Item 1.   Business

 

OVERVIEW

We are a multi-line healthcare enterprise operating in two segments: Medicaid Managed Care and Specialty Services.  Our Medicaid Managed Care segment provides Medicaid and Medicaid-related health plan coverage to individuals through government subsidized programs, including Medicaid, the State Children’s Health Insurance Program, or SCHIP, Foster Care, Medicare Special Needs Plans and the Supplemental Security Income Program, also known as the Aged, Blind or Disabled Program, or collectively ABD.  Medicaid currently accounts for 73% of our membership, while SCHIP (also including Foster Care) and ABD (also including Medicare) account for 22% and 5%, respectively.  Our Specialty Services segment provides specialty services, including behavioral health, individual health insurance, life and health management, long-term care programs, managed vision, nurse triage, and pharmacy benefits management to state programs, healthcare organizations, employer groups and other commercial organizations, as well as to our own subsidiaries.  Our Specialty Services segment also provides a full range of healthcare solutions for the rising number of uninsured Americans.

During 2008, we announced our intention to sell certain assets of University Health Plans, Inc.  This pending sale is discussed in detail under the caption “Discontinued Operations” under “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Accordingly, our New Jersey health plan operations are presented as discontinued operations for all periods in our consolidated financial statements beginning with this Annual Report on Form 10-K.  The following discussion and analysis is presented primarily in the context of continuing operations unless otherwise identified.  For the year ended December 31, 2008, our revenues, total cash flow from operations, and net earnings were $3.4 billion, $222.0 million and $84.2 million, respectively.

 

Our Medicaid Managed Care segment membership totaled approximately 1.2 million as of December 31, 2008, while our Specialty Services segment external membership totaled 163,100.  We currently have health plan subsidiaries offering healthcare services in Arizona, Georgia, Indiana, Ohio, South Carolina, Texas and Wisconsin, as well as New Jersey.  Additionally, effective in July 2007, we acquired a minority interest in Access Health Solutions, LLC, or Access, which provides managed care on a non-risk basis for Medicaid recipients in Florida.  In February 2009, we began operations in Florida through our wholly-owned subsidiary, Sunshine State Health Plan, Inc.  We provide member-focused services through locally based staff by assisting in accessing care, coordinating referrals to related health and social services and addressing member concerns and questions.  We also provide education and outreach programs to inform and assist members in accessing quality, appropriate healthcare services.

 

We believe our local approach to managing our health plans, including provider and member services, enables us to provide accessible, quality, culturally-sensitive healthcare coverage to our communities.  Our health management, educational and other initiatives are designed to help members best utilize the healthcare system to ensure they receive appropriate, medically necessary services and effective management of routine, severe and chronic health problems, resulting in better health outcomes.  We combine our decentralized local approach for care with a centralized infrastructure of support functions such as finance, information systems and claims processing.

 

Our initial health plan commenced operations in Wisconsin in 1984.  We were organized in Wisconsin in 1993 as a holding company for our initial health plan and reincorporated in Delaware in 2001.  Our corporate office is located at 7711 Carondelet Avenue, St. Louis, Missouri 63105, and our telephone number is (314) 725-4477.  Our stock is publicly traded on the New York Stock Exchange under the ticker symbol “CNC.”

 

INDUSTRY

We provide our services to organizations and individuals primarily through Medicaid, SCHIP, Foster Care and ABD programs.  The federal Centers for Medicare and Medicaid Services, or CMS, estimated the total Medicaid market was approximately $311 billion in 2006, and estimate the market will grow to $720 billion by 2017.  According to the most recent information provided by the Kaiser Commission on Medicaid and the Uninsured, Medicaid spending increased by 5.3% in fiscal 2008 and states appropriated an increase of 5.8% for Medicaid in fiscal 2009 budgets.

 

Established in 1965, Medicaid is the largest publicly funded program in the United States, and provides health insurance to low-income families and individuals with disabilities.  Authorized by Title XIX of the Social Security Act, Medicaid is an entitlement program funded jointly by the federal and state governments and administered by the states.  The majority of funding is provided at the federal level.  Each state establishes its own eligibility standards, benefit packages, payment rates and program administration within federal standards.  As a result, there are 56 Medicaid programs— one for each U.S. state, each U.S. territory and the District of Columbia.  Many states have selected Medicaid managed care as a means of delivering quality healthcare and controlling costs, including states that automatically enroll Medicaid recipients who don’t select a health plan.  We refer to these states as mandated managed care states.  Eligibility is based on a combination of household income and assets, often determined by an income level relative to the federal poverty level.  Historically, children have represented the largest eligibility group.

 

Established in 1972, and authorized by Title XVI of the Social Security Act, ABD covers low-income persons with chronic physical disabilities or behavioral health impairments.  ABD beneficiaries represent a growing portion of all Medicaid recipients.  In addition, ABD recipients typically utilize more services because of their critical health issues.

 

The Balanced Budget Act of 1997 created SCHIP to help states expand coverage primarily to children whose families earned too much to qualify for Medicaid, yet not enough to afford private health insurance.  Some states include the parents of these children in their SCHIP programs.  SCHIP is the single largest expansion of health insurance coverage for children since the enactment of Medicaid.  Costs related to the largest eligibility group, children, are primarily composed of pediatrics and family care.  These costs tend to be more predictable than other healthcare issues which predominantly affect the adult population.

 

A portion of Medicaid beneficiaries are dual eligibles, low-income seniors and people with disabilities who are enrolled in both Medicaid and Medicare.  According to CMS, there were approximately seven million dual eligible enrollees in 2006.  These dual eligibles may receive assistance from Medicaid for Medicaid benefits, such as nursing home care and/or assistance with Medicare premiums and cost sharing.  Dual eligibles also use more services due to their tendency to have more chronic health issues.  We serve dual eligibles through our ABD and long-term care programs, and beginning in 2008, through Special Needs Plans.

 

While Medicaid programs have directed funds to many individuals who cannot afford or otherwise maintain health insurance coverage, they did not initially address the inefficient and costly manner in which the Medicaid population tends to access healthcare.  Medicaid recipients in non-managed care programs typically have not sought preventive care or routine treatment for chronic conditions, such as asthma and diabetes.  Rather, they have sought healthcare in hospital emergency rooms, which tends to be more expensive.  As a result, many states have found that the costs of providing Medicaid benefits have increased while the medical outcomes for the recipients remained unsatisfactory.

 

Since the early 1980s, increasing healthcare costs, combined with significant growth in the number of Medicaid recipients, have led many states to establish Medicaid managed care initiatives.  Additionally, a number of states are designing programs to cover the rising number of uninsured Americans.  The US Census Bureau estimated there were 45.7 million Americans in 2007 that lacked health insurance.  Continued pressure on states’ Medicaid budgets should cause public policy to recognize the value of managed care as a means of delivering quality healthcare and effectively controlling costs.  A growing number of states have mandated that their Medicaid recipients enroll in managed care plans.  Other states are considering moving to a mandated managed care approach.  As a result, a significant market opportunity exists for managed care organizations with operations and programs focused on the distinct socio-economic, cultural and healthcare needs of the uninsured population and the Medicaid, SCHIP, Foster Care and ABD populations.  We believe our approach and strategy enable us to be a growing participant in this market.

OUR COMPETITIVE STRENGTHS

Our multi-line managed care approach is based on the following key attributes:

 

Ÿ

Strong Historic Operating Performance.   We have increased revenues as we have grown in existing markets, expanded into new markets and broadened our product offerings.  We entered the Wisconsin market in 1984, the Indiana market in 1995, the Texas market in 1999, the Ohio market in 2004, the Georgia market in 2006, and the South Carolina market in 2007.  We have increased our membership through participation in new programs in existing states.  For example, in 2008, we began operations in the Texas Foster Care program and began serving Acute Care members in the Yavapai county of Arizona.  We have also increased membership by acquiring Medicaid businesses, contracts and other related assets from competitors in existing markets, most recently in South Carolina in 2007.  Our Medicaid Managed Care membership totaled approximately 1.2 million as of December 31, 2008.  For the year ended December 31, 2008, we had revenues of $3.4 billion, representing a 40% Compound Annual Growth Rate, or CAGR, since the year ended December 31, 2004.  We generated total cash flow from operations of $222.0 million and net earnings of $84.2 million for the year ended December 31, 2008.

Ÿ

Medicaid Expertise.   Over the last 20 years, we have strived to develop a specialized Medicaid expertise that has helped us establish and maintain relationships with members, providers and state governments.  We have implemented programs developed to achieve savings for state governments and improve medical outcomes for members by reducing inappropriate emergency room use, inpatient days and high cost interventions, as well as by managing care of chronic illnesses.  Our experience in working with state regulators helps us implement and deliver programs and services efficiently and affords us opportunities to provide input regarding Medicaid industry practices and policies in the states in which we operate.  We work with state agencies on redefining benefits, eligibility requirements and provider fee schedules in order to maximize the number of uninsured individuals covered through Medicaid, SCHIP, Foster Care and ABD and expand these types of benefits offered.  Our approach is to accomplish this while maintaining adequate levels of provider compensation and protecting our profitability.

 

 

Ÿ

Diversified Business Lines.   We continue to broaden our service offerings to address areas that we believe have been traditionally underserved by Medicaid managed care organizations.  In addition to our Medicaid and Medicaid-related managed care services, our service offerings include behavioral health, individual health insurance, life and health management, long-term care programs, managed vision, nurse triage and pharmacy benefits management.  Through the utilization of a multi-business line approach, we are able to diversify our revenues and help control our medical costs.

 

Ÿ

Localized Approach with Centralized Support Infrastructure.   We take a localized approach to managing our subsidiaries, including provider and member services.  This approach enables us to facilitate access by our members to high quality, culturally sensitive healthcare services.  Our systems and procedures have been designed to address these community-specific challenges through outreach, education, transportation and other member support activities.  For example, our community outreach programs work with our members and their communities to promote health and self-improvement through employment and education on how best to access care.  We complement this localized approach with a centralized infrastructure of support functions such as finance, information systems and claims processing, which allows us to minimize general and administrative expenses and to integrate and realize synergies from acquisitions.  We believe this combined approach allows us to efficiently integrate new business opportunities in both Medicaid and specialty services while maintaining our local accountability and improved access.

Ÿ

Specialized and Scalable Systems and Technology.   Through our specialized information systems, we work to strengthen relationships with providers and states which help us grow our membership base.  We continue to develop our specialized information systems which allow us to support our core processing functions under a set of integrated databases, designed to be both replicable and scalable.  Physicians can use claims, utilization and membership data to manage their practices more efficiently, and they also benefit from our timely payments.  State agencies can use data from our information systems to demonstrate that their Medicaid populations receive quality healthcare in an efficient manner.  These systems also help identify needs for new healthcare and specialty programs.  We have the ability to leverage our platform for one state configuration into new states or for health plan acquisitions.  Our ability to access data and translate it into meaningful information is essential to operating across a multi-state service area in a cost-effective manner.

 

OUR BUSINESS STRATEGY

 

Our objective is to become the leading multi-line healthcare enterprise focusing on the uninsured population and state funded healthcare initiatives.  We intend to achieve this objective by implementing the following key components of our strategy:

 

Ÿ

Increase Penetration of Existing State Markets.   We seek to continue to increase our Medicaid membership in states in which we currently operate through alliances with key providers, outreach efforts, development and implementation of community-specific products and acquisitions.  In 2006, we were awarded two regions in connection with Ohio’s statewide restructuring of its Medicaid managed care program, expanding the number of counties we serve from three to 27.  We also were awarded a Medicaid ABD contract in four regions in Ohio.  In Texas, we expanded our operations to the Corpus Christi market in 2006, began managing care for ABD recipients in February 2007 and began operations in the Foster Care program in April 2008.  In Arizona, we began serving members within a long-term care plan in 2006 and within an acute care plan in 2008.  In 2008, we began serving Medicare members within Special Needs Plans in Arizona, Ohio, Texas and Wisconsin. We may also increase membership by acquiring Medicaid businesses, contracts and other related assets from our competitors in our existing markets or by enlisting additional providers.  For example, in 2005 and 2006, we acquired certain Medicaid-related assets in Ohio.

Ÿ

Diversify Business Lines.   We seek to broaden our business lines into areas that complement our existing business to enable us to grow and diversify our revenue.  We are constantly evaluating new opportunities for expansion both domestically and abroad.  For instance, in July 2008, we completed the acquisition of Celtic Insurance Company, or Celtic, a national individual health insurance provider, in October 2006, we commenced operations under our managed care program contracts to provide long-term care services in Arizona, and in January 2006, we completed the acquisition of US Script, a pharmacy benefits manager.  We are also considering other premium based or fee-for-service lines of business that would provide additional diversity.  We employ a disciplined acquisition strategy that is based on defined criteria including internal rate of return, accretion to earnings per share, market leadership and compatibility with our information systems.  We engage our executives in the relevant operational units or functional areas to ensure consistency between the diligence and integration process.

Ÿ

Address Emerging State Needs.   We work to assist the states in which we operate in addressing the operating challenges they face.  We seek to assist the states in balancing premium rates, benefit levels, member eligibility, policies and practices, and provider compensation.  For example, in 2008, we began operating under a contract with the Texas Health and Human Services Commission for Comprehensive Health Care for Children in Foster Care, a new statewide program providing managed care services to participants in the Texas Foster Care program.  In 2005, we began performing under our contracts with the State of Arizona to facilitate the delivery of mental health and substance abuse services to behavioral health recipients in Arizona.  Effective January 1, 2005, we were awarded a behavioral health contract to serve SCHIP members in Kansas.  By helping states structure an appropriate level and range of Medicaid, SCHIP and specialty services, we seek to ensure that we are able to continue to provide those services on terms that achieve targeted gross margins, provide an acceptable return and grow our business.

Ÿ

Develop and Acquire Additional State Markets.   We continue to leverage our experience to identify and develop new markets by seeking both to acquire existing business and to build our own operations.  We expect to focus expansion in states where Medicaid recipients are mandated to enroll in managed care organizations, because we believe member enrollment levels are more predictable in these states.  For example, effective June 1, 2006, we began managing care for Medicaid and SCHIP members in Georgia.  In addition, we focus our attention on states converting to a full-risk, managed care model.  For example, in 2007, we entered the South Carolina market and we participated in the state’s conversion to at-risk managed care.   In February 2009, we began managed care operations in Florida through conversion of members in certain counties from Access Health Solutions to at-risk managed care in Sunshine State Health Plan, through our new state contract.

Ÿ

Leverage Established Infrastructure to Enhance Operating Efficiencies.   We intend to continue to invest in infrastructure to further drive efficiencies in operations and to add functionality to improve the service provided to members and other organizations at a low cost.  Our centralized functions enable us to add members and markets quickly and economically.

Ÿ

Maintain Operational Discipline.   We monitor our cost trends, operating performance, regulatory relationships and the Medicaid political environment in our existing markets.  We seek to operate in markets that allow us to meet our internal metrics including membership growth, plan size, market leadership and operating efficiency.  We may divest contracts or health plans in markets where the state’s Medicaid environment, over a long-term basis, does not allow us to meet our targeted performance levels.  We use multiple techniques to monitor and reduce our medical costs, including on-site hospital review by staff nurses and involvement of medical management and finance personnel in significant cases.  Our financial management teams evaluate the financial impact of proposed changes in provider relationships.  We also conduct monthly reviews of member demographics for each health plan.

(1)	Represents Medicaid and SCHIP membership as of December 31, 2008 as a percentage of total eligible Medicaid and SCHIP members in each state.  ABD programs are excluded.

(2)	We began membership operations in Florida in February 2009.

(3)	In November 2008, we announced our intention to sell University Health Plans.  As a result, this plan is presented as discontinued operations in our consolidated financial statements, however as of December 31, 2008, the plan was still operated by Centene Corporation.

All of our revenue is derived from operations within the United States and its territories.  We generally receive a fixed premium per member per month pursuant to our state contracts.  Our medical costs have a seasonality component due to cyclical illness, for example cold and flu season, resulting in higher medical expenses beginning in the fourth quarter and continuing throughout the first quarter of each year.  Our managed care subsidiaries in Georgia, Ohio, and Texas had revenues from their respective state governments that each exceeded 10% of our consolidated total revenues in 2008.  Other financial information about our segments is found in Note 20, Segment Information , of our Notes to Consolidated Financial Statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K.

 

Benefits to States

 

Our ability to establish and maintain a leadership position in the markets we serve results primarily from our demonstrated success in providing quality care while reducing and managing costs, and from our specialized programs in working with state governments.  Among the benefits we are able to provide to the states with which we contract are:

Ÿ

Significant cost savings compared to state paid reimbursement for services.   We bring bottom-line management experience to our health plans.  On the administrative and management side, we bring experience including quality of care improvement methods, utilization management procedures, an efficient claims payment system, and provider performance reporting, as well as managers and staff experienced in using these key elements to improve the quality of and access to care.

 

Ÿ

Data-driven approaches to balance cost and verify eligibility.   Our Medicaid health plans have conducted enrollment processing and activities for state programs since 1984.  We seek to ensure effective enrollment procedures that move members into the plan, then educate them and ensure they receive needed services as quickly as possible.  Our IT department has created mapping/translation programs for loading membership and linking membership eligibility status to all of Centene’s subsystems.

Ÿ

Establishment of realistic and meaningful expectations for quality deliverables.   We have collaborated with state agencies in redefining benefits, eligibility requirements and provider fee schedules with the goal of maximizing the number of individuals covered through Medicaid, SCHIP, Foster Care and ABD programs.

Ÿ

Managed care expertise in government subsidized programs.   Our expertise in Medicaid has helped us establish and maintain strong relationships with our constituent communities of members, providers and state governments.  We provide access to services through local providers and staff that focus on the cultural norms of their individual communities.  To that end, systems and procedures have been designed to address community-specific challenges through outreach, education, transportation and other member support activities.

Ÿ	Improved medical outcomes.   We have implemented programs developed to achieve savings for state governments and improve medical outcomes for members by reducing inappropriate emergency room use, inpatient days and high cost interventions, as well as by managing care of chronic illness.

Ÿ	Timely payment of provider claims.   We are committed to ensuring that our information systems and claims payment systems meet or exceed state requirements.  We continuously endeavor to update our systems and processes to improve the timeliness of our provider payments.

Ÿ

Cost saving outreach and specialty programs.   Our health plans have adopted a physician-driven approach where network providers are actively engaged in developing and implementing healthcare delivery policies and strategies.  This approach is designed to eliminate unnecessary costs, improve services to members and simplify the administrative burdens placed on providers.

Ÿ

Responsible collection and dissemination of utilization data.   We gather utilization data from multiple sources, allowing for an integrated view of our members’ utilization of services.  These sources include medical, vision and behavioral health claims and encounter data, pharmacy data, dental vendor claims and authorization data from the authorization and case management system utilized by us to coordinate care.

Ÿ	Timely and accurate reporting.   Our information systems have reporting capabilities which have been instrumental in identifying the need for new and/or improved healthcare and specialty programs.  For state agencies, our reporting capability is important in demonstrating an auditable program.

We also provide the following education and outreach programs to inform and assist members in accessing quality, appropriate healthcare services in an efficient manner:

 

Ÿ

Member Connections   is a community face-to-face outreach and education program designed to create a link between the member and the provider and help identify potential challenges or risk elements to a member’s health, such as nutritional challenges and health education shortcomings.  Member Connections representatives also contact new members by phone or mail to discuss managed care, the Medicaid program and our services.  Our Member Connections representatives make home visits, conduct educational programs and represent our health plans at community events such as health fairs.

Ÿ

Start Smart For Your Baby is a prenatal and infant health program designed to increase the percentage of pregnant women receiving early prenatal care, reduce the incidence of low birth weight babies, identify high risk pregnancies, increase participation in the federal Women, Infant and Children program, prevent hospital admissions in the first year of life and increase well-child visits.  The program includes risk assessments, education through face-to-face meetings and materials, behavior modification plans, assistance in selecting a provider for the infant and scheduling newborn follow-up visits.

Ÿ

EPSDT Case Management is a preventive care program designed to educate our members on the benefits of Early and Periodic Screening, Diagnosis and Treatment, or EPSDT, services.  We have a systematic program of communicating, tracking, outreach, reporting and follow-through that promotes state EPSDT programs.

Ÿ

Life and Health Management Programs are designed to help members understand their disease and treatment plan and improve their wellness in a cost effective manner.  These programs address medical conditions that are common within the Medicaid population such as asthma, diabetes and pregnancy.  Our Specialty Services segment manages many of our life and health management programs.  Our ABD program uses a proprietary assessment tool that effectively identifies barriers to care, unmet functional needs, available social supports and the existence of behavioral health conditions that impede a member’s ability to maintain a proper health status.  Care coordinators develop individual care plans with the member and healthcare providers ensuring the full integration of behavioral, social and acute care services.  These care plans, while specific to an ABD member, incorporate “Condition Specific” practices in collaboration with physician partners and community resources.

 

 

(1)	In November 2008, we announced our intention to sell University Health Plans.  As a result, this plan is presented as discontinued operations in our consolidated financial statements, however as of December 31, 2008, the plan was still operated by Centene Corporation.

 

Our network of primary care physicians is a critical component in care delivery, management of costs and the attraction and retention of new members.  Primary care physicians include family and general practitioners, pediatricians, internal medicine physicians and obstetricians and gynecologists.  Specialty care physicians provide medical care to members generally upon referral by the primary care physicians.  Specialty care physicians include, but are not limited to, orthopedic surgeons, cardiologists and otolaryngologists.  We also provide education and outreach programs to inform and assist members in accessing quality, appropriate healthcare services.

 

Our health plans facilitate access to healthcare services for our members primarily through contracts with our providers.  Our contracts with primary and specialty care physicians and hospitals usually are for one to two-year periods and renew automatically for successive one-year terms, but generally are subject to termination by either party upon 90 to 120 days prior written notice.  In the absence of a contract, we typically pay providers at state Medicaid reimbursement levels.  We pay physicians under a fee-for-service, capitation arrangement, or risk-sharing arrangement.

 

Ÿ

Under our fee-for-service contracts with physicians, particularly specialty care physicians, we pay a negotiated fee for covered services.  This model is characterized as having no financial risk for the physician.  In addition, this model requires management oversight because our total cost may increase as the units of services increase or as more expensive services replace less expensive services.  We have prior authorization procedures in place that are intended to make sure that certain high cost diagnostic and other services are medically appropriate.

 

Ÿ

Under our capitated contracts, primary care physicians are paid a monthly fee for each of our members assigned to his or her practice and are at risk for all costs associated with primary and specialty physician and emergency room services.  In return for this payment, these physicians provide all primary care and preventive services, including primary care office visits and EPSDT services.  If these physicians also provide non-capitated services to their assigned members, they may receive payment under fee-for-service arrangements at standard Medicaid rates.

Ÿ

Under risk-sharing arrangements, physicians are paid under a capitated or fee-for-service arrangement.  The arrangement, however, contains provisions for additional bonus to the physicians or reimbursement from the physicians based upon cost and quality factors.  We often refer to these arrangements as Model 1 contracts.

We work with physicians to help them operate efficiently by providing financial and utilization information, physician and patient educational programs and disease and medical management programs.  Our programs are also designed to help the physicians coordinate care outside of their offices.  In addition, we are governed by state prompt payment policies.

 

We believe our collaborative approach with physicians gives us a competitive advantage in entering new markets.  Our physicians serve on local committees that assist us in implementing preventive care programs, managing costs and improving the overall quality of care delivered to our members, while also simplifying the administrative burdens on our providers.  This approach has enabled us to strengthen our provider networks through improved physician recruitment and retention that, in turn, have helped to increase our membership base.  The following are among the services we provide to support physicians:

Ÿ

Customized Utilization Reports provide certain of our contracted physicians with information that enables them to run their practices more efficiently and focuses them on specific patient needs.  For example, quarterly detail reports update physicians on their status within their risk pools.  Equivalency reports provide physicians with financial comparisons of capitated versus fee-for-service arrangements.

Ÿ

Case Management Support helps the physician coordinate specialty care and ancillary services for patients with complex conditions and direct members to appropriate community resources to address both their health and socio-economic needs.

Ÿ

Web-based Claims and Eligibility Resources have been implemented in selected markets to provide physicians with on-line access to perform claims and eligibility inquiries.

Our contracted physicians also benefit from several of the services offered to our members, including the Member Connections , EPSDT case management and health management programs.  For example, the Member Connections staff facilitates doctor/patient relationships by connecting members with physicians, the EPSDT programs encourage routine checkups for children with their physicians and the health management programs assist physicians in managing their patients with chronic disease.

Where appropriate, our health plans contract with our specialty services organizations to provide services and programs such as behavioral health, health management, managed vision, nurse triage, pharmacy benefit management, and treatment compliance.  When necessary, we also contract with third-party providers on a negotiated fee arrangement for physical therapy, home healthcare, diagnostic laboratory tests, x-ray examinations, ambulance services and durable medical equipment.  Additionally, we contract with dental vendors in markets where routine dental care is a covered benefit.

 

Quality Management

 

Our medical management programs focus on improving quality of care in areas that have the greatest impact on our members.  We employ strategies, including health management and complex case management, that are adjusted for implementation in our individual markets by a system of physician committees chaired by local physician leaders.  This process promotes physician participation and support, both critical factors in the success of any clinical quality improvement program.

We have implemented specialized information systems to support our medical quality management activities.  Information is drawn from our data warehouse, clinical databases and our membership and claims processing system, to identify opportunities to improve care and to track the outcomes of the interventions implemented to achieve those improvements.  Some examples of these intervention programs include:

Ÿ	appropriate leveling of care for neonatal intensive care unit (NICU) hospital admissions, other inpatient hospital admissions, and observation admissions, in accordance with Interqual criteria;

Ÿ	tightening of our pre-authorization list and more stringent review of durable medical equipment and injectibles.

Ÿ	emergency department (ED) program designed to collaboratively work with hospitals to steer non-emergency care away from the costly ED setting (through patient education, on-site alternative urgent care settings, etc.);

Ÿ	increase emphasis on case management and clinical rounding where case managers are nurses or social workers who are employed by the health plan to assist selected patients with the coordination of healthcare services in order to meet a patient's specific healthcare needs;

Ÿ	incorporation of disease management, which is a comprehensive, multidisciplinary, collaborative approach to chronic illnesses such as asthma and diabetes;

Ÿ	Smart Start For Your Baby, a prenatal case management program aimed at helping women with high-risk pregnancies deliver full-term, healthy infants.

We provide reporting on a regular basis using our data warehouse.  State and Health Employer Data and Information Set, or HEDIS, reporting constitutes the core of the information base that drives our clinical quality performance efforts.  This reporting is monitored by Plan Quality Improvement Committees and our corporate medical management team.

 

In an effort to ensure the quality of our provider networks, we undertake to verify the credentials and background of our providers using standards that are supported by the National Committee for Quality Assurance.

 

Information Technology

 

The ability to access data and translate it into meaningful information is essential to operating across a multi-state service area in a cost-effective manner.  Our centralized information systems, which are located in St. Louis, Missouri, support our core processing functions under a set of integrated databases and are designed to be both replicable and scalable to accommodate organic growth and growth from acquisitions.  We continue to enhance our systems in order to leverage the platform we have developed for our existing states for configuration into new states or health plan acquisitions.

 

        Our integrated approach helps to assure that consistent sources of claim and member information are provided across all of our health plans.  Our membership and claims processing system is capable of expanding to support additional members in an efficient manner.  We have a disaster recovery and business resumption plan developed and implemented in conjunction with a third party.  This plan allows us complete access to the business resumption centers and hot-site facilities provided by the plan.

 

SPECIALTY SERVICES

Ÿ eligibility, enrollment and disenrollment processes;		Ÿ health education and wellness and prevention programs;
Ÿ covered services;		Ÿ timeliness of claims payment;
Ÿ eligible providers;		Ÿ financial standards;
Ÿ subcontractors;		Ÿ safeguarding of member information;
Ÿ record-keeping and record retention;		Ÿ fraud and abuse detection and reporting;
Ÿ periodic financial and informational reporting;		Ÿ grievance procedures; and
Ÿ quality assurance;		Ÿ organization and administrative systems.

State Contract		Expiration Date		Renewal or Extension by the State		Termination by the State
Arizona – Acute Care		September 30, 2011		May be extended for up to two additional one-year terms.		May be terminated for convenience or an event of default.
Arizona – Behavioral Health		June 30, 2009		May be extended for up to one additional year.		May be terminated for convenience or an event of default.
Arizona – Long-term Care		September 30, 2009		May be extended for up to two additional years.		May be terminated for convenience, an event of default or lack of funding.
Arizona – Special Needs Plan (Medicare)		December 31, 2009		Renewable annually for successive 12-month periods.		May be terminated by an event of default.
Florida - Medicaid		August 31, 2009		Renewable through the state’s recertification process.		May be terminated for an event of default or lack of federal funding.
Georgia – Medicaid & SCHIP		June 30, 2009		Renewable for three additional one-year terms.		May be terminated for an event of default or significant changes in circumstances.
Indiana – Medicaid & SCHIP		December 31, 2010		May be extended for up to two additional years.		May be terminated for convenience or an event of default.
Kansas – Behavioral Health		June 30, 2009		May be extended with three one-year renewal options.		May be terminated for cause, or without cause for lack of funding.
New Jersey – Medicaid, SCHIP & ABD		June 30, 2009		Renewable annually for successive 12-month periods.		May be terminated for convenience or an event of default.
Ohio – Medicaid & SCHIP		June 30, 2009		Renewable annually for successive 12-month periods.		May be terminated for an event of default.
Ohio – Aged, Blind or Disabled (ABD)		June 30, 2009		Renewable annually for successive 12-month periods.		May be terminated for an event of default.
Ohio – Special Needs Plan (Medicare)		December 31, 2009		Renewable annually for successive 12-month periods.		May be terminated by an event of default.
South Carolina – Medicaid & ABD		March 31, 2009		Renewable annually for successive 12-month periods.		May be terminated for convenience or an event of default.
South Carolina – SCHIP		March 31, 2009		May be extended for up to one additional year.		May be terminated for convenience, an event of default or lack of federal funding.
Texas  –Medicaid, SCHIP & ABD		August 31, 2010		May be extended for up to four additional years.		May be terminated for convenience, an event of default or lack of federal funding.
Texas – Exclusive Provider Organization (SCHIP)		August 31, 2009		May be extended for up to one additional year.		May be terminated upon any event of default or in the event of lack of state or federal funding.
Texas – Foster Care		August 31, 2010		May be extended for up to four and a half additional years.		May be terminated for convenience, an event of default, or non-appropriation of funds.
Texas – Special Needs Plan (Medicare)		December 31, 2009		Renewable annually for successive 12-month periods.		May be terminated by an event of default.
Wisconsin –Medicaid & ABD		December 31, 2009		May be extended for up to one additional year.		May be terminated if a change in state or federal laws, rules or regulations materially affects either party’s right or responsibilities or for an event of default or lack of funding.
Wisconsin – Network Health Plan Subcontract		December 31, 2011		Renews automatically for successive five-year terms.		May be terminated upon two-years notice prior to the end of the then current term or if a change in state or federal laws, rules or regulations materially affects either party’s rights or responsibilities under the contract, or if Network Health Plan’s contract with the State is terminated.
Wisconsin – Special Needs Plan (Medicare)		December 31, 2009		Renewable annually for successive 12-month periods.		May be terminated by an event of default.

EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth information regarding our executive officers, including their ages, at January 31, 2009:

 

Name		Age		Position
Michael F. Neidorff		66		Chairman and Chief Executive Officer
Mark W. Eggert		47		Executive Vice President, Health Plan Business Unit
Carol E. Goldman		51		Executive Vice President and Chief Administrative Officer
Cary D. Hobbs		41		Senior Vice President, Business Management and Integration
Jesse N. Hunter		33		Executive Vice President, Corporate Development
Donald G. Imholz		56		Senior Vice President and Chief Information Officer
Edmund E. Kroll		49		Senior Vice President, Finance and Investor Relations
Frederick J. Manning		61		Executive Vice President, Celtic Insurance Company
William N. Scheffel		55		Executive Vice President, Specialty Business Unit
Jeffrey A. Schwaneke		33		Vice President, Corporate Controller and Chief Accounting Officer
Eric R. Slusser		48		Executive Vice President, Chief Financial Officer and Treasurer
Keith H. Williamson		56		Senior Vice President, General Counsel and Secretary

Item 1B.    Unresolved Staff Comments

None.

Item 2.   Properties

We own our corporate office headquarters building located in St. Louis, Missouri.  During 2008, our capital expenditures included land and fees for the construction of a new real estate development on the property adjoining our corporate office, which we believe is necessary to accommodate our growing business.  We are currently negotiating our involvement as a joint venture partner in the entity that will develop the relevant properties.

We generally lease space in the states where our health plans, specialty companies and claims processing facilities operate.  We are required by various insurance and regulatory authorities to have offices in the service areas where we provide benefits.  We believe our current facilities are adequate to meet our operational needs for the foreseeable future.

17

---

Table of Contents

Item 3.   Legal Proceedings

On January 8, 2009, we filed a complaint in the Chancery Division of the Superior Court of New Jersey, asserting a breach of contract claim against AMERIGROUP New Jersey, or AGPNJ, and a tortuous interference with contract claim against AMERIGROUP Corporation, in connection with AGPNJ’s refusal to proceed to closing under its contract to purchase certain assets of University Health Plan’s or, UHP’s, business.  In December 2008, AGPNJ sent us a termination notice claiming that a material adverse effect had occurred under the contract and attempted to terminate the contract.  We are contesting whether a material adverse effect occurred and correspondingly the propriety and validity of the purported termination, and are seeking to obtain specific performance of the contract and damages.

 

We routinely are subjected to legal proceedings in the normal course of business. While the ultimate resolution of such matters is uncertain, we do not expect the results of any of these matters individually, or in the aggregate, to have a material effect on our financial position or results of operations.

Item 4.   Submission of Matters to a Vote of Security Holders

None.

 

18

---

Table of Contents

PART II

 

Item 5 .   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Market for Common Stock; Dividends

 

Our common stock has been traded and quoted on the New York Stock Exchange under the symbol “CNC” since October 16, 2003.

 

		2008 Stock Price						2007 Stock Price
		High			Low			High			Low
First Quarter		$	28.49		$	13.58		$	26.66		$	20.68
Second Quarter			21.70			13.10			24.28			19.35
Third Quarter			24.67			16.40			23.79			17.65
Fourth Quarter			21.61			15.23			27.73			21.26

 

As of February 6, 2009, there were 49 holders of record of our common stock.

 

We have never declared any cash dividends on our capital stock and currently anticipate that we will retain any future earnings for the development, operation and expansion of our business.

Issuer Purchases of Equity Securities

 

In October 2008, our board of directors extended the previously adopted November 2005 stock repurchase program, authorizing us to repurchase up to four million shares of common stock from time to time on the open market or through privately negotiated transactions.  The repurchase program expires October 31, 2009, but we reserve the right to suspend or discontinue the program at any time.  We have established a trading plan with a registered broker to repurchase shares under certain market conditions.  During the year ended December 31, 2008, we repurchased 1,218,858 shares at an average price of $19.29 and an aggregate cost of $23.5 million.  During the quarter ended December 31, 2008, with the exception of the 11,346 shares footnoted below, we did not repurchase any shares other than through this publicly announced program.

 

Issuer Purchases of Equity Securities Fourth Quarter 2008
Period		Total Number of Shares Purchased				Average Price Per Share			Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs			Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
October 1 – October 31, 2008			264,307	1		$	18.94			264,008			1,934,481
November 1 – November 30, 2008			2,597	2			17.12			—			1,934,481
December 1 – December 31, 2008			8,450	2			16.07			—			1,934,481
TOTAL			275,354			$	18.83			264,008			1,934,481

________________

1 299 shares acquired in October 2008 represent shares relinquished to the Company by certain employees for payment of taxes upon vesting of restricted stock units.

2 Shares acquired in November and December 2008 represent shares relinquished to the Company by certain employees for payment of taxes upon vesting of restricted stock units.

 

Stock Performance Graphs

 

The graph below compares the cumulative total stockholder return on our common stock for the period from December 31, 2003 to December 31, 2008 with the cumulative total return of the New York Stock Exchange Composite Index and the Morgan Stanley Health Care Payor Index over the same period.  The graph assumes an investment of $100 on December 31, 2003 in our common stock (at the last reported sale price on such day), the New York Stock Exchange Composite Index and the Morgan Stanley Health Care Payor Index and assumes the reinvestment of any dividends.

 

 

 

		12/31/2003				12/31/2004				12/31/2005				12/31/2006				12/31/2007				12/31/2008
Centene Corporation		$	100.00			$	202.36			$	187.65			$	175.37			$	195.86			$	140.69
New York Stock Exchange Composite Index		$	100.00			$	112.16			$	119.96			$	141.38			$	150.69			$	89.06
MS Health Care Payor Index		$	100.00			$	146.27			$	200.56			$	213.90			$	248.53			$	112.32

19

---

Table of Contents

 

Item 6.   Selected Financial Data

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K.  The assets, liabilities and results of operations of FirstGuard and University Health Plans have been classified as discontinued operations for all periods presented.  The data for the years ended December 31, 2008, 2007 and 2006 and as of December 31, 2008 and 2007 are derived from consolidated financial statements included elsewhere in this filing.  The data for the years ended December 31, 2005 and 2004 and as of December 31, 2006, 2005 and 2004 are derived from consolidated financial statements not included in this filing.

 

		Year Ended December 31,
		2008				2007				2006				2005				2004
		(In thousands, except share data)
Consolidated Statements of Operations:
Revenues:
Premium		$	3,199,360			$	2,611,953			$	1,707,439			$	1,095,308			$	851,794
Premium tax			90,202				76,567				35,848				6,079				4,911
Service			74,953				80,508				79,159				13,456				8,532
Total revenues			3,364,515				2,769,028				1,822,446				1,114,843				865,237
Expenses:
Medical costs			2,640,335				2,190,898				1,436,371				897,077				692,348
Cost of services			56,920				61,348				60,287				5,608				7,771
General and administrative expenses			444,733				384,970				267,712				162,432				111,924
Premium tax expense			90,966				76,567				35,848				6,079				4,911
Total operating expenses			3,232,954				2,713,783				1,800,218				1,071,196				816,954
Earnings from operations			131,561				55,245				22,228				43,647				48,283
Other income (expense):
Investment and other income			21,728				24,452				15,511				8,417				6,066
Interest expense			(16,673	)			(15,626	)			(10,574	)			(3,985	)			(680	)
Earnings from continuing operations before income taxes			136,616				64,071				27,165				48,079				53,669
Income tax expense			52,435				23,031				9,565				17,242				19,835
Net earnings from continuing operations			84,181				41,040				17,600				30,837				33,834
Discontinued operations, net of income tax (benefit) expense of $(281), $(31,563), $12,412, $12,982, and $6,140, respectively			(684	)			32,362				(61,229	)			24,795				10,478
Net earnings (loss)		$	83,497			$	73,402			$	(43,629	)		$	55,632			$	44,312
Net earnings (loss) per common share:
Basic:
Continuing operations		$	1.95			$	0.95			$	0.41			$	0.73			$	0.83
Discontinued operations			(0.02	)			0.74				(1.42	)			0.58				0.26
Basic earnings (loss) per common share		$	1.93			$	1.69			$	(1.01	)		$	1.31			$	1.09
Diluted:
Continuing operations		$	1.90			$	0.92			$	0.39			$	0.69			$	0.78
Discontinued operations			(0.02	)			0.72				(1.37	)			0.55				0.24
Diluted earnings (loss) per common share		$	1.88			$	1.64			$	(0.98	)		$	1.24			$	1.02
Weighted average number of common shares outstanding:
Basic			43,275,187				43,539,950				43,160,860				42,312,522				40,820,909
Diluted			44,398,955				44,823,082				44,613,622				45,027,633				43,616,445

		December 31,
		2008				2007				2006				2005				2004
			(In thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents		$	370,999			$	267,305			$	237,514			$	112,269			$	55,850
Investments and restricted deposits			451,058				369,545				174,431				163,489				186,777
Total assets			1,451,152				1,121,824				894,980				668,030				527,934
Medical claims liability			373,037				313,364				232,496				123,102				121,790
Long-term debt			264,637				206,406				174,646				92,448				46,973
Total stockholders’ equity			501,272				415,047				326,423				352,048				271,312

 

20

---

Table of Contents

 

Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this filing.  The discussion contains forward-looking statements that involve known and unknown risks and uncertainties, including those set forth under Item 1A.  “Risk Factors” of this Form 10-K.

 

OVERVIEW

We are a multi-line healthcare enterprise operating in two segments.  Our Medicaid Managed Care segment provides Medicaid and Medicaid-related programs to organizations and individuals through government subsidized programs, including Medicaid, the State Children’s Health Insurance Program, or SCHIP, and, Supplemental Security Income including Aged, Blind or Disabled programs, or ABD. Our Specialty Services segment provides specialty services, including behavioral health, individual health insurance, life and health management, long-term care programs, managed vision, nurse triage, and pharmacy benefits management, to state programs, healthcare organizations, employer groups and other commercial organizations, as well as to our own subsidiaries.   Our Specialty Services segment also provides a full range of healthcare solutions for the rising number of uninsured Americans.

During 2008, we announced our intention to sell certain assets of University Health Plans, Inc, or UHP, our New Jersey health plan.  In addition, our Medicaid contract in Kansas terminated effective December 31, 2006, and we sold the operating assets of FirstGuard Health Plan, Inc., our Missouri health plan, effective February 1, 2007.  Unless specifically noted, the discussions below are in the context of continuing operations, and therefore, exclude our New Jersey health plan, UHP, as well as our Kansas and Missouri health plans, collectively referred to as FirstGuard.  The results of operations for UHP and FirstGuard are classified as discontinued operations for all periods presented.

Our financial performance for 2008 is summarized as follows:

—	Year-end Medicaid Managed Care membership of 1,184,800.

—	Revenues of $3.4 billion.

—	Health Benefits Ratio, or HBR, of 82.5%.

—	General and Administrative, or G&A, expense ratio of 13.6%.

—	Diluted net earnings per share of $1.90.

—	Total operating cash flows of $222.0 million.

The following new contracts and acquisitions contributed to our growth over the last two years:

—	In October 2008, we began operating under our contract in Arizona to provide Acute Care services in Yavapai county, with 14,900 members at December 31, 2008.
—	Effective July 1, 2008, we completed the previously announced acquisition of Celtic, a health insurance carrier focused on the individual health insurance market.

—	In April 2008, we began operating under our new contract in Texas to provide statewide managed care services to participants in the Texas Foster Care program, with 33,100 members at December 31, 2008.

—

In 2007, we acquired PhyTrust of South Carolina, LLC, as well as Physician’s Choice, LLC, both of which managed care on a non-risk basis for Medicaid members in South Carolina.  We became licensed in 2007 to provide risk-based managed care in the State and participated in the transition of the State’s conversion to at-risk managed care.  We served 31,300 at-risk members in South Carolina at December 31, 2008.

—	In July 2007, we acquired a 49% ownership interest in Access Health Solutions, LLC, or Access, which provides managed care for Medicaid recipients in Florida, with 97,100 members at December 31, 2008.
—	In February 2007, we began managing care for ABD recipients in the San Antonio and Corpus Christi markets of Texas with 34,600 members at December 31, 2008.
—	In 2007, we began managing care for ABD members in Ohio, with 13,900 members at December 31, 2008.

We have opportunities to continue our growth through the following:

—	In November 2008, we announced the planned acquisition of certain assets of AMERIGROUP Community Care of South Carolina.  We expect this acquisition to close during the first quarter of 2009.

—	In February 2009, we began converting membership in Florida from Access, on a non-risk basis to our new subsidiary, Sunshine State Health Plan on an at-risk basis.

RESULTS OF CONTINUING OPERATIONS AND KEY METRICS

The following discussion and analysis is based on our consolidated statements of operations, which reflect our results of operations for the years ended December 31, 2008, 2007 and 2006, as prepared in accordance with generally accepted accounting principles in the United States, or GAAP.

Summarized comparative financial data for 2008, 2007 and 2006 are as follows ($ in millions):

		2008				2007				2006				% Change 2007-2008				% Change 2006-2007
Premium		$	3,199.3			$	2,611.9			$	1,707.4				22.5	%			53.0	%
Premium tax			90.2				76.6				35.8				17.8	%			113.6	%
Service			75.0				80.5				79.2				(6.9	) %			1.7	%
Total revenues			3,364.5				2,769.0				1,822.4				21.5	%			51.9	%
Medical costs			2,640.3				2,190.9				1,436.4				20.5	%			52.5	%
Cost of services			56.9				61.3				60.3				(7.2	)%			1.8	%
General and administrative expenses			444.7				385.0				267.7				15.5	%			43.8	%
Premium tax expense			91.0				76.6				35.8				18.8	%			113.6	%
Earnings from operations			131.6				55.2				22.2				138.1	%			148.5	%
Investment and other income, net			5.0				8.8				5.0				(42.7	)%			78.8	%
Earnings before income taxes			136.6				64.0				27.2				113.2	%			135.9	%
Income tax expense			52.4				23.0				9.6				127.7	%			140.8	%
Net earnings from continuing operations			84.2				41.0				17.6				105.1	%			132.2	%
Discontinued operations, net of income tax (benefit) expense of $(0.3), $(31.6) and $12.4 respectively			(0.7	)			32.4				(61.2	)			(102.1	)%			(152.9	)%
Net earnings (loss)		$	83.5			$	73.4			$	(43.6	)			13.8	%			(268.2	)%
Diluted earnings (loss) per common share:
Continuing operations		$	1.90			$	0.92			$	0.39				106.5	%			135.9	%
Discontinued operations			(0.02	)			0.72				(1.37	)			(102.8	)%			(152.6	)%
Total diluted earnings (loss) per common share		$	1.88			$	1.64			$	(0.98	)			14.6	%			(267.3	)%

 

21

---

Table of Contents

 

Revenues and Revenue Recognition

 

Our Medicaid Managed Care segment generates revenues primarily from premiums we receive from the states in which we operate health plans.  We receive a fixed premium per member per month pursuant to our state contracts.  We generally receive premium payments during the month we provide services and recognize premium revenue during the period in which we are obligated to provide services to our members.  In some instances, our base premiums are subject to an adjustment, or risk score, based on the acuity of our membership.  Generally, the risk score is determined by the State analyzing encounter submissions of processed claims data to determine the acuity of our membership relative to the entire state’s Medicaid membership.  Some states enact premium taxes or similar assessments, collectively, premium taxes, and these taxes are recorded as a component of revenues as well as operating expenses.  Some contracts allow for additional premium associated with certain supplemental services provided such as maternity deliveries.  Revenues are recorded based on membership and eligibility data provided by the states, which may be adjusted by the states for updates to this data.  These eligibility adjustments have been immaterial in relation to total revenue recorded and are reflected in the period known.

 

Our Specialty Services segment generates revenues under contracts with state programs, healthcare organizations, and other commercial organizations, as well as from our own subsidiaries.  Revenues are recognized when the related services are provided or as ratably earned over the covered period of services.

Premium and service revenues collected in advance are recorded as unearned revenue.  For performance-based contracts, we do not recognize revenue subject to refund until data is sufficient to measure performance.  Premium and service revenues due to us are recorded as premium and related receivables and are recorded net of an allowance based on historical trends and our management’s judgment on the collectibility of these accounts.  As we generally receive payments during the month in which services are provided, the allowance is typically not significant in comparison to total revenues and does not have a material impact on the presentation of our financial condition or results of operations.

 

Our total revenue increased in the year ended December 31, 2008 over the previous year primarily through 1) membership growth in the Medicaid Managed Care segment, 2) premium rate increases, and 3) growth in our Specialty Services segment.

 

1.

Membership growth

From December 31, 2006 to December 31, 2008, we increased our Medicaid Managed Care membership by 11.3%.  The following table sets forth our membership by state in our Medicaid Managed Care segment:

		December 31,
		2008		2007		2006
Georgia		288,300		287,900		308,800
Indiana		175,300		154,600		183,100
Ohio		133,400		128,700		109,200
South Carolina		31,300		31,800		—
Texas		431,700		354,400		298,500
Wisconsin		124,800		131,900		164,800
Total		1,184,800		1,089,300		1,064,400

The following table sets forth our membership by line of business in our Medicaid Managed Care segment:

 

		December 31,
		2008		2007		2006
Medicaid		862,500		807,600		843,700
SCHIP/Foster Care		257,300		214,600		205,800
ABD/Medicare		65,000		67,100		14,900
Total		1,184,800		1,089,300		1,064,400

 

From December 31, 2007 to December 31, 2008 our membership increased as a result of growth in Indiana and Texas.  In Texas, we increased our membership through organic growth of SCHIP, especially in the Exclusive Provider Organization, or EPO, market.  In addition, we increased Texas membership through our new Foster Care program, with 33,100 members at December 31, 2008.  We increased our membership in Indiana through temporary eligibility determinations and network expansions.  Our membership decreased in Wisconsin due to the termination of certain provider contracts.  In South Carolina, we continue to add at-risk membership as additional counties convert, with 31,300 at-risk members at December 31, 2008.  Substantially all of the prior year membership in South Carolina was on a non-risk basis.  In Florida, Access served 97,100 members on a non-risk basis at December 31, 2008.

From December 31, 2006 to December 31, 2007, our membership increased primarily as a result of increases in Ohio, South Carolina and Texas.  We increased our Medicaid membership in Ohio by adding members under our new contract in the Northwest region. We also increased our membership in Ohio with the commencement of our new contract to serve Aged, Blind or Disabled members.  Our membership in South Carolina was primarily on a non-risk basis; we began conversion to at-risk in December 2007, with 100 at-risk members at December 31, 2007.  In Texas, we increased our membership through new Medicaid, SCHIP and ABD contracts in the Corpus Christi, San Antonio, Austin, and Lubbock markets. Our membership decreased in Wisconsin because of more stringent state eligibility requirements for the Medicaid and SCHIP programs, eligibility administration issues and the termination of certain physician contracts associated with a high cost hospital system. Our membership decreased in Indiana primarily due to adjustments made to our provider network made in connection with our new state-wide contract as well as the termination of certain non-exclusive physician contracts.  In Florida, Access served 90,600 members on a non-risk basis at December 31, 2007.

The total revenue associated with University Health Plans included in results from discontinued operations was $150.6 million, $150.3 million, and $139.5 million in 2008, 2007 and 2006, respectively.  Our University Health Plan membership was 55,200, 57,300 and 58,900 at December 31, 2008, 2007 and 2006, respectively.  The total revenue associated with FirstGuard included in results from discontinued operations was $0, $6.7 million, and $317.0 million in 2008, 2007 and 2006, respectively.  Our FirstGuard membership was 138,900 at December 31, 2006.

2.

Premium rate increases

In 2008, we received premium rate increases in some markets which yield a 2.7% composite increase across all of our markets.  In 2007, we received premium rate increases in some markets which yield a 2.6% composite increase across all of our markets.

In November 2007, we received a contract amendment from the State of Georgia providing for an effective premium rate increase in Georgia of approximately 3.8% effective July 1, 2007.  The state also mandated service changes, retroactively recalculated certain rate cells and adjusted for duplicate member issues.  We executed this amendment on November 16, 2007.  The State of Georgia returned the fully executed contract in January 2008 and, accordingly, we recorded the additional revenue, retroactive to July 1, 2007, in the first quarter of 2008.  This premium revenue, related to the period from July 1, 2007 to December 31, 2007, totals approximately $20.8 million.  Approximately $7.3 million of this amount is related to the mandated services, rate cell changes and duplicate member issues, the remaining $13.5 million yields the calculated 3.8% increase.

 

3.

Specialty Services segment growth

For the year ended December 31, 2008, Specialty Services segment revenue from external customers was $344.3 million compared to $245.4 million for the same prior year period.  The increase is primarily attributable to the acquisition of Celtic as well as increasing membership for both our behavioral health company, Cenpatico, and Bridgeway.

The following table sets forth our membership by line of business in our Specialty Services segment:

		December 31,
		2008		2007		2006
Cenpatico Behavioral Health:
Kansas		41,100		39,000		36,600
Arizona		105,000		99,900		94,500
Bridgeway:
Long-term Care		2,100		1,600		900
Acute Care		14,900		—		—

22

---

Table of Contents

 

Operating Expenses

 

Medical Costs

 

Our medical costs include payments to physicians, hospitals, and other providers for healthcare and specialty services claims. Medical costs also include estimates of medical expenses incurred but not yet reported, or IBNR, and estimates of the cost to process unpaid claims. We use our judgment to determine the assumptions to be used in the calculation of the required IBNR estimate.  The assumptions we consider include, without limitation, claims receipt and payment experience (and variations in that experience), changes in membership, provider billing practices, health care service utilization trends, cost trends, product mix, seasonality, prior authorization of medical services, benefit changes, known outbreaks of disease or increased incidence of illness such as influenza, provider contract changes, changes to Medicaid fee schedules, and the incidence of high dollar or catastrophic claims.

Our development of the IBNR estimate is a continuous process which we monitor and refine on a monthly basis as claims receipts and payment information becomes available.  As more complete information becomes available, we adjust the amount of the estimate, and include the changes in estimates in medical expense in the period in which the changes are identified.

Additionally, we contract with independent actuaries to review our estimates on a quarterly basis.  The independent actuaries provide us with a review letter that includes the results of their analysis of our medical claims liability.  We do not solely rely on their report to adjust our claims liability. We utilize their calculation of our claims liability only as additional information, together with management’s judgment to determine the assumptions to be used in the calculation of our liability for medical costs.

While we believe our IBNR estimate is appropriate, it is possible future events could require us to make significant adjustments for revisions to these estimates.  Accordingly, we can not assure you that healthcare claim costs will not materially differ from our estimates.

 

Our results of operations depend on our ability to manage expenses associated with health benefits and to accurately predict costs incurred. Our health benefits ratio, or HBR, represents medical costs as a percentage of premium revenues (excluding premium taxes) and reflects the direct relationship between the premium received and the medical services provided. The table below depicts our HBR for our external membership by member category:

 

		Year Ended December 31,
		2008				2007				2006
Medicaid and SCHIP			80.6	%			82.8	%			84.0	%
ABD and Medicare			91.1				91.4				88.8
Specialty Services			83.8				78.4				83.9
Total			82.5				83.9				84.1

 

Our consolidated HBR for the year ended December 31, 2008 was 82.5%, a decrease of 1.4% over 2007.  The decrease for the year ended December 31, 2008 over 2007 is due to the effect of recording the Georgia premium rate increase retroactive to July 1, 2007 in 2008.  Our consolidated HBR for the year ended December 31, 2007 was 83.9%, a decrease of 0.2% over 2006.  The decrease is primarily attributable to increased premium yield combined with a moderating medical cost trend particularly with a decrease in pharmacy costs, offset by the new ABD business in Ohio and the transition of these new members into a managed care environment.

Cost of Services

Our cost of services expense includes the pharmaceutical costs associated with our pharmacy benefit manager’s external revenues. Cost of services also includes all direct costs to support the functions responsible for generation of our services revenues. These expenses consist of the salaries and wages of the professionals and teachers who provide the services and expenses associated with facilities and equipment used to provide services.

General and Administrative Expenses

Our general and administrative expenses, or G&A, primarily reflect wages and benefits, including stock compensation expense, and other administrative costs associated with our health plans, specialty companies and centralized functions that support all of our business units. Our major centralized functions are finance, information systems and claims processing. G&A increased in both the years ended December 31, 2008 and December 31, 2007 primarily due to expenses for additional facilities and staff to support our growth.  G&A also increased in 2008 as a result of the acquisition of Celtic.  G&A in 2007 also included charges totaling $12.4 million for fixed asset impairment, severance for an organizational realignment, and a contribution to our charitable foundation with a portion of the proceeds from the sale of FirstGuard Missouri.  The fixed asset impairment resulted from abandoning a previously planned headquarters development in Clayton, Missouri.

Our G&A expense ratio represents G&A expenses as a percentage of the sum of Premium revenues and Service revenues, and reflects the relationship between revenues earned and the costs necessary to earn those revenues.  The consolidated G&A expense ratio for the years ended December 31, 2008, 2007 and 2006 were 13.6%, 14.3% and 15.0%, respectively.  The decrease in the ratio in 2008 primarily reflects the overall leveraging of our expenses over higher revenues, partially offset by the effect of the acquisition of Celtic and of our start-up costs in Florida and for our Texas Foster Care product.  The decrease in the ratio in 2007 primarily reflects the overall leveraging of our expenses over higher revenues offset by the effect of our start-up costs in South Carolina and for our Texas Foster Care product, and the $12.4 million charge discussed above.

Other Income (Expense)

The following table summarizes the components of investment and other income, net:

		Year Ended December 31,
		2008				2007				2006
Investment income		$	15.3			$	23.9			$	15.5
Earnings from equity method investee			6.4				0.5				—
Interest expense			(16.7	)			(15.6	)			(10.5	)
Investment and other income, net		$	5.0			$	8.8			$	5.0

Other income (expense) consists principally of investment income from our cash and investments, our equity in earnings of investments, and interest expense on our debt. Investment income decreased $8.6 million in 2008, over the comparable periods in 2007.  The decrease in 2008 was due to a loss on investments of $4.5 million recorded in the third quarter of 2008 and an overall decline in market interest rates.  The loss was primarily related to investments in the Reserve Primary money market fund whose Net Asset Value fell below $1.00 per share.  The loss represents less than 1% of Centene’s cash and investment portfolio as of December 31, 2008.  We expect to recover 95% of our Reserve Primary Fund investments.  Money market funds are generally recorded in Cash and cash equivalents in our balance sheet, however, our investment in the Reserve Primary money market fund is recorded in Short-term investments due to the restrictions placed on redemptions imposed by the fund.  As of December 31, 2008 we had recovered most of the investment in the Reserve Primary Fund.  These decreases were partially offset by an increase in earnings from our equity method investee, Access.  Investment income increased $8.4 million in 2007, over the comparable period in 2006.  The increase was primarily a result of larger investment balances.  Interest expense increased in 2007, over the comparable period in 2006 due to larger debt balances resulting from our senior notes issuance.

Income Tax Expense

Our effective tax rate in 2008 was 38.4% compared to 35.9% in 2007.  The increase in the current year was due to higher state taxes as a result of a change in the estimated benefit to be realized from New Jersey State net operating loss carryforwards.   Our 2007 effective tax rate was 35.9% compared to 35.2% for the corresponding period in 2006.  The decrease was primarily due to the effect of an increase in tax-exempt investment income and lower state taxes.

23

---

Table of Contents

 

Discontinued Operations

In November 2008, we announced our intention to sell certain assets of University Health Plans, Inc, or UHP, our New Jersey health plan.  Accordingly, the results of operations for UHP are reported as discontinued operations for all periods presented.  UHP was previously reported in the Medicaid Managed Care segment.  In November 2008, we announced a definitive agreement to sell certain assets of our New Jersey health plan to AMERIGROUP New Jersey, or AGPNJ.  In December 2008, AGPNJ sent us a termination notice.  We have filed a complaint seeking specific performance of the contract and damages.  Additional information regarding this matter is included in “Item 3. Legal Proceedings” included elsewhere in this Annual Report on Form 10-K.

In August 2006, FirstGuard Health Plan Kansas, Inc., or FirstGuard Kansas, our wholly owned subsidiary, received notification from the Kansas Health Policy Authority that its Medicaid contract scheduled to terminate December 31, 2006 would not be renewed.   In 2006, we also evaluated our strategic alternatives for our FirstGuard Missouri health plan and decided to divest the business.  The sale of the operating assets of FirstGuard Missouri was completed effective February 1, 2007.  Accordingly, the results of operations for FirstGuard Kansas and FirstGuard Missouri are reported as discontinued operations for all periods presented.   FirstGuard Kansas and FirstGuard Missouri were previously reported in the Medicaid Managed Care segment.  Additionally, the assets and liabilities of the discontinued businesses are segregated in the consolidated balance sheet.

Net earnings (losses) from discontinued operations were a net loss of $0.7 million in 2008 compared to earnings of $32.4 million in 2007 and a net loss of $61.2 million in 2006.  The 2008 results include a one-time charge of $3.7 million primarily for asset impairments and employee severance related to the sale of the New Jersey health plan.  At December 31, 2008, the remaining liability for these charges was $1.1 million.  In 2007, we abandoned the stock of our FirstGuard health plans resulting in tax benefits of $32.6 million, net of the associated asset write-offs.  The 2007 results also included a gain on the sale of FirstGuard Missouri of $7.5 million, as well as operational and exit costs associated with FirstGuard.  The 2006 results included a FirstGuard goodwill impairment charge of $81.1 million, a FirstGuard intangible asset impairment charge of $6.0 million, as well as operational and exit costs associated with FirstGuard.

 

LIQUIDITY AND CAPITAL RESOURCES

 

 

Shown below is a condensed schedule of cash flows for the years ended December 31, 2008, 2007 and 2006, that we use throughout our discussion of liquidity and capital resources (in millions).

 

		Year Ended December 31,
		2008				2007				2006
Net cash provided by operating activities		$	222.0			$	202.2			$	195.0
Net cash used in investing activities			(153.9	)			(225.5	)			(150.2	)
Net cash provided by financing activities			42.4				20.8				78.9
Net increase (decrease) in cash and cash equivalents		$	110.5			$	(2.5	)		$	123.7

We finance our activities primarily through operating cash flows and borrowings under our revolving credit facility.  Our total operating activities provided cash of $222.0 million in 2008, $202.2 million in 2007 and $195.0 million in 2006.  Cash flow from operations in 2008 reflected an increase in our Medical claims liability as a result of new business in Texas, South Carolina and Arizona.  Cash flow from operations also increased by a change in our cash management procedure whereby negative book cash balances resulting from checks issued but not yet presented to our bank for payment are now included in Accounts payable and accrued expenses.  These factors were partially offset by a decrease in unearned revenue resulting from a timing difference with the receipt of our December revenue for our Ohio health plan.  The Medical claims liability increased in 2007 reflecting new business in Ohio and Texas, offset by the payment in 2007 of FirstGuard claims incurred in 2006.

 

Our investing activities used cash of $153.9 million in 2008, $225.5 million in 2007 and $150.2 million in 2006.  Cash flows from investing activities in 2008 included the purchase price of Celtic which we acquired on July 1, 2008, capital expenditures and our investment in the Reserve Primary fund previously discussed.  At December 31, 2008, our investment in the Reserve Fund totaled $13.0 million  and was included in Short-term investments.  Our investing activities in 2007 consisted primarily of additions to the investment portfolios of our regulated subsidiaries including transfers from cash and cash equivalents to long-term investments.  Our investment policies are designed to provide liquidity, preserve capital and maximize total return on invested assets within our guidelines.  Net cash provided by and used in investing activities will fluctuate from year to year due to the timing of investment purchases, sales and maturities.  As of December 31, 2008, our investment portfolio consisted primarily of fixed-income securities with an average duration of 2.4 years. Cash is invested in investment vehicles such as municipal bonds, corporate bonds, instruments of the U.S. Treasury, insurance contracts, commercial paper and equity securities.  These securities generally are actively traded in secondary markets and the reported fair market value is determined based on recent trading activity and other observable inputs.  The states in which we operate prescribe the types of instruments in which our regulated subsidiaries may invest their cash.

We spent $65.2 million, $53.9 million and $50.3 million in 2008, 2007 and 2006, respectively, on capital assets consisting primarily of software and hardware upgrades, and furniture, equipment and leasehold improvements associated with office and market expansions.  The expenditures in 2008 included $32.0 million for computer hardware and software.  We anticipate spending approximately $30 million on capital expenditures in 2009, primarily associated with system enhancements and market expansions.

In 2008, our capital expenditures included $27.0 million for land and fees associated with the construction of a real estate development on the property adjoining our corporate office, which we believe is necessary to accommodate our growing business.  We are currently negotiating our involvement as a joint venture partner in an entity that will develop the properties.  If the Company is unable to complete the development or if the Company delays or abandons the real estate project, it may have an adverse impact on our financial position, results of operations or cash flows.  Our operations and efficiency could also be impacted if the development is not completed as there is limited office space for us to expand in the market near our existing headquarters as our business continues to grow.

Our financing activities provided cash of $42.4 million in 2008, $20.8 million in 2007 and $78.9 million in 2006.  During 2008, our financing activities primarily related to proceeds from borrowings under our $300 million credit facility and stock repurchases.  During 2007, our financing activities primarily related to proceeds from issuance of $175 million in senior notes as discussed below.

At December 31, 2008, we had working capital, defined as current assets less current liabilities, of $25.4 million, as compared to $(40.5) million at December 31, 2007.  We manage our short-term and long-term investments with the goal of ensuring that a sufficient portion is held in investments that are highly liquid and can be sold to fund short-term requirements as needed.  Our working capital was negative at December 31, 2007 due to our efforts to increase investment returns through purchases of investments that have maturities of greater than one year and, therefore, are classified as long-term.

Cash, cash equivalents and short-term investments were $480.4 million at December 31, 2008 and $313.4 million at December 31, 2007.  Long-term investments were $341.7 million at December 31, 2008 and $323.5 million at December 31, 2007, including restricted deposits of $9.3 million and $6.4 million, respectively.  At December 31, 2008, cash and investments held by our unregulated entities totaled $24.1 million while cash and investments held by our regulated entities totaled $798.0 million.  Additionally, we held regulated cash and investments of $30.1 million from discontinued operations.  Upon completion of the sale of assets of UHP and the subsequent payment of medical claims liabilites and other liabilities at the closing date, the remaining regulated cash of UHP will be transferred to our unregulated cash.

We have a $300 million revolving credit agreement. Borrowings under the agreement bear interest based upon LIBOR rates, the Federal Funds Rate or the Prime Rate.  There is a commitment fee on the unused portion of the agreement that ranges from 0.15% to 0.275% depending on the total debt to EBITDA ratio.  The agreement contains non-financial and financial covenants, including requirements of minimum fixed charge coverage ratios, maximum debt to EBITDA ratios and minimum net worth.  The agreement will expire in September 2011.  As of December 31, 2008, we had $63.0 million in borrowings outstanding under the agreement and $24.1 million in letters of credit outstanding, leaving availability of $212.9 million.  As of December 31, 2008, we were in compliance with all covenants.

In 2007, we issued $175 million aggregate principal amount of our 7 ¼% Senior Notes due April 1, 2014, or the Notes.  The Notes were registered under the Securities Act of 1933, pursuant to a registration rights agreement with the initial purchasers.  The indenture governing the Notes contains non-financial and financial covenants, including requiring a minimum fixed charge coverage ratio.  Interest is paid semi-annually in April and October.  As of December 31, 2008, we were in compliance with all covenants.

We have a stock repurchase program authorizing us to repurchase up to four million shares of common stock from time to time on the open market or through privately negotiated transactions.  In October 2008, the repurchase program was extended through October 31, 2009, but we reserve the right to suspend or discontinue the program at any time.  During the year ended December 31, 2008, we repurchased 1,218,858 shares at an average price of $19.29.  We have established a trading plan with a registered broker to repurchase shares under certain market conditions.

On July 1, 2008 we completed the acquisition of Celtic for a purchase price of approximately $82.0 million, net of unregulated cash acquired.  Concurrent with the acquisition, we received regulatory approval to pay a dividend from Celtic to Centene in an amount of $31.4 million, while still maintaining a capital structure we believe to be conservative. As a result of the dividend, the net effect on our unregulated cash was approximately $50 million.  During the year ended December 31, 2008, we received additional dividends of $17.0 million from other regulated subsidiaries.

Based on our operating plan, we expect that our available cash, cash equivalents and investments, cash from our operations and cash available under our credit facility will be sufficient to finance our planned acquisition of AMERIGROUP Community Care of South Carolina, our general operations and capital expenditures for at least 12 months from the date of this filing.

 

24

---

Table of Contents

.

Our contractual obligations at December 31, 2008 consisted of medical claims liability, debt, operating leases, purchase obligations, interest on long-term debt, unrecognized tax benefits and other long-term liabilities.  Our debt consists of borrowings from our credit facilities, mortgages and capital leases.  The purchase obligations consist primarily of software purchase and maintenance contracts.  The contractual obligations and estimated period of payment over the next five years and beyond are as follows (in thousands):

 

		Payments Due by Period
		Total				Less Than 1 Year				1-3 Years				3-5 Years				More Than 5 Years
Medical claims liability		$	373,037			$	373,037			$	—			$	—			$	—
Debt 1			264,892				255				83,861				534				180,242
Operating lease obligations			121,795				20,490				32,563				20,248				48,494
Purchase obligations			38,474				19,426				13,878				3,546				1,624
Interest on long-term debt 2			69,781				12,687				25,375				25,375				6,344
Unrecognized tax benefits 3			4,054				—				3,982				72				—
Other long-term liabilities 4			39,337				—				10,884				8,594				19,859
Total		$	911,370			$	425,895			$	170,543			$	58,369			$	256,563

________________________________

1 Includes debt related to capital lease obligations.

2 Interest on $175,000 Senior Notes.

3 Unrecognized tax benefits relate to the provision for FASB Interpretation No. 48.

4 Includes $15,949 s epar ate account liabilities from third party reinsurance that will not be settled in cash.

 

REGULATORY CAPITAL AND DIVIDEND RESTRICTIONS

 

Our Medicaid Managed Care operations are conducted through our subsidiaries.  As managed care organizations, these subsidiaries are subject to state regulations that, among other things, require the maintenance of minimum levels of statutory capital, as defined by each state, and restrict the timing, payment and amount of dividends and other distributions that may be paid to us.  Generally, the amount of dividend distributions that may be paid by a regulated subsidiary without prior approval by state regulatory authorities is limited based on the entity’s level of statutory net income and statutory capital and surplus.

Our subsidiaries are required to maintain minimum capital requirements prescribed by various regulatory authorities in each of the states in which we operate.  As of December 31, 2008, our subsidiaries, including UHP, had aggregate statutory capital and surplus of $391.4 million, compared with the required minimum aggregate statutory capital and surplus requirements of $241.5 million and we estimate our Risk Based Capital, or RBC, percentage to be 340% of the Authorized Control Level.

The National Association of Insurance Commissioners has adopted rules which set minimum risk-based capital requirements for insurance companies, managed care organizations and other entities bearing risk for healthcare coverage.  As of December 31, 2008, each of our health plans were in compliance with the risk-based capital requirements enacted in those states.

RECENT ACCOUNTING PRONOUNCEMENTS

In December 2007, the Financial Accounting Standards Board, or FASB, issued FASB Statement No.141 (revised 2007), Business Combinations .  The purpose of issuing the statement was to replace current guidance in FASB Statement No.141, Business Combinations, to better represent the economic value of a business combination transaction. The changes to be effected with FASB Statement  No. 141R from the current guidance include, but are not limited to: (1) acquisition costs will be recognized separately from the acquisition; (2) known contractual contingencies at the time of the acquisition will be considered part of the liabilities acquired and and measured at their fair value; all other contingencies will be part of the liabilities acquired and measured at their fair value only if it is more likely than not that they meet the definition of a liability; (3) contingent consideration based on the outcome of future events will be recognized and measured at the time of the acquisition; (4) business combinations achieved in stages (step acquisitions) will need to recognize the identifiable assets and liabilities, as well as noncontrolling interests, in the acquiree, at the full amounts of their fair values; and (5) a bargain purchase (defined as a business combination in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any noncontrolling interest in the acquiree) will require that excess to be recognized as a gain attributable to the acquirer. FASB Statement No. 141R will be effective for any business combinations that occur after January 1, 2009.

 

In December 2007, the FASB issued FASB Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements , which was issued to improve the relevance, comparability, and transparency of financial information provided to investors by requiring all entities to report noncontrolling (minority) interests in subsidiaries in the same way, that is, as equity in the consolidated financial statements. Moreover, FASB Statement No. 160 eliminates the diversity that currently exists in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions. FASB Statement No. 160 will be effective January 1, 2009.  The adoption of FASB Statement No. 160 will not have a material impact on our financial statements and disclosures.

We have determined that all other recently issued accounting pronouncements will not have a material impact on our consolidated financial position, results of operations and cash flows, or do not apply to our operations.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements which have been prepared in accordance with GAAP.  In connection with the preparation of our consolidated financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures.  We base our assumptions, estimates and judgments on historical experience, current trends and other factors we believe to be relevant at the time we prepared our consolidated financial statements.  On a regular basis, we review the accounting policies, assumptions, estimates and judgments to ensure that our consolidated financial statements are presented fairly and in accordance with GAAP.  However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

The preparation of our consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions.  These estimates and assumptions affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Future events and their effects cannot be predicted with certainty, and accordingly, our accounting estimates require the exercise of judgment.  The accounting estimates used in the preparation of our consolidated financial statements will change as new events occur, as more experience is acquired, as additional information is obtained and as our operating environment changes.  We evaluate and update our assumptions and estimates on an ongoing basis and may employ outside experts to assist in our evaluations. Actual results could differ from the estimates we have used.

Our significant accounting policies are more fully described in Note 2, Summary of Significant Accounting Policies, to our consolidated financial statements included elsewhere herein.  Our accounting policies regarding medical claims liability and intangible assets are particularly important to the portrayal of our financial position and results of operations and require the application of significant judgment by our management.  As a result, they are subject to an inherent degree of uncertainty.  We have reviewed these critical accounting policies and related disclosures with the Audit Committee of our board of directors.

 

Medical claims liability

Our medical claims liability includes claims reported but not yet paid, or inventory, estimates for claims incurred but not reported, or IBNR, and estimates for the costs necessary to process unpaid claims at the end of each period.  We estimate our medical claims liability using actuarial methods that are commonly used by health insurance actuaries and meet Actuarial Standards of Practice.  These actuarial methods consider factors such as historical data for payment patterns, cost trends, product mix, seasonality, utilization of healthcare services and other relevant factors.  

25

---

Table of Contents

 

Actuarial Standards of Practice generally require that the medical claims liability estimates be adequate to cover obligations under moderately adverse conditions.  Moderately adverse conditions are situations in which the actual claims are expected to be higher than the otherwise estimated value of such claims at the time of estimate.  In many situations, the claims amounts ultimately settled will be different than the estimate that satisfies the Actuarial Standards of Practice.  We include in our IBNR an estimate for medical claims liability under moderately adverse conditions which represents the risk of adverse deviation of the estimates in our actuarial method of reserving.

We use our judgment to determine the assumptions to be used in the calculation of the required estimates.  The assumptions we consider when estimating IBNR include, without limitation, claims receipt and payment experience (and variations in that experience), changes in membership, provider billing practices, health care service utilization trends, cost trends, product mix, seasonality, prior authorization of medical services, benefit changes, known outbreaks of disease or increased incidence of illness such as influenza, provider contract changes, changes to Medicaid fee schedules, and the incidence of high dollar or catastrophic claims.

       We apply various estimation methods depending on the claim type and the period for which claims are being estimated.  For more recent periods, incurred non-inpatient claims are estimated based on historical per member per month claims experience adjusted for known factors.  Incurred hospital inpatient claims are estimated based on known inpatient utilization data and prior claims experience adjusted for known factors.  For older periods, we utilize an estimated completion factor based on our historical experience to develop IBNR estimates.  The completion factor is an actuarial estimate of the percentage of claims incurred during a given period that have been received or adjudicated as of the reporting period to the estimate of the total ultimate incurred costs.  When we commence operations in a new state or region, we have limited information with which to estimate our medical claims liability.  See “Risk Factors – Failure to accurately predict our medical expenses could negatively affect our financial position, results of operations or cash flows.”  These approaches are consistently applied to each period presented.

Additionally, we contract with independent actuaries to review our estimates on a quarterly basis.  The independent actuaries provide us with a review letter that includes the results of their analysis of our medical claims liability.  We do not solely rely on their report to adjust our claims liability. We utilize their calculation of our claims liability only as additional information, together with management’s judgment to determine the assumptions to be used in the calculation of our liability for claims.

Our development of the medical claims liability estimate is a continuous process which we monitor and refine on a monthly basis as additional claims receipts and payment information becomes available.  As more complete claim information becomes available, we adjust the amount of the estimates, and include the changes in estimates in medical costs in the period in which the changes are identified.  In every reporting period, our operating results include the effects of more completely developed medical claims liability estimates associated with previously reported periods.  We consistently apply our reserving methodology from period to period.  As additional information becomes known to us, we adjust our actuarial model accordingly to establish medical claims liability estimates.

 

The completion factor, claims per member per month and per diem cost trend factors are the most significant factors affecting the IBNR estimate.  The following table illustrates the sensitivity of these factors and the estimated potential impact on our operating results caused by changes in these factors based on December 31, 2008 data:

Completion Factors (1):						Cost Trend Factors (2):
(Decrease) Increase in Factors			Increase (Decrease) in Medical Claims Liabilities			(Decrease) Increase in Factors			Increase (Decrease) in Medical Claims Liabilities
			(in thousands)							(in thousands)
(3	)%		$	68,400		(3	)%		$	(17,700	)
(2	)			45,100		(2	)			(11,900	)
(1	)			22,400		(1	)			(5,900	)
1				(21,900	)	1				5,900
2				(43,300	)	2				12,000
3				(64,300	)	3				18,100

(1)	Reflects estimated potential changes in medical claims liability caused by changes in completion factors.
(2)	Reflects estimated potential changes in medical claims liability caused by changes in cost trend factors for the most recent periods.

While we believe our estimates are appropriate, it is possible future events could require us to make significant adjustments for revisions to these estimates.  For example, a 1% increase or decrease in our estimated medical claims liability would have affected net earnings by $2.3 million for the year ended December 31, 2008.  The estimates are based on our historical experience, terms of existing contracts, our observance of trends in the industry, information provided by our providers and information available from other outside sources, as appropriate.

 

The change in medical claims liability is summarized as follows (in thousands):

 

		Year Ended December 31,
		2008				2007				2006
Balance, January 1		$	313,364			$	232,496			$	123,102
Acquisitions			15,398				—				1,788
Incurred related to:
Current year			2,659,036				2,212,901				1,450,116
Prior years			(18,701	)			(22,003	)			(13,745	)
Total incurred			2,640,335				2,190,898				1,436,371
Paid related to:
Current year			2,303,473				1,902,610				1,220,872
Prior years			292,587				207,420				107,893
Total paid			2,596,060				2,110,030				1,328,765
Balance, December 31		$	373,037			$	313,364			$	232,496
Claims inventory, December 31			269,300				323,200				389,100
Days in claims payable 1			48.5				48.3				46.0

________________________

1 Days in claims payable is a calculation of medical claims liability at the end of the period divided by average expense per calendar day for the fourth quarter of each year.

 

The acquisition in 2008 includes reserves acquired in connection with our acquisition of Celtic.  The acquisition in 2006 includes reserves acquired in connection with our acquisition of OptiCare.

 

Medical claims are usually paid within a few months of the member receiving service from the physician or other healthcare provider.  As a result, the liability generally is described as having a “short-tail,” which causes less than 5% of our medical claims liability as of the end of any given year to be outstanding the following year.  We believe that substantially all the development of the estimate of medical claims liability as of December 31, 2008 will be known by the end of 2009.

Changes in estimates of incurred claims for prior years are primarily attributable to reserving under moderately adverse conditions.  Changes in medical utilization and cost trends and the effect of medical management initiatives may also contribute to changes in medical claim liability estimates.  While we have evidence that medical management initiatives are effective on a case by case basis, medical management initiatives primarily focus on events and behaviors prior to the incurrence of the medical event and generation of a claim.  Accordingly, any change in behavior, leveling of care, or coordination of treatment occurs prior to claim generation and as a result, the costs prior to the medical management initiative are not known by us.  Additionally, certain medical management initiatives are focused on member and provider education with the intent of influencing behavior to appropriately align the medical services provided with the member’s acuity.  In these cases, determining whether the medical management initiative changed the behavior cannot be determined.  Because of the complexity of our business, the number of states in which we operate, and the volume of claims that we process, we are unable to practically quantify the impact of these initiatives on our changes in estimates of IBNR.

26

---

Table of Contents

The following medical management initiatives may have contributed to the favorable development through lower medical utilization and cost trends:

·	Appropriate leveling of care for neonatal intensive care unit (NICU) hospital admissions, other inpatient hospital admissions, and observation admissions, in accordance with Interqual criteria.

·	Tightening of our pre-authorization list and more stringent review of durable medical equipment (DME) and injectibles.

·	Emergency department (ED) program designed to collaboratively work with hospitals to steer non-emergency care away from the costly ED setting (through patient education, on-site alternative urgent care settings, etc.)

·	Increase emphasis on case management and clinical rounding where case managers are nurses or social workers who are employed by the health plan to assist selected patients with the coordination of healthcare services in order to meet a patient's specific healthcare needs.

·	Incorporation of disease management which is a comprehensive, multidisciplinary, collaborative approach to chronic illnesses such as asthma.

 

 

Goodwill and Intangible Assets

 

We have made several acquisitions that have resulted in our recording of intangible assets.  These intangible assets primarily consist of customer relationships, purchased contract rights, provider contracts, trade names and goodwill.  At December 31, 2008, we had $163.4 million of goodwill and $17.6 million of other intangible assets.

Intangible assets are amortized using the straight-line method over the following periods:

Intangible Asset		Amortization Period
Purchased contract rights		5 – 10 years
Provider contracts		5 – 10 years
Customer relationships		5 – 15 years
Trade names		20 years

Our management evaluates whether events or circumstances have occurred that may affect the estimated useful life or the recoverability of the remaining balance of goodwill and other identifiable intangible assets.  If the events or circumstances indicate that the remaining balance of the intangible asset or goodwill may be impaired, the potential impairment will be measured based upon the difference between the carrying amount of the intangible asset or goodwill and the fair value of such asset.  Our management must make assumptions and estimates, such as the discount factor, future utility and other internal and external factors, in determining the estimated fair values.  While we believe these assumptions and estimates are appropriate, other assumptions and estimates could be applied and might produce significantly different results.

 

Goodwill is reviewed every year during the fourth quarter for impairment.  In addition, an impairment analysis of intangible assets would be performed based on other factors.  These factors include significant changes in membership, state funding, medical contracts and provider networks and contracts.

 

In November 2008, as a result of our decision to divest the New Jersey health plan, we concluded it was necessary to conduct an impairment analysis of the identifiable intangible assts.  As a result of the analysis and expected selling price, we determined that the identifiable intangible assets were not impaired.

In August 2006, FirstGuard Health Plan Kansas, Inc., or FirstGuard Kansas, our wholly owned subsidiary, received notification from the Kansas Health policy Authority that its Medicaid contract scheduled to terminate December 31, 2006 would not be renewed.  As a result of these events, we concluded it was necessary to conduct an impairment analysis of the identifiable intangible assets and goodwill of the FirstGuard reporting unit, which encompasses both the Kansas and Missouri FirstGuard health plans.  The fair value of our FirstGuard reporting unit was determined using discounted expected cash flows and estimated market value.  The impairment analysis resulted in a total non-cash intangible asset impairment charge of $87.1 million, consisting of $81.1 million of goodwill and $6.0 million of other identifiable intangible assets, which was recorded in discontinued operations in the consolidated statement of operations for the year ended December 31, 2006.

Item 7A.   Quantitative and Qualitative Disclosures About Market Risk

 

INVESTMENTS

 

As of December 31, 2008, we had short-term investments of $109.4 million and long-term investments of $341.7 million, including restricted deposits of $9.3 million.  The short-term investments generally consist of highly liquid securities with maturities between three and 12 months.  The long-term investments consist of municipal, corporate and U.S. Agency bonds, life insurance contracts, U.S. Treasury investments and equity securities and have maturities greater than one year.  Restricted deposits consist of investments required by various state statutes to be deposited or pledged to state agencies.  Due to the nature of the states’ requirements, these investments are classified as long-term regardless of the contractual maturity date.  Our investments are subject to interest rate risk and will decrease in value if market rates increase.   Assuming a hypothetical and immediate 1% increase in market interest rates at December 31, 2008, the fair value of our fixed income investments would decrease by approximately $6.2 million.  Declines in interest rates over time will reduce our investment income.  For a discussion of the interest rate risk that our investments are subject to, see "Risk Factors–Risks Related to Our Business–Our investment portfolio may suffer losses from reductions in market interest rates and changes in market conditions which could materially and adversely affect our results of operations or liquidity.”

 

INFLATION

 

While the inflation rate in 2008 for medical care costs was slightly less than that for all items, historically inflation for medical care costs has generally exceeded that for all items.  We use various strategies to mitigate the negative effects of healthcare cost inflation.  Specifically, our health plans try to control medical and hospital costs through our state savings initiatives and contracts with independent providers of healthcare services.  Through these contracted care providers, our health plans emphasize preventive healthcare and appropriate use of specialty and hospital services.

 

While we currently believe our strategies to mitigate healthcare cost inflation will continue to be successful, competitive pressures, new healthcare and pharmaceutical product introductions, demands from healthcare providers and customers, applicable regulations or other factors may affect our ability to control the impact of healthcare cost increases.

 

Item 8.   Financial Statements and Supplementary Data

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Stockholders

Centene Corporation:

 

We have audited the accompanying consolidated balance sheets of Centene Corporation and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Centene Corporation and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Centene Corporation’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 22, 2009 expressed   an unqualified opinion on the effectiveness of the operation of internal control over financial reporting.

 

(signed) KPMG LLP

 

St. Louis, Missouri

February 22, 2009

27

---

Table of Contents

  CENTENE CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

		December 31,
		2008				2007
ASSETS
Current assets:
Cash and cash equivalents of continuing operations		$	370,999			$	267,305
Cash and cash equivalents of discontinued operations			8,100				1,279
Total cash and cash equivalents			379,099				268,584
Premium and related receivables, net of allowance for uncollectible accounts of $595 and $258, respectively			92,531				79,492
Short-term investments, at fair value (amortized cost $108,469 and $46,193, respectively)			109,393				46,074
Other current assets			75,333				39,382
Current assets of discontinued operations other than cash			9,987				12,807
Total current assets			666,343				446,339
Long-term investments, at fair value (amortized cost $329,330 and $314,681, respectively)			332,411				317,041
Restricted deposits, at fair value (amortized cost $9,124 and $6,383, respectively)			9,254				6,430
Property, software and equipment, net			175,858				135,883
Goodwill			163,380				138,862
Intangible assets, net			17,575				11,337
Other long-term assets			59,083				36,067
Long-term assets of discontinued operations			27,248				29,865
Total assets		$	1,451,152			$	1,121,824
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Medical claims liability		$	373,037			$	313,364
Accounts payable and accrued expenses			219,566				102,944
Unearned revenue			17,107				44,016
Current portion of long-term debt			255				971
Current liabilities of discontinued operations			31,013				25,505
Total current liabilities			640,978				486,800
Long-term debt			264,637				206,406
Other long-term liabilities			43,539				13,300
Long-term liabilities of discontinued operations			726				271
Total liabilities			949,880				706,777
Commitments and contingencies
Stockholders’ equity:
Common stock, $.001 par value; authorized 100,000,000 shares; issued and outstanding 42,987,764 and 43,667,837 shares, respectively			43				44
Additional paid-in capital			222,841				221,693
Accumulated other comprehensive income:
Unrealized gain on investments, net of tax			3,152				1,571
Retained earnings			275,236				191,739
Total stockholders’ equity			501,272				415,047
Total liabilities and stockholders’ equity		$	1,451,152			$	1,121,824

 

The accompanying notes to the consolidated financial statements are an integral part of these statements.

 

 

28

---

Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share data)

 

		Year Ended December 31,
		2008				2007				2006
Revenues:
Premium		$	3,199,360			$	2,611,953			$	1,707,439
Premium tax			90,202				76,567				35,848
Service			74,953				80,508				79,159
Total revenues			3,364,515				2,769,028				1,822,446
Expenses:
Medical costs			2,640,335				2,190,898				1,436,371
Cost of services			56,920				61,348				60,287
General and administrative expenses			444,733				384,970				267,712
Premium tax			90,966				76,567				35,848
Total operating expenses			3,232,954				2,713,783				1,800,218
Earnings from operations			131,561				55,245				22,228
Other income (expense):
Investment and other income			21,728				24,452				15,511
Interest expense			(16,673	)			(15,626	)			(10,574	)
Earnings from continuing operations before income tax expense			136,616				64,071				27,165
Income tax expense			52,435				23,031				9,565
Net earnings from continuing operations			84,181				41,040				17,600
Discontinued operations, net of income tax (benefit) expense of $(281), $(31,563), and $12,412			(684	)			32,362				(61,229	)
Net earnings (loss)		$	83,497			$	73,402			$	(43,629	)
Net earnings (loss) per share:
Basic:
Continuing operations		$	1.95			$	0.95			$	0.41
Discontinued operations			(0.02	)			0.74				(1.42	)
Basic earnings (loss) per common share		$	1.93			$	1.69			$	(1.01	)
Diluted:
Continuing operations		$	1.90			$	0.92			$	0.39
Discontinued operations			(0.02	)			0.72				(1.37	)
Diluted earnings (loss) per common share		$	1.88			$	1.64			$	(0.98	)
Weighted average number of shares outstanding:
Basic			43,275,187				43,539,950				43,160,860
Diluted			44,398,955				44,823,082				44,613,622

The accompanying notes to the consolidated financial statements are an integral part of these statements

 

29

---

Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

 

	Common Stock
	$.001 Par Value Shares			Amt		Additional Paid-in Capital			Accumulated Other Comprehensive Income			Retained Earnings			Total
Balance, December 31, 2005	42,988,230		$	43		$	191,840		$	(1,754	)	$	161,919		$	352,048
Net loss	—			—			—			—			(43,629	)		(43,629	)
Change in unrealized investment losses, net of $306 tax	—			—			—			503			—			503
Comprehensive loss																(43,126	)
Common stock issued for stock options and employee stock purchase plan	783,823			1			7,497			—			—			7,498
Common stock repurchases	(402,135	)		—			(7,944	)		—			—			(7,944	)
Stock compensation expense	—			—			14,904			—			—			14,904
Excess tax benefits from stock compensation	—			—			3,043			—			—			3,043
Balance, December 31, 2006	43,369,918		$	44		$	209,340		$	(1,251	)	$	118,290		$	326,423
Net earnings	—			—			—			—			73,402			73,402
Change in unrealized investment losses, net of $1,625 tax	—			—			—			2,822			—			2,822
Comprehensive earnings																76,224
Common stock issued for stock options and employee stock purchase plan	765,076			—			6,113			—			—			6,113
Common stock repurchases	(467,157	)		—			(9,541	)		—			—			(9,541	)
Stock compensation expense	—			—			15,781			—			—			15,781
Adjustment for adoption of FASB Interpretation No. 48	—			—			—			—			47			47
Balance, December 31, 2007	43,667,837		$	44		$	221,693		$	1,571		$	191,739		$	415,047
Net earnings	—			—			—			—			83,497			83,497
Change in unrealized investment gains, net of $882 tax	—			—			—			1,581			—			1,581
Comprehensive earnings																85,078
Common stock issued for stock options and employee stock purchase plan	538,785			—			6,229			—			—			6,229
Common stock repurchases	(1,218,858	)		(1	)		(23,509	)		—			—			(23,510	)
Stock compensation expense	—			—			15,328			—			—			15,328
Excess tax benefits from stock compensation	—			—			3,100			—			—			3,100
Balance, December 31, 2008	42,987,764		$	43		$	222,841		$	3,152		$	275,236		$	501,272

 

The accompanying notes to the consolidated financial statements are an integral part of these statements.

 

30

---

Table of Contents

CENTENE CORPORATION AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

		Year Ended December 31,
		2008				2007				2006
Cash flows from operating activities:
Net earnings (loss)		$	83,497			$	73,402			$	(43,629	)
Adjustments to reconcile net earnings (loss) to net cash provided by operating activities—
Depreciation and amortization			35,414				27,807				20,600
Stock compensation expense			15,328				15,781				14,904
Loss on sale of investments, net			4,988				106				59
Gain on sale of FirstGuard Missouri			—				(7,472	)			—
Impairment loss			2,546				7,207				88,268
Deferred income taxes			1,286				(10,223	)			(6,692	)
Changes in assets and liabilities—
Premium and related receivables			(1,548	)			1,663				(39,765	)
Other current assets			(4,244	)			(6,253	)			5,352
Other assets			(2,700	)			(348	)			91
Medical claims liability			46,337				56,287				108,003
Unearned revenue			(36,447	)			10,085				20,035
Accounts payable and accrued expenses			75,112				31,234				28,136
Other operating activities			2,409				2,964				(330	)
Net cash provided by operating activities			221,978				202,240				195,032
Cash flows from investing activities:
Capital expenditures			(65,156	)			(53,937	)			(50,318	)
Purchase of investments			(549,652	)			(606,366	)			(319,322	)
Sales and maturities of investments			546,264				456,738				286,155
Proceeds from asset sales			—				14,102				—
Investments in acquisitions, net of cash acquired and investment in equity method investee			(85,377	)			(36,001	)			(66,772	)
Net cash used in investing activities			(153,921	)			(225,464	)			(150,257	)
Cash flows from financing activities:
Proceeds from exercise of stock options			5,354				5,464				6,953
Proceeds from borrowings			236,005				212,000				94,359
Payment of long-term debt and notes payable			(178,491	)			(181,981	)			(17,355	)
Excess tax benefits from stock compensation			3,100				—				3,043
Common stock repurchases			(23,510	)			(9,541	)			(7,833	)
Debt issue costs			—				(5,181	)			(253	)
Net cash provided by financing activities			42,458				20,761				78,914
Net increase (decrease) in cash and cash equivalents			110,515				(2,463	)			123,689
Cash and cash equivalents, beginning of period			268,584				271,047				147,358
Cash and cash equivalents, end of period		$	379,099			$	268,584			$	271,047
Supplemental disclosures of cash flow information:
Interest paid		$	15,312			$	11,945			$	10,680
Income taxes paid		$	36,801			$	7,348			$	16,418
Supplemental disclosure of non-cash investing and financing activities:
Property acquired under capital lease obligation		$	—			$	1,736			$	366

 

The accompanying notes to the consolidated financial statements are an integral part of these statements.

 

31

---

Table of Contents