UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2008

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______________ to _________________

COMMISSION FILE NUMBER 1-16477

COVENTRY HEALTH CARE, INC.

(Exact name of registrant as specified in its charter)

6705 Rockledge Drive, Suite 900, Bethesda, Maryland 20817

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (301) 581-0600

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x 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.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

COVENTRY HEALTH CARE, INC.

FORM 10-Q

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION

ITEM 1: Financial Statements

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)

See accompanying notes to the condensed consolidated financial statements.

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

See accompanying notes to the condensed consolidated financial statements.

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes to the condensed consolidated financial statements.

COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

The condensed consolidated financial statements of Coventry Health Care, Inc. and its subsidiaries (“Coventry” or the “Company”) contained in this report are unaudited but reflect all normal recurring adjustments which, in the opinion of management, are necessary for the fair presentation of the results of the interim periods reflected. Certain information and footnote disclosures normally included in the consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission. Therefore, it is suggested that these condensed consolidated financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10–K for the year ended December 31, 2007. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. The year end balance sheet data included in this report was derived from audited financial statements but does not include all disclosures required by GAAP.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. The Company adopted the provisions of SFAS No. 157 as of January 1, 2008, for its financial instruments. The adoption of SFAS No. 157 did not have a material effect on the Company’s consolidated financial position or results of operations. The disclosures required by SFAS No. 157 are contained in Note J., Fair Value Measurements, herein.

On May 14, 2008, the Company completed its acquisition of a majority ownership interest in Group Dental Services (“GDS”) in an all-cash transaction for approximately $36.7 million. GDS is a dental company based in Rockville, Maryland. The acquisition was accounted for using the purchase method of accounting and accordingly the Company’s ownership interest in GDS’ operating results have been included in its consolidated financial statements since the date of acquisition.

On February 13, 2008, the Company completed its acquisition of Mental Health Network Institutional Services, Inc. (“MHNet”) in an all-cash transaction for approximately $103.3 million, including working capital. MHNet, previously privately owned, is a mental-behavioral health company based in Austin, Texas. MHNet has served as a multi-year vendor to certain of the Company’s subsidiaries. The acquisition was accounted for using the purchase method of accounting and accordingly MHNet’s operating results have been included in the Company’s consolidated financial statements since the date of acquisition.

The Company’s outstanding debt as of June 30, 2008, and December 31, 2007, consisted of the following:

The Company’s senior notes and credit facility contain certain covenants and restrictions regarding additional debt, dividends or other restricted payments, transactions with affiliates, asset dispositions, and consolidations or mergers. Additionally, the Company’s credit facility requires compliance with a leverage ratio. As of June 30, 2008, the Company was in compliance with all applicable covenants and restrictions under its senior notes and credit facility.

As described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007, the Company was a defendant in the provider track of the In Re: Managed Care Litigation filed in the United States District Court for the Southern District of Florida, Miami Division, Multi-District Litigation (“MDL”), No. 1334, in the action captioned, Charles B. Shane., et al., vs. Humana, Inc., et al. The trial court granted summary judgment in favor of the Company on all claims asserted in the litigation. The Eleventh Circuit Court of Appeals affirmed the trial court’s order granting summary judgment. The Shane lawsuit has triggered the filing of copycat class action complaints by other health care providers such as chiropractors, podiatrists, acupuncturists and other licensed health care professionals. Each of these actions has been transferred to the MDL and has been designated as “tag-along” actions. There are three tag-along actions currently filed against the Company. The trial court had entered an order which stayed all proceedings in these tag-along actions. Recently, the trial court requested the parties in the tag-along actions to refile all motions pending at the time of the stay and to file any new motions. On July 14, 2008, the trial court entered an order in the Harrison vs. Coventry Health Care of Georgia, Inc. (“CHCGA”) tag along action which dismissed all of the plaintiffs’ claims except their breach of contract claim which the court ordered to arbitration. In addition, the court deferred to the arbitrator for decision, the Company’s affirmative defenses that the plaintiffs waived their right to arbitration and/or their claim is barred by the doctrines of collateral estoppel and res judicata. The Harrison tag along action is a purported class action on behalf of all physicians in Georgia who had written provider contracts with CHCGA. The plaintiffs allege that CHCGA breached their contracts by not paying statutory interest on claims not adjudicated in compliance with Georgia’s prompt pay statute. CHCGA denies the allegation. Although the Company can not predict the outcome, it believes that the tag-along actions will not have a material adverse effect on its financial position or the results of operations. The Company also believes that the claims asserted in these lawsuits are without merit and intends to defend its position.

The Company has received a subpoena from the U.S. Attorney for the District of Maryland, Northern Division, requesting information regarding the operational process for confirming Medicare eligibility for the Workers Compensation set-aside product. The Company is fully cooperating and is providing the requested information. The Company can not predict what, if any, actions may be taken by the U.S. Attorney. However, based on the information known to date, the Company does not believe that the outcome of this inquiry will have a material adverse effect on its financial position or results of operations.

Stock Options

The Company granted 1.9 million stock options during the six months ended June 30, 2008. The Company recorded compensation expense related to stock options of approximately $8.6 million and $9.3 million for the quarters ended June 30, 2008 and 2007, respectively, and $18.1 million and $17.2 million for the six months ended June 30, 2008 and 2007, respectively. The total intrinsic value of options exercised was $0.4 million and $21.5 million for the quarters ended June 30, 2008 and 2007, respectively, and $8.7 million and $52.8 million for the six months ended June 30, 2008 and 2007, respectively. As of June 30, 2008, there was $73.9 million of total unrecognized compensation cost (net of expected forfeitures) related to nonvested stock option grants which is expected to be recognized over a weighted average period of 2.7 years.

The following table summarizes stock option activity for the six months ended June 30, 2008:

The Company continues to use the Black-Scholes-Merton option pricing model and amortizes compensation expense over the requisite service period of the grant. The methodology used in 2008 to derive the assumptions used in the valuation model is consistent with that used in 2007. The following average values and weighted-average assumptions for the quarters and six months ended June 30, 2008 and 2007 were used for option grants.

The Company awarded 0.8 million shares of restricted stock in the six months ended June 30, 2008. The value of the restricted shares is amortized over various vesting periods through 2012. The Company recorded compensation expense related to restricted stock grants, including restricted stock granted in prior periods, of approximately $6.4 million and $7.6 million for the quarters ended June 30, 2008 and 2007, respectively, and $13.6 million and $14.4 million for the six months ended June 30, 2008 and 2007, respectively. The total unrecognized compensation cost (net of expected forfeitures) related to the restricted stock was $33.5 million at June 30, 2008, and is expected to be recognized over a weighted average period of 2.2 years. The total fair value of shares vested during the six months ended June 30, 2008 and 2007 was $16.3 million and $35.8 million, respectively.

The following table summarizes restricted stock award activity for the six months ended June 30, 2008:

In May 2008, the Company’s Board of Directors approved an increase to the share repurchase program in an amount equal to 5% of the Company’s then outstanding common stock, thus increasing the Company’s repurchase authorization by 7.5 million shares. Under the share repurchase program, the Company purchased 1.0 million shares and 4.2 million shares of its common stock during the three and six month periods ended June 30, 2008, respectively, at an aggregate cost of $44.7 million and $215.4 million, respectively. As of June 30, 2008, the total remaining number of common shares the Company is authorized to repurchase under this program is 9.9 million.

Comprehensive income was as follows (in thousands):

The Company’s unrealized holding loss on its investment portfolio during the quarters and six months ended June 30, 2008, primarily resulted from increases in interest rates during the periods.

The Company has three reportable segments: Commercial, Individual Consumer & Government, and Specialty. Each of these segments, which the Company also refers to as “Divisions,” is separately managed and provides separate operating results that are evaluated by the Company’s chief operating decision maker. Beginning in 2008, in order to reflect a change in the management of its operations, the Company reclassified its network rental business operating results from its Commercial Division to its Specialty Division. The network rental business operating results for the corresponding 2007 periods have been reclassified to conform to the 2008 segment presentation. The Commercial Division is comprised of all of the Company’s commercial employer-focused businesses, including the traditional health plan group risk and ASO products as well as the National Accounts and Federal Employees Health Benefit Plans (“FEHBP”). The Individual Consumer & Government Division contains the Company’s individual consumer products and all Medicare and Medicaid products. The Specialty Division includes the Company’s workers’ compensation services businesses, network rental business, mental-behavioral health benefits business and the newly acquired group dental services business.

The table below summarizes the operating results of the Company’s reportable segments (in thousands) through the gross margin level, as gross margin is the measure of profitability used by the Company’s chief operating decision maker to assess segment performance and make decisions regarding the allocation of resources. Additionally, the medical loss ratio (“MLR”) is presented for each applicable segment, as management believes that MLR is an important performance measure. The “other” column represents the elimination of premium and management service fees charged among segments. Total assets by reportable segment are not disclosed as these assets are not reported on a segment basis internally by the Company and therefore, are not reviewed separately by the Company’s chief operating decision maker.

SFAS No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1 - defined as observable inputs such as quoted prices in active markets; Level 2 - defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3 - defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The following table presents the fair value hierarchy for the Company’s financial assets measured at fair value on a recurring basis at June 30, 2008 (in thousands):

The Company’s Level 1 securities primarily consist of US Treasury securities and cash. The Company determines the estimated fair value for its Level 1 securities using quoted (unadjusted) prices for identical assets or liabilities in active markets.

The Company’s Level 2 securities primarily consist of government-sponsored enterprise securities, state and municipal bonds, mortgage-backed securities, asset-backed securities, corporate debt, and money market funds. The Company determines the estimated fair value for its Level 2 securities using the following methods: quoted prices for similar assets/liabilities in active markets, quoted prices for identical or similar assets in non-active markets (few transactions, limited information, non-current prices, high variability over time), inputs other than quoted prices that are observable for the asset/liability (e.g. interest rates, yield curves volatilities, default rates, etc.), and inputs that are derived principally from or corroborated by other observable market data.

The Company’s Level 3 securities consist of three asset-backed securities and one corporate bond. The Company determines the estimated fair value for its Level 3 securities using unobservable inputs that cannot be corroborated by observable market data, such as broker quotes.

The following table provides a summary of changes in the fair value of the Company’s Level 3 financial assets for the quarter and six months ended June 30, 2008 (in thousands):

Realized gains and losses are recorded in other income, net in the accompanying consolidated statement of operations.

Earnings Per Share: Basic earnings per share is calculated using the weighted average number of common shares outstanding during the period. Diluted earnings per share assumes the exercise of all options and the vesting of all restricted stock using the treasury stock method. The Company excluded potential common stock equivalents to purchase 7.7 million and 3.3 million shares for the quarters ended June 30, 2008 and 2007, respectively, and 6.1 million and 3.2 million shares for the six months ended June 30, 2008 and 2007, respectively, from its computation of diluted earnings per share as these potential common stock equivalents were anti-dilutive.

Other Income: Other income includes interest income of $24.9 million and $33.0 million for the quarters ended June 30, 2008 and 2007, respectively and $54.6 million and $65.8 million for the six months ended June 30, 2008 and 2007, respectively.

ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

General Information

This Form 10–Q contains forward-looking statements which are subject to risks and uncertainties in accordance with the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements typically include assumptions, estimates or descriptions of our future plans, strategies and expectations, and are generally identifiable by the use of the words “anticipate,” “will,” “believe,” “estimate,” “expect,” “intend,” “seek,” or other similar expressions. Examples of these include discussions regarding our operating and growth strategy, projections of revenue, income or loss and future operations. Unless this Form 10–Q indicates otherwise or the context otherwise requires, the terms “we,” “our,” “our Company,” “the Company” or “us” as used in this Form 10-Q refer to Coventry Health Care, Inc. and its subsidiaries.

These forward–looking statements may be affected by a number of factors, including, but not limited to, the “Risk Factors” contained in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10–K for the year ended December 31, 2007. Actual operations and results may differ materially from those forward-looking statements expressed in this Form 10–Q.

The following discussion and analysis relates to our financial condition and results of operations for the quarters and six months ended June 30, 2008 and 2007. This discussion should be read in conjunction with the condensed consolidated financial statements and other information presented herein as well as in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Annual Report on Form 10–K for the year ended December 31, 2007, including the critical accounting policies discussed therein.

Summary of Second Quarter 2008 Performance  

New Accounting Standards

For this information, refer to Note B., New Accounting Standards, in the Notes to Condensed Consolidated Financial Statements, herein.

Acquisitions

For this information, refer to Note C., Acquisitions, in the Notes to Condensed Consolidated Financial Statements, herein.

Membership

The following table presents our membership as of June 30, 2008 and 2007 (amounts in thousands).

Commercial group risk membership increased 113,000 from the prior year, primarily due to members that were added through the acquisitions of Florida Health Plan Administrators, LLC (“Vista”) and of certain group health businesses from Mutual of Omaha (“Mutual”). Collectively, these resulted in an additional 166,000 members. Health plan ASO membership increased 115,000 from the prior year, primarily due to acquisitions, which contributed 99,000 members, and due to new sales and certain groups changing from a risk product to a non-risk product. Additionally, Other ASO membership decreased by 47,000 from the prior year.

Individual Consumer & Government Division membership increased 500,000 from the prior year, primarily due to organic growth in all products and expansion into new areas. Additionally, the acquisition of Vista added 142,000 members.

Results of Operations

Consolidated Financial Results

The following table is provided to facilitate a discussion regarding the comparison of our consolidated operating results for the quarters and six months ended June 30, 2008 and 2007 (dollars in thousands, except diluted earnings per share amounts).

Managed care premium revenue increased in both our Individual Consumer & Government Division and Commercial Division. The increase is a result of growth in existing products as well as from our acquisitions described herein. Partially offsetting the increase was a decline in same store Commercial risk membership over the prior year quarter.

Management services revenue increased compared to the prior year quarter primarily as a result of continued growth in our workers’ compensation services business and the acquisition of Mutual, discussed herein. This increase was partially offset by the Other ASO membership decline described above.

Medical costs increased as a result of new business in both our Individual Consumer & Government Division and Commercial Division discussed above. Medical costs also increased due to increased Commercial medical cost trend as well as unfavorable IBNR reserve development on our Medicare Private-Fee-For-Service (“PFFS”) business. Total medical costs as a percentage of premium revenue (“medical loss ratio”) increased 6.2% from the prior year quarter as a result of our Commercial and Medicare businesses. The Commercial medical loss ratio increase is a result of higher than expected levels of inpatient and outpatient facility cost trends. To a lesser extent the increase is also due to the mix of business from the inclusion of Vista and Mutual. The increase in the Medicare PFFS medical loss ratio is a result of receiving a much higher than expected level of PFFS claims related to prior periods, as well as a resulting higher outlook for the current year. We expect the Medicare Advantage medical loss ratio to be in the mid 80’s for the last six months of 2008. The Medicare Part D medical loss ratio increase was a result of the premium rate changes from the annual competitive bid filings for our Medicare part D products as well as a widening of the risk corridors and growth in our low-income auto-assign population in 2008.

Selling, general and administrative expense increased primarily due to operating costs associated with our recent acquisitions of Mutual and Vista, as well as costs related to the growth of our Medicare business.

Depreciation and amortization expense increased as a result of the expense associated with the fixed assets and identifiable intangible assets acquired with the recent acquisitions.

Interest expense increased primarily as a result of the issuance of debt during the prior year third quarter.

Other income decreased primarily as a result of lower interest rates as well as a smaller portfolio balance.

The income tax provision decreased due to a decrease in earnings. The effective tax rate increased to 38.0%, as compared to 37.5% for the prior year quarter, primarily as a result of a change in the proportion of earnings in states with higher tax rates.

Six Months Ended June 30, 2008 and 2007

Managed care premium revenue increased in both our Individual Consumer & Government Division and Commercial Division. The increase is a result of growth in existing products as well as from the acquisitions described above. Partially offsetting the increase was a decline in same store Commercial risk membership over the prior year period.

Management services revenue increased compared to the prior year period primarily as a result of the acquisition of Concentra, described above, and continued organic growth in our workers’ compensation services business. This increase was partially offset by the Other ASO membership decline described above.

Medical costs increased as a result of new business in both our Individual Consumer & Government Division and Commercial Division discussed above. Medical cost also increased due to increased Commercial medical cost trend as well as unfavorable IBNR reserve development on our Medicare PFFS business. The Medicare Part D medical loss ratio increase over the prior year period was driven by a widening of the risk corridors and growth in our low-income auto-assign population in 2008.

Medical costs for the six months ended June 30, 2008 included approximately $34.2 million of favorable medical cost development related to prior calendar years. On a full year basis we expect favorable development related to prior calendar years to be slightly higher than that recorded for the first half of 2008. Comparatively, medical costs for the six months ended June 30, 2007, included approximately $111.8 million of favorable medical cost development related to prior calendar years. For the full year of 2007 we experienced favorable medical cost development of $135.1 million. The decline in favorable development during the 2008 six month period was primarily a result of receiving a higher than expected level of Medicare PFFS claims in 2008 related to the 2007 period, which was inconsistent with claims submission patterns of our network based Medicare Advantage products. In particular, the lag in claims submission on this product was longer than we had assumed at the end of 2007 and longer than what we experienced on our Medicare Advantage HMO business.

Selling, general and administrative expense increased primarily due to normal operating costs associated with our recent acquisitions of Concentra, Mutual and Vista, as well as costs related to growth of our Medicare business.

Depreciation and amortization expense increased as a result of the expense associated with the identifiable intangible assets acquired with the recent acquisitions.

Interest expense increased primarily as a result of the issuance of debt during the prior year. The increase is partially offset by the redemption during the first quarter of 2007 of our $170.5 million of outstanding 8.125% senior notes due February 15, 2012. Associated with this redemption, we recognized $9.1 million of interest expense in the prior year first quarter for both the premium paid on redemption as well as the write off of associated deferred financing costs.

Other income decreased primarily as a result of lower interest rates as well as a smaller portfolio balance.

The income tax provision decreased due to a decrease in earnings. The effective tax rate increased to 37.9%, as compared to 37.2% for the prior year six months, primarily as a result of a change in the proportion of earnings in states with higher tax rates.

Segment Results

We have three reportable segments: Commercial, Individual Consumer & Government, and Specialty. Each of these segments is separately managed and separate operating results are available that are evaluated by the chief operating decision maker. Beginning in 2008, in order to reflect a change in the manner in which we manage our operations, our network rental business operations were reclassified from our Commercial Division to our Specialty Division. Our network rental business results for the 2007 period have been reclassified to conform to the 2008 presentation. The Commercial Division is comprised of all of our commercial employer-focused businesses, including the traditional health plan group risk and ASO products as well as the National Accounts and FEHBP. The Individual Consumer & Government Division contains our individual consumer products and all Medicare and Medicaid products. The Specialty Division includes our workers’ compensation services businesses, network rental business and the newly acquired mental-behavioral health benefits business of Mental Health Network Institutional Services, Inc. (“MHNet”) and the dental benefits business of Group Dental Services (“GDS”).

Quarters and Six Months Ended June 30, 2008 and 2007

Commercial group risk premium revenue increased for the quarter and six months ended June 30, 2008 from the same periods in 2007 as a result of the acquisitions of Mutual and Vista, which accounted for $151 million in current quarter revenue and $302 million for the six months ended June 30, 2008. The increase was also a result of an increase in average realized premium yields per member per month in our commercial group risk business, resulting from renewal rate increases net of benefit buy downs on renewing groups and the mix of new group business net of terminated groups. This increase in revenue was partially offset by membership declines in our same store commercial group risk business. However, a portion of those members changed from our risk products to our non-risk products.

Commercial management services revenue declined from the prior year periods due to membership losses in our national accounts non-risk business as well as due to fee negotiations related to the long-term renewal of our contract as plan administrator to the Mail Handler’s Benefit Plan. These declines are partially offset by an increase in our commercial health plan ASO membership.

Gross margin decreased as a result of the increase in the Commercial health plan medical loss ratio in 2008 compared to 2007 and the decline in commercial management services revenue discussed above. The decrease is partially offset by the gross margin derived from the acquisitions discussed above.

Individual Consumer & Government Division

Quarters and Six Months Ended June 30, 2008 and 2007

Individual Consumer & Government Division revenue increased for the quarter and six months ended June 30, 2008 from the same periods in 2007 as a result of membership growth from our Medicare Advantage business, as well as increased Medicare Part D, Medicaid and Individual membership, both organic and acquired.

Medicare Advantage risk premium yields, excluding the effect of revenue ceded to external parties, per member per month increased as a result of the rate increases from the annual competitive bid filings for our Medicare Advantage products as well as from increases in risk factor adjustment scores for our Medicare Advantage products. With the effect of the ceded revenue being included in the premium yield, the Medicare Advantage risk premium yields per member per month for the six month period ending June 30 decreased to $747.36 in 2008 from $802.97 in 2007. The decrease is a result of a larger portion of our Medicare PFFS business in 2008 being ceded to external parties through quota share arrangements. This average premium yield decrease was partially offset by the annual competitive bid filings and risk factor scores noted above.

Part D premium yields for the six month period ending June 30, 2008 excluding the effect of CMS risk sharing premium adjustments and revenue ceded to external parties, have declined in 2008 compared to 2007 primarily due to the annual competitive bid filings for our Part D products as well as the mix of products sold. Including the effect of the CMS risk sharing premium adjustments as well as the ceded revenue, the yields were $92.60 in 2008 compared to $99.26 in 2007.

When reviewing the premium yield for Medicare Advantage and Part D business, adjusting for the ceded revenue is useful for comparisons to competitors that may not have similar ceding arrangements. When reviewing the Medicare Part D business, adjusting for the risk share amounts is useful to understand the results of the Part D business because of our expectation that the risk sharing revenue will eventually be insignificant on a full year basis.

Medicaid premium yields increased for the quarter and six month 2008 periods as a result of a rate increase in Missouri, our largest Medicaid market, effective July 1, 2007, as well as the inclusion in our results of Vista, which has a higher Medicaid premium yield.

The decrease in gross margin for the quarter ended June 30, 2008 was driven by increased medical costs associated with our Medicare PFFS business in 2008. This decrease is partially offset by higher gross margins for our Medicaid HMO and Individual businesses associated with the membership growth, both organic and acquired, as discussed above. Medicare Part D medical costs as a percentage of premium revenue have increased over the prior year quarter as a result of a widening of the risk corridors and growth in our low-income auto-assign population in 2008. Medicaid medical costs as a percentage of premium revenue decreased over the prior year quarter as a result of the premium yield increases discussed above.

Specialty Division

Quarters and Six Months Ended June 30, 2008 and 2007

Specialty Division revenue increased primarily as a result of the acquisition of Concentra during the second quarter of 2007, as well as continued organic growth in our workers’ compensation services business. The increase was also a result of the acquisition of MHNet in the first quarter of 2008 and to a lesser extent the acquisition of GDS in the second quarter of 2008.

Specialty Division gross margin increased during the quarter and six month 2008 periods as a result of the revenue increases discussed above partially offset by an increase in medical costs and costs of sales associated with the revenue growth.

Liquidity and Capital Resources

Liquidity

Our investment guidelines require our fixed income securities to be investment grade in order to provide liquidity to meet future payment obligations and minimize the risk to the principal. The fixed income portfolio includes government and corporate securities with an average quality rating of “AA+” and a modified duration of 3.8 years as of June 30, 2008. Typically, the amount and duration of our short-term assets are more than sufficient to pay for our short-term liabilities, and we do not anticipate that sales of our long-term investment portfolio will be necessary to fund our claims liabilities.