**United States**

**Securities and Exchange Commission**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **

**QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934**

** **

**For the Period Ended September 30, 2001**

** **

**Commission File Number 1-14177**

** **

**COBALT CORPORATION**

(Exactname of registrant as specified in its charter)

** **

| **Wisconsin**                                         |   | **39-1931212**                        |
|-------------------------------------------------------|--------|---------------------------------------|
| (State  of incorporation)                             |   | (I.R.S.  Employer Identification No.) |
|                                                  |   |                                  |
| **401 West Michigan Street, Milwaukee,  Wisconsin**   |   | **53203-2896**                        |
| (Address  of principal executive offices)             |   | (Zip  Code)                           |
|                                                  |   |                                  |
| **(414) 226-6900**                                    |
| (Registrant's  telephone number, including area code) |

 

Indicate by check mark whether registrant (1)has filed all documents and reports required to be filed by Section 13, or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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   **ý****                **No   o

 

Indicate the number of shares outstanding ofeach of the issuer's classes of common stock, as of the latest

practical date:

 

**Commonstock outstanding as of October 31, 2001 was 40,547,183.**

** **

 

COBALT CORPORATION

 

INDEX TO

QUARTERLY REPORT ON FORM 10-Q

 

For the Period Ended September 30, 2001

 
| **PART I**                                                                                  |
|---------------------------------------------------------------------------------------------|
|                                                                                        |
| Financial Statements and Supplementary Data                                                 |
|                                                                                        |
| Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|                                                                                        |
| Quantitative and Qualitative Disclosures  about Market Risk                                 |
|                                                                                        |
| **PART II**                                                                                 |
|                                                                                        |
| Other  Information                                                                          |
|                                                                                        |
| Signature Page                                                                              |

 

 

**PART1.  FINANCIAL INFORMATION**

**Item 1. Financial Statements**

 

**COBALTCORPORATIONCONSOLIDATED BALANCE SHEETS**

 
|                                             |   | **September  30,**   |    | **December  31** |   |
|--------------------------------------------------|--------|----------------------|---------|------------------|--------|
|                                             |   | **2001**             |    | **2000**         |   |
|                                             |   | ***(Unaudited)***    |    | ***(Note A)***   |   |
|                                             |   | ***(In thousands)*** |    |
| ASSETS                                           |   |                 |    |             |   |   |
|                                             |   |                 |    |             |   |   |
| Current assets:                                  |   |                 |    |             |   |
|                                             |   |                 |    |             |   |
| Cash and cash equivalents                        |   | $                    | 37,897  |             | $      | 1,305 |   |
| Investments--available-for-sale, at fair value   |   | 172,802              |    | 44,373           |   |
| Due from affiliates                              |   | 5,881                |    | 12,896           |   |
| Premium receivables                              |   | 41,785               |    | 3,325            |   |
| Due from clinics and providers                   |   | 12,467               |    | 7,063            |   |
| Other receivables                                |   | 57,234               |    | 28,127           |   |
| Prepaid expenses and other current assets        |   | 28,022               |    | 18,385           |   |
|                                             |   |                 |    |             |   |
| Total current assets                             |   | 356,088              |    | 115,474          |   |
|                                             |   |                 |    |             |   |
| Investments--held-to-maturity, at amortized cost |   | 24,954               |    | -                |   |
| Investments in affiliates, net                   |   | 103,838              |    | 105,609          |   |
| Property and equipment, net                      |   | 35,706               |    | 25,139           |   |
| Goodwill                                         |   | 98,230               |    | 8,020            |   |
| Note receivable from affiliate                   |   | -                    |    | 70,000           |   |
| Prepaid pension                                  |   | 50,176               |    | 36,471           |   |
| Deferred income taxes                            |   | 29,767               |    | 19,067           |   |
| Other noncurrent assets                          |   | 34,359               |    | 14,425           |   |
|                                             |   |                 |    |             |   |
| Total noncurrent assets                          |   | 377,030              |    | 278,731          |   |
|                                             |   |                 |    |             |   |
| Total assets                                     |   | $                    | 733,118 |             | $      | 394,205 |   |

 

See Notes to Interim Consolidated Financial Statements.

 

**COBALT CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                                        |   | **September  30,**   |    | **December  31,** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|---------|-------------------|--------|
|                                                                                                                                                        |   | **2001**             |    | **2000**          |   |
|                                                                                                                                                        |   | ***(Unaudited)***    |    | ***(Note A)***    |   |
|                                                                                                                                                        |   | ***(In thousands)*** |    |
| LIABILITIES AND SHAREHOLDERS' EQUITY                                                                                                                        |   |                 |    |              |   |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Current liabilities:                                                                                                                                        |   |                 |    |              |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Medical and other benefits payable                                                                                                                          |   | $                    | 220,674 |              | $      | 104,415 |   |
| Advance premiums                                                                                                                                            |   | 90,912               |    | 40,745            |   |
| Due to affiliates                                                                                                                                           |   | 153                  |    | 910               |   |
| Payables and accrued expenses                                                                                                                               |   | 49,475               |    | 29,597            |   |
| Short-term debt                                                                                                                                             |   | 13,087               |    | -                 |   |
| Other current liabilities                                                                                                                                   |   | 19,266               |    | 5,162             |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Total current liabilities                                                                                                                                   |   | 393,567              |    | 180,829           |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Noncurrent liabilities:                                                                                                                                     |   |                 |    |              |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Other benefits payable                                                                                                                                      |   | 44,199               |    | -                 |   |
| Deferred income taxes                                                                                                                                       |   | 29,767               |    | 20,699            |   |
| Postretirement benefits other than pension                                                                                                                  |   | 17,761               |    | 12,722            |   |
| Other noncurrent liabilities                                                                                                                                |   | 14,661               |    | 11,012            |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Total liabilities                                                                                                                                           |   | 499,955              |    | 225,262           |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Shareholders' equity:                                                                                                                                       |   |                 |    |              |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Common stock (no par value, no stated value, 48,442,428 issued,  7,949,904 held in treasury (see Note A) and 40,492,523 outstanding at  September 30, 2001) |   | 249,017              |    | -                 |   |
| Retained earnings (deficit)                                                                                                                                 |   | (21,774              | )       | 170,907           |   |
| Accumulated other comprehensive income (loss)                                                                                                               |   | 5,920                |    | (1,964            | )      |
|                                                                                                                                                        |   |                 |    |              |   |
| Total shareholders' equity                                                                                                                                  |   | 233,163              |    | 168,943           |   |
|                                                                                                                                                        |   |                 |    |              |   |
| Total liabilities and shareholders' equity                                                                                                                  |   | $                    | 733,118 |              | $      | 394,205 |   |
|                                                                                                                                                             |        |                      |         |                   |        |  |  |  |

 

See Notes to Interim Consolidated Financial Statements.

 

**COBALT CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(UNAUDITED)

 
|                                                 |   | **Three  months ended**                 |       | **Nine  months ended** |   |
|------------------------------------------------------|--------|-----------------------------------------|------------|------------------------|--------|
|                                                 |   | **September  30,**                      |       | **September  30,**     |   |
|                                                 |   | **2001**                                |       | **2000**               |   | **2001** |   | **2000** |   |
|                                                 |   | ***(In thousands, except share data)*** |
| Revenues:                                            |   |                                    |       |                   |   |   |   |   |   |
| Health services revenue:                             |   |                                    |       |                   |   |   |   |   |   |
| Premium revenue                                      |   | $                                       | 371,882    |                   | $      | 140,176 |   | $ | 891,035 |   | $ | 393,611 |   |
| Government contract fees                             |   | 32,817                                  |       | 18,795                 |   | 88,827 |   | 49,910 |   |
| Other revenue                                        |   | 16,970                                  |       | 6,001                  |   | 42,300 |   | 18,169 |   |
| Investment results                                   |   | 3,479                                   |       | 2,520                  |   | 9,048 |   | 7,493 |   |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Total revenues                                       |   | 425,148                                 |       | 167,492                |   | 1,031,210 |   | 469,183 |   |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Expenses:                                            |   |                                    |       |                   |   |   |   |   |   |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Medical and other benefits                           |   | 333,186                                 |       | 141,324                |   | 795,203 |   | 377,473 |   |
| Selling, general,administrative and other            |   | 89,587                                  |       | 47,892                 |   | 232,596 |   | 129,183 |   |
| Profit sharing on joint ventures                     |   | 341                                     |       | -                      |   | 443 |   | - |   |
| Interest                                             |   | 234                                     |       | 84                     |   | 441 |   | 280 |   |
| Amortization of goodwill                             |   | 1,792                                   |       | 180                    |   | 3,725 |   | 440 |   |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Total expenses                                       |   | 425,140                                 |       | 189,480                |   | 1,032,408 |   | 507,376 |   |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Operating income (loss)                              |   | 8                                       |       | (21,988                | )      | (1,198 | ) | (38,193 | ) |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Equity in net income (loss) of affiliate, net of tax |   | 1,581                                   |       | (2,228                 | )      | 388 |   | (2,358 | ) |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Pre-tax income (loss)                                |   | 1,589                                   |       | (24,216                | )      | (810 | ) | (40,551 | ) |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Income tax expense                                   |   | 532                                     |       | 548                    |   | 645 |   | 548 |   |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Net income (loss)                                    |   | $                                       | 1,057      |                   | $      |  (24,764 | ) | $ | (1,455 | ) | $ | (41,099 | ) |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Basic earnings (loss) per common share               |   | $                                       |  0.03 |                   | $      | (0.79 | ) | $ | (0.04 | ) | $ | (1.31 | ) |
|                                                 |   |                                    |       |                   |   |   |   |   |   |
| Diluted earnings (loss) per common share             |   | $                                       | 0.03       |                   | $      | (0.79 | ) | $ | (0.04 | ) | $ | (1.31 | ) |
|                                                      |        |                                         |            |                        |        |  |  |  |  |  |  |  |  |  |  |

 

See Notes to Interim Consolidated Financial Statements.

 

 

**COBALT CORPORATION**

**CONSOLIDATED STATEMENT OF CHANGES INSHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)**

(UNAUDITED)

** **
|                                                           |   |                                    |   |       |    |          |   | **Accumulated**   |   |              |    |
|----------------------------------------------------------------|--------|-----------------------------------------|--------|------------|---------|---------------|--------|-------------------|--------|-------------------|---------|
|                                                           |   |                                    |   |       |    |          |   | **Other**         |   |              |    |
|                                                           |   | **Common**                              |   |       |    | **Retained**  |   | **Comprehensive** |   | **Total**         |    |
|                                                           |   | **Shares**                              |   | **Common** |    | **Earnings**  |   | **Income**        |   | **Shareholders'** |    |
|                                                           |   | **Outstanding**                         |   | **Stock**  |    | **(Deficit)** |   | **(Loss)**        |   | **Equity**        |    |
|                                                           |   | ***(In thousands, except share data)*** |
| Balance at December 31, 2000                                   |   | -                                       |   | $          | -       |          | $      | 170,907           |   | $                 | (1,964  | ) | $ | 168,943 |   |
| Capitalization of Wisconsin United for Health Foundation, Inc. |   | 31,313,390                              |   | 192,577    |    | (192,577      | )      | -                 |   | -                 |    |
| Issuance of common stock - acquisition                         |   | 9,096,303                               |   | 55,938     |    | -             |   | -                 |   | 55,938            |    |
| Issuance of common stock - options exercised                   |   | 11,250                                  |   | 52         |    | -             |   | -                 |   | 52                |    |
| Issuance of common stock - 401(k)                              |   | 71,580                                  |   | 450        |    | -             |   | -                 |   | 450               |    |
| Adjustments as a result of purchase accounting                 |   | -                                       |   | -          |    | 82            |   | -                 |   | 82                |    |
| Change in ownership of affiliates                              |   | -                                       |   | -          |    | 1,269         |   | -                 |   | 1,269             |    |
| Comprehensive income (loss):                                   |   | -                                       |   | -          |    |          |   | -                 |   |              |    |
| Net loss                                                       |   | -                                       |   | -          |    | (1,455        | )      | -                 |   | (1,455            | )  |
| Change in unrealized gains/losses on investments, net of tax   |   | -                                       |   | -          |    |          |   | 7,884             |   | 7,884             |    |
| Comprehensive income                                           |   | -                                       |   | -          |    | -             |   |              |   | 6,429             |    |
| Balance at September 30, 2001                                  |   | 40,492,523                              |   | $          | 249,017 |          | $      | (21,774           | )      | $                 | 5,920   |   | $ | 233,163 |   |

** **

See Notes to Interim Consolidated Financial Statements.

** **

**COBALT CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(UNAUDITED)

 
|                                                              |   | **Nine months ended** |   |
|-------------------------------------------------------------------|--------|-----------------------|--------|
|                                                              |   | **September 30,**     |   |
|                                                              |   | **2001**              |   | **2000** |   |
|                                                              |   | ***(in  thousands)*** |   |
| Operating activities:                                             |   |                  |   |   |   |
| Net loss                                                          |   | $                     | (1,455 | ) | $ | (41,099 | ) |
| Adjustments to reconcile net loss to net cash                     |   |                  |   |   |   |
| provided by (used in) operating activities:                       |   |                  |   |   |   |
| Equity in (gain) loss of affiliates                               |   | (388                  | )      | 2,358 |   |
| Depreciation and amortization                                     |   | 13,383                |   | 6,408 |   |
| Realized investment (gains) losses, net                           |   | (380                  | )      | (76 | ) |
| Changes in operating accounts, net of acquisitions:               |   |                  |   |   |   |
| Premium receivables                                               |   | 7,986                 |   | (284 | ) |
| Other receivables                                                 |   | (8,196                | )      | (6,542 | ) |
| Due from clinics and providers                                    |   | 5,064                 |   | 71 |   |
| Medical and other benefits payable                                |   | (5,291                | )      | 29,909 |   |
| Advance premiums                                                  |   | 76                    |   | 3,461 |   |
| Due to affiliates, net                                            |   | (9,777                | )      | (3,033 | ) |
| Other, net                                                        |   | (56                   | )      | (2,839 | ) |
|                                                              |   |                  |   |   |   |
| Net cash provided by (used in) operating activities               |   | 966                   |   | (11,666 | ) |
|                                                              |   |                  |   |   |   |
| Investing activities:                                             |   |                  |   |   |   |
| Acquisition of subsidiaries                                       |   | 48,341                |   | (1,013 | ) |
| Purchases of available-for-sale investments                       |   | (81,764               | )      | (3,075 | ) |
| Purchases of held-to-maturity investments                         |   | (15,323               | )      | - |   |
| Proceeds from sale and maturity of available-for-sale investments |   | 84,690                |   | 19,687 |   |
| Proceeds from maturity of held-to maturity investments            |   | 250                   |   | 655 |   |
| Additions to property and equipment                               |   | (3,749                | )      | (3,421 | ) |
|                                                              |   |                  |   |   |   |
| Net cash provided by investing activities                         |   | 32,445                |   | 12,833 |   |
|                                                              |   |                  |   |   |   |
| Financing activities:                                             |   |                  |   |   |   |
| Proceeds from (repayment of) line of credit, net                  |   | 3,181                 |   | (6,995 | ) |
|                                                              |   |                  |   |   |   |
| Net cash provided by (used in) financing activities               |   | 3,181                 |   | (6,995 | ) |
|                                                              |   |                  |   |   |   |
| Cash and cash equivalents:                                        |   |                  |   |   |   |
| Increase (decrease) during period                                 |   | 36,592                |   | (5,828 | ) |
| Balance at beginning of year                                      |   | 1,305                 |   | (5,054 | ) |
| Balance at end of period                                          |   | $                     | 37,897 |   | $ | (10,882 | ) |

 

See Notes to Interim Consolidated Financial Statements.

 

**COBALT CORPORATION**

**NOTES TO INTERIMCONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

** **

September 30, 2001

 

Note A. Basis of Presentation

 

The accompanying unaudited interim consolidated financial statementshave been prepared in accordance with accounting principles generally acceptedfor interim financial information and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States(“GAAP”) for complete financial statements. In the opinion of management, all adjustments (consisting of only normalrecurring adjustments) considered necessary for a fair presentation have beenincluded.  Operating results for thethree and nine months ended September 30, 2001 are not necessarily indicativeof the results that may be expected for the year ending December 31, 2001.These interim consolidated financial statements should be read in conjunctionwith the audited consolidated financial statements for the year ended December31, 2000 and footnotes thereto included in the Cobalt Corporation (“Cobalt”)Form 8-K, as filed with the Securities and Exchange Commission (“SEC”) on April9, 2001.

 

On March 23, 2001, Blue Cross & Blue Shield United of Wisconsin(“BCBSUW”) converted to a stock corporation and became a wholly ownedsubsidiary of United Wisconsin Services, Inc. (“UWS”), (the"combination").  UWS wasrenamed Cobalt Corporation, and in exchange for ownership of BCBSUW, Cobaltissued 31,313,390 shares of newly issued common stock to the Wisconsin Unitedfor Health Foundation, Inc. (the “Foundation”).

 

The combination is treated as a purchase by BCBSUW of the 9,096,303shares of UWS that it did not already own at the market price of $6.15 pershare as of the closing date.  UnderGAAP, the excess of the market price over the adjusted book value per share ofUWS was recorded as goodwill under the purchase method of accounting.  The 7,949,904 shares of Cobalt common stockowned by BCBSUW are treated as treasury stock for the purposes of calculatingearnings per share (“EPS”). Goodwill is currently being amortized over a periodof 15 years. See Note I, “Recent Accounting Pronouncements,” of this quarterlyreport on Form 10-Q.

 

Cobalt’s balance sheet as of September 30, 2001 reflects the purchaseaccounting adjustments for the combination transaction, which was finalizedMarch 23, 2001.  The balance sheet as ofDecember 31, 2000 reflects only BCBSUW. The combination is treated as a reverse purchase whereby BCBSUW becomesthe reporting entity.  Accordingly, thehistorical consolidated statements of operations for Cobalt include theoperations of BCBSUW and its wholly owned subsidiary, United Government ServicesLLC (“UGS”).  The pro forma statementsof operations for Cobalt presented in Note C., include the operations of theformer UWS and BCBSUW with elimination of intercompany transactions, therecording of purchase accounting adjustments and the amortization of goodwillcalculated as if the transaction was completed at the beginning of thereporting period.

 

Note B. Net Income (Loss) PerShare

 

Basic EPS are computed by dividing net income (loss) by the weightedaverage number of common shares outstanding.  Diluted EPS are computed by dividing net income by the weightedaverage number of common shares outstanding, adjusted for the potentialdilutive effect of outstanding stock options. When Cobalt reports a net loss, potentially dilutive securities are not includedin the calculation of EPS because their inclusion would have an antidilutiveeffect.

 

The weighted averagenumber of common shares outstanding used in the calculation of basic EPS is40,438,098 for the three months ended September 30, 2001.  The weighted average number of sharesoutstanding used in the calculation of diluted EPS is 40,658,298 for the threemonths ended September 30, 2001, which includes options to purchase 981,467shares for which the options’ exercise prices were less than the average marketprice of the outstanding shares. Options to purchase 2,648,196 shares were not included in thecomputation of diluted EPS for the three months ended September 30, 2001 sincethe options’ exercise prices were greater than the average market price of theoutstanding common shares.

 

The weighted average number of common shares outstanding used in boththe calculation of basic and diluted EPS is 37,722,313 for the nine monthsended September 30, 2001.  Options topurchase 2,648,940 common shares were not included in the computation ofdiluted earnings per common share for the nine months ended September 30, 2001since the options’ exercise prices were greater than the average market priceof the outstanding common shares.  Inaddition, 996,467 potentially dilutive common shares for the nine months endedSeptember 30, 2001 were not included because Cobalt had a net loss for theperiod and their inclusion would have been antidilutive.

 

Note C. Pro Forma FinancialInformation (Unaudited)

 

**PRO FORMA COBALT STATEMENT OF OPERATIONS**

 
|                                                   |   | **Three months ended  September 30,** |    | **Nine months ended  September 30,** |   |
|--------------------------------------------------------|--------|--------------------------------------------|---------|-------------------------------------------|--------|
|                                                   |   | **2001**                                   |    | **2000**                                  |   | **2001** |   | **2000** |   |
|                                                   |   | **(Actual)**                               |    |                                      |   |   |   |   |   |
|                                                   |   | ***(In thousands, except share data)***    |    |
| Revenues:                                              |   |                                       |    |                                      |   |   |   |   |   |
| Health services revenue:                               |   |                                       |    |                                      |   |   |   |   |   |
| Premium                                                |   | $                                          | 371,882 |                                      | $      | 321,640 |   | $ | 1,109,234 |   | $ | 940,750 |   |
| Government  contract fees                              |   | 32,817                                     |    | 18,795                                    |   | 88,827 |   | 49,910 |   |
| Other                                                  |   | 16,970                                     |    | 16,632                                    |   | 52,712 |   | 48,097 |   |
| Investment  results                                    |   | 3,479                                      |    | 2,873                                     |   | 10,498 |   | 9,408 |   |
| Total  revenues                                        |   | 425,148                                    |    | 359,940                                   |   | 1,261,271 |   | 1,048,165 |   |
| Expenses:                                              |   |                                       |    |                                      |   |   |   |   |   |
| Medical and other benefits                             |   | 333,186                                    |    | 308,818                                   |   | 987,399 |   | 877,053 |   |
| Selling, general, administrative and other             |   | 89,587                                     |    | 78,846                                    |   | 267,372 |   | 219,502 |   |
| Profit sharing on joint venture                        |   | 341                                        |    | 188                                       |   | 443 |   | 420 |   |
| Interest                                               |   | 234                                        |    | 437                                       |   | 624 |   | 1,104 |   |
| Amortization of goodwill                               |   | 1,792                                      |    | 1,580                                     |   | 5,270 |   | 4,588 |   |
| Total expenses                                         |   | 425,140                                    |    | 389,869                                   |   | 1,261,108 |   | 1,102,667 |   |
| Operating income (loss)                                |   | 8                                          |    | (29,929                                   | )      | 163 |   | (54,502 | ) |
| Equity in net income (loss) of affiliates,  net of tax |   | 1,581                                      |    | (596                                      | )      | (46 | ) | 1,021 |   |
| Pre-tax  income (loss)                                 |   | 1,589                                      |    | (30,525                                   | )      | 117 |   | (53,481 | ) |
| Income tax expense                                     |   | 532                                        |    | 178                                       |   | 1,122 |   | 534 |   |
| Net income (loss)                                      |   | $                                          | 1,057   |                                      | $      | (30,703 | ) | $ | (1,005 | ) | $ | (54,015 | ) |
|                                                   |   |                                       |    |                                      |   |   |   |   |   |
| Earnings (loss) per share:                             |   |                                       |    |                                      |   |   |   |   |   |
| Basic                                                  |   | $                                          | 0.03    |                                      | $      | (0.76 | ) | $ | (0.03 | ) | $ | (1.34 | ) |
| Diluted                                                |   | $                                          | 0.03    |                                      | $      | (0.76 | ) | $ | (0.03 | ) | $ | (1.34 | ) |
|                                                   |   |                                       |    |                                      |   |   |   |   |   |
| Weighted average shares outstanding:                   |   |                                       |    |                                      |   |   |   |   |   |
| Basic                                                  |   | 40,438,098                                 |    | 40,412,393                                |   | 40,422,017 |   | 40,412,393 |   |
| Diluted                                                |   | 40,658,298                                 |    | 40,412,393                                |   | 40,422,017 |   | 40,412,393 |   |

 

 

**MEMBERSHIP ANALYSIS:**

** **
| Members at end of period:                      |   | **September 30,** |   |
|------------------------------------------------|--------|-------------------|--------|
|                                           |   | **2001**          |   | **2000** |   |
|                                           |   |              |   | **Pro forma** |   |
| Medical (by product type):                     |   |              |   |   |   |   |
| HMO                                            |   | 218,075           |   | 195,553 |   |
| PPO                                            |   | 134,558           |   | 139,230 |   |
| Point of  Service                              |   | 83,331            |   | 92,164 |   |
| Medicaid                                       |   | 4,214             |   | 4,144 |   |
| Medicare Risk                                  |   | 10,382            |   | 14,545 |   |
| Other/Individual                               |   | 89,764            |   | 91,987 |   |
| Total insured  members                         |   | 540,324           |   | 537,623 |   |
| Self-funded:                                   |   |              |   |   |   |
| Non-HMO                                        |   | 162,432           |   | 234,494 |   |
| HMO                                            |   | 5,216             |   | 6,458 |   |
| Total medical  members                         |   | 707,972           |   | 778,575 |   |
|                                           |   |              |   |   |   |
| Specialty  products and services:              |   |              |   |   |   |   |
| UWG  Life/AD&D                             |   | 155,992           |   | 159,007 |   |
| Dental                                         |   | 318,773           |   | 340,578 |   |
| Disability and  Other                          |   | 119,202           |   | 114,579 |   |
| Behavioral  Health & Medical Management    |   | 1,552,767         |   | 1,459,992 |   |
|                                           |   |              |   |   |   |
| Workers’  Compensation policies in force: |   | 720               |   | 659 |   |
|                                                |        |                   |        |  |  |  |  |  |

###  

### Someof the trends and developments of the Cobalt business after the date of thecombination, and BCBSUW and UWS together on a pro forma basis from January 1,2001 through the date of the combination, as compared with pro forma combinedstatements of operations in the comparable periods in 2000, are as follows:

###  

### Premiumrevenue increases in 2001 are attributable to the re-pricing of the insuredmedical products. The increase in Health Maintenance Organization("HMO") membership is primarily due to the acquisition of theinsurance business of Family Health Plan during the fourth quarter of 2000,offset by January cancellations. Despite the increase in premium revenues, the loss ratio for the HMObusiness also increased to 96.2% for the three months ended September 30, 2001from 95.8% for the three months ended September 30, 2000, due to higher thananticipated medical cost trends.  Theloss ratio was 94.7% and 94.2% for the nine months ended September 30, 2001 and2000, respectively.

###  

### TheBCBSUW business within the insured medical segment has shown significantimprovement in the 2001 operating results. The loss ratio has improved from 97.0% for the nine months endedSeptember 30, 2000 to 85.7% for the nine months ended September 30, 2001.  This improvement is due in large part to therecording of a premium deficiency reserve of $11.3 million on the Medicare riskbusiness during the third quarter of 2000. As of September 30, 2001, the premium deficiency reserve was $0.5million.  Management believes theremaining reserve is sufficient to cover estimated losses on thisbusiness.  The improved loss ratio alsoreflects premium revenue increases related to re-pricing of all products.

###  

### Theassumption of the State of Wisconsin life insurance business, which wasreported in the specialty risk segment, was cancelled in November of 2000.  This business accounted for approximately$5.7 million and $16.4 million in premiums for the three months and nine monthsended September 30, 2000, respectively, with a loss ratio of 95.3% and 94.5%,respectively.  The cancellation of thisbusiness had a favorable impact on the overall loss ratio for the specialtyrisk business, which improved to 74.5% and 75.0% for the three and nine monthsended September 30, 2001, respectively, from 75.4% and 76.9% for the comparableperiods in 2000.

###  

### Overall,the expense ratio for Cobalt has improved to 21.2% for the three months endedSeptember 30, 2001 from 22.1% for the three months ended September 30, 2000, asa result of increased premium rates and continued cost saving measures beingimplemented.  These measures have heldthe overall expense ratio steady at 21.4% for the nine months ended September30, 2001, as compared to 21.1% for the nine months ended September 30, 2000,despite transaction costs incurred in 2001 which related to the combination ofBCBSUW and UWS.

###  

### Includedin the pro forma other operations for the nine months ended September 30, 2001is $3.7 million in transaction expenses related to the combination of BCBSUWand UWS, of which $2.6 million was recorded by BCBSUW and $1.1 million recordedby UWS.   The majority of these expenseswere recorded in the first quarter of 2001.

###  

### Note D.Related Party

###  

### Asdisclosed in Note A., on March 23, 2001 BCBSUW converted to a stock corporationand became a wholly owned subsidiary of UWS. UWS was renamed Cobalt Corporation, and in exchange for ownership ofBCBSUW, Cobalt issued 31,313,390 shares of newly issued common stock to theFoundation.

###  

### Note E.Investment in Affiliates

###  

### CondensedStatements of Operations as reported by American Medical Security Group, Inc.(“AMSG”) (NYSE:AMZ):

 
|                       |   | **Three months ended** |    | **Nine months ended** |   |
|----------------------------|--------|------------------------|---------|-----------------------|--------|
|                       |   | **September 30,**      |    | **September 30,**     |   |
|                       |   | **2001**               |    | **2000**              |   | **2001** |   | **2000** |   |
|                       |   | ***(In thousands)***   |    |
| Premium revenue            |   | $                      | 204,399 |                  | $      | 231,963 |   | $ | 640,514 |   | $ | 720,405 |   |
|                       |   |                   |    |                  |   |   |   |   |   |
| Medical and other benefits |   | 144,000                |    | 180,141               |   | 466,754 |   | 550,216 |   |
|                       |   |                   |    |                  |   |   |   |   |   |
| Underwriting gain          |   | 60,399                 |    | 51,822                |   | 173,760 |   | 170,189 |   |
|                       |   |                   |    |                  |   |   |   |   |   |
| Net  income (loss)         |   | 3,504                  |    | (1,376                | )      | (170 | ) | 2,543 |   |
|                            |        |                        |         |                       |        |  |  |  |  |  |  |  |  |

 

As of September 30, 2001 and 2000, Cobalt owned 45.2% and 43.4%,respectively of AMSG.

 

Note F. Comprehensive Income(Loss)

 

A reconciliation from net income (loss) reported in the ConsolidatedStatements of Operations to comprehensive income (loss) is stated below:

 
|                                                              |   | **Three months ended** |   | **Nine months ended** |   |
|-------------------------------------------------------------------|--------|------------------------|--------|-----------------------|--------|
|                                                              |   | **September 30,**      |   | **September 30,**     |   |
|                                                              |   | **2001**               |   | **2000**              |   | **2001** |   | **2000** |   |
|                                                              |   | ***(In thousands)***   |   |
| Net income (loss) per  Consolidated Statement of Operations       |   | $                      | 1,057  |                  | $      | (24,764) |   | $ | (1,455) |   | $ | (41,099) |   |
|                                                              |   |                   |   |                  |   |   |   |   |   |
| Change in unrealized gains  (losses) on investments, net of taxes |   | 7,572                  |   | 1,617                 |   | 7,884 |   | 1,428 |   |
|                                                              |   |                   |   |                  |   |   |   |   |   |
| Comprehensive income (loss)                                       |   | $                      | 8,629  |                  | $      | (23,147 | ) | $ | 6,429 |   | $ | (39,671 | ) |

 

Comprehensive income(loss) is defined as all changes in equity during the period, exceptthose resulting from shareholder equity contributions and distributions.

 

Note G. Segment Reporting

 

Cobalt has five reportable business segments: insured medical products,specialty risk products, specialty service products, self-funded products andgovernment services. Insured medical products include: full coverage,copayment, preferred provider organization, Medicare supplement, interimcoverage, HMO and point of service products sold primarily in Wisconsin.  The specialty risk products include dental,life, disability and workers’ compensation products. The specialty serviceproducts include managed care consulting, electronic claim submission services,pharmaceutical management, managed behavioral health services, case managementand receivables management services. The specialty service products segmentincludes activity from UWS subsidiaries; and therefore, on a historical basisthis segment does not have any activity until the second quarter of 2001.  The specialty products and services are soldthroughout the United States.  Theself-funded products consist of administrative services and access to Cobalt’sextensive provider networks for uninsured contracts. Government servicesinclude processing services for Medicare providers throughout the United Statesand for Medicaid in the State of Wisconsin.

 

"Other Operations" include activities not directly related tothe business segments, unallocated corporate items (i.e. equity in net income(loss) of affiliates, amortization of goodwill and unallocated overheadexpenses) and intercompany eliminations. Cobalt evaluates segment performance based on profit or loss fromoperations before income taxes. The accounting policies of the reportablesegments are the same as those described in the December 31, 2000 auditedfinancial statements in the summary of significant accounting policies.

 

Financial data by segment is asfollows:

 
|                       |   | **Three months ended** |    | **Nine months ended** |   |
|----------------------------|--------|------------------------|---------|-----------------------|--------|
|                       |   | **September 30,**      |    | **September 30,**     |   |
|                       |   | **2001**               |    | **2000**              |   | **2001** |   | **2000** |   |
|                       |   | ***(In thousands)***   |    |
| Health services revenue:   |   |                   |    |                  |   |   |   |   |   |
| Insured medical products   |   | $                      | 336,935 |                  | $      | 133,303 |   | $ | 814,253 |   | $ | 373,043 |   |
| Specialty risk products    |   | 41,190                 |    | 7,491                 |   | 90,071 |   | 22,405 |   |
| Specialty service products |   | 15,555                 |    | -                     |   | 31,042 |   | - |   |
| Government services        |   | 32,817                 |    | 18,795                |   | 88,827 |   | 49,910 |   |
| Self-funded products       |   | 6,431                  |    | 6,001                 |   | 21,136 |   | 18,169 |   |
| Other operations           |   | (11,259                | )       | (618                  | )      | (23,167 | ) | (1,837 | ) |
| Total consolidated         |   | $                      | 421,669 |                  | $      | 164,972 |   | $ | 1,022,162 |   | $ | 461,690 |   |
|                       |   |                   |    |                  |   |   |   |   |   |
| Investment results:        |   |                   |    |                  |   |   |   |   |   |
| Insured medical products   |   | $                      | 3,851   |                  | $      | 2,121 |   | $ | 9,525 |   | $ | 6,288 |   |
| Specialty risk products    |   | 1,636                  |    | 120                   |   | 3,219 |   | 379 |   |
| Specialty service products |   | 83                     |    | -                     |   | 194 |   | - |   |
| Government services        |   | 133                    |    | 183                   |   | 406 |   | 519 |   |
| Self-funded products       |   | 7                      |    | 96                    |   | 47 |   | 307 |   |
| Other operations           |   | (2,231                 | )       | -                     |   | (4,343 | ) | - |   |
| Total consolidated         |   | $                      | 3,479   |                  | $      | 2,520 |   | $ | 9,048 |   | $ | 7,493 |   |

 

 
|                       |   | **Three months ended  September 30,** |   | **Nine months ended  September 30,** |   |
|----------------------------|--------|---------------------------------------|--------|--------------------------------------|--------|
|                       |   | **2001**                              |   | **2000**                             |   | **2001** |   | **2000** | ** ** |
|                       |   | ***(In thousands)***                  |   |
| Pre-tax  income (loss):    |   |                                  |   |                                 |   |   |   |   |   |
| Insured medical products   |   | $                                     | 447    |                                 | $      | (20,310 | ) | $ | 4,439 |   | $ | (28,527 | ) |
| Specialty risk products    |   | 2,238                                 |   | 500                                  |   | 3,965 |   | 6 |   |
| Specialty service products |   | 1,477                                 |   | -                                    |   | 2,607 |   | - |   |
| Government services        |   | 366                                   |   | 357                                  |   | 966 |   | 874 |   |
| Self-funded products       |   | (847                                  | )      | (1,168                               | )      | (3,284 | ) | (7,775 | ) |
| Other operations           |   | (2,092                                | )      | (3,595                               | )      | (9,503 | ) | (5,129 | ) |
| Total consolidated         |   | $                                     | 1,589  |                                 | $      | (24,216 | ) | $ | (810 | ) | $ | (40,551 | ) |

 

|                       |   | **September 30,**    |    | **December 31,** |   |
|----------------------------|--------|----------------------|---------|------------------|--------|
|                       |   | **2001**             |    | **2000**         |   |
|                       |   | ***(In thousands)*** |    |
| Total assets:              |   |                 |    |             |   |
| Insured medical products   |   | $                    | 552,484 |             | $      | 240,787 |   |
| Specialty risk products    |   | 66,676               |    | 14,100           |   |
| Specialty service products |   | 25,025               |    | -                |   |
| Government services        |   | 24,895               |    | 22,061           |   |
| Self-funded products       |   | 11,848               |    | 11,648           |   |
| Other  operations          |   | 52,190               |    | 105,609          |   |
| Total  consolidated        |   | $                    | 733,118 |             | $      | 394,205 |   |

 

Total assets (excluding government services assets and investment inaffiliate) are allocated by segment based on the percentage of pro formarevenue for the nine months ended September 30, 2001 and historical revenue forthe year ended December 31, 2000.  Otheroperations include the investment in unconsolidated affiliates, goodwill fromthe combination and the elimination of intercompany balances.

 
|                                                                    |   | **Three months ended** |    | **Nine months ended** |   |
|-------------------------------------------------------------------------|--------|------------------------|---------|-----------------------|--------|
|                                                                    |   | **September 30,**      |    | **September 30,**     |   |
|                                                                    |   | **2001**               |    | **2000**              |   | **2001** |   | **2000** |   |
|                                                                    |   | ***(In thousands)***   |    |
| Health services revenue from  transactionswith other business segments: |   |                   |    |                  |   |   |   |   |   |
| Insured medical products                                                |   | $                      | (5,428) |                  | $      | (618) |   | $ | (11,679) |   | $ | (1,837) |   |
| Specialty risk products                                                 |   | (698                   | )       | -                     |   | (1,352 | ) | - |   |
| Specialty service products                                              |   | (5,133                 | )       | -                     |   | (10,136 | ) | - |   |
|                                                                         |        |                        |         |                       |        |  |  |  |  |  |  |  |  |

 

Note H. Statutory Financial Information

 

The Codification of Statutory Accounting Principles (“Codification”)promulgated by the National Association of Insurance Commissioners and adoptedby the Office of the Commissioner of Insurance for the State of Wisconsin tookeffect on January 1, 2001.  Codificationimpacts the calculation of statutory surplus for Cobalt’s insurancesubsidiaries.  The impact varies bysubsidiary with the most significant changes in surplus resulting from thetreatment of deferred tax assets and health care and pharmacy rebatereceivables.  The 2001 statutoryfinancial statements for all quarterly periods within the nine months endedSeptember 30, 2001 fully reflect the implementation of Codification.  Cobalt has taken certain actions includingthe reallocation of capital to mitigate the impact of Codification on itssubsidiaries.

 

In order to satisfy certain intercompanyreceivables and continue to comply with minimum capital and licensingstandards, management has considered selling certain subsidiaries, as well assome portion or all of its investment in AMSG, or obtaining capital fromoutside sources.

 

Note I.  Recent Accounting Pronouncements

 

*Financial AccountingStandards Board (“FASB”) #142. *OnJune 29, 2001, the FASB approved the issuance of statement 142 “Goodwill andOther Intangibles.”  Management hasreviewed the statement with respect to the goodwill it carries on its balancesheet and the value of BCBSUW’s investment in AMSG.  Discontinuance of goodwill amortization, excluding its investmentin AMSG, is estimated to reduce expense by approximately $1.8 million perquarter.  Cobalt will adopt FASB #142 onJanuary 1, 2002 and is currently in the process of analyzing any possiblegoodwill impairment.

 

As of September 30, 2001 BCBSUW owns 6.3 million shares in AMSG commonstock representing a 45% ownership interest. Under GAAP, BCBSUW’s investment in AMSG is recorded using the equitymethod of accounting.  As of September30, 2001, AMSG’s book value per share was significantly higher than the quotedmarket value of a share of stock.  Thequoted market value of a share of stock is not the sole measurement basis ofthe fair value of AMSG's reporting units. A write down of the goodwill balance by AMSG will result in a reductionof the AMSG carrying value at BCBSUW and a reduction in BCBSUW’s statutorycapital and surplus.  Any impairmentcharge recognized as of January 1, 2002 would be reported as the cumulativeeffect of a change in accounting principle. Based on current GAAP methods of measuring goodwill impairment, there isno goodwill impairment indicated.

 

Note J. Reclassifications

 

Certain reclassifications have been made to the consolidated interimfinancial statements for 2000 to conform with the 2001 presentation.

**COBALT CORPORATIONMANAGEMENT'S DISCUSSION AND ANALYSIS OF**

**FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**Overview**

 

                The registrant, formerly known as UWS (aWisconsin corporation), was renamed Cobalt Corporation upon completion of thecombination of BCBSUW and UWS on March 23, 2001.  BCBSUW was organized in 1939 and provides health and dentalinsurance coverage and related services to both the private and public sectors.BCBSUW offers full coverage, co-payment, preferred provider organization,Medicare supplement and interim coverage options to groups and individuals.BCBSUW is the only health insurer in the state operating full-service regionalsales and customer service centers. Through BCBSUW’s wholly owned subsidiaryUGS, BCBSUW is a government contractor and processes Medicare claims forproviders in all 50 states and is currently the largest Part A Medicareprocessor in the nation.  Cobalt is alsoa leading provider of managed health care services and employee benefitproducts through the historical UWS subsidiaries, which also provide HMOproducts, dental, life, disability and workers’ compensation products, managedcare consulting, electronic claim submission services, pharmaceutical management,managed behavioral health services, case management and receivables managementservices. The activity from the UWS subsidiaries is reflected in the discussionbelow for periods after March 31, 2001. Since the combination is accounted for under GAAP as a purchase byBCBSUW of the 53.4% of UWS it did not already own, BCBSUW is considered theregistrant for SEC accounting purposes, and thus, activity reported for periodsthrough March 31, 2001 represents BCBSUW activity only.

 

The followingManagement’s Discussion and Analysis should be read in conjunction with theaudited consolidated financial statements for the year ended December 31, 2000and footnotes thereto included in the Cobalt Form 8-K, as filed with the SEC.

 

                In the discussion below, the number of"members" is equivalent to the number of persons covered by contractsin force.

 

### **Summaryof Membership and Ratios**

** **

|                                                 |   | **September 30,** |   |
|------------------------------------------------------|--------|-------------------|--------|
|                                                 |   | **2001**          |   | **2000** |   |
| Membership at end of period:                         |   |              |   |   |   |
| Insured medical products                             |   | 540,324           |   | 253,328 |   |
| Specialty risk products                              |   | 1,091,495         |   | 146,625 |   |
| Specialty  service products                          |   | 1,055,239         |   | - |   |
| Self–funded products:                           |   |              |   |   |   |
| Non-HMO                                              |   | 162,432           |   | 234,494 |   |
| HMO                                                  |   | 5,216             |   | - |   |
| Total membership                                     |   | 2,854,706         |   | 634,447 |   |
|                                                 |   |              |   |   |   |
| Workers’  Compensation – Policies in force |   | 720               |   | - |   |
|                                                 |   |              |   |   |   |
|                                                 |   |              |   |   |   |
| Membership (as a percentage of the total):           |   |              |   |   |   |
| Insured  medical products                            |   | 18.9              | %      | 39.9 | % |
| Specialty risk products                              |   | 38.2              |   | 23.1 |   |
| Specialty  service products                          |   | 37.0              |   | - |   |
| Self–funded products                            |   | 5.9               |   | 37.0 |   |
| Total membership                                     |   | 100.0             | %      | 100.0 | % |

 

#  

# **Summary ofOperating Results and Ratios**

 
|                                                         |   | **Three months ended   September 30,** |    | **Nine months ended   September 30,** |   |
|--------------------------------------------------------------|--------|----------------------------------------|---------|---------------------------------------|--------|
|                                                         |   | **2001**                               |    | **2000**                              |   | **2001** |   | **2000** |   |
|                                                         |   | ***(In thousands)***                   |    |
| Revenue:                                                     |   |                                   |    |                                  |   |   |   |   |   |
| Insured medical products                                     |   | $                                      | 336,935 |                                  | $      | 133,303 |   | $ | 814,253 |   | $ | 373,043 |   |
| Specialty risk products                                      |   | 41,190                                 |    | 7,491                                 |   | 90,071 |   | 22,405 |   |
| Specialty service products                                   |   | 15,555                                 |    | -                                     |   | 31,042 |   | - |   |
| Government services                                          |   | 32,817                                 |    | 18,795                                |   | 88,827 |   | 49,910 |   |
| Self–funded products                                    |   | 6,431                                  |    | 6,001                                 |   | 21,136 |   | 18,169 |   |
| Intercompany eliminations                                    |   | (11,259                                | )       | (618                                  | )      | (23,167 | ) | (1,837 | ) |
| Total health services revenue                                |   | 421,669                                |    | 164,972                               |   | 1,022,162 |   | 461,690 |   |
| Investment results                                           |   | 3,479                                  |    | 2,520                                 |   | 9,048 |   | 7,493 |   |
| Total revenue                                                |   | $                                      | 425,148 |                                  | $      | 167,492 |   | $ | 1,031,210 |   | $ | 469,183 |   |
|                                                         |   |                                   |    |                                  |   |   |   |   |   |
| Health services revenue (as a percentage of the total): |   |                                   |    |                                  |   |   |   |   |   |
| Insured  medical products                                    |   | 79.9                                   | %       | 80.8                                  | %      | 79.7 | % | 80.8 | % |
| Specialty risk products                                      |   | 9.8                                    |    | 4.6                                   |   | 8.8 |   | 4.9 |   |
| Specialty  service products                                  |   | 3.7                                    |    | -                                     |   | 3.0 |   | - |   |
| Government services                                          |   | 7.8                                    |    | 11.4                                  |   | 8.7 |   | 10.8 |   |
| Self–funded products                                    |   | 1.5                                    |    | 3.6                                   |   | 2.1 |   | 3.9 |   |
| Intercompany eliminations                                    |   | (2.7                                   | )       | (0.4                                  | )      | (2.3 | ) | (0.4 | ) |
| Total                                                        |   | 100.0                                  | %       | 100.0                                 | %      | 100.0 | % | 100.0 | % |
|                                                         |   |                                   |    |                                  |   |   |   |   |   |
| Operating ratios:                                            |   |                                   |    |                                  |   |   |   |   |   |
| Insured medical loss ratio(1)                                |   | 91.6                                   | %       | 102.4                                 | %      | 90.9 | % | 97.0 | % |
| Specialty risk products loss ratio(1)                        |   | 74.5                                   | %       | 73.2                                  | %      | 75.3 | % | 78.0 | % |
|                                                         |   |                                   |    |                                  |   |   |   |   |   |
| Selling, general, and administrative  expense:               |   |                                   |    |                                  |   |   |   |   |   |
| Insured medical SGA ratio(2)                                 |   | 9.3                                    | %       | 14.3                                  | %      | 9.6 | % | 12.2 | % |
| Specialty risk products SGA ratio(2)                         |   | 24.0                                   | %       | 21.6                                  | %      | 23.9 | % | 23.5 | % |
| Government services SGA ratio(3)                             |   | 99.3                                   | %       | 99.1                                  | %      | 99.4 | % | 99.3 | % |
|                                                         |   |                                   |    |                                  |   |   |   |   |   |
| Self–funded admin. fees per member  per month           |   | $                                      | 13.20   |                                  | $      | 8.53 |   | $ | 14.03 |   | $ | 8.44 |   |
| Self–funded SGA per member per month                    |   | $                                      | 14.95   |                                  | $      | 10.31 |   | $ | 16.24 |   | $ | 12.17 |   |

 

----

(1)           Insured medical andother benefits as a percentage of premium revenue.

 

(2)           Insuredselling, general and administrative expenses as a percentage of premiumrevenue.

 

(3)           Governmentservices selling, general and administrative expenses as a percentage ofgovernment services revenue.

 

                Cobalt's revenues are derived primarily frompremiums, while medical benefits constitute the majority of expenses.Profitability is directly affected by many factors including, among others,premium rate adequacy, estimates of medical benefits, health care utilization,effective administration of benefit payments, operating efficiency, investmentreturns and federal and state laws and regulations.

##### *Results of Operations*

 

Total Revenues

 

                Total revenues for the three months ended September30, 2001 increased 153.8% to $425.1 million from $167.5 million forthe three months ended September 30, 2000. For the nine months ended September 30, 2001, total revenues increased119.8% to $1,031.2 million, compared to $469.2 million for the nine monthsended September 30, 2000.  This increasewas due primarily to the addition of the UWS revenues, which resulted from theMarch 23, 2001 combination of BCBSUW and UWS to form Cobalt.  UWS contributed $238.4 million in revenue forthe three months ended September 30, 2001 or 142.3% of the total 153.8%increase for the quarter.  UWScontributed $472.6 million in revenue for the nine months ended September 30,2001 or 100.7% of the total 119.8% increase for the period.  Other factors contributing toward theincrease include premium rate increases on the medical insurance business, there-pricing of self-funded products and new government fee based contracts.

 

Health Services Revenue

 

                *InsuredMedical Products.  *Insuredmedical premium for the three months ended September 30, 2001 increased 152.7%to $336.9 million from $133.3 million for the three months ended September30, 2000.  The increase is primarily dueto growth in membership resulting from the addition of UWS business.  The addition of UWS premiums resulted in anincrease to premium revenue for the three months ended September 30, 2001 of$192.2 million or 144.2% of the total 152.7% increase.  Also contributing toward the total increasein premium is an increase in average premium revenue per member per month.  Average insured medical premium per memberfor the three months ended September 30, 2001 increased 18.5% from the sameperiod in 2000.  The number of insuredmedical members as of September 30, 2001 increased 113.3% to 540,324 from253,328 as of September 30, 2000.  Forthe nine months ended September 30, 2001, insured medical premium increased118.3% to $814.3 million from $373.0 million for the nine monthsended September 30, 2000.  The additionof UWS premiums resulted in an increase to premium revenue for the nine monthsended September 30, 2001 of $380.4 million or 102.0% of the total 118.3%increase for the period.  Averageinsured medical premium per member for the nine months ended September 30, 2001increased 21.1% from the same period in 2000. The average number of insured medical members for the nine months endedSeptember 30, 2001 increased 80.2% to 444,204 from 246,496 for the nine monthsended September 30, 2000.

 

                *SpecialtyRisk Products. *Specialtyrisk premium for the three months ended September 30, 2001 increased 449.3% to$41.2 million from $7.5 million for the three months ended September 30, 2000.The increase primarily resulted from the addition of $34.3 million in revenuesfrom the UWS specialty risk lines including life, accidental death anddismemberment, dental, disability, workers’ compensation and behavioral health.The number of specialty risk members as of September 30, 2001 increased to1,091,495 from 146,625 as of September 30, 2000.  The total increase in membership of 944,870 reflects a decreaseof 15,108 members in BCBSUW insured dental membership, offset by the additionof 959,978 members from the UWS specialty risk lines.  For the nine months ended September 30, 2001, specialty risk premiumincreased to $90.1 million from $22.4 million for the nine months endedSeptember 30, 2000, also primarily attributable to the addition of the UWSbusiness.

 

*Specialty Service Products. *Health servicesrevenue for the three and nine month periods ended September 30, 2001 includes$15.6 million and $31.0 million, respectively, related to the UWS specialtyservice products, which include workers’ compensation TPA business, subrogationand receivables collection, audit, electronic claims, and medical, pharmacy andbehavioral health management services.

                *Government Services. *Governmentservices revenue for the three months ended September 30, 2001 increased 74.5%to $32.8 million from $18.8 million for the three months ended September 30,2000.  Government Services revenue forthe nine months ended September 30, 2001 increased 78.0% to $88.8 million from$49.9 million for the nine months ended September 30, 2000.  The increase from 2000 to 2001 isattributable to significant growth in the volume of Medicare claims processed,due to being awarded additional government contracts.  Effective December 1, 2000, UGS became the Medicare Part AIntermediary for the states of California, Nevada and Hawaii, and the territoriesof Guam, Mariana Islands and American Samoa. In addition, also effective December 1, 2000, UGS became the RegionalHome Health Intermediary for the states of California, Nevada, Arizona, Hawaii,Oregon, Idaho, Washington, and Alaska, and the territory of Guam.

 

                *Self-fundedProducts.*  Self-fundedadministrative fees for the three months ended September 30, 2001 increased6.7% to $6.4 million from $6.0 million for the three months ended September 30,2000. The average self-funded monthly administrative fee per member increasedby 54.7% to $13.20 for the three months ended September 30, 2001 from $8.53 forthe three months ended September 30, 2000. The number of self-funded members asof September 30, 2001 decreased 30.7% to 162,432 from 234,494 as of September30, 2000. The increase in the monthly per member fee and decrease in totalmembers for 2001 is due to aggressive pricing on targeted group contracts andsubsequent loss of unprofitable business. For the nine months ended September 30, 2001, self-funded administrativefees increased 15.9% to $21.1 million from $18.2 million for the nine monthsended September 30, 2000.  The averageself-funded administrative fee per member per month for the nine months endedSeptember 30, 2001 increased 66.2% to $14.03 from $8.44 for the nine monthsended September 30, 2000.

 

InvestmentResults

 

                Net investment results include investment income andrealized gains (losses) on the sale of investments. Net investment results forthe three months ended September 30, 2001 increased 40.0% to $3.5 millionfrom $2.5 million for the three months ended September 30, 2000, primarilydue to the addition of the UWS business. Average annual investment yields,excluding net realized gains, investment income from affiliates and otherinterest income were 5.4% for the three months ended September 30, 2001,compared to 8.0% for the three months ended September 30, 2000.  Net investment results for the nine monthsended September 30, 2001 increased 20.0% to $9.0 million from $7.5 millionfor the nine months ended September 30, 2000.

 

                Average invested assets for the three months endedSeptember 30, 2001 increased 460.1% to $221.8 million, compared to$39.6 million for the three months ended September 30, 2000. Theimprovement during the three months ended September 30, 2001 is primarily theresult of acquisition of UWS at the end of first quarter, which increasedCobalt’s invested assets by $192.4 million as of September 30, 2001.

 

                Net investment gains (losses) are realized inthe normal investment process in response to market opportunities. Investmentgains of $0.3 million were realized for the three months ended September 30,2001.  Realized gains were insignificantfor the three months ended September 30, 2000. Net investment gains of $0.4 million were realized for the nine monthsended September 30, 2001, compared to a net realized gain of $0.1 million forthe nine months ended September 30, 2000.

###### Expense Ratios

 

*                Loss Ratio. *Theinsured medical products loss ratio for the three months ended September 30,2001 was 91.6%, compared with 102.4% for the three months ended September 30,2000.  For the nine months endedSeptember 30, 2001, the insured medical products loss ratio was 90.9%, comparedwith 97.0% for the nine months ended September 30, 2000.  The decrease in the medical loss ratio isprimarily the result of pricing increases and other cost control measuresinstituted in response to higher than anticipated medical utilization and costtrends.  In addition, the higher lossratios for the three and nine month periods ended September 30, 2000 alsoreflect the effect of a premium deficiency reserve (“PDR”) of $11.3 millionrecorded during the third quarter of 2000 on the Medicare Risk business.  The PDR amount recorded represented estimatedlosses through the remainder of 2000 and throughout 2001.  As of September 30, 2001, the PDR was $0.5million.  Management believes theremaining reserve is sufficient to cover estimated losses on this business.  Although increases in the level ofgovernment reimbursement, along with pricing increases and other costcontainment measures have resulted in somewhat improved 2001 results on thisline of business, profitability remains below targeted levels.  As a result, Cobalt has announced that itwill exit this market effective January 1, 2002.

 

The specialtyrisk products loss ratio increased slightly to 74.5% for the three months endedSeptember 30, 2001 compared to 73.2% for the three months ended September 30,2000.  The ratio for the nine monthsended September 30, 2001 improved to 75.3% from 78.0% for the nine months endedSeptember 30, 2000.  Results for theprior year were entirely comprised of the BCBSUW insured dental line, whichshowed a slight increase in the loss ratio to 80.8% for the nine months endedSeptember 30, 2001.  The overallimprovement for the nine months ended September 30, 2001 resulted from theaddition of the UWS specialty risk product line, which ran at a loss ratio of73.7% for the nine months ended September 30, 2001.  This loss ratio reflects improvement from past results for theUWS specialty product lines, which on a stand-alone basis, ran at a loss ratioof 76.6% for the nine months ended September 30, 2000.

 

                *Selling,General and Administrative Expense Ratio*. The selling, general andadministrative ("SGA") expense ratio includes commissions,administrative expenses, premium taxes and other assessments and claim interestexpense. The insured medical products SGA expense ratio for the three monthsended September 30, 2001 was 9.3%, compared with 14.3% for the three monthsended September 30, 2000.  The insuredmedical products SGA expense ratio for the nine months ended September 30, 2001was 9.6%, compared with 12.2% for the nine months ended September 30, 2000. Theimproved SGA expense ratio in 2001 is the result of expense control measuresinstituted, combined with a higher premium base in 2001 due to pricingincreases.  In addition, the insuredmedical products SGA ratios for the three and nine month periods ended September30, 2000 include the effect of a $2.4 million write-off of deferred acquisitioncosts related to the Medicare Risk business. The specialty risk products SGAratio increased to 24.0% for the three months ended September 30, 2001 from21.6% for the three months ended September 30, 2000. For the nine months endedSeptember 30, 2001, the specialty risk products SGA ratio was 23.9% compared to23.5% for the nine months ended September 30, 2000.  The change in the ratio reflects changes in the mix of specialtyrisk business due to the addition of the UWS business.

 

The averageself-funded SGA expense per member per month increased 45.0% for the threemonths ended September 30, 2001 to $14.95 from $10.31 for the three monthsended September 30, 2000.  The averageself-funded SGA expense per member per month increased 33.4% for the ninemonths ended September 30, 2001 to $16.24 from $12.17 for the nine months endedSeptember 30, 2000.  The decrease in theself-funded membership caused the SGA expense per member per month toincrease.  Additional expense reductionmeasures are currently targeted in this area.

 

*Operating Expense Ratio. *The operatingexpense ratio for Government services for the three months ended September 30,2001 increased to 99.3% from 99.1% for the three months ended September 30, 2000.   The operating expense ratio for Governmentservices increased to 99.4% for the nine months ended September 30, 2001compared to 99.3% for September 30, 2000. The slight increase in the 2001 operating expense ratios results fromadministrative fee reimbursement arrangements on new government contracts.

Other Expenses

 

                BCBSUW has a bank line of credit, in whichCobalt subsidiaries participate, that permits aggregate borrowings up to$20.0 million. Interest expense, related to the bank line of credit, was$0.2 million and $0.1 million for the three months ended September 30, 2001 andSeptember 30, 2000, respectively. Interest expense was $0.4 million and $0.3million for the nine months ended September 30, 2001 and September 30, 2000,respectively.

 

                Goodwill amortization totaling $1.8 millionand $0.2 million has been recorded for the three months ended September 30,2001 and 2000, respectively.  For thenine months ended September 30, 2001 and 2000, goodwill amortization totaling$3.7 million and $0.4 million, respectively, has been recorded.  Goodwill amortization for the three monthsended September 30, 2001 primarily relates to $75.1 million in goodwillrecorded in 2001 for Cobalt as a result of purchase accounting, which iscurrently being amortized on a straight-line basis over a period of 15years.  Amortization expense for thethree and nine month periods ended September 30, 2000 includes amortizationrelated to the purchase by BCBSUW of 1.4 million additional shares of UWSstock.  The excess of cost over the fairvalue of net assets acquired was recorded as goodwill by BCBSUW and wasamortized on a straight-line basis over a period of 15 years.  As a result of purchase accounting, thisgoodwill was transferred to Cobalt during the first quarter of 2001 and isincluded in the $75.1 million of Cobalt goodwill discussed above.  In addition, goodwill amortization has beenrecorded for various past acquisitions of subsidiaries and additional insurancebusiness completed by UWS and BCBSUW.

 

Profit sharingexpenses of $0.3 million were recorded for the three months ended September 30,2001, which relate primarily to two HMO joint venture provider arrangementswithin the insured medical products segment. Profit sharing expenses of $0.4 million were recorded for the ninemonths ended September 30, 2001.

 

Net Income(Loss)

 

                Consolidated net results improved for thethree months ended September 30, 2001 to a gain of $1.1 million compared to aloss of $24.8 million for the three months ended September 30, 2000.   For the nine months ended September 30,2001, the net results improved to a loss of $1.5 million compared to a loss of$41.1 for the nine months ended September 30, 2000.  The $1.1 million gain for the three months ended September 30,2001 was the combination of a $0.5 million after tax operating loss offset bya  $1.6 million equity in the net incomeof affiliates, net of tax.  The improved2001 operating results reflect improvement in the insured loss and SGA ratios,increases in administrative fees on the self-funded business and continuedgrowth in government contract business over the prior year.

 

                As of September 30, 2001, Cobalt had federalnet operating loss carry-forwards of approximately $140 million available tooffset future taxable income.  A fullvaluation allowance has been established against net deferred tax assets.

 

**Liquidity and Capital Resources**

 

                Cobalt's sources of cash flow consistprimarily of health services revenues and investment income. The primary usesof cash include medical and other benefit payments, as well as operatingexpense payments. Positive cash flows are invested pending future payments ofmedical and other benefits and other operating expenses. Cobalt's investmentpolicies are designed to maximize yield, preserve principal and provideliquidity to meet anticipated payment obligations.

 

                Cobalt's cash flow reflects an additional$37.7 million in cash and cash equivalents as of September 30, 2001 as a resultof the acquisition of UWS.

 

                As a Primary Licensee of the BlueCrossBlueShield Association (the “Association”), Cobalt is required to maintain aprescribed liquidity ratio of certain liquid assets to average monthlyexpenses, as defined, in accordance with licensure requirements of theAssociation.  BCBSUW and Compcare HealthServices Insurance Corporation ("Compcare") are both consideredlarger controlled affiliate licensees by the Association and must also adhereto these requirements.  Cobaltmaintained these required levels as of September 30, 2001.

                Cobalt's investmentportfolio consists primarily of investment–grade bonds and governmentsecurities and has a limited exposure to equity securities. At September 30,2001, $193.9 million or 98.1% of Cobalt's total investment portfolio wasinvested in bonds compared with $29.3 million or 64.3% at September 30,2000. The bond portfolio had an average quality rating by Moody's InvestorService of "Aa3" and “A1” at September 30, 2001 and September 30,2000, respectively.  At September 30,2001, $172.8 million or 87.4% of Cobalt’s total investment portfolio wasclassified as available-for-sale compared with $45.5 million or 100.0% as ofSeptember 30, 2000.   The market valueof the total investment portfolio, which includes stocks and bonds, was greaterthan amortized cost by $4.7 million and less than amortized cost by $0.4million at September 30, 2001 and September 30, 2000, respectively. Unrealizedgains and losses on bonds classified as available-for-sale are included as acomponent of shareholders' equity, net of applicable deferred taxes. Cobalt hasno investments in mortgage loans, no non-publicly traded securities (except forinvestments related to its affiliates), real estate held for investment orfinancial derivatives (except for principal-only strips of U.S. Governmentsecurities).

 

                Cobalt has an outstanding line of credit inthe amount of $15.0 million as of September 30, 2001 available to HealthProfessionals of Wisconsin, Inc. The balance was $4.6 million as of September 30, 2001 and September30, 2000. Interest on the line of credit is calculated using prime rate.

 

Cobalt isrequired to maintain certain levels of statutory capital and surplus under theNAIC Risk Based Capital (“RBC”) requirements. Wisconsin insurers are alsosubject to compulsory and security surplus requirements based upon the amountand type of premiums written.  Inaddition to statutory capital requirements, Cobalt, BCBSUW and Compcare arerequired to maintain certain levels as determined by the Association.  Cobalt, BCBSUW and Compcare are incompliance with these requirements as of September 30, 2001.  In orderto satisfy certain intercompany receivables and continue to comply with minimumcapital and licensing standards, management has considered selling certainsubsidiaries, as well as some portion or all of its investment in AmericanMedical Security Group, Inc., or obtaining capital from outside sources.

 

                Included in the statutory capital of certaininsurance subsidiaries of Cobalt are particular interests in, or obligationsof, affiliates, which are subject to potential change in valuation due to thediscretion of the insurers’ regulators and the implementation of new accountingstandards related to goodwill.  UnitedWisconsin Insurance Company (a wholly-owned subsidiary of Compcare) and BCBSUWcarry intercompany receivables from Cobalt as admitted assets, togethertotaling approximately $50 million. Intercompany receivables are carried at face value but could be subjectto revaluation if OCI concludes a different interpretation of the relevantstatutory accounting rules is applicable. BCBSUW also carries two additional assets, which could be subject tofuture change in valuation.  Theseassets are (i) a $70 million secured note obligation from Cobalt payableJanuary 1, 2002, the extension of which is subject to OCI approval, and (ii)BCBSUW’s investment in AMSG, the carrying value of which could be affected dueto the implementation of accounting changes in calendar year 2002 resultingfrom the adoption of FAS 142 regarding the valuation of goodwill.  If any of these assets were subject to amaterial revaluation in the future, it would be necessary for Cobalt to obtainreplacement capital in order to continue to satisfy the capital requirements imposedby the State of Wisconsin and the Association. Cobalt believes that its current low leverage, and the value of otherassets which could be sold or contributed to the affected subsidiaries, aresufficient to address such circumstances if they arise.

 

The Health Insurance Portability and Accountability Act of 1996(“HIPAA”) includes administrative simplification provisions directed atsimplifying electronic data interchange through standardizing transactions,establishing uniform health care provider, payer and employer identifiers andseeking protections for confidentiality and security of patient data. Under thenew HIPAA privacy rules, Cobalt will be required to (1) comply with a varietyof requirements concerning its use and disclosure of individuals’ protectedhealth information, (2) establish specific internal procedures to protecthealth information and (3) enter into business associate contracts with thosecompanies to whom protected health information is disclosed.  Violations of these rules could subjectCobalt to significant penalties. Compliance with HIPAA regulations requires systems enhancements,training and administrative effort.  Thefinal rules do not provide for complete federal preemption of state laws, butrather preempt all contrary state laws unless the state law is morestringent.  HIPAA could expose Cobalt toadditional liability for, among other things, violations by its businessassociates.

**Quantitative and Qualitative Disclosuresabout Market Risk**

 

                Because of Cobalt's investment policies, theprimary market risks associated with Cobalt's portfolio are interest rate risk,credit risk and the risk related to fluctuations in equity prices. With respectto interest rate risk, a reasonably near-term rise in interest rates couldnegatively affect the fair value of Cobalt's bond portfolio.  However, because Cobalt considers itunlikely that Cobalt would need or choose to substantially liquidate itsportfolio, Cobalt believes that such an increase in interest rates would nothave a material impact on future earnings or cash flows. In addition, Cobalt isexposed to the risk of loss related to changes in credit spreads. Credit spreadrisk arises from the potential that changes in an issuer's credit rating orcredit perception may affect the value of financial instruments.

 

                The overall goal of the investment portfoliois to support the ongoing operations of Cobalt. Cobalt's philosophy is tomanage assets to maximize total return over a multiple-year time horizon,subject to appropriate levels of risk. Cobalt manages these risks byestablishing gain and loss tolerances, targeting asset–class allocations,diversifying among asset classes and segments within various asset classes, andusing performance measurement and reporting.

 

                Cobalt uses a sensitivity model to assess theinterest rate risk of its fixed income investments. The model includes allfixed income securities held as of September 30, 2001 and incorporatesassumptions regarding the impact of changing interest rates on expected cashflows for certain financial assets with prepayment features, such as callablebonds and mortgage–backed securities. The reduction in the fair value ofCobalt’s modeled financial assets (aggregate of BCBSUW and UWS portfolios)resulting from a hypothetical instantaneous 100 basis point increase in theU.S. Treasury yield curve is estimated at $7.8 million as of September 30,2001.

 

**PART II.OTHER INFORMATION**

 

**Cobalt Corporation**

 
| **Item 1.** | **Legal Proceedings**                                   |
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| **Item 2.** | **Changes in Securities**                               |
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| **Item 3.** | **Defaults Upon Senior Securities**                     |
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| **Item 4.** | **Submission of Matters to a Vote of Security Holders** |
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| **Item 5.** | **Other Information**                                   |
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|        | None                                                    |
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| **Item 6.** | **Exhibits and Reports on Form 8-K**                    |
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|        | (a)                                                     | Exhibits |
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|        |                                                    | None |
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|        | (b)                                                     | Reports on  Form 8-K |
|        |                                                    |   |
|        |                                                    | None |

 

** **
| **SIGNATURE**                                                                                                                                                                              |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                       |   |
| Pursuant to the requirements of the Securities  Exchange Act of 1934, the Registrant has duly caused this report to be signed  on its behalf by the undersigned thereunto duly authorized. |
|                                                                                                                                                                                       |   |
| November 13, 2001                                                                                                                                                                          | COBALT CORPORATION |
|                                                                                                                                                                                       |   |
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|                                                                                                                                                                                       | By:   /s/ Gail L. Hanson |   |
|                                                                                                                                                                                       |   |
|                                                                                                                                                                                       | Gail L. Hanson |
|                                                                                                                                                                                       | Senior Vice President, Treasurer and |
|                                                                                                                                                                                       | Chief Financial Officer |
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