The Commissioner of Insurance of the Commonwealth of Puerto Rico recognizes only statutory accounting practices for determining and reporting the financial condition and results of operations of an insurance company, for determining its solvency under the Puerto Rico insurance laws and for determining whether its financial condition warrants the payment of a dividend to its stockholders. No consideration is given by the Commissioner of Insurance of the Commonwealth of Puerto Rico to financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) in making such determinations. See note 25 to our audited consolidated financial statements.
Intersegment revenues and expenses are reported on a gross basis in each of the operating segments but eliminated in the consolidated results. Except as otherwise indicated, the numbers presented in this Annual Report on Form 10-K do not reflect intersegment eliminations. These intersegment revenues and expenses affect the amounts reported on the financial statement line items for each segment, but are eliminated in consolidation and do not change net income. The following table shows premiums earned, net and net fee revenue and operating income for each segment, as well as the intersegment premiums earned, service revenues and other intersegment transactions, which are eliminated in the consolidated results:

                                                       Years ended December 31,
     (Dollar amounts in millions)                  2008          2007          2006

     Premiums earned, net:
     Managed care                               $ 1,513.0       1,301.8       1,339.8
     Life insurance                                  92.8          88.9          86.9
     Property and casualty insurance                 93.8          96.9          88.5
     Intersegment premiums earned                    (4.1 )        (4.0 )        (3.6 )

     Consolidated premiums earned, net          $ 1,695.5       1,483.6       1,511.6


     Administrative service fees:
     Managed care                               $    22.5          17.2          16.9
     Intersegment premiums earned                    (3.3 )        (3.2 )        (2.8 )

     Consolidated administrative service fees   $    19.2          14.0          14.1


     Operating income:
     Managed care                               $    52.6          57.4          45.5
     Life insurance                                  12.5          10.7          11.2
     Property and casualty insurance                 13.1          10.7          11.2
     Intersegment premiums earned                     5.9           4.7           5.4

     Consolidated operating income              $    84.1          83.5          73.3

We have one-year contracts with the government of Puerto Rico to be the Reform insurance carrier for two of the eight geographical regions into which Puerto Rico is divided for purposes of the Reform. In October 2006, the contract for the Metro-North region, for which we were the carrier, was awarded to another managed care company, effective November 1, 2006. This region was awarded to us again on an ASO basis for a one year period beginning November 1, 2008. The premiums earned, net of the Metro-North region during the years 2006 and 2005 amounted to $161.6 million and $200.9 million, respectively. The operating income of this region during the years 2006 and 2005 amounted to $5.4 million and $3.5 million, respectively.
Results of Operations
Revenue
General. Our revenue consists primarily of (i) premium revenue we generate from our managed care business, (ii) administrative service fees we receive for administrative services provided to self-insured employers (ASO), (iii) premiums we generate from our life insurance and property and casualty insurance businesses and (iv) investment income.

Managed Care Premium Revenue. Our revenue primarily consists of premiums earned from the sale of managed care products to the Commercial market sector, including corporate accounts, U.S. federal government employees, local government employees, individual accounts and Medicare Supplement, as well as to the Medicare Advantage (including PDP) and Reform sectors. We receive a monthly payment from or on behalf of each member enrolled in our commercial managed care plans (excluding ASO). We recognize all premium revenue in our managed care business during the month in which we are obligated to provide services to an enrolled member. Premiums we receive in advance of that date are recorded as unearned premiums.
Premiums are generally fixed by contract in advance of the period during which healthcare is covered. Our Commercial premiums are generally fixed for the plan year in the annual renewal process. Our Medicare Advantage contracts entitle us to premium payments from CMS on behalf of each Medicare beneficiary enrolled in our plans, generally on a per member per month (PMPM) basis. We submit rate proposals to CMS in June for each Medicare Advantage product that will be offered beginning January 1 of the subsequent year in accordance with the new competitive bidding process under the MMA. Retroactive rate adjustments are made periodically with respect to our Medicare Advantage plans based on the aggregate health status and risk scores of our plan participants.
Premium payments from CMS in respect of our Medicare Part D prescription drug plans are based on written bids submitted by us which include the estimated costs of providing the prescription drug benefits.
Administrative Service Fees. Administrative service fees include amounts paid to us for administrative services provided to self-insured employers. We provide a range of customer services pursuant to our administrative services only (ASO) contracts, including claims administration, billing, access to our provider networks and membership services. Administrative service fees are recognized in the month in which services are provided.
Other Premium Revenue. Other premium revenue includes premiums generated from the sale of life insurance and property and casualty insurance products. Premiums on life insurance policies are billed in the month prior to the effective date of the policy, with a one-month grace period, and the related revenue is recorded as earned during the coverage period. If the insured fails to pay within the one-month grace period, we may cancel the policy. We recognize premiums on property and casualty contracts as earned on a pro rata basis over the policy term. Property and casualty policies are subscribed through general agencies, which bill policy premiums to their clients in advance or, in the case of new business, at the inception date and remit collections to us, net of commissions. The portion of premiums related to the period prior to the end of coverage is recorded in the consolidated balance sheet as unearned premiums and is transferred to premium revenue as earned.
Investment Income and Other Income. Investment income consists of interest income and other income consists of net realized gains (losses) on investment securities. See note 2(e) to our audited consolidated financial statements. Expenses
Claims Incurred. Our largest expense is medical claims incurred, or the cost of medical services we arrange for our members. Medical claims incurred include the payment of benefits and losses, mostly to physicians, hospitals and other service providers, and to policyholders. We generally pay our providers on one of three bases: (1) fee-for-service contracts based on negotiated fee schedules;
(2) capitated arrangements, generally on a fixed PMPM payment basis, whereby the provider generally assumes some of the medical expense risk; and
(3) risk-sharing arrangements, whereby we advance a capitated PMPM amount and share the risk of the medical costs of our members with the provider based on actual experience as measured against pre-determined sharing ratios. Claims incurred also include claims incurred in our life insurance and property and casualty insurance businesses. Each segment's results of operations depend in significant part on our ability to accurately predict and effectively manage claims. A portion of the claims incurred for each period consists of claims reported but not paid during the period, as well as a management and actuarial estimate of claims incurred but not reported during the period. The medical loss ratio (MLR), which is calculated by dividing managed care claims incurred by managed care premiums earned, net is one of our primary management tools for measuring these costs and their

impact on our profitability. The medical loss ratio is affected by the cost and utilization of services. The cost of services is affected by many factors, in particular our ability to negotiate competitive rates with our providers. The cost of services is also influenced by inflation and new medical discoveries, including new prescription drugs, therapies and diagnostic procedures. Utilization rates, which reflect the extent to which beneficiaries utilize healthcare services, significantly influence our medical costs. The level of utilization of services depends in large part on the age, health and lifestyle of our members, among other factors. As the medical loss ratio is the ratio of claims incurred to premiums earned, net it is affected not only by our ability to contain cost trends but also by our ability to increase premium rates to levels consistent with or above medical cost trends. We use medical loss ratios both to monitor our management of healthcare costs and to make various business decisions, including what plans or benefits to offer and our selection of healthcare providers.
Operating Expenses. Operating expenses include commissions to external brokers, general and administrative expenses, cost containment expenses such as case and disease management programs, and depreciation and amortization. The operating expense ratio is calculated by dividing operating expenses by premiums earned, net and administrative service fees. A significant portion of our operating expenses are fixed costs. Accordingly, it is important that we maintain or increase our volume of business in order to distribute our fixed costs over a larger membership base. Significant changes in our volume of business will affect our operating expense ratio and results of operations. We also have variable costs, which vary in proportion to changes in volume of business. Membership
Our results of operation depend in large part on our ability to maintain or grow our membership. In addition to driving revenues, membership growth is necessary to successfully introduce new products, maintain an extensive network of providers and achieve economies of scale. Our ability to maintain or grow our membership is affected principally by the competitive environment and general market conditions.
In recent years, we have experienced a decrease in our fully insured commercial membership due to the highly aggressive pricing of our competitors, which has also affected our ability to increase premiums, and the shifting of Medicare eligibles from our Medicare Supplement program to Medicare Advantage plans offered by our competitors and, to a lesser extent, ourselves. Membership in our Reform program has also been affected by the shifting of Reform program members to such Medicare Advantage plans.
The Medicare Advantage program (including PDP) provided us a significant opportunity for growth in membership. We commenced offering Medicare Advantage products in 2005, with the introduction of our Medicare Selecto and Medicare Optimo plans. Membership enrolled in our Medicare Advantage programs increased by 71.4% in 2008; from 38,070 as of December 31, 2007 to 65,243 members as of December 31, 2008. In January 2006, we launched our stand-alone PDP plan, FarmaMed, which as of December 31, 2008 and 2007 had 10,037 and 11,175 members, respectively. We expect our Medicare Advantage enrollment to continue to grow, but not at the same pace as we have seen in the past.
The following table sets forth selected membership data as of the dates set forth below:

                                             As of December 31,
                                      2008           2007          2006

                 Commercial (1)       592,723       574,251       580,850
                 Reform(2)            527,447       353,694       357,515
                 Medicare (3)          75,280        49,245        41,141

                 Total              1,195,450       977,190       979,506

(1) Commercial membership includes corporate accounts, self-funded employers, individual accounts, Medicare Supplement, Federal government employees and local government employees.

(2) Includes rated and self-funded members.

(3) Includes Medicare Advantage as well as stand-alone PDP plan membership.

Consolidated Operating Results
The following table sets forth our consolidated operating results for the years
ended December 31, 2008, 2007 and 2006.

(Dollar amounts in millions)                                 2008               2007               2006


Years ended December 31,
Revenues:
Premiums earned, net                                      $ 1,695.5            1,483.6            1,511.6
Administrative service fees                                    19.2               14.0               14.1
Net investment income                                          56.2               47.2               42.7

Total operating revenues                                    1,770.9            1,544.8            1,568.4
Net realized investment (losses) gains                        (13.9 )              5.9                0.8
Net unrealized investment gain (loss) on trading
securities                                                    (21.1 )             (4.1 )              7.7
Other income (expense), net                                    (2.5 )              3.2                2.3

Total revenues                                              1,733.4            1,549.8            1,579.2

Benefits and expenses:
Claims incurred                                             1,434.9            1,223.8            1,259.0
Operating expenses                                            251.9              237.5              236.1

Total operating costs                                       1,686.8            1,461.3            1,495.1
Interest expense                                               14.7               15.9               16.6

Total benefits and expenses                                 1,701.5            1,477.2            1,511.7

Income before taxes                                            31.9               72.6               67.5

Income tax expense                                              7.1               14.1               13.0

Net income                                                $    24.8               58.5               54.5

Year ended December 31, 2008 compared with the year ended December 31, 2007 Operating Revenues
Consolidated premiums earned, net and administrative service fees increased by $217.1 million, or 14.5%, to $1.7 billion during the year ended December 31, 2008 compared to the year ended December 31, 2007. This increase was primarily due to an increase in the premiums earned, net in our managed care segment, principally due to a higher volume in the Medicare Advantage business and general increases in premium rates. The administrative service fees of the managed care segment also increased during the 2008 period mostly as the result of an increased member months enrollment that is mainly attributed to the contract for the Reform's Metro-North region, which began on November 1, 2008 on an ASO basis.
Consolidated net investment income presented an increase of $9.0 million, or 19.1%, to $56.2 million during the year ended December 31, 2008. This increase is attributed to a higher yield in 2008 as well as to a higher balance of invested assets.
Net Realized Investment Losses
Consolidated net realized investment losses of $13.9 million during the year ended December 31, 2008 are primarily the result of other-than-temporary impairments related to equity and fixed income securities amounting to $16.5 million due to other-than-temporary impairments in three equity mutual funds that replicate the Russell 1000, Standard & Poor's 500 and EAFE indexes as well as for certain perpetual preferred securities. The other-than-temporary impairments were offset in part by $2.6 million of net realized gains from the sale of fixed income and equity securities.
Net Unrealized Loss on Trading Securities and Other Income (Expense), Net The combined balance of our consolidated net unrealized loss on trading securities and other income (expense), net was a loss of $23.6 million during the year ended December 31, 2008, an increase of $22.7

million, as compared to the combined loss of $0.9 million in 2007. This increase is attributable to the net result of the unrealized loss on the trading portfolio, together with a decrease the fair value of the derivative component of our investment in structured notes linked to the Euro Stoxx 50 and Nikkei 225 stock indexes amounting to $4.7 million due to general market conditions. The unrealized loss experienced on trading securities represents a decrease of 36.67% and 35.78% in TSI and 36.82% in STS in the fair value of the portfolio, which is lower than the decrease experienced by the comparable indexes of 37.0% in the S&P 500 Index and 38.44% in the Russell 1000. The change in the fair value of the derivative component of these structured notes is included within other income (expense), net.
Claims Incurred
Consolidated claims incurred during the year ended December 31, 2008 increased by $211.1 million, or 17.2%, to $1.4 billion when compared to the claims incurred during the year ended December 31, 2007. This increase is principally due to increased claims in the managed care segment as a result of higher enrollment and utilization trends. The consolidated loss ratio increased by 2.1 percentage points, to 84.6% in the 2008 period, primarily due to higher utilization trends in the managed care segment for the period, particularly in the Medicare Advantage business.
Operating Expenses
Consolidated operating expenses during the year ended December 31, 2008 increased by $14.4 million, or 6.1%, to $251.9 million as compared to operating expenses during the 2007 period. This increase is primarily attributed to a higher volume of business, particularly in the Medicare business of our Managed Care segment. The consolidated operating expense ratio decreased by 1.2 percentage points, to 14.7%, during the 2008 period mainly due to the aforementioned increase in volume.
Income tax expense
The decrease in consolidated income tax expense during the year ended December 31, 2008 is primarily the result of the lower income before tax during the period. The consolidated effective tax rate for the 2008 period reflects an increase of 2.9 percentage points as compared to the 2007 period, from 19.4% in 2007 to 22.3% in 2008, due to a lower taxable income during 2008 as compared to the 2007 period.
Year ended December 31, 2007 compared with the year ended December 31, 2006 Operating Revenues
Consolidated premiums earned, net and administrative service fees decreased by $28.1 million, or 1.8%, to $1.5 billion during the year ended December 31, 2007 compared to the year ended December 31, 2006. This decrease was primarily due to a decrease in the premiums earned, net in our managed care segment, principally due to the decreased volume of the Reform business after the termination of the contract for the Metro-North region, offset in part by the growth of our Medicare Advantage business and the increases in premium rates of the Reform business during 2007.
Consolidated net investment income presented an increase of $4.5 million, or 10.5%, to $47.2 million during the year ended December 31, 2007. This increase is primarily the result of an increase of $3.5 million attributed to a higher yield in 2007, a higher balance of invested assets and the acquisition of GA Life effective January 31, 2006. Net investment income earned by GA Life during the month of January 2006 amounted to $1.0 million, which is not included in our consolidated financial statements.
Net Realized Investment Gains
Consolidated net realized investment gains increased by $5.1 million to $5.9 million during 2007. This increase is primarily the result of higher sales of investments in 2007, particularly in trading securities, in order to keep the portfolio within our established targets in each investment sector. Net Unrealized Gain (Loss) on Trading Securities and Other Income, Net The combined balance of our consolidated net unrealized loss on trading securities and other income, net was a loss of $0.9 million during the year ended December 31, 2007, a decrease of $10.9 million, as compared to the combined gain of $10.0 million in 2006. This decrease is attributable to the net result of

the unrealized loss on the trading portfolio, offset in part by an increase in the fair value of the derivative component of our investment in structured notes linked to foreign stock indexes. This unrealized loss on trading securities is due to the sale of one equity portfolio which had a net unrealized gain at the time of sale. This sale had the effect of eliminating the unrealized gain that was offsetting unrealized losses in our trading portfolio. Claims Incurred
Consolidated claims incurred during the year ended December 31, 2007 decreased by $35.2 million, or 2.8%, to $1.2 billion when compared to the claims incurred during the year ended December 31, 2006. This decrease is principally due to decreased claims in the managed care segment as a result of the decreased volume of the Reform business due to the termination of the contract for the Metro-North region, net of increased enrollment in the Medicare Advantage business. The consolidated loss ratio decreased by 0.8 percentage points, to 82.5% in the 2007 period. The lower loss ratio is mainly the result of an overall increase in premium rates, lower utilization trends and a change in the mix of business. During the year ended December 31, 2007, the weight in the mix of business of the managed care segment corresponding to the Reform business decreased as a result of the termination of the contract for the Metro-North area. The Reform business has a higher loss ratio than other businesses within this segment. On the other hand, the Medicare Advantage business, which at the time had a lower loss ratio than other businesses within the managed care segment, has a higher weight in the mix of business in the 2007 period. Operating Expenses
Consolidated operating expenses during the year ended December 31, 2007 increased by $1.4 million, or 0.6%, to $237.5 million as compared to operating expenses during the 2006 period. This increase is primarily attributed to increases in professional services expense (mainly legal expenses), normal increases in payroll and payroll related expense, as well as higher technology related costs due to the new systems initiative of our managed care subsidiary. This increase is offset in part by the decrease in the operating expenses for the Reform business resulting from the reduction in volume of this business. The consolidated operating expense ratio increased by 0.4 percentage points during the 2007 period mainly due to fixed expenses not affected by a reduction in volume.
Income tax expense
The consolidated effective tax rate remained flat, with a slight increase of 0.1 percentage points, from 19.3% in 2006 to 19.4% in 2007. Managed Care Operating Results
We offer our products in the managed care segment to three distinct market sectors in Puerto Rico: Commercial, Reform and Medicare (including Medicare Advantage and PDP). For the year ended December 31, 2008, the Commercial sector represented 43.3% and 37.7% of our consolidated premiums earned, net and operating income, respectively. During the same period the Reform sector represented 20.1% and 12.5%, of our consolidated premiums earned, net and our operating income, respectively. Premiums earned, net and operating income generated from our Medicare contracts (including PDP) during the year ended December 31, 2008 represented 25.9% and 12.4%, respectively, of our consolidated earned premiums, net and operating income, respectively.