UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

Commission File Number: 001-32739

HealthSpring, Inc.

(Exact Name of Registrant as Specified in Its Charter)

Delaware		20-1821898
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
9009 Carothers Parkway
Suite 501
Franklin, Tennessee		37067
(Address of Principal Executive Offices)		(Zip Code)

(615) 291-7000
(Registrant’s Telephone Number, Including Area Code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o      No o

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

		Outstanding at July 31, 2009
Common Stock, Par Value $0.01 Per Share		57,578,469 Shares

 

 

TABLE OF CONTENTS

		Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at June 30, 2009 and December 31, 2008			1
Condensed Consolidated Statements of Income for the three and six months ended June 30, 2009 and 2008			2
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2009 and 2008			3
Notes to Condensed Consolidated Financial Statements			4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
Item 3. Quantitative and Qualitative Disclosures About Market Risk			32
Item 4. Controls and Procedures			32
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			33
Item 1A. Risk Factors			33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			34
Item 3. Defaults Upon Senior Securities			34
Item 4. Submission of Matters to a Vote of Security Holders			34
Item 5. Other Information			34
Item 6. Exhibits			34
EX-10.1
EX-10.2
EX-31.1
EX-31.2
EX-32.1
EX-32.2

Part I — FINANCIAL INFORMATION

Item 1:		Financial Statements

HEALTHSPRING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

		June 30,				December 31,
		2009				2008
Assets
Current assets:
Cash and cash equivalents		$	295,010			$	282,240
Accounts receivable, net			139,741				74,398
Investment securities available for sale			3,049				3,259
Investment securities held to maturity			24,812				24,750
Funds due for the benefit of members			38,617				40,212
Deferred income taxes			6,303				4,198
Prepaid expenses and other			9,438				6,560
Total current assets			516,970				435,617
Investment securities available for sale			24,095				30,463
Investment securities held to maturity			32,330				20,086
Property and equipment, net			26,397				26,842
Goodwill			590,016				590,016
Intangible assets, net			212,775				221,227
Restricted investments			15,379				11,648
Risk corridor receivable from CMS			21,839				—
Other			17,592				8,878
Total assets		$	1,457,393			$	1,344,777
Liabilities and Stockholders’ Equity
Current liabilities:
Medical claims liability		$	221,459			$	190,144
Accounts payable, accrued expenses and other current liabilities			25,800				35,050
Risk corridor payable to CMS			2,656				1,419
Current portion of long-term debt			28,724				32,277
Total current liabilities			278,639				258,890
Deferred income taxes			85,406				89,615
Long-term debt, less current portion			222,611				235,736
Funds held for the benefit of members			51,934				—
Other long-term liabilities			9,726				9,658
Total liabilities			648,316				593,899
Stockholders’ equity:
Common stock, $0.01 par value, 180,000,000 shares authorized, 58,106,776 shares issued and 54,911,801 outstanding at June 30, 2009, 57,811,927 shares issued and 54,619,488 outstanding at December 31, 2008			581				578
Additional paid in capital			509,579				504,367
Retained earnings			347,673				295,170
Accumulated other comprehensive loss, net of tax			(1,423	)			(1,955	)
Treasury stock, at cost, 3,194,975 shares at June 30, 2009 and 3,192,439 shares at December 31, 2008			(47,333	)			(47,282	)
Total stockholders’ equity			809,077				750,878
Total liabilities and stockholders’ equity		$	1,457,393			$	1,344,777

See accompanying notes to condensed consolidated financial statements.

HEALTHSPRING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share data)
(unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
Revenue:
Premium revenue		$	671,450			$	554,667			$	1,306,046			$	1,095,558
Management and other fees			9,987				8,842				19,956				15,850
Investment income			1,106				3,365				2,656				8,175
Total revenue			682,543				566,874				1,328,658				1,119,583
Operating expenses:
Medical expense			558,403				436,157				1,088,002				880,339
Selling, general and administrative			62,306				55,979				134,557				118,879
Depreciation and amortization			7,642				6,985				15,166				14,233
Interest expense			3,970				4,590				8,251				9,993
Total operating expenses			632,321				503,711				1,245,976				1,023,444
Income before income taxes			50,222				63,163				82,682				96,139
Income tax expense			(18,331	)			(22,941	)			(30,179	)			(34,859	)
Net income		$	31,891			$	40,222			$	52,503			$	61,280
Net income per common share:
Basic		$	0.59			$	0.72			$	0.96			$	1.09
Diluted		$	0.58			$	0.72			$	0.96			$	1.09
Weighted average common shares outstanding:
Basic			54,497,780				55,863,208				54,490,155				56,361,007
Diluted			54,770,212				55,959,111				54,794,251				56,460,143

See accompanying notes to condensed consolidated financial statements.

HEALTHSPRING, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

		Six Months Ended
		June 30,
		2009				2008
Cash flows from operating activities:
Net income		$	52,503			$	61,280
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization			15,166				14,233
Stock-based compensation			5,158				4,485
Amortization of deferred financing cost			1,203				1,241
Equity in earnings of unconsolidated affiliate			(103	)			(200	)
Deferred tax benefit			(6,585	)			(3,468	)
Increase (decrease) in cash due to:
Accounts receivable			(75,159	)			(122,813	)
Prepaid expenses and other current assets			(2,734	)			(446	)
Medical claims liability			31,315				41,504
Accounts payable, accrued expenses, and other current liabilities			(9,246	)			15,837
Risk corridor payable to/receivable from CMS			(20,602	)			(17,930	)
Other			654				(995	)
Net cash used in operating activities			(8,430	)			(7,272	)
Cash flows from investing activities:
Additional consideration paid on acquisition			(910	)			—
Purchases of property and equipment			(5,502	)			(3,838	)
Purchases of investment securities			(28,687	)			(31,758	)
Maturities of investment securities			23,174				40,115
Purchases of restricted investments			(10,123	)			(4,510	)
Maturities of restricted investments			6,392				3,951
Distributions to affiliates			—				124
Net cash (used in) provided by investing activities			(15,656	)			4,084
Cash flows from financing activities:
Funds received for the benefit of the members			325,004				249,014
Funds withdrawn for the benefit of members			(271,476	)			(219,838	)
Payments on long-term debt			(16,678	)			(17,371	)
Proceeds from stock options exercised			6				288
Purchase of treasury stock			—				(28,344	)
Net cash provided by (used in) financing activities			36,856				(16,251	)
Net increase (decrease) in cash and cash equivalents			12,770				(19,439	)
Cash and cash equivalents at beginning of period			282,240				324,090
Cash and cash equivalents at end of period		$	295,010			$	304,651
Supplemental disclosures:
Cash paid for interest		$	7,329			$	8,346
Cash paid for taxes		$	37,749			$	33,909

See accompanying notes to condensed consolidated financial statements

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     (1) Organization and Basis of Presentation

     HealthSpring, Inc., a Delaware corporation (the “Company”), was organized in October 2004 and began operations in March 2005 in connection with a recapitalization transaction accounted for as a purchase. The Company is one of the country’s largest coordinated care plans whose primary focus is on Medicare, the federal government sponsored health insurance program for United States citizens aged 65 and older, qualifying disabled persons, and persons suffering from end-stage renal disease. Through its health maintenance organization (“HMO”) and regulated insurance subsidiaries, the Company operates Medicare Advantage health plans in the states of Alabama, Florida, Illinois, Mississippi, Tennessee, and Texas and offers Medicare Part D prescription drug plans on a national basis. The Company also provides management services to health plans and physician partnerships.

     The accompanying condensed consolidated financial statements are unaudited and should be read in conjunction with the consolidated financial statements and notes thereto of HealthSpring, Inc. as of and for the year ended December 31, 2008, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 as filed with the Securities and Exchange Commission (the “SEC”) on February 25, 2009 (the “2008 Form 10-K”).

     The accompanying unaudited condensed consolidated financial statements reflect the Company’s financial position as of June 30, 2009, the Company’s results of operations for the three and six months ended June 30, 2009 and 2008 and cash flows for the six months ended June 30, 2009 and 2008. Certain 2008 amounts have been reclassified to conform to the 2009 presentation.

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Accordingly, certain information and footnote disclosures normally included in complete financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations applicable to interim financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (including normally recurring accruals) necessary to present fairly the Company’s financial position at June 30, 2009, and its results of operations for the three and six months ended June 30, 2009 and 2008, and its cash flows for the six months ended June 30, 2009 and 2008.

     The results of operations for the 2009 interim period are not necessarily indicative of the operating results that may be expected for the year ending December 31, 2009. Subsequent events have been evaluated through August 4, 2009, the date of the issuance of the Company’s condensed consolidated financial statements.

     The preparation of the condensed consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the period. The most significant item subject to estimates and assumptions is the actuarial calculation for obligations related to medical claims. Other significant items subject to estimates and assumptions include the Company’s estimated risk adjustment payments receivable from The Centers for Medicare & Medicaid Services (“CMS”), the valuation of goodwill and intangible assets, the useful life of definite-lived assets, the valuation of debt securities carried at fair value, and certain amounts recorded related to the Part D program. Actual results could differ significantly from those estimates. Illiquid credit markets and volatile equity markets, among other things, have increased the uncertainty inherent in certain estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.

     The Company’s HMO and regulated insurance subsidiaries are restricted from making distributions without appropriate regulatory notifications and approvals or to the extent such distributions would put them out of compliance with statutory net worth requirements or requirements under the Company’s credit facilities. At June 30, 2009, $337.0 million of the Company’s $394.7 million of cash, cash equivalents, investment securities and restricted investments were held by the Company’s HMO and regulated insurance subsidiaries and subject to these dividend restrictions.

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     (2) Recently Adopted Accounting Pronouncements

     In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 establishes a common definition for fair value to be applied to GAAP requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for financial assets and financial liabilities for fiscal years beginning after November 15, 2007. Issued in February 2008, FASB Staff Position (“FSP”) 157-1 “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13” removed leasing transactions accounted for under Statement 13 and related guidance from the scope of SFAS No. 157. FSP 157-2 “Partial Deferral of the Effective Date of Statement 157” (“FSP 157-2”), deferred the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008. The implementation of SFAS No. 157 for financial assets and financial liabilities, effective January 1, 2008, did not have a material impact on the Company’s consolidated financial position and results of operations. The adoption of this statement for nonfinancial assets and nonfinancial liabilities, effective January 1, 2009, did not have a material impact on the Company’s financial statements.

     In December 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS No. 141(R)”). SFAS No. 141(R) will significantly change the accounting for business combinations. Under SFAS No. 141(R), an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS No. 141(R) also includes a substantial number of new disclosure requirements. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008, which is the year beginning January 1, 2009 for us. The adoption of this statement did not have a material effect on the Company’s financial statements. The provisions of SFAS No. 141(R) will only impact the Company if it is party to a business combination that is consummated after January 1, 2009.

     In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS No. 160”). This statement improves the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards that require all entities to report noncontrolling (minority) interests in subsidiaries as equity in the consolidated financial statements. Additionally, SFAS No. 160 requires that entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 affects those entities that have an outstanding noncontrolling interest in one or more subsidiaries or that deconsolidate a subsidiary. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company adopted SFAS No. 160 effective January 1, 2009. The adoption of this statement did not impact the Company’s financial statements.

     In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”). SFAS No. 161 requires enhanced disclosures about an entity’s derivative and hedging activities and is effective for the Company as of the first quarter of fiscal 2009. The adoption of this statement as of January 1, 2009 required additional disclosures related to renewal or extension assumptions, but did not have a material impact on the Company’s financial statements.

     In April 2008, the FASB issued FSP No. FAS 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. FAS 142-3”), which amends the list of factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under SFAS No. 142, “Goodwill and Other Intangible Assets”. The new guidance applies to (1) intangible assets that are acquired individually or with a group of other assets and (2) intangible assets acquired in both business combinations and asset acquisitions. Under FSP No. FAS 142-3, companies estimating the useful life of a recognized intangible asset must consider their historical experience in renewing or extending similar arrangements or, in the absence of historical experience, must consider assumptions that market participants would use about renewal or extension. For the Company, this FSP requires certain additional disclosures beginning January 1, 2009 and application to useful life estimates prospectively for intangible assets acquired after December 31, 2008. The adoption of this FSP did not have a material impact on the Company’s financial statements.

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

          In April 2009, the FASB issued FSP FAS No. 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 107-1 and APB 28-1”). FSP 107-1 and APB 28-1 require disclosures about fair value of financial instruments for interim reporting periods as well as in annual financial statements. The adoption of FSP 107-1 and APB 28-1 as of the quarter ending June 30, 2009 required additional disclosures, but did not have a material impact on the Company’s financial statements.

          In April 2009, the FASB issued FSP No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”, (“FSP 157-4”). FSP 157-4 provides additional guidance to highlight and expand on the factors that should be considered in estimating fair value when there has been a significant decrease in market activity for a financial asset. This FSP also requires new disclosures relating to fair value measurement inputs and valuation techniques (including changes in inputs and valuation techniques). The adoption of FSP 157-4, as of the quarter ending June 30, 2009 did not impact the Company’s financial statements.

          In April 2009, the FASB issued FSP No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP 115-2 and FAS 124-2”). FSP 115-2 and FAS 124-2 amends current other-than-temporary impairment guidance in GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. The FSP applies to fixed maturity securities only and requires separate display of losses related to credit deterioration and losses related to other market factors. The adoption of FSP 115-2 and FAS 124-2, as of June 30, 2009 did not impact the Company’s financial statements.

     In June 2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS No. 165”). SFAS No. 165 establishes general standards for accounting for and disclosure of events that occur after the balance sheet date but before financial statements are available to be issued (“subsequent events”). More specifically, SFAS No. 165 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition in the financial statements, identifies the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that should be made about events or transactions that occur after the balance sheet date. See Note 1, “Organization and Basis of Presentation” for the related disclosures. The adoption of SFAS No. 165 in the second quarter of 2009 did not impact the Company’s financial statements.

     (3) Accounts Receivable

     Accounts receivable at June 30, 2009 and December 31, 2008 consisted of the following (in thousands):

		June 30,				December 31,
		2009				2008
Medicare premium receivables		$	100,265			$	31,535
Rebates			37,350				25,603
Due from providers			13,468				17,409
Other			2,004				1,871
		$	153,087			$	76,418
Allowance for doubtful accounts			(3,530	)			(2,020	)
Total (including non-current receivables)		$	149,557			$	74,398

     Medicare premium receivables at June 30, 2009 include $94.0 million for receivables from CMS related to the accrual of retroactive risk adjustment payments (including $9.8 million which will not be paid until the second half of 2010 and which is classified as non-current and included in other assets on the Company’s balance sheet). Subsequent to June 30, 2009, the Company received retroactive risk payments from CMS of $88.2 million, consisting of the Initial CMS Settlement (as defined below) for the 2009 plan year and Final CMS Settlement (as defined below) amounts for the 2008 plan year.

     The Company’s Medicare premium revenue is subject to adjustment based on the health risk of its members. This process for adjusting premiums is referred to as the CMS risk adjustment payment methodology. Under the risk adjustment payment

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

methodology, coordinated care plans must capture, collect, and report diagnosis code information to CMS. After reviewing the respective submissions, CMS establishes the payments to Medicare plans generally at the beginning of the calendar year, and then adjusts premiums on two separate occasions on a retroactive basis.

     The first retroactive risk premium adjustment for a given fiscal year generally occurs during the third quarter of such fiscal year. This initial settlement (the “Initial CMS Settlement”) represents the updating of risk scores for the current year based on updated diagnoses from the prior year. CMS then issues a final retroactive risk premium adjustment settlement for that fiscal year in the following year (the “Final CMS Settlement”).

     All such estimated amounts are periodically updated as additional diagnosis code information is reported to CMS and are adjusted to actual amounts when the ultimate settlements are known to the Company.

     During the 2009 second quarter, the Company updated its estimated Final CMS Settlement payment amounts for 2008 as a result of receiving notification in July 2009 from CMS of Final CMS Settlements for 2008. The change in estimate related to the 2008 plan year resulted in an additional $7.9 million of premium revenue in the second quarter of 2009. The impact of the change in estimate during 2009 relating to the 2008 plan year on net income, after the expense for risk sharing with providers and income tax expense, for the three and six months ended June 30, 2009, was $2.6 million and $2.1 million, respectively. Similarly, the impact of the change in estimate related to the 2007 plan year resulted in an additional $17.3 million and $29.3 million of premium revenue for the three and six months ended June 30, 2008, respectively. The resulting impact of such changes on net income, after the expense for risk sharing with providers and income tax expense, for the three and six months ended June 30, 2008, was $8.1 million and $13.4 million, respectively.

     Rebates for drug costs represent estimated rebates owed to the Company from prescription drug companies. The Company has entered into contracts with certain drug manufacturers which provide for rebates to the Company based on the utilization of specific prescription drugs by the Company’s members. Accounts receivable relating to unpaid health plan enrollee premiums are recorded during the period the Company is obligated to provide services to enrollees and do not bear interest. The Company does not have any off-balance sheet credit exposure related to its health plan enrollees. Due from providers primarily includes management fees receivable as well as amounts owed to the Company for the refund of certain medical expenses paid by the Company under risk sharing agreements.

(4) Investment Securities

     There were no investment securities classified as trading as of June 30, 2009 or December 31, 2008. Investment securities available for sale classified as current assets are as follows (in thousands):

June 30, 2009

December 31, 2008

Gross

Gross

Gross

Gross

Unrealized

Unrealized

Estimated

Unrealized

Unrealized

Estimated

Amortized

Holding

Holding

Fair

Amortized

Holding

Holding

Fair

Cost

Gains

Losses

Value

Cost

Gains

Losses

Value

Municipal bonds

$

3,021

28

—

3,049

$

3,195

64

—

3,259

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     Investment securities available for sale classified as non-current assets are as follows (in thousands):

		June 30, 2009																December 31, 2008
						Gross				Gross												Gross				Gross
						Unrealized				Unrealized												Unrealized				Unrealized
		Amortized				Holding				Holding				Estimated				Amortized				Holding				Holding				Estimated
		Cost				Gains				Losses				Fair Value				Cost				Gains				Losses				Fair Value
Municipal bonds		$	21,151				345				(39	)			21,457			$	24,874				262				(206	)			24,930
Corporate debt securities			2,638				—				—				2,638				5,533				—				—				5,533
		$	23,789				345				(39	)			24,095			$	30,407				262				(206	)			30,463

     Investment securities held to maturity classified as current assets are as follows (in thousands):

		June 30, 2009																December 31, 2008
						Gross				Gross												Gross				Gross
						Unrealized				Unrealized												Unrealized				Unrealized
		Amortized				Holding				Holding				Estimated				Amortized				Holding				Holding				Estimated
		Cost				Gains				Losses				Fair Value				Cost				Gains				Losses				Fair Value
U.S. Treasury securities		$	2,632				5				—				2,637			$	3,649				22				—				3,671
Municipal bonds			1,786				18				—				1,804				1,738				7				—				1,745
Government agencies			11,077				62				—				11,139				10,761				134				—				10,895
Corporate debt securities			9,317				74				(1	)			9,390				8,602				15				(26	)			8,591
		$	24,812				159				(1	)			24,970			$	24,750				178				(26	)			24,902

     Investment securities held to maturity classified as non-current assets are as follows (in thousands):

		June 30, 2009																December 31, 2008
						Gross				Gross												Gross				Gross
						Unrealized				Unrealized												Unrealized				Unrealized
		Amortized				Holding				Holding				Estimated				Amortized				Holding				Holding				Estimated
		Cost				Gains				Losses				Fair Value				Cost				Gains				Losses				Fair Value
Municipal bonds		$	19,269				197				(135	)			19,331			$	7,500				97				(71	)			7,526
Government agencies			3,396				16				—				3,412				3,081				243				—				3,324
Corporate debt securities			9,665				215				(16	)			9,864				9,505				85				(70	)			9,520
		$	32,330				428				(151	)			32,607			$	20,086				425				(141	)			20,370

     There are no realized gains or losses on maturities of investment securities for the three and six months ended June 30, 2009 and 2008.

     Maturities of investments are as follows at June 30, 2009 (in thousands):

		Available for sale								Held to maturity
		Amortized				Estimated				Amortized				Estimated
		Cost				Fair Value				Cost				Fair Value
Due within one year		$	3,021				3,049			$	24,812				24,970
Due after one year through five years			11,298				11,637				26,394				26,686
Due after five years through ten years			1,480				1,484				5,936				5,921
Due after ten years			11,011				10,974				—				—
		$	26,810				27,144			$	57,142				57,577

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     Maturities of investments are as follows at December 31, 2008 (in thousands):

		Available for sale								Held to maturity
		Amortized				Estimated				Amortized				Estimated
		Cost				Fair Value				Cost				Fair Value
Due within one year		$	3,195				3,259			$	24,750				24,902
Due after one year through five years			11,618				11,847				17,508				17,812
Due after five years through ten years			5,048				5,043				1,582				1,511
Due after ten years			13,741				13,573				996				1,047
		$	33,602				33,722			$	44,836				45,272

     Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2009, are as follows (in thousands):

		Less Than								More Than
		12 Months								12 Months								Total
		Unrealized				Fair				Unrealized				Fair				Unrealized				Fair
		Losses				Value				Losses				Value				Losses				Value
Municipal bonds		$	135				7,514				39				996				174				8,510
Corporate debt securities			16				2,294				1				250				17				2,544
Total		$	151				9,808				40				1,246				191				11,054

     The Company reviews fixed maturities and equity securities with a decline in fair value from cost for impairment based on criteria that include duration and severity of decline; financial viability and outlook of the issuer; and changes in the regulatory, economic and market environment of the issuer’s industry or geographic region.

     Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2008, are as follows (in thousands):

		Less Than								More Than
		12 Months								12 Months								Total
		Unrealized				Fair				Unrealized				Fair				Unrealized				Fair
		Losses				Value				Losses				Value				Losses				Value
Municipal bonds		$	277				5,894				—				—				277				5,894
Corporate debt securities			95				10,959				1				299				96				11,258
Total		$	372				16,853				1				299				373				17,152

     Municipal Bonds and Government Agencies: The unrealized gains/losses on investments in municipal bonds were caused by an increase in investment yields as a result of a widening of credit spreads. The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. For periods prior to April 1, 2009, the Company determined that it had the ability and intent to hold these investments until recovery, thus these investments are not considered other-than-temporarily impaired. For periods beginning on or after April 1, 2009, the Company determined that it did not intend to sell these investments and that it was not more-likely-than-not that it would be required to sell these investments prior to their recovery, thus these investments are not considered other-than-temporarily impaired.

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     Corporate Debt Securities: The unrealized losses on corporate debt securities were caused by an increase in investment yields as a result of a widening of credit spreads. The contractual terms of the bonds do not allow the issuer to settle the securities at a price less than the face value of the bonds. For periods prior to April 1, 2009, the Company determined that it had the ability and intent to hold these investments until recovery, thus these investments are not considered other-than-temporarily impaired. For periods beginning on or after April 1, 2009, the Company determined that it did not intend to sell these investments and that it was not more-likely-than-not that it would be required to sell these investments prior to their recovery, thus these investments are not considered other-than-temporarily impaired.

     (5) Fair Value Measurements

     The Company’s 2009 second quarter condensed consolidated balance sheet includes the following financial instruments: cash and cash equivalents, accounts receivable, investment securities, restricted investments, accounts payable, medical claims liabilities, interest rate swap agreements, funds due (held) from CMS for the benefit of members, and long-term debt. The carrying amounts of accounts receivable, funds due (held) from CMS for the benefit of members, accounts payable, and medical claims liabilities approximate their fair value because of the relatively short period of time between the origination of these instruments and their expected realization. The fair value of the Company’s long-term debt (including the current portion) was $237.5 million at June 30, 2009 and consisted solely of non-tradable bank debt.

     Cash and cash equivalents consist of such items as certificates of deposit, commercial paper, and money market funds. The original cost of these assets approximates fair value due to their short-term maturity. The fair value of the Company’s interest rate swap agreements are derived from a discounted cash flow analysis based on the terms of the contract and the interest rate curve. In addition, the Company incorporates credit valuation adjustments to appropriately reflect both its own non-performance or credit risk and the counterparties’ non-performance or credit risk in the fair value measurements. Credit risk under these swap arrangements is believed to be remote as the counterparties to our interest rate swap agreements are major financial institutions and the Company does not anticipate non-performance by the counterparties. The Company has designated its interest rate swaps as cash flow hedges which are recorded in the Company’s consolidated balance sheet at fair value. The fair value of the Company’s interest rate swaps at June 30, 2009 reflected a liability of approximately $2.7 million and is included in other long term liabilities in the accompanying consolidated balance sheet. The fair values available for sale securities is determined by pricing models developed using market data provided by a third party vendor.

     The following are the levels of the hierarchy as defined by SFAS No. 157 and a brief description of the type of valuation information (“inputs”) that qualifies a financial asset for each level:

Level Input		Input Definition
Level I		Inputs are unadjusted quoted prices for identical assets or liabilities in active markets at the measurement date.
Level II		Inputs other than quoted prices included in Level I that are observable for the asset or liability through corroboration with market data at the measurement date.
Level III		Unobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

     When quoted prices in active markets for identical assets are available, the Company uses these quoted market prices to determine the fair value of financial assets and classifies these assets as Level I. In other cases where a quoted market price for identical assets in an active market is either not available or not observable, the Company obtains the fair value from a third party vendor that uses pricing models, such as matrix pricing, to determine fair value. These financial assets would then be classified as Level II. In the event quoted market prices were not available, the Company would determine fair value using broker quotes or an internal analysis of each investment’s financial statements and cash flow projections. In these instances, financial assets would be classified based upon the lowest level of input that is significant to the valuation. Thus, financial assets might be classified in Level III even though there could be some significant inputs that may be readily available.

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     The following table summarizes fair value measurements by level at June 30, 2009 for assets and liabilities measured at fair value on a recurring basis (in thousands):

		Level I				Level II				Level III				Total
Assets
Cash and cash equivalents		$	295,010			$	—			$	—			$	295,010
Investment securities, available for sale:
Municipal bonds			—				24,506				—				24,506
Corporate debt securities			—				2,638				—				2,638
Total investment securities, available for sale:		$	—			$	27,144			$	—			$	27,144
Liabilities
Derivative — interest rate swaps		$	—			$	2,667			$	—			$	2,667

     (6) Medical Liabilities

     The Company’s medical liabilities at June 30, 2009 and December 31, 2008 consisted of the following (in thousands):

		June 30,				December 31,
		2009				2008
Medicare medical liabilities		$	160,879			$	126,762
Pharmacy liabilities			60,580				63,382
Total		$	221,459			$	190,144

     (7) Medicare Part D

     Total Part D related net assets (excluding medical claims payable) of $38,793 at December 31, 2008 all relate to the 2008 CMS plan year. The Company’s Part D related assets and liabilities (excluding medical claims payable) at June 30, 2009 were as follows (in thousands):

		Related to the				Related to the
		2008 plan year				2009 plan year				Total
Current assets (liabilities):
Funds due for the benefit of members		$	38,617			$	—			$	38,617
Risk corridor payable to CMS		$	(2,656	)		$	—			$	(2,656	)
Non-current assets (liabilities):
Risk corridor receivable from CMS		$	—			$	21,839			$	21,839
Funds held for the benefit of members		$	—			$	(51,934	)		$	(51,934	)

     Balances associated with risk corridor amounts are expected to be settled in the second half of the year following the year to which they relate. Current year Part D amounts are routinely updated in subsequent periods as a result of retroactivity.

     (8) Derivatives

     In October 2008, the Company entered into two interest rate swap agreements relating to the floating interest rate component of the term loan agreement under its $400.0 million, five year credit facility (collectively, the “Credit Agreement”). The total notional amount covered by the agreements is $100.0 million of the currently $251.3 million outstanding under the term loan agreement. Under the swap agreements, the Company is required to pay a fixed interest rate of 2.96% and is entitled to receive LIBOR every month until

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

October 31, 2010. The actual interest rate payable under the Credit Agreement in each case contains an applicable margin, which is not affected by the swap agreements. The interest rate swap agreements are classified as cash flow hedges, as defined by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” See Note 5 for a discussion of fair value accounting related to the swap agreements.

     The Company entered into the two interest rate swap derivatives to convert floating-rate debt to fixed-rate debt. The Company’s interest rate swap agreements involve agreements to pay a fixed rate and receive a floating rate, at specified intervals, calculated on an agreed-upon notional amount. The Company’s objective in entering into these financial instruments is to mitigate its exposure to significant unplanned fluctuations in earnings caused by volatility in interest rates. The Company does not use any of these instruments for trading or speculative purposes.

     Derivative instruments used by the Company involve, to varying degrees, elements of credit risk, in the event a counterparty should default, and market risk, as the instruments are subject to interest rate fluctuations.

     All derivatives are recognized on the balance sheet at their fair value. To date, the two derivatives entered into by the Company qualify for and are designated as cash flow hedges. To the extent that the cash flow hedges are effective, changes in their fair value are recorded in other comprehensive income (loss) until earnings are affected by the variability of cash flows of the hedged transaction (e.g. until periodic settlements of a variable asset or liability are recorded in earnings). Any hedge ineffectiveness (which represents the amount by which the changes in the fair value of the derivatives differ from changes in the fair value of the hedged instrument) is recorded in current-period earnings. Also, on a quarterly basis, the Company measures hedge effectiveness by completing a regression analysis comparing the present value of the cumulative change in the expected future interest to be received on the variable leg of its swap against the present value of the cumulative change in the expected future interest payments on its variable rate debt.

     A summary of the aggregate notional amounts, balance sheet location and estimated fair values of derivative financial instruments at June 30, 2009 is as follows (in thousands):

Notional

Estimated Fair Value

Hedging instruments

Amount

Balance Sheet Location

Asset

(Liability)

Interest rate swaps

$

100,000

Other noncurrent liabilities

—

(2,667

)

          A summary of the effect of cash flow hedges on our financial statements is as follows (in thousands):

Effective Portion

Hedge

Gain (Loss)

Income Statement

Reclassified

Pretax Hedge Gain

Location of Gain

from

Ineffective Portion

(Loss) Recognized

(Loss) Reclassified

Accumulated

Income Statement

in Other

from Accumulated

Other

Location of Gain

Comprehensive

Other Comprehensive

Comprehensive

(Loss)

Hedge Gain (Loss)

Type of Cash Flow Hedge

Income

Income

Income

Recognized

Recognized

For the three months ended June 30, 2009:

Interest rate swaps

$

374

Interest Expense

$

—

None

$

—

For the six months ended June 30, 2009:

Interest rate swaps

$

588

Interest Expense

$

—

None

$

—

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     (9) Stock-Based Compensation

Stock Options

     The Company granted options to purchase 440,528 shares of common stock pursuant to the 2006 Equity Incentive Plan during the six months ended June 30, 2009. Options for the purchase of 4,044,790 shares of common stock were outstanding under this plan at June 30, 2009. The outstanding options vest and become exercisable based on time, generally over a four-year period, and expire ten years from their grant dates. Upon exercise, options are settled with authorized but unissued Company common stock or treasury shares.

     There were no options granted during the three month periods ended June 30, 2009 and 2008. The fair value for all options granted during the six months ended June 30, 2009 and 2008 was determined on the date of grant and was estimated using the Black-Scholes option-pricing model with the following assumptions:

		Six Months Ended
		June 30,
		2009				2008
Expected dividend yield			0.0	%			0.0	%
Expected volatility			43.6	%			36.2	%
Expected term		5		years		5		years
Risk-free interest rates			1.88	%			2.93	%

     The weighted average fair values of stock options granted during the six months ended June 30, 2009 and 2008 were $6.12 and $7.13, respectively. The cash proceeds to the Company from stock options exercised during the three and six months ended June 30, 2009 were immaterial.

     Total compensation expense related to unvested options not yet recognized was $12.1 million at June 30, 2009. The Company expects to recognize this compensation expense over a weighted average period of 2.2 years.

Restricted Stock

     During the three and six months ended June 30, 2009, the Company granted -0- and 233,091 shares, respectively, of restricted stock to employees pursuant to the 2006 Equity Incentive Plan, the restrictions of which lapse 50%, 25%, and 25% on the second, third, and fourth anniversaries, respectively, of the grant date. Additionally, in the first quarter of 2009, 67,809 shares were purchased by certain executives pursuant to the Management Stock Purchase Program (the “MSPP”). The restrictions on shares purchased under the MSPP lapse on the second anniversary of the acquisition date.

     During the three months ended June 30, 2009, the Company awarded 60,516 shares of restricted stock to non-employee directors pursuant to the 2006 Equity Incentive Plan, all of which were outstanding at June 30, 2009. The restrictions relating to the restricted stock awarded in the current period lapse one year from the grant date. In the event a director resigns or is removed prior to the lapsing of the restriction, or if the director fails to attend 75% of the board and applicable committee meetings during the one-year period, shares would be forfeited unless resignation or failure to attend is caused by disability.

     Total compensation expense related to unvested restricted stock awards not yet recognized, including awards made in previous periods, was $4.1 million at June 30, 2009. The Company expects to recognize this compensation expense over a weighted average period of approximately 2.8 years. Unvested restricted stock at June 30, 2009 totaled 453,340 shares.

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Stock-based Compensation

     Stock-based compensation is included in selling, general and administrative expense. Stock-based compensation for the three and six months ended June 30, 2009 and 2008 consisted of the following (in thousands):

										Total
		Compensation Expense Related To:								Compensation
		Restricted Stock				Stock Options				Expense
Three months ended June 30, 2009		$	387			$	1,867			$	2,254
Three months ended June 30, 2008			396				1,733				2,129
Six months ended June 30, 2009			1,015				4,143				5,158
Six months ended June 30, 2008			703				3,782				4,485

     (10) Net Income Per Common Share

     The following table presents the calculation of the Company’s net income per common share — basic and diluted (in thousands, except share data):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
Numerator:
Net income		$	31,891			$	40,222			$	52,503			$	61,280
Denominator:
Weighted average common shares outstanding — basic			54,497,780				55,863,208				54,490,155				56,361,007
Dilutive effect of stock options			71,278				80,498				74,652				83,931
Dilutive effect of unvested restricted shares			201,154				15,405				229,444				15,205
Weighted average common shares outstanding — diluted			54,770,212				55,959,111				54,794,251				56,460,143
Net income per common share:
Basic		$	0.59			$	0.72			$	0.96			$	1.09
Diluted		$	0.58			$	0.72			$	0.96			$	1.09

     Diluted earnings per share (“EPS”) reflects the potential dilution that could occur if stock options or other share-based awards were exercised or converted into common stock. The dilutive effect is computed using the treasury stock method, which assumes all share-based awards are exercised and the hypothetical proceeds from exercise are used by the Company to purchase common stock at the average market price during the period. The incremental shares (difference between shares assumed to be issued versus purchased), to the extent they would have been dilutive, are included in the denominator of the diluted EPS calculation. Options with respect to 4.1 million shares and 3.6 million shares were antidilutive and therefore excluded from the computation of diluted earnings per share for the three and six months ended June 30, 2009 and 2008, respectively.

     In June 2007, the Company’s Board of Directors authorized a stock repurchase program to buy back up to $50.0 million of the Company’s common stock over the subsequent 12 months. In May 2008, the Company’s Board of Directors extended this program to June 30, 2009. On June 30, 2009 the repurchase program expired in accordance with its terms. Over the life of the repurchase program, the Company repurchased approximately 2.8 million shares of its common stock for approximately $47.3 million, at an average cost of $16.65 per share.

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     (11) Intangible Assets

     A breakdown of the identifiable intangible assets and their assigned value and accumulated amortization at June 30, 2009 is as follows (in thousands):

		Gross Carrying				Accumulated
		Amount				Amortization				Net
Trade name		$	24,500			$	—			$	24,500
Noncompete agreements			800				693				107
Provider network			137,619				17,327				120,292
Medicare member network			93,588				26,851				66,737
Management contract right			1,554				415				1,139
		$	258,061			$	45,286			$	212,775

     Amortization expense on identifiable intangible assets for the three months ended June 30, 2009 and 2008 was approximately $4.6 million and $4.7 million, respectively. Amortization expense on identifiable intangible assets for the six months ended June 30, 2009 and 2008 was approximately $9.2 million and $9.8 million, respectively.

     (12) Comprehensive Income

     The following table presents details supporting the determination of comprehensive income for the three and six months ended June 30, 2009 and 2008 (in thousands):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
Net income		$	31,891			$	40,222			$	52,503			$	61,280
Net unrealized (loss) gain on available for sale investment securities, net of tax			14				(138	)			138				105
Net gain on interest rate swaps, net of tax			230				—				394				—
Comprehensive income, net of tax		$	32,135			$	40,084			$	53,035			$	61,385

     (13) Segment Information

     The Company reports its business in four segments: Medicare Advantage, stand-alone Prescription Drug Plan, Commercial, and Corporate. Medicare Advantage (“MA-PD”) consists of Medicare-eligible beneficiaries receiving healthcare benefits, including prescription drugs, through a coordinated care plan qualifying under Part C and Part D of the Medicare Program. Stand-alone Prescription Drug Plan (“PDP”) consists of Medicare-eligible beneficiaries receiving prescription drug benefits on a stand-alone basis in accordance with Medicare Part D. Commercial consists of the Company’s commercial health plan business. The Commercial segment was insignificant as of June 30, 2009 and June 30, 2008. The Corporate segment consists primarily of corporate expenses not allocated to the other reportable segments. The Company identifies its segments in accordance with the aggregation provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” which aggregates products with similar economic characteristics. These characteristics include the nature of customer groups as well as pricing and benefits. These segment groupings are also consistent with information used by the Company’s chief executive officer in making operating decisions.

     The accounting policies of each segment are the same and are described in Note 1 to the 2008 Form 10-K. The results of each segment are measured and evaluated by earnings before interest expense, depreciation and amortization expense, and income taxes (“EBITDA”). The Company does not allocate certain corporate overhead amounts (classified as selling, general and administrative expenses) or interest expense to the segments. The Company evaluates interest expense, income taxes, and asset and liability details

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

on a consolidated basis as these items are managed in a corporate shared service environment and are not the responsibility of segment operating management.

     Revenue includes premium revenue, management and other fee income, and investment income.

     Asset and equity details by reportable segment have not been disclosed, as the Company does not internally report such information.

     Financial data by reportable segment for the three and six months ended June 30 is as follows (in thousands):

		MA-PD				PDP				Commercial				Corporate				Total
Three months ended June 30, 2009
Revenue		$	594,255			$	87,496			$	779			$	13			$	682,543
EBITDA			62,797				5,788				6				(6,757	)			61,834
Depreciation and amortization expense			6,366				20				—				1,256				7,642
Three months ended June 30, 2008
Revenue		$	494,179			$	71,574			$	1,049			$	72			$	566,874
EBITDA			82,757				613				(918	)			(7,714	)			74,738
Depreciation and amortization expense			5,961				3				—				1,021				6,985
Six months ended June 30, 2009
Revenue		$	1,147,004			$	180,114			$	1,515			$	25			$	1,328,658
EBITDA			111,882				7,913				(8	)			(13,688	)			106,099
Depreciation and amortization expense			12,722				40				—				2,404				15,166
Six months ended June 30, 2008
Revenue		$	963,984			$	152,006			$	3,386			$	207			$	1,119,583
EBITDA			133,281				1,545				(604	)			(13,857	)			120,365
Depreciation and amortization expense			12,200				3				—				2,030				14,233

     As of January 1, 2009, the Company revised its methodology for allocating the selling, general, and administrative expenses, but only within its prescription drug operations, which resulted in its allocating a greater share of such expenses to its MA-PD segment. As such, the MA-PD and PDP segment EBITDA amounts for the 2008 period include reclassification adjustments between segments such that the periods presented are comparable.

     A reconciliation of reportable segment EBITDA to net income included in the consolidated statements of income for the three and six months ended June 30 is as follows (in thousands):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2009				2008				2009				2008
EBITDA		$	61,834			$	74,738			$	106,099			$	120,365
Income tax expense			(18,331	)			(22,941	)			(30,179	)			(34,859	)
Interest expense			(3,970	)			(4,590	)			(8,251	)			(9,993	)
Depreciation and amortization			(7,642	)			(6,985	)			(15,166	)			(14,233	)
Net Income		$	31,891			$	40,222			$	52,503			$	61,280

     The Company uses segment EBITDA as an analytical indicator for purposes of assessing segment performance, as is common in the healthcare industry. Segment EBITDA should not be considered as a measure of financial performance under generally accepted accounting principles and segment EBITDA, as presented, may not be comparable to other companies.

HEALTHSPRING, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

     (14) Related Parties

     Renaissance Physician Organization (“RPO”) is a Texas non-profit corporation the members of which are GulfQuest L.P., one of the Company’s wholly owned HMO management subsidiaries, and 14 affiliated independent physician associations, comprised of over 1,000 physicians providing medical services primarily in and around counties surrounding and including the Houston, Texas metropolitan area. Texas HealthSpring, LLC, the Company’s Texas HMO, has contracted with RPO to provide professional medical and covered medical services and procedures to its members. Pursuant to that agreement, RPO shares risk relating to the provision of such services, both upside and downside, with the Company on a 50%/50% allocation. Another agreement the Company has with RPO delegates responsibility to GulfQuest L.P. for medical management, claims processing, provider relations, credentialing, finance, and reporting services for RPO’s Medicare and commercial members. Pursuant to that agreement, GulfQuest L.P. receives a management fee, calculated as a percentage of Medicare premiums, plus a dollar amount per member per month for RPO’s commercial members. In addition, RPO pays GulfQuest, L.P. 25% of the profits from RPO’s operations.

     FASB Interpretation No. 46 (Revised December 2003), “Consolidation of Variable Interest Entities — an interpretation of ARB No. 51” (“FIN46R”), requires an entity to consolidate a variable interest entity (“VIE”) if that entity holds a variable interest that will absorb a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both. The entity required to consolidate a VIE is known as the primary beneficiary. The Company has evaluated its interests in RPO and concluded that it is not the primary beneficiary of RPO, and as such is not required to consolidate RPO. The Company does not carry any investment in RPO on its balance sheet but does record management and other fees as well as medical expenses (under the contractual provisions discussed above) in its results from operations. Under FIN46R, VIEs are reassessed for consolidation when reconsideration events occur. Reconsideration events include changes to the VIEs’ governing documents that reallocate the expected losses/returns of the VIE between the primary beneficiary and other variable interest holders or sales and purchases of variable interests in the VIE.

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

     You should read the following discussion and analysis in conjunction with our condensed consolidated financial statements and related notes included elsewhere in this report and our audited consolidated financial statements and the notes thereto for the year ended December 31, 2008, appearing in our Annual Report on Form 10-K that was filed with the Securities and Exchange Commission (“SEC”) on February 25, 2009 (the “2008 Form 10-K”). Statements contained in this Quarterly Report on Form 10-Q that are not historical fact are forward-looking statements that the company intends to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Statements that are predictive in nature, that depend on or refer to future events or conditions, or that include words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” and similar expressions are forward-looking statements.

     The company cautions that forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements. Forward-looking statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties. Given these uncertainties, you should not place undue reliance on these forward-looking statements.

     In evaluating any forward-looking statement, you should specifically consider the information set forth under the captions “Special Note Regarding Forward-Looking Statements” and “Item 1A. Risk Factors” in the 2008 Form 10-K and the information set forth under “Cautionary Statement Regarding Forward-Looking Statements” in our earnings and other press releases, as well as other cautionary statements contained elsewhere in this report, including the matters discussed in “Critical Accounting Policies and Estimates” and “Item 1A. Risk Factors.” We undertake no obligation beyond that required by law to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur in the future. You should read this report and the documents that we reference in this report and have filed as exhibits to this report completely and with the understanding that our actual future results may be materially different from what we expect.

Overview

General

     HealthSpring, Inc. (the “company” or “HealthSpring”) is one of the country’s largest coordinated care plans whose primary focus is Medicare, the federal government-sponsored health insurance program for U.S. citizens aged 65 and older, qualifying disabled persons, and persons suffering from end-stage renal disease.

     We operate Medicare Advantage plans in Alabama, Florida, Illinois, Mississippi, Tennessee, and Texas and offer Medicare Part D prescription drug plans on a national basis. We sometimes refer to our Medicare Advantage plans, including plans providing prescription drug benefits, or “MA-PD,” collectively as “Medicare Advantage” plans and our stand-alone prescription drug plan as our “PDP.” For purposes of additional analysis, the company provides membership and certain financial information, including premium revenue and medical expense, for our Medicare Advantage (including MA-PD) and PDP plans.

     We disclose our results by reportable segment in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information.” We report our business in four segments: Medicare Advantage, PDP, Commercial, and Corporate. The following discussion of our results of operations includes a discussion of revenue and certain expenses by reportable segment. See “— Segment Information” below for additional information related thereto.

     Results of Operations

     The consolidated results of operations include the accounts of HealthSpring and its subsidiaries. The following tables set forth the consolidated statements of income data expressed in dollars (in thousands) and as a percentage of total revenue for each period indicated:

		Three Months Ended June 30,
		2009								2008
Revenue:
Premium revenue		$	671,450				98.4	%		$	554,667				97.8	%
Management and other fees			9,987				1.5				8,842				1.6
Investment income			1,106				0.1				3,365				0.6
Total revenue			682,543				100.0				566,874				100.0
Operating expenses:
Medical expense			558,403				81.8				436,157				77.0
Selling, general and administrative			62,306				9.1				55,979				9.9
Depreciation and amortization			7,642				1.1				6,985				1.2
Interest expense			3,970				0.6				4,590				0.8
Total operating expenses			632,321				92.6				503,711				88.9
Income before income taxes			50,222				7.4				63,163				11.1
Income tax expense			(18,331	)			(2.7	)			(22,941	)			(4.0	)
Net income		$	31,891				4.7	%		$	40,222				7.1	%

		Six Months Ended June 30,
		2009								2008
Revenue:
Premium revenue		$	1,306,046				98.3	%		$	1,095,558				97.9	%
Management and other fees			19,956				1.5				15,850				1.4
Investment income			2,656				0.2				8,175				0.7
Total revenue			1,328,658				100.0				1,119,583				100.0
Operating expenses:
Medical expense			1,088,002				81.9				880,339				78.6
Selling, general and administrative			134,557				10.1				118,879				10.6
Depreciation and amortization			15,166				1.1				14,233				1.3
Interest expense			8,251				0.7				9,993				0.9
Total operating expenses			1,245,976				93.8				1,023,444				91.4
Income before income taxes			82,682				6.2				96,139				8.6
Income tax expense			(30,179	)			(2.3	)			(34,859	)			(3.1	)
Net income		$	52,503				3.9	%		$	61,280				5.5	%