Summary of HEALTHSPRING, INC.

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, 2007, appearing in our Annual Report on Form 10-K that was filed with the Securities and Exchange Commission ("SEC") on February 29, 2008 (the "2007 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 2007 Form 10-K, "Part II, Item 1A. Risk Factors" below and in our Quarterly Reports on Form 10-Q for the quarterly period ended March 31, 2008 as filed with the SEC on May 2, 2008 (the "Q1-10Q"), and for the quarterly period ended June 30, 2008 as filed with the SEC on August 1, 2008 (the "Q2-10Q") 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." 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 a managed care organization 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 to persons in all 50 states. 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 separately provides membership and certain financial information, including premium revenue and medical expense, for our Medicare Advantage (including MA-PD) and PDP plans.
The results of Leon Medical Centers Health Plans, Inc. ("LMC Health Plans"), our Florida Medicare Advantage plan, are included in our results from October 1, 2007, the date of acquisition by the company.

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In July 2008, the U.S. Congress passed legislation halting the scheduled reduction in fees payable to physicians under the Medicare program and increasing slightly the physician fee schedule for 2009. The legislation contains several provisions that have been reported as adverse to Medicare Advantage plans, but we do not expect such changes to have a material adverse effect on our business. Starting in 2010, the Indirect Medical Education, or IME, component of our base Medicare rates will be gradually eliminated (but will be reduced by no more than .60% per county in 2010). Because of the gradual nature of the phase-out, we do not expect to experience a material financial impact from the diminution in base rates. The legislation and related CMS regulations also placed new limitations on Medicare Advantage plan sales and marketing activities beginning with the current open enrollment period for plan year 2009. CMS recently issued regulations restricting certain sales and marketing activities pursuant to this legislation. We believe we have adapted our plan sales and marketing activities to be compliant with the new requirements. We believe that private fee-for-service, or PFFS, plans are likely to be most negatively impacted by the new requirements. We do not operate any PFFS plans.
The current volatility in the securities and credit markets has not had a material adverse effect on the company's financial condition or results of operations and, at least as currently foreseeable by management of the company, such crises are not expected to materially adversely affect the company's liquidity or operations. Substantially all of the company's liquidity is in the form of cash and cash equivalents ($427.2 million at September 30, 2008), the majority of which ($369.2 million at September 30, 2008) is held by the company's regulated insurance subsidiaries, which amounts are required by law and by our credit agreement to be invested in low-risk, short-term, highly-liquid investments (such as government securities, money market funds, deposit accounts, and overnight repurchase agreements). The company also invests in securities ($92.1 million at September 30, 2008), primarily corporate and government debt securities, that it generally intends, and has the ability, to hold to maturity. Because the company is not relying on these debt instruments for liquidity, short term fluctuations in market pricing do not generally affect the company's ability to meet its liquidity needs. To date, the company has not experienced any material issuer defaults on its debt investments. As of September 30, 2008, the company had approximately $12.3 million of investments that are collateralized by mortgages, no material amount of which are collateralized by subprime mortgages.
On October 31, 2008, the company announced that effective November 1, 2008, it had appointed Michael G. Mirt to be President and Sharad Mansukani, M.D., to be Executive Vice President-Chief Strategy Officer. Both gentlemen report directly to Herbert A. Fritch, who continues to be the Chairman and Chief Executive Officer.

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   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 September 30,
                                                        2008                            2007
Revenue:
Premium:
Medicare                                      $ 514,932           97.6 %      $ 342,173           93.4 %
Commercial                                          960            0.2           10,876            3.0

Total premium revenue                           515,892           97.8          353,049           96.4
Management and other fees                         8,051            1.5            6,528            1.8
Investment income                                 3,800            0.7            6,765            1.8

Total revenue                                   527,743          100.0          366,342          100.0

Operating expenses:
Medical expense:
Medicare                                        411,413           78.0          279,923           76.4
Commercial                                          290              -            8,338            2.3

Total medical expense                           411,703           78.0          288,261           78.7
Selling, general and administrative              58,634           11.1           40,161           11.0
Depreciation and amortization                     7,047            1.3            3,016            0.8
Interest expense                                  4,520            0.9              123              -

Total operating expenses                        481,904           91.3          331,561           90.5

Income before equity in earnings of
unconsolidated affiliate and income
taxes                                            45,839            8.7           34,781            9.5
Equity in earnings of unconsolidated
affiliate                                           156              -              158              -

Income before income taxes                       45,995            8.7           34,939            9.5
Income tax expense                              (16,635 )         (3.1 )        (12,574 )         (3.4 )

Net income                                    $  29,360            5.6 %      $  22,365            6.1 %

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                                                            Nine Months Ended September 30,
                                                         2008                              2007
Revenue:
Premium:
Medicare                                      $ 1,607,104           97.6 %      $ 1,033,481           93.4 %
Commercial                                          4,346            0.3             36,225            3.3

Total premium revenue                           1,611,450           97.9          1,069,706           96.7
Management and other fees                          23,699            1.4             18,613            1.7
Investment income                                  11,975            0.7             17,972            1.6

Total revenue                                   1,647,124          100.0          1,106,291          100.0

Operating expenses:
Medical expense:
Medicare                                        1,287,761           78.2            838,798           75.8
Commercial                                          4,281            0.2             28,934            2.6

Total medical expense                           1,292,042           78.4            867,732           78.4
Selling, general and administrative               177,512           10.8            131,314           11.9
Depreciation and amortization                      21,280            1.3              8,850            0.8
Impairment of intangible assets                         -              -              4,537            0.4
Interest expense                                   14,513            0.9                357              -

Total operating expenses                        1,505,347           91.4          1,012,790           91.5

Income before equity in earnings of
unconsolidated affiliate and income
taxes                                             141,777            8.6             93,501            8.5
Equity in earnings of unconsolidated
affiliate                                             357              -                275              -

Income before income taxes                        142,134            8.6             93,776            8.5
Income tax expense                                (51,494 )         (3.1 )          (33,519 )         (3.1 )


Net income                                    $    90,640            5.5 %      $    60,257            5.4 %

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Membership
   Our primary source of revenue is monthly premium payments we receive based on
membership enrolled in our managed care plans. The following table summarizes
our Medicare Advantage (including MA-PD), stand-alone PDP, and commercial plan
membership as of the dates indicated.

                                    September 30,      December 31,      September 30,
                                         2008              2007               2007
   Medicare Advantage Membership
   Tennessee                             49,366              50,510           50,228
   Texas                                 39,896 (1)          36,661           36,491
   Alabama                               28,651              30,600           30,642
   Florida                               27,204              25,946                - (2)
   Illinois                               9,005               8,639            8,453
   Mississippi                            2,183                 841              802

   Total                                156,305             153,197          126,616


   Medicare PDP Membership              272,469             139,212          128,127


   Commercial Membership
   Tennessee                                  2              11,046           11,702
   Alabama                                  919                 755              751

   Total                                    921              11,801           12,453

(1) Does not include approximately 2,900 members in the Valley Baptist Health Plan (the "Valley Plan"), whose Medicare Advantage plan contract was acquired effective October 1, 2008.

(2) The company acquired LMC Health Plans on October 1,
2007. LMC
Health Plans' Medicare Advantage membership was 25,840 at September 30, 2007.

Medicare Advantage. Our Medicare Advantage membership increased by 23% to 156,305 members at September 30, 2008 as compared to 126,616 members at September 30, 2007, primarily as a result of membership gained in the acquisition of LMC Health Plans. As anticipated, our Alabama membership decreased slightly as of September 30, 2008 compared to membership at both December 31, 2007 and September 30, 2007 as a result of the Company exiting certain counties. Similarly, the Tennessee market experienced slight and anticipated decreases in membership as of September 30, 2008 compared to December 31, 2007 and September 30, 2007 as a result of discontinuing and changing certain products. We anticipate small but incremental membership growth during the remainder of 2008 through the offering of products to the dual-eligible population, who are not restricted by the lock-in rules, and through our new OptimaCare product, our special needs plan ("SNP") focused on the treatment of individuals with chronic conditions such as diabetes, hypertension, and hyperlipidemia.
Effective October 1, 2008, the Company acquired the Medicare Advantage contract from the Valley Plan, operating in the Texas Rio Grande Valley counties of Hidalgo, Willacy, and Cameron, for approximately $7.2 million in cash. The Valley Plan currently includes approximately 2,900 members. The cash consideration is included as a deposit on the Company's balance sheet at September 30, 2008. Additional cash consideration of up to $2.0 million is potentially payable to the seller based upon membership levels retained as of April 1, 2009 and April 1, 2010.
PDP. PDP membership increased by 113% to 272,469 members at September 30, 2008 as compared to 128,127 at September 30, 2007, primarily as a result of the auto-assignment of members in the California and New York regions at the beginning of the year. We do not actively market our PDPs and have relied on CMS auto-assignments of dual-eligible beneficiaries for membership. We have continued to receive assignments or otherwise enroll dual-eligible beneficiaries in our PDP plans during lock-in and expect continued incremental growth for the balance of the year.

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According to a release by The Centers for Medicare & Medicaid Services ("CMS") of 2009 Medicare prescription drug plan (PDP) coverage, we expect to retain auto-assigned dual-eligible PDP membership in 24 of the 34 CMS PDP regions for 2009. This compares to 31 regions in which HealthSpring received auto-assigned membership in 2008. Based upon recent data released by CMS, the Company now estimates that it will have approximately 260,000 - 270,000 members in these 24 regions as of January 1, 2009. HealthSpring's membership in its stand-alone PDP as of October 1, 2008 was approximately 276,000.
Commercial. Our commercial HMO membership declined from 12,453 members at September 30, 2007 to 921 members at September 30, 2008, primarily as a result of the non-renewal of coverage by employer groups in Tennessee, which was expected.
Risk Adjustment Payments
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 methodology, managed 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"). Prior to 2007, the company was unable to estimate the impact of either of these risk adjustment settlements primarily because of the lack of historical risk-based diagnosis code data and insufficient historical experience regarding risk premium settlement adjustments on which to base a reasonable estimate of future risk premium adjustments and, as such, recorded them upon notification from CMS of such amounts.
In the first quarter of 2007, the company began estimating and recording on a monthly basis the Initial CMS Settlement, as the company concluded it had sufficient historical experience and available risk-based data to reasonably estimate such amounts. In the fourth quarter of 2007, the company began estimating and recording the Final CMS Settlement, in that case for 2007 (based on risk score data available at that time), as the company concluded such amounts were reasonably estimable.
During the 2008 first quarter, the company updated its estimated Final CMS Settlement payment amounts for 2007 based on its evaluation of additional diagnosis code information reported to CMS in 2008 and updated its estimate again in the 2008 second quarter as a result of receiving notification in July 2008 from CMS of the Final CMS Settlement for 2007. These changes in estimate related to the 2007 plan year resulted in an additional $12.0 million and $17.3 million of premium revenue in the first and second quarters of 2008, respectively. The resulting impact on net income for the three and nine months ended September 30, 2008, after the expense for risk sharing with providers and income tax expense, was $-0- million and $13.4 million, respectively. For the nine months ended September 30, 2007, the impact on premium revenue and net income from the recording of the 2006 Final CMS Settlement was $15.5 million and $7.7 million, respectively.
Total Final CMS Settlement for the 2007 plan year was $57.9 million and represented 4.4% of total Medicare Advantage premiums, as adjusted for risk payments, for the 2007 plan year. Total Final CMS Settlement for the 2006 plan year was $16.1 million and represented 1.6% of total Medicare Advantage premiums, as adjusted for risk payments, received for the 2006 plan year. Amounts received for Final CMS settlements for any given plan year should not be considered indicative of amounts to be received for any future plan year.

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Reconciliation of 2007 Part D Activity with CMS In October 2008, the Company received notification from CMS that the Company's obligation to CMS for all Part D activity for the 2007 plan year totaled $111.5 million. The Company anticipates settling such amounts from 2007 with CMS in the fourth quarter of 2008. There was no material impact on the Company's financial condition and results of operations as of and for the three months ended September 30, 2008 as a result of adjusting our estimates to final settlement amounts.
Comparison of the Three-Month Period Ended September 30, 2008 to the Three-Month Period Ended September 30, 2007
Revenue
Total revenue was $527.7 million in the three-month period ended September 30, 2008 as compared with $366.3 million for the same period in 2007, representing an increase of $161.4 million, or 44.1%. The components of revenue were as follows:
Premium Revenue: Total premium revenue for the three months ended September 30, 2008 was $515.9 million as compared with $353.0 million in the same period in 2007, representing an increase of $162.9 million, or 46.1%. The components of premium revenue and the primary reasons for changes were as follows:
Medicare Advantage: Medicare Advantage (including MA-PD) premiums were $455.8 million for the three months ended September 30, 2008 versus $315.2 million in the third quarter of 2007, representing an increase of $140.6 million, or 44.6%. The increase in Medicare Advantage premiums in 2008 is primarily attributable to the inclusion of LMC Health Plans' results and to increases in per member per month, or "PMPM," premium rates in all of our plans. PMPM premiums for the 2008 third quarter averaged $977, which reflects an increase of 17.4% as compared to the 2007 third quarter. The PMPM premium increase in the current quarter is primarily the result of rate increases in base rates as well as rate increases related to risk scores and the inclusion of LMC Health Plans' results in the 2008 third quarter, as LMC Health Plans has historically experienced higher PMPM premiums than our other markets. PDP: PDP premiums (after risk corridor adjustments) were $59.1 million in the three months ended September 30, 2008 compared to $26.9 million in the same period of 2007, an increase of $32.2 million, or 119.4%. The increase in premiums for the 2008 third quarter is primarily the result of increases in membership. Our average PMPM premiums (after risk corridor adjustments) were $72.92 in the 2008 third quarter versus $72.20 during the 2007 third quarter. Commercial: Commercial premiums were $1.0 million in the three months ended September 30, 2008 as compared with $10.9 million in the 2007 comparable period, reflecting a decrease of $9.9 million, or 91.2%. The decrease was attributable to the reduction in membership versus the prior year quarter.
Fee Revenue. Fee revenue was $8.1 million in the third quarter of 2008 compared to $6.5 million for the third quarter of 2007, an increase of $1.6 million. The increase in the current period is attributable to increased management fees as a result of new independent physician associations ("IPAs") under contract since the 2007 third quarter and higher premiums in managed IPAs compared to the same period last year.
Investment Income. Investment income was $3.8 million for the third quarter of 2008 versus $6.8 million for the comparable period of 2007, reflecting a decrease of $3.0 million, or 43.8%. The decrease is attributable to a decrease in the average yield on invested and cash balances.
We expect decreases in the amount of investment income in future periods as a result of the settlement of 2007 Part D activity in the fourth quarter of 2008 and the corresponding payment to CMS of $111.5 million in cash.

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Medical Expense
Medicare Advantage. Medicare Advantage (including MA-PD) medical expense for the three months ended September 30, 2008 increased $102.8 million, or 39.8%, to $361.1 million from $258.3 million for the comparable period of 2007, which is primarily attributable to the inclusion of medical expense incurred by LMC Health Plans in the 2008 quarter. For the three months ended September 30, 2008, the Medicare Advantage medical loss ratio, or "MLR," was 79.2% versus 81.9% for the same period of 2007. The MLR improvement in the 2008 third quarter is primarily the result of PMPM premium increases in excess of PMPM medical expense increases.
Our Medicare Advantage medical expense calculated on a PMPM basis was $774 for the three months ended September 30, 2008, compared with $682 for the comparable 2007 quarter, reflecting an increase of 13.5%, primarily as a result of the inclusion of LMC Health Plans' results in the current quarter, and increased drug costs. LMC Health Plans incurs a substantially higher PMPM medical expense than our other plans.
PDP. PDP medical expense for the three months ended September 30, 2008 increased $28.7 million to $50.3 million, compared to $21.6 million in the same period last year. PDP MLR for the 2008 third quarter was 85.1%, compared to 80.2% in the 2007 third quarter. The increase in PDP MLR for the current quarter was primarily a result of unfavorable utilization patterns that were different than our prior experience, particularly in California and New York, and cost trends, both of which we expect will continue for the balance of 2008.
Commercial. Commercial medical expense decreased by $8.0 million, or 96.5%, to $0.3 million for the third quarter of 2008 as compared to $8.3 million for the same period of 2007. The decrease in the current quarter was attributable to the reduction in membership versus the prior year quarter. Selling, General, and Administrative Expense Selling, general, and administrative expense, or "SG&A," for the three months ended September 30, 2008 was $58.6 million as compared with $40.2 million for the same prior year period, an increase of $18.4 million, or 46.0%. The increase in the 2008 third quarter as compared to the same period of the prior year is the result of the inclusion of LMC Health Plans, personnel and other administrative costs increases in the current period, and costs related to PDP membership increases. As a percentage of revenue, SG&A expense increased approximately 10 basis points for the three months ended September 30, 2008 compared to the prior year third quarter.
Consistent with historical trends, the company expects the majority of its sales and marketing expenses to be incurred in the first and fourth quarters of each year in connection with the annual Medicare enrollment cycle. Depreciation and Amortization Expense
Depreciation and amortization expense was $7.0 million in the three months ended September 30, 2008 as compared with $3.0 million in the same period of . . .