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, 2008

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, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

     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 31, 2008 the registrant had 26,896,325 outstanding shares of Class A-1 Common Stock, $.01 Par Value, and 2,767,251 outstanding shares of Class A-2 Common Stock, $.01 Par Value.

 

 

HEALTHMARKETS, INC.
and Subsidiaries

Third Quarter 2008 Form 10-Q

TABLE OF CONTENTS

				Page
PART I		FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)
		Consolidated Condensed Balance Sheets as of September 30, 2008 and December 31, 2007			1
		Consolidated Condensed Statements of Income (Loss) for the Three and Nine Months Ended September 30, 2008 and 2007			2
		Consolidated Condensed Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2008 and 2007			3
		Consolidated Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007			4
		Notes to Consolidated Condensed Financial Statements			5
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			31
Item 4.		Controls and Procedures			32
PART II		OTHER INFORMATION
Item 1.		Legal Proceedings			32
Item 1A.		Risk Factors			32
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			33
Item 6.		Exhibits			34
SIGNATURES					35
EX-31.1
EX-31.2
EX-32

PART 1. FINANCIAL INFORMATION

ITEM 1. Financial Statements

HEALTHMARKETS, INC.
and Subsidiaries

CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except per share data)

		September 30,				December 31,
		2008				2007
		(Unaudited)
ASSETS
Investments:
Securities available for sale —
Fixed maturities, at fair value (cost: 2008—$1,009,227; 2007—$1,314,069)		$	951,410			$	1,304,424
Equity securities, at fair value (cost: 2008—$290; 2007—$300)			334				346
Policy loans			168				14,279
Short-term and other investments, at fair value (cost: 2008—$190,919; 2007—$163,727)			190,794				162,552
Total investments			1,142,706				1,481,601
Cash and cash equivalents			—				14,309
Investment income due and accrued			11,212				14,527
Due premiums			3,258				4,055
Reinsurance receivables			6,610				4,211
Reinsurance recoverable — ceded policy liabilities			397,614				68,821
Agent and other receivables			28,177				63,956
Deferred acquisition costs			76,004				197,979
Property and equipment, net			65,361				69,939
Goodwill and other intangible assets			87,968				89,194
Recoverable federal income taxes			—				4,962
Assets held for sale			93,434				110,355
Other assets			34,233				31,673
Total assets		$	1,946,577			$	2,155,582
LIABILITIES AND STOCKHOLDERS’ EQUITY
Policy liabilities:
Future policy and contract benefits		$	478,442			$	463,277
Claims			433,574				435,099
Unearned premiums			69,168				92,266
Other policy liabilities			12,720				10,764
Accounts payable and accrued expenses			54,089				69,510
Cash overdraft			2,931				—
Other liabilities			76,965				110,624
Federal income tax payable			6,571				—
Deferred federal income tax			30,505				84,968
Debt			481,070				481,070
Liabilities held for sale			89,200				99,109
Net liabilities of discontinued operations			2,434				2,635
Total liabilities			1,737,669				1,849,322
Stockholders’ Equity:
Preferred stock, par value $0.01 per share			—				—
Common stock, par value $0.01 per share			310				310
Additional paid-in capital			54,577				55,754
Accumulated other comprehensive loss			(42,939	)			(13,132	)
Retained earnings			236,905				281,141
Treasury stock, at cost			(39,945	)			(17,813	)
Total stockholders’ equity			208,908				306,260
Total liabilities and stockholders’ equity		$	1,946,577			$	2,155,582

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF INCOME (LOSS)
(In thousands, except per share data)
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
REVENUE
Health premiums		$	315,765			$	330,742			$	959,068			$	999,008
Life premiums and other considerations			673				18,165				37,189				51,990
			316,438				348,907				996,257				1,050,998
Investment income			14,539				22,565				49,770				69,687
Other income			19,597				25,402				61,915				78,291
Realized losses, net			(15,322	)			(458	)			(18,561	)			(1,210	)
			335,252				396,416				1,089,381				1,197,766
BENEFITS AND EXPENSES
Benefits, claims, and settlement expenses			211,500				188,755				661,795				600,599
Underwriting, acquisition, and insurance expenses			113,862				126,791				381,846				380,682
Other expenses			25,379				19,904				75,612				64,659
Interest expense			12,607				10,361				32,078				33,241
			363,348				345,811				1,151,331				1,079,181
Income (loss) from continuing operations before income taxes			(28,096	)			50,605				(61,950	)			118,585
Federal income tax expense (benefit)			(9,312	)			17,279				(22,866	)			40,486
Income (loss) from continuing operations			(18,784	)			33,326				(39,084	)			78,099
Income (loss) from discontinued operations, net			70				155				(5,152	)			1,436
Net income (loss)		$	(18,714	)		$	33,481			$	(44,236	)		$	79,535
Basic earnings per share:
Income (loss) from continuing operations		$	(0.63	)		$	1.08			$	(1.29	)		$	2.57
Income (loss) from discontinued operations			0.00				0.01				(0.17	)			0.05
Net income (loss) per share, basic		$	(0.63	)		$	1.09			$	(1.46	)		$	2.62
Diluted earnings per share:
Income (loss) from continuing operations		$	(0.63	)		$	1.06			$	(1.29	)		$	2.49
Income (loss) from discontinued operations			0.00				0.00				(0.17	)			0.05
Net income (loss) per share, diluted		$	(0.63	)		$	1.06			$	(1.46	)		$	2.54

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Net income (loss)		$	(18,714	)		$	33,481			$	(44,236	)		$	79,535
Other comprehensive income (loss):
Unrealized gains (losses) on securities available for sale arising during the period			(27,956	)			13,523				(45,954	)			(6,093	)
Reclassification of investment (gains) losses included in net income			(756	)			42				(1,170	)			690
Effect on other comprehensive income (loss) from investment securities			(28,712	)			13,565				(47,124	)			(5,403	)
Unrealized gains (losses) on derivatives used in cash flow hedging during the period			(901	)			(4,788	)			(2,881	)			(2,050	)
Reclassification adjustments included in net income			1,891				(30	)			4,188				(303	)
Effect on other comprehensive income (loss) from hedging activities			990				(4,818	)			1,307				(2,353	)
Other comprehensive income (loss) before tax			(27,722	)			8,747				(45,817	)			(7,756	)
Income tax expense (benefit) related to items of other comprehensive income (loss)			(9,691	)			3,051				(16,010	)			(2,727	)
Other comprehensive income (loss) net of tax			(18,031	)			5,696				(29,807	)			(5,029	)
Comprehensive income (loss)		$	(36,745	)		$	39,177			$	(74,043	)		$	74,506

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

		Nine Months Ended
		September 30
		2008				2007
Operating Activities:
Net income (loss)		$	(44,236	)		$	79,535
Adjustments to reconcile net income (loss) to cash provided by operating activities:
(Income) loss from discontinued operations			5,152				(1,436	)
Realized losses on investments			14,043				1,210
Change in deferred income taxes			(38,220	)			4,592
Depreciation and amortization			22,275				19,327
Amortization of prepaid monitoring fees			9,375				9,375
Equity based compensation expense			3,477				6,593
Provision for doubtful accounts			4,614				308
Other items, net			3,652				3,501
Changes in assets and liabilities:
Investment income due and accrued			3,272				2,146
Due premiums			797				(580	)
Reinsurance receivables			(2,399	)			(4,671	)
Reinsurance recoverable — ceded policy liabilities			(328,793	)			84,336
Other receivables			32,726				(15,847	)
Deferred acquisition costs			121,975				(2,243	)
Other assets			(3,072	)			(2,823	)
Prepaid monitoring fees			(12,500	)			(12,500	)
Current income tax recoverable			10,323				26,443
Policy liabilities			11,412				(104,840	)
Other liabilities and accrued expenses			(30,948	)			(2,615	)
Cash (used in) provided by continuing operations			(217,075	)			89,811
Cash (used in) provided by discontinued operations			2,503				(1,839	)
Net cash (used in) provided by operating activities			(214,572	)			87,972
Investing Activities:
Decrease in investment assets			247,395				285,204
Purchases of property and equipment			(13,698	)			(22,584	)
Net proceeds from sale of businesses and assets			4,665				—
Distributions from investment in Grapevine Finance LLC			175				581
(Increase) decrease in agent receivables			2,923				3,700
Cash provided by continuing operations			241,460				266,901
Cash provided by discontinued operations			8,557				16,689
Net cash provided by investing activities			250,017				283,590
Financing Activities:
Repayment of notes payable			—				(75,000	)
Change in cash overdraft			2,931				2,132
Decrease in investment products			(1,322	)			(5,387	)
Proceeds from exercise of stock options			110				404
Excess tax benefits from equity based compensation			(320	)			126
Proceeds from shares issued to agent plans and other			9,813				37,822
Purchases of treasury stock			(51,566	)			(30,318	)
Dividends paid			—				(316,996	)
Other			—				49
Cash used in continuing operations			(40,354	)			(387,168	)
Cash used in discontinued operations			(9,400	)			(17,150	)
Net cash used in financing activities			(49,754	)			(404,318	)
Net change in cash and cash equivalents			(14,309	)			(32,756	)
Cash and cash equivalents at beginning of period			14,309				32,756
Cash and cash equivalents at end of period in continuing operations		$	—			$	—
Supplemental disclosures:
Income taxes paid			2,588				10,103
Interest paid			35,966				30,656

The “Reinsurance recoverable — ceded policy liabilities” and “Deferred acquisition costs” line items reflected in the “Operating activities” section of this statement were particularly impacted by the “Exit from Life Insurance Division Business” as discussed in Note 2.

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)

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 condensed balance sheets, statements of income (loss), statements of comprehensive income (loss) and statements of cash flows for the periods presented. Operating results for the three and nine month periods ended September 30, 2008 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2008. 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, 2007.

          Certain amounts in the prior period financial statements have been reclassified to conform to the 2008 financial statement presentation.

Recent Accounting Pronouncements

          In October 2008, the Financial Accounting Standard Board (“FASB”) issued FASB Staff Position (“FSP”) FAS No. 157-3 Determining the Fair Value of a Financial Asset When a Market for that Asset is Not Active (“FSP 157-3”) which clarifies the application of FAS No. 157, Fair Value Measurements (“FAS 157”), in a market that is not active and provides an example to illustrate key conditions in determining the fair value of a financial asset when a market for that financial asset is not active. This FSP became effective upon issuance, including prior periods for which financial statements have not been issued. This FSP is not expected to have a significant impact on the Company’s results of operations, or financial positions.

          In May 2008, the FASB issued FAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“FAS 162”). The statement is intended to improve financial reporting by identifying a consistent hierarchy for selecting accounting principles to be used in preparing financial statements that are prepared in conformance with GAAP. Unlike Auditing Standards No. 69, The Meaning of Present Fairly in Conformity With GAAP, FAS 162 is directed to the entity rather than the auditor. The statement will be effective 60 days following the Securities Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity with GAAP, and is not expected to have any impact on the Company’s results of operations, and financial position.

          In April 2008, the FASB issued FSP FAS No. 142-3, which amends the factors that must be considered in developing renewal or extension assumptions used to determine the useful life over which to amortize the cost of a recognized intangible asset under FAS No. 141(R), Business Combinations (“FAS 141(R)”). The FSP requires an entity to consider its own assumptions about renewal or extension of the term of the arrangement, consistent with its expected use of the asset, in an attempt to improve consistency between the useful life of a recognized intangible asset under FAS No. 142, Goodwill and Other Intangible Assets, and the period of expected cash flows used to measure the fair value of the asset under FAS 141(R). The FSP is effective for fiscal years beginning after December 15, 2008, and the guidance for determining the useful life of a recognized intangible asset must be applied prospectively to intangible assets acquired after the effective date. The FSP is not expected to have a significant impact on the Company’s results of operations, or financial positions.

          On March 19, 2008, the FASB issued FAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, which amends FAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“FAS 161”). FAS 161 requires companies with derivative instruments to disclose information that should enable financial statement users to understand how and why a company uses derivative instruments, how derivative instruments and related hedged items are accounted for under FAS No. 133, and how derivative instruments and related hedged items affect a company’s financial position, financial performance, and cash flows. The required disclosures include the fair value of derivative instruments and their gains or losses in tabular format, information about credit risk related contingent features in derivative

agreements, counterparty credit risk, and a company’s strategies and objectives for using derivative instruments. The statement expands the current disclosure framework in FAS No. 133. FAS No. 161 is effective prospectively for periods beginning on or after November 15, 2008.

          In December 2007, the FASB issued FAS 141(R), which replaces FAS No. 141, Business Combinations. FAS 141(R) retains the underlying concepts of FAS No. 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting, but FAS 141(R) changed the method of applying the acquisition method in a number of significant aspects. Acquisition costs will generally be expensed as incurred; non-controlling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. FAS 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first annual period subsequent to December 15, 2008, with the exception of the accounting for changes in valuation allowances on deferred taxes and acquired tax contingencies related to acquisitions prior to the date of adoption of FAS 141 (R). Early adoption is not permitted. The provisions of FAS 141(R) are effective for the fiscal year beginning on or after December 15, 2008, which for the Company is fiscal year 2009. We are currently evaluating the impact of the provisions of FAS 141(R).

2. EXIT FROM LIFE INSURANCE DIVISION BUSINESS

          On September 30, 2008 (the “Closing Date”), HealthMarkets LLC, a subsidiary of the Company, completed the transactions contemplated by the Agreement for Reinsurance and Purchase and Sale of Assets dated June 12, 2008 (the “Master Agreement”), previously reported in the Company’s Current Report on Form 8-K dated June 18, 2008. Pursuant to the Master Agreement, Wilton Reassurance Company or its affiliates (“Wilton”) acquired substantially all of the business of the Company’s Life Insurance Division, which operated through The Chesapeake Life Insurance Company (“Chesapeake”), Mid-West National Life Insurance Company of Tennessee (“Mid-West”) and The MEGA Life and Health Insurance Company (“MEGA”) (collectively the “Ceding Companies”), and all of the Company’s 79% equity interest in each of U.S. Managers Life Insurance Company, Ltd. and Financial Services Reinsurance, Ltd. As part of the transaction, under the terms of the Coinsurance Agreements entered into with each of the Ceding Companies on the Closing Date, Wilton has agreed effective July 1, 2008 (the “Coinsurance Effective Date”), to reinsure on a 100% coinsurance basis substantially all of the insurance policies associated with the Company’s Life Insurance Division (the “Coinsured Policies”).

          Under the terms of the Coinsurance Agreements, Wilton has assumed responsibility for all insurance liabilities associated with the Coinsured Policies. The Ceding Companies have transferred to Wilton cash in an amount equal to the net statutory reserves and liabilities corresponding to the Coinsured Policies, which amount was approximately $344.5 million. Wilton has agreed to be responsible for administration of the Coinsured Policies, subject to certain transition services to be provided by the Ceding Companies to Wilton. The Ceding Companies remain primarily liable to the policyholders on those policies with Wilton assuming the risk from the Ceding Companies pursuant to the terms of the Coinsurance Agreements. As a result, in accordance with guidance provided in Financial Accounting Standard No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts, the Company reported and will continue to report the policy liabilities ceded to Wilton under “Policy liabilities” and record a corresponding asset as “Reinsurance recoverable — ceded policy liabilities” on its consolidated condensed balance sheet. As of September 30, 2008, the Company had ceded policy liabilities in the amount of $365.2 million associated with the Coinsured Policies and a corresponding amount has been recorded in “Reinsurance recoverable — ceded policy liabilities” on the Company’s consolidated condensed balance sheet.

          The Company and the Ceding Companies received total consideration of approximately $139.2 million, including $134.5 million in aggregate ceding allowances with respect to the reinsurance of the Coinsured Policies. Under certain circumstances, the Master Agreement also provides for the payment of additional consideration to the Company following the closing based on the five year financial performance of the Coinsured Policies. The reinsurance transaction resulted in a pre-tax loss of $17.6 million of which $13.0 million was recorded in the second quarter as an impairment to the Life Insurance Division’s deferred acquisition costs with the remainder of $4.6 million recorded in the third quarter in “Realized losses, net” in the Company’s consolidated condensed statement of income (loss).

          In connection with these transactions the Company incurred $6.3 million in investment banker fees and legal fees recorded as “Other expense” on the Company’s consolidated condensed statement of income (loss), of which $5.0 million was incurred during the three months ended September 30, 2008. The Company also incurred $6.4 million of employee and lease termination costs and other costs recorded in “Underwriting, acquisition and insurance expense,” of which $3.2 million was incurred during the three months ended September 30, 2008. See Note 10 — Transactions with Related Parties. In addition, the Company incurred interest expense of $3.0 million during the third quarter of 2008 associated with the use

of the cash transferred to Wilton during the period from the Effective Date of the Life transaction to the Closing Date. Lastly, the Ceding Companies wrote-off deferred acquisition costs of $101.1 million, representing all of the deferred acquisition costs associated with the Coinsured Policies subject to the transaction, which is included in the realized loss on the transaction. This write-off of deferred acquisition costs correspondingly reduced the related deferred tax assets by $36.7 million.

           As a consequence of the transactions and related financial implications as described above, the Consolidated Condensed Statement of Cash Flows reflects substantial changes in reinsurance recoverable, deferred acquisition costs and deferred income taxes for the nine months ended September 30, 2008.

          As previously disclosed, in connection with the execution of the Master Agreement, HealthMarkets, LLC entered into a definitive Stock Purchase Agreement (the “Stock Purchase Agreement”) pursuant to which Wilton agreed to purchase the Company’s student loan funding vehicles and related student association, CFLD-I, Inc., UICI Funding Corp. 2 and The National Student Association, LLC. The closing of the transactions contemplated by the Stock Purchase Agreement has not occurred due to certain closing conditions that have not yet been satisfied. The Company has presented the assets and liabilities of CFLD-I, Inc. and UICI Funding Corp. 2 as held for sale on the Company’s balance sheet for all periods presented. Additionally, the Company has included the results of operations of CFLD-I, Inc. and UICI Funding Corp. 2 in discontinued operations on the Company’s condensed consolidated statement of income for all periods presented.

          Nonetheless, in accordance with the terms of the Coinsured Policies, Wilton will fund student loans; provided, however, that Wilton will not be required to fund any student loan that would cause the aggregate par value of all such loans funded by Wilton, following the coinsurance effective date, to exceed $10.0 million.

          The assets and liabilities of the business classified as held for sale on the consolidated condensed balance sheet consist of the following:

		September 30,				December 31,
		2008				2007
		(in thousands)
Assets
Restricted cash		$	7,729			$	8,496
Student loans			92,051				99,179
Provision for loan losses			(11,554	)			(2,925	)
Investment income due and accrued			5,178				5,587
Other assets and receivables			30				18
Total assets held for sale		$	93,434			$	110,355
Liabilities
Accounts payable and accrued expenses		$	328			$	377
Student Loan Credit Facility			88,000				97,400
Other Liabilities			872				1,332
Total liabilities held for sale		$	89,200			$	99,109

          The results of discontinued operations were as follows:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(in thousands)
Revenue from discontinued operations
Student loan business		$	1,818			$	2,889			$	6,514			$	8,914
Other discontinued operations			128				267				234				437
			1,946				3,156				6,748				9,351
Expenses from discontinued operations
Student loan business			1,836				2,999				9,331				7,766
Other discontinued operations			2				(81	)			5				(624	)
			1,838				2,918				9,336				7,142
Increase in provision for loan allowance on student loans			—				—				(5,338	)			—
Income (loss) from discontinued operations before income taxes			108				238				(7,926	)			2,209
Income tax benefits (expenses)			(38	)			(83	)			2,774				(773	)
Income (loss) from discontinued operations (net of income taxes)		$	70			$	155			$	(5,152	)		$	1,436

3. INVESTMENTS

          A. Other Than Temporary Impairment

          Investments are reviewed at least quarterly, using both quantitative and qualitative factors, to determine if they have experienced an impairment of value that is considered other than temporary. In its review, management considers the following indicators of impairment: fair value significantly below cost; decline in fair value attributable to specific adverse conditions affecting a particular investment; decline in fair value attributable to specific conditions, such as conditions in an industry or in a geographic area; decline in fair value for an extended period of time; downgrades by rating agencies from investment grade to non-investment grade; financial condition deterioration of the issuer and situations where dividends have been reduced or eliminated or scheduled interest payments have not been made. If investments are determined to be other than temporarily impaired, a realized loss is recognized at the date of determination.

          The Company recorded realized losses from other than temporary impairment of $16.8 million and $22.4 million for the three and nine months ended September 30, 2008, respectively. These impairments, which the Company deemed were other than temporary reductions, were due to a decline in the fair values of the investments below the Company’s cost basis resulting partially from liquidity issues experienced in the global credit and capital markets. The significant other than temporary impairment charges recognized during the three months ended September 30, 2008 resulted from certain corporate debt and collateralized debt obligation securities, all of which are classified as “corporate debt and other” in the fair value table below.

          B. Fair Value Measurement

          Effective January 1, 2008, the Company adopted FAS 157 for financial assets and liabilities. FAS 157 defines fair value, expands disclosure requirements, and specifies a hierarchy of valuation techniques. The disclosure of fair value estimates in the FAS 157 hierarchy is based on whether the significant inputs into the valuation are observable. In determining the level of hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Company’s significant market assumptions. The Company measures certain assets and liabilities at fair value on a recurring basis, including securities available for sale, derivatives, and agent and employee stock plans. Following is a brief description of the type of valuation information (“inputs”) that qualifies a financial asset or a liability for each level:

	•		Level 1 — Unadjusted quoted market prices for identical assets or liabilities in active markets which are accessible by the Company.
	•		Level 2 — Observable prices in active markets for similar assets or liabilities. Prices for identical or similar assets or liabilities in markets that are not active. Directly observable market inputs for substantially the full term of the asset or liability, e.g., interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, default rates, and credit spreads. Market inputs that are not directly observable but are derived from or corroborated by observable market data.
	•		Level 3 — Unobservable inputs based on the Company’s own judgment as to assumptions a market participant would use, including inputs derived from extrapolation and interpolation that are not corroborated by observable market data.

          The Company evaluates the various types of securities in its investment portfolio to determine the appropriate level in the fair value hierarchy based upon trading activity and the observability of market inputs. The Company employs control processes to validate the reasonableness of the fair value estimates of its assets and liabilities, including those estimates based on prices and quotes obtained from independent third party sources. The Company’s procedures generally include, but are not limited to, initial and on-going evaluation of methodologies used by independent third parties and monthly analytical reviews of the prices against current pricing trends and statistics.

Valuation of Investments

          Where possible, the Company utilizes quoted market prices to measure fair value. For investments that have quoted market prices in active markets, the Company uses the quoted market price as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices in active markets are unavailable, the Company determines fair values using various valuation techniques and models based on a range of observable market inputs including pricing models, quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, prepayment speeds, default rates and discounted cash flow. In most cases, these estimates are

determined based on independent third party valuation information, and the amounts are disclosed in the Level 2 of the fair value hierarchy. Generally, the Company obtains a single price or quote per instrument from independent third parties to assist in establishing the fair value of these investments.

          If quoted market prices and independent third party valuation information are unavailable, the Company produces an estimate of fair value based on internally developed valuation techniques, which, depending on the level of observable market inputs, will render the fair value estimate as Level 2 or Level 3. On occasions when pricing service data is unavailable, the Company may rely on bid/ask spreads from dealers in determining fair value. When dealer quotations are used to assist in establishing the fair value, the Company generally obtains one quote per instrument. The quotes obtained from dealers or brokers are generally non-binding. When dealer quotations are used, the Company uses the mid-mark as fair value. When broker or dealer quotations are used for valuation or price verification, greater priority is given to executable quotes. As part of the price verification process, valuations based on quotes are corroborated by comparison both to other quotes and to recent trading activity in the same or similar instruments.

          Historically, the Company had not experienced a circumstance where it has determined that an adjustment to a quote or price received from an independent third party valuation source is required. To the extent the Company determines that a price or quote is inconsistent with actual trading activity observed in that investment or similar investments, or if the Company does not think the quote is reflective of the market value for the investment, the Company would internally develop a fair value using this observable market information and disclose the occurrence of this circumstance. During the quarter ended September 30, 2008, the Company determined that the non-binding quote received from an independent third party broker for a particular collateralized debt obligation investment did not reflect fair value. In accordance with guidance provided in FSP 157-3, the Company determined the fair value of this security based on other internally developed approaches, which are discussed below in the last two paragraphs under the “Fixed Income Investments” caption.

          In accordance with FAS 157, the Company has categorized its securities available for sale into a three level fair value hierarchy based on the priority of inputs to the valuation techniques. The fair values of investments disclosed in Level 1 of the fair value hierarchy include money market funds and certain U.S. government securities, while the investments disclosed in Level 2 include the majority of the Company’s fixed income investments. In cases where there is limited activity or less transparency around inputs to the valuation, the Company classifies the fair value estimates within Level 3 of the fair value hierarchy.

          As of September 30, 2008, all of the Company’s investments classified within Level 2 and Level 3 of the fair value hierarchy are valued based on quotes or prices obtained from independent third parties, except for $99.6 million of “corporate debt and other” classified as Level 2, $2.6 million of “corporate debt and other” classified as Level 3, $1.7 million of “mortgage and asset-backed” investments classified as Level 3 and $1.7 million included in “short-term and other investments” classified as Level 3. The $99.6 million of “corporate debt and other” investments classified as Level 2 noted above includes $84.3 million of an investment grade corporate bond issued by UnitedHealth Group that was received as consideration for the sale of the Company’s former Student Insurance Division in December 2006.

Fair Value Hierarchy on a Recurring Basis

          Assets and liabilities measured at fair value on a recurring basis are categorized in the tables below based upon the lowest level of significant input to the valuations.

Assets at Fair Value as of September 30, 2008

In thousands		Level 1				Level 2				Level 3				Total
Government agencies		$	12,410			$	26,159			$	—			$	38,569
Corporate debt and other			—				439,380				3,950				443,330
Mortgage and asset-backed			—				265,674				2,077				267,751
Municipals			—				180,433				21,327				201,760
Corporate equities			44				—				—				44
Short-term and other investments (1)			168,406				—				1,748				170,154
		$	180,860			$	911,646			$	29,102			$	1,121,608

Liabilities at Fair Value as of September 30, 2008

In thousands		Level 1				Level 2				Level 3				Total
Interest rate swaps		$	—			$	8,404			$	—			$	8,404
Agent and employee plans			—				—				21,287				21,287
		$	—			$	8,404			$	21,287			$	29,691

          The following is a description of the valuation methodologies used for certain assets and liabilities of the Company measured at fair value on a recurring basis, including the general classification of such assets pursuant to the valuation hierarchy.

Short-term and other investments

          The Company’s “short-term and other investments” primarily consist of highly liquid money market funds, which are reflected within Level 1 of the fair value hierarchy. Additionally, the fair value of one of the Company’s investment assets included in “short-term and other investments” is determined based on unobservable inputs. Accordingly, the fair value of this asset is reflected within Level 3 of the fair value hierarchy.

Fixed Income Investments

          The Company’s fixed income investments include investments in U.S. treasury securities, U.S. government agencies bonds, corporate bonds, mortgage and asset backed securities, and municipal auction rate securities and bonds.

          The Company estimates the fair value of its U.S. treasury securities using unadjusted quoted market prices, and accordingly, discloses these investments in Level 1 of the fair value hierarchy.

          In general, the fair values of the majority of the fixed income investments held by the Company are determined based on observable market inputs provided by independent third party valuation information. The market inputs utilized in the pricing evaluation include but are not limited to, benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The Company classifies the fair value estimates based on these observable market inputs within Level 2 of the fair value hierarchy. Investments classified within Level 2 consist of U.S. government agencies bonds, corporate bonds, mortgage and asset backed securities, and municipal bonds.

          The Company also holds a small number of fixed income investments, including certain mortgage and asset backed securities, and collateralized debt obligations, for which it estimates the fair value using internal pricing matrices with some unobservable inputs that are significant to the valuation. Additionally, during the quarter ended June 30, 2008, the Company began estimating the fair value of its entire municipal auction rate securities based on non-binding quotes received from independent third parties due to limited activity and market data for auction rate securities as a result of liquidity issues in the global credit and capital markets. Consequently, the lack of transparency in the inputs and the availability of independent third party pricing information for these investments resulted in their fair values being classified within the Level 3 of the hierarchy. As of September 30, 2008, the fair values of certain municipal auction rate securities, collateralized debt obligations and mortgage and asset-backed securities which represent approximately 3% of the Company’s total fixed income investments are reflected within the Level 3 of the fair value hierarchy.

          During the quarter ended September 30, 2008, the Company determined that the non-binding quoted price received from an independent third party broker for a particular collateralized debt obligation investment did not reflect a value based on an active market. During discussions with the independent third party broker, the Company learned that the price quote was established by applying a 15% discount to the most recent price that the broker had offered the investment. However, there were no responding bids to purchase the investment at that price. As this price was not set based on an active market, the Company developed a fair value for the investment.

          The Company established a fair value for the investment based on information about the underlying pool of assets supplied by the investment’s asset manager. The Company developed a discounted cash flow valuation for the investment by applying assumptions for a variety of factors including among other things, default rates, recovery rates and a discount rate. The Company believes the assumptions for these factors were developed in a manner consistent with those that a market participant would use in valuation and were based on the information provided regarding the underlying pool of assets, various current market benchmarks, industry data for similar assets types, and particular market observations about similar assets.

Equities

          The Company maintains one investment in “Equity securities” in which the Company uses a quoted market price based on observable market transactions. The Company includes the fair value estimate for this stock in Level 1 of the hierarchy. The remaining amount in “Equity securities” represents one security accounted for using the equity method of accounting and, therefore, does not require fair value disclosure under the provisions of FAS 157.

Derivatives

          The Company’s derivative instruments are valued utilizing valuation models that primarily use market observable inputs and are traded in the markets where quoted market prices are not readily available, and accordingly, these instruments are reflected within the Level 2 of the fair value hierarchy.

Agent and Employee Stock Plans

          The Company accounts for its agent and employee stock plan liabilities based on the Company’s share price at the end of each reporting period. The Company’s share price at the end of each reporting period is based on the prevailing fair value as determined by the Company’s Board of Directors. The Company largely uses unobservable inputs in deriving the fair value of its share price and the value is, therefore, reflected in Level 3 of the hierarchy.

Changes in Level 3 Assets and Liabilities

          The tables below summarize the change in balance sheet carrying values associated with Level 3 financial instruments and agent and employee stock plans for the three months and nine months ended September 30, 2008. During the quarter ended September 30, 2008, the Company determined that certain collateralized debt obligation investments previously presented in Level 2 of the hierarchy should be classified as Level 3 due to a significant level of unobservable inputs used to determine its fair value at September 30, 2008. The Company transferred the fair value of these collateralized debt obligations to Level 3 of the fair value hierarchy during the quarter ended September 30, 2008.

          During the quarter ended June 30, 2008, the Company began estimating the fair values of its municipal auction rate securities based on non-binding quotes received from independent third party sources due to unavailability of observable inputs in the market place as a result of liquidity issues in the global credit and capital markets. These quotes from independent third parties are derived from their internally developed pricing models, which utilize various unobservable inputs. As a result, the Company’s municipal auction rate securities were transferred to Level 3.

Changes in Level 3 Assets and Liabilities Measured at Fair Value for the Three Months Ended September 30, 2008

										Purchases,
						Unrealized				Sales,								Transfer in/
		Beginning				Gains or				Payments and				Realized				(out) of				Ending
		Balance				(Losses)				Issuances, Net				Losses(1)				Level 3, Net				Balance
		In Thousands
Assets
Corporate debt and other		$	—			$	5,326			$	—			$	(7,956	)		$	6,580			$	3,950
Mortgage and asset-backed			2,279				(102	)			(100	)			—				—				2,077
Municipals			21,682				(355	)			—				—				—				21,327
Other invested assets			2,015				(125	)			(142	)			—				—				1,748
Liabilities
Agent and Employee Stock Plans		$	20,246			$	(49	)		$	1,090			$	—			$	—			$	21,287

Changes in Level 3 Assets and Liabilities Measured at Fair Value for the Nine Months Ended September 30, 2008

										Purchases,
						Unrealized				Sales,								Transfer in/
		Beginning				Gains or				Payments and				Realized				(out) of				Ending
		Balance				(Losses)				Issuances, Net				Losses(1)				Level 3, Net				Balance
		In Thousands
Assets
Corporate debt and other		$	—			$	5,326			$	—			$	(7,956	)		$	6,580			$	3,950
Mortgage and asset-backed			2,579				(220	)			(282	)			—				—				2,077
Municipals			—				(1,773	)			—				—				23,100				21,327
Other invested assets			3,380				1,050				(636	)			(2,046	)			—				1,748
Liabilities
Agent and Employee Stock Plans		$	37,273			$	(4,927	)		$	(11,059	)		$	—			$	—			$	21,287

4. MEDICARE DIVISION

Exit from the Medicare Market

          In late 2007, the Company expanded into the Medicare market by offering a new portfolio of Medicare Advantage Private-Fee-for-Service Plans (“PFFS”) — called HealthMarkets Care Assured Plans^sm (“HMCA Plans”) — in selected markets in 29 states with coverage effective for January 1, 2008. Policies are issued by Chesapeake, one of the Company’s subsidiaries, under a contract with the Centers for Medicare and Medicaid Services (“CMS”). The HMCA Plans are offered to Medicare eligible beneficiaries as a replacement for original Medicare and Medigap (Supplement) policies. They provide enrollees with the actuarial benefit equivalence they would receive under original Medicare, as well as certain additional benefits or benefit options, such as preventive care, pharmacy benefits, and vision, dental and hearing services.

          On July 15, 2008, the Medicare Improvements for Patients and Providers Act of 2008 (HR. 6331) was enacted, resulting in significant changes to the Medicare program. These changes include, among other things, the phased elimination of Medicare Advantage PFFS “deeming” arrangements with providers beginning in 2011. The Company believes that this new law will make it difficult for the Company to operate effectively in the Medicare market. As a result, in July 2008, the Company decided that it will not participate in the Medicare Advantage marketplace beyond the current year. The Company will continue to serve its current members through 2008 and fulfill its obligations under the current Medicare contract with CMS.

          In connection with its exit from the Medicare market, the Company expects to incur employee termination costs of $2.4 million, of which $371,000 was paid in the third quarter. In addition, the Company incurred asset impairment charges of $1.1 million in the third quarter associated with technology assets unique to its Medicare business. The Company believes that its exit from the Medicare market will not, in the aggregate, have a material adverse effect on the Company’s consolidated financial position, but may potentially have a material adverse effect on the results of operations or cash flows in any given accounting period.

          Included in the nine months ended September 30, 2008, the Company recognized a $4.9 million expense, recorded in “underwriting, acquisition and insurance expenses,” associated with a minimum volume guarantee fee related to the Company’s contract with a third party administrator, of which $3.7 million was paid in the three months ended September 30, 2008. This minimum volume guarantee fee was for member months over the three year term of the contract covering calendar years 2008 through 2010. To the extent the Company incurred a contract termination fee instead, based on the decision to exit the Medicare market, the amount of the minimum volume guarantee fee was limited to the amount of the anticipated contract termination fee.

5. DEBT

          On April 5, 2006, the HealthMarkets, LLC 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. At September 30, 2008, 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.

          In addition, 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%.

          On April 29, 2004, UICI Capital Trust I (a 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. The 2004 Notes accrue interest at a floating rate equal to three-month LIBOR plus 3.50%, payable quarterly.

          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				Ended				Ended
		September 30,				September 30,				September 30,
		2008				2008				2008
2006 credit agreement:
Term loan		$	362,500			$	5,203			$	15,796
$75 Million revolver (non-use fee)			—				33				105
Trust preferred securities:
UICI Capital Trust I			15,470				247				788
HealthMarkets Capital Trust I			51,550				768				2,534
HealthMarkets Capital Trust II			51,550				1,102				3,283
Other:
Interest on Deferred Tax Gain			—				1,085				3,181
Interest on Coinsurance			—				3,030				3,030
Amortization of financing fees			—				1,139				3,361
Total		$	481,070			$	12,607			$	32,078

          Management uses derivative instruments to protect against the risk of changes in prevailing interest rates adversely affecting future cash flows associated with changes in the LIBOR rate applicable to its 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.

          The Company owns 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, 2008, the interest rate swaps had an aggregate fair value of approximately $8.4 million, which is reflected under the caption “Other Liabilities.” During the three and nine months ended September 30, 2008, the Company incurred a loss of $19,000 and $54,000, 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, 2008, pretax expense of $1.7 million ($1.1 million net of tax) was reclassified into interest expense from accumulated other comprehensive income as adjustments to interest payments on variable rate term loan. In addition, expense of $173,000 ($113,000 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, 2008, pretax expense of $3.6 million ($2.4 million net of tax) was reclassified into interest expense from accumulated other comprehensive income as adjustments to interest payments on variable rate term loan. In addition, expense of $514,000 ($334,000 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, 2008, accumulated other comprehensive income included a deferred after-tax net loss of $5.3 million related to the interest rate swaps of which $1.3 million ($849,000 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.

6. NET INCOME (LOSS) 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,
		2008				2007				2008				2007
		(In thousands, except per share amounts)
Income (loss) from continuing operations		$	(18,784	)		$	33,326			$	(39,084	)		$	78,099
Income (loss) from discontinued operations			70				155				(5,152	)			1,436
Net income (loss) available to common shareholders		$	(18,714	)		$	33,481			$	(44,236	)		$	79,535
Weighted average shares outstanding, basic			29,913				30,675				30,363				30,398
Dilutive effect of stock options and other shares			—				951				—				858
Weighted average shares outstanding, dilutive			29,913				31,626				30,363				31,256
Basic earnings (losses) per share:
From continuing operations		$	(0.63	)		$	1.08			$	(1.29	)		$	2.57
From discontinued operations			—				0.01				(0.17	)			0.05
Net income (loss) per share, basic		$	(0.63	)		$	1.09			$	(1.46	)		$	2.62
Diluted earnings (losses) per share:
From continuing operations		$	(0.63	)		$	1.06			$	(1.29	)		$	2.49
From discontinued operations			—				—				(0.17	)			0.05
Net income (loss) per share, basic		$	(0.63	)		$	1.06			$	(1.46	)		$	2.54

          The common stock equivalents for the three and nine months ended September 30, 2008 are excluded from the weighted average shares used to compute diluted net loss per share as they would be anti-dilutive to the per share calculation. The Company’s diluted weighted average shares outstanding for the three and nine months ended September 30, 2008 were 887,856 and 751,147, respectively.

          As of September 30, 2008, 27,000,062 shares of Class A-1 common stock were issued, of which 26,896,325 were outstanding and 103,737 shares were held in treasury and 4,026,104 shares of Class A-2 common stock were issued, of which 2,883,030 shares were outstanding and 1,143,074 shares were held in treasury. As of December 31, 2007, 27,000,062 shares of Class A-1 common stock were issued, of which 26,899,056 were outstanding and 101,006 shares were held in treasury and 3,952,204 shares of Class A-2 common stock were issued, of which 3,623,266 shares were outstanding and 328,938 shares were held in treasury.

7. COMMITMENTS AND CONTINGENCIES

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

Association Group Litigation

          As previously disclosed, HealthMarkets and MEGA were named as defendants in an action filed on May 31, 2006 (Linda L. Hopkins and Jerry T. Hopkins v. HealthMarkets, MEGA, the National Association for the Self Employed, et al.) pending in the Superior Court for the County of Los Angeles, California, Case No. BC353258. Plaintiffs have alleged several causes of action, including breach of fiduciary duty, negligent failure to obtain insurance, intentional misrepresentation, fraud by concealment, promissory fraud, negligent misrepresentation, civil conspiracy, professional negligence, negligence, intentional infliction of emotional distress, and violation of the California Consumer Legal Remedies statute, California Civil Code Section 1750, et seq. Plaintiffs seek injunctive relief, disgorgement of profits and general and punitive monetary damages in an unspecified amount. The Court granted MEGA’s motion for summary judgment and dismissed the case on July 10, 2008.

          HealthMarkets, HealthMarkets Lead Marketing Group, Mid-West National Life Insurance Company of Tennessee (“Mid-West”) and Mid-West agent Stephen Casey were named as defendants in an action filed on December 4, 2006 (Howard Woffinden, individually, and as Successor in interest to Mary Charlotte Woffinden, deceased v. HealthMarkets, Mid-West, et al.) pending in the Superior Court for the County of Los Angeles, California, Case No. LT061371. Plaintiffs have alleged several causes of action, including breach of fiduciary duty, negligent failure to obtain insurance, intentional misrepresentation, fraud by concealment, promissory fraud, civil conspiracy, professional negligence, intentional infliction of emotional distress, and violation of the California Consumer Legal Remedies statute, California Civil Code Section 1750, et seq. Plaintiff seeks injunctive relief, and general and punitive monetary damages in an unspecified amount. On October 5, 2007, the Court granted a motion to quash service of summons for defendants HealthMarkets and HealthMarkets Lead Marketing Group, removing them from the case. The Court granted Mid-West’s motion for summary judgment and dismissed the case against Mid-West on August 12, 2008. On October 15, 2008, the Court granted judgment in favor of defendant Casey.

          The resolution of the above proceedings did not have a material adverse effect on the Company’s consolidated financial condition or results of operations.

Fair Labor Standards Act Agent Litigation

          HealthMarkets is a party to three separate collective actions filed under the Federal Fair Labor Standards Act (“FLSA”) (Sherrie Blair et al., v. Cornerstone America et al., filed on May 26, 2005 in the United States District Court for the Northern District of Texas, Fort Worth Division, Civil Action No. 4:04-CV-333-Y; Norm Campbell et al., v. Cornerstone America et al., filed on May 26, 2005 in the United States District Court for the Northern District of Texas, Fort Worth Division, Civil Action No. 4:05-CV-334-Y; and Joseph Hopkins et al., v. Cornerstone America et al., filed on May 26, 2005 in the United States District Court for the Northern District of Texas, Fort Worth Division, Civil Action No. 4:05-CV-332-Y). On December 9, 2005, the Court consolidated all of the actions and made the Hopkins suit the lead case. In each of the cases, plaintiffs, for themselves and on behalf of others similarly situated, seek to recover unpaid overtime wages alleged to be due under section 16(b) of the FLSA. The complaints allege that the named plaintiffs (consisting of former district sales leaders and regional sales leaders in the Cornerstone America independent agent hierarchy) were employees within the meaning of the FLSA and are therefore entitled, among other relief, to recover unpaid overtime wages under the terms of the FLSA. The parties filed motions for summary judgment on August 1, 2006, and, on March 30, 2007, the Court denied HealthMarkets and Mid-West’s motion and granted the plaintiffs’ motion.

          On August 2, 2007, the District Court granted HealthMarkets and Mid-West’s motion for interlocutory appeal but denied requests to stay the litigation. On September 14, 2007, the United States Fifth Circuit Court of Appeals (the “Fifth Circuit”) granted HealthMarkets and Mid-West’s petition to hear the interlocutory appeal.

          In April 2008, a court-approved notice to prospective participants in the collective action was mailed, providing prospective participants with the ability to file “opt-in” elections. At the present time, there are 64 participants in this action.

          In September 2008, oral arguments were heard before a three-judge panel of the Fifth Circuit. In October 2008, the Fifth Circuit affirmed the trial court’s ruling in favor of plaintiffs on the issue of their status as employees under the FLSA and remanded the case to the trial court for further proceedings. HealthMarkets and Mid-West filed their petition for rehearing before the Fifth Circuit panel in late October 2008, which was denied on November 10, 2008.

          Discovery in this matter is ongoing. At present, the Company is unable to determine what, if any, impact these matters may have on the Company’s consolidated financial condition or results of operation.

Commonwealth of Massachusetts Litigation

          As previously disclosed, 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. The Complaint was served on MEGA on or around January 19, 2007. 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. On August 22, 2007, the Attorney General filed an amended complaint which added HealthMarkets and Mid-West as defendants in this 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 mandatory benefits. This proceeding is in an early stage and its outcome is uncertain. Civil discovery has commenced and motions on various points of law and procedure have been filed by the parties, including a motion to dismiss filed by defendants which was denied in March 2008. At present, the Company is unable to determine what, if any, impact this matter may have on the Company’s consolidated financial condition or results of operation.

Credit Insurance Litigation

          Mid-West has been named as a defendant in a putative class action filed on November 7, 2008 (Cynthia Hrnyak, on behalf of herself and all others similarly situated v. Mid-West National Life Insurance Company of Tennessee) pending in the United States District Court for the Northern District of Ohio, Case No. 1:08CV2642. Plaintiff has alleged several causes of action, including breach of contract, unjust enrichment and violation of the Ohio Revised Code Annotated Section 3918.08, arising from the alleged failure to refund unearned premium on credit insurance policies issued by Mid-West in connection with automobile loans when such loans terminated early. Plaintiff seeks an order certifying the suit as a nationwide class action, compensatory and punitive damages and injunctive relief. Mid-West has not yet been served with the complaint. The Company is unable to determine what, if any, impact this matter may have on the Company’s consolidated financial condition or results of operations.

Other Litigation Matters

          MEGA was named as a defendant in an action filed on April 8, 2003 (Lucinda Myers v. MEGA et al.) pending in the District Court of Potter County, Texas, Case No. 90826-E. Plaintiff has alleged several causes of action, including breach of contract, breach of the duty of good faith and fair dealing, negligence, unfair claims settlement practices,

violation of the Texas Deceptive Trade Practices-Consumer Protection Act, mental anguish, and felony destruction of records and securing execution by deception. Plaintiff seeks monetary damages in an unspecified amount, and declaratory relief. MEGA asserted a counterclaim alleging, among other things, a cause of action against the plaintiff for rescission of the health insurance contract due to material misrepresentations in the application for insurance. Following a trial held in February 2006, a jury rendered a verdict in favor of MEGA with respect to MEGA’s claim for rescission of the policy, effectively disposing of all causes of action against the defendants and the Court rendered final judgment for defendants on March 9, 2006. Plaintiff filed a notice of appeal and, on April 17, 2008, the appellate court reversed the lower court’s judgment and remanded the case for further proceedings. On October 16, 2008, the appellate court denied MEGA’s motion for rehearing.

          Mid-West was named as a defendant in an action filed on January 15, 2004 (Howard Myers v. Alliance for Affordable Services, Mid-West et al.) in the District Court of El Paso County, Colorado, Case No. 04-CV-192. Plaintiff alleged fraud, breach of contract, negligence, negligent misrepresentation, bad faith, and breach of the Colorado Unfair Claims Practices Act. Plaintiff seeks unspecified compensatory, punitive, special and consequential damages, costs, interest and attorneys’ fees. Mid-West removed the case to the United States District Court for the District of Colorado. On August 26, 2008, the Court granted Mid-West’s motion for summary judgment and dismissed all claims. Plaintiff has filed a motion to stay the Court’s judgment which is pending before the Court. On June 16, 2008, plaintiff filed a related action with similar allegations naming HealthMarkets, Cornerstone America and Cornerstone agent Steve Kirsch (Lukas Myers and Howard Myers et al. v. HealthMarkets, Inc., Cornerstone America, et al.) in the District Court of Arapahoe County, Colorado, Case No. 08-CV-1236. Plaintiffs have alleged several causes of action, including fraud, fraudulent misrepresentation, breach of contract, bad faith and breach of the Colorado Consumer Protection Act, and seek unspecified compensatory and punitive damages, treble damages under the Colorado Consumer Protection Act, costs and attorneys’ fees. HealthMarkets removed the case to the United States District Court for the District of Colorado on July 22, 2008 and the matter is pending before the Court.

          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 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 — Rhode Island

          The Rhode Island Office of the Health Insurance Commissioner conducted a targeted market conduct examination regarding MEGA’s small employer market practices during 2005. As a result of that examination, MEGA is in the process of negotiating a settlement with the Office of the Health Insurance Commissioner. The Company anticipates that Mid-West will also agree to a settlement with the Office of the Health Insurance Commissioner since it sells similar plans in Rhode Island. The Company believes that this settlement will be on terms that will not have a material adverse effect upon the Company’s consolidated financial condition or results of operations. Negotiations are on-going and the settlement is not final.

Regulatory Matters — Multi-state Market Conduct Examination

          As previously disclosed, in March 2005, HealthMarkets received notification that the Market Analysis Working Group of the NAIC had chosen the states of Washington and Alaska to lead a multi-state market conduct examination of HealthMarkets’ principal insurance subsidiaries (the “Insurance Subsidiaries”) for the examination period January 1, 2000 through December 31, 2005. Thirty-six (36) states elected to participate in the examination. The examiners issued a final examination report on December 20, 2007.

          The findings of the final examination report cite deficiencies in five major areas of operation: (i) insufficient training of agents and lack of oversight of agent activities, (ii) deficient claims handling practices, (iii) insufficient disclosure of the relationship with affiliates and the membership associations, (iv) deficient handling of complaints and grievances, and (v) failure to maintain a formal corporate compliance plan and centralized corporate compliance department.

          In connection with the issuance of the final examination report, the Washington Office of Insurance Commissioner issued an order adopting the findings of the final examination report and ordering the Insurance Subsidiaries to comply with certain required actions set forth in the report. The order requires the Insurance Subsidiaries to file a detailed report

specifying how they have addressed each of the requirements of the order and another report outlining, by examination area, all business reforms, improvements and changes to policies and procedures.

          During 2004, in response to state specific examination findings, the Insurance Subsidiaries began making significant changes to their structure and operational processes. These changes included the enhancement of its agent training and oversight programs, the reorganization and consolidation of the Company’s compliance department, the adoption of additional methods to monitor agent sales activities, the implementation of a benefits confirmation telephone call program to obtain further assurances that customers understand their health insurance coverage and the creation of a Regulatory Advisory Panel consisting of former regulators to provide objective advice to the Board and management. The Company believes the Insurance Subsidiaries have effectively addressed or are in the process of addressing many of the findings identified in the final examination report. Many of these enhancements occurred after the examination period and are therefore not reflected in the examination report findings.

          On May 29, 2008, the Insurance Subsidiaries entered into a regulatory settlement agreement (“RSA”) with the Director of the Alaska Division of Insurance and the Insurance Commissioner of Washington State (the “Lead Regulators”) that provides for the settlement of the examination on the following terms:

(1)		A monetary penalty in the amount of $20 million, payable within ten business days of the effective date of the RSA. This amount was recognized in the Company’s results of operations for the year ending December 31, 2007;
(2)		A monetary penalty of up to an additional $10 million if the Insurance Subsidiaries are found not to comply with the requirements of the RSA when re-examined. Compliance will be monitored by the Lead Regulators, the Insurance Subsidiaries’ domestic regulators (The Insurance Commissioner of the State of Oklahoma and the Commissioner of Insurance of the State of Texas) and the California Department of Insurance (collectively, the “Monitoring Regulators”). The Monitoring Regulators will determine the amount, if any, of the penalty for failure to comply with the requirements of the RSA through a follow-up examination scheduled to occur during 2010. The Company has not recognized any expense associated with this contingent penalty as it is not deemed probable;
(3)		An “Outreach Program” to be administered by the Insurance Subsidiaries with certain existing insureds, which will be implemented within six months of the effective date of the RSA. The Insurance Subsidiaries will send a notice to all existing insureds whose medical coverage was issued by the Insurance Subsidiaries prior to August 1, 2005, which will include contact information for insureds to obtain information about their coverage and the address of a website responsive to coverage questions; and
(4)		Ongoing monitoring of the Insurance Subsidiaries’ compliance with the RSA by the Monitoring Regulators, through periodic reports from the Insurance Subsidiaries. The Insurance Subsidiaries will be required to continue their implementation of certain corrective actions, the standards of which must be met by December 31, 2009. The Insurance Subsidiaries will bear the reasonable costs of monitoring by the Monitoring Regulators and their designees. In the event that the Monitoring Regulators find that the Insurance Subsidiaries have intentionally breached the terms of the RSA, resulting penalties and fines as a result of such finding will not be limited to the monetary penalties of the RSA.

          According to its terms, the RSA became effective on August 15, 2008, which is thirty days after it was executed by twenty-seven states. Forty-eight states, the District of Columbia, Puerto Rico and Guam have signed the RSA. The payment of the $20.0 million monetary penalty was made in August 2008. The Outreach Program is underway and the Company’s insurance subsidiaries are preparing to file the first of the semi-annual status reports showing status of compliance with the required standards referenced in No. 4 above.

Regulatory Matters — General

          In addition to the regulatory matters discussed above, the Company’s insurance subsidiaries are subject to various pending market conduct or other regulatory examinations, inquiries or proceedings arising in the ordinary course of business. State insurance regulatory agencies have authority to levy significant fines and penalties and require remedial action resulting from findings made during the course of such matters. Market conduct or other regulatory examinations, inquiries or proceedings could result in, among other things, changes in business practices that require the Company to incur substantial costs. Such results, singly or in combination, could injure our reputation, cause negative publicity, adversely affect our debt and financial strength ratings, place us at a competitive disadvantage in marketing or administering our products or impair our ability to sell or retain insurance policies, thereby adversely affecting our business, and potentially materially adversely affecting the results of operations in a period, depending on the results of

operations for the particular period. Determination by regulatory authorities that we have engaged in improper conduct could also adversely affect our defense of various lawsuits.

8. 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 Medicare Division and Other Insurance Division. Other Key Factors includes investment income not allocated to the Insurance segment, realized gains or losses, interest expense on corporate debt, general expenses relating to corporate operations, variable non-cash stock-based compensation and operations that do not constitute reportable operating segments. Disposed Operations includes the Company’s Life Insurance Division, 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,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
Revenue from continuing operations:
Insurance:
Self-Employed Agency Division		$	310,944			$	355,497			$	949,368			$	1,078,117
Medicare Division			26,519				—				72,537				—
Other Insurance Division			6,576				8,145				22,487				23,653
Total Insurance			344,039				363,642				1,044,392				1,101,770
Other Key Factors			(8,803	)			9,354				(2,503	)			29,285
Intersegment Eliminations			(39	)			178				(130	)			(800	)
Total revenue excluding disposed operations			335,197				373,174				1,041,759				1,130,255
Disposed Operations			55				23,242				47,622				67,511
Total revenue from continuing operations		$	335,252			$	396,416			$	1,089,381			$	1,197,766

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
Income (loss) from continuing operations before federal income taxes:
Insurance:
Self-Employed Agency Division		$	16,374			$	63,072			$	47,119			$	148,002
Medicare Division			(3,077	)			(2,592	)			(15,381	)			(3,999	)
Other Insurance Division			(1,348	)			1,807				2,893				3,568
Total Insurance			11,949				62,287				34,631				147,571
Other Key Factors			(36,537	)			(11,861	)			(73,545	)			(30,181	)
Total operating income (loss) excluding disposed operations			(24,588	)			50,426				(38,914	)			117,390
Disposed Operations			(3,508	)			179				(23,036	)			1,195
Total income (loss) from continuing operations before taxes		$	(28,096	)		$	50,605			$	(61,950	)		$	118,585

		September 30,				December 31,
		2008				2007
		(In thousands)
Assets
Insurance:
Self-Employed Agency Division		$	843,017			$	878,911
Medicare Division			24,340				—
Other Insurance Division			18,358				21,034
Total Insurance			885,715				899,945
Other Key Factors			561,871				553,855
Total Assets excluding disposed operations and held for sale			1,477,586				1,453,800
Assets held for sale			93,434				110,355
Disposed Operations			405,557				591,427
		$	1,946,577			$	2,155,582

          The Life Insurance Division (included in Disposed Operations) assets of $377.1 million and $540.5 million at September 30, 2008 and December 31, 2007, respectively, primarily represent a reinsurance recoverable associated with coinsurance agreements entered into with an insurance affiliate of Wilton Reassurance Company.

          The Student Insurance Division (included in Disposed Operations) assets of $28.5 million and $50.9 million at September 30, 2008 and December 31, 2007, respectively, primarily represent a reinsurance recoverable associated with a coinsurance agreement entered into with an insurance affiliate of UnitedHealth Group.

2006 Sale of Student Insurance Division

          On December 1, 2006, the Company sold substantially all of the assets formerly comprising MEGA’s Student Insurance Division. The purchase price is subject to downward or upward adjustment based on the amount of premium for the 2007-2008 school year and actual claims experience with respect to the in-force block of student insurance business at the time of the sale. The Company recognized $5.0 million of contingent consideration in the quarter ended September 30, 2008 for this premium based purchase price adjustment, which was recorded as a realized gain.

          The Company has recognized $518,000, $1.2 million and $6.5 million of realized gains as an adjustment to the purchase price in 2008, 2007 and 2006, respectively, related to positive claim experience with respect to the in-force block of student insurance business at the time of the sale. In May 2008, the Company received $8.2 million associated with the final upward adjustment related to the actual claim experience. The Company does not expect to incur any additional compensation related to the premium provision or claim experience in the future.

9. 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 the Company.

          The following table sets forth the total compensation expense, recorded in “underwriting, acquisition and insurance expenses,” and tax benefit associated with the Company’s Agent Plans for the three and nine months ended September 30, 2008 and 2007:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
SEA and Medicare Division stock-based compensation expense		$	1,230			$	1,682			$	3,833			$	7,779
Other Key Factors variable non-cash stock-based compensation (benefit) expense			(607	)			2,552				(3,825	)			2,547
Total Agent Plan compensation (benefit) expense			623				4,234				8				10,326
Related Tax Benefit			218				1,482				3				3,614
Net (benefit) expense included in financial results		$	405			$	2,752			$	5			$	6,712

          At December 31, 2007, the Company had recorded 1,446,624 unvested matching credits associated with the Agent Plans, of which 430,455 vested in January 2008. Upon vesting, the Company decreased additional paid-in capital by $359,000, decreased treasury shares by $15.4 million and decreased other liabilities by $15.1 million. At September 30, 2008, the Company had recorded 1,165,239 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

          During the quarter ended September 30, 2008, options to purchase a total of 246,666 shares of Class A-1 common stock were granted under the 2006 Management Option Plan at an exercise price of $24.00, 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.

10. TRANSACTIONS WITH RELATED PARTIES

          As of September 30, 2008, affiliates of The Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners (the “Private Equity Investors”) held 55.4%, 22.7%, and 11.3%, 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.

          Each of the Private Equity Investors provides to the Company ongoing monitoring, advisory and consulting services, for which the Company pays 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, $3.2 million and $1.6 million, respectively. Aggregate annual monitoring fees in the amount of $12.5 million for 2008 were paid in full to the Private Equity Investors on January 8, 2008. The Company has expensed $9.4 million through September 30, 2008.

          In connection with the completion of the transactions contemplated by the Agreement for Reinsurance and Purchase and Sale of Assets dated June 12, 2008 pursuant to which Wilton Reassurance Company or its affiliates acquired substantially all of the business of the Company’s Life Insurance Division, the Company recognized transaction fees payable to affiliates of The Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners of $1.2 million, $479,000 and $240,000, respectively, which fees were paid in full on October 27, 2008.

          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. During the quarter ended September 30, 2008, the Company did not receive a capital distribution (return of capital) from Goldman Sachs Real Estate Partners, L.P. During the nine months ended September 30, 2008, the Company received $431,000 ($403,000 return of capital and $28,000 income) in capital distributions from Goldman Sachs Real Estate Partners, L.P. The Company funded $3.3 million in capital calls through December 31, 2007. The Company did not fund any additional capital calls in 2008.

          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. During the quarter ended September 30, 2008, the Company did not fund any capital calls. During the nine months ended September 30, 2008, the Company funded $1.5 million in capital calls. The Company previously funded $1.6 million in capital calls through December 31, 2007.

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

Cautionary Statements Regarding Forward-Looking Statements

          This report and other documents or oral presentations prepared or delivered by and on behalf of the Company contain or may contain “forward-looking statements” within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements based upon management’s expectations at the time such statements are made. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements are subject to risks and uncertainties that could cause the Company’s actual results to differ materially from those contemplated in the statements. Readers are cautioned not to place undue reliance on the forward-looking statements. When used in written documents or oral presentations, the terms “anticipate,” “believe,” “estimate,” “expect,” “may,” “objective,” “plan,” “possible,” “potential,” “project,” “will” and similar expressions are intended to identify forward-looking statements. In addition to the assumptions and other factors referred to specifically in connection with such statements, factors that could impact the Company’s business and financial prospects include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 31, 2007 under the caption “Item 1 Business”, “Item 1A. Risk Factors” and “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations” and those discussed from time to time in the Company’s various filings with the Securities and Exchange Commission or in other publicly disseminated written documents.

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 Medicare Division and Other Insurance Division. Other Key Factors includes investment income not allocated to the Insurance segment, realized gains or losses, interest expense on corporate debt, general expenses relating to corporate operations, variable non-cash stock-based compensation and operations that do not constitute reportable operating segments. Disposed Operations includes the Life Insurance Division, former Star HRG Division and former Student Insurance Division.

          Through our SEA Division, we offer a broad range of health insurance products for self-employed individuals and individuals who work for small businesses. Our basic hospital-medical and catastrophic hospital expense plans are designed to accommodate individual needs and include traditional fee-for-service indemnity plans, preferred provider organization (“PPO”) plans, basic medical-surgical expense plans, catastrophic expense PPO plans, as well as other supplemental types of coverage.

          We market these products to the self-employed and individual markets through independent contractor agents associated with UGA-Association Field Services (“UGA”) and Cornerstone America (“Cornerstone”), which are our “dedicated” agency sales forces that primarily sell the Company’s products. The Company has approximately 1,300 independent writing agents per week in the field selling health insurance to the self-employed market in 44 states.

          In 2007, we initiated efforts to expand into the Medicare market. In the fourth quarter of 2007, we began offering a new portfolio of Medicare Advantage Private-Fee-for-Service Plans— called HealthMarkets Care Assured Plans^SM (“HMCA Plans”) — in selected markets in 29 states with coverage effective for January 1, 2008. Policies are issued by our Chesapeake subsidiary, under a contract with the Centers for Medicare and Medicaid Services (“CMS”). In July 2008, the Company determined it would not continue to participate in the Medicare business after the 2008 plan year.

          Our Other Insurance Division consists of ZON Re-USA, LLC (“ZON Re”) (an 82.5%-owned subsidiary) which underwrites, administers and issues accidental death, accidental death and dismemberment (“AD&D”), accident medical, and accident disability insurance products, both on a primary and on a reinsurance basis. We distribute these products through professional reinsurance intermediaries and a network of independent commercial insurance agents, brokers and third party administrators (“TPAs”).

Exit from Life Insurance Division Business

          On September 30, 2008 (the “Closing Date”), HealthMarkets LLC, a subsidiary of the Company, completed the transactions contemplated by the Agreement for Reinsurance and Purchase and Sale of Assets dated June 12, 2008 (the “Master Agreement”), previously reported in the Company’s Current Report on Form 8-K dated June 18, 2008. Pursuant to the Master Agreement, Wilton Reassurance Company or its affiliates (“Wilton”) acquired substantially all of the business of the Company’s Life Insurance Division, which operated through The Chesapeake Life Insurance Company

(“Chesapeake”), Mid-West National Life Insurance Company of Tennessee (“Mid-West”) and The MEGA Life and Health Insurance Company (“MEGA”) (collectively the “Ceding Companies”), and all of the Company’s 79% equity interest in each of U.S. Managers Life Insurance Company, Ltd. and Financial Services Reinsurance, Ltd. As part of the transaction, under the terms of the Coinsurance Agreements entered into with each of the Ceding Companies on the Closing Date, Wilton has agreed, effective July 1, 2008 (the “Coinsurance Effective Date”), to reinsure on a 100% coinsurance basis substantially all of the insurance policies associated with the Company’s Life Insurance Division (the “Coinsured Policies”).

          Under the terms of the Coinsurance Agreements, Wilton has assumed responsibility for all insurance liabilities associated with the Coinsured Policies. The Ceding Companies have transferred to Wilton cash in an amount equal to the net statutory reserves and liabilities corresponding to the Coinsured Policies, which amount was approximately $344.5 million. Wilton has agreed to be responsible for administration of the Coinsured Policies, subject to certain transition services to be provided by the Ceding Companies to Wilton. The Ceding Companies remain primarily liable to the policyholders on those policies with Wilton assuming the risk from the Ceding Companies pursuant to the terms of the Coinsurance Agreements. As a result, in accordance with guidance provided in Financial Accounting Standard No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts, the Company reported and will continue to report the policy liabilities ceded to Wilton under “Policy liabilities” and record a corresponding asset as “Reinsurance recoverable — ceded policy liabilities” on its consolidated condensed balance sheet. As of September 30, 2008, the Company had ceded policy liabilities in the amount of $365.2 million associated with the Coinsured Policies and a corresponding amount has been recorded in “Reinsurance recoverable — ceded policy liabilities” on the Company’s consolidated condensed balance sheet.

          The Company and the Ceding Companies received total consideration of approximately $139.2 million, including $134.5 million in aggregate ceding allowances with respect to the reinsurance of the Coinsured Policies. Under certain circumstances, the Master Agreement also provides for the payment of additional consideration to the Company following the closing based on the five year financial performance of the Coinsured Policies. The reinsurance transaction resulted in a pre-tax loss of $17.6 million of which $13.0 million was recorded in the second quarter as an impairment to the Life Insurance Division’s deferred acquisition costs with the remainder of $4.6 million recorded in the third quarter in “Realized losses, net” in the Company’s consolidated condensed statement of income (loss).

          In connection with these transactions the Company incurred $6.3 million in investment banker fees and legal fees recorded as “Other expense” on the Company’s consolidated condensed statement of income (loss), of which $5.0 million was incurred during the three months ended September 30, 2008. The Company also incurred $6.4 million of employee and lease termination costs and other costs recorded in “Underwriting, acquisition and insurance expense,” of which $3.2 million was incurred during the three months ended September 30, 2008. In addition, the Company incurred interest expense of $3.0 million during the third quarter of 2008 associated with the use of the cash transferred to Wilton during the period from the Effective Date of the Life transaction to the Closing Date. Lastly, the Ceding Companies wrote-off deferred acquisition costs of $101.1 million, representing all of the deferred acquisition costs associated with the Coinsured Policies subject to the transaction, which is included in the realized loss on the transaction. This write-off of deferred acquisition costs correspondingly reduced the related deferred tax assets by $36.7 million.

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, 2008 and 2007:

		Three Months Ended								Percentage				Nine Months Ended								Percentage
		September 30,								Increase				September 30,								Increase
		2008				2007				(Decrease)				2008				2007				(Decrease)
		(Dollars in thousands)												(Dollars in thousands)
REVENUE
Health premiums		$	315,765			$	330,742				(5	)%		$	959,068			$	999,008				(4	)%
Life premiums and other considerations			673				18,165				(96	)%			37,189				51,990				(28	)%
			316,438				348,907				(9	)%			996,257				1,050,998				(5	)%
Investment income			14,539				22,565				(36	)%			49,770				69,687				(29	)%
Other income			19,597				25,402				(23	)%			61,915				78,291				(21	)%
Loss on sale of investments			(15,322	)			(458	)		NM					(18,561	)			(1,210	)		NM
			335,252				396,416				(15	)%			1,089,381				1,197,766				(9	)%
BENEFITS AND EXPENSES
Benefits, claims, and settlement expenses			211,500				188,755				12	%			661,795				600,599				10	%
Underwriting, policy acquisition costs, and insurance expenses			113,862				126,791				(10	)%			381,846				380,682				0	%
Other expenses			25,379				19,904				28	%			75,612				64,659				17	%
Interest expense			12,607				10,361				22	%			32,078				33,241				(3	)%
			363,348				345,811				5	%			1,151,331				1,079,181				7	%
Income (loss) from continuing operations before income taxes			(28,096	)			50,605			NM					(61,950	)			118,585			NM
Federal income taxes expense (loss)			(9,312	)			17,279			NM					(22,866	)			40,486			NM
Income (loss) from continuing operations			(18,784	)			33,326			NM					(39,084	)			78,099			NM
Income (loss) from discontinued operations, net			70				155			NM					(5,152	)			1,436			NM
Net income (loss)		$	(18,714	)		$	33,481			NM				$	(44,236	)		$	79,535			NM

          Revenue and income (loss) 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,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
Revenue from continuing operations:
Insurance:
Self-Employed Agency Division		$	310,944			$	355,497			$	949,368			$	1,078,117
Medicare Division			26,519				—				72,537				—
Other Insurance Division			6,576				8,145				22,487				23,653
Total Insurance			344,039				363,642				1,044,392				1,101,770
Other Key Factors			(8,803	)			9,354				(2,503	)			29,285
Intersegment Eliminations			(39	)			178				(130	)			(800	)
Total revenue excluding disposed operations			335,197				373,174				1,041,759				1,130,255
Disposed Operations			55				23,242				47,622				67,511
Total revenue from continuing operations		$	335,252			$	396,416			$	1,089,381			$	1,197,766