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 June 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 incorporation or organization)		(I.R.S. Employer 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 o No þ

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

Large accelerated filer o		Accelerated filer o		Non-accelerated filer þ		Smaller reporting company o
				(Do not check if a smaller reporting company)

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

     On August 18, 2008 the registrant had 26,937,996 outstanding shares of Class A-1 Common Stock, $.01 Par Value, and 3,057,110 outstanding shares of Class A-2 Common Stock, $.01 Par Value.

 

 

HEALTHMARKETS, INC.
and Subsidiaries

Second Quarter 2008 Form 10-Q

TABLE OF CONTENTS

		Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Condensed Balance Sheets as of June 30, 2008 and December 31, 2007			1
Consolidated Condensed Statements of Income (Loss) for the Three and Six Months Ended June 30, 2008 and 2007			2
Consolidated Condensed Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2008 and 2007			3
Consolidated Condensed Statements of Cash Flows for the Six Months Ended June 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			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			27
Item 4T. Controls and Procedures			27
PART II OTHER INFORMATION
Item 1. Legal Proceedings			27
Item 1A. Risk Factors			28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			28
Item 4. Submission of Matters to a Vote of Security Holders			29
Item 5. Other Information			29
Item 6. Exhibits			30
SIGNATURES
Certificate of Incorporation, as amended May 22, 2008
Amended Bylaws
Regulatory Settlement Agreement
Rule 13a-14(a)/15d-14(a) Certification
Rule 13a-14(a)/15d-14(a) Certification
Section 1350 Certification

PART 1. FINANCIAL INFORMATION

ITEM 1. Financial Statements

HEALTHMARKETS, INC.
and Subsidiaries

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

		June 30,				December 31,
		2008				2007
		(Unaudited)
ASSETS
Investments:
Securities available for sale —
Fixed maturities, at fair value (cost: 2008—$1,146,936; 2007—$1,314,069)		$	1,117,711			$	1,304,424
Equity securities, at fair value (cost: 2008—$290; 2007—$300)			330				346
Policy loans			14,423				14,279
Short-term and other investments, at fair value (cost: 2008—$311,865; 2007—$163,727)			311,865				162,552
Total investments			1,444,329				1,481,601
Cash and cash equivalents			3,903				14,309
Investment income due and accrued			12,273				14,527
Due premiums			3,497				4,055
Reinsurance receivables			47,581				73,032
Agent and other receivables			33,238				63,956
Deferred acquisition costs			181,337				197,979
Property and equipment, net			69,593				69,939
Goodwill and other intangible assets			88,377				89,194
Recoverable federal income taxes			26,193				4,962
Assets held for sale			95,630				110,355
Other assets			42,471				31,673
Total assets		$	2,048,422			$	2,155,582
LIABILITIES AND STOCKHOLDERS’ EQUITY
Policy liabilities:
Future policy and contract benefits		$	473,780			$	463,277
Claims			431,227				435,099
Unearned premiums			75,226				92,266
Other policy liabilities			10,452				10,764
Accounts payable and accrued expenses			65,746				69,510
Other liabilities			83,506				110,624
Deferred federal income tax			77,293				84,968
Debt			481,070				481,070
Liabilities held for sale			91,480				99,109
Net liabilities of discontinued operations			2,561				2,635
Total liabilities			1,792,341				1,849,322
Commitments and contingencies
Stockholders’ Equity:
Preferred stock, par value $0.01 per share			—				—
Common stock, par value $0.01 per share			310				310
Additional paid-in capital			56,380				55,754
Accumulated other comprehensive loss			(24,908	)			(13,132	)
Retained earnings			255,619				281,141
Treasury stock, at cost			(31,320	)			(17,813	)
Total stockholders’ equity			256,081				306,260
Total liabilities and stockholders’ equity		$	2,048,422			$	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								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
REVENUE
Health premiums		$	326,038			$	334,504			$	643,303			$	668,266
Life premiums and other considerations			17,761				17,444				36,516				33,825
			343,799				351,948				679,819				702,091
Investment income			15,674				23,544				35,231				47,122
Other income			20,390				27,445				42,318				52,889
Losses on sales of investments			(4,616	)			(3,155	)			(3,239	)			(752	)
			375,247				399,782				754,129				801,350
BENEFITS AND EXPENSES
Benefits, claims, and settlement expenses			226,038				196,513				450,295				411,844
Underwriting, acquisition, and insurance expenses			139,678				133,444				267,984				253,891
Other expenses			27,268				23,646				50,233				44,755
Interest expense			9,480				11,424				19,471				22,880
			402,464				365,027				787,983				733,370
Income (loss) from continuing operations before income taxes			(27,217	)			34,755				(33,854	)			67,980
Federal income tax expense (benefit)			(11,533	)			12,061				(13,554	)			23,207
Income (loss) from continuing operations			(15,684	)			22,694				(20,300	)			44,773
Income (loss) from discontinued operations, net			(3,545	)			669				(5,222	)			1,281
Net income (loss)		$	(19,229	)		$	23,363			$	(25,522	)		$	46,054
Basic earnings per share:
Income (loss) from continuing operations		$	(0.51	)		$	0.75			$	(0.66	)		$	1.48
Income (loss) from discontinued operations			(0.12	)			0.02				(0.17	)			0.04
Net income (loss) per share, basic		$	(0.63	)		$	0.77			$	(0.83	)		$	1.52
Diluted earnings per share:
Income (loss) from continuing operations		$	(0.51	)		$	0.73			$	(0.66	)		$	1.44
Income (loss) from discontinued operations			(0.12	)			0.02				(0.17	)			0.04
Net income (loss) per share, diluted		$	(0.63	)		$	0.75			$	(0.83	)		$	1.48

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

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

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
Net income (loss)		$	(19,229	)		$	23,363			$	(25,522	)		$	46,054
Other comprehensive income (loss):
Unrealized losses on securities available for sale arising during the period			(14,547	)			(21,256	)			(17,998	)			(18,320	)
Reclassification for investment (gains) losses included in net income			91				229				(414	)			(648	)
Effect on other comprehensive income (loss) from investment securities			(14,456	)			(21,027	)			(18,412	)			(18,968	)
Unrealized gains (losses) on derivatives used in cash flow hedging during the period			5,351				3,647				(1,980	)			2,738
Reclassification adjustments included in net income			1,763				(213	)			2,297				(273	)
Effect on other comprehensive income from hedging activities			7,114				3,434				317				2,465
Other comprehensive loss before tax			(7,342	)			(17,593	)			(18,095	)			(16,503	)
Income tax benefit related to items of other comprehensive income			(2,544	)			(6,160	)			(6,319	)			(5,778	)
Other comprehensive loss net of tax			(4,798	)			(11,433	)			(11,776	)			(10,725	)
Comprehensive income (loss)		$	(24,027	)		$	11,930			$	(37,298	)		$	35,329

See Notes to Consolidated Condensed Financial Statements.

HEALTHMARKETS, INC.
and Subsidiaries

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

		Six Months Ended
		June 30
		2008				2007
Operating Activities:
Net income (loss)		$	(25,522	)		$	46,054
Adjustments to reconcile net income (loss) to cash provided by operating activities:
(Income) loss from discontinued operations			5,222				(1,281	)
Loss on sales of investments			3,239				752
Change in deferred income taxes			(1,354	)			5,141
Depreciation and amortization			13,750				12,803
Amortization of prepaid monitoring fees			6,250				6,250
Equity based compensation expense			(520	)			2,932
Provision for doubtful accounts			1,021				131
Changes in assets and liabilities:
Investment income due and accrued			2,254				2,028
Due premiums			558				(258	)
Reinsurance receivables			25,451				50,217
Other receivables			31,030				(6,856	)
Deferred acquisition costs			16,642				(2,027	)
Prepaid monitoring fees			(12,500	)			(12,500	)
Current income tax recoverable			(21,231	)			18,529
Policy liabilities			(5,924	)			(65,131	)
Other liabilities and accrued expenses			(13,850	)			(295	)
Other items, net			(2,558	)			996
Cash provided by continuing operations			21,958				57,485
Cash (used in) provided by discontinued operations			2,443				(2,131	)
Net cash provided by operating activities			24,401				55,354
Investing Activities:
Decrease in investment assets			12,441				301,308
Purchases of property and equipment			(10,364	)			(12,940	)
Distributions from investment in Grapevine Finance LLC			81				468
Decrease (increase) in agent receivables			(815	)			2,767
Cash provided by continuing operations			1,343				291,603
Cash provided by discontinued operations			6,457				14,464
Net cash provided by investing activities			7,800				306,067
Financing Activities:
Repayment of notes payable			—				(75,000	)
Change in cash overdraft			—				1,263
Decrease in investment products			(4,796	)			(3,183	)
Proceeds from exercise of stock options			93				51
Excess tax benefits from equity based compensation			(260	)			126
Proceeds from shares issued to officers, directors and agent plans			7,334				34,758
Purchases of treasury stock			(37,878	)			(21,344	)
Dividends paid			—				(316,996	)
Other			—				(2	)
Cash used in continuing operations			(35,507	)			(380,327	)
Cash used in discontinued operations			(7,100	)			(13,850	)
Net cash used in financing activities			(42,607	)			(394,177	)
Net change in cash and cash equivalents			(10,406	)			(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		$	3,903			$	—
Supplemental disclosures:
Income taxes paid			6,481				102
Interest paid			19,621				22,810

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 six month periods ending June 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 May 2008, the Financial Accounting Standard Board (“FASB”) issued Statement of Financial Accounting Standard (“FAS”) No. 163, Accounting for Financial Guarantee Insurance Contracts, an interpretation of FAS No. 60, Accounting and Reporting by Insurance Enterprises. Diversity exists in practice in accounting for financial guarantee insurance contracts by insurance enterprises under FAS 60. That diversity results in inconsistencies in the recognition and measurement of claim liabilities because of differing views about when a loss has been incurred under FASB Statement No. 5, Accounting for Contingencies. FAS 163 requires that an insurance enterprise recognize a claim liability prior to an event of default (insured event) when there is evidence that credit deterioration has occurred in an insured financial obligation. FAS 163 also clarifies how FAS 60 applies to financial guarantee insurance contracts, including the recognition and measurement to be used to account for premium revenue and claim liabilities. Those clarifications will increase comparability in financial reporting of financial guarantee insurance contracts by insurance enterprises. The statement requires expanded disclosures about financial guarantee insurance contracts. The statement is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal years, except for some disclosures about the insurance enterprise’s risk-management activities. The statement requires that disclosures about the risk-management activities of the insurance enterprise be effective for the first period (including interim periods) beginning after issuance of this statement. Except for those disclosures, earlier application is not permitted. The Company does not enter into financial guarantee insurance contracts and therefore this statement will not have a material impact on its financial position or results of operations.

     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 is 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 FASB Staff Position (“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 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

     As previously disclosed, on June 12, 2008, HealthMarkets, LLC, entered into a definitive Agreement for Reinsurance and Purchase and Sale of Assets (the “Master Agreement”) pursuant to which Wilton Reassurance Company (“Wilton”) or its affiliates will acquire substantially all of the business of the Company’s Life Insurance Division, operating through Chesapeake, Mid-West and MEGA (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 to be entered into with each of the Ceding Companies on or before the closing date, Wilton will, effective July 1, 2008, 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 will assume responsibility for all insurance liabilities associated with the Coinsured Policies on the effective date. The Ceding Companies will transfer to Wilton cash in an amount equal to the net statutory reserves and liabilities corresponding to the Coinsured Policies, which amount, as of June 30, 2008, was approximately $341.0 million. Following the closing, Wilton will be responsible for administration of the Coinsured Policies, subject to certain transition services to be provided by the Ceding Companies to Wilton.

     At the closing, the Company or the Ceding Companies will receive total consideration of approximately $140.0 million, subject to certain adjustments, 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 Company expects the reinsurance transaction to result in a pre-tax loss estimated to be approximately $13.0 million, which was recognized in the three months ended June 30, 2008 as an impairment to the Life Insurance Division’s deferred acquisition costs.

     These transactions, which are subject to customary closing conditions, including the receipt of approvals by certain state insurance regulators and the receipt of certain other required consents, are expected to close in the fall of 2008. Subject to certain conditions, the Master Agreement may be terminated by either party if the closing has not occurred by November 30, 2008.

     In addition, on June 12, 2008, HealthMarkets, LLC entered into a definitive Stock Purchase Agreement (the “Stock Purchase Agreement ”) pursuant to which Wilton will purchase the Company’s student loan funding vehicles, CFLD-I, Inc., and UICI Funding Corp. 2 and the related student association. The Company will receive a purchase price based on the amount of cash and student loans held by UICI Funding Corp. 2 at the time of closing, subject to certain adjustments, which purchase price is estimated to be approximately $4.2 million. The Company expects the transactions contemplated by the Stock Purchase Agreement to result in a pre-tax loss estimated to be approximately $5.3 million which was recognized as a reduction in the value of the Company’s student loan portfolio as of June 30, 2008. 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 statement of income for all periods presented.

     Wilton will fund student loans in accordance with the terms of the Coinsured Policies; 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 closing of the transactions contemplated by the Stock Purchase Agreement is subject to customary closing conditions. Subject to certain conditions, the Stock Purchase Agreement will terminate upon the termination of the Master Agreement or may be terminated by either party if the closing has not occurred by March 31, 2009.

     In connection with the transactions discussed above the Company incurred $4.5 million in legal costs, employee termination costs and other costs during the three months ended June 30, 2008. The Company expects to incur an additional $6.5 million in expenses associated with these transactions including investment banker fees, legal fees, contract termination costs and other costs.

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

		June 30,				December 31,
		2008				2007
		(In thousands)
Assets
Restricted cash		$	7,716			$	8,496
Student loans			94,207				99,179
Provision for loan losses			(11,570	)			(2,925	)
Investment income due and accrued			5,057				5,587
Other assets and receivables			220				18
Total assets held for sale		$	95,630			$	110,355
Liabilities
Accounts payable and accrued expenses		$	227			$	377
Student Loan Credit Facility			90,300				97,400
Other Liabilities			953				1,332
Total liabilities held for sale		$	91,480			$	99,109

     The results of discontinued operations were as follows:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
		(In thousands)
Revenue from discontinued operations
Student loan business		$	2,157			$	2,875			$	4,696			$	5,927
Other discontinued operations			57				101				106				170
			2,214				2,976				4,802				6,097
Expenses from discontinued operations
Student loan business			2,329				2,455				7,495				4,669
Other discontinued operations			1				(508	)			3				(543	)
			2,330				1,947				7,498				4,126
Increase in provision for loan allowance on student loans			(5,338	)			—				(5,338	)			—
Income (loss) from discontinued operations before income taxes			(5,454	)			1,029				(8,034	)			1,971
Income tax benefits (expenses)			1,909				(360	)			2,812				(690	)
Income from discontinued operations (net of income taxes)		$	(3,545	)		$	669			$	(5,222	)		$	1,281

3. 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 certain vision, dental and hearing services.

     On July 15, 2008, the Medicare Improvements for Patients and Providers Act of 2008 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 will incur employee termination costs of approximately $2.5 million and asset impairment charges of $1.2 million. In accordance with FAS 144, the results of operations of Medicare Division will continue to be included in continuing operations on its Consolidated Condensed Statements of Income (Loss) until the “run-off” operation ceases. 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.

Charges Incurred in the Current Period

     During the three months ended June 30, 2008, the Company recognized a $4.9 million expense associated with a minimum volume guarantee fee related to the Company’s contract with a third party administrator. 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 will now incur 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.

4. DEBT

     In connection with the Merger completed on April 5, 2006, HealthMarkets, LLC, a direct wholly-owned subsidiary of the Company, entered into a credit agreement, providing for a $500.0 million term loan facility and a $75.0 million

revolving credit facility, which includes a $35.0 million letter of credit sub-facility. The full amount of the term loan was drawn at closing, and the proceeds were used to fund a portion of the consideration paid in the Merger. At June 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.

     Also in connection with the merger, 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				Six Months
		at				Ended				Ended
		June 30, 2008				June 30, 2008				June 30, 2008
2006 credit agreement:
Term loan		$	362,500			$	5,168			$	10,593
$75 Million revolver (non-use fee)			—				35				72
Trust preferred securities:
UICI Capital Trust I			15,470				249				541
HealthMarkets Capital Trust I			51,550				762				1,766
HealthMarkets Capital Trust II			51,550				1,091				2,181
Other:
Interest on Deferred Tax			—				1,054				2,096
Amortization of financing fees			—				1,121				2,222
Total		$	481,070			$	9,480			$	19,471

     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 June 30, 2008, the interest rate swaps had an aggregate fair value of approximately $9.2 million, which is reflected under the caption “Other Liabilities.” During the three and six months ended June 30, 2008, the Company incurred a loss of $18,000 and $35,000, 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 June 30, 2008, pretax expense of $1.6 million ($1.0 million net of tax) was reclassified into interest expense from accumulated other comprehensive income as adjustments to interest payments on variable rate debt.

In addition, expense of $171,000 ($111,000 net of tax) was reclassified into earnings associated with the previous termination of the hedging relationship in the fourth quarter of 2006.

     During the six months ended June 30, 2008, pretax expense of $1.9 million ($1.2 million net of tax) was reclassified into interest expense from accumulated other comprehensive income as adjustments to interest payments on variable rate debt. In addition, expense of $341,000 ($221,000 net of tax) was reclassified into earnings associated with the previous termination of the hedging relationship in the fourth quarter of 2006.

     At June 30, 2008, accumulated other comprehensive income included a deferred after-tax net loss of $6.0 million related to the interest rate swaps of which $1.5 million ($962,000 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.

5. NET INCOME (LOSS) PER SHARE

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

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
		(In thousands, except per share amounts)
Income (loss) from continuing operations		$	(15,684	)		$	22,694			$	(20,300	)		$	44,773
Income (loss) from discontinued operations			(3,545	)			669				(5,222	)			1,281
Net income (loss) available to common shareholders		$	(19,229	)		$	23,363			$	(25,522	)		$	46,054
Weighted average shares outstanding, basic			30,447				30,353				30,587				30,289
Dilutive effect of stock options and other shares			—				804				—				817
Weighted average shares outstanding, dilutive			30,447				31,157				30,587				31,106
Basic earnings (losses) per share:
From continuing operations		$	(0.51	)		$	0.75			$	(0.66	)		$	1.48
From discontinued operations			(0.12	)			0.02				(0.17	)			0.04
Net income (loss) per share, basic		$	(0.63	)		$	0.77			$	(0.83	)		$	1.52
Diluted earnings (losses) per share:
From continuing operations		$	(0.51	)		$	0.73			$	(0.66	)		$	1.44
From discontinued operations			(0.12	)			0.02				(0.17	)			0.04
Net income (loss) per share, basic		$	(0.63	)		$	0.75			$	(0.83	)		$	1.48

     The common stock equivalents for the three and six months ended June 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 six months ended June 30, 2008 were 676,513 and 689,988, respectively.

     As of June 30, 2008, 27,000,062 shares of Class A-1 common stock were issued, of which 26,903,513 were outstanding and 96,549 shares were held in treasury and 4,026,104 shares of Class A-2 common stock were issued, of which 3,225,913 shares were outstanding and 800,191 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.

6. COMMITMENTS AND CONTINGENCIES

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

Association Group Litigation

     As previously disclosed, on September 26, 2003, HealthMarkets and The MEGA Life and Health Insurance Company (“MEGA”) were named as cross-defendants in a lawsuit initially filed on July 30, 2003 (Retailers’ Credit Association of Grass Valley, Inc. v. Henderson et al. v. UICI et al.) in the Superior Court of the State of California for the County of Nevada, Case No. L69072. In the suit, cross-plaintiffs asserted several causes of action, including breach of the

implied covenant of good faith and fair dealing, fraud, violation of California Business and Professions Code § 17200 and negligent and intentional misrepresentation, and sought injunctive relief and monetary damages in an unspecified amount. On August 28, 2006, the Court entered a final judgment in favor of all named cross-defendants. On March 26, 2008, the California Court of Appeals affirmed the trial court’s judgment and on June 3, 2008, the California Supreme Court denied cross-plaintiff’s petition for review. No further avenues of appeal are available to cross-plaintiffs and thus this case is concluded with respect to HealthMarkets and MEGA.

     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, 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 and Mid-West National Life Insurance Company of Tennessee (“Mid-West”) 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 sustained Mid-West’s demurrer, without leave to amend, disposing of plaintiff’s claim for violation of the California Consumer Legal Remedies statute. The Court granted Mid-West’s motion for summary judgment and dismissed the case on August 12, 2008.

     The Company currently believes that resolution of the above proceedings will 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 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 an interlocutory appeal but denied requests to stay the litigation. On September 14, 2007, the United States Fifth Circuit Court of Appeals granted HealthMarkets and Mid-West’s petition to hear the interlocutory appeal, which is pending before the Fifth Circuit.

     In April 2008, a court-approved notice to prospective participants in the collective action was mailed. A total of 54 prospective participants have given notice of their “opt-in” elections, which together with the original 14 plaintiffs brings the total number of participants in the collective action to 68. 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.

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 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. MEGA filed a motion for rehearing with the appellate court on May 12, 2008, which is pending before the appellate court.

     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 April 22, 2008, Mid-West filed a motion for summary judgment which 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;
	(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. As of August 15, 2008, forty-eight states had signed the RSA.

Regulatory Matters — General

     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. Historically, our insurance subsidiaries have from time to time been subject to such fines and penalties, none of which individually or in the aggregate have had a material adverse effect on our results of operations or financial condition. However, the multi-state market conduct examination and 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.

7. SEGMENT INFORMATION

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

reportable operating segments. Disposed Operations includes the Company’s former Star HRG Division and former Student Insurance Division.

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

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

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
Revenue from continuing operations:
Insurance:
Self-Employed Agency Division		$	315,535			$	362,380			$	638,424			$	722,620
Life Insurance Division			23,305				22,706				47,395				44,260
Medicare Division			29,916				—				46,018				—
Other Insurance Division			8,219				7,882				15,911				15,508
Total Insurance			376,975				392,968				747,748				782,388
Other Key Factors			(1,859	)			7,263				6,300				19,931
Intersegment Eliminations			(44	)			(490	)			(91	)			(978	)
Total revenue excluding disposed operations			375,072				399,741				753,957				801,341
Disposed Operations			175				41				172				9
Total revenue from continuing operations		$	375,247			$	399,782			$	754,129			$	801,350

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
Income (loss) from continuing operations before federal income taxes:
Insurance:
Self-Employed Agency Division		$	18,450			$	49,500			$	30,745			$	84,930
Life Insurance Division			(17,860	)			488				(19,980	)			517
Medicare Division			(7,327	)			(1,270	)			(12,304	)			(1,407	)
Other Insurance Division			3,169				1				4,241				1,761
Total Insurance			(3,568	)			48,719				2,702				85,801
Other Key Factors			(24,292	)			(14,107	)			(37,008	)			(18,320	)
Total operating income (loss) excluding disposed operations			(27,860	)			34,612				(34,306	)			67,481
Disposed Operations			643				143				452				499
Total income (loss) from continuing operations before taxes		$	(27,217	)		$	34,755			$	(33,854	)		$	67,980

		June 30,				December 31,
		2008				2007
		(In thousands)
Assets
Insurance:
Self-Employed Agency Division		$	824,816			$	878,911
Life Insurance Division			544,928				540,474
Medicare Division			22,704				—
Other Insurance Division			19,841				21,034
Total Insurance			1,412,289				1,440,419
Other Key Factors			515,010				553,855
Total Assets excluding disposed operations and held for sale			1,927,299				1,994,274
Assets held for sale			95,630				110,355
Disposed Operations			25,493				50,953
		$	2,048,422			$	2,155,582

     The Student Insurance Division (included in Disposed Operations) assets of $25.5 million and $51.0 million at June 30, 2008 and December 31, 2007, respectively, primarily represent a reinsurance receivable 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 to be generated with respect to 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 has made no adjustment to the purchase price due to the premium provision and will continue to examine whether any adjustments should be made in the future.

     The Company has recorded $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.

8. AGENT AND EMPLOYEE STOCK PLANS

Agent Stock Accumulation Plans

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

     The following table sets forth the total compensation expense and tax benefit associated with the Company’s Agent Plans for the three and six months ended June 30, 2008 and 2007:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
SEA and Medicare Division stock-based compensation expense		$	1,283			$	1,476			$	2,603			$	6,097
Other Key Factors variable non-cash stock-based compensation (benefit) expense			(3,508	)			1,546				(3,218	)			(5	)
Total Agent Plan compensation (benefit) expense			(2,225	)			3,022				(615	)			6,092
Related Tax Benefit (Expense)			(779	)			1,058				(215	)			2,132
Net (benefit) expense included in financial results		$	(1,446	)		$	1,964			$	(400	)		$	3,960

     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 June 30, 2008, the Company had recorded 1,100,526 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 June 30, 2008, options to purchase a total of 1,035,000 shares of Class A-1 common stock were granted under the 2006 Plan at an exercise price of $34.80, 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.

9. TRANSACTIONS WITH RELATED PARTIES

     On April 5, 2006, the Company completed its Merger and, as a result, affiliates of The Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners (the “Private Equity Investors”) held, as of June 30, 2008, approximately 54.7%, 22.4%, and 11.2%, respectively, of the Company’s outstanding equity securities. Certain members of the Board of Directors of the Company are affiliated with the Private Equity Investors.

     In accordance with the terms of Transaction and Monitoring Fee Agreements with advisory affiliates of each of the Private Equity Investors, the advisory affiliates of each of the Private Equity Investors agreed to provide to the Company ongoing monitoring, advisory and consulting services, for which the Company agreed to pay to affiliates of each of The Blackstone Group, Goldman Sachs Capital Partners and DLJ Merchant Banking Partners an annual monitoring fee in an amount equal to $7.7 million, $3.2 million and $1.6 million, respectively. Aggregate annual monitoring fees in the amount

of $12.5 million with respect to 2008 were paid in full to the advisory affiliates of the Private Equity Investors on January 8, 2008. The Company has expensed $6.3 million through June 30, 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 June 30, 2008, the Company received $317,000 in a capital distribution (return of capital) from Goldman Sachs Real Estate Partners, L.P. During the six months ended June 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 June 30, 2008, the Company funded $1.4 million in capital calls. During the six months ended June 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.

10. INVESTMENTS

     A. Other Than Temporary Impairment

     Investments are reviewed quarterly (or more frequently if certain indicators arise) to determine if they have suffered 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 loss is recognized at the date of determination.

     During the quarter ended June 30, 2008, the Company recognized impairment charges of $5.6 million primarily related to certain investments in collateralized debt obligations. These impairment charges resulted from other than temporary reductions in the fair value of the investments compared to the Company’s cost basis.

     B. Fair Value Measurement

     Effective January 1, 2008, HealthMarkets adopted FAS No. 157, Fair Value Measurements, for financial assets and liabilities. FAS No. 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. Following is a brief description of the type of valuation information (“inputs”) that qualifies a financial asset 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.

Valuation of Investments

     For investments that have quoted market prices in active markets, the Company uses the quoted market prices 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, fair values are estimated by management based on independent external valuation information, which utilizes various models and valuation techniques based on a range of 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 general, the fair values based on these observable market inputs fall into the Level 2 of the hierarchy, but in certain cases where there is limited activity or less transparency around inputs to the valuation, the fair values are reflected within Level 3 of the valuation hierarchy. When relying on bid/ask spreads from dealers, the Company typically uses the mid-mark to determine fair value. In extreme cases, where the bid/ask spread is unusually wide, the Company may use a convention other than the mid-mark to determine fair value based on other observable inputs.

     The following is a description of the valuation methodologies used for financial assets measured at fair value, including the general classification of such assets pursuant to the valuation hierarchy.

Fixed Income Investments

     Fixed income investments, other than U.S. Treasury securities, generally do not trade on a daily basis. The fair value estimates for the majority of these securities are estimated by management based on independent external valuation information, which utilizes available market data such as relevant market information, benchmark curves, benchmarking of like securities, sector groupings, and matrix pricing. Option adjusted spread model is also used to develop prepayment and interest rate scenarios.

     Each asset class is evaluated based on relevant market information, relevant credit information, perceived market movements and sector news. The market inputs utilized in the pricing evaluation, listed in the approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. The extent of the use of each market input depends on the asset class and the market conditions. The Company may have to make assumptions for market based inputs that are unavailable due to market conditions.

     Because the fair value estimates of most fixed income investments are determined by evaluations that are based on observable market information rather than market quotes, all estimates of fair value for fixed income investments, other than U.S. Treasury securities, are disclosed in Level 2 of the hierarchy. The estimated values of U.S. Treasury securities are included in the amount disclosed in Level 1 as the estimates are based on unadjusted market prices.

     While the vast majority of the Company’s fixed income investments are included in Level 2, the Company holds a small number of fixed income investments where it estimates the fair value of these bonds using internal pricing matrices with some unobservable inputs that are significant to the valuation. Due to the limited amount of observable market information, the Company includes the fair value estimates for these particular bonds in Level 3 of the hierarchy.

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 using models that primarily use market observable inputs and, therefore, are classified as Level 2 because they are traded in markets where quoted market prices are not readily available.

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.

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 June 30, 2008

In thousands		Level 1				Level 2				Level 3				Total
Government and agencies		$	10,859			$	30,285			$	—			$	41,144
Corporate debt and other			—				537,365				—				537,365
Mortgage and asset-backed			—				316,444				2,279				318,723
Municipals			—				198,797				21,682				220,479
Corporate equities			40				—				—				40
Short-term and other investments			288,299				—				2,015				290,314
		$	299,198			$	1,082,891			$	25,976			$	1,408,065

Liabilities at Fair Value as of June 30, 2008

In thousands		Level 1				Level 2				Level 3				Total
Interest rate swaps		$	—			$	9,237			$	—			$	9,237
Agent and employee plans			—				—				20,246				20,246
		$	—			$	9,237			$	20,246			$	29,483

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 six months ended June 30, 2008. As of the quarter ended June 30, 2008, the Company determined that its municipal auction rate security investments previously presented in Level 2 of the hierarchy, should be classified as Level 3 due to no available observable markets inputs and, therefore, transferred them on the disclosure table.

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

										Purchases,
										Sales,
										Payments								Transfer in/
						Unrealized				and								(out) of
		Beginning				Gains or				Issuances,				Realized				Level 3,				Ending
		Balance				(losses)				Net				Losses(1)				Net				Balance
										(In Thousands)
Assets
Other invested assets		$	2,464			$	1,833			$	(236	)		$	(2,046	)		$	—			$	2,015
Mortgage and asset-backed			2,428				(50	)			(99	)			—				—				2,279
Municipals			—				(1,418	)			—				—				23,100				21,682
Liabilities
Agent and Employee Stock Plans		$	22,957			$	(4,878	)		$	2,167			$	—			$	—			$	20,246

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

										Purchases,
										Sales,
										Payments								Transfer in
						Unrealized				and								/(out) of
		Beginning				Gains or				Issuances,				Realized				Level 3,				Ending
		Balance				(losses)				Net				Losses(1)				Net				Balance
										(In Thousands)
Assets
Other invested assets		$	3,380			$	1,175			$	(494	)		$	(2,046	)		$	—			$	2,015
Mortgage and asset-backed			2,579				(118	)			(182	)			—				—				2,279
Municipals			—				(1,418	)			—				—				23,100				21,682
Liabilities
Agent and Employee Stock Plans		$	37,273			$	(4,878	)		$	(12,149	)		$	—			$	—			$	20,246

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

     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 and preferred provider organization (“PPO”) plans, as well as other supplemental types of coverage. In addition, we offer on a selective state-by-state basis a suite of health insurance products to the self-employed and individual market, including a basic medical-surgical expense plan, catastrophic expense PPO plans and catastrophic expense consumer guided health plans.

     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.

     Through our Life Insurance Division, we issue universal life, whole life and term life insurance products to individuals in four markets that we believe are underserved: the self-employed market, the middle income market, the Hispanic market and the senior market. We distribute these products directly to individual customers through our UGA and Cornerstone agents and other independent agents contracted through two key unaffiliated marketing companies. These two marketing companies, in turn, distribute our life products through managing general agent (MGA) networks. In June 2008, the Company entered into an agreement to sell substantially all of the business of the Life Insurance Division.

     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 elect to continue 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”).

Results of Operations

     The table below sets forth certain summary information about the Company’s operating results for the three and six months ended June 30, 2008 and 2007:

		Three Months Ended								Percentage				Six Months Ended								Percentage
		June 30,								Increase				June 30,								Increase
		2008				2007				(Decrease)				2008				2007				(Decrease)
		(Dollars in thousands)												(Dollars in thousands)
REVENUE
Health premiums		$	326,038			$	334,504				(3	)%		$	643,303			$	668,266				(4	)%
Life premiums and other considerations			17,761				17,444				2	%			36,516				33,825				8	%
			343,799				351,948				(2	)%			679,819				702,091				(3	)%
Investment income			15,674				23,544				(33	)%			35,231				47,122				(25	)%
Other income			20,390				27,445				(26	)%			42,318				52,889				(20	)%
Loss on sale of investments			(4,616	)			(3,155	)			NM				(3,239	)			(752	)			NM
			375,247				399,782				(6	)%			754,129				801,350				(6	)%
BENEFITS AND EXPENSES
Benefits, claims, and settlement expenses			226,038				196,513				15	%			450,295				411,844				9	%
Underwriting, policy acquisition costs, and insurance expenses			139,678				133,444				5	%			267,984				253,891				6	%
Other expenses			27,268				23,646				15	%			50,233				44,755				12	%
Interest expense			9,480				11,424				(17	)%			19,471				22,880				(15	)%
			402,464				365,027				10	%			787,983				733,370				7	%
Income (loss) from continuing operations before income taxes			(27,217	)			34,755				NM				(33,854	)			67,980				NM
Federal income taxes			(11,533	)			12,061				NM				(13,554	)			23,207				NM
Income (loss) from continuing operations			(15,684	)			22,694				NM				(20,300	)			44,773				NM
Income (loss) from discontinued operations, net			(3,545	)			669				NM				(5,222	)			1,281				NM
Net income (loss)		$	(19,229	)		$	23,363				NM			$	(25,522	)		$	46,054				NM

NM: not meaningful

     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								Six Months Ended
		June 30,								June 30,
		2008				2007				2008				2007
		(In thousands)								(In thousands)
Revenues from continuing operations:
Insurance:
Self-Employed Agency Division		$	315,535			$	362,380			$	638,424			$	722,620
Life Insurance Division			23,305				22,706				47,395				44,260
Medicare Division			29,916				—				46,018				—
Other Insurance			8,219				7,882				15,911				15,508
Total Insurance			376,975				392,968				747,748				782,388
Other Key Factors			(1,859	)			7,263				6,300				19,931
Intersegment Eliminations			(44	)			(490	)			(91	)			(978	)
Total revenues excluding disposed operations			375,072				399,741				753,957				801,341
Disposed Operations			175				41				172				9
Total revenues from continuing operations		$	375,247			$	399,782			$	754,129			$	801,350