UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

For the quarterly period ended September 30, 2007

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

For the transition period from                      to                     .

HEALTHMARKETS, INC.

Delaware		75-2044750
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.       Yes  þ       No  o  

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. (See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).

Large accelerated filer o      Accelerated filer o      Non-accelerated filer þ

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

     On October 26, 2007 the registrant had 26,816,670 outstanding shares of Class A-1 Common Stock, $.01 Par Value, and 3,758,559 outstanding shares of Class A-2 Common Stock, $.01 Par Value.

 

 

HEALTHMARKETS, INC.
and Subsidiaries

Third Quarter 2007 Form 10-Q

TABLE OF CONTENTS

				Page
PART I		FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)
		Consolidated Condensed Balance Sheets as of September 30, 2007 and December 31, 2006		1
		Consolidated Condensed Statements of Income for the Three Months and Nine Months Ended September 30, 2007 and 2006		2
		Consolidated Condensed Statements of Comprehensive Income for the Three Months and Nine Months Ended September 30, 2007 and 2006		3
		Consolidated Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2007 and 2006		4
		Notes to Consolidated Condensed Financial Statements		5
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		23
Item 4.		Controls and Procedures		23
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings		23
Item 1A.		Risk Factors		23
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		24
Item 6.		Exhibits		24
SIGNATURES
Rule 13a-14a/15d-14(a) Certification by President and CEO
Rule 13a-14a/15d-14(a) Certification by Executive VP and CFO
Certifications Required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350

PART 1. FINANCIAL INFORMATION

HEALTHMARKETS, INC.
and Subsidiaries

CONSOLIDATED CONDENSED BALANCE SHEETS

		September 30,				December 31,
		2007				2006
		(Unaudited)
ASSETS
Investments:
Securities available for sale —
Fixed maturities, at fair value (cost: 2007—$1,348,980 ; 2006—$1,391,275)		$	1,326,701			$	1,374,403
Equity securities, at fair value (cost: 2007—$312 ; 2006—$283)			351				318
Policy loans			14,336				14,625
Short-term and other investments			167,122				412,498
Total investments			1,508,510				1,801,844
Cash and cash equivalents			—				32,756
Student loans			97,365				105,846
Restricted cash			9,464				16,238
Investment income due and accrued			20,964				22,633
Due premiums			3,879				3,299
Reinsurance receivables			75,618				155,283
Agents’ and other receivables			51,071				39,232
Deferred acquisition costs			200,000				197,757
Property and equipment, net			72,411				64,436
Goodwill and other intangible assets			85,585				86,871
Recoverable federal income taxes			—				23,929
Other assets			36,454				38,205
Total assets		$	2,161,321			$	2,588,329
LIABILITIES AND STOCKHOLDERS’ EQUITY
Policy liabilities:
Future policy and contract benefits		$	463,643			$	453,715
Claims			457,803				517,132
Unearned premiums			92,691				151,758
Other policy liabilities			10,808				12,569
Accounts payable and accrued expenses			56,883				48,363
Cash overdraft			2,132				—
Other liabilities			98,536				128,018
Federal Income tax payable			2,514				—
Deferred federal income tax			75,438				73,575
Debt			481,070				556,070
Student loan credit facility			101,800				118,950
Net liabilities of discontinued operations			2,708				3,794
Total liabilities			1,846,026				2,063,944
Commitments and contingencies
Stockholders’ Equity:
Preferred stock, par value $0.01 per share			—				—
Common stock, par value $0.01 per share			309				300
Additional paid-in capital			52,543				12,529
Accumulated other comprehensive loss			(17,581	)			(12,552	)
Retained earnings			290,519				527,978
Treasury stock, at cost			(10,495	)			(3,870	)
Total stockholders’ equity			315,295				524,385
Total liabilities and stockholders’ equity		$	2,161,321			$	2,588,329

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF INCOME

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
REVENUE
Health premiums		$	330,742			$	395,557			$	999,008			$	1,286,587
Life premiums and other considerations			18,165				16,664				51,990				49,144
			348,907				412,221				1,050,998				1,335,731
Investment income			25,231				25,699				77,963				77,012
Other income			25,561				25,456				78,768				76,790
Gains (losses) on sales of investments			(458	)			99,192				(1,210	)			101,733
			399,241				562,568				1,206,519				1,591,266
BENEFITS AND EXPENSES
Benefits, claims, and settlement expenses			188,755				226,881				600,599				755,403
Underwriting, acquisition, and insurance expenses			126,791				140,332				380,682				451,567
Other expenses			21,374				27,782				67,833				130,193
Interest expense			11,826				13,421				37,671				27,759
			348,746				408,416				1,086,785				1,364,922
Income from continuing operations before income taxes			50,495				154,152				119,734				226,344
Federal income taxes			17,240				64,278				40,888				91,944
Income from continuing operations			33,255				89,874				78,846				134,400
Income from discontinued operations, net of income tax			226				301				689				20,663
Net income		$	33,481			$	90,175			$	79,535			$	155,063
Basic earnings per share:
Income from continuing operations		$	1.08			$	3.01			$	2.59			$	3.68
Income from discontinued operations			0.01				0.01				0.03				0.57
Net income per share, basic		$	1.09			$	3.02			$	2.62			$	4.25
Diluted earnings per share:
Income from continuing operations		$	1.05			$	2.94			$	2.52			$	3.60
Income from discontinued operations			0.01				0.01				0.02				0.56
Net income per share, diluted		$	1.06			$	2.95			$	2.54			$	4.16

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
Net income		$	33,481			$	90,175			$	79,535			$	155,063
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale			13,523				31,609				(6,093	)			(7,518	)
Reclassification for investment gains (losses) included in net income			42				(679	)			690				(187	)
Effect on other comprehensive income from investment securities			13,563				30,930				(5,403	)			(7,705	)
Unrealized losses on derivatives used in cash flow hedging during the period			(4,788	)			(5,092	)			(2,050	)			(2,568	)
Reclassification adjustment for losses included in net income			(30	)			(27	)			(303	)			(47	)
Effect on other comprehensive income from hedging activities			(4,818	)			(5,119	)			(2,353	)			(2,615	)
Other comprehensive income (losses) before tax			8,747				25,811				(7,756	)			(10,320	)
Income tax expense (benefit) related to items of other comprehensive income (loss)			3,051				9,033				(2,727	)			(3,613	)
Other comprehensive income (loss) net of tax			5,696				16,778				(5,029	)			(6,707	)
Comprehensive income		$	39,177			$	106,953			$	74,506			$	148,356

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

		Nine Months Ended
		September 30,
		2007				2006
Operating Activities:
Net income		$	79,535			$	155,063
Income from discontinued operations			(689	)			(20,663	)
Adjustments to reconcile net income to cash provided by operating activities:
Gains (losses) on sales of investments			1,210				(101,733	)
Change in deferred income taxes			4,592				1,348
Depreciation and amortization			19,327				17,349
Equity based compensation expense			4,046				3,076
Variable non-cash stock-based compensation			2,547				3,024
Changes in assets and liabilities, net of effects from acquisitions:
Investment income due and accrued			(1,418	)			(2,642	)
Due premiums			(580	)			123
Reinsurance receivables			79,665				(20,985	)
Other receivables			(15,847	)			3,894
Deferred acquisition costs			(2,243	)			2,371
Prepaid monitoring fees			(3,125	)			—
Current income tax payable			26,443				40,623
Policy liabilities			(104,840	)			(2,816	)
Other liabilities and accrued expenses			(2,900	)			14,377
Other items, net			70				(479	)
Cash provided by continuing operations			85,797				91,930
Cash (used in) provided by discontinued operations			(397	)			19,825
Net cash provided by operating activities			85,396				111,755
Investing Activities:
Decrease in investment assets			287,780				34,896
Decrease in student loans			9,915				6,210
Decrease in restricted cash			6,774				2,996
Purchase of property and equipment			(22,584	)			(9,601	)
Intangible asset acquired			—				(47,500	)
Distribution from investment in Grapevine Finance LLC			581				71,929
Decrease (increase) in agents’ receivables			3,700				(6,835	)
Decrease in other investing activities			—				10,321
Net cash used in investing activities			286,166				62,416
Financing Activities:
Increase in investment products			(5,387	)			(7,038	)
Repayment of student loan credit facility			(17,150	)			(8,000	)
Debt proceeds (proceeds received for merger)			—				603,100
Repayment of debt			(75,000	)			(62,500	)
Purchase of treasury stock			(30,318	)			(1,618,103	)
Dividends paid			(316,996	)			—
Change in cash overdraft			2,132				(3,736	)
Capitalized debt issuance costs			—				(32,539	)
Equity costs related to Merger			—				(31,650	)
Excess tax benefits from equity-based compensation			126				1,289
Contributions from private equity investors			—				985,000
Proceeds from issuance of common stock, net of expenses			404				2,449
Proceeds from sale of shares to agent plans			37,822				6,356
Other			49				621
Net cash used in financing activities			(404,318	)			(164,751	)
Net change in cash and cash equivalents			(32,756	)			9,420
Cash and cash equivalents at beginning of period			32,756				—
Cash and cash equivalents at end of period in continuing operations		$	—			$	9,420

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

 
1. BASIS OF PRESENTATION  

     The accompanying unaudited consolidated condensed financial statements for HealthMarkets, Inc. (the “Company” or “HealthMarkets”) and its subsidiaries have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, such financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, these financial statements include all adjustments, consisting of normal recurring adjustments and accruals, necessary for a fair presentation of the consolidated balance sheets, statements of income, statements of comprehensive income and statements of cash flows for the periods presented. Operating results for the three and nine month periods ended September 30, 2007 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2007. For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Claim Liability Estimates – Self-Employed Agency Division

     As more particularly described below, results at the SEA Division for the nine months ended September 30, 2007 reflected benefits associated with refinements in the Company’s estimate of its claim liability. For financial reporting purposes, these refinements are considered to be changes in estimates resulting from additional information.

     During the second and third quarters of 2007, the Company experienced a reduction to the claim liability of $5.0 million and $4.5 million, respectively. The decrease in the third quarter is attributable to an update of the completion factors used in estimating the claim liability for the Accumulated Covered Expense (“ACE”) rider, an optional benefit available with certain scheduled/basic health insurance products. The reduction in the second quarter reflects an increasing reliance on actual historical data for the ACE rider in lieu of large claim data derived from other products. Also, during the third quarter of 2007, the claim liability was reduced by $12.4 million resulting from a refinement to the estimate of unpaid claim liability specifically for the most recent incurral months. In particular, the Company reassessed its claim liability estimates among product lines between the more mature scheduled benefit products that have more historical data and are more predictable, and the newer products that are less mature, have less historical data and are more susceptible to adverse deviation.

Recent Accounting Pronouncements

     In February 2007, the Financial Accounting Standards Board (“FASB”) issued FAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159). FAS 159 permits an entity to elect fair value as the initial and subsequent measurement attribute for many financial assets and liabilities. Entities electing the fair value option would be required to recognize changes in fair value in earnings. Entities electing the fair value option are required to distinguish on the face of the statement of financial position, the fair value of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute. FAS 159 is effective for fiscal year 2008. The adjustment to reflect the difference between the fair value and the carrying amount would be accounted for as a cumulative-effect adjustment to retained earnings as of the date of initial adoption. The Company is currently evaluating the impact, if any, of FAS 159 on the Consolidated Condensed Financial Statements.

     In September 2006, the FASB issued Statement No. 157, Fair Value Measurement (FAS 157), which defines fair value as the price that would be received to sell an asset or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. FAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. FAS 157 will be effective for financial statements issued for fiscal year 2008. The Company is currently evaluating the impact, if any, of FAS 157 on the Consolidated Condensed Financial Statements.

     In 2005, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or Exchanges of Insurance Contracts, for implementation in the first quarter of 2007. The SOP requires that deferred acquisition costs be expensed in full when the original contract is substantially changed by election or amendment of an existing contract feature or by replacement with a new contract. The Company implemented the SOP for contract changes beginning in the first quarter of 2007 with no material effects to the financial statements at implementation.

2. DEBT

     In connection with the Merger completed on April 5, 2006, HealthMarkets, LLC, a direct wholly-owned subsidiary of the Company, entered into a credit agreement, providing for a $500.0 million term loan facility and a $75.0 million revolving credit facility, which includes a $35.0 million letter of credit sub-facility. The full amount of the term loan was drawn at closing, and the proceeds were used to fund a portion of the consideration paid in the Merger. At September 30, 2007, the Company had an aggregate of $362.5 million of indebtedness outstanding under the term loan facility, which indebtedness bore interest at the London inter-bank offered rate (“LIBOR”) plus a borrowing margin of 1.00%. The Company has not drawn on the $75.0 million revolving credit facility.

     The revolving credit facility will mature on April 5, 2011, and the term loan facility will mature on April 5, 2012. The term loan requires nominal quarterly installments (not exceeding 0.25% of the aggregate principal amount at the date of issuance) until the maturity date at which time the remaining principal amount is due. Borrowings under the credit agreement may be subject to certain mandatory prepayments. At HealthMarkets, LLC’s election, the interest rates per annum applicable to borrowings under the credit agreement will be based on a fluctuating rate of interest measured by reference to either (a) LIBOR plus a borrowing margin, or (b) a base rate plus a borrowing margin. HealthMarkets, LLC will pay (a) fees on the unused loan commitments of the lenders, (b) letter of credit participation fees for all letters of credit issued, plus fronting fees for the letter of credit issuing bank, and (c) other customary fees in respect of the credit facility. Borrowings and other obligations under the credit agreement are secured by a pledge of HealthMarkets, LLC’s interest in substantially all of its subsidiaries, including the capital stock of The MEGA Life and Health Insurance Company (“MEGA”), Mid-West National Life Insurance Company of Tennessee (“Mid-West”) and The Chesapeake Life Insurance Company (“Chesapeake”).

     On April 5, 2006, HealthMarkets Capital Trust I and HealthMarkets Capital Trust II (two newly formed Delaware statutory business trusts, collectively the “Trusts”) issued $100.0 million of floating rate trust preferred securities (the “Trust Securities”) and $3.1 million of floating rate common securities. The Trusts invested the proceeds from the sale of the Trust Securities, together with the proceeds from the issuance to HealthMarkets, LLC by the Trusts of the common securities, in $100.0 million principal amount of HealthMarkets, LLC’s Floating Rate Junior Subordinated Notes due June 15, 2036 (the “Notes”), of which $50.0 million principal amount accrue interest at a floating rate equal to three-month LIBOR plus 3.05% and $50.0 million principal amount accrue interest at a fixed rate of 8.367% through but excluding June 15, 2011 and thereafter at a floating rate equal to three-month LIBOR plus 3.05%. Distributions on the Trust Securities will be paid at the same interest rates paid on the Notes.

     The Notes, which constitute the sole assets of the Trusts, are subordinate and junior in right of payment to all senior indebtedness of HealthMarkets, LLC. The Company has fully and unconditionally guaranteed the payment by the Trusts of distributions and other amounts payable under the Trust Securities. The guarantee is subordinated to the same extent as the Notes.

     The Trusts are obligated to redeem the Trust Securities when the Notes are paid at maturity or upon any earlier prepayment of the Notes. Prior to June 15, 2011, the Notes may be redeemed only upon the occurrence of certain tax or investment company events at 105.0% of the principal amount thereof in the first year reducing by 1.25% per year until it reaches 100.0%. On and after June 15, 2011 the Notes are redeemable, in whole or in part, at the option of the Company at 100.0% of the principal amount thereof.

     On April 29, 2004, UICI Capital Trust I (a newly formed Delaware statutory business trust, the “2004 Trust”) completed the private placement of $15.0 million aggregate issuance amount of floating rate trust preferred securities with an aggregate liquidation value of $15.0 million (the “2004 Trust Preferred Securities”). The 2004 Trust invested the $15.0 million proceeds from the sale of the 2004 Trust Preferred Securities, together with the proceeds from the issuance to the Company by the 2004 Trust of its floating rate common securities in the amount of $470,000 (the “Common Securities” and, collectively with the 2004 Trust Preferred Securities, the “2004 Trust Securities”), in an equivalent face amount of the Company’s Floating Rate Junior Subordinated Notes due 2034 (the “2004 Notes”). The 2004 Notes will mature on April 29, 2034, which date may be accelerated to a date not earlier than April 29, 2009. The 2004 Notes may be prepaid prior to April 29, 2009, at 107.5% of the principal amount thereof, upon the occurrence of certain events, and thereafter at 100.0% of the principal amount thereof. The 2004 Notes, which constitute the sole assets of the 2004 Trust, are subordinate and junior in right of payment to all senior indebtedness (as defined in the Indenture, dated April 29, 2004, governing the terms of the 2004 Notes) of the Company. The 2004 Notes accrue interest at a floating rate equal to three-month LIBOR plus 3.50%, payable quarterly on February 15, May 15, August 15, and November 15 of each year. The quarterly distributions on the 2004 Trust Securities are paid at the same interest rate paid on the 2004 Notes.

     The following table sets forth detail of the Company’s debt and interest expense (dollars in thousands):

										Interest Expense
		Principal Amount								Three Months				Nine Months
		at				Interest rate at				Ended				Ended
		September 30, 2007				September 30, 2007				September 30, 2007				September 30, 2007
2006 credit agreement:
Term loan		$	362,500				6.36	%		$	5,617			$	18,861
$75 Million revolver (non-use fee)			—				N/A				40				121
Trust preferred securities:
UICI Capital Trust I			15,470				9.06	%			355				1,044
HealthMarkets Capital Trust I			51,550				8.74	%			1,115				3,294
HealthMarkets Capital Trust II			51,550				8.37	%			1,102				3,271
Other:
Interest on Deferred Tax			—				8.0	%			1,065				3,219
Student loan credit facility			101,800				6.52	%			1,465				4,430
Amortization of financing fees			—				N/A				1,067				3,431
Total		$	582,870							$	11,826			$	37,671

     Principal payments required for the Company’s non-student loan debt for the remainder of 2007 and each of the next five years and thereafter are as follows (in thousands):

Remainder of 2007		$	—
2008			—
2009			—
2010			—
2011			—
2012			362,500
2013 and thereafter			118,570
		$	481,070

     Management uses derivative instruments to protect against the risk of changes in prevailing interest rates adversely affecting future cash flows associated with the term loan credit facility discussed above. The derivative instrument used by the Company to protect against such risk is the interest rate swap. The Company accounts for its interest rate swaps in accordance with FAS 133, Accounting for Derivative Instruments and Hedging Activities.

     As with any financial instrument, derivative instruments have inherent risks, primarily market and credit risk. Market risk associated with changes in interest rates is managed as part of the Company’s overall market risk monitoring process by establishing and monitoring limits as to the degree of risk that may be undertaken. Credit risk occurs when a counterparty to a derivative contract in which the Company has an unrealized gain fails to perform according to the terms of the agreement. The Company minimizes its credit risk by entering into transactions with counterparties that maintain high credit ratings.

     For a derivative instrument designated as a cash flow hedge, the effective portion of changes in the fair value of the derivative instrument is recorded under the caption “Unrealized gains (losses) on securities and hedging activities” in the Company’s Consolidated Condensed Statement of Comprehensive Income and is recognized in the income statement when the hedged item affects results of operations. If it is determined that (i) an interest rate swap is not highly effective in offsetting changes in the cash flows of a hedged item, (ii) the derivative expires or is sold, terminated or exercised, or (iii) the derivative is undesignated as a hedge instrument because it is unlikely that a forecasted transaction will occur, the Company discontinues hedge accounting prospectively.

     If hedge accounting is discontinued, the derivative instrument will continue to be carried at fair value, with changes in the fair value of the derivative instrument recognized in the current period’s results of operations. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the accumulated gains and losses included in accumulated other comprehensive income will be recognized immediately in results of operations. When hedge accounting is discontinued because the derivative instrument has not been or will not continue to be highly effective as a hedge, hedge accounting is discontinued and the remaining amount in accumulated other comprehensive income is amortized into earnings over the remaining life of the derivative.

     At the effective date of the Merger, an affiliate of The Blackstone Group assigned to the Company three interest rate swap agreements with an aggregate notional amount of $300.0 million. The terms of the swaps are 3, 4 and 5 years beginning on April 11, 2006. The Company presents the fair value of the interest rate swap agreements at the end of the period in either “Other assets” or “Other liabilities,” as applicable, on its consolidated condensed balance sheet. At September 30, 2007, the interest rate swaps had an aggregate fair value of approximately $2.6 million, which is reflected under the caption “Other Liabilities.” The Company redesignated the hedging relationship in February 2007 to hedge the risk of changes in the Company’s cash flow attributable to changes in the LIBOR rate applicable to its variable-rate term loan. The Company assesses, on a quarterly basis, the ineffectiveness of the hedging relationship and any gains or losses related to the ineffectiveness are recorded in “Other investment income” on its consolidated condensed statement of income. During the three and nine months ended September 30, 2007, the Company incurred a loss of $78,000 and $24,000, respectively, related to the ineffectiveness of the interest rate swap. The Company does not expect the ineffectiveness related to its hedging activity to be material to the Company’s financial results in the future. There were no components of the derivative instruments that were excluded from the assessment of hedge effectiveness.

     During the quarter ended September 30, 2007, pretax income of $273,000 ($177,000 net of tax) was reclassified into interest expense from accumulated other comprehensive income as adjustments to interest payments on variable rate debt. In addition, $165,000 ($107,000 net of tax) was reclassified into earnings associated with the previous termination of the hedging relationship in the fourth quarter of 2006.

     During the nine months ended September 30, 2007, pretax income of $816,000 ($530,000 net of tax) was reclassified into interest expense from accumulated other comprehensive income as adjustments to interest payments on variable rate debt. In addition, $489,000 ($318,000 net of tax) was reclassified into earnings associated with the previous termination of the hedging relationship in the fourth quarter of 2006. At September 30, 2007, accumulated other comprehensive income included a deferred after-tax net loss of $3.1 million related to the interest rate swaps of which $2.0 million ($1.3 million net of tax) is the remaining amount of loss associated with the previous terminated hedging relationship. This amount is expected to be reclassified into earnings in conjunction with the interest payments on the variable rate debt through April 2011.

     The Company uses regression analysis to assess the hedge effectiveness in achieving the offsetting cash flows attributable to the risk being hedged. In addition, the Company utilizes the hypothetical derivative methodology for the measurement of ineffectiveness. Derivative gains and losses not effective in hedging the expected cash flows will be recognized immediately in earnings.

3. FEDERAL INCOME TAXES

     In June 2006, the FASB issued FASB Interpretation 48, Accounting for Uncertainty in Income Taxes, an interpretation of FAS No. 109 Accounting for Income Taxes. The Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of the tax benefits from the tax position taken or expected to be taken in a tax return. Adoption of this pronouncement did not effect the Company’s financial position and no cumulative effect adjustment was required to the January 1, 2007 balance of retained earnings.

     As of January 1, 2007, the Company maintained a liability for uncertain tax positions in the amount of $1.1 million which consists solely of accrued interest related to a tax position that involves the uncertain timing of a deduction claimed on a tax return. Accrued interest and applicable penalties, if any, on uncertain tax positions are recorded as a component of income taxes but is not significant for the quarter ended September 30, 2007. The uncertain tax position is currently under examination. The years that remain subject to federal tax examination are all years after 2002.

4. NET INCOME PER SHARE

     The following table sets forth the computation of basic and diluted earnings per share:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
		(In thousands, except per share amounts)
Income from continuing operations		$	33,255			$	89,874			$	78,846			$	134,400
Income from discontinued operations			226				301				689				20,663
Net income available to common shareholders		$	33,481			$	90,175			$	79,535			$	155,063
Weighted average shares outstanding, basic			30,675				29,825				30,398				36,466
Dilutive effect of stock options and other shares			951				748				858				764
Weighted average shares outstanding, dilutive			31,626				30,573				31,256				37,230
Basic earnings per share:
From continuing operations		$	1.08			$	3.01			$	2.59			$	3.68
From discontinued operations			0.01				0.01				0.03				0.57
Net income per share, basic		$	1.09			$	3.02			$	2.62			$	4.25
Diluted earnings per share:
From continuing operations		$	1.05			$	2.94			$	2.52			$	3.60
From discontinued operations			0.01				0.01				0.02				0.56
Net income per share, diluted		$	1.06			$	2.95			$	2.54			$	4.16

     As of September 30, 2007, 26,917,310 shares of Class A-1 common stock were issued, of which 26,816,670 were outstanding and 100,640 shares were held in treasury and 3,952,204 shares of Class A-2 common stock were issued, of which 3,795,268 shares were outstanding and 156,936 shares were held in treasury.

5. COMMITMENTS AND CONTINGENCIES

The Company is a party to the following material legal proceedings:

Academic Management Services Corp. — Related Litigation

     As previously disclosed, in May and June 2004, HealthMarkets and certain officers and current and former directors of HealthMarkets were named as defendants in four separate class action suits arising out of HealthMarkets’ announcement in July 2003 of a shortfall in the type and amount of collateral supporting securitized student loan financing facilities of Academic Management Services Corp., formerly a wholly-owned subsidiary of HealthMarkets until its disposition in November 2003. On October 18, 2004, the four separate cases were consolidated as a single action, in HealthMarkets Securities Litigation, Case No. 3-04-CV-1149-P, pending in the United States District Court for the Northern District of Texas, Dallas Division. On May 27, 2005, plaintiffs on behalf of the purported class of similarly situated individuals who purchased HealthMarkets common stock during the period commencing February 7, 2002 and ending on July 21, 2003, filed a First Amended Consolidated Complaint alleging among other things that HealthMarkets, AMS, the Company’s former chief financial officer, the Company’s former chief executive officer and AMS’ former president failed to disclose all material facts relating to the condition of AMS, in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. On October 4, 2007, the parties executed a settlement agreement and, on October 11, 2007, the Court entered an order preliminarily approving the settlement. The final settlement hearing has been scheduled for January 23, 2008. The Company currently believes that resolution of this matter will not have a material adverse effect on the Company’s consolidated financial condition or results of operations.

     HealthMarkets has agreed to advance the expenses of the individual defendants incurred in connection with the defense of the case, subject to the defendants’ undertaking to repay such advances unless it is ultimately determined that they are or would have been entitled to indemnification by HealthMarkets under the terms of the Company’s bylaws.

Association Group Litigation

     The health insurance products issued by the Company’s insurance subsidiaries in the self-employed market are primarily issued to members of various membership associations that make available to their members the health insurance and other insurance products issued by the Company’s insurance subsidiaries. The associations provide their membership with a number of benefits and products, including the opportunity to apply for health insurance underwritten by the Company’s health insurance subsidiaries. As previously disclosed, the Company and/or its insurance company subsidiaries have been named as defendants in numerous cases in California and in other jurisdictions challenging, among other things, the manner in which the defendants market health insurance products in the self-employed market and the nature of the relationship between the Company’s insurance companies and the associations that have made available to their members the insurance companies’ health insurance products. Plaintiffs in such cases generally seek injunctive relief and monetary damages in an unspecified amount. Reference is made to the discussion of these cases contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 under the caption “Item 3 — Legal Proceedings” and in Note P of Notes to the Company’s Consolidated Financial Statements included in such report.

     As previously disclosed, the Company and MEGA were named as defendants in an action filed on February 11, 2002 (Martha R. Powell and Keith P. Powell v. UICI, MEGA, the National Association for the Self-Employed et al.) pending in the Second Judicial District Court for the County of Bernalillo, New Mexico, Cause No. CV-2 002-1156. Plaintiffs have alleged breach of contract, fraud, negligent misrepresentation, civil conspiracy, breach of third-party beneficiary contract, breach of the duty of good faith and fair dealing, breach of fiduciary duty, negligence, and violations of the New Mexico Insurance Practices Act, the New Mexico Insurance Code, and the New Mexico Unfair Practices Act. Plaintiff seeks injunctive relief and monetary damages in an unspecified amount. On November 8, 2007, the parties completed the negotiation of definitive settlement documentation and are in the process of obtaining signatures of all parties to the settlement agreement. Final resolution of this case is subject to approval by the Court. The Company currently believes that the terms of the settlement as contemplated by the settlement agreement will not have a material adverse effect on the Company’s consolidated financial condition or results of operation.

     As previously disclosed, the Company and MEGA were named as defendants in an action filed on June 25, 2006 (Christopher Closson, individually, and as Successor in interest to Kathy Closson, deceased v. HealthMarkets, MEGA, National Association for the Self-Employed, et al.) pending in the Superior Court for the County of Riverside, California, Case No. RIC453741. Plaintiff has alleged several causes of action, including breach of fiduciary duty, negligent failure to obtain insurance, fraud by concealment, promissory fraud, civil conspiracy, professional negligence, negligence, intentional infliction of emotional distress, and violation of the California Consumer Legal Remedies Act. Plaintiff seeks injunctive relief, and general and punitive monetary damages in an unspecified amount. On September 8, 2006, the Company and MEGA filed a motion in the United States District Court for the Northern District of Texas, Dallas Division (the “Texas Court”), to enjoin plaintiff from pursuing claims that were the subject of a previous class action settlement. As part of the previous settlement, the Texas Court barred and permanently enjoined class members from reasserting, in another proceeding, claims that were the subject of the settlement. On August 2, 2007, the Texas Court denied the motion to enjoin and on August 16, 2007, the Company and MEGA filed a motion for clarification with the Texas Court. The Company currently believes that resolution of this matter will not have a material adverse effect on the Company’s consolidated financial condition or results of operations.

Commonwealth of Massachusetts Litigation

     On October 23, 2006, MEGA was named as a defendant in an action filed by the Commonwealth of Massachusetts (Commonwealth of Massachusetts v. The MEGA Life and Health Insurance Company), pending in the Superior Court of Suffolk County, Massachusetts, Case Number 06-4411. Plaintiff has alleged that MEGA engaged in unfair and deceptive practices by issuing policies that contained exclusions of, or otherwise failed to cover, certain benefits mandated under Massachusetts law. In addition, plaintiff has alleged that MEGA violated Massachusetts laws that (i) require health insurance policies to provide coverage for outpatient contraceptive services to the extent the policies provide coverage for other outpatient services and (ii) limit exclusions of coverage for pre-existing conditions. By agreement of the parties, the suit was stayed through August 7, 2007 while the Attorney General continued its investigation. On August 22, 2007, the Attorney General filed an amended complaint which added the Company and Mid-West as defendants in the action and broadened Plaintiff’s original allegations. The amended complaint includes allegations that the defendants engaged in unfair and deceptive trade practices and illegal association membership practices, imposed illegal waiting periods and restrictions on coverage of pre-existing conditions and failed to comply with Massachusetts law regarding certain mandatory benefits. The Company currently believes that the resolution of this proceeding will not have a material adverse effect on the Company’s financial condition or results of operation.

Other Litigation Matters

     The Company and its subsidiaries are parties to various other pending and threatened legal proceedings, claims, demands, disputes and other matters arising in the ordinary course of business, including some asserting significant liabilities arising from claims, demands, disputes and other matters with respect to insurance policies, relationships with agents, relationships with former or current employees, and other matters. From time to time, some such matters, where appropriate, may be the subject of internal investigation by management, the Board of Directors, or a committee of the Board of Directors. The Company currently believes that the liability, if any, resulting from the disposition of such proceedings, claims, demands, disputes or matters would not be material to the Company’s financial condition or results of operations.

Regulatory Matters

     On March 22, 2005, HealthMarkets received notification that the Market Analysis Working Group of the National Association of Insurance Commissioners had chosen the states of Washington and Alaska to lead a multi-state market conduct examination of HealthMarkets’ principal insurance subsidiaries. The Company believes that 36 states have elected to participate in the examination, which commenced in May 2005 and is ongoing. The examiners have completed the onsite phases of the examination. The Company received a draft of the examination report on July 31, 2007 and responded to it on September 14, 2007. The lead states are evaluating the Company’s response.  The Company’s insurance subsidiaries are subject to various other pending market conduct examinations arising in the ordinary course of business. State insurance regulatory agencies have authority to levy monetary fines and penalties and require remedial action resulting from findings made during the course of such market conduct examinations. The Company currently believes that the liability, if any, resulting from the disposition of the multi-state market conduct examination or other market conduct examinations would not be material to the Company’s financial condition or results of operations.

6. SEGMENT INFORMATION

     The Company operates three business segments, the Insurance segment, Other Key Factors and Disposed Operations. The Insurance segment includes the Company’s Self-Employed Agency Division (“SEA”), the Life Insurance Division and Other Insurance Division. Other Key Factors includes investment income not allocated to the Insurance segment, realized gains or losses on sale of investments, interest expense on corporate debt, general expenses relating to corporate operations, merger transaction expenses, variable non-cash stock-based compensation and operations that do not constitute reportable operating segments. Disposed Operations includes the Company’s former Star HRG Division and former Student Insurance Division.

     Allocations of investment income and certain general expenses are based on a number of assumptions and estimates, and the business segments reported operating results would change if different methods were applied. Certain assets are not individually identifiable by segment and, accordingly, have been allocated by formulas. Segment revenue includes premiums and other policy charges and considerations, net investment income, fees and other income. Management does not allocate income taxes to segments. Transactions between reportable operating segments are accounted for under respective agreements, which provide for such transactions generally at cost.

     Revenue from continuing operations, income (loss) from continuing operations before income taxes, and assets by operating segment are set forth in the tables below:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
		(In thousands)								(In thousands)
Revenue from continuing operations:
Insurance:
Self-Employed Agency Division		$	355,497			$	365,599			$	1,078,117			$	1,095,369
Life Insurance Division			23,751				21,973				68,011				65,801
Other Insurance Division			8,145				8,006				23,653				27,327
Total Insurance			387,393				395,578				1,169,781				1,188,497
Other Key Factors			12,179				9,746				38,038				34,227
Gain on sale of Star HRG			—				101,015				—				101,015
Intersegment Eliminations			178				(275	)			(800	)			(854	)
Total revenue excluding disposed operations			399,750				506,064				1,207,019				1,322,885
Disposed Operations:
Student Insurance Division			—				57,171				—				193,085
Star HRG			(509	)			(667	)			(500	)			75,296
Total Disposed Operations			(509	)			56,504				(500	)			268,381
Total revenue from continuing operations		$	399,241			$	562,568			$	1,206,519			$	1,591,266

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
		(In thousands)								(In thousands)
Income from continuing operations before federal income taxes:
Insurance:
Self-Employed Agency Division		$	63,072			$	67,670			$	148,002			$	186,908
Life Insurance Division			559				1,865				1,076				4,021
Other Insurance Division			1,807				682				3,568				3,429
Total Insurance			65,438				70,217				152,646				194,358
Other Key Factors:
Investment income on equity, interest expense, realized gains and losses, general corporate expenses and other items			(12,012	)			(17,080	)			(30,485	)			(30,784	)
Merger transaction expenses			—				—				—				(48,019	)
Gain on sale of Star HRG			—				101,015				—				101,015
Variable stock-based compensation expense			(2,552	)			(2,294	)			(2,547	)			(3,024	)
Total Other Key Factors			(14,564	)			81,641				(33,032	)			19,188
Total operating income excluding disposed operations			50,874				151,858				119,614				213,546
Disposed Operations:
Student Insurance Division			106				2,534				436				9,743
Star HRG Division			(485	)			(240	)			(316	)			3,055
Total Disposed Operations			(379	)			2,294				120				12,798
Total income from continuing operations before taxes		$	50,495			$	154,152			$	119,734			$	226,344

		September 30,				December 31,
		2007				2006
		(In thousands)
Assets
Insurance:
Self-Employed Agency Division		$	892,725			$	930,856
Life Insurance Division			540,965				552,723
Other Insurance Division			16,015				20,419
Total Insurance			1,449,705				1,503,998
Other Key Factors			657,899				943,360
Total Assets excluding disposed operations			2,107,604				2,447,358
Disposed Operations:
Student Insurance Division			53,669				124,738
Star HRG Division			48				16,233
Total Disposed Operations			53,717				140,971
		$	2,161,321			$	2,588,329

     The Student Insurance Division assets of $53.7 million at September 30, 2007 represent a reinsurance receivable associated with a coinsurance agreement entered into with an insurance affiliate of UnitedHealth Group, Incorporated. 

7. AGENT AND EMPLOYEE STOCK PLANS

     Agent Stock Accumulation Plans

     The Company sponsors a series of stock accumulation plans (the “Agent Plans”) established for the benefit of the independent insurance agents and independent sales representatives associated with UGA — Association Field Services, New United Agency, and Cornerstone America.

     The Agent Plans generally combine an agent-contribution feature and a Company-match feature. The agent-contribution feature generally provides that eligible participants are permitted to allocate a portion (subject to prescribed limits) of their commissions or other compensation earned on a monthly basis to purchase shares of HealthMarkets Class A-2 common stock at the fair market value of such shares at the time of purchase. Under the Company-match feature of the Agent Plans, participants are eligible to have posted to their respective Agent Plan accounts book credits in the form of equivalent shares based on the number of shares of HealthMarkets Class A-2 common stock purchased by the participant under the agent-contribution feature of the Agent Plans. The “matching credits” vest over time, generally in prescribed increments over a ten-year period, commencing the plan year following the plan year during which contributions are first made under the agent-contribution feature. Vested matching credits in a participant’s plan account in January of each year are converted from book credits to an equivalent number of shares of HealthMarkets common stock. Matching credits forfeited by participants no longer eligible to participate in the Agent Plans are reallocated each year among eligible participants and credited to eligible participants’ Agent Plan accounts. Share requirements of the Agent Plans may be met from either unissued or treasury shares.

     The Agent Plans do not constitute qualified plans under Section 401(a) of the Internal Revenue Code of 1986 or employee benefit plans under the Employee Retirement Income Security Act of 1974 (“ERISA”), and the Agent Plans are not subject to the vesting, funding, nondiscrimination and other requirements imposed on such plans by the Internal Revenue Code and ERISA.

     For financial reporting purposes, the Company accounts for the Company-match feature of its Agent Plans by recognizing compensation expense over the vesting period in an amount equal to the fair market value of vested shares at the date of their vesting and distribution to the participants. The Company estimates its current liability for unvested matching credits by reference to the number of unvested credits, the prevailing “fair market value” (as determined by the Company’s Board of Directors) of the Company’s common stock, and the Company’s estimate of the percentage of the vesting period that has elapsed up to the current quarter end. Changes in the liability from one quarter to the next are accounted for as an increase in, or decrease to, compensation expense, as the case may be. Upon vesting, the Company reduces the accrued liability in an amount equal to the market value of the vested shares at date of vesting with a corresponding increase to equity. Unvested matching credits are considered share equivalents outstanding for purposes of the computation of earnings per share.

     The portion of compensation expense associated with the Agent Plans reflected in the results of the SEA Division is based on the prevailing fair value of Class A-2 common stock (as determined by the Board of Directors of the Company since the Merger or, prior to the Merger, by reference to the fair value of the Company’s common stock) on or about the time the unvested matching credits are granted to participants. In accordance with the terms of the Agent Plans, the Board of Directors of the Company establishes the fair market value of Class A-2 common stock on a quarterly basis. The remaining portion of the compensation expense associated with the Agent Plans, consisting of variable stock-based compensation expense, is reflected in the results of the Company’s “Other Key Factors” business segment.

     Set forth in the table below is the total compensation expense and tax benefit associated with the Company’s Agent Plans for the three and nine months ended September 30, 2007 and 2006:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
		(In thousands)								(In thousands)
SEA Division stock-based compensation expense		$	1,682			$	2,959			$	7,779			$	8,450
Other Key Factors variable non-cash stock-based compensation expense			2,552				2,294				2,547				3,024
Total Agent Plan compensation expense			4,234				5,253				10,326				11,474
Related Tax Benefit			1,482				1,839				3,614				4,016
Net expense included in financial results		$	2,752			$	3,414			$	6,712			$	7,458

     The SEA stock-based compensation expense represents the cost of Class A-2 common stock (determined by reference to the prevailing fair value of Class A-2 common stock as determined by the Board of Directors of the Company or, prior to the Merger, by reference to the market price of HealthMarkets (formerly UICI) common shares) on or about the time that unvested matching credits are granted to participants in the Agent Plan. This amount is reflected in the caption “Underwriting, policy acquisition costs, and insurance expenses” on the Company’s Consolidated Condensed Statement of Income.

     The Other Key Factors stock-based compensation expense represents the total stock-based compensation expense associated with the Agent Plans less the expense incurred by the Company on or about the time that unvested matching credits are granted to participants in the Agent Plan. This amount is reflected in the caption “Underwriting, policy acquisition costs, and insurance expenses” on the Company’s Consolidated Condensed Statement of Income.

     At December 31, 2006, the Company had recorded 1,373,456 unvested matching credits associated with the Agent Plans, of which 423,145 vested in January 2007. Upon vesting, the Company increased additional paid-in capital by $17.3 million, decreased treasury shares by $3.9 million and decreased other liabilities by $21.2 million. At September 30, 2007, the Company had recorded 1,442,112 unvested matching credits.

     Agent Plan transactions are not reflected in the Consolidated Condensed Statement of Cash Flows since issuance of equity securities to settle the Company’s liabilities under the Agent Plans are non-cash transactions.

Employee Stock Option Plans

     At the Board of Directors meeting held on May 3, 2007, the Board approved an amendment to the 1987 Stock Option Plan (the“1987 Plan”) which provided that in the event of an extraordinary cash dividend, the Company may make such adjustments to options granted under the 1987 Plan as it determines are equitable and/or appropriate. The Board approved an adjustment to options pursuant to which the number of options increased and the exercise price of such options decreased. The value of the options was maintained pre- and post-dividend. To prevent a dilution in the rights of participants in the 2006 Management Stock Option Plan (the “2006 Plan”), the Board of Directors also approved an adjustment of options granted under the 2006 Plan pursuant to which the exercise price was reduced by $10.51 per share – the amount of the extraordinary cash dividend. The modifications will result in a total expense to the Company of $3.4 million of which $1.6 million and $200,000 were recognized in the second and third quarters of 2007, respectively, and the remaining amount will be recognized over the remaining life of the options.

     During the quarter ended September 30, 2007, options to purchase a total of 37,802 shares of Class A-1 common stock were granted under the 2006 Plan to seven employees and one director at an exercise price of $40.97, which represented the fair value of Class A-1 common stock as determined by the Board of Directors on the date of grant of such options.

     Included in the 37,802 options granted in the current quarter are 10,566 Performance-Based options where no performance goals have been established. Because performance goals have not been established on certain Performance-Based options, the fair value of the grant cannot be determined and no compensation expense has been recorded for these options.

8. TRANSACTIONS WITH RELATED PARTIES

     On April 5, 2006, the Company completed its Merger and, as a result, affiliates of The Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners (the “Private Equity Investors”) held, as of the effective date of the Merger, approximately 55.3%, 22.7% and 11.3%, respectively, of the Company’s outstanding equity securities. At September 30, 2007, affiliates of The Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners held approximately 53.9%, 22.1% and 11.0%, respectively, of the Company’s outstanding equity securities. Certain members of the Board of Directors of the Company are affiliated with the Private Equity Investors; in particular, Chinh E. Chu and Matthew S. Kabaker serve as Senior Managing Director and a Principal, respectively, of The Blackstone Group, Adrian M. Jones and Sumit Rajpal serve as a Managing Director and Vice President, respectively, of Goldman, Sachs & Co., and Kamil M. Salame is a partner of DLJ Merchant Banking Partners.

     In accordance with the terms of Transaction and Monitoring Fee Agreements with advisory affiliates of each of the Private Equity Investors, the advisory affiliates of each of the Private Equity Investors agreed to provide to the Company ongoing monitoring, advisory and consulting services, for which the Company agreed to pay to affiliates of each of The Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners an annual monitoring fee in an amount equal to $7.7 million, $3.5 million and $1.3 million, respectively. The annual monitoring fees are in each case subject to upward adjustment in each year based on the ratio of the Company’s consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) in such year to consolidated EBITDA in the prior year, provided that the aggregate monitoring fees paid to all advisors pursuant to the Transaction and Monitoring Fee Agreements in any year shall not exceed the greater of $15.0 million or 3% of consolidated EBITDA in such year. The aggregate annual monitoring fees in the amount of $12.5 million payable with respect to 2007 were paid in full to the advisory affiliates of the Private Equity Investors on January 3, 2007. The Company has expensed $9.4 million through September 30, 2007.

     On May 3, 2007, the Company’s Board of Directors declared an extraordinary cash dividend in the amount of $10.51 per share for Class A-1 and Class A-2 common stock to holders of record as of close of business on May 9, 2007, payable on May 14, 2007. In connection with the extraordinary cash dividend, affiliates of each of The Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners were paid dividends in the amount of $173.3 million, $71.0 million and $35.5 million, respectively. See Note 9.

     On April 20, 2007, the Company’s Board of Directors approved a $10.0 million investment by Mid-West National Life Insurance Company of Tennessee in Goldman Sachs Real Estate Partners, L.P., a commercial real estate fund managed by an affiliate of Goldman Sachs Capital Partners. The Company has committed such investment to be funded over a series of capital calls. On July 18, 2007, the Company funded the first capital call in the amount of $1.5 million. On November 9, 2007, the Company funded the second capital call in the amount of $1.8 million.

     On April 20, 2007, the Company’s Board of Directors approved a $10.0 million investment by The MEGA Life and Health Insurance Company in Blackstone Strategic Alliance Fund L.P., a hedge fund of funds managed by an affiliate of The Blackstone Group. The Company has committed such investment to be funded over a series of capital calls. On August 30, 2007, the Company funded the first capital call in the amount of $430,000. On September 27, 2007, the Company funded the second capital call in the amount of $957,000.

9. EXTRAORDINARY CASH DIVIDEND

     On May 3, 2007, the Company’s Board of Directors declared an extraordinary cash dividend in the amount of $10.51 per share for Class A-1 and Class A-2 common stock to holders of record as of close of business on May 9, 2007, payable on May 14, 2007. In connection with the extraordinary cash dividend, the Company paid dividends to stockholders in the aggregate amount of $317.0 million.

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

Introduction

     The Company operates three business segments, the Insurance segment, Other Key Factors and Disposed Operations. The Insurance segment includes the Company’s Self-Employed Agency Division (“SEA”), the Life Insurance Division and Other Insurance Division. Other Key Factors includes investment income not allocated to the Insurance segment, realized gains or losses on sale of investments, interest expense on corporate debt, general expenses relating to corporate operations, merger transaction expenses, variable non-cash stock-based compensation and operations that do not constitute reportable operating segments. Disposed Operations includes the Company’s former Star HRG Division and former Student Insurance Division.

Results of Operations

     The table below sets forth certain summary information about the Company’s operating results for the three and nine months ended September 30, 2007 and 2006:

		Three Months Ended								Percentage				Nine Months Ended								Percentage
		September 30,								Increase				September 30,								Increase
		2007				2006				(Decrease)				2007				2006				(Decrease)
		(Dollars in thousands)												(Dollars in thousands)
REVENUE
Health premiums		$	330,742			$	395,557				(16.4	)%		$	999,008			$	1,286,587				(22.4	)%
Life premiums and other considerations			18,165				16,664				9.0	%			51,990				49,144				5.8	%
			348,907				412,221				(15.4	)%			1,050,998				1,335,731				(21.3	)%
Investment income			25,231				25,699				(1.8	)%			77,963				77,012				1.2	%
Other income			25,561				25,456				20.9	%			78,768				76,790				9.4	%
Gains on sale of investments			(458	)			99,192			NM					(1,210	)			101,733			NM
			399,241				562,568				(28.1	)%			1,206,519				1,591,266				(23.9	)%
BENEFITS AND EXPENSES
Benefits, claims, and settlement expenses			188,755				226,881				(16.8	)%			600,599				755,403				(20.5	)%
Underwriting, policy acquisition costs, and insurance expenses			126,791				140,332				(9.6	)%			380,682				451,567				(15.7	)%
Other expenses			21,374				27,782				(4.3	)%			67,833				130,193				(43.9	)%
Interest expense			11,826				13,421				(11.9	)%			37,671				27,759				35.7	%
			348,746				408,416				(13.3	)%			1,086,785				1,364,922				(20.0	)%
Income from continuing operations before income taxes			50,495				154,152				(67.2	)%			119,734				226,344				(47.1	)%
Federal income taxes			17,240				64,278				(73.2	)%			40,888				91,944				(55.5	)%
Income from continuing operations			33,255				89,874				(63.0	)%			78,846				134,400				(41.3	)%
Income from discontinued operations (net of income tax)			226				301				(24.9	)%			689				20,663				(96.7	)%
Net income		$	33,481			$	90,175				(62.9	)%		$	79,535			$	155,063				(48.7	)%

NM: not meaningful

     Revenue and income from continuing operations before federal income taxes (“operating income”) by business segment are summarized in the tables below:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
		(In thousands)								(In thousands)
Revenue from continuing operations:
Insurance:
Self-Employed Agency Division		$	355,497			$	365,599			$	1,078,117			$	1,095,369
Life Insurance Division			23,751				21,973				68,011				65,801
Other Insurance Division			8,145				8,006				23,653				27,327
Total Insurance			387,393				395,578				1,169,781				1,188,497
Other Key Factors			12,179				9,746				38,038				34,227
Gain on sale of Star HRG			—				101,015				—				101,015
Intersegment Eliminations			178				(275	)			(800	)			(854	)
Total revenue excluding disposed operations			399,750				506,064				1,207,019				1,322,885
Disposed Operations:
Student Insurance Division			—				57,171				—				193,085
Star HRG			(509	)			(667	)			(500	)			75,296
Total Disposed Operations			(509	)			56,504				(500	)			268,381
Total revenue from continuing operations		$	399,241			$	562,568			$	1,206,519			$	1,591,266

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2007				2006				2007				2006
		(In thousands)								(In thousands)
Income from continuing operations before federal income taxes:
Insurance:
Self-Employed Agency Division		$	63,072			$	67,670			$	148,002			$	186,908
Life Insurance Division			559				1,865				1,076				4,021
Other Insurance Division			1,807				682				3,568				3,429
Total Insurance			65,438				70,217				152,646				194,358
Other Key Factors:
Investment income on equity, interest expense, realized gains and losses, general corporate expenses and other items			(12,012	)			(17,080	)			(30,485	)			(30,784	)
Merger transaction expenses			—				—				—				(48,019	)
Gain on sale of Star HRG			—				101,015				—				101,015
Variable stock-based compensation expense			(2,552	)			(2,294	)			(2,547	)			(3,024	)
Total Other Key Factors			(14,564	)			81,641				(33,032	)			19,188
Total operating income excluding disposed operations			50,874				151,858				119,614				213,546
Disposed Operations:
Student Insurance Division			106				2,534				436				9,743
Star HRG Division			(485	)			(240	)			(316	)			3,055
Total Disposed Operations			(379	)			2,294				120				12,798
Total income from continuing operations before taxes		$	50,495			$	154,152			$	119,734			$	226,344

     HealthMarkets’ results of operations for the three and nine months ended September 30, 2007 were particularly impacted by the following factors:

Self- Employed Agency Division

     Set forth below is certain summary financial and operating data for the Company’s Self-Employed Agency Division for the three and nine months ended September 30, 2007 and 2006:

		Self-Employed Agency Division
		Three Months Ended								Percentage				Nine Months Ended								Percentage
		September 30,								Increase				September 30,								Increase
		2007				2006				(Decrease)				2007				2006				(Decrease)
		(Dollars in thousands)
Revenue
Earned premium revenue		$	322,682			$	333,260				(3.2	)%		$	976,522			$	997,913				(2.1	)%
Investment income			7,800				7,830				(0.4	)%			23,390				23,806				(1.7	)%
Other income			25,015				24,509				20.6	%			78,205				73,650				6.2	%
Total revenue			355,497				365,599				(2.8	)%			1,078,117				1,095,369				(1.6	)%
Benefits and Expenses
Benefit expenses			171,017				176,007				(2.8	)%			547,510				528,077				3.7	%
Underwriting and policy acquisition expenses			109,746				107,611				2.0	%			341,563				335,669				1.8	%
Other expenses			11,662				14,311				(18.5	)%			41,042				44,715				8.2	%
Total expenses			292,425				297,929				(1.8	)%			930,115				908,461				2.4	%
Operating income		$	63,072			$	67,670				(6.8	)%		$	148,002			$	186,908				(20.8	)%
Other operating data:
Loss ratio			53.0	%			52.8	%							56.1	%			52.9	%
Expense ratio			34.0	%			32.3	%							35.0	%			33.6	%
Combined ratio			87.0	%			85.1	%							91.1	%			86.5	%
Average number of writing agents in period			1,826				2,137								1,988				2,186
Submitted annualized volume		$	156,851			$	194,455							$	542,677			$	613,509