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, 2007

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, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act (check one).

Large accelerated filer x Accelerated filer o Non-accelerated filer o

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

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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.

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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.

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COVENTRY HEALTH CARE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

See accompanying notes to the condensed consolidated financial statements.

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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 have been omitted pursuant to applicable rules and regulations of the Securities and Exchange Commission. The results of operations for the interim periods reported herein are not necessarily indicative of results to be expected for the full year. 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 most recent Annual Report on Form 10–K for the year ended December 31, 2006.

Cost of Sales

Cost of sales is a new line on our statements of operations this quarter and is a direct result of the Concentra, Inc. (“Concentra”) acquisition. Cost of sales consists of the expense for prescription drugs provided by the Company’s workers’ compensation pharmacy benefit manager and for the independent medical examinations performed by physicians on injured workers. These costs are associated with fee-based products and this amount excludes the cost of drugs related to our risk products which are recorded in medical costs.

Recent Accounting Pronouncements

In May 2007, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (“FSP”) FIN 48-1 Definition of Settlement in FASB Interpretation No. 48 (FSP FIN 48-1). FSP FIN 48-1 provides guidance on how to determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. FSP FIN 48-1 is effective retroactively to January 1, 2007. The implementation of this standard did not have a material impact on our consolidated financial position or results of operations.

Effective February 1, 2007, the Company completed its purchase of approximately 26,500 members from FirstGuard Health Plan Missouri, Inc., a wholly-owned subsidiary of Centene Corporation.

On April 2, 2007, the Company completed its acquisition of the workers’ compensation managed care services businesses of Concentra in an all-cash transaction for approximately $387.5 million. Included in the assets acquired was $304.4 million in goodwill and $70.9 million of identifiable intangibles, subject to amortization, consisting of customer lists and a provider network with a weighted average useful life of 11.7 years. Under the terms of the agreement between the Company and Concentra, the Company acquired Concentra’s workers’ compensation preferred provider organization (“PPO”), provider bill review, pharmacy benefit management, field case management, telephonic case management and independent medical exam businesses.

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D.      DEBT

The Company’s outstanding debt as of June 30, 2007, and December 31, 2006, consists of the following (in thousands):

On February 15, 2007, the Company redeemed all $170.5 million of its outstanding 8.125% Senior Notes due February 15, 2012. The Company redeemed the notes at a redemption price equal to 104.1% of the principal amount plus interest accrued on the redemption date. As a result of the redemption, the Company recognized $6.9 million of interest expense for the premium paid on redemption and wrote off $2.2 million of deferred financing costs related to the senior notes. The funds for payment of the redemption price were provided by cash on hand.

On March 20, 2007, the Company completed the sale of $400 million aggregate principal amount of its 5.95% Senior Notes due March 15, 2017 (the “Notes”) at the issue price of 99.63% per Note. The Notes were offered and sold by the Company pursuant to its automatic shelf registration statement and are now registered with the Securities and Exchange Commission. The notes are senior unsecured obligations of Coventry and rank equally with all of its other senior unsecured indebtedness.

The Company’s senior notes and credit facilities require compliance with specified financial ratios and contain certain covenants and restrictions regarding incurring additional debt, limiting dividends or other restricted payments, restricting transactions with affiliates, disposing of assets and consolidations or mergers. The Company has complied with all ratios and covenants under the senior notes and credit facilities.

See Note L for additional information related to the credit facilities.

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. This lawsuit was filed by a group of physicians as a class action against Coventry and nine other companies in the managed care industry. The plaintiffs alleged violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”), conspiracy to violate RICO and aiding and abetting a scheme to violate RICO. In addition to these federal law claims, the complaint included state law claims for breach of contract, violations of various state prompt payment laws and equitable claims for unjust enrichment and quantum meruit. The trial court dismissed several of the state law claims and ordered all physicians who had an arbitration provision in their provider contracts to submit their direct RICO claims and their remaining state law claims to arbitration. As a consequence of this ruling, the plaintiffs who had arbitration provisions voluntarily dismissed their claims that were subject to arbitration. In its order, the trial court also held that the plaintiffs’ claims of (1) conspiracy to violate RICO and (2) aiding and abetting violations of RICO were not subject to arbitration. The trial court then certified various subclasses of plaintiffs with respect to these two federal law claims.

Seven defendants entered into settlement agreements with the plaintiffs, which received final approval from the trial court. On June 16, 2006, the trial court filed an order in the Shane lawsuit which granted summary judgment on all claims in favor of the Company. The trial court also granted summary judgment on all claims in favor of two other defendants. The plaintiffs appealed the trial court’s summary judgment order to the Eleventh Circuit Court of Appeals. By an order dated June 13, 2007, the Eleventh Circuit affirmed the trial court’s order granting summary judgment in favor of the Company. 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 have been designated as “tag-along” actions. The trial court has entered an order which has stayed all proceedings in the tag-along actions. Although the Company can not predict the outcome, management believes that the tag-along actions will not have a material adverse effect on its financial position or its results of operations. Management also believes that the claims asserted in these lawsuits are without merit and the Company intends to defend its position.

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Stock Options

The Company granted 1.9 million stock options during the current quarter. The Company recorded $9.3 million and $17.2 million of compensation expense related to stock options in its statement of operations for the three and six months ended June 30, 2007, respectively. The total intrinsic value of options exercised was $21.5 million and $14.7 million for the quarters ended June 30, 2007 and 2006, respectively, and $52.8 million and $32.1 million for the six months ended June 30, 2007 and 2006, respectively. As of June 30, 2007, there was $85.5 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 2.8 years.

The following table summarizes stock option activity for the six months ended June 30, 2007:

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 2007 to derive the assumptions used in the valuation model is consistent with that used in 2006. The following average values and weighted-average assumptions were used for option grants:

Restricted Stock Awards

The Company awarded 0.6 million shares of restricted stock in the current quarter. The value of the restricted shares is amortized over various vesting periods through 2011. The Company recorded compensation expense related to restricted stock grants, including restricted stock granted in prior periods, of approximately $7.6 million and $6.4 million for the quarters ended June 30, 2007 and 2006, respectively, and $14.4 million and $12.6 million for the six months ended June 30, 2007 and 2006, respectively. The total unrecognized compensation cost related to the restricted stock was $60.5 million at June 30, 2007, and is expected to be recognized over a weighted average period of 2.4 years. The total fair value of shares vested during the six months ended June 30, 2007 and 2006 was $35.8 million and $33.3 million, respectively.

The following table summarizes restricted stock award activity for the six months ended June 30, 2007:

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In February 2007, 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 7.9 million shares. Under the share repurchase program, the Company purchased 2.5 million shares and 6.5 million shares of the Company’s common stock during the three and six months ended June 30, 2007, at an aggregate cost of $148.9 million and $370.2 million, respectively. As of June 30, 2007, the total remaining number of common shares the Company is authorized to repurchase under this program is 7.5 million.

In July 2006, the Financial Accounting Standards Board (FASB) issued "Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes--an Interpretation of FASB Statement No. 109", which clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109. FIN 48 prescribes a more-likely-than-not threshold for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. For a tax benefit to be recognized, a tax position must be more likely than not to be sustained upon examination by applicable taxing authorities. The benefit recognized is the amount that has a greater than 50% likelihood of being realized upon final settlement of the tax position. The Company adopted FIN 48 effective January 1, 2007. The change in net assets, because of applying this pronouncement, is considered a change in accounting principle with the cumulative effect of the change required to be treated as an adjustment to the opening balance of retained earnings.

The cumulative effect of implementing FIN 48 was a decrease of $3.4 million in reserves for uncertain tax positions, which was accounted for as an increase to the beginning balance of retained earnings. As of the effective date of January 1, 2007, the balance of the Company’s total gross unrecognized tax benefit was $26.6 million, of which $15.1 million would affect the effective income tax rate if recognized. Interest and penalties accrued as of January 1, 2007, net of related tax benefit was $6.2 million.

Penalties and tax-related interest expense are reported as a component of income tax expense. As of June 30, 2007, the total amount of income tax-related accrued interest and penalties, net of related tax benefit, included in income tax expense was $2.2 million.

Coventry Health Care, Inc. and its subsidiaries are subject to U.S. federal income tax as well as state and local income tax in various jurisdictions. Tax years 2003-2006 remain open to examination by these tax jurisdictions. The Company believes appropriate provisions for all outstanding issues have been made for all jurisdictions and all open years.

Comprehensive income was as follows (in thousands):

The unrealized loss on the Company’s investment portfolio for the quarter and six months ended June 30, 2007 was primarily a result of an increasing interest rate environment during the second quarter.

Earnings Per Share - Basic earnings per share are based on the weighted average number of common shares outstanding during the year. Diluted earnings per share assume the exercise of all options and the vesting of all restricted stock using the treasury stock method. Potential common stock equivalents to purchase 3.3 million and 3.8 million shares for the quarters ended June 30, 2007 and 2006, respectively, and 3.2 million and 0.4 million shares for the six months ended June 30, 2007 and 2006, respectively, were excluded from the computation of diluted earnings per share because the potential common stock equivalents were anti-dilutive.

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Other Income - Other income includes interest income of $33.0 million and $23.0 million for the quarters ended June 30, 2007 and 2006, respectively, and $65.8 million and $43.9 million for the six months ended June 30, 2007 and 2006, respectively.

In an effort to further integrate the First Health business acquired in January of 2005, the Company has realigned into new operating units which are based on the product sold. The Company’s new organizational structure capitalizes on existing synergies and brings enhanced focus on areas of growth opportunities. As a result of the new organizational structure, the Company’s reportable segments have changed. The Company has three reportable segments: Commercial, Individual Consumer & Government, and Specialty. Each of the Company’s three new segments is managed separately and separate operating results are available that are evaluated by the chief operating decision maker. The Commercial Business 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, Federal Employees Health Benefit Plans (FEHBP), and Network Rental businesses. 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.

The Commercial Business Division provides commercial HMO, PPO and POS products to a cross section of employer groups of all sizes through its health plans. HMO products provide comprehensive health care benefits to members primarily through a primary care physician. PPO and POS products permit members to participate in managed care but allow them the flexibility to utilize out-of-network providers in exchange for increased out-of-pocket costs. Additionally, the Commercial Business Division provides network rental services and other managed care products through a national PPO network to national, regional and local third party administrators and insurance carriers.

The Individual Consumer & Government Division provides comprehensive health benefits to members participating in the Medicare Advantage HMO, Medicare Advantage PPO, Medicare Advantage Private-Fee-For-Service, Medicare Prescription Drug, and Medicaid programs and receives premium payments from federal and state governments. This division also provides commercial fully-insured managed care services on an individual basis and offers products and services more specialized to the needs of state governments such as pharmacy benefit management, clinical management and fiscal intermediary services on a fee-for-service basis.

The Specialty Business Division currently provides workers’ compensation managed care services on a fee-based basis, including access to our provider network, pharmacy benefits management, field case management, telephonic case management, independent medical exam and bill review capabilities. This division includes the workers’ compensation managed care services businesses acquired from Concentra on April 2, 2007. See Note B to the Condensed Consolidated Financial Statements for additional information related to the Concentra acquisition.

The Company evaluates performance and allocates resources based on gross margin. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in Footnote A in Item 8 of the Company’s 10-K for the year ended December 31, 2006.

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The table below summarizes the Company’s reportable segments (in thousands) through gross margin and includes a medical loss ratio (“MLR”) calculation. “Other” represents the elimination of fees charged between segments. Disclosure of total assets by reportable segment has not been included; as such assets are not reported on a segment basis internally by the Company and are not reviewed separately by the Company’s chief operating decision maker.

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On July 2, 2007, the Company completed its acquisition of certain group health insurance businesses from Mutual of Omaha for approximately $120.0 million in an all-cash transaction. Under the terms of the agreement, the Company acquired Mutual of Omaha’s commercial employer group health business in Nebraska and Iowa as well as its national Federal Employees Health Benefits (FEHB) administration business, representing approximately 215,000 members in total.

On July 6, 2007, the Company signed a definitive agreement to acquire Florida Health Plan Administrators, LLC, owner of Vista Healthplans, for an aggregate purchase price of approximately $685.0 million, subject to certain adjustments. The closing of the Vista acquisition, which is expected to occur by year-end, is subject to closing conditions, regulatory and other customary approvals. Vista is a privately-owned, Florida-based diversified health plan serving approximately 295,000 members consisting of 153,000 commercial employer group members, 33,000 individual members, 26,000 Medicare Advantage HMO members and 83,000 state program members comprised of Medicaid and Healthy Kids. Approximately 85% of the membership is in the south Florida market with the remainder in north central Florida and the state’s panhandle.

On July 11, 2007, the Company executed an Amended and Restated Credit Agreement. The Credit Agreement provides for a five-year revolving credit facility in the principal amount of $850.0 million, with the Company having the ability to request an increase in the facility amount up to an aggregate principal amount not to exceed $1.0 billion. The obligations under the Credit Agreement are general unsecured obligations of the Company. The Company drew $80.0 million under the credit facility to pay off the Company’s $80.0 million five-year term loan.

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

Quarters Ended June 30, 2007 and 2006

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, 2006. Actual operations and results may differ materially from those expressed in this Form 10–Q.

The following discussion and analysis relates to our financial condition and results of operations for the quarters ended June 30, 2007 and 2006. 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, 2006, including the critical accounting policies discussed therein.

Summary of Second Quarter 2007 Performance  

Acquisitions

Effective February 1, 2007, we completed our purchase of approximately 26,500 members from FirstGuard Health Plan Missouri, Inc., a wholly-owned subsidiary of Centene Corporation.

On April 2, 2007, the Company completed its acquisition of the workers’ compensation managed care services businesses of Concentra, Inc. (“Concentra”) in an all-cash transaction for approximately $387.5 million. Included in the assets acquired was $304.4 million in goodwill and $70.9 million of identifiable intangibles, subject to amortization, consisting of customer lists and a provider network with a weighted average useful life of 11.7 years. Under the terms of the agreement between the Company and Concentra, the Company acquired Concentra’s workers’ compensation PPO, provider bill review, pharmacy benefit management, field case management, telephonic case management and independent medical exam businesses.

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Membership

The following tables present our membership as of June 30, 2007 and 2006 (amounts in thousands).

Commercial membership decreased from the prior year quarter. Within that decrease, a portion of the members transferred from our risk product to our ASO product.

Individual Consumer & Government membership increased from the prior year quarter primarily due to our new Medicare Private-Fee-For-Service (“PFFS”) product and additional Medicare Part D members. Commencing January 1, 2007, we offered Medicare Advantage Private Fee for Service plans to individuals in 43 states under the name Advantra Freedom. The increase in membership related to PFFS was 125,000 during the six months ended June 30, 2007.

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Results of Operations

Consolidated Financial Results

The following table is provided to facilitate a more meaningful discussion regarding the comparison of our operations for the quarters and six months ended June 30, 2007 and 2006 (in thousands, except EPS and membership).

Quarters Ended June 30, 2007 and 2006

Managed care premium revenue increased as a result of growth in our Individual Consumer and Government Business division. This growth is primarily a result of new membership from our new Medicare Private-Fee-For-Service products and additional members in both our Medicare Part D and Medicare Advantage products. Additionally, we completed an acquisition of Medicaid membership in our Missouri market effective February 1, 2007. Partially offsetting the increase was a decline of managed care premium revenue in our Commercial Business division as a result of a decline in membership over the prior year quarter.

Management services revenue increased compared to the prior year quarter as a result of the acquisition of Concentra. This increase is partially offset by a decline of management services revenue in our Commercial division, primarily as a result of membership losses in our National Accounts business.

Medical costs increased almost exclusively as a result of new business in our Individual Consumer and Government Business division discussed above. Medical costs as a percentage of premium revenue decreased 0.4% compared with the prior year quarter. This decrease is primarily a result of the improved performance of our Medicare Part D and Medicare Advantage business over the prior year quarter.

Cost of sales is a new line on our statements of operations this quarter and is a direct result of the Concentra acquisition. Cost of sales consists of the expense for prescription drugs provided by our workers’ compensation pharmacy benefit manager and for the independent medical examinations performed by physicians on injured workers. These costs are associated with fee-based products and this amount excludes the cost of drugs related to our risk products recorded in medical costs.

Selling, general and administrative expense increased primarily due to normal operating costs of the recent acquisition of Concentra as well as costs related to the new Medicare Private-Fee-For-Service business in 2007. The additional Medicare Private-Fee-For-Service costs are primarily made up of sales commissions paid to brokers, but also include wages and other enrollment costs. The increase in total selling, general and administrative expense is also attributable to increased salary and benefit expense as we position for future growth and as a result of normal annual compensation increases.

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Depreciation and amortization increased primarily as a result of the expense associated with the fixed assets and identifiable intangible assets acquired with the acquisition of Concentra as well as a result of an increase in property and equipment over the past twelve months.

Interest expense increased as a result of the issuance during the first quarter of 2007 of the $400 million 5.95% Senior Notes due 2017 and is partially offset by the redemption, also during the first quarter of 2007, of all $170.5 million 8.125% senior notes due February 15, 2012.

Other income increased primarily as a result of a larger investment portfolio.

Our provision for income taxes increased due to an increase in earnings. The effective tax rate was 37.5% in the second quarter of 2007 compared to 37.7% for the same period in 2006.

Six Months Ended June 30, 2007 and 2006

Managed care premium revenue increased as a result of growth in our Individual Consumer and Government Business division described above. Additionally, we completed an acquisition of Medicaid membership in our Missouri market effective February 1, 2007. Partially offsetting the increase was a decline of managed care premium revenue in our Commercial Business division, also described above.

Management services revenue increased compared to the prior year quarter as a result of the acquisition of Concentra. This increase is partially offset by a decline of management services revenue in our Commercial division, primarily as a result of membership losses in our National Accounts business.

Medical costs increased almost exclusively as a result of new business in our Individual Consumer and Government Business division discussed above. Medical costs as a percentage of premium revenue were unchanged from prior year period.

Medical expenses for the six months ended June 30, 2007, include approximately $111.8 million of favorable medical cost development related to prior calendar years. The favorable development in 2007 is a result of $94.8 million of lower than anticipated medical cost increases and $17.0 million higher than expected completion factors. Comparatively, medical expenses for the six months ended June 30, 2006, included approximately $116.9 million of favorable medical cost development related to prior calendar years. The favorable development during 2006 was larger as a result of the uncertainties at December 31, 2005 regarding our Louisiana operations and the effects from Hurricane Katrina. For the full-year 2006, we experienced favorable development of $130.9 million related to prior year reserves. For 2007, on a full-year basis, we expect favorable development to be slightly lower than that recorded in 2006.

Selling, general and administrative expense increased primarily due to normal operating costs of the recent acquisition of Concentra as well as costs related to the new Medicare Private-Fee-For-Service business in 2007. The increase in total selling, general and administrative expense is also attributable to increased salary and benefit expense as we position for future growth and as a result of normal annual compensation increases.

Depreciation and amortization increased as a result of the expense associated with the fixed assets and identifiable intangible assets acquired with the acquisition of Concentra as well as a result of an increase in property and equipment over the past twelve months.

Interest expense increased primarily as a result of the redemption during the first quarter of 2007 of all $170.5 million of our outstanding 8.125% senior notes due February 15, 2012. The Company redeemed the notes at a redemption price equal to 104.1% of the principal amount plus interest accrued on the redemption date. As a result of the redemption, we recognized $6.9 million of interest expense for the premium paid on redemption and wrote off $2.2 million of deferred financing costs related to the senior notes.

Other income increased primarily as a result of a larger investment portfolio.

Our provision for income taxes increased due to an increase in earnings. The effective tax rate decreased to 37.2% compared to 37.5% for the same period in 2006 primarily as a result of a change in the proportion of Company earnings to states with lower tax rates.

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Business Segments

In an effort to further integrate the First Health business acquired in January of 2005, we have realigned into new operating units which are based on the product sold. Our new organizational structure capitalizes on existing synergies and brings enhanced focus on areas of growth opportunities. As a result of the new organizational structure, our reportable segments have changed. Each of our three new segments is managed separately and separate operating results are available that are evaluated by the chief operating decision maker. The Commercial Business 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, FEHBP, and Network Rental businesses. The Individual Consumer & Government Division contains the individual consumer products and all Medicare and Medicaid products. The Specialty Division currently includes our workers’ compensation services businesses. For additional detail regarding the Company’s segments, please refer to Note K to the Condensed Consolidated Financial Statements located in Part I, Item 1 of this Form 10–Q.

Operating Revenues (in thousands)