial statements to state regulatory agencies. For those financial statements, in accordance with state regulations, this receivable is being treated as an admitted asset in its entirety.
The Company believes its allowance for doubtful accounts adequately provides for estimated losses as of March 31, 2013.  The Company has a risk of incurring losses if such allowances are not adequate. 
The Company contracts with a pharmacy benefit management (“PBM”) vendor to manage pharmacy benefits for its members and to provide rebate administration services on behalf of the Company.  The Company had pharmacy rebate receivables of $302.5 million and $305.4 million as of March 31, 2013 and December 31, 2012, respectively, due from the PBM vendor resulting from the normal cycle of rebate processing, data submission and collection of rebates.  The Company has credit risk due to the concentration of receivables with this single vendor; although the Company does not consider the associated credit risk to be significant.  The Company only records the pharmacy rebate receivables to the extent that the amounts are deemed probable of collection.


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Table of Contents

ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations 
General Information
This quarterly report on Form 10-Q (this “Form 10-Q”) contains forward–looking statements which are subject to risks and uncertainties in accordance with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically include assumptions, estimates or descriptions of our future plans, strategies and expectations and are generally identifiable by the use of the words “anticipate,” “will,” “believe,” “estimate,” “expect,” “intend,” “seek,” or other similar expressions. Examples of these include discussions regarding our operating and growth strategy, projections of revenue, income or loss and future operations. Unless this Form 10-Q indicates otherwise or the context otherwise requires, the terms “we,” “our,” “our Company,” “the Company” or “us” as used in this Form 10-Q refer to Coventry Health Care, Inc. and its subsidiaries. 
These forward–looking statements may be affected by a number of factors; including, but not limited to, the “Risk Factors” contained in Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the year ended December 31, 2012, contained in Part II, Item 1A, “Risk Factors,” of this Form 10-Q, and as may be further updated from time to time in our subsequent quarterly reports on Form 10-Q. Actual operations and results may differ materially from those forward-looking statements expressed in this Form 10-Q. 
The following discussion and analysis relates to our financial condition and results of operations for the quarters ended March 31, 2013 and 2012. This discussion should be read in conjunction with our condensed consolidated financial statements and other information presented herein as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10-K for the year ended December 31, 2012, including the critical accounting policies discussed therein. 

Health Care Reform
In June 2012, the U.S. Supreme Court generally upheld the provisions of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, “PPACA”), except that the court held that the Department of Health and Human Services may not withhold existing Medicaid funding from states that refuse to adopt the Medicaid expansion provisions of PPACA, but may withhold new Medicaid funding associated with the expansion.
Given the complexities of PPACA, the numerous regulations still to be issued that will detail its requirements, continued issuance of interpretive guidance and the inherent difficulty to foresee how individuals and businesses will respond to the choices afforded them by the law, we cannot predict the full effect of PPACA on us at this time. We also cannot predict the changes that government authorities may implement in the future or assure you that those changes will not have an adverse effect on our business or results of operations. For additional discussion regarding PPACA, refer to Part I, Item 1, “Business-Government Regulation,” and Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the year ended December 31, 2012.

Proposed Merger
On August 19, 2012, the Company, Aetna Inc. (“Aetna”) and Jaguar Merger Subsidiary, Inc. (“Merger Sub”) entered into an Agreement and Plan of Merger, pursuant to which, subject to the satisfaction or waiver of certain conditions, Merger Sub will be merged with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly-owned subsidiary of Aetna. A copy of the Agreement and Plan of Merger was filed as Exhibit 2.1 to our Current Report on Form 8-K filed on August 20, 2012. We subsequently entered into Amendment No. 1 and Amendment No. 2 to the Agreement and Plan of Merger, which were filed as Exhibit 2.1 to our Current Reports on Form 8-K filed on October 23, 2012 and November 13, 2012, respectively. As used herein, the “Merger Agreement” means the Agreement and Plan of Merger, by and among Coventry, Aetna and Merger Sub, as amended. Under the terms of the Merger Agreement, our shareholders will receive $27.30 in cash, without interest, and 0.3885 of an Aetna common share for each share of Coventry common stock. The total transaction was estimated at approximately $7.3 billion, including the assumption of Coventry debt, based on the closing price of Aetna common shares on August 17, 2012.
On November 21, 2012, our stockholders voted at the stockholder special meeting to approve the adoption of the Merger Agreement. Of the 104,941,398 shares voting at the special meeting of stockholders, more than 99% voted in favor of the adoption of the Merger Agreement, which represented approximately 78% of our total outstanding shares of common stock as of the October 15, 2012 record date.
The consummation of the Merger is subject to customary closing conditions, including, among others, the absence of certain legal impediments to the consummation of the Merger, the receipt of specified governmental consents and approvals, the early termination or expiration of the waiting period under the Hart-Scott-Rodino Antitrust Improvement Act of 1976, as amended, and, subject to certain exceptions, the accuracy of representations and warranties made by the Company and Aetna, respectively, and compliance by the Company and Aetna with their respective obligations under the Merger Agreement. The Merger is expected to close in mid-2013.


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Summary of First Quarter 2013 Performance 
Operating revenues of $3.5 billion, a decrease of 4.7% from the prior year quarter.
Kentucky medical loss ratio (“MLR”) of 92.3%, compared to 120.9% in the prior year quarter.
Selling, general and administrative expense of 14.8% of total revenue, an increase of 120 basis points from the prior year quarter.
Diluted earnings per common share of $1.00, compared to $1.20 from the prior year quarter.
Total membership of 5.2 million, a decrease of 90,000 members from the prior year quarter.
Medicare Advantage Coordinated Care Plan (“Medicare Advantage CCP”) membership was 309,000, an increase of 59,000 members from the prior year quarter.

New Accounting Standards 
See Note B, New Accounting Standards, to the condensed consolidated financial statements for information and disclosures related to new accounting standards, which is incorporated herein by reference. 

Membership 
The following table presents our membership (in thousands): 
 
As of March 31,
 
Increase
Membership by Product
2013
 
2012
 
(Decrease)
Health Plan Commercial Risk
1,404

 
1,549

 
(145
)
Health Plan Commercial ASO
778

 
725

 
53

Medicare Advantage CCP
309

 
250

 
59

Medicaid Risk
892

 
924

 
(32
)
Other National ASO
339

 
356

 
(17
)
Medicare Part D
1,450

 
1,458

 
(8
)
Total Membership
5,172

 
5,262

 
(90
)
The decrease in Health Plan Commercial Risk membership was due to attrition, in-group changes and certain groups moving from Commercial Risk to Administrative Services Only (“ASO”) products primarily in our Florida and Pennsylvania markets, partially offset by same-store membership growth in our Georgia and Utah markets. Medicaid Risk membership decreased due to the non-renewal of the State of Kansas Medicaid contract. This Medicaid Risk membership decline was partially offset by expansions into new regions primarily in Pennsylvania, Virginia, and Nebraska as well as same-store growth in Missouri. The increase in Medicare Advantage CCP was due to continued growth throughout the majority of our markets.

Results of Operations 
The following table is provided to facilitate a discussion regarding the comparison of our consolidated results of operations for the quarters ended March 31, 2013 and 2012 (dollars in thousands, except diluted earnings per share amounts): 
 
Quarters Ended March 31,
 
Increase
 
2013
 
2012
 
(Decrease)
Total operating revenues
$
3,520,235

 
$
3,691,967

 
(4.7
)%
Operating earnings
$
216,168

 
$
276,476

 
(21.8
)%
Operating earnings as a percentage of revenues
6.1
%
 
7.5
%
 
(1.4
)%
Net earnings
$
135,369

 
$
170,719

 
(20.7
)%
Diluted earnings per common share
$
1.00

 
$
1.20

 
(16.7
)%
Selling, general and administrative as a percentage of revenue
14.8
%

13.6
%
 
1.2
 %
 

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Comparison of Quarters Ended March 31, 2013 and 2012
Managed Care Premiums and Management Services 
Managed care premium revenue decreased from the prior year quarter primarily as a result of the declining Commercial Risk membership noted earlier. Commercial Risk revenue also decreased from the prior year quarter as the prior year quarter included favorable minimum medical loss ratio rebate accrual reductions of $36.3 million related to the 2011 plan year as a result of new guidance issued in the first quarter of 2012 on capitated medical contracts. The decrease is also attributable to Medicare Part D as a result of membership shifting to lower priced premium products.
The managed care premium decrease was also due to Medicare Advantage CCP revenue declines from the prior year as a result of the RADV audit reserve releases that were recorded in the prior year quarter. On February 24, 2012, CMS released a “Notice of Final Payment Error Calculation Methodology for Part C Medicare Advantage Risk Adjustment Data Validation (RADV) Contract-Level Audits.” In that notice, CMS announced which contract years will be subject to the CMS RADV audits and other core areas of the audit methodology. We maintain reserves for our exposure to the RADV audits, and during the first quarter of 2012 released RADV audit reserves, related to the 2007 through 2011 contract years, resulting in an increase in operating earnings of $133.0 million in the prior year quarter. The Medicare Advantage CCP revenue decrease is almost entirely offset by continued growth of the Medicare Advantage CCP membership.
The Company’s Medicaid revenue increased from the prior year quarter primarily driven by membership growth and entry into new regions in our Nebraska and Pennsylvania markets. This was partially offset by Medicaid revenue reductions associated with the Company’s Medicaid contract with the State of Kansas, which ended effective December 31, 2012.
Management services revenue decreased from the prior year quarter due to the loss of a Workers’ Compensation customer account, which was partially offset by certain groups moving from Commercial Risk to ASO products.
Medical Costs and Cost of Sales
Medical costs decreased from the prior year quarter primarily as a result of decreases in Commercial Risk membership, as noted above. The decrease is also attributable to Medicaid as a result of improvements in the Kentucky market, discussed below, and the Company’s contract with the State of Kansas ending effective December 31, 2012. These decreases were partially offset by medical cost increases as a result of organic membership growth for the Medicare Advantage CCP business and Medicaid growth in our Nebraska and Pennsylvania markets.
Total medical costs as a percentage of premium revenue (“medical loss ratio” or “MLR”) increased 0.1% over the prior year quarter, from 82.9% to 83.0%, primarily as a result of the increased Medicare Advantage CCP MLR results offset by the decreased Medicaid MLR results. The Medicare Advantage CCP MLR increased as a result of the RADV audit reserve release in the prior year quarter. The overall Medicaid MLR decreased from the prior year quarter, from 100.0% to 86.4%, primarily due to lower medical costs associated with the Kentucky Medicaid contract which incurred a MLR of 92.3% for the current quarter compared to a MLR of 120.9% during the prior year quarter. The higher costs in the prior year quarter related to transitioning a highly unmanaged Medicaid population to a managed care environment. Many initiatives to improve care and reduce medical costs, which include the introduction of member co-pays and changes made to the provider network, continue to improve the Kentucky Medicaid financial results. Additionally, we received a previously contracted 5.3% rate increase in October 2012 as well as entered into a contract amendment during the current year quarter with the Commonwealth of Kentucky that resulted in a 7% rate increase, effective January 1, 2013.
Cost of sales associated with the Workers’ Compensation Division decreased due to the loss of a customer account.
Selling, General and Administrative
Selling, general and administrative expense increased over the prior year quarter primarily due to an increase in the number of full-time employees, particularly those associated with the growth of the Medicare Advantage CCP and Medicaid products. These increases in normal operating costs; include, but not limited to, salaries and benefits and professional fees. The increase is also attributable to higher stock-based compensation and incentive compensation expense in the current year quarter. For more information regarding stock-based compensation, refer to Note H, Stock-Based Compensation, to the condensed consolidated financial statements, which is incorporated herein by reference. The increases are partially offset by a general reduction in marketing, advertising, print and postage costs.
Selling, general and administrative expense, as a percentage of revenue, increased 1.2% over the prior year quarter as a result of the items mentioned above.
Depreciation and Amortization
Depreciation and amortization expense was higher during the current quarter primarily due to the additional depreciations associated with placing certain internally developed medical quality improvement software into service.

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Table of Contents

Interest Expense and Other Income, Net
Interest expense in the current quarter was relatively consistent with the prior year quarter. The slight decrease from the prior year quarter was due to lower interest expense associated with the repayment, at maturity, of the $233.9 million outstanding balance of our 5.875% Senior Notes in January 2012.
Other income, net increased as income in the current quarter included larger realized gains on the sales of investments.
Income Taxes
The provision for income taxes decreased from the prior year quarter primarily due to a decrease in earnings, partially offset by an increase in the current quarter effective tax rate. The effective tax rate on operations increased to 39.0% as compared to 38.0% for the prior year quarter, primarily due to the proportion of earnings in states with higher tax rates and compliance with new health care reform regulations that limit the deductibility of certain employees’ compensation.


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Table of Contents

Segment Results 
The following table is provided to facilitate a discussion regarding the comparison of our segment results of operations for the quarters ended March 31, 2013 and 2012
 
Quarters Ended
March 31,
 
Increase
 
2013
 
2012
 
(Decrease)
Operating Revenues (in thousands)
 
 
 
 
Commercial Risk
$
1,322,718

 
$
1,481,275

 
$
(158,557
)
Commercial Management Services
108,084

 
113,777

 
(5,693
)
Commercial Products Division
1,430,802

 
1,595,052

 
(164,250
)
Medicare Advantage (1)
831,378

 
834,312

 
(2,934
)
Medicaid Risk
690,800

 
668,060

 
22,740

Medicare Part D
406,548

 
413,423

 
(6,875
)
Government Programs Division
1,928,726

 
1,915,795

 
12,931

Workers’ Compensation
175,488

 
191,922

 
(16,434
)
Other/Eliminations
(14,781
)
 
(10,802
)
 
(3,979
)
Total Operating Revenues
$
3,520,235

 
$
3,691,967

 
$
(171,732
)
 
 
 
 
 
 
Gross Margin (in thousands)
 

 
 

 
 

Commercial Products Division
$
409,017

 
$
417,067

 
$
(8,050
)
Government Programs Division (1)
249,079

 
274,630

 
(25,551
)
Workers’ Compensation
116,003

 
123,970

 
(7,967
)
Other/Eliminations

 

 

Total Gross Margin (1)
$
774,099

 
$
815,667

 
$
(41,568
)
 
 
 
 
 
 
Revenue and Medical Cost Statistics
 
 

 
 

Managed Care Premium Yields (PMPM):
 
 

 
 

Health Plan Commercial Risk
$
306.18

 
$
311.92

 
(1.8
%)
Medicare Advantage Risk (1)
$
899.28

 
$
1,048.93

 
(14.3
%)
Medicare Part D
$
93.95

 
$
95.60

 
(1.7
%)
Medicaid Risk
$
266.74

 
$
238.74

 
11.7
%
 
 
 
 
 
 
Medical Loss Ratios (MLR):
 

 
 

 
 

Health Plan Commercial Risk
77.9
%
 
79.9
%
 
(2.0
%)
Medicare Advantage Risk (1)
84.6
%
 
74.1
%
 
10.5
%
Medicare Part D
93.4
%
 
94.9
%
 
(1.5
%)
Medicaid Risk
86.4
%
 
100.0
%
 
(13.6
%)
Total MLR
83.0
%
 
82.9
%
 
0.1
%
 
(1) 
The quarter ended March 31, 2012 includes the effect of the RADV reserve release.






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Table of Contents

Commercial Products Division
Quarters Ended March 31, 2013 and 2012
Commercial risk revenue decreased from the prior year quarter due to lower membership as a result of attrition, in-group changes and certain groups moving from Commercial Risk to ASO products as well as declining Commercial membership as a result of an overall challenging sales environment. Commercial Risk revenue also decreased from the prior year quarter as the prior year quarter included favorable minimum medical loss ratio rebate accrual reductions of $36.3 million related to the 2011 plan year as a result of new guidance issued in 2012 on capitated medical contracts. The minimum medical loss ratio accrual reductions also contributed to a decrease in the current quarter average realized premium PMPM when compared to the prior year quarter.
The gross margin for this Division decreased from the prior year quarter primarily due to a decline in Commercial Risk membership and the resulting lower premium revenue. The Commercial Risk MLR decreased from the prior year quarter as we are experiencing lower medical trends.
Government Programs Division
Quarters Ended March 31, 2013 and 2012
Medicaid revenue increased over the prior year quarter primarily as a result of membership growth and the entry into new regions in our Nebraska and Pennsylvania markets. This was partially offset by the Company’s Medicaid contract with the State of Kansas which ended on December 31, 2012. The Medicare Advantage CCP revenue decrease reflects the RADV audit reserve releases partially offset by membership growth, as previously discussed.
Medicare Part D revenue decreased due to membership shifting to lower priced premium products. Premiums decreased to $93.95 PMPM in 2013, compared to $95.60 PMPM in 2012, primarily due to the continued growth in a new lower priced premium preferred network product.
The gross margin decrease from the prior year quarter for the Government Programs Division is primarily driven by the Medicare Advantage RADV audit reserve releases in 2012 as well as increased membership and premium PMPM increases for Medicaid Risk. These decreases were partially offset by a lower Medicaid Risk MLR. The lower Medicaid Risk MLR was driven by improved medical costs associated with the Kentucky business. As previously mentioned, the higher costs in the prior year quarter related to transitioning a highly unmanaged Medicaid population to a managed care environment. Many initiatives to improve care and reduce medical costs, which include the introduction of member co-pays and changes made to the provider network, continue to improve the Kentucky Medicaid financial results. Additionally, we received a previously contracted 5.3% rate increase in October 2012 as well as entered into a contract amendment during the current year quarter with the Commonwealth of Kentucky that resulted in a 7% rate increase, effective January 1, 2013. The Kentucky Medicaid contract incurred a MLR of 92.3% for the current quarter compared to a MLR of 120.9% during the prior year quarter.
Workers’ Compensation Division
Quarters Ended March 31, 2013 and 2012
The Workers’ Compensation Division revenue and gross margin decreased for the quarter ended March 31, 2013 as compared to the quarter ended March 31, 2012 in part due to the loss of a customer account. The revenue decrease is partially offset by increased revenue in our clinical programs as a result of higher volumes of referrals.

Liquidity and Capital Resources 
Liquidity 
Our investment guidelines require our fixed income securities to be investment grade in order to provide liquidity to meet future payment obligations and minimize the risk to principal. The fixed income portfolio includes, among other investment categories, government and corporate securities and has an average credit quality rating of “AA-” and an effective duration of 4.09 years as of March 31, 2013. The average credit quality rating is based on the weighted average credit rating as provided by Standard & Poor’s. See Footnote F, Investments, to the condensed consolidated financial statements for more information regarding our investments, which is incorporated herein by reference. Typically, the amount and duration of our short-term assets are more than sufficient to pay for our short-term liabilities, and we do not anticipate that sales of our long-term investment portfolio will be necessary to fund our claims liabilities. 
Our cash and investments, consisting of cash, cash equivalents, short-term investments and long-term investments, but excluding deposits of $72.6 million at March 31, 2013 and $71.1 million at December 31, 2012 that are restricted under state regulations, increased by $0.2 billion to $4.3 billion at March 31, 2013 from $4.1 billion at December 31, 2012
We have classified all of our investments as available-for-sale securities. Contractual maturities of the securities are disclosed in Note F, Investments, to the condensed consolidated financial statements, which is incorporated herein by reference. 

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Table of Contents

During the quarter ended March 31, 2013, the Board of Directors declared a quarterly cash dividend of $0.125 per share, or $16.8 million. The cash dividend for the quarter ended March 31, 2013 was accrued in “accounts payable and other accrued liabilities” in the accompanying balance sheet at March 31, 2013, and subsequently paid on April 9, 2013. 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. 
The demand for our products and services is subject to many economic fluctuations, risks, and uncertainties that could materially affect the way we do business. Management believes that the combination of our ability to generate cash flows from operations, cash and investments on hand, and the excess funds held in certain of our regulated subsidiaries will be sufficient to fund continuing operations, capital expenditures, debt interest costs, debt principal repayments, cash dividends, and any other reasonably likely future cash requirements. In addition, our long-term investment portfolio is available for further liquidity needs including satisfaction of policy holder benefits. Please refer to Part II, Item 1A, “Risk Factors,” of this Form 10-Q and Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10–K for the year ended December 31, 2012, for more information about how risks and uncertainties could materially affect our business. 
Cash Flows 
Operating Activities
Net cash from operating activities for the quarter ended March 31, 2013 was an inflow primarily as a result of net earnings, net of adjustments, and an increase in medical liabilities primarily related to the continued growth of both the Pennsylvania and Kentucky Medicaid businesses. Offsetting these inflows was an increase in other receivables related to the settlement timing of Medicare risk adjuster receivables due from CMS.
Our net cash from operating activities for the quarter ended March 31, 2013 decreased by $198.3 million from the corresponding 2012 period.  The decrease was primarily a result of the deferred revenue related to the early receipt in March 2012 of the April 2012 Medicare premium payment from CMS which did not occur for the period ended March 31, 2013. Offsetting this decrease in net cash from operating activities was lower outflows within accounts payable and other accrued liabilities related to the timing of incentive compensation and stock-based award payments and an increase to net earnings, net of adjustments.
Investing Activities
Net cash from investing activities was an outflow for the quarter ended March 31, 2013 primarily due to investment purchases and capital expenditures.  This outflow was partially offset by the proceeds received from the sales and maturities of investments.
Projected capital expenditures for fiscal year 2013 are estimated at $95 to $105 million and consist primarily of computer hardware, software and other equipment.
Cash flows used for investing activities for the quarter ended March 31, 2013 increased by $32.9 million from the corresponding 2012 period. The increase is primarily due to higher investment purchases in 2013 partially offset by no payments for acquisitions in 2013.
Financing Activities
Net cash from financing activities was an outflow, primarily due to the payment for cash dividends during the quarter ended March 31, 2013. 
Cash flows used for financing activities for the quarter ended March 31, 2013 decreased by $197.7 million from the corresponding 2012 period. The decrease is primarily due to share repurchases related to the vesting of stock-based awards to satisfy employees’ minimum statutory tax withholding obligations in 2012, which were minimal in 2013, as well as the repayment of debt in 2012 related to our Senior Notes due January 2012. This decrease in cash flows used for financing activities was partially offset by a cash dividend payment in 2013.
Health Plans 
Our regulated health maintenance organization and insurance company subsidiaries are required by state regulatory agencies to maintain minimum surplus balances, thereby limiting the dividends our parent company may receive from our regulated subsidiaries. During the quarter ended March 31, 2013, we received no dividends from our regulated subsidiaries and made no capital contributions to them.  We had approximately $2.3 billion of regulated capital and surplus at March 31, 2013.
We believe that all of our subsidiaries that incur medical claims maintain more than adequate liquidity and capital resources to meet these short-term obligations as a matter of both our policy and state insurance regulations. 
Excluding funds held by entities subject to regulation and excluding our equity method investments, we had cash and investments of approximately $1.2 billion at March 31, 2013 and December 31, 2012


24

Table of Contents

Legal Proceedings 
See Note E, Contingencies, to the condensed consolidated financial statements for information and disclosures related to contingencies, which is incorporated herein by reference. 

ITEM 3: Quantitative and Qualitative Disclosures About Market Risk 
These disclosures should be read in conjunction with the condensed consolidated financial statements, Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and other information presented herein as well as in Part II, Item 7a “Quantitative and Qualitative Disclosures About Market Risk” of our Annual Report on Form 10–K for the year ended December 31, 2012
No material changes have occurred in our exposure to market risk since the date of our Annual Report on Form 10–K for the year ended December 31, 2012.

ITEM 4: Controls and Procedures 
We have performed an evaluation as of the end of the period covered by this report of the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer.  Based upon our evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2013. 
There have been no significant changes in our internal control over financial reporting (as defined in Rule 13a–15(f) promulgated under the Securities and Exchange Act of 1934) during the quarter ended March 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 



25

Table of Contents

PART II.  OTHER INFORMATION
ITEM 1: Legal Proceedings 
See Note E, Contingencies, to the condensed consolidated financial statements for information and disclosures related to contingencies, which is incorporated herein by reference.

ITEM 1A: Risk Factors 
With the exception of the new risk factor below related to federal spending cuts, there have been no material changes with respect to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012.
We may be adversely affected by changes in government funding related to the automatic spending cuts that are occurring due to federal sequestration.
The Budget Control Act of 2011 (the “BCA”) requires automatic spending reductions of $1.2 trillion for federal fiscal years 2013 through 2021, minus any deficit reductions enacted by Congress and debt service costs. However the percentage reduction for Medicare may not be more than 2% for a fiscal year, with a uniform percentage across all Medicare programs. In addition, some programs, such as Medicaid, are exempt from the reductions. These BCA-mandated spending cuts are commonly referred to as “sequestration.” Sequestration began on March 1, 2013, and CMS began imposing a 2% reduction on Medicare funding to Medicare Health Plans as of April 1, 2013. Unless Congress and the President take action and reach an agreement to change the law, federal spending will be subject to sequestration until the end of federal fiscal year 2021.
The full effect of sequestration on our operations is uncertain. We cannot predict with certainty whether changes to Medicare funding will have an adverse effect on our business or results of operations or our ability to reduce related provider payments to offset such changes to Medicare funding. We are also unable to predict what other deficit reduction initiatives may be proposed by Congress or whether Congress will attempt to restructure or suspend sequestration.

ITEM 2: Unregistered Sales of Equity Securities and Use of Proceeds 
The following table presents information about our purchases of our common shares during the quarter ended March 31, 2013 (in thousands, except average price paid per share information): 
 
Total Number of
Shares Purchased (1)
 
Average Price Paid
per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans
 
Maximum Number of Shares That May Yet Be Purchased Under The Plan or Program(2)
January 1 - 31, 2013
4

 
$
46.19

 

 
6,537

February 1 - 28, 2013
2

 
$
46.15

 

 
6,537

March 1 - 31, 2013
8

 
$
45.85

 

 
6,537

Totals
14

 
$
45.99

 

 
6,537

 
(1) 
Includes shares purchased in connection with the vesting of restricted stock awards to satisfy employees’ minimum statutory tax withholding obligations.
(2) 
These shares are under a stock repurchase program previously announced on December 20, 1999, as amended.

ITEM 3: Defaults Upon Senior Securities 
Not Applicable. 
ITEM 4: Mine Safety Disclosures
Not Applicable.
ITEM 5: Other Information
Not Applicable.

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Table of Contents

ITEM 6: Exhibits
Exhibit No.
 
Description of Exhibit
 
 
 
31.1
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by Allen F. Wise, Chief Executive Officer and Chairman.
 
 
 
31.2
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by Randy P. Giles, Executive Vice President, Chief Financial Officer and Treasurer.
 
 
 
32
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, made by Allen F. Wise, Chief Executive Officer and Chairman, and Randy P. Giles, Executive Vice President, Chief Financial Officer and Treasurer.
 
 
 
101
 
The following financial statements from Coventry Health Care, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations and Comprehensive Income,  (iii) Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.

27

Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
COVENTRY HEALTH CARE, INC.
 
 
(Registrant)
 
 
 
Date:
May 1, 2013
By: /s/ Allen F. Wise 
 
 
Allen F. Wise
 
 
Chief Executive Officer and Chairman
 
 
 
Date:
May 1, 2013
By: /s/ Randy P. Giles 
 
 
Randy P. Giles
 
 
Executive Vice President, Chief Financial Officer and Treasurer
 
 
 
Date:
May 1, 2013
By: /s/ John J. Ruhlmann 
 
 
John J. Ruhlmann
 
 
Senior Vice President and Corporate Controller

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Table of Contents

INDEX TO EXHIBITS
 
Exhibit No.
 
Description of Exhibit
 
 
 
31.1
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by Allen F. Wise, Chief Executive Officer and Chairman.
 
 
 
31.2
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by Randy P. Giles, Executive Vice President, Chief Financial Officer and Treasurer.
 
 
 
32
 
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, made by Allen F. Wise, Chief Executive Officer and Chairman, and Randy P. Giles, Executive Vice President, Chief Financial Officer and Treasurer.
 
 
 
101
 
The following financial statements from Coventry Health Care, Inc.’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations and Comprehensive Income,  (iii) Condensed Consolidated Statements of Cash Flows, and (iv) Notes to Condensed Consolidated Financial Statements.

29


Exhibit 31.1 
 
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Allen F. Wise, certify that:
1.
I have reviewed this quarterly report on Form 10-Q of Coventry Health Care, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a.
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c.
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d.
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a.
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
By: /s/ Allen F. Wise
 
Allen F. Wise
 
Chief Executive Officer and Chairman
 
Date: May 1, 2013





Exhibit 31.2
 
CERTIFICATION PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Randy P. Giles, certify that:
1.
I have reviewed this quarterly report on Form 10-Q of Coventry Health Care, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a.
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b.
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
c.
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d.
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant's fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a.
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b.
any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
By: /s/ Randy P. Giles 
 
Randy P. Giles
 
Executive Vice President, Chief Financial Officer and Treasurer
 
Date: May 1, 2013


v2.4.0.6
EARNINGS PER SHARE (Details) (USD $)
In Thousands, except Share data, unless otherwise specified
3 Months Ended
Mar. 31, 2013
Mar. 31, 2012
Basic earnings per common share    
Net earnings $ 135,369 $ 170,719
Less: Distributed and undistributed earnings allocated to participating securities (1,155) (2,472)
Net earnings allocable to common shares 134,214 168,247
Basic weighted average common shares outstanding 133,464,000 139,323,000
Basic earnings per common share $ 1.01 $ 1.21
Diluted earnings per common share    
Net earnings 135,369 170,719
Less: Distributed and undistributed earnings allocated to participating securities (1,149) (2,459)
Net earnings allocable to common shares $ 134,220 $ 168,260
Basic weighted average common shares outstanding 133,464,000 139,323,000
Effect of dilutive options 836,000 844,000
Diluted weighted average common shares outstanding 134,300,000 140,167,000
Diluted earnings per common share $ 1.00 $ 1.20
Potential common stock equivalents excluded from computation of diluted earnings per share 2,400,000 7,500,000
v2.4.0.6
BASIS OF PRESENTATION AND SIGNIFICANT EVENTS (Details) (USD $)
3 Months Ended
Mar. 31, 2013
Mar. 31, 2012
Schedule of Revenue Recognition, RADV release [Abstract]    
RADV release $ 0 $ 132,977,000
Business Combinations [Abstract]    
Price per share paid in cash 27.30  
Amount of Aetna common share received per Coventry common share 0.3885  
Estimated purchase price $ 7,300,000,000  
Shares of Common Stock Held by Voting Stockholder Special Meeting 104,941,398  
Percent of Favorable Votes Regarding Merger 99.00%  
Ratio of Shares Voting in Favor of Merger 78.00%  
v2.4.0.6
DEBT
3 Months Ended
Mar. 31, 2013
Debt Instruments [Abstract]  
DEBT
DEBT
The Company’s outstanding debt consisted of the following (in thousands): 
 
March 31,
2013
 
December 31,
2012
6.300% Senior notes due 8/15/14, net of unamortized discount of $322 at March 31, 2013
$
374,775

 
$
374,718

6.125% Senior notes due 1/15/15
228,845

 
228,845

5.950% Senior notes due 3/15/17, net of unamortized discount of $561 at March 31, 2013
382,674

 
382,639

5.450% Senior notes due 6/7/21, net of unamortized discount of $982 at March 31, 2013
599,018

 
598,988

Total debt, including current portion
1,585,312

 
1,585,190

Less current portion of total debt

 

Total long-term debt
$
1,585,312

 
$
1,585,190

 
In January 2012, at maturity, the Company repaid the $233.9 million outstanding balance of its 5.875% Senior Notes. 
During 2011, the Company entered into a Credit Agreement (the “Credit Facility”).  The Credit Facility provides for a five-year revolving credit facility in the principal amount of $750.0 million, with the Company having the ability to request an increase in the facility amount up to an aggregate principal amount not to exceed $1 billion.  As of March 31, 2013 and December 31, 2012, there were no amounts outstanding under the Credit Facility.
The Company’s senior notes and Credit Facility contain certain covenants and restrictions regarding, among other things, liens, asset dispositions and consolidations or mergers.  Additionally, the Company’s Credit Facility requires compliance with a leverage ratio of 3 to 1 and limits subsidiary debt.  As of March 31, 2013, the Company was in compliance with the applicable covenants and restrictions under its senior notes and Credit Facility.
v2.4.0.6
INVESTMENTS (Details) (USD $)
3 Months Ended
Mar. 31, 2013
Mar. 31, 2012
Dec. 31, 2012
Available-for-sale securities [Abstract]      
Amortized cost $ 2,721,791,000   $ 2,644,753,000
Unrealized gain 90,344,000   111,913,000
Unrealized loss (2,217,000)   (947,000)
Fair value 2,809,918,000   2,755,719,000
Fair value of equity method investments 24,118,000 [1]   24,605,000 [1]
Fair value of investments 2,834,036,000   2,780,324,000
Continuous unrealized loss position, fair value [Abstract]      
Less than 12 months 375,565,000   204,949,000
12 months or more 214,000   1,738,000
Total 375,779,000   206,687,000
Continuous unrealized loss position, aggregate losses [Abstract]      
Less than 12 months (2,213,000)   (944,000)
12 months or more (4,000)   (3,000)
Total (2,217,000)   (947,000)
Available-for-sale securities, debt maturities, amortized cost basis [Abstract]      
Within 1 year 468,436,000   362,116,000
1 to 5 years 725,945,000   798,143,000
5 to 10 years 711,930,000   652,941,000
Over 10 years 815,480,000   831,553,000
Total 2,721,791,000   2,644,753,000
Available-for-sale securities, debt maturities, fair value [Abstract]      
Within 1 year 470,166,000   363,559,000
1 to 5 years 747,376,000   822,448,000
5 to 10 years 745,058,000   693,504,000
Over 10 years 847,318,000   876,208,000
Available-for-sale securities, debt maturities, fair value 2,809,918,000   2,755,719,000
Gross investment gains on sale of investments 12,800,000 4,300,000  
Gross investment losses on sale of investments 300,000 0  
State and municipal bonds [Member]
     
Available-for-sale securities [Abstract]      
Amortized cost 1,120,913,000   1,176,016,000
Unrealized gain 66,748,000   78,272,000
Unrealized loss (726,000)   (499,000)
Fair value 1,186,935,000   1,253,789,000
Continuous unrealized loss position, fair value [Abstract]      
Less than 12 months 110,627,000   61,342,000
12 months or more 102,000   0
Total 110,729,000   61,342,000
Continuous unrealized loss position, aggregate losses [Abstract]      
Less than 12 months (725,000)   (499,000)
12 months or more (1,000)   0
Total (726,000)   (499,000)
Available-for-sale securities, debt maturities, fair value [Abstract]      
Available-for-sale securities, debt maturities, fair value 1,186,935,000   1,253,789,000
U.S. Treasury securities [Member]
     
Available-for-sale securities [Abstract]      
Amortized cost 114,448,000   78,264,000
Unrealized gain 577,000   669,000
Unrealized loss (1,000)   (2,000)
Fair value 115,024,000   78,931,000
Continuous unrealized loss position, fair value [Abstract]      
Less than 12 months 1,774,000   2,458,000
12 months or more 0   1,065,000
Total 1,774,000   3,523,000
Continuous unrealized loss position, aggregate losses [Abstract]      
Less than 12 months (1,000)   (1,000)
12 months or more 0   (1,000)
Total (1,000)   (2,000)
Available-for-sale securities, debt maturities, fair value [Abstract]      
Available-for-sale securities, debt maturities, fair value 115,024,000   78,931,000
Government-sponsored enterprise securities [Member]
     
Available-for-sale securities [Abstract]      
Amortized cost 79,039,000   72,394,000
Unrealized gain 248,000   1,139,000
Unrealized loss (2,000)   (1,000)
Fair value 79,285,000   73,532,000
Continuous unrealized loss position, fair value [Abstract]      
Less than 12 months 11,786,000   15,714,000
12 months or more 0   0
Total 11,786,000   15,714,000
Continuous unrealized loss position, aggregate losses [Abstract]      
Less than 12 months (2,000)   (1,000)
12 months or more 0   0
Total (2,000)   (1,000)
Available-for-sale securities, debt maturities, fair value [Abstract]      
Available-for-sale securities, debt maturities, fair value 79,285,000   73,532,000
Residential mortgage-backed securities [Member]
     
Available-for-sale securities [Abstract]      
Amortized cost 328,940,000 [2]   302,012,000 [2]
Unrealized gain 9,051,000 [2]   10,703,000 [2]
Unrealized loss (793,000) [2]   (74,000) [2]
Fair value 337,198,000 [2]   312,641,000 [2]
Continuous unrealized loss position, fair value [Abstract]      
Less than 12 months 120,987,000   23,861,000
12 months or more 60,000   59,000
Total 121,047,000   23,920,000
Continuous unrealized loss position, aggregate losses [Abstract]      
Less than 12 months (792,000)